In the Line of Fiduciary Duty
Adam Wowak & Donald Hambrick
Strategic Management Journal, August 2010, Pages 803-821
Abstract:
A wealth of research indicates that both executive characteristics and incentive compensation affect organizational outcomes, but the literatures within these two domains have followed distinct, separate paths. Our paper provides a framework for integrating these two perspectives. We introduce a new model that specifies how executive characteristics and incentives operate in tandem to influence strategic decisions and firm performance. We then illustrate our model by portraying how executive characteristics interact with a specific type of pay instrument - stock options - to affect executive behaviors and organizational outcomes. Focusing on three individual-level attributes (executive motives and drives, cognitive frame, and self-confidence), we develop propositions detailing how executives will vary in their risk-taking behaviors in response to stock options. We further argue that stock options will amplify the implications of executive ability, such that option-heavy incentive schemes will increase the performance of talented executives but worsen the performance of low-ability executives. Our framework and propositions are meant to provide a starting point for future theorizing and empirical testing of the interactive effects of executive characteristics and incentive compensation on strategic decisions and organizational performance.
-----------------------
Pascual Berrone, Cristina Cruz, Luis Gomez-Mejia & Martin Larraza-Kintana
Administrative Science Quarterly, March 2010, Pages 82-113
Abstract:
This paper compares the environmental performance of family and nonfamily public corporations between 1998 and 2002, using a sample of 194 U.S. firms required to report their emissions. We found that family-controlled public firms protect their socioemotional wealth by having a better environmental performance than their nonfamily counterparts, particularly at the local level, and that for the nonfamily firms, stock ownership by the chief executive officer (CEO) has a negative environmental impact. We also found that the positive effect of family ownership on environmental performance persists independently of whether the CEO is a family member or serves both as CEO and board chair.
-----------------------
CEO Ability, Pay and Firm Performance
Candie Chang, Sudipto Dasgupta & Gilles Hilary
Management Science, forthcoming
Abstract:
Do CEOs really matter? Do cross-sectional differences in firm performance and CEO pay reflect differences in CEO ability? Examining CEO departures over 1992-2002, we first find that the stock price reaction upon departure is negatively related to the firm's prior performance and to the CEO's prior pay. Second, the CEO's subsequent labor market success is greater if the firm's pre-departure performance is better, the prior pay is higher, and the stock market's reaction is more negative. Finally, better prior performance, higher prior pay, and a more negative stock market reaction are associated with worse post-departure firm performance. Collectively, these results reject the view that differences in firm performance stem entirely from non-CEO factors such as the firms' assets, other employees or "luck," and that CEO pay is unrelated to the CEO's contribution to firm value.
-----------------------
Detecting Management Fraud in Public Companies
Mark Cecchini, Haldun Aytug, Gary Koehler & Praveen Pathak
Management Science, July 2010, Pages 1146-1160
Abstract:
This paper provides a methodology for detecting management fraud using basic financial data. The methodology is based on support vector machines. An important aspect therein is a kernel that increases the power of the learning machine by allowing an implicit and generally nonlinear mapping of points, usually into a higher dimensional feature space. A kernel specific to the domain of finance is developed. This financial kernel constructs features shown in prior research to be helpful in detecting management fraud. A large empirical data set was collected, which included quantitative financial attributes for fraudulent and nonfraudulent public companies. Support vector machines using the financial kernel correctly labeled 80% of the fraudulent cases and 90.6% of the nonfraudulent cases on a holdout set. Furthermore, we replicate other leading fraud research studies using our data and find that our method has the highest accuracy on fraudulent cases and competitive accuracy on nonfraudulent cases. The results validate the financial kernel together with support vector machines as a useful method for discriminating between fraudulent and nonfraudulent companies using only publicly available quantitative financial attributes. The results also show that the methodology has predictive value because, using only historical data, it was able to distinguish fraudulent from nonfraudulent companies in subsequent years.
-----------------------
Harland Prechel & Theresa Morris
American Sociological Review, June 2010, Pages 331-354
Abstract:
This article examines the causes of financial malfeasance in the largest U.S. corporations between 1995 and 2004. The findings support organizational-political embeddedness theory, which suggests that differential social structures create dependencies, incentives, and opportunities to engage in financial malfeasance. The historical analysis shows that neoliberal policies enacted between 1986 and 2000 resulted in organizational and political structures that permitted managers to engage in financial malfeasance. Our quantitative analysis provides three main findings. First, capital dependence on investors creates incentives to engage in financial malfeasance. Second, managerial strategies to increase shareholder value create incentives to engage in financial malfeasance. Third, the multilayer-subsidiary form and the political structure permitting corporate PAC contributions create opportunities to engage in financial malfeasance. These findings have important implications for public policy; the corporate and state structures enacted in the late-twentieth century were the outcome of a long-term, well-financed, and systematic political strategy that provided managers with unprecedented power, autonomy, and opportunity to engage in financial malfeasance.
