Divided governance
Birds of a feather: Value implications of political alignment between top management and directors
Jongsub Lee, Kwang Lee & Nandu Nagarajan
Journal of Financial Economics, May 2014, Pages 232–250
Abstract:
For 2,695 US corporations from 1996 to 2009, we find that alignment in political orientation between the chief executive officer (CEO) and independent directors is associated with lower firm valuations, lower operating profitability, and increased internal agency conflicts such as a reduced likelihood of dismissing poorly performing CEOs, a lower CEO pay-performance sensitivity, and a greater likelihood of accounting fraud. Importantly, we show that our results are driven neither by the effects associated with various measures of similarity and diversity within the board nor the effects of local director labor market and political conditions on board structure. We provide evidence that our measure of individual political orientation reflects the person's political beliefs rather than opportunistic attempts to seek political favor. Overall, our results suggest that diversity in political beliefs among corporate board members is valuable.
----------------------
Yuanzhi Li & David Yermack
NBER Working Paper, March 2014
Abstract:
We study the location and timing of annual shareholder meetings. When companies move their annual meetings a great distance from headquarters, they tend to announce disappointing earnings results and experience pronounced stock market underperformance in the months after the meeting. Companies appear to schedule meetings in remote locations when the managers have private, adverse information about future performance and wish to discourage scrutiny by shareholders, activists, and the media. However, shareholders do not appear to decode this signal, since the disclosure of meeting locations leads to little immediate stock price reaction. We find that voter participation drops when meetings are held at unusual hours, even though most voting is done electronically during a period of weeks before the meeting convenes.
----------------------
Joshua Murray
Global Networks, April 2014, Pages 230–250
Abstract:
Transnational capitalist class (TCC) theory is rooted in the claim that the globalization of the economy has led to a globalization of economic interests and of class formation. However, systematic evidence linking the indicators of transnational class formation with political behaviour is largely missing. In this article, I combine data on board of director interlocks among the 500 largest business firms in the world between 2000 and 2006 with data on the political donations to US elections of foreign corporations via the corporate political action committees (PACs) of their subsidiaries, divisions or affiliates. Controlling for the various interests of individual firms, I find that foreign firms that are highly central in the transnational intercorporate network contribute more money to US elections than do the less central foreign firms. Given prior research on board of director interlocks, this finding suggests that a segment of the transnational business community has emerged as a class-for-itself.
----------------------
Political Affiliation and Dividend Tax Avoidance: Evidence from the 2013 Fiscal Cliff
Urs Peyer & Theo Vermaelen
INSEAD Working Paper, March 2014
Abstract:
This paper uses the 2013 fiscal cliff as a natural experiment to examine how the political affiliation of the CEO affected a firm’s response to an expected increase in personal taxes on dividends. Firms could avoid such additional taxes by paying extra dividends and accelerating dividends in the last two months of 2012. These tax avoiders are compared with a sample that could have easily accelerated dividend payments, but did not. We find that the difference in behaviour between firms that avoid taxes and firms that do not, but could have, is explained by the CEO’s political sympathies: Republican CEOs are more likely to help their investors to save money on income taxes. However, other effects seem to be more significant, such as: the consequences for the CEO’s personal wealth as well as the percentage of insider holdings. Larger firms are also more reluctant to engage in avoiding taxes for “the rich”, possibly indication reputational concerns.
----------------------
Peer Effects and Corporate Corruption
Christopher Parsons, Johan Sulaeman & Sheridan Titman
University of California Working Paper, March 2014
Abstract:
We find evidence that financial misbehavior occurs in regionally concentrated waves: a firm’s tendency to engage in misconduct increases with the misconduct rates of neighboring firms. This effect appears to be the result of peer effects, rather than exogenous shocks like regional variation in enforcement. Further, local waves of financial misconduct are correlated with non-financial misconduct, such as political fraud. Both firm and city performance suffer in the wake of local corruption waves.
