Big governance
Excessive financial services CEO pay and financial crisis: Evidence from calibration estimation
Nathan Dong
Journal of Empirical Finance, forthcoming
Abstract:
The questions of whether there ever existed excessive risk-taking incentives from executive compensation in the financial industry, and whether top executives of financial services firms actually responded to such excessive incentives that eventually led to the crisis remain unanswered. The prior research has attempted to answer the second question, however, with conflicting evidence and without a clear definition of excessive. To answer the first question, this paper uses a numerical calibration approach to estimate the optimal level of CEO pay and derive the excessive compensation which in turn provides excessive risk-taking incentives. We then examine the extent of excessive compensation in the financial industry relative to the non-financial industries during the 2000s and whether there were changes in compensation practices between the post Sarbanes-Oxley period and the prior crisis period. We find mixed evidence in favor of the presence of higher excessive pay in the financial industry, and the CEO compensation practices remained largely unchanged over time. In addition, the relation between excessive pay and excessive risk-taking in the financial industry is somewhat weak, suggesting that CEO compensation might not be a major cause for the crisis in 2008.
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Director Gender and Mergers and Acquisitions
Maurice Levi, Kai Li & Feng Zhang
Journal of Corporate Finance, forthcoming
Abstract:
Does director gender influence CEO empire building? Does it affect the bid premium paid for target firms? Less overconfident female directors less overestimate merger gains. As a result, firms with female directors are less likely to make acquisitions and if they do, pay lower bid premia. Using acquisition bids by S&P 1500 companies during 1997-2009 we find that each additional female director is associated with 7.6 percent fewer bids, and each additional female director on a bidder board reduces the bid premium paid by 15.4 percent. Our findings support the notion that female directors help create shareholder value through their influence on acquisition decisions. We also discuss other possible interpretations of our findings.
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Beauty is Wealth: CEO Appearance and Shareholder Value
Joseph Taylor Halford & Scott Hsu
University of Wisconsin Working Paper, November 2013
Abstract:
This paper examines whether and how the appearance of chief executives officers (CEOs) affects shareholder value. We obtain a Facial Attractiveness Index of 677 CEOs from the S&P 500 companies based on their facial geometry. CEOs with a higher Facial Attractiveness Index are associated with better stock returns around their first days on the job and higher acquirer returns upon acquisition announcements. To mitigate endogeneity concerns, we compare stock returns surrounding CEO television news events with stock returns surrounding a matched sample of news article events. CEOs’ Facial Attractiveness Index positively affects the stock returns on the television news date, but not around the news article date. The findings suggest that CEO appearance matters for shareholder value and provide an explanation why more attractive CEOs receive “beauty premiums” in their compensation.
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Independent director incentives: Where do talented directors spend their limited time and energy?
Ronald Masulis & Shawn Mobbs
Journal of Financial Economics, forthcoming
Abstract:
We study reputation incentives in the director labor market and find that directors with multiple directorships distribute their effort unequally based on the directorship’s relative prestige. When directors experience an exogenous increase in a directorship’s relative ranking, their board attendance rate increases and subsequent firm performance improves. Also, directors are less willing to relinquish their relatively more prestigious directorships, even when firm performance declines. Finally, forced Chief Executive Officer departure sensitivity to poor performance rises when a larger fraction of independent directors view the board as relatively more prestigious. We conclude that director reputation is a powerful incentive for independent directors.
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CEO Compensation and Future Shareholder Returns: Evidence from the London Stock Exchange
Nikolaos Balafas & Chris Florackis
Journal of Empirical Finance, forthcoming
Abstract:
This study examines the ex-post consequences of CEO compensation for shareholder value. The main objective is to explore whether companies that pay their CEO excessive fees (in comparison to those of peer firms in the same industry and size group) generate superior future returns and better operating performance. Our analysis, which separately considers the cash-based and incentive/equity-based components of CEO compensation, is based on a large sample of UK-listed companies over the period 1998–2010. We find that CEO incentive pay is negatively associated with short-term subsequent returns. Interestingly, firms that pay their CEOs at the bottom of the incentive-pay distribution earn positive abnormal returns and, also, significantly outperform those at the top of the incentive-pay distribution. Further analysis reveals that such outperformance can be largely explained by the excessive exposure of low-incentive-pay firms to idiosyncratic risk. Finally, evidence from panel regressions suggests that, in addition to its negative relationship with returns, incentive pay is also inversely associated with future operating performance.
