Executive decisions
The Bright Side of Financial Derivatives: Options Trading and Firm Innovation
Iván Blanco & David Wehrheim
Journal of Financial Economics, forthcoming
Abstract:
Do financial derivatives enhance or impede innovation? We answer this question by examining the relationship between equity options markets and standard measures of firm innovation. We find that firms with more options trading activity generate more patents and patent citations per dollar invested in research and development (R&D), after accounting for other confounding factors. These results are confirmed when we use a propensity score matching procedure and an instrumental variable approach to control for the potential endogeneity of options trading. The evidence is consistent with the notion that the enhanced informational efficiency induced by options leads to an improved allocation of corporate resources. We further discuss possible underlying economic mechanisms through which more active options markets boost innovation and show that the effect remains substantial even after controlling for these mechanisms. Considering the average increase in the dollar volume of options traded for our sample firms, we conclude that a 200% move in options volume increases firm innovation by about 31%.
Globalization and Executive Compensation
Wolfgang Keller & William Olney
NBER Working Paper, May 2017
Abstract:
This paper examines the role of globalization in the rapid increase in top incomes. Using a comprehensive data set of thousands of executives at U.S. firms from 1993-2013, we find that exports, along with technology and firm size, have contributed to rising executive compensation. Isolating changes in exports that are unrelated to the executive's talent and actions, we show that globalization has affected executive pay not only through market channels but also through non-market channels. Furthermore, exogenous export shocks raise executive compensation mostly through bonus payments in poor-governance settings, in line with the hypothesis that globalization has enhanced the executive's rent capture opportunities. Overall, these results indicate that globalization has played a more central role in the rapid growth of executive compensation and U.S. inequality than previously thought, and that rent capture is an important part of this story.
Do Investors Benefit from Selective Access to Management?
Brian Bushee, Michael Jung & Gregory Miller
Journal of Financial Reporting, forthcoming
Abstract:
This paper examines whether selective access to corporate managers allows investors to revise their beliefs and execute profitable trades. We examine whether investors benefit from two potential opportunities for selective access at invitation-only investor conferences: one-on-one meetings with managers throughout the day and breakout sessions with managers after the webcast presentation. We find significant increases in trade sizes during the hours when firms provide offline access to investors, consistent with selective access providing investors with information they perceive to be valuable enough to trade upon. We also find significant potential trading gains concentrated primarily in three-day horizons after the conference for firms providing formal offline access, suggesting that selective access can lead to profitable trading opportunities. These trading gains are associated with analyst notes published during that period, indicating that such notes are one potential source of revelation to the broader market. Our evidence suggests that selective access to management conveys benefits to certain investors even in the post-Reg FD period.
CEO political ideology and mergers and acquisitions decisions
Ahmed Elnahas & Dongnyoung Kim
Journal of Corporate Finance, August 2017, Pages 162–175
Abstract:
We examine the relation between CEOs political ideology and their firms' investment decisions, particularly their M&A decisions. Employing individual financial contributions data for the period from 1993 to 2006, we find that firm's investment decisions vary with CEO's political ideology. Our evidence indicates that Republican CEOs are less likely to engage in M&A activities. When they do undertake acquisitions, they are more likely to use cash as the method of payment, and their targets are more likely to be public firms and to be from the same industry. Further, Republican CEOs tend to avoid high information asymmetry acquisitions that involve the use of “earnout” clauses. Conditional on the merger, CEO political ideology appears to have a significantly positive impact on long-run firm valuation. However, we find no evidence that CEO political ideology creates value in the short-run. All our results are robust to controlling for CEO overconfidence.
Corporate Scandals and Regulation
Luzi Hail, Ahmed Tahoun & Clare Wang
University of Pennsylvania Working Paper, April 2017
Abstract:
Are regulatory interventions delayed reactions to market failures or can regulators proactively pre-empt corporate misbehavior? From a public interest view, we would expect “effective” regulation to ex ante mitigate agency conflicts between corporate insiders and outsiders, and prevent corporate misbehavior from occurring or quickly rectify transgressions. However, regulators are also self-interested and may be captured, uninformed, or ideological, and become less effective as a result. We develop a historical time series of corporate (accounting) scandals and (accounting) regulations for a panel of 26 countries from 1800 to 2015. An analysis of the lead-lag relations at both the global and individual country level yields the following insights: (i) Corporate scandals are an antecedent to regulation over long stretches of time, suggesting that regulators are typically less flexible and informed than firms. (ii) Regulation is positively related to the incidence of future scandals, suggesting that regulators are not fully effective, that explicit rules are required to identify scandalous corporate actions, or that new regulations have unintended consequences. (iii) There exist systematic differences in these lead-lag relations across countries and over time suggesting that the effectiveness of regulation is shaped by fundamental country characteristics like market development and legal tradition.
