Executive summary
Executives' "Off-The-Job" Behavior, Corporate Culture, and Financial Reporting Risk
Robert Davidson, Aiyesha Dey & Abbie Smith
Journal of Financial Economics, forthcoming
Abstract:
We examine how executives' behavior outside the workplace, as measured by their ownership of luxury goods (low "frugality") and prior legal infractions, is related to financial reporting risk. We predict and find that chief executive officers (CEOs) and chief financial officers (CFOs) with a legal record are more likely to perpetrate fraud. In contrast, we do not find a relation between executives' frugality and the propensity to perpetrate fraud. However, as predicted, we find that unfrugal CEOs oversee a relatively loose control environment characterized by relatively high and increasing probabilities of other insiders perpetrating fraud and unintentional material reporting errors during their tenure. Further, cultural changes associated with an increase in fraud risk are more likely during unfrugal (vs. frugal) CEOs' reigns, including the appointment of an unfrugal CFO, an increase in executives' equity-based incentives to misreport, and a decline in measures of board monitoring intensity.
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Gina Nicolosi
Journal of Corporate Finance, December 2013, Pages 54-70
Abstract:
Using seventeen observable demographic characteristics, we investigate the impact of six CEO profiles on dividend policy. Firms headed by married, Republican, Christian CEOs with children maintain higher dividend yields and are more likely to considerably increase their dividend payout. Following substantial dividend hikes, firms led by CEOs with these more traditional personal lives exhibit deteriorating performance. Potential explanations include managerial optimism coupled with dividend signaling and the possibility that CEO profiles proxy for an unobserved firm effect such as firm maturity. However, the associations above continue to persist in both mature firm and turnover sub-samples. Overall, this suggests that these relationships are related to characteristics of the CEOs themselves.
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Itzhak Ben-David, John Graham & Campbell Harvey
Quarterly Journal of Economics, forthcoming
Abstract:
Using a unique 10-year panel that includes more than 13,300 expected stock market return probability distributions, we find that executives are severely miscalibrated, producing distributions that are too narrow: realized market returns are within the executives' 80% confidence intervals only 36% of the time. We show that executives reduce the lower bound of the forecast confidence interval during times of high market uncertainty; however, ex post miscalibration is worst during periods of high uncertainty. We also find that executives who are miscalibrated about the stock market show similar miscalibration regarding their own firms' prospects. Finally, firms with miscalibrated executives seem to follow more aggressive corporate policies: investing more and using more debt financing.
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Governance and CEO Turnover: Do Something or Do the Right Thing?
Raymond Fisman et al.
Management Science, forthcoming
Abstract:
We study how corporate governance affects firm value through the decision of whether to fire or retain the chief executive officer (CEO). We present a model in which weak governance - which prevents shareholders from controlling the board - protects inferior CEOs from dismissal, while at the same time insulates the board from pressures by biased or uninformed shareholders. Whether stronger governance improves retain/replace decisions depends on which of these effects dominates. We use our theoretical framework to assess the effect of governance on the quality of firing and hiring decisions using data on the CEO dismissals of large U.S. corporations during 1994-2007. Our findings are most consistent with a beneficent effect of weak governance on CEO dismissal decisions, suggesting that insulation from shareholder pressure may allow for better long-term decision making.
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Do cash stockpiles fuel cash acquisitions?
Lee Pinkowitz, Jason Sturgess & Rohan Williamson
Journal of Corporate Finance, forthcoming
Abstract:
U.S. firms currently hold a $2 trillion cash stockpile. We examine if cash stockpiles fuel cash acquisitions by studying the method of payment decision for cash-rich firms. Surprisingly, cash-rich firms are 23% less likely to make cash bids than stock bids, relative to firms that are not cash rich. We examine several potential explanations related to omitted variable bias and endogeneity and the result remains. More specifically, the results are robust to explanations related to agency, financial constraints, tax-related explanations, equity overvaluation, and capital structure. Our evidence implies that the link between cash stockpiles and cash acquisitions is not obvious.
