At the top
Managerial Attitudes and Corporate Actions
John Graham, Campbell Harvey & Manju Puri
Journal of Financial Economics, forthcoming
Abstract:
We administer psychometric tests to senior executives to obtain evidence on their underlying psychological traits and attitudes. We find US CEOs differ significantly from non-US CEOs in terms of their underlying attitudes. In addition, we find that CEOs are significantly more optimistic and risk-tolerant than the lay population. We provide evidence that CEOs' behavioral traits such as optimism and managerial risk-aversion are related to corporate financial policies. Further, we provide new empirical evidence that CEO traits such as risk-aversion and time preference are related to their compensation.
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Is Disclosure an Effective Cleansing Mechanism? The Dynamics of Compensation Peer Benchmarking
Michael Faulkender & Jun Yang
Review of Financial Studies, forthcoming
Abstract:
Firms routinely justify CEO compensation by benchmarking against companies with highly paid CEOs. We examine whether the 2006 regulatory requirement of disclosing compensation peers mitigated firms' opportunistic peer selection activities. We find that strategic peer benchmarking did not disappear after enhanced disclosure. In fact, it intensified at firms with low institutional ownership, low director ownership, low CEO ownership, busy boards, large boards, and non-intensive monitoring boards, and at firms with shareholders complaining about compensation practices. The effect is also stronger at firms with new CEOs. These findings call into question whether disclosure regulation can remedy potential problems in compensation practices.
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Shareholder voting rights in early American corporations
Eric Hilt
Business History, forthcoming
Abstract:
In early American corporations, the power of large shareholders was frequently limited by voting rules that partially disenfranchised them. In particular, stock held in an individual's name was granted a number of votes per share that decreased with the number of shares held. Using data from the corporations created in New York up to 1825, this paper analyses the use of these ‘graduated' voting rights. Consistent with the view that they were intended to help small investors protect themselves against the predations of controlling shareholders, the data indicate that graduated voting rights were imposed in industries that attracted small investments from ordinary households. The results highlight the importance of concerns over the controlling influence of large shareholders in early corporate governance.
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A Paper Tiger? An Empirical Analysis of Majority Voting
Jay Cai, Jacqueline Garner & Ralph Walkling
Journal of Corporate Finance, forthcoming
Abstract:
Majority voting in board elections has emerged as a dominant theme in recent proxy seasons. Analysis of majority voting is important: first, the impact is controversial yet scant empirical evidence exists. Second, Congress is still considering mandating this practice. Third, there has been a tectonic shift in adoptions of majority voting, from 16% to over 67% of S&P 500 firms in just two years. Fourth, the vast majority of shareholder proposals for majority voting are sponsored by unions with little shareholdings. Proponents argue that majority voting aligns shareholder-director interests. Opponents argue that the practice will be disruptive and could result in the failure of boards to meet exchange and SEC requirements. Others assert that majority voting is a paper tiger, amounting to form over substance, particularly since many adoptions are non-binding. We provide an empirical analysis of the wealth effects, characteristics, and efficacy of majority voting. Our results are consistent with the paper tiger hypothesis.
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Are U.S. CEOs Paid More? New International Evidence
Nuno Fernandes et al.
Review of Financial Studies, February 2013, Pages 323-367
Abstract:
This paper challenges the widely accepted stylized fact that chief executive officers (CEOs) in the United States are paid significantly more than their foreign counterparts. Using CEO pay data across fourteen countries with mandated pay disclosures, we show that the U.S. pay premium is economically modest and primarily reflects the performance-based pay demanded by institutional shareholders and independent boards. Indeed, we find no significant difference in either level of CEO pay or the use of equity-based pay between U.S. and non-U.S. firms exposed to international and U.S. capital, product, and labor markets. We also show that U.S. and non-U.S. CEO pay has largely converged in the 2000s.
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The acquisitiveness of youth: CEO age and acquisition behavior
Soojin Yim
Journal of Financial Economics, forthcoming
Abstract:
I demonstrate that acquisitions are accompanied by large, permanent increases in Chief Executive Officer (CEO) compensation, which create strong financial incentives for CEOs to pursue acquisitions earlier in their career. Accordingly, I document that a firm's acquisition propensity is decreasing in the age of its CEO: a firm with a CEO who is 20 years older is ∼30% less likely to announce an acquisition. This negative effect of CEO age on acquisitions is strongest among firms where CEOs likely anticipate or can influence high post-acquisition compensation, and is absent for other investment decisions that are not rewarded with permanent compensation gains. The age effect cannot be explained by the selection of young CEOs by acquisition-prone firms, nor by a story of declining overconfidence with age. This paper underscores the relevance of CEO personal characteristics and CEO-level variation in agency problems for corporate decisions.
