Good for Business
Bank CEO incentives and the credit crisis
Rüdiger Fahlenbrach & René Stulz
Journal of Financial Economics, forthcoming
Abstract:
We investigate whether bank performance during the recent credit crisis is related to chief executive officer (CEO) incentives before the crisis. We find some evidence that banks with CEOs whose incentives were better aligned with the interests of shareholders performed worse and no evidence that they performed better. Banks with higher option compensation and a larger fraction of compensation in cash bonuses for their CEOs did not perform worse during the crisis. Bank CEOs did not reduce their holdings of shares in anticipation of the crisis or during the crisis. Consequently, they suffered extremely large wealth losses in the wake of the crisis.
-----------------------
Arresting Banking Panics: Fed Liquidity Provision and the Forgotten Panic of 1929
Mark Carlson, Kris James Mitchener & Gary Richardson
NBER Working Paper, October 2010
Abstract:
Scholars differ on whether Federal Reserve intervention mitigated banking panics during the Great Depression and in recent years. The last panic prior to the Depression sheds light on this debate. In April 1929, a fruit fly infestation in Florida forced the U.S. government to quarantine fruit shipments from the state and destroy infested groves. When Congress recessed in June without approving compensation for farmers, depositors in citrus growing regions began withdrawing deposits from banks, culminating in runs on institutions in the financial center of Tampa and surrounding cities. Using archival evidence, we describe how the Federal Reserve Bank of Atlanta halted the spread of the panic by rushing currency to member banks. Analysis based on a new micro-level database of commercial banks in Florida shows that bank failures would have been twice as high without the Fed's intervention. The policy response of the Fed ended the panic and suggests that similar interventions by the Fed may have been useful during the Great Depression, even in cases where banks faced questions about their solvency.
-----------------------
Do Unions Impact Efficiency?: Evidence from the U.S. Manufacturing Sector
Pandej Chintrakarn & Yi-Yi Chen
Contemporary Economic Policy, forthcoming
Abstract:
This study investigates the impact of labor unions on productivity and technical inefficiency of the U.S. manufacturing sector, using state-level panel data on 48 states from 1983 to 1996. The results indicate that while labor unions reduce firms' technical progress, they improve firm efficiency in utilizing the existing technology. The findings also suggest that the decline of unionization rate in the sample period impaired firms' technical efficiency by 2.4 percentage points.
-----------------------
Does it really pay to be green? Determinants and consequences of proactive environmental strategies
Peter Clarkson, Yue Li, Gordon Richardson & Florin Vasvari
Journal of Accounting and Public Policy, forthcoming
Abstract:
This study examines what factors affect firms' decisions to adopt a proactive environmental strategy and whether pursuing proactive environmental strategies leads to improved financial performance. Using longitudinal data from 1990 to 2003 for the four most polluting industries in the US (Pulp & Paper, Chemical, Oil & Gas, and Metals & Mining), this research empirically models the causal relations between firms' environmental performance and their financial resources and management capability. Our results show that positive (negative) changes in firms' financial resources in the prior periods are followed by significant improvements (declines) in firm's relative environmental performance in the subsequent periods. In addition, we also find that significant improvements (declines) in environmental performance in the prior periods can lead to improvements (declines) in financial performance in the subsequent periods after controlling for the impact of Granger causality. Finally, 3SLS analysis suggests that the positive association between environmental performance and financial performance is robust. Overall, our results are consistent with predictions of the resource-based view of the firm and indicate that although becoming "green" is associated with improvement in firm performance, such a strategy cannot be easily mimicked by all firms.
-----------------------
Raghuram Rajan & Rodney Ramcharan
Journal of Finance, forthcoming
Abstract:
We find that in the early 20th century, counties in the United States where the agricultural elite had disproportionately large land holdings had significantly fewer banks per capita, even correcting for state level effects. Moreover, credit appears to have been costlier, and access to it more limited, in these counties. The evidence is suggestive that elites may restrict financial development in order to limit access to finance, and they may be able to do so even in countries with well developed political institutions.
-----------------------
Constraints and incentives for making long horizon corporate investments
David Souder & Myles Shaver
Strategic Management Journal, December 2010, Pages 1316-1336
Abstract:
This paper examines the conditions under which firms make long horizon investments (i.e., investments that take a long period of time to pay off). We predict firms are constrained from making long horizon investments when short-term performance is poor-and this effect is especially pronounced for young firms. Moreover, we argue that when managers hold high levels of exercisable stock options, their firms are less likely to make long-term investments. However, firms are more likely to pursue long horizon investments when managerial stock options are not yet exercisable. Based on analysis of investments made by cable television operators from 1972-1996, we find support for these predictions. In addition to enhancing our understanding of investment choices, these results-derived from the temporally focused analysis of an investment's payoff horizon-suggest that payoff horizon is an important investment attribute in its own right and should be analyzed distinctly from and in addition to other aspects of investments, such as expected return and risk.