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The Efficacy of Shareholder Voting: Evidence from Equity Compensation Plans
Christopher Armstrong, Ian Gow & David Larcker
Journal of Accounting Research, forthcoming
Abstract:
This study examines the effects of shareholder support for equity compensation plans on subsequent chief executive officer (CEO) compensation. Using cross-sectional regression, instrumental variable, and regression discontinuity research designs, we find little evidence that either lower shareholder voting support for, or outright rejection of, proposed equity compensation plans leads to decreases in the level or composition of future CEO incentive-compensation. We also find that in cases where the equity compensation plan is rejected by shareholders, firms are more likely to propose, and shareholders are more likely to approve, a plan the following year. Our results suggest that shareholder votes for equity pay plans have little substantive impact on firms' incentive-compensation policies. Thus, recent regulatory efforts aimed at strengthening shareholder voting rights, particularly in the context of executive compensation, may have limited effect on firms' compensation policies.
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Pandej Chintrakarn, Pornsit Jiraporn & J.C. Kim
Finance Research Letters, forthcoming
Abstract:
CEOs are "lucky" when they receive stock option grants on days when the stock price is the lowest in the month of the grant, implying opportunistic timing. Extending the work of Bebchuk, Grinstein, Peyer (2010), we explore the effect of overall corporate governance quality on CEO luck. Provided by the Institutional Shareholder Services (ISS), our comprehensive governance metrics are much broader than those used in prior studies, encompassing more diverse aspects of corporate governance, such as audit, state laws, boards, ownership, and director education. We show that an improvement in governance quality by one standard deviation diminishes CEO luck by 14.77-21.06%. The governance standards recommended by ISS appear to be effective in deterring the opportunistic timing of option grants.
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Why Do Firms Pay Dividends?: Evidence from an Early and Unregulated Capital Market
John Turner, Qing Ye & Wenwen Zhan
Review of Finance, September 2013, Pages 1787-1826
Abstract:
Why do firms pay dividends? To answer this question, we use a hand-collected data set of companies traded on the London stock market between 1825 and 1870. As tax rates were effectively zero, the capital market was unregulated, and there were no institutional stockholders, we can rule out these potential determinants ex ante. We find that, even though they were legal, share repurchases were not used by firms to return cash to shareholders. Instead, our evidence provides support for the information-communication explanation for dividends, while providing little support for agency, illiquidity, catering, or behavioral explanations.
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Quadratic Vote Buying as Efficient Corporate Governance
Eric Posner & Glen Weyl
University of Chicago Law Review, forthcoming
Abstract:
Shareholder voting is a weak and much criticized mechanism for controlling managerial opportunism. Among other problems, shareholders are often too uninformed to vote wisely, and majority and supermajority rule permits large shareholders to exploit small shareholders. We propose a new voting system called Quadratic Vote Buying (QVB), according to which shareholders are not given voting rights but may purchase votes, with the price of votes being a quadratic function of the number of votes purchased. QVB ensures that voting outcomes are efficient under reasonable conditions. We argue that corporations should implement QVB and that the law permits them to do so. Certain legal protections for shareholders, such as the appraisal remedy, are unnecessary if QVB is implemented.
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Keeping Up with CEO Jones: Benchmarking and Executive Compensation
Ron Laschever
Journal of Economic Behavior & Organization, September 2013, Pages 78-100
Abstract:
This paper seeks to understand the role that peer comparisons play in the determination of executive compensation. I exploit a recent change in the Securities and Exchange Commission's regulations that requires firms to disclose the peer companies used for determining the compensation of their top executives. Using a new dataset of S&P 900 companies' choice of benchmarking firms during two fiscal periods (2007 and 2008), I investigate what determines the choice of comparison firms. I find that companies have a preference for choosing higher-CEO-compensation firms as their benchmark. Though I find that companies prefer to choose as their benchmark peers with similar firm characteristics, for CEO compensation, this effect is countered by a preference for firms with higher-than-own CEO compensation. Using the complete map of firms' choices, I implement an instrumental variable strategy that uses the characteristics of peers-of-peers to estimate the effect of others' compensation on own compensation. For Fiscal Year 2007, I find an elasticity of 0.5.