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Ali Akyol, Wei Fen Lim & Patrick Verwijmeren
Journal of Financial and Quantitative Analysis, September/October 2012, Pages 1029-1057
Abstract:
Current attempts to reform financial markets presume that shareholder empowerment benefits shareholders. We investigate the wealth effects associated with the Securities and Exchange Commission's rule to facilitate director nominations by shareholders. Our results are not in line with shareholder empowerment creating value: The average daily abnormal returns surrounding events that increase (decrease) the probability of the proposal's passage are significantly negative (positive). Furthermore, given an increase in the probability of the proposal's passage, firms whose shareholders are more likely to use the rule to nominate directors experience more negative abnormal returns.
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Industry Structure, Executive Pay, and Short-Termism
John Thanassoulis
Management Science, forthcoming
Abstract:
This study outlines a new theory linking industry structure to optimal employment contracts and executive short-termism. Firms hire their executives using optimal contracts derived within a competitive labour market. To motivate effort, firms must use some variable remuneration. Such remuneration introduces a myopia problem: an executive would wish to inflate early expected earnings at some risk to future profits. To manage this short-termism, some bonus pay is deferred. Convergence in size among firms makes the cost of managing the myopia problem grow faster than the cost of managing the effort problem. Eventually, the optimal contract jumps from one deterring myopia to one tolerating myopia. Under some conditions, the industry partitions: the largest firms hire executives on contracts tolerant of myopia; smaller firms ensure myopia is ruled out.
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CEO wage dynamics: Estimates from a learning model
Lucian Taylor
Journal of Financial Economics, forthcoming
Abstract:
The level of Chief Executive Officer (CEO) pay responds asymmetrically to good and bad news about the CEO's ability. The average CEO captures approximately half of the surpluses from good news, implying CEOs and shareholders have roughly equal bargaining power. In contrast, the average CEO bears none of the negative surplus from bad news, implying CEOs have downward rigid pay. These estimates are consistent with the optimal contracting benchmark of Harris and Hölmstrom (1982) and do not appear to be driven by weak governance. Risk-averse CEOs accept significantly lower compensation in return for the insurance provided by downward rigid pay.
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Joseph Engelberg, Pengjie Gao & Christopher Parsons
Review of Financial Studies, January 2013, Pages 79-114
Abstract:
CEOs with large networks earn more than those with small networks. An additional connection to an executive or director outside the firm increases compensation by about $17,000 on average, more so for "important" members, such as CEOs of big firms. Pay-for-connectivity is unrelated to several measures of corporate governance, evidence in favor of an efficient contracting explanation for CEO pay.
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Boardroom centrality and firm performance
David Larcker, Eric So & Charles Wang
Journal of Accounting and Economics, forthcoming
Abstract:
Firms with central boards of directors earn superior risk-adjusted stock returns. A long (short) position in the most (least) central firms earns average annual returns of 4.68%. Firms with central boards also experience higher future return-on-assets growth and more positive analyst forecast errors. Return prediction, return-on-assets growth, and analyst errors are concentrated among high growth opportunity firms or firms confronting adverse circumstances, consistent with boardroom connections mattering most for firms standing to benefit most from information and resources exchanged through boardroom networks. Overall, our results suggest that director networks provide economic benefits that are not immediately reflected in stock prices.
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The Potential for Catastrophic Auditor Litigation
Dain Donelson
American Law and Economics Review, forthcoming
Abstract:
Audit firms continue to lobby for legal liability limits based on their contention that catastrophic civil litigation is a realistic possibility. However, others disagree that catastrophic litigation is a viable threat to the audit firms and oppose legal reform at this time. To inform this debate, this study estimates the probability that a Big Four audit firm will face catastrophic litigation. Estimates are based upon recent disclosures by audit firms regarding settlements, litigation cost, and internal financial information. The results indicate that the likelihood of catastrophic liability is low in absolute terms. Assuming liquidation only when liability reaches a threshold that includes annual income, retirement benefits, and windup costs for the firm, the likelihood of at least one Big Four firm facing litigation substantial enough to trigger voluntary liquidation is ∼0.6% over a 5-year period. These findings are consistent with auditors being able to sustain litigation under the current legal system. However, the probability would increase dramatically if firms changed their financial structures to remove partner retirement benefits. In such a case, I estimate that the likelihood of catastrophic litigation is as high as 2.8% over a 1-year period and 14.1% over a 5-year period, depending on the level of variable associated litigation costs assumed.