-----------------------
A few bad apples: An analysis of CEO performance pay and firm productivity
Laarni Bulan, Paroma Sanyal & Zhipeng Yan
Journal of Economics and Business, July-August 2010, Pages 273-306
Abstract:
We investigate the relationship between CEO performance pay incentives and firm productivity. In general, we find an inverse U-shaped relationship between productivity and the sensitivity of CEO wealth to share value (delta) and a positive relationship between productivity and the sensitivity of CEO option wealth to stock return volatility (vega). Thus, a high delta associated with CEO risk-aversion lowers productivity, but a high vega from stock options offsets this effect. In looking at delta and vega jointly, we also find that options do not always achieve their intended purpose. These results are stronger among firms that are weakly governed or when high transaction costs prevent the writing of an optimal compensation contract.
-----------------------
Rating the ratings: How good are commercial governance ratings?
Robert Daines, Ian Gow & David Larcker
Journal of Financial Economics, forthcoming
Abstract:
Proxy advisory and corporate governance rating firms (such as RiskMetrics/Institutional Shareholder Services, GovernanceMetrics International, and The Corporate Library) play an increasingly important role in U.S. public markets. They rank the quality of firm corporate governance, advise shareholders how to vote, and sometimes press for governance changes. We examine whether commercially available corporate governance rankings provide useful information for shareholders. Our results suggest that they do not. Commercial ratings do not predict governance-related outcomes with the precision or strength necessary to support the bold claims made by most of these firms. Moreover, we find little or no relation between the governance ratings provided by RiskMetrics with either their voting recommendations or the actual votes by shareholders on proxy proposals.
-----------------------
Itzhak Ben-David, John Graham & Campbell Harvey
NBER Working Paper, July 2010
Abstract:
Miscalibration is a form of overconfidence examined in both psychology and economics. Although it is often analyzed in lab experiments, there is scant evidence about the effects of miscalibration in practice. We test whether top corporate executives are miscalibrated, and study the determinants of their miscalibration. We study a unique panel of over 11,600 probability distributions provided by top financial executives and spanning nearly a decade of stock market expectations. Our results show that financial executives are severely miscalibrated: realized market returns are within the executives' 80% confidence intervals only 33% of the time. We show that miscalibration improves following poor market performance periods because forecasters extrapolate past returns when forming their lower forecast bound ("worst case scenario"), while they do not update the upper bound ("best case scenario") as much. Finally, we link stock market miscalibration to miscalibration about own-firm project forecasts and increased corporate investment.
-----------------------
Tracing the Woes: An Empirical Analysis of the Airline Industry
Steven Berry & Panle Jia
American Economic Journal: Microeconomics, August 2010, Pages 1-43
Abstract:
The US airline industry went through tremendous turmoil in the early 2000s, with four major bankruptcies, two major mergers, and various changes in network structure. This paper presents a structural model of the industry, and estimates the impact of demand and supply changes on profitability. Compared with 1999, we find that, in 2006, air-travel demand was 8 percent more price sensitive, passengers displayed a stronger preference for nonstop flights, and changes in marginal cost significantly favored nonstop flights. Together with the expansion of low-cost carriers, they explain more than 80 percent of legacy carriers' variable profit reduction.
-----------------------
Board meetings, committee structure, and firm value
Ivan Brick & N.K. Chidambaran
Journal of Corporate Finance, September 2010, Pages 533-553
Abstract:
In this study, we examine the determinants of board monitoring activity and its impact on firm value for a broad panel of firms over a six-year period from 1999 to 2005. During this period, Congress and the exchanges promulgated regulations that increased pressure upon firms for more independent and active boards. Economists have debated whether board activity and externally imposed regulations benefit or harm firms. We develop and examine several proxies for board monitoring and examine the relationship between board monitoring activity, firm characteristics, and firm value in a structural equation framework. One set of our proxies is based on the number of annual board and Audit Committee meetings. We show that prior performance, firm characteristics and governance characteristics are important determinants of board activity. We also show that the board monitoring is driven by corporate events, such as an acquisition or a restatement of financial statements. We find that board activity has a positive impact on firm value. Our results also indicate that the external pressure has had a salutary effect and recent regulations have led to some increase in firm value. A second set of proxies is based on the shift to a fully independent Audit, Compensation and Nominating Committees. We find that firms increased the independence of these Board committees following the enactment of the 2002 Sarbanes-Oxley Act.
-----------------------
Xue Wang
Journal of Accounting Research, September 2010, Pages 885-920
Abstract:
I study how increased internal control disclosure requirements mandated by the Sarbanes-Oxley Act (SOX) affect annual corporate governance decisions regarding CFOs. Using non-CEO, non-COO executive officers as a control group, I find that CFOs of firms with weak internal controls receive lower compensation and experience higher forced turnover rates after the passage of SOX. In contrast, CFOs of firms with strong internal controls receive higher compensation and do not experience significant changes in forced turnover rates. These results are consistent with the "disclosure of type" hypothesis, which suggests that the mandatory internal control disclosures under SOX are a credible mechanism that effectively distinguishes good CFOs from bad ones by revealing the firm's internal control quality. The empirical evidence thus supports the notion that mandated increases in disclosure reduce information asymmetry in the executive labor market.