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Unethical Culture, Suspect CEOs and Corporate Misbehavior
Lee Biggerstaff, David Cicero & Andy Puckett
NBER Working Paper, August 2013
Abstract:
We show that firms with CEOs who personally benefitted from options backdating were more likely to engage in other forms of corporate misbehavior, suggestive of an unethical corporate culture. These firms were more likely to overstate firm profitability and to engage in less profitable acquisition strategies. The increased level of corporate misbehaviors is concentrated in firms with suspect CEOs who were outside hires, consistent with adverse selection in the market for chief executives. Difference-in-differences tests confirm that the propensity to engage in these activities is significantly increased following the arrival of an outside-hire 'suspect' CEO, suggesting that causation flows from the top executives to the firm. Finally, while these suspect CEOs appear to have avoided market discipline when the market was optimistic, they were more likely to lose their jobs and their firms were more likely to experience dramatic declines in value during the ensuing market correction.
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Shareholder Democracy in Play: Career Consequences of Proxy Contests
Vyacheslav Fos & Margarita Tsoutsoura
University of Chicago Working Paper, July 2013
Abstract:
This paper shows that proxy contests have a significant adverse effect on careers of incumbent directors. Following a proxy contest, directors experience a significant decline in number of directorships not only in the targeted company, but also in other non-targeted companies. The results are established using the universe of all proxy contests during 1996-2010. To establish that this effect of proxy contests is causal, we use within-firm variation in directors' exposure to proxy contests and exploit the predetermined schedule of staggered boards that only allows a fraction of directors to be nominated for election every year. We find that nominated directors relative to non-nominated ones lose 45% more seats on other boards. We discuss that this pattern can be expected if proxy contest mechanism imposes a significant career cost on incumbent directors.
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Skill Differences in Corporate Acquisitions
Jeffrey Jaffe, David Pedersen & Torben Voetmann
Journal of Corporate Finance, forthcoming
Abstract:
Are there skill differences in mergers and acquisitions? To investigate this question, we focus on persistence in the performance of corporate acquirers. We find persistence only when successive deals occur under the same CEO and conclude that skill differences in acquisitions reside with the CEO, not with the firm as a whole. These differences are economically meaningful. An acquirer that was successful in its last deal and kept its CEO earns 1.02% more on its next deal than does a previously-unsuccessful firm that kept its CEO. This percentage difference is equivalent to a $175 million difference in value creation.
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Boards, CEO entrenchment, and the cost of capital
James Dow
Journal of Financial Economics, forthcoming
Abstract:
Existing research on chief executive officer (CEO) turnover focuses on CEO ability. This paper argues that board ability is also important. Corporate boards are reluctant to replace CEOs, as this makes financing expensive by sending a negative signal about board ability. Entrenchment in this model does not result from CEO power, or from agency problems. Entrenchment is mitigated when there are more assets-in-place relative to investment opportunities. The paper also compares public and private equity. Private ownership eliminates CEO entrenchment, but market signals improve investment decisions. Finally, the model implies that board choice in publicly listed firms will be conservative.
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Yihui Pan, Tracy Yue Wang & Michael Weisbach
NBER Working Paper, August 2013
Abstract:
This paper documents the existence of a CEO Investment Cycle, in which firms disinvest early in a CEO's tenure and increase investment subsequently, leading to "cyclical" firm growth in assets as well as in employment over CEO tenure. The CEO investment cycle occurs for both firings and non-performance related CEO turnovers, and for CEOs with different relationships with the firm prior to becoming CEO. The magnitude of the CEO cycle is substantial: The estimated difference in investment rate between the first three years of a CEO's tenure and subsequent years is approximately 6 to 8 percentage points, which is of the same order of magnitude as the differences caused by other factors known to affect investment, such as business cycles or financial constraints. We present a variety of tests suggesting that this investment cycle is best explained by a combination of agency-based theories: Early in his tenure the CEO disinvests poorly performing assets that his predecessor established and was unwilling to give up on. Subsequently, the CEO overinvests when he gains more control over his board. There is no evidence that the investment cycles occur because of shifting CEO skill or productivity shocks. Overall, the results imply that public corporations' investments deviate substantially from the first-best, and that governance-related factors internal to the firm are as important as economy-wide factors in explaining firms' investments.
