Inside out
Short Selling and Earnings Management: A Controlled Experiment
Vivian Fang, Allen Huang & Jonathan Karpoff
Journal of Finance, forthcoming
Abstract:
During 2005 to 2007, the SEC ordered a pilot program in which one-third of the Russell 3000 index were arbitrarily chosen as pilot stocks and exempted from short-sale price tests. Pilot firms' discretionary accruals and likelihood of marginally beating earnings targets decrease during this period, and revert to pre-experiment levels when the program ends. After the program starts, pilot firms are more likely to be caught for fraud initiated before the program, and their stock returns better incorporate earnings information. These results indicate that short selling, or its prospect, curbs earnings management, helps detect fraud, and improves price efficiency.
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The Culture of Corruption and the Value of Corporate Governance
Nishant Dass, Vikram Nanda & Steven Chong Xiao
Georgia Tech Working Paper, September 2015
Abstract:
We present evidence on the relation between local public corruption and the conduct of corporate managers in the United States. We show that managers of firms that are located in states with more public corruption are also likely to engage in more corrupt practices. Hence, corruption of local public officials appears to reflect a broader "culture of corruption" in the state. Using difference-in-differences tests, we show that, after the passage of Foreign Corrupt Practices Act that curbed bribery by U.S. firms in foreign countries, firms headquartered in more corrupt states lost the most value (Tobin's Q). The culture of corruption is also associated with greater agency problems in firms. For instance, the passage of anti-takeover laws hurt firm performance in more corrupt states, while the passage of Sarbanes-Oxley Act lowered discretionary accrual of earnings mainly of the firms in these states. Overall, our findings suggest that corruption hurts economic activity not only due to rent-seeking public officials but also on account of social norms and mores that are more accepting of corrupt activities.
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Opportunistic Proposals by Union Shareholders
John Matsusaka, Oguzhan Ozbas & Irene Yi
University of Southern California Working Paper, September 2015
Abstract:
Effective corporate governance requires mechanisms that allow shareholders to influence corporate decisions. This paper investigates the use of shareholder proposals, an increasingly prominent governance mechanism, by labor unions. Activist union pension funds are subject to cross-pressures: they wish to increase fund returns to help beneficiaries but also to aid current union workers. We show theoretically that shareholder proposals can be used as bargaining chips in contract negotiations. Empirically, we use variation in the expiration of collective bargaining agreements to identify exogenous changes in the value of making proposals. We find that during contract negotiation years, unions increase the number of proposals they make by about one-quarter (and by about two-thirds during contentious negotiations), and change the subject of proposals to focus on matters personally costly to managers. We do not find similar changes in proposal behavior by nonunion shareholders. Opportunistic union proposals are also associated with better wage agreements for the union. The evidence suggests that some union proposals are intended to influence collective bargaining outcomes rather than maximize shareholder value, and that increasing proposal rights will not necessarily help shareholders at large if some shareholders use those rights to advance their private interests.
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Hard Marriage with Heavy Burdens: Labor Unions as Takeover Deterrents
Xuan Tian & Wenyu Wang
Indiana University Working Paper, September 2015
Abstract:
We examine the causal effect of unionization on a firm's takeover exposure and merger gains. To establish causality, we use a regression discontinuity design that relies on "locally" exogenous variation generated by union elections that pass or fail by a small margin of votes. Barely passing a union election leads to a significant reduction in a firm's probability of receiving a takeover bid. A barely unionized target also enjoys a lower announcement return, receives a lower offer premium, and experiences longer bid duration. The negative effect of unions on targets' takeover exposure and merger gains is more pronounced when the union elections are held in states without right-to-work legislation, in states with more union-friendly successor statutes, when the mergers are horizontal, and when the unions are large. Bidders of unionized targets have more experience in making merger deals, possess higher bargaining power, and face less union threat by themselves. Our paper provides new insights into the real effects of unionization in terms of the market for corporate control.