Is the SEC Captured? Evidence from Comment-Letter Reviews
Jonas Heese, Mozaffar Khan & Karthik Ramanna
Harvard Working Paper, April 2017
Abstract:
SEC oversight of publicly listed firms ranges from comment letter (CL) reviews of firms’ reporting compliance to pursuing enforcement actions against violators. Prior literature finds that firm political connections (PC) negatively predict enforcement actions, inferring SEC capture. We present new evidence that firm PC positively predict CL reviews and substantive characteristics of such reviews, including the number of issues evaluated and the seniority of SEC staff involved. These results, robust to identification concerns, are inconsistent with SEC capture and indicate a more nuanced relation between firm PC and SEC oversight than previously suggested.
Network connections, CEO compensation and involuntary turnover: The impact of a friend of a friend
Steven Balsam, So Yean Kwack & Jae Young Lee
Journal of Corporate Finance, forthcoming
Abstract:
We show that hard to observe, indirect connections between a CEO and “independent” board members are associated with higher CEO compensation. While we find this result for the “friend of a friend” connection, we do not find it for direct connections, i.e. friends sitting on the board. We postulate that this differential result is caused by directors with readily observable connections to the CEO being wary of provoking outrage. In contrast we find both types of connections associated with reduced involuntary CEO turnover, suggesting that outrage is not as big a concern, e.g., compensation is the foci of stakeholders.
More Cash, Less Innovation: The Effect of the American Jobs Creation Act on Patent Value
Heitor Almeida et al.
University of Illinois Working Paper, April 2017
Abstract:
We find evidence that firms can become less innovative following a sudden inflow of cash. Specifically, after the 2004 American Jobs Creation Act (AJCA), multinational firms that were able to repatriate cash to the U.S. as a result of the AJCA generate less valuable patents than similar firms that could not benefit from this Act. The effect is stronger among firms with weaker governance prior to the AJCA, is mainly driven by reduction in exploratory innovation, and only exists in U.S.-originated patents. Repatriating firms also experience less turnover in patent inventors and CEOs after the AJCA. These results appear to be consistent with the “quiet life” agency story.
Stock Price Management and Share Issuance: Evidence from Equity Warrants
Mary Barth et al.
Stanford Working Paper, April 2017
Abstract:
We address whether firms manage stock prices in anticipation of share issuances. A literature in finance attributes negative returns following share issuances to market timing, whereas studies in accounting interpret similar return patterns as evidence of firms managing investor expectations prior to share issuances. To establish that one or the other explains the patterns, one must hold fixed either issuance timing or issuance price. Because warrant expiration dates, which can result in share issuances, are fixed several years in advance, we use stock price patterns before and after the expiration dates to determine whether firms manage stock prices in anticipation of share issuances. Using a sample of warrants over 16 years, we find evidence consistent with firms managing stock prices around warrant expiration dates to induce (prevent) warrant exercise when issuing new shares is expected to be anti-dilutive (dilutive) to existing shareholders. In particular, the return patterns we document are consistent with firms accelerating (delaying) bad news and delaying (accelerating) good news to prevent (induce) warrant exercise and, thus, share issuance. Taken together, our findings reveal that in anticipation of share issuances firms engage in stock price management that increases firm value for existing shareholders.
The Decline of Social Entrenchment: Social Network Cohesion and Board Responsiveness to Shareholder Activism
Richard Benton
Organization Science, March-April 2017, Pages 262-282
Abstract:
Shareholder activism through corporate governance proposals is a prominent avenue for investors to voice their concerns in corporate governance matters. However, shareholder proposals have an uneven effect on corporate governance. This paper contributes to research on shareholder activism by joining social movement approaches to activism with network theoretic approaches to corporate governance. The paper examines how firms’ position within cohesive sections of the board interlock network, termed “social entrenchment,” predicts (1) the likelihood of being targeted by activist investors and (2) firms’ responsiveness to proposal demands. First, a firm’s position in the board network serves as a salient network prism, attracting activists’ attention. This is especially true for activist investors who lack other backchannel avenues for engagement or seek to use public reputational penalties as part of their activism strategy. Second, the board network traditionally served as an important collective infrastructure among managerial elites helping them preserve autonomy and power. However, the network has become fractured in recent years, raising questions about its continued role in supporting elite cohesion. Results indicate that prior to the mid-2000s socially entrenched firms were less responsive to shareholder proposals. After the mid-2000s, socially entrenched firms were no less responsive. Findings suggest that the board interlock network may have traditionally helped protect corporate elites from external shareholder pressures but the network may have lost its capacity to help corporate leaders preserve their cohesion and autonomy.