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CEO Career Variety: Effects on Firm-level Strategic and Social Novelty
Craig Crossland et al.
Academy of Management Journal, forthcoming
Abstract:
We introduce the concept of CEO career variety - defined as the array of distinct professional and institutional experiences an executive has had prior to becoming CEO. Using a longitudinal sample of Fortune 250 CEOs, we hypothesize, and find strong evidence, that CEO career variety is positively associated with firm-level strategic novelty - manifested in strategic dynamism (period-on-period change) and strategic distinctiveness (deviance from industry central tendencies). We also find mixed evidence that CEO career variety is positively associated with social novelty - manifested in top management team turnover and heterogeneity.
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Group Polarization in Board Decisions About CEO Compensation
David Zhu
Organization Science, forthcoming
Abstract:
This study examines how chief executive officer (CEO) compensation decisions may be influenced by a major group decision-making tendency referred to as group polarization among outside directors. I start by explaining why outside directors on average tend to support relatively high (low) CEO compensation when they previously witnessed relatively high (low) CEO compensation across different boards. Group polarization theory then suggests that when outside directors on average tend to support relatively high (low) CEO compensation prior to board discussions, they will support even higher (lower) focal CEO compensation after the discussions. In addition, this study proposes three important moderators of the group polarization effect. Specifically, (1) demographic homogeneity among outside directors and (2) the similarity of the minority's prior decision context are proposed to weaken the group polarization effect, whereas (3) outside directors' power relative to inside directors is predicted to strengthen it. Longitudinal analyses (1995-2006) of Fortune 500 CEOs' compensation provide support for these theoretical predictions. This study contributes to corporate governance research on CEO compensation by advancing a novel group decision-making approach to examining this important decision.
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Who Says Yes When the Headhunter Calls? Understanding Executive Job Search Behavior
Peter Cappelli & Monika Hamori
NBER Working Paper, August 2013
Abstract:
We examine an aspect of job search in the important context of executive-level jobs using a unique data set from a prominent executive search firm. Specifically, we observe whether or not executives pursue offers to be considered for a position at other companies. The fact that the initial call from the search firm, which we observe, is an exogenous event for the executive makes the context particularly useful. We use insights from the Multi-Arm Bandit problem to analyze the individual's decision as it emphasizes assessments of future prospects in the decision process, which are particularly relevant for executive careers. More than half the executives we observe were willing to be a candidate for a job elsewhere. Executives are more likely to search where their current roles are less certain and where their career experience has been broader. Search is more likely even for broader experience within the same employer. In the latter case, the array of likely opportunities is also broader, making search more useful.
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Human capital, capital structure, and employee pay: An empirical analysis
Thomas Chemmanur, Yingmei Cheng & Tianming Zhang
Journal of Financial Economics, forthcoming
Abstract:
We test the predictions of Titman (1984) and Berk, Stanton, and Zechner (2010) by examining the effect of leverage on labor costs. Leverage has a significantly positive impact on cash, equity-based, and total compensation of chief executive officers (CEOs). Compensation of new CEOs hired from outside the firm is positively related to prior-year firm leverage. In addition, leverage has a positive and significant impact on average employee pay. The incremental total labor expenses associated with an increase in leverage are large enough to offset the incremental tax benefits of debt. The empirical evidence supports the theoretical prediction that labor costs limit the use of debt.
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Asymmetric Benchmarking of Pay in Firms
Bill Francis et al.