----------------------
Corporate Socially Responsible Investments: CEO Altruism, Reputation, and Shareholder Interests
Richard Borghesi, Joel Houston & Andy Naranjo
Journal of Corporate Finance, June 2014, Pages 164–181
Abstract:
Corporate managers often invest in activities that are deemed to be socially responsible. In some instances, these investments enhance shareholder value. However, in other cases, altruistic managers or managers who privately benefit from the positive attention arising from these activities may choose to make socially responsible investments even if they are not value enhancing. Given this backdrop, we investigate the various factors that motivate firm managers to make socially responsible investments. We find that larger firms, firms with greater free cash flow, and higher advertising outlays demonstrate higher levels of corporate social responsibility (CSR). We also find that companies with stronger institutional ownership are less likely to invest in CSR – which casts doubt on the argument that these investments are designed to promote shareholder value. Consistent with the literature that explores how CEO personal attributes influence corporate decision making, we find that female CEOs, younger CEOs, and managers who donate to both Republican and Democratic parties are significantly more likely to invest in CSR. This latter result suggests that CSR investments may not be driven solely for altruistic reasons, but instead may be part of a broader strategy to create goodwill and/or help maintain good political relations. Finally, we find a strong positive connection between the level of media scrutiny surrounding the firm and its CEO, and the level of CSR investment. This finding suggests that media attention helps induce firms to make socially responsible investments.
----------------------
Ioannis Ioannou & George Serafeim
Strategic Management Journal, forthcoming
Abstract:
We explore the impact of corporate social responsibility (CSR) ratings on sell-side analysts’ assessments of firms’ future financial performance. We suggest that when analysts perceive CSR as an agency cost they produce pessimistic recommendations for firms with high CSR ratings. Moreover, we theorize that over time, the emergence of a stakeholder focus shifts the analysts’ perceptions of CSR. Using a large sample of publicly traded U.S. firms over 15 years, we confirm that in the early 1990s, analysts issue more pessimistic recommendations for firms with high CSR ratings. However, analysts progressively assess these firms more optimistically over time. Furthermore, we find that analysts of highest status are the first to shift the relation between CSR ratings and investment recommendation optimism.
----------------------
Jeffrey Coles, Naveen Daniel & Lalitha Naveen
Review of Financial Studies, forthcoming
Abstract:
We develop two measures of board composition to investigate whether directors appointed by the CEO have allegiance to the CEO and decrease their monitoring. Co-option is the fraction of the board comprised of directors appointed after the CEO assumed office. As Co-option increases, board monitoring decreases: turnover-performance sensitivity diminishes, pay increases (without commensurate increase in pay-performance sensitivity), and investment increases. Non-Co-opted Independence — the fraction of directors who are independent and were appointed before the CEO — has more explanatory power for monitoring effectiveness than the conventional measure of board independence. Our results suggest that not all independent directors are effective monitors.
----------------------
Governance in the Executive Suite and Board Independence
Han Kim & Yao Lu
University of Maryland Working Paper, January 2014
Abstract:
The overall independence of a firm’s governance system depends not only on the independence of its board of directors but also on CEO influence over the other top executives. We find that board independence and independence from CEO influence in the executive suite are inversely related. Difference-in-difference estimates using a regulatory shock reveal that strengthening board independence weakens executive suite independence, which is proxied by (the inverse of) the fraction of top executives appointed by a current CEO. We also find that the greater the increase in the fraction of the current CEO’s appointees in the executive suite, the lesser the improvement in monitoring CEO compensation and the lower the shareholder value enhancement in the aftermath of the regulation. These findings imply that one cannot infer overall independence based on board independence alone and that strengthening a specific governance mechanism by regulation can have undesirable spillover effects to a seemingly unrelated governing body.