Corporate donations and shareholder value
Hao Liang & Luc Renneboog
Oxford Review of Economic Policy, Summer 2017, Pages 278-316
Abstract:
Do corporate donations enhance shareholder wealth or reflect agency problems? We address this question for a global sample of firms whereby we distinguish between charitable and political donations, as well as between donations in cash and in kind. We find that charitable donations are positively related to financial performance and firm value, which is consistent with the value-enhancement hypothesis. This positive effect on firm value is stronger for cash than in-kind donations. In contrast, political donations do not appear to enhance shareholder value, but rather tend to reflect agency problems, as they are higher for firms with poor internal corporate governance and strong managerial entrenchment. We address endogeneity concerns by using peer firms’ donations as an instrument in a two-stage least squares (2SLS) setting and by conducting a difference-in-difference analysis around a general election.
CEO talent, CEO compensation, and product market competition
Hae Won (Henny) Jung & Ajay Subramanian
Journal of Financial Economics, forthcoming
Abstract:
We develop a structural industry equilibrium model to show how competitive chief executive officer (CEO)-firm matching and product markets jointly determine firm value and CEO pay. We analytically derive testable implications for the effects of product market characteristics on firm size, CEO pay, and CEO impact on firm value. CEO talent matters more in more competitive markets with greater product substitutabilities. Our CEO impact estimates are much higher than those obtained by previous structural approaches that abstract away from CEO market segmentation. The estimates differ across industries primarily due to variation in product market competition, rather than variation in the CEO talent distribution.
Home Alone: The Effect of Lone-Insider Boards on CEO Pay, Financial Misconduct, and Firm Performance
Michelle Zorn et al.
Strategic Management Journal, forthcoming
Abstract:
Corporate scandals of the previous decade have heightened attention on board independence. Indeed, boards at many large firms are now so independent that the CEO is ‘home alone’ as the lone inside member. We build upon ‘pro-insider’ research within agency theory to explain how the growing trend toward lone-insider boards affects key outcomes and how external governance forces constrain their impact. We find evidence among S&P 1500 firms that having a lone-insider board is associated with (1) excess CEO pay and a larger CEO-top management team pay gap, (2) increased likelihood of financial misconduct, and (3) decreased firm performance, but that stock analysts and institutional investors reduce these negative effects. The findings raise important questions about the efficacy of leaving the CEO ‘home alone.’
Corporate Culture and Financial Reporting Risk: Looking Through the Glassdoor
Yuan Ji, Oded Rozenbaum & Kyle Welch
George Washington University Working Paper, January 2017
Abstract:
We study whether financial reporting risk is associated with job satisfaction, company culture, and opinions of senior leadership. We use novel data on employees’ perspectives obtained from the website Glassdoor, covering 14,282 firm-years in the period 2008-2015. We find that firms with lower levels of “culture and values” (as measured by employees) and lower levels of job satisfaction are more likely to be subjected to SEC fraud enforcement actions and securities class action lawsuits. The same measures of corporate climate are also associated with an increased likelihood that a company will narrowly meet or beat market earnings estimates. Conversely, we find job satisfaction and positive employee opinions of senior leadership to be associated with lower abnormal accruals. We also find that the association between firms’ culture and financial reporting risk is stronger for firms with weaker board independence. Thus the work environment, as perceived by employees, appears to play a critical role in financial-reporting risk.
CEO Age and Stock Price Crash Risk
Panayiotis Andreou, Christodoulos Louca & Andreas Petrou
Review of Finance, May 2017, Pages 1287-1325
Abstract:
We show that firms with younger CEOs are more likely to experience stock price crashes, including crashes caused by revelation of negative news in the form of breaks in strings of consecutive earnings increases. Such strings are accompanied by large increases in CEO compensation that do not dissipate with crashes. These findings suggest that CEOs have financial incentives to hoard bad news earlier in their career, which increases future crashes. This negative impact of CEO age effect is strongest in the presence of managerial discretion. Overall, the findings highlight the importance of CEO age for firm policies and outcomes.