Journal of Corporate Finance, December 2013, Pages 39-53
Abstract:
This paper examines whether asymmetric benchmarking of pay exists for vice presidents (VPs). Using ExecuComp data for 1992-2007, we find that companies reward VPs for good luck but do not penalize them for bad luck. However, asymmetric benchmarking of VP pay is mitigated by governance, power, gender, and industry factors. The presence of asymmetric benchmarking of pay could suggest that managers are involved in skimming, or it could mean that firms insulate managers from poor firm performance to prevent them from accessing outside opportunities. We also find that unlike CEOs, asymmetric benchmarking of pay for VPs is not consistent with the skimming hypothesis.
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CEO compensation and corporate risk: Evidence from a natural experiment
Todd Gormley, David Matsa & Todd Milbourn
Journal of Accounting and Economics, forthcoming
Abstract:
This paper examines the two-way relationship between managerial compensation and corporate risk by exploiting an unanticipated change in firms' business risks. The natural experiment provides an opportunity to examine two classic questions related to incentives and risk - how boards adjust incentives in response to firms' risk and how these incentives affect managers' risk-taking. We find that, after left-tail risk increases, boards reduce managers' exposure to stock price movements and that less convexity from options-based pay leads to greater risk-reducing activities. Specifically, managers with less convex payoffs tend to cut leverage and R&D, stockpile cash, and engage in more diversifying acquisitions.
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Duration of Executive Compensation
Radhakrishnan Gopalan et al.
Journal of Finance, forthcoming
Abstract:
Extensive discussions on the inefficiencies of "short-termism" in executive compensation notwithstanding, little is known empirically about the extent of such short-termism. We develop a novel measure of executive pay duration that reflects the vesting periods of different pay components, thereby quantifying the extent to which compensation is short-term. We calculate pay duration in various industries and document its correlation with firm characteristics. Pay duration is longer in firms with more growth opportunities, more long-term assets, greater R&D intensity, lower risk, and better recent stock performance. Longer CEO pay duration is negatively related to the extent of earnings-increasing accruals.
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The harder they fall, the faster they rise: Approach and avoidance focus in Narcissistic CEOs
Pankaj Patel & Danielle Cooper
Strategic Management Journal, forthcoming
Abstract:
Drawing on theoretical underpinnings of approach-avoidance motivation and CEO narcissism, we provide a framework examining stronger approach focus (motivation towards desirable outcomes) and weaker avoidance focus (motivation away from undesirable outcomes) in narcissistic CEOs using a quasi-natural experimental setting - the economic crisis beginning in 2007. Because highly narcissistic CEOs possess lower avoidance motivation in the pre-crisis period, their firms face greater declines in the onset of the crisis. However, their greater tendency towards approach motivation enables narcissistic CEOs to increase firm performance in the post-crisis period. While narcissistic CEOs are less likely to protect against potential shocks, they are adept at helping firms quickly recover from such shocks. Using a sample of 392 CEOs representing 2,352 CEO-firm-years, we find support for the proposed framework.
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Board structure and role of monitoring committees
Arun Upadhyay, Rahul Bhargava & Sheri Faircloth
Journal of Business Research, forthcoming
Abstract:
Regulators and researchers alike have focused significant attention on the structure of the corporate board. In general, the results of prior empirical studies suggest that larger boards are costly to firms because of communication and co-ordination problems. How firms use committees to mitigate these costs, however, has not received as much attention. Since boards delegate authority for specific tasks to monitoring committees with independent directors, we re-examine the impact of board structure on firm performance by specifically focusing on the number of monitoring committees. Using ROA and EVA, we find that board size is positively associated with firm performance when firms use more than three monitoring committees. We also find that the previously documented negative association between board size and Tobin's Q disappears when a firm uses more than three monitoring committees. Overall, the results suggest that firms use monitoring committees to mitigate the costs associated with larger boards.
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How Do Public Companies Adjust Their Board Structures?