----------------------
The Idealized Electoral College voting mechanism and shareholder power
Edward Van Wesep
Journal of Financial Economics, forthcoming
Abstract:
Increasing concern over corporate governance has led to calls for more shareholder influence over corporate decisions, but allowing shareholders to vote on more issues may not affect the quality of governance. We should expect instead that, under current rules, shareholder voting will implement the preferences of the majority of large shareholders and management. This is because majority rule offers little incentive for small shareholders to vote. I offer a potential remedy in the form of a new voting rule, the Idealized Electoral College (IEC), modeled on the American Electoral College, that significantly increases the expected impact that a given shareholder has on election. The benefit of the mechanism is that it induces greater turnout, but the cost is that it sometimes assigns a winner that is not preferred by a majority of voters. Therefore, for issues on which management and small shareholders are likely to disagree, the IEC is superior to majority rule.
----------------------
Corporate social responsibility and stock price crash risk
Yongtae Kim, Haidan Li & Siqi Li
Journal of Banking & Finance, June 2014, Pages 1–13
Abstract:
This study investigates whether corporate social responsibility (CSR) mitigates or contributes to stock price crash risk. Crash risk, defined as the conditional skewness of return distribution, captures asymmetry in risk and is important for investment decisions and risk management. If socially responsible firms commit to a high standard of transparency and engage in less bad news hoarding, they would have lower crash risk. However, if managers engage in CSR to cover up bad news and divert shareholder scrutiny, CSR would be associated with higher crash risk. Our findings support the mitigating effect of CSR on crash risk. We find that firms’ CSR performance is negatively associated with future crash risk after controlling for other predictors of crash risk. The result holds after we account for potential endogeneity. Moreover, the mitigating effect of CSR on crash risk is more pronounced when firms have less effective corporate governance or a lower level of institutional ownership. The results are consistent with the notion that firms that actively engage in CSR also refrain from bad news hoarding behavior and thus reducing crash risk. This role of CSR is particularly important when governance mechanisms, such as monitoring by boards or institutional investors, are weak.
----------------------
Takeover defenses, innovation, and value creation: Evidence from acquisition decisions
Mark Humphery-Jenner
Strategic Management Journal, May 2014, Pages 668–690
Abstract:
The desirability of antitakeover provisions (ATPs) is a contentious issue. ATPs might enable managerial empire building by insulating managers from disciplinary takeovers. However, some companies, such as “hard-to-value” (HTV) companies, might trade at a discount due to valuation difficulties, thereby exposing HTV companies to opportunistic takeovers and creating agency conflicts of managerial risk aversion. ATPs might ameliorate such managerial risk aversion by inhibiting opportunistic takeovers. This paper analyzes acquisitions made by HTV firms, focusing on whether the acquirer (not the target) is entrenched in order to examine the impact of entrenchment managerial decision making. The results show that HTV firms that are entrenched make acquisitions that generate more shareholder wealth and are more likely to increase corporate innovation, suggesting that ATPs can be beneficial in some firms.
----------------------
Commitment to Social Good and Insider Trading
Feng Gao, Ling Lei Lisic & Ivy Xiying Zhang
Journal of Accounting and Economics, forthcoming
Abstract:
A firm's investment in corporate social responsibility (CSR) builds a positive image of caring for social good and imposes additional costs on executives' informed trading, which is widely perceived self-serving. We thus expect executives of CSR-conscious firms to be more likely to refrain from informed trading. We find that executives of CSR-conscious firms profit significantly less from insider trades and are less likely to trade prior to future news than executives of non-CSR-conscious firms. The negative association between CSR and insider trading profits is more pronounced when executives' personal interests are more aligned with the interests of the firm.
----------------------
CEO Inside Debt Incentives and Corporate Tax Policy
Sabrina Chi, Shawn Huang & Juan Manuel Sanchez
Arizona State University Working Paper, March 2014
Abstract:
This paper examines the relation between CEO inside debt holdings (pension benefits and deferred compensation) and corporate tax avoidance. Because inside debt holdings are generally unsecured and unfunded liabilities of the firm, CEOs are exposed to risk similar to that faced by outside creditors. As such, theory suggests that inside debt holdings negatively impact CEO risk-appetite. To the extent that aggressive tax policies involve significant cash flow shortfalls, high cash flow volatility, and losses in firm and CEO reputation in the future, we expect that inside debt holdings will curb CEOs from engaging in risky tax strategies. Consistent with the prediction, we document a negative association between CEO inside debt holdings and tax avoidance. Overall, our results highlight the importance of investigating the implication of CEO debt-like compensation for firm tax policies.