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U.S. Congressional Committees and SEC Enforcement Against Financial Misconduct
Mihir Mehta & Wanli Zhao
University of Michigan Working Paper, October 2015
Abstract:
We document that firms in jurisdictions served by powerful representation on U.S. congressional committees that have Securities and Exchange Commission (SEC) oversight responsibilities are less likely to face regulatory scrutiny for financial misconduct. Conditional on the issuance of an SEC enforcement action, the same firms also receive materially smaller monetary penalties relative to other transgressing firms. An exogenous decrease in a firm's powerful committee representation results in an increase in the likelihood that the firm will subsequently face SEC enforcement actions. Our findings do not appear to be driven by regulatory capture but rather, by firm and auditor efforts to limit exposure to political costs. In sum, political representation on specific U.S. congressional committees appears to have direct effects on the financial reporting practices of constituent firms.
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The Valuation Impact of SEC Enforcement Actions on Nontarget Foreign Firms
Roger Silvers
Journal of Accounting Research, forthcoming
Abstract:
This study shows that the Securities and Exchange Commission's (SEC) enforcement intensity toward the foreign firms under its jurisdiction has increased dramatically over the past two decades. Because enforcement events signify an increased threat of future enforcement, I examine the stock returns of foreign firms not targeted by the SEC during windows around enforcement actions that target foreign firms. This design captures the net effects of public enforcement and helps to rule out omitted variables as alternative explanations, because other factors would have to align with enforcement events that do not occur in an obvious pattern (and are therefore unlikely to map onto other news). Nontarget firms experience positive stock returns during the event windows, which is consistent with enforcement constraining the risks of expropriation. The cross-sectional pattern in returns reveals greater returns for firms from weak home legal environments. Finally, consistent with the market adjusting to a new enforcement regime, the magnitude of event returns declines over time. Overall, SEC enforcement is associated with increases in the value of foreign firms, supporting the premise of the legal bonding hypothesis.
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The effect of poison pill adoptions and court rulings on firm entrenchment
Randall Heron & Erik Lie
Journal of Corporate Finance, December 2015, Pages 286-296
Abstract:
We challenge a common presumption that poison pills and two Delaware case rulings in 1995 validating such pills materially entrench firms. Based on unsolicited takeover attempts from 1985 to 2009, we find that poison pills enhance takeover premiums, but do not reduce completion rates. Furthermore, the 1995 Delaware rulings affected neither the use of poison pills among the targets, the effectiveness of the pills that were used, the completion rate of the takeover attempts, nor the takeover premiums.
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The product market effects of hedge fund activism
Hadiye Aslan & Praveen Kumar
Journal of Financial Economics, forthcoming
Abstract:
We examine the product market spillover effects of hedge fund activism (HFA) on the industry rivals of target firms. HFA has negative real and stockholder wealth effects on the average rival firm. The effects on rivals' product market performance is commensurate with post-activism improvements in target's productivity, cost and capital allocation efficiency, and product differentiation. Financially constrained rivals accommodate these improvements but those facing high intervention threat respond effectively to them. The spillover effects are strengthened in less concentrated and low entry barrier industries. The results are robust to the alternative hypothesis of strategic target selection by hedge funds.
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Activist hedge funds and firm disclosure
Jing Chen & Michael Jung
Review of Financial Economics, forthcoming
Abstract:
This study examines whether firms' disclosure decisions are affected by the presence of activist hedge funds. Using a large sample of firms that experienced increases in ownership by activist hedge funds, we find that firms are more likely to cease providing financial guidance or reduce the information in the guidance in the quarter subsequent to new investment by activist hedge funds. These results hold even for firms that experienced good quarters and consistently provided guidance in previous quarters. Since guidance has been shown to be beneficial to capital market participants in many ways, reduced guidance has meaningful market implications. Our findings highlight a negative and possible unintended consequence of activist hedge funds' investment in firms, which provides some counterbalance to the numerous positive consequences documented in the prior literature on hedge fund activism.