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Do Women Directors Improve Firm Performance in China?
Yu Liu, Zuobao Wei & Feixue Xie
Journal of Corporate Finance, forthcoming
Abstract:
This paper examines the effect of board gender diversity on firm performance in China's listed firms from 1999 to 2011. We document a positive and significant relation between board gender diversity and firm performance. Female executive directors have a stronger positive effect on firm performance than female independent directors, indicating that the executive effect outweighs the monitoring effect. Moreover, boards with three or more female directors have a stronger impact on firm performance than boards with two or fewer female directors, consistent with the critical mass theory. Finally, we find that the impact of female directors on firm performance is significant in legal person-controlled firms but insignificant in state-controlled firms. This paper sheds new light on China's boardroom dynamics. As governments increasingly contemplate board gender diversity policies, our study offers useful empirical guidance to Chinese regulators on the issue.
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Pandej Chintrakarn, Pornsit Jiraporn & Napatsorn Jiraporn
Finance Research Letters, forthcoming
Abstract:
CEOs are “lucky” when they are granted stock options on days when the stock price is lowest in the month of the grant, implying opportunistic timing and severe agency problems (Bebchuck, Grinstein, and Peyer, 2010). Using idiosyncratic volatility as our measure of stock price informativeness, we find that lucky CEOs improve the informativeness of stock prices significantly. In particular, CEO luck raises the degree of informativeness by 4.39%. Powerful CEOs who can circumvent governance mechanisms and successfully practice opportunistic timing of options grants are so secured in their positions that they have fewer incentives to conceal information, thereby improving informativeness.
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Are incentives without expertise sufficient? Evidence from Fortune 500 firms
Emilie Feldman & Cynthia Montgomery
Strategic Management Journal, forthcoming
Abstract:
Agency theory predicts that incentives will align agents’ interests with those of principals. However, the resource–based view suggests that to be effective, the incentive to deliver must be paired with the ability to deliver. Using Fortune 500 boards as an empirical context, this study shows that the presence of directors who lack top–level experience but own large shareholdings is negatively associated with firm value, an effect that increases in the number of such directors. Firm value rises after such directors depart from boards, with the greatest increases occurring when many of these directors leave. While agency theory highlights the importance of the right incentives being in place, this research suggests that doing so can be ineffective if the right resources are not also in place.
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CEO Stock Ownership Policies - Rhetoric and Reality
Nitzan Shilon
Harvard Working Paper, November 2013
Abstract:
This paper is the first academic endeavor to analyze the efficacy and transparency of current stock ownership policies (SOPs) in U.S. public firms. SOPs generally require managers to hold some of their firms’ stock for the long term. Firms universally adopted these policies following the 2008 financial crisis and cite them more than any other policy as a key element in their mitigation of risk. However, my analysis of the current SOPs of S&P 500 CEOs disputes what firms claim about their SOPs. First, I find that these policies are extremely ineffective because the way they function generally allows CEOs to immediately unload virtually all the stock they own. Second, I show that firms camouflage this weakness in their public filings. I explain why my findings are troubling, and I propose a regulatory reform to make SOPs transparent in order to improve the content of these policies.
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Knowledge, Compensation, and Firm Value: An Empirical Analysis of Firm Communication
Feng Li et al.
Stanford Working Paper, August 2013
Abstract:
Modern theories of the firm suggest that identifying the location of knowledge within an organization is the key to understanding the organization’s decision-making processes. We hypothesize that external communication patterns reveal the underlying knowledge dispersion within the management team. Using a large database of firm conference call transcripts, we find evidence to support our hypothesis. CEOs speak less in settings where they are unlikely to be fully informed and these CEOs also receive a smaller proportion of total management team compensation. Firms that do not adhere to the above communication-pay pattern have a lower industry-adjusted Tobin’s Q. These findings are consistent with modern theories of the firm.