----------------------
Knowledge, Compensation, and Firm Value: An Empirical Analysis of Firm Communication
Feng Li et al.
Stanford Working Paper, January 2014
Abstract:
Knowledge is central to managing an organization, but its presence in employees is difficult to measure directly. We hypothesize that external communication patterns reveal the location of knowledge within the management team. Using a large database of firm conference call transcripts, we find that CEOs speak less in settings where they are likely to be relatively less knowledgeable. CEOs who speak more are also paid more, and firms whose CEO pay is not commensurate with CEO speaking have a lower industry-adjusted Tobin’s Q. Communication thus appears to reveal knowledge.
----------------------
Market Efficiency, Managerial Compensation, and Real Efficiency
Rajdeep Singh & Vijay Yerramilli
Journal of Corporate Finance, forthcoming
Abstract:
We examine how an exogenous improvement in market efficiency, which allows the stock market to obtain more precise information about the firm’s intrinsic value, affects the shareholder-manager contracting problem, managerial incentives, and shareholder value. A key assumption in the model is that stock market investors do not observe the manager’s pay-performance sensitivity ex ante. We show that an increase in market efficiency weakens managerial incentives by making the firm’s stock price less sensitive to the firm’s current performance. The impact on real efficiency and shareholder value varies depending on the composition of the firm’s intrinsic value.
----------------------
Insider Purchases Amid Short Interest Spikes: A Semi-Pooling Equilibrium
Chattrin Laksanabunsong & Wei Wu
University of Chicago Working Paper, January 2014
Abstract:
We study corporate insiders’ purchase behavior amid short interest spikes. The cumulative abnormal returns associated with insider purchases amid short interest spikes increase in the short run but decrease significantly in the long run, which is in sharp contrast to those associated with typical insider purchases. Moreover, insider purchases amid short interest spikes are on average followed by negative rather than positive earnings surprises. Our results suggest corporate insiders, provided with the right incentive, can strategically use purchases to shape firm information environments, steer stock prices, and thus disrupt market efficiency.
----------------------
Amy Dittmar & Ran Duchin
University of Maryland Working Paper, January 2014
Abstract:
We track the employment history of over 9,000 managers to study the effects of professional experiences on corporate policies. Our identification strategy exploits exogenous CEO turnovers and employment in other firms, in non-CEO roles and early in their career. Firms run by CEOs who experienced distress issue less debt, save more cash, and invest less than other firms. Past experience affects both managerial appointments and corporate policies, with stronger effects in poorly governed firms. We find similar effects on debt and cash, but not investment, for CFOs. The results suggest that policies vary with managers’ experiences and throughout their careers.
----------------------
Service on a Stigmatized Board, Social Capital, and Change in Number of Directorships
Kurt Wurthmann
Journal of Management Studies, forthcoming
Abstract:
This article seeks to develop a nuanced understanding about the relationship between service on a stigmatized board and reduced opportunities for future directorships on other boards by examining the moderating effects of different dimensions of director social capital on this relationship. Evidence based on a unique sample of firms with boards that were viewed as being stigmatized by a group of corporate governance experts suggests that while serving on a stigmatized board is related to a reduction in future number of directorships held, this relationship is significantly mitigated for directors of upper-class origins. However, social capital related to affiliations with other elite institutions does not appear to mitigate reduction in future number of directorships held by outside directors who serve on a stigmatized board. Implications and future directions in research on class-based influence in the corporate community and stigmatization and devaluation of elites associated with corporate failures are discussed.
----------------------
Reputation Effects in the Market of Certifiers: Evidence from the Audit Industry
Áron Tóth
Economic Inquiry, April 2014, Pages 505–517
Abstract:
Certifiers verify unobserved product characteristics for buyers and thereby alleviate informational asymmetries and facilitate trade. When sellers pay for the certification, however, certifiers can be tempted to bias their opinion to favor sellers. Indeed, accounting scandals and inflated credit ratings suggest sellers may prefer to select dishonest certifiers. I test this proposition by estimating the effect of adverse quality signals on audit demand. Exploiting the natural experiment of Arthur Andersen's demise, I find that auditors with worse quality signals experience a fall in demand. This suggests that reputation effects are at work even in the presence of conflicts of interest.