-----------------------
Incentives, Targeting, and Firm Performance: An Analysis of Non-executive Stock Options
Yael Hochberg & Laura Lindsey
Review of Financial Studies, forthcoming
Abstract:
We examine whether options granted to non-executive employees affect firm performance. Using new data on option programs, we explore the link between broad-based option programs, option portfolio implied incentives, and firm operating performance, utilizing an instrumental variables approach to identify causal effects. Firms whose employee option portfolios have higher implied incentives exhibit higher subsequent operating performance. Intuitively, the implied incentive-performance relation is concentrated in firms with fewer employees and in firms with higher growth opportunities. Additionally, the effect is concentrated in firms that grant options broadly to non-executive employees, consistent with theories of cooperation and mutual monitoring among co-workers.
-----------------------
Corporate Social Responsibility as a Conflict Between Shareholders
Amir Barnea & Amir Rubin
Journal of Business Ethics, November 2010, Pages 71-86
Abstract:
In recent years, firms have greatly increased the amount of resources allocated to activities classified as Corporate Social Responsibility (CSR). While an increase in CSR expenditure may be consistent with firm value maximization if it is a response to changes in stakeholders' preferences, we argue that a firm's insiders (managers and large blockholders) may seek to over- invest in CSR for their private benefit to the extent that doing so improves their reputations as good global citizens and has a "warm-glow" effect. We test this hypothesis by investigating the relation between firms' CSR ratings and their ownership and capital structures. Employing a unique data set that categorizes the largest 3000 U.S. corporations as either socially responsible (SR) or socially irresponsible (SI), we find that on average, insiders' ownership and leverage are negatively related to the firm's social rating, while institutional ownership is uncorrelated with it. Assuming that higher CSR ratings is associated with higher CSR expenditure level, these results support our hypothesis that insiders induce firms to over-invest in CSR when they bear little of the cost of doing so.
-----------------------
The gains from improved market efficiency: Trade before and after the transatlantic telegraph
Mette Ejrnaes & Karl Gunnar Persson
European Review of Economic History, December 2010, Pages 361-381
Abstract:
This article looks at the gains from improved market efficiency in long-distance grain trade in the second half of the nineteenth century, when violations of the law of one price were reduced due to improved information transmission. Two markets, a major export centre, Chicago, and a major importer, Liverpool, are analysed. We show that the law of one price equilibrium was an ‘attractor equilibrium'. The implication is that prices converged to that equilibrium in a tâtonnement process. Because of asymmetrically timed information between markets separated by long distances there were periods of excess demand as well as excess supply, which triggered off the tâtonnement process. Over time, adjustments to equilibrium, as measured by the half-life of a shock, became faster and violations of the law of one price become smaller. There were significant gains from improved market efficiency, which took place after the information ‘regime' shifted from pre-telegraphic communication to a regime with swift transmission of information in an era that saw the development of a sophisticated commercial press and telegraphic communication. This article is the first attempt to actually measure the gains from improved market efficiency and it demonstrates that improved market efficiency probably stimulated trade more than falling transatlantic transport costs. Deadweight losses decline significantly as markets became more efficient. The conventional view that Harberger triangles are almost always insignificant is challenged.
-----------------------
The Colonel's Strategy: KFC, PETA, and Superficial Appeasement
Heather Griffiths & Christopher Steinbrecher
Sociological Spectrum, November 2010, Pages 725-741
Abstract:
Researchers analyzed YUM(!) Brand/Kentucky Fried Chicken's (KFC's) response to the People for the Ethical Treatment of Animals' (PETA's) KFC cruelty campaign in order to add a new component to the current organizational deviance literature related to how corporations defend themselves against attacks. KFC's reaction to PETA's attempts to label it deviant is a unique pattern of response we dub strategic interaction, in which each tactic used by PETA is met with a new and adaptive response by KFC. After an extensive campaign, PETA was still unable to succeed at changing KFC's policies. We attempt to explain PETA's lack of success in terms of superficial appeasement and appropriation. Superficial appeasement is a newly identified stalling tactic, which may provide organizations with the time they need to create a history of corporate responsibility in response to accusations of deviance. Appropriation involved KFC's co-optation of a joint panel that was intended to facilitate dialogue between the two organizations, but instead became almost entirely filled with panelists sympathetic to KFC's existing corporate policies, a technique that may facilitate other corporations attempting to defend themselves.