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Market Forces and CEO Pay: Shocks to CEO Demand Induced by IPO Waves
Jordan Nickerson
University of Texas Working Paper, November 2013
Abstract:
I develop a simple competitive equilibrium model and derive predictions regarding the change in wages when an inelastic supply of CEO labor cannot match an increase in demand. The model predicts that CEO pay-size elasticity increases when more firms compete for a fixed supply of managers. I then empirically test this prediction using industry-level IPO waves as a proxy for increased competition among firms for CEOs. Consistent with the model, I find that pay-size elasticity increases by 5.9% following a one standard deviation increase in an industry’s IPO activity. This effect is stronger in industries which require more specialized skills and prior industry experience, which have less sales overlap from other industries, and have less correlated returns with other industries. I also find that increased IPO activity leads to a greater likelihood of executive transitions between firms. Finally, I find indirect evidence that IPO activity draws down the talent pool of an industry, leading to an increase in the likelihood of a firm hiring an industry outsider following CEO turnover. Overall, the findings indicate that market forces play a key role in the determination of CEO pay.
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Antitakeover Provisions, Managerial Entrenchment and Firm Innovation
Atreya Chakraborty, Zaur Rzakhanov & Shahbaz Sheikh
Journal of Economics and Business, March–April 2014, Pages 30–43
Abstract:
We explore the relation between antitakeover provisions (i.e. managerial entrenchment) and firm performance in innovation. Empirical results indicate that an increase in antitakeover provisions is negatively related to number of patents and number of citations to patents. Thus managers who are protected from takeover market perform worse on innovation. However, the negative relation between antitakeover provisions and firm innovation holds only for low-tech firms. For high-tech firms, this relation is not statistically significant. One possible explanation is that high-tech firms have to innovate continuously to survive in the long run. The competitive pressure to innovate or perish dissipates the negative effect of managerial entrenchment on firm innovation. Overall, our results support the agency based explanation of the relation between antitakeover provisions and firm performance in innovation.
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Director Networks and Takeovers
Luc Renneboog & Yang Zhao
Journal of Corporate Finance, forthcoming
Abstract:
We study the impact of corporate networks on the takeover process. We find that better connected companies are more active bidders. When a bidder and a target have one or more directors in common, the probability that the takeover transaction will be successfully completed augments, and the duration of the negotiations is shorter. Connected targets more frequently accept offers that involve equity. Directors of the target firm (who are not interlocked) have a better chance to be invited to the board of the combined firm in connected M&As. While connections have a clear impact on the takeover strategy and process, we do not find evidence that the market acknowledges connections between bidders and targets as the announcement returns are not statistically different from those bidders and targets which are ex ante not connected.
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The Influence of Capital Structure on Strategic Human Capital: Evidence From U.S. and Canadian Firms
Xiangmin Liu et al.
Journal of Management, forthcoming
Abstract:
Strategic human capital research has emphasized the importance of human capital as a resource for sustained competitive advantage, but firm investments in this intangible asset vary considerably. This article examines whether and how external pressures on firms from capital markets influence their human capital strategy. These pressures have increased over the past three decades due to banking deregulation, technological innovation, and the rise of institutional investors and new financial intermediaries. Against this backdrop, this study examines whether a firm’s capital structure as measured by share turnover, shareholder concentration, and financial leverage is associated with firm investment in strategic human capital. Based on survey and objective financial data from 221 establishments in the United States and Canada, our analysis indicates that firms with greater share turnover, higher shareholder concentration, and higher levels of financial leverage are less likely to invest in human resource systems that create strategic human capital. Differences in national financial systems also lead to differential effects for U.S. and Canadian firms.
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Competition for Talent Under Performance Manipulation: CEOs on Steroids
Ivan Marinovic & Paul Povel
Stanford Working Paper, October 2013
Abstract:
We study how competition for talent affects CEO compensation, taking into consideration that CEO decisions are not contractible, CEO skills or talent are not observable, and CEOs can manipulate performance as measured by outsiders. Firms compete to appoint a CEO by offering contracts that generate large rents for the CEO. However, the incentive problems restrict how such rents can be created. We derive the equilibrium compensation contract offered by the firms, and we describe how the outcome is affected. Competition for talent leads to excessively high-powered performance compensation. Competition for talent can thus explain the increase in pay-performance sensitivity over the last few decades, and the extremely high-powered compensation packages observed in some markets. Given the high-powered incentive compensation, CEOs exert inefficiently high levels of effort and also distort the performance measure excessively. If the cost of manipulating performance is low, competition for talent may reduce the overall surplus, compared with a setup in which one firm negotiates with one potential CEO (and the firm extracts the rents). We discuss possible remedies, including regulatory limits to incentive compensation.