----------------------
The Executive Turnover Risk Premium
Florian Peters & Alexander Wagner
Journal of Finance, forthcoming
Abstract:
We establish that CEOs of companies experiencing volatile industry conditions are more likely to be dismissed. At the same time, accounting for various other factors, industry risk is unlikely to be associated with CEO compensation other than through dismissal risk. Using this identification strategy, we document that CEO turnover risk is significantly positively associated with compensation. This finding is important because job-risk-compensating wage differentials arise naturally in competitive labor markets. By contrast, the evidence rejects an entrenchment model according to which powerful CEOs have lower job risk and at the same time secure higher compensation.
----------------------
Acquirer-target social ties and merger outcomes
Joy Ishii & Yuhai Xuan
Journal of Financial Economics, forthcoming
Abstract:
This article investigates the effect of social ties between acquirers and targets on merger performance. We find that the extent of cross-firm social connection between directors and senior executives at the acquiring and the target firms has a significantly negative effect on the abnormal returns to the acquirer and to the combined entity upon merger announcement. Moreover, acquirer-target social ties significantly increase the likelihood that the target firm's chief executive officer (CEO) and a larger fraction of the target firm's pre-acquisition board of directors remain on the board of the combined firm after the merger. In addition, we find that acquirer CEOs are more likely to receive bonuses and are more richly compensated for completing mergers with targets that are highly connected to the acquiring firms, that acquisitions are more likely to take place between two firms that are well connected to each other through social ties, and that such acquisitions are more likely to subsequently be divested for performance-related reasons. Taken together, our results suggest that social ties between the acquirer and the target lead to poorer decision making and lower value creation for shareholders overall.
----------------------
Danny Miller, Xiaowei Xu & Vikas Mehrotra
Strategic Management Journal, forthcoming
Abstract:
We investigate whether and when highly trained human capital constitutes a rent-sustaining resource. Our study of 444 CEOs celebrated on the covers of major US business magazines found an advantage accruing to graduates of selective universities. Such CEOs led firms with higher and more sustained market valuations. The advantage was strongest for undergraduate programs as these related to the kinds of talent demanded of a CEO. The advantage also was greatest in smaller firms where CEO discretion might be highest and for younger CEOs who may benefit most from college and are less able to appropriate rents. Finally, the advantage accrued to graduates of more recent years, when selective schools had become less socially elitist and increasingly meritocratic, thus favoring human versus social capital.
----------------------
Management earnings forecasts, insider trading, and information asymmetry
Anastasia Kraft, Bong Soo Lee & Kerstin Lopatta
Journal of Corporate Finance, June 2014, Pages 96–123
Abstract:
We investigate whether senior officers use accrual-based earnings management to meet voluntary earnings disclosure (i.e., management earnings forecasts) before selling or buying their own shares when they have private information. This study is the first to use the differences in timing of trades by senior officers and other insiders (e.g., directors or large shareholders) to infer information asymmetry. We hypothesize that the timing of senior officers’ trades with no other insiders’ trades at the same time indicates opportunistic trades and asymmetric information between senior officers and other insiders. Our results show that senior officers’ exclusive sales are negatively associated with future returns, indicating that they tend to use insider information. Moreover, senior officers are more likely to meet their earnings forecasts when they plan to sell stocks.