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Strategic management guidance and insider trading activities
Bruce Billings & William Buslepp
Journal of Accounting and Public Policy, forthcoming
Abstract:
We assess whether managers engage in ex ante strategic behavior when issuing earnings forecasts in a novel context. We posit that some managers provide inaccurate downward guidance to increase the positive surprise and pricing premium at the earnings announcement, thereby maximizing profits from selling shares following the earnings announcement. In support, we document that managers are more likely to have issued prior inaccurate downward guidance when they sell more shares or increase their selling activities following the earnings announcement. Further, we show that these managers benefit economically by linking inaccurate downward guidance to greater pricing premiums at the earnings announcement date and more positive cumulative stock returns over the period from inaccurate downward guidance to subsequent earnings announcement.
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CEO Turnover and Relative Performance Evaluation
Dirk Jenter & Fadi Kanaan
Journal of Finance, October 2015, Pages 2155-2184
Abstract:
This paper shows that CEOs are fired after bad firm performance caused by factors beyond their control. Standard economic theory predicts that corporate boards filter out exogenous industry and market shocks from firm performance before deciding on CEO retention. Using a hand-collected sample of 3,365 CEO turnovers from 1993 to 2009, we document that CEOs are significantly more likely to be dismissed from their jobs after bad industry and, to a lesser extent, after bad market performance. A decline in industry performance from the 90th to the 10th percentile doubles the probability of a forced CEO turnover.
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Shareholders have a say in executive compensation: Evidence from say-on-pay in the United States
Marinilka Kimbro & Danielle Xu
Journal of Accounting and Public Policy, forthcoming
Abstract:
We examine the 2011 and 2012 shareholder votes soon after the implementation of the SEC regulation that requires a non-binding general shareholder vote on executive compensation, or "say-on-pay" (SOP). Firms with high SOP approval have better performance and returns, higher CEO ownership, lower institutional ownership, lower CEO compensation, lower return volatility, and better accounting quality than do firms with high SOP dissent. Different from that noted in previous shareholder proposal studies and research on SOP in the United Kingdom, shareholder discontent is associated with high or excessive CEO compensation. We also find that SOP rejection votes are more sensitive to stock and stock option compensation. Finally, boards respond to SOP rejection votes by reducing the growth of CEO compensation, and shareholders respond positively to these changes by voting to approve SOP, regardless of firm performance. Our results provide evidence that SOP general shareholder voting rights could be an effective mechanism of corporate governance.
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Public Audit Oversight and Reporting Credibility: Evidence from the PCAOB Inspection Regime
Brandon Gipper, Christian Leuz & Mark Maffett
NBER Working Paper, September 2015
Abstract:
This paper examines how audit oversight by a public-sector regulator affects investors' assessments of reporting credibility. We analyze whether the introduction of the Public Company Accounting Oversight Board (PCAOB) and its inspection regime have strengthened capital-market responses to unexpected earnings releases, as theory predicts when reporting credibility increases. To identify the effects, we use a difference-in-differences design that exploits the staggered introduction of the inspection regime, which affects firms at different points in time depending on their fiscal year-ends, auditors, and the timing of PCAOB inspections. We find that capital-market responses to unexpected earnings increase significantly following the introduction of the PCAOB inspection regime. Corroborating these findings, we also find an increase in abnormal volume responses to firms' 10-K filings after the new regime. Overall, our results are consistent with public audit oversight increasing the credibility of financial reporting.
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The Real Effects of Share Repurchases
Heitor Almeida, Vyacheslav Fos & Mathias Kronlund
Journal of Financial Economics, forthcoming
Abstract:
We employ a regression discontinuity design to identify the real effects of share repurchases on other firm outcomes. The probability of share repurchases that increase earnings per share (EPS) is sharply higher for firms that would have just missed the EPS forecast in the absence of the repurchase, when compared with firms that " just beat" the EPS forecast. We use this discontinuity to show that EPS-motivated repurchases are associated with reductions in employment and investment, and a decrease in cash holdings. Our evidence suggests that managers are willing to trade off investments and employment for stock repurchases that allow them to meet analyst EPS forecasts.