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David Zhu
Strategic Management Journal, forthcoming
Abstract:
This study investigates how a fundamental group decision-making bias referred to as group polarization can influence boards' acquisition premium decisions. The theory suggests that when prior premium experience would lead directors on average to support a relatively high premium prior to board discussions, they will support a focal premium that is even higher after discussions; but when directors' prior premium experience would lead them on average to support a relatively low premium prior to board discussions, they will support a focal premium that is even lower after discussions. Results provided strong support for the theory. Moreover, group polarization was reduced by demographic homogeneity among directors and by minority expertise but increased by board influence. This study introduces a fundamental group decision-making bias into governance research and explains how group processes can influence network diffusions.
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Learning and the Disappearing Association between Governance and Returns
Lucian Bebchuk, Alma Cohen & Charles Wang
Journal of Financial Economics, forthcoming
Abstract:
The correlation between governance indices and abnormal returns documented for 1990-1999 subsequently disappeared. The correlation and its disappearance are both due to market participants' gradually learning to appreciate the difference between good-governance and poor-governance firms. Consistent with learning, the correlation's disappearance was associated with increases in market participants' attention to governance; market participants and security analysts were, until the beginning of the 2000s but not subsequently, more positively surprised by the earning announcements of good-governance firms; and, although governance indices no longer generated abnormal returns during the 2000s, their negative association with firm value and operating performance persisted.
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Executive Compensation, Risk Taking And The State of The Economy
Alon Raviv & Elif Sisli-Ciamarra
Journal of Financial Stability, forthcoming
Abstract:
In this paper we present a model of executive compensation to analyze the link between incentive compensation and risk taking. Our model takes into account the loss in the value of an executive's expected wealth from employment if the firm becomes insolvent during a bad state of the economy. We illustrate that a given compensation package may lead to different levels of asset risk under different economic states. Most importantly, we show that the positive relationship between equity-based compensation and risk taking may weaken and possibly disappear during systemic financial crises. An important policy implication from our analysis is that similar regulations may have different effects on risk taking depending on the state of the economy.
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How Do Staggered Boards Affect Shareholder Value? Evidence from a Natural Experiment
Alma Cohen & Charles Wang
Harvard Working Paper, September 2012
Abstract:
This paper examines whether staggered boards reduce firm value or are merely associated with it due to the tendency of low-value firms to maintain staggered boards. To analyze this causal question, we take advantage of a natural experiment involving two recent court rulings, separated by several weeks, that affected in opposite directions the antitakeover force of staggered boards. We find evidence consistent with the hypothesis that the market viewed the antitakeover force of staggered boards as value reducing. Our findings have implications for the long-standing policy debate on the desirability of staggered boards.
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Hermann Achidi Ndofor, Curtis Wesley & Richard Priem
Journal of Management, forthcoming
Abstract:
Opportunities for financial reporting fraud arise because of information asymmetries - often labeled "lack of transparency" - between top managers and their diverse shareholders. We evaluate the relative contributions of information asymmetries arising from industry-level and firm-level complexities to the likelihood of top managers committing financial reporting fraud. Using a sample of 453 matched pairs of firms that have and have not been identified as having committed financial reporting fraud, we found that information asymmetries arising from industry- and firm-level complexities increase the likelihood of financial fraud. Moreover, more CEO stock options increase the likelihood of fraud when industry complexity is high, while aggressive monitoring by the audit committee reduces the likelihood of reporting fraud when firm-level complexity is high.
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Generalists versus specialists: Lifetime work experience and chief executive officer pay
Cláudia Custódio, Miguel Ferreira & Pedro Matos
Journal of Financial Economics, forthcoming
Abstract:
We show that pay is higher for chief executive officers (CEOs) with general managerial skills gathered during lifetime work experience. We use CEOs' résumés of Standard and Poor's 1,500 firms from 1993 through 2007 to construct an index of general skills that are transferable across firms and industries. We estimate an annual pay premium for generalist CEOs (those with an index value above the median) of 19% relative to specialist CEOs, which represents nearly a million dollars per year. This relation is robust to the inclusion of firm- and CEO-level controls, including fixed effects. CEO pay increases the most when firms externally hire a new CEO and switch from a specialist to a generalist CEO. Furthermore, the pay premium is higher when CEOs are hired to perform complex tasks such as restructurings and acquisitions. Our findings provide direct evidence of the increased importance of general managerial skills over firm-specific human capital in the market for CEOs in the last decades.