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Communication and Decision-Making in Corporate Boards
Nadya Malenko
Review of Financial Studies, forthcoming
Abstract:
Time constraints, managerial power, and reputational concerns can impede board communication. This paper develops a model where board decisions depend on directors' effort in communicating their information to others. I show that directors communicate more effectively when pressure for conformity is stronger — that is, when directors are more reluctant to disagree with each other. Hence, open ballot voting can be optimal, even though it induces directors to disregard their information and conform their votes to others. I also show that communication can be more efficient when directors' preferences are more diverse. The analysis has implications for executive sessions, transparency, and committees.
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Golden Parachutes and the Wealth of Shareholders
Lucian Bebchuk, Alma Cohen & Charles Wang
Journal of Corporate Finance, forthcoming
Abstract:
Golden parachutes (GPs) have attracted substantial attention from investors and public officials for more than two decades. We find that GPs are associated with higher expected acquisition premiums and that this association is at least partly due to the effect of GPs on executive incentives. However, we also find that firms that adopt GPs experience negative abnormal stock returns both during and subsequent to the period surrounding their adoption. This finding raises the possibility that even though GPs facilitate some value-increasing acquisitions, they do have, on average, an overall negative effect on shareholder wealth; this effect could be due to GPs weakening the force of the market for control and thereby increasing managerial slack, and/or to GPs making it attractive for executives to go along with some value-decreasing acquisitions that do not serve shareholders’ long-term interests. Our findings have significant implications for ongoing debates on GPs and suggest the need for additional work identifying the types of GPs that drive the identified correlation between GPs and reduced shareholder value.
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CEO pay and voting dissent before and after the crisis
Ian Gregory-Smith, Steve Thompson & Peter Wright
Economic Journal, forthcoming
Abstract:
Say on pay - that is empowering shareholders to vote on the remuneration arrangements of their firm's senior executives - has become an international policy response to the perceived explosion in rewards for top management. In this paper we examine the operation of say in pay in the UK, the country which pioneered its adoption, using the population of non-investment trust companies in the FTSE 350 over the period 2003-2012. We find executive remuneration and dissent on the remuneration committee report are positively correlated. However, the magnitude of this effect is small.We find that dissent plays a role in moderating future executive compensation levels, although this effect is restricted to levels of dissent above 10%, and primarily acting upon the higher quantiles of rewards. We find no evidence of an increased restraining effect of dissent on pay following the onset of the financial crisis.
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Board Expertise: Do Directors from Related Industries Help Bridge the Information Gap?
Nishant Dass et al.
Review of Financial Studies, forthcoming
Abstract:
We analyze the role of “directors from related industries” (DRIs) on a firm's board. DRIs are officers and/or directors of companies in the upstream/downstream industries of the firm. DRIs are more likely when the information gap vis-à-vis related industries is more severe or the firm has greater market power. DRIs have a significant impact on firm value/performance, especially when information problems are worse. Furthermore, DRIs help firms handle industry shocks and shorten their cash conversion cycles. Overall, our evidence suggests that firms choose DRIs when the adverse effects due to conflicts of interest are dominated by the benefits due to DRIs' information and expertise.
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Options, Option Repricing in Managerial Compensation: Their Effects on Corporate Investment Risk
Nengjiu Ju, Hayne Leland & Lemma Senbet
Journal of Corporate Finance, forthcoming
Abstract:
While stock options are commonly used in managerial compensation to provide desirable incentives, they can create adverse incentives to distort the choice of investment risk. Relative to the risk level that maximizes firm value, call options in a compensation contract can induce too much or too little corporate risk-taking, depending on managerial risk aversion and the underlying investment technology. We show that inclusion of lookback call options in compensation packages has desirable countervailing effects on managerial choice of corporate risk policies and can induce risk policies that increase shareholder wealth. We argue that lookback call options are analogous to the observed practice of option repricing.