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Analysts' strategic inducement of management guidance
Jie Zhou
Journal of Accounting and Public Policy, forthcoming
Abstract:
I examine whether and to what extent analysts strategically issue optimistic forecasts to induce management guidance in the post-Reg FD period, when private communication is prohibited. I hypothesize that in rational anticipation of managerial incentive to meet or beat earnings targets, analysts may strategically report optimistic initial forecasts in an effort to induce management guidance. Supporting this prediction, I find that analysts' initial forecasts are more optimistic for firms that are less likely to guide. To show that analysts' strategies are a credible "threat," I examine how analysts revise their forecasts in response to management guidance. I find that analysts tend to revise their forecasts up when managers do not guide as expected. Furthermore, the negative relationship between analysts' initial forecasts and management guidance is less pronounced when there are more analysts forecasting the same firm (free-riding effect). This finding suggests that the public good aspect of management guidance results in free-rider problems that create circumstances in which analysts' incentives to issue optimistic forecasts are insufficient to induce management guidance. This study provides new evidence on how analysts act strategically to induce public information, and it contributes to the further understanding of the effect of Reg FD on the relations between analysts and managers.
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Why Are CEOs Paid for Good Luck? An Empirical Comparison of Explanations for Pay-For-Luck Asymmetry
Colin Campbell & Mary Elizabeth Thompson
Journal of Corporate Finance, December 2015, Pages 247-264
Abstract:
We independently and jointly test multiple proposed explanations for chief executive officer (CEO) pay-for-luck asymmetry, comparing their contributions to the observed asymmetry. Measuring luck based on both stock and operating performance, we analyze pay asymmetry for both the average and median CEO. We document that favorable labor market opportunities - measuring executive retention concerns - most consistently underlie pay asymmetry across specifications, while CEO power and bankruptcy avoidance incentives are only weakly related. However, none of these independently explains pay asymmetry across our expanded tests. Our results highlight important empirical modeling concerns and provide valuable insight for future theoretical and empirical work.
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Firm-level tournament incentives and corporate tax aggressiveness
Thomas Kubick & Adi Masli
Journal of Accounting and Public Policy, forthcoming
Abstract:
Theory and prior research suggests that tournament incentives promote greater risk-taking by senior executives in order to increase the likelihood of being promoted. In this study, we hypothesize and confirm that tournament incentives of the CFO are positively associated with measures of tax aggressiveness. We conduct numerous robustness tests, including instrumental variables estimation and firm fixed effects. Further, we find the effect of tournament incentives to be incremental to equity incentives. We conclude that tournament incentives have a meaningful impact on corporate tax aggressiveness.
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When governance fails: Naming directors in class action lawsuits
Claire Crutchley, Kristina Minnick & Patrick Schorno
Journal of Corporate Finance, December 2015, Pages 81-96
Abstract:
This paper examines one type of failure in the governance system, the case where directors do not protect shareholders from securities fraud. We find that shareholders can influence large changes in governance and compensation by targeting the full board of directors, but it is more costly in terms of legal fees. Naming directors in a class action lawsuit based on securities fraud, on average, leads to increases in CEO incentive pay, but decreases in director incentive pay. Additionally, naming directors results in a greater change in board composition. These changes in compensation and corporate governance appear to lead to enhanced performance in the years following the lawsuit.
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Amy Dittmar & Ran Duchin
Review of Financial Studies, forthcoming
Abstract:
We track the employment history of over 9,000 managers to study the effects of professional experiences on corporate policies. Our identification strategy exploits exogenous CEO turnovers and employment in other firms and in non-CEO roles. Firms run by CEOs who experienced distress have less debt, save more cash, and invest less than other firms, with stronger effects in poorly governed firms. Experience has a stronger influence when it is more recent or occurs during salient periods in a manager's career. We find similar effects for CFOs. The results suggest that policies vary with managers' experiences and throughout managers' careers.