-----------------------
How did increased competition affect credit ratings?
Bo Becker & Todd Milbourn
NBER Working Paper, September 2010
Abstract:
The credit rating industry has historically been dominated by just two agencies, Moody's and S&P, leading to longstanding legislative and regulatory calls for increased competition. The material entry of a third rating agency (Fitch) to the competitive landscape offers a unique experiment to empirically examine how in fact increased competition affects the credit ratings market. Increased competition from Fitch coincides with lower quality ratings from the incumbents: rating levels went up, the correlation between ratings and market-implied yields fell, and the ability of ratings to predict default deteriorated. We offer several possible explanations for these findings that are linked to existing theories.
-----------------------
Control of Corporate Decisions: Shareholders vs. Management
Milton Harris & Artur Raviv
Review of Financial Studies, forthcoming
Abstract:
This article addresses the issue of whether shareholders would be better off with enhanced control over corporate decisions. The issue has been hotly debated in the recent literature. Our main contribution is to use formal modeling to uncover some factors overlooked in these arguments. For example, we show that claims that shareholder control would reduce value because shareholders lack sufficient information to make important decisions or because they have a non-value-maximizing agenda are flawed. We also show, however, that even if shareholders seek to maximize firm value and can delegate decisions to management, shareholders should not control all major decisions.
-----------------------
Why Do CFOs Become Involved in Material Accounting Manipulations?
Mei Feng, Weili Ge, Shuqing Luo & Terry Shevlin
Journal of Accounting and Economics, forthcoming
Abstract:
This paper examines why CFOs become involved in material accounting manipulations. We find that while CFOs bear substantial legal costs when involved in accounting manipulations, these CFOs have similar equity incentives to the CFOs of matched non-manipulation firms. In contrast, CEOs of manipulation firms have higher equity incentives and more power than CEOs of matched firms. Taken together, our findings are consistent with the explanation that CFOs are involved in material accounting manipulations because they succumb to pressure from CEOs, rather than because they seek immediate personal financial benefit from their equity incentives. AAER content analysis reinforces this conclusion.
-----------------------
Estimating return on leadership development investment
Bruce Avolio, James Avey & David Quisenberry
Leadership Quarterly, August 2010, Pages 633-644
Abstract:
When making capital investment decisions organizational leaders are trained to consider the financial return on investment. Yet, the same expectation typically does not exist for investments in leadership training. We suggest that decisions regarding leadership training and development ought to use a similar approach as the process leads to organizations incurring cost for an anticipated benefit, like any other investment. In the current paper, we describe how to estimate the return on leadership development investment (RODI) and the implications for measuring organizational effectiveness from such analyses. Using different guiding assumptions, scenarios, length of the intervention, and level of management participating in the leader development program, the expected return on investment from leadership development interventions ranged from a low negative RODI to over 200%.
-----------------------
Why do healthy firms freeze their defined benefit pension plans?
Christina Atanasova & Karel Hrazdil
Global Finance Journal, forthcoming
Abstract:
We examine firms' decisions in freezing their defined-benefit pension plans and the effect it has on shareholders' wealth. Plan freezes help relieve sponsors of the implicit promises made to employees regarding future compensation. We find evidence that a pension plan freeze has a positive impact on sponsors' equity returns and credit ratings. Firms that choose to freeze their pension plans experience an increase in equity return and a decrease in the probability of a credit downgrade.
-----------------------
Lauren Cohen, Christopher Malloy & Lukasz Pomorski
NBER Working Paper, October 2010
Abstract:
Using a simple empirical strategy, we decode the information in insider trades. Exploiting the fact that insiders trade for a variety of reasons, we show that there is predictable, identifiable "routine" insider trading that is not informative for the future of firms. Stripping away these routine trades, which comprise over half the entire universe of insider trades, leaves a set of information-rich "opportunistic" trades that contains all the predictive power in the insider trading universe. A portfolio strategy that focuses solely on opportunistic insider trades yields value-weight abnormal returns of 82 basis points per month, while the abnormal returns associated with routine traders are essentially zero. Further, opportunistic trades predict future news and events at a firm level, while routine trades do not.