David Cicero, Babajide Wintoki & Tina Yang
Journal of Corporate Finance, December 2013, Pages 108-127
Abstract:
We show that public companies frequently changed their board structures before implementation of the Sarbanes-Oxley Act, with two-thirds of firms changing board size or independence during an average two-year period. Board changes were associated with changes in firm-specific fundamentals, but the rate of change toward predicted structures was negatively associated with the level of CEO influence. Companies changed board structures in either direction as underlying firm fundamentals changed, consistent with the pursuit of economically efficient board structures. However, board changes have become less frequent since the Sarbanes-Oxley Act was enacted. We provide some evidence that companies became less likely to decrease board independence when changes in fundamentals suggested they should, which may reflect a loss of economic efficiency.
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Effect of Decision Makers' Education Level on their Corporate Risk Taking
Yonghai Wang, Wei Zhou & Ke-Chiun Chang
Social Behavior and Personality, August 2013, Pages 1225-1229
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We examined whether or not the education level of corporate decision makers helps explain their level of corporate risk taking. Using a sample population of listed companies in China, we documented a significant negative correlation between decision makers' education level and their level of corporate risk taking. Corporations run by more highly educated decision makers were found to have lower leverage and less volatile earnings. These results have important implications for corporate governance and educational choices.
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Which U.S. Market Interactions Affect CEO Pay? Evidence from UK Companies
Joseph Gerakos, Joseph Piotroski & Suraj Srinivasan
Management Science, forthcoming
Abstract:
This paper examines how different types of interactions with U.S. markets by non-U.S. firms are associated with higher levels of CEO pay, greater emphasis on incentive-based compensation, and smaller pay gaps with U.S. firms. Using a sample of CEOs of UK firms and using both broad cross-sectional and narrow event-window tests, we find that capital market relationship in the form of a U.S. exchange listing is related to higher UK CEO pay; however, the effect is similar when UK firms have a listing in any foreign country, implying a foreign listing effect not unique to the United States. Product market relationships measured by the extent of sales in the United States by UK companies are associated with higher pay, greater use of U.S.-style pay arrangements, and a reduction in the U.S.-UK pay gap. The product market effect is incremental to the effect of a U.S. exchange listing, the extent of the firm's non-U.S. foreign market interactions, and the characteristics of the executive. The U.S-UK CEO pay gap reduces in UK firms that make U.S. acquisitions. Furthermore, the firm's use of a U.S. compensation consultant increases the sensitivity of UK pay practices to U.S. product market relationships.
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Should Entrepreneurially Oriented Firms Have Narcissistic CEOs?
Andreas Engelen, Christoph Neumann & Susanne Schmidt
Journal of Management, forthcoming
Abstract:
Extant research has shown that firms with high levels of entrepreneurial orientation (EO) outperform competitors. The present study sheds light on this performance relationship in large, publicly listed high-tech firms by examining whether the strength of this relationship depends upon the CEO's narcissism, an executive personality trait recently debated controversially in both academic and practitioner publications. A theoretically derived research model is empirically validated by means of multisource secondary data for 41 S&P 500 firms from 2005 to 2007. Findings indicate that narcissistic CEOs usually weaken the EO-performance relationship, although the opposite is true under some conditions, such as in highly concentrated and dynamic markets.
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Directors' and officers' liability insurance and loan spreads
Chen Lin et al.
Journal of Financial Economics, October 2013, Pages 37-60
Abstract:
We analyze the effect of directors' and officers' liability insurance (D&O insurance) on the spreads charged on bank loans. We find that higher levels of D&O insurance coverage are associated with higher loan spreads and that this relation depends on loan characteristics in economically sensible ways and is attenuated by monitoring mechanisms. This association between loan spreads and D&O insurance coverage is robust to controlling for endogeneity (because both could be related to firm risk), including instrumental variable specifications, change regressions, and regressions using an exogenous regulatory event that increases managerial liability. Our evidence suggests that lenders view D&O insurance coverage as increasing credit risk (potentially via moral hazard or information asymmetry). Further analyses show that higher levels of D&O insurance coverage are associated with greater risk taking and higher probabilities of financial restatement due to aggressive financial reporting. While greater use of D&O insurance appears to raise the cost of debt financing, the purchase of D&O insurance might not necessarily be harmful to shareholders. We find some evidence that D&O insurance coverage appears to improve the value of investment in firms with better internal and external governance.