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A Comparison of CEO Pay-Performance Sensitivity in Privately-Held and Public Firms
Huasheng Gao & Kai Li
Journal of Corporate Finance, forthcoming
Abstract:
In this paper we study CEO contract design employing a unique dataset on privately-held and public firm CEO annual compensation over the period 1999-2011. We first show that CEOs in public firms are paid 30% more than CEOs in comparable privately-held firms. We further show that both private and public firm CEO pay is positively and significantly related to firm accounting performance, and that the pay-performance link is much weaker in privately-held firms. We then show that the above findings are robust to accounting for firms' self-selection into being privately-held, and a number of important differences between privately-held and public firms, including CEO ownership, employee stock ownership, stock liquidity, discipline from the takeover market, and the availability of different performance measures. Overall, our results support the view that concentrated ownership substitutes for CEO performance-based compensation contracts.
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The effects of takeover defenses: Evidence from closed-end funds
Matthew Souther
Journal of Financial Economics, forthcoming
Abstract:
I use a sample of closed-end funds to examine how takeover defenses impact shareholder value and promote managerial entrenchment. These funds use the same defenses as general corporations but provide an ideal, homogeneous environment for testing their effects. Defenses are associated with lower fund market values, weaker reactions to activist 13D filings, and higher compensation levels for both fund managers and directors. This study provides greater clarity on the unresolved impact of takeover defenses on firm value, while showing for the first time that directors, who are responsible for adopting takeover defenses, financially benefit from their use.
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Is an Outside Chair Always Better? The Role of Non-CEO Inside Chairs on Corporate Boards
Shawn Mobbs
Financial Review, November 2015, Pages 547-574
Abstract:
Proponents of separating the CEO and chairman positions advocate having an outside chairperson, although having an inside chairperson can be valuable for some firms. I find inside chairs are more likely where firm-specific human capital is more important and, in these firms, inside chairs are associated with higher firm valuation and better operating performance. Furthermore, skilled inside chairs increase forced CEO turnover sensitivity to performance. The evidence suggests that certain inside chairs can be valuable when firm-specific information is important for monitoring and an outside chair may be costly.
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Andrew Gunnoe
Social Forces, forthcoming
Abstract:
This paper draws on theories of socio-economic change stemming from political economy and economic sociology to examine the financialization of the US forest products industry. I argue that the widespread adoption of shareholder value norms of corporate governance constitutes one of the core ideological foundations for explaining how the financialization of non-financial firms was accomplished. At the same time, I suggest that economic sociologists' emphasis on the role of shareholder value ideology tends to obscure the concrete realities of contemporary capitalism and the socio-economic relations that underlie managerial conceptions of control. In this paper, I adopt a dialectical methodology that works at multiple levels of abstraction in order to highlight the internal relationship that exists between managerial conceptions of control and the material processes of capital accumulation. Using data mined from corporate proxy statements, I show that increases in concentrated stock ownership among institutional investors and the use of incentive-based compensation - among other important factors - underlie the adoption of shareholder value strategies in the US forest products sector. I then demonstrate how the pursuit of shareholder value reshaped the US forest products in the interests of the financial community while undermining long-term stability of the industry and the people who depend on it.
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The ownership and trading of debt claims in Chapter 11 restructurings
Victoria Ivashina, Benjamin Iverson & David Smith
Journal of Financial Economics, forthcoming
Abstract:
Using a novel data set that covers individual debt claims against 136 bankrupt US companies and includes information on a subset of claims transfers, we provide new empirical insight regarding how a firm's debt ownership relates to bankruptcy outcomes. Firms with higher debt concentration at the start of the case are more likely to file prearranged bankruptcy plans, to move quickly through the restructuring process, and to emerge successfully as independent going concerns. Moreover, higher ownership concentration within a debt class is associated with higher recovery rates to that class. Trading of claims during bankruptcy concentrates ownership further, but this trading is not associated with subsequent improvements in bankruptcy outcomes and could, at the margin, increase the likelihood of liquidation.