Do takeover laws matter? Evidence from five decades of hostile takeovers
Matthew Cain, Stephen McKeon & Steven Davidoff Solomon
Journal of Financial Economics, June 2017, Pages 464–485
Abstract:
This study evaluates the relation between hostile takeovers and 17 takeover laws from 1965 to 2014. Using a data set of largely exogenous legal changes, we find that certain takeover laws, such as poison pill and business combination laws, have no discernible impact on hostile activity, while others such as fair price laws have reduced hostile takeovers. We construct a Takeover Index from the laws and find that higher takeover protection is associated with lower firm value, consistent with entrenchment and agency costs. However, conditional on a bid, firms with more protection achieve higher premiums, consistent with increased bargaining power.
How Disclosure Medium Affects Investor Reactions to CEO Bragging, Modesty, and Humblebragging
Stephanie Grant, Frank Hodge & Roshan Sinha
University of Washington Working Paper, March 2017
Abstract:
We examine if investor expectations of two common disclosure mediums (conference calls and Twitter) interact with a CEO’s communication style to influence investor judgments. Consistent with theory, results show that when the disclosure medium is a conference call, investors are more willing to invest when the CEO brags about positive firm performance compared to when the CEO is modest. In contrast, when the disclosure medium is Twitter, investors are less willing to invest when the CEO brags about positive firm performance compared to when the CEO is modest. Further analysis reveals that CEO credibility mediates the influence of a CEO’s communication style and disclosure medium on investor judgments. Additionally, we find that regardless of the disclosure medium, investors are less willing to invest in a firm when the CEO humblebrags about positive firm performance relative to when she brags or is modest. Our study contributes to the emerging literature on social media and disclosures, and to the literature investigating how style features of disclosures influence investor judgments. Our results also have practical implications for firms and managers developing communication strategies for new disclosure mediums like Twitter.
Benefits and costs of Sarbanes-Oxley Section 404(b) exemption: Evidence from small firms’ internal control disclosures
Weili Ge, Allison Koester & Sarah McVay
Journal of Accounting and Economics, April–May 2017, Pages 358–384
Abstract:
We quantify measurable benefits and costs of exempting firms from auditor oversight of internal control effectiveness disclosures. We measure the benefit of exemption as an aggregate $388 million in audit fee savings from 2007–2014. The costs stem from internal control misreporting: an aggregate $719 million of lower operating performance due to non-remediation and a $935 million delay in aggregate market value decline due to the failure to disclose ineffective internal controls. The audit fee savings benefit shareholders of all exempt firms, whereas the costs are borne by shareholders of only a fraction of exempt firms (the internal control misreporters).
Insider versus Outsider CEOs, Executive Compensation, and Accounting Manipulation
Prasart Jongjaroenkamol & Volker Laux
Journal of Accounting and Economics, April–May 2017, Pages 253–261
Abstract:
This paper examines the role of the financial reporting environment in selecting a new CEO from within versus outside the organization. Weak reporting controls allow the CEO to misreport performance information, which reduces the board's ability to detect and replace poorly-performing CEOs as well as aggravates incentive contracting. We show that these adverse effects are stronger when the CEO is an outsider rather than an insider. Our model predicts that boards are more likely to recruit a CEO from the outside when the performance measures with which the new hire is assessed are harder to manipulate.
Do Investors Care About Director Tenure? Insights from Executive Cognition and Social Capital Theories
Jill Brown et al.
Organization Science, forthcoming
Abstract:
Governance scholars debate the value of directors as an effective governance mechanism. We suggest that this value varies with director tenure. We study both how shareholder assessments of the value of individual directors vary with director tenure and whether director tenure actually makes a practical difference to governance effectiveness. Using data from abnormal stock price reactions to the sudden deaths of 274 outside directors, and integrating executive cognition and social capital perspectives applied to the dual roles of director monitoring and advising, our results confirm a curvilinear relationship between the assessed value of directors and tenure. We find that directors are more highly valued by investors over a tenure period between 7 and 18 years, moderated by director involvement on key committees. Further, in examining the S&P 1,500, we find that a one standard deviation increase in the percentage of outside directors in this prime tenure period strengthens the CEO pay-performance linkage by 2.5%, suggesting that directors in this tenure period are more effective in aligning CEO and shareholder interests. Our results demonstrate that individual director tenure makes a difference in governance effectiveness, and shareholders accurately assess this difference. Additionally, our findings provide important boundary conditions for when theories of executive cognition and social capital may be more/less applicable regarding director tenure.