----------------------
Advantageous Comparison and Rationalization of Earnings Management
Timothy Brown
Journal of Accounting Research, forthcoming
Abstract:
This paper proposes that psychological factors can change a manager's beliefs about earnings management when they choose to engage in it. I show that, under certain circumstances, engaging in a small amount of earnings management alters a manager's beliefs about the appropriateness of the act, which may increase the likelihood of further earnings management. Specifically, I predict and find in two experiments that participants who initially choose to manage earnings are motivated to rationalize their behavior. Participants who are exposed to an egregious example of earnings management (which are commonly the focus of enforcement actions and press reports) have the opportunity to rationalize their behavior through a mechanism called “advantageous comparison”, where participants compare their behavior against the egregious example and conclude that what they did was relatively innocuous and appropriate. My analysis also indicates that presenting participants with an example of earnings management which is similar to the initial decision they made mitigates advantageous comparison. These results have implications for academics interested in how earnings management, and perhaps fraud, can accrete over time and for regulators and practitioners who are interested in preventing it.
----------------------
Upper-Echelon Executive Human Capital And Compensation: Generalist Vs Specialist Skills
Sudip Datta & Mai Iskandar-Datta
Strategic Management Journal, forthcoming
Abstract:
This study extends current knowledge of upper echelon executive compensation beyond the CEO, specifically CFO compensation, based on whether they possess generalist or specialist skills. We find that ‘strategic’ CFOs with an elite MBA (generalist) consistently command a compensation premium, while ‘accounting’ CFOs (specialist) and CFOs with a non-MBA master's degree, even from an elite institution, do not. Further, scarce ‘strategic’ CFOs are awarded both higher salaries and higher equity-based compensation. Our findings support the view that unique complementarities between scarce CFOs and firms increase these executives’ bargaining power leading to pay premium. Our results are robust to post-hiring years, firm sizes, board characteristics, and CFO’s insider/outsider status. We contribute at the confluence of upper-echelon compensation, executive human capital, resource-based view, and assortative matching literatures.
----------------------
Substitutes or Complements? A Configurational Examination of Corporate Governance Mechanisms
Vilmos Misangyi & Abhijith Acharya
Academy of Management Journal, forthcoming
Abstract:
We examine the nature of the relationships among the bundle of governance mechanisms that have been theorized to effectively control the agency problem. To do so, we performed a qualitative comparative analysis using the fuzzy-set approach to study the combinations of governance mechanisms that yield high firm performance among the S&P 1500 firms. Our configurational approach allowed us to explore the complex interrelationships among the many different governance mechanisms and to elaborate theory on the many ways in which they combine. Our study shows that some type of CEO incentive mechanism and some type of monitoring mechanism are always present among firms that achieve high profitability, thereby suggesting that such mechanisms are complements. Our findings also highlight the simultaneity of substitution and complementarity among and across the various monitoring mechanisms. Finally, our findings suggest that the effectiveness of board independence and CEO non-duality, mechanisms widely held to resolve the agency problem, are a function of how they combine with the other mechanisms in the governance bundle.
----------------------
Outside Options and CEO Turnover: The Network Effect
Yun Liu
Journal of Corporate Finance, forthcoming
Abstract:
Most studies consider chief executive officer (CEO) turnover from the firm’s perspective. In this paper, I suggest that the labor market conditions for CEOs affect turnover outcomes. I use CEOs’ positions on corporate executive and director networks to assess their employment options. Controlling for performance, firm characteristics, and personal traits, I find that CEO connectedness significantly increases turnover probability, especially for poor performers. I also show that connectedness increases the likelihood of CEOs leaving for other full-time positions, or their retiring and taking part-time positions elsewhere, but does not have a significant effect on the likelihood that they will step down and remain with the firm in other capacities. The evidence supports the idea that a CEO’s connectedness expands outside options and thus increases turnover probability.
----------------------
The role of investment banker directors in M&A
Qianqian Huang et al.
Journal of Financial Economics, May 2014, Pages 269–286
Abstract:
We examine how directors with investment banking experience affect firms’ acquisition behavior. We find that firms with investment bankers on the board have a higher probability of making acquisitions. Furthermore, acquirers with investment banker directors experience higher announcement returns, pay lower takeover premiums and advisory fees, and exhibit superior long-run performance. Overall, our results suggest that directors with investment banking experience help firms make better acquisitions, both by identifying suitable targets and by reducing the cost of the deals.