-----------------------
William Carroll & Jean Philippe Sapinski
International Sociology, July 2010, Pages 501-538
Abstract:
This article presents a network analysis of elite interlocks among the world's 500 largest corporations and a purposive sample of transnational policy-planning boards. The analysis compares the situation in 1996 with 2006 and reveals a process of transnational capitalist class formation that is regionally uneven. Network analysis points to a process of structural consolidation through which policy boards have become more integrative nodes, brokering elite relations between firms from different regions, especially Europe and North America. As national corporate networks have thinned, the global corporate-policy network's centre of gravity has shifted towards Europe, both at the level of individuals and organizations. Although this study finds a modest increase in participation of corporate elites from the Global South, a North Atlantic ruling class remains at the centre of the process of transnational capitalist class formation.
-----------------------
Christopher Tuggle, David Sirmon, Christopher Reutzel & Leonard Bierman
Strategic Management Journal, September 2010, Pages 946-968
Abstract:
Boards of directors' attention to monitoring represents an understudied topic in corporate governance. By analyzing hundreds of board meeting transcripts, we find that board members do not maintain constant levels of attention toward monitoring, but instead selectively allocate attention to their monitoring function. Drawing from the attention-based view, prospect theory, and the literature on power, we find that deviation from prior performance and CEO duality affect this allocation. Specifically, while negative deviation from prior performance increases boards' attention to monitoring, positive deviation from prior performance reduces it. The presence of duality also reduces the boards' allocation of attention to monitoring. Additional analysis demonstrates that the effects of duality are realized in part by the CEO-chair's control of the meeting's agenda and location. Finally, the results show that duality and deviation from prior performance interactively affect boards' attention to monitoring. In total, we find that board members do not consistently monitor management in order to protect shareholder value, a proposition often assumed within governance research; rather, our results demonstrate that board members' monitoring behaviors are contextually dependent. The contextual dependency of board attention to monitoring suggests that additional efforts may be needed to ensure the protection of shareholders' interests.
-----------------------
The long-run performance of firms emerging from Chapter 11 bankruptcy
Surendranath Jory & Jeff Madura
Applied Financial Economics, July 2010, Pages 1145-1161
Abstract:
In this article, we assess the stock price performance of 184 firms emerging from Chapter 11 bankruptcy between 1980 and 2006. We find their mean post-bankruptcy performance to be similar to the performance of their size and-book-to-market control firms, as well as to the performance of their respective New York Stock Exchange-American Stock Exchange (NYSE-AMEX) beta decile-portfolio. We also analyse the effects of the bankruptcy process, new equity ownership and Chief Executive Officer (CEO) changes on the stock price performance of firms that emerged from Chapter 11. We find that being incorporated in the state of Delaware, the bankruptcy duration, a prepackaged bankruptcy, and the proportion of equity retained by the pre-Chapter 11 shareholders positively influence stock price performance. We also find that filing Chapter 11 with the Delaware Bankruptcy District Court, a change in the company's name, equity ownership by management, and the experience of the new CEO leading the firm out of bankruptcy do not lead to improved performance post-bankruptcy.
-----------------------
Shveta Kapoor & H.S. Sandhu
Global Business Review, June 2010, Pages 185-208
Abstract:
This article attempts to examine the impact of corporate social responsibility (CSR)on corporate financial performance (CFP)in terms of profitability and growth after controlling for the effect of other variables on financial performance. Secondary data on CSR based on 93 companies operating in India have been analyzed by applying content analysis of annual reports for the year 2005-06 and individual websites of the companies. For CFP and control variables, secondary data have been collected for seven-year period from 1999-2000 to 2005-06 from Prowess, electronic database developed by Centre for Monitoring Indian Economy (CMIE), Mumbai. Statistical tests like factor analysis and multiple regression analysis have been applied. The results indicate significant positive impact of CSR on corporate profitability and insignificant positive impact on corporate growth. The present study is helpful for managers in considering the positive impact of CSR on corporate profitability while taking decisions about investing in CSR areas.
-----------------------
The quality of accounting information in politically connected firms
Paul Chaney, Mara Faccio & David Parsley
Journal of Accounting and Economics, forthcoming
Abstract:
We document that the quality of earnings reported by politically connected firms is significantly poorer than that of similar non-connected companies. Our results are not due to firms with ex-ante poor earnings quality establishing connections more often. Instead, our results suggest that, because of a lesser need to respond to market pressures to increase the quality of information, connected companies can afford disclosing lower quality accounting information. In particular, lower quality reported earnings is associated with a higher cost of debt only for the non-politically connected firms in the sample.