-----------------------
Injunctions, Hold-Up, and Patent Royalties
Carl Shapiro
American Law and Economics Review, forthcoming
Abstract:
A simple model is developed to study royalty negotiations between a patent holder and a downstream firm whose product is more valuable if it includes a feature covered by the patent. The downstream firm must make specific investments to develop, design, and sell its product before patent validity and infringement will be determined. The hold-up component of the negotiated royalties is greatest for weak patents covering a minor feature of a product with a high margin between price and marginal cost. For weak patents, the hold-up component of negotiated royalties remains unchanged even if negotiations take place before the downstream firm designs its product. The analysis has implications for the use of injunctions in patent infringement cases.
-----------------------
Andrew Daughety & Jennifer Reinganum
Journal of Law, Economics, & Organization, December 2010, Pages 460-492
Abstract:
We explore how the incentives of a plaintiff, when considering filing suit and bargaining over settlement, differ between suits associated with stand-alone torts cases and suits involving mass torts. We contrast "individual-based liability determination" (IBLD), wherein a clear description of the mechanism by which a defendant's actions translate into a plaintiff's harm is available, with "population-based liability determination" (PBLD), wherein cases rely on the prevalence of harm in the population to persuade a judge or jury to draw an inference of causation or fault. PBLD creates a "rational optimism effect" on the plaintiff's part that is inherent in many mass tort settings. This effect creates incentives for higher settlement demands and results in greater interim expected payoffs for plaintiffs and, thus, an increased propensity to file suit. Consequently, defendants in PBLD cases face increased ex ante expected costs compared with the IBLD regime, thereby increasing incentives to take care.
-----------------------
The International and Domestic Determinants of Insider Trading Laws
Andrew Kerner & Jeffrey Kucik
International Studies Quarterly, September 2010, Pages 657-682
Abstract:
Why do some countries protect minority shareholders from rent-seeking by corporate insiders while others do not? To the extent that there has been convergence toward shareholder-friendly laws, what factors have shaped that convergence? We explore this question by examining the worldwide diffusion of insider trading laws through a series of event history analyses. We argue that variation in the adoption and enforcement in insider trading laws can be best explained by the interaction of rising international competitive pressures to attract investment capital through investor-friendly laws and electoral laws that make governments more or less vulnerable to economic voting. We find that governments are more likely to adopt and enforce insider trading laws when they face reelection under electoral laws that make them relatively vulnerable to economic voting and when they face international competitive pressures. Moreover, we find that the impact of domestic political institutions declines in significance as international competitive pressures increase, and vice-versa.
-----------------------
Is there an Anglo-American corporate governance model?
Andrew Mullineux
International Economics and Economic Policy, December 2010, Pages 437-448
Abstract:
This paper questions the existence of an Anglo-American model of corporate governance and capitalism. Significant differences between the UK and US models of corporate governance are identified. The UK is a principles orientated system based more on voluntary codes operated on a ‘comply or explain' basis, whilst the US system is more rules based and litigious. The UK focuses more on ex ante protection of ‘outside' shareholders, whilst the US focuses on ex post protection of share traders. Institutional investors are expected to play a more prominent and wide ranging role in corporate governance in the UK than the US, though the evidence on their voting behaviour and wider ‘engagement' activity is not readily available. The explosion of private equity led leveraged buy-out activity in the mid 2000s challenges the efficiency of both models and could be a harbinger of a ‘new capitalism'; relying more on incentive compatible remuneration packages and less on public disclosure and market discipline. Alternatively, it could simply be driven by the tax advantages currently enjoyed by debt over equity, the special deferred capital gains (‘carried interest') tax treatment enjoyed by private equity, low (long as well as short term) real interest rates (‘cheap money'), and rising equity prices.
-----------------------
Limited liability, shareholder rights and the problem of corporate irresponsibility
Paddy Ireland
Cambridge Journal of Economics, September 2010, Pages 837-856
Abstract:
There has long been a tendency to see the corporate legal form as presently constituted as economically determined, as the more or less inevitable product of the demands of advanced technology and economic efficiency. Through an examination of its historical emergence, focusing in particular on the introduction of general limited liability and the development of the modern doctrine of separate corporate personality, this paper takes issue with this view, arguing that the corporate legal form was, and is, in large part a political construct developed to accommodate and protect the rentier investor. It is, moreover, a construct which institutionalises irresponsibility. Against this backdrop different ways of trying to resolve the problem of corporate irresponsibility are explored. The key, the paper suggests, is to be found in decoupling the privilege of limited liability from rights of control.