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It Pays to Follow the Leader: Acquiring Targets Picked by Private Equity
Amy Dittmar, Di Li & Amrita Nain
Journal of Financial and Quantitative Analysis, September/October 2012, Pages 901-931
Abstract:
This paper examines the impact of financial sponsor competition on corporate buyers. We find that corporate acquirers who purchase targets that financial buyers also bid on outperform corporate acquirers who buy targets bid on by corporate firms only. Deal characteristics, acquirer abilities, and observable target characteristics cannot explain this difference in returns. Corporate acquirers have higher returns when they follow a first bid by a financial buyer rather than a first bid by another corporate buyer. The results suggest that financial bidders identify targets with high potential for value improvement and winning corporate bidders are competent in exploiting this potential.
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The Ethics of Hedging by Executives
Lee Dunham & Ken Washer
Journal of Business Ethics, December 2012, Pages 157-164
Abstract:
Executives of many publicly held firms agree to compensation packages that create immense exposure to their employer's stock. Corporate boards, aspiring to motivate executives to make value-maximizing decisions, often tie an executive's earnings to stock price performance through stock or option awards. However, this engenders a significant ethical dilemma for many executives who are uncomfortable with sizable, firm-specific risk and desire to reduce it through hedging activities. Recent research has shown that executive hedging has become more prevalent. In essence, managers are unwinding the acute economic incentive to act in the best interest of the owners. This appears to violate the spirit of the compensation contract and from a normative standpoint, is not how executives should act. In this article, we describe how some executives are acting in regard to this issue (descriptive ethics), how they should act (normative ethics) and how they can be helped to get from what they are doing, to what they should be doing (prescriptive ethics).
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Director capital and corporate disclosure quality
David Reeb & Wanli Zhao
Journal of Accounting and Public Policy, forthcoming
Abstract:
Conventional wisdom regarding board effectiveness emphasizes the role of board composition and incentives in alleviating conflicts of interest. We argue that board capital, however, may be a more important aspect of board efficacy since directors are the highest level agents of shareholders, meet infrequently, and shareholders have limited recourse for poor decision-making. In contrast, shareholders and the SEC can sue/prosecute directors for conflicts of interest or bias. One role of the board involves determining the depth and degree of the firm's financial disclosures. To test the idea that high capital boards seek to provide greater disclosure quality to investors, we manually collect data on director attributes and apply factor analysis to measure the networking, educational, and experience capital of the board. The results indicate that board capital is positively related to disclosure quality, with differing key attributes for inside and outside directors. These results are robust to 2SLS and difference-in-difference approaches.
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Corporate Governance and Value Creation: Evidence from Private Equity
Viral Acharya et al.
Review of Financial Studies, February 2013, Pages 368-402
Abstract:
Using deal-level data from transactions initiated by large private equity houses, we find that the abnormal performance of deals is positive on average, after controlling for leverage and sector returns. Higher abnormal performance is related to improvement in sales and operating margin during the private phase, relative to that for quoted peers. General partners who are ex-consultants or ex-industry managers are associated with outperforming deals focused on internal value-creation programs, and ex-bankers or ex-accountants with outperforming deals involving significant mergers and acquisitions. The findings suggest the presence, on average, of positive but heterogeneous skills at the deal-partner level in large private equity transactions.
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The Value of "Boutique" Financial Advisors in Mergers and Acquisitions
Weihong Song, Jie (Diana) Wei & Lei Zhou
Journal of Corporate Finance, April 2013, Pages 94-114
Abstract:
Between 1995 and 2006 about a quarter of merging firms hired boutique banks as their advisors on mergers and acquisitions (M&A). Boutique advisors, often specialized by industry, are generally smaller and more independent than full-service banks. This paper investigates firms' choice between boutique and full-service advisors and the impact of advisor choice on deal outcomes. We find that both acquirers and targets are more likely to choose boutique advisors in complex deals, suggesting that boutique advisors are chosen for their skill and expertise. After controlling for the endogenous choice of advisors, we find lower deal premiums when acquirers hire boutique advisors. In addition, boutique advisors spend more time, probably on due diligence and negotiation, to complete deals. Overall, our findings suggest that boutique advisors are chosen in more complex deals and they achieve more favorable deal outcomes.
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Boards of Directors and Financial Risk during the Credit Crisis
Terry McNulty, Chris Florackis & Phillip Ormrod
Corporate Governance, January 2013, Pages 58-78
Research Question/Issue: This research examines the relationship between board processes and corporate financial risk. Using a unique questionnaire survey about board behavior, several measures related to board processes are developed and used to explain certain aspects of financial risk during the recent crisis.
Research Findings/Insights: In a sample of 141 companies with complete data collected from company chairs on both board structure and process, board process is found to be an important determinant of financial risk during the crisis of 2008-2009. In particular, financial risk is lower where non-executive directors have high effort norms and where board decision processes are characterized by a degree of cognitive conflict. The impact of cognitive conflict is, however, found to be less pronounced in boards with high levels of cohesiveness.