Limited liability
The Anglo-American misconception of stockholders as ‘owners’ and ‘members’: Its origins and consequences
David Ciepley
Journal of Institutional Economics, forthcoming
Abstract:
That stockholders “own” the corporation and are its “members,” are assumptions deeply embedded in Anglo-American treatments of the business corporation. They are also principal supports of the policy of “shareholder primacy” and, in the United States, of the corporate claim to constitutional rights. This article critiques these assumptions, while also explaining why they took hold. Among several reasons for this, the primary explanation is to be found in the peculiar parentage of England's first major business corporation, the English East India Company (EIC). The EIC did not begin its life as a true business corporation, but as a cross between a guild (a form of member corporation) and a joint stock company (a form of partnership). In the transition to a unified business corporation, its stockholders inherited the monikers of “member” and “owner” from their guild and partner forebears. This mis-description set the legal mold for all subsequent Anglo-American treatments of stockholders.
Political Ideology of The Board and CEO Dismissal Following Financial Misconduct
David Park, Warren Boeker & David Gomulya
Strategic Management Journal, forthcoming
Abstract:
Why do some boards refuse to take serious action against CEOs who have committed financial misconduct? Past work has directed attention to the antecedents of misconduct while largely overlooking this question. The relatively few studies that examined it have typically revolved around agency arguments. This study instead examines how the beliefs and values held by board members can influence their actions following financial misconduct. Focusing on political ideology, we argue that politically conservative boards are more likely to respond by dismissing the CEO than are liberal boards as the result of ideo‐attribution and threat management tendencies. Using data from S&P 1500 firms that were involved with financial misconduct, we find support for our arguments while addressing sample‐induced endogeneity and alternative explanations with additional analyses.
Workplace Inequality in Pay Growth: A First Look
Jie He, Lei Li & Tao Shu
Federal Reserve Working Paper, August 2019
Abstract:
While previous literature of within-firm pay inequality exclusively focuses on the difference in pay levels between executives and employees, we study the difference in pay growth between the two groups (i.e., “pay growth gap”), especially its relation with a firm’s past idiosyncratic stock return, the “skill” component of stock performance. Using granular, individual-level compensation data for US public companies, we find a negative relation between pay growth gap and past performance, suggesting that executives enjoy higher relative pay growth when firms perform worse. This “reverse incentive alignment” exists in firms with poor performance but not those with good performance. Further, it is driven by the pay growth of executives, especially higher-ranked ones, rather than that of employees. Among poorly performing firms, turnover rates of executives relative to employees are also lower upon worse past performance. Our evidence is more consistent with managerial rent extraction than with other explanations such as differential talent or labor market conditions across the corporate hierarchy.
Institutional Ownership and Labor-Related Misconduct: Evidence from U.S. Federal Violations
Xi Li & Aneesh Raghunandan
London School of Economics Working Paper, September 2019
Abstract:
Using a novel, comprehensive dataset on penalties assessed by U.S. federal agencies for labor-related misconduct, we examine the effect of institutional investors on firms’ employee practices. We find that ownership by institutions is associated with a lower likelihood of firms receiving federal penalties for labor-related violations, especially those pertaining to workplace safety. We also find evidence consistent with institutional investors inducing anti-union behavior in portfolio firms. Although the direct penalty amounts are typically immaterial for violating firms, we find that firms receiving such penalties face a higher likelihood of employee lawsuits in subsequent years, a decrease in employee productivity, and a negative contemporaneous stock returns. These findings suggest that labor-related misconduct is potentially value-destroying. We also document evidence suggesting that reputational damage may also explain institutional investors’ aversion to labor violations. Finally, we explore shareholder voice via board influence and voting on shareholder proposals as channels through which institutional investors can exert influence over portfolio firms to reduce labor-related misconduct.
Informational benefits of managerial myopia
Cheng Li
Economics Letters, forthcoming
Abstract:
We show that managerial myopia has an informational benefit that has been overlooked in the prior research. Compared with managers who care sufficiently about the long-term, a moderately myopic manager incentivizes the proponent of a risky long-term project to produce more information about the project, leading to more informed decision making and higher firm value.
The Economic Effects of Private Equity Buyouts
Steven Davis et al.
University of Chicago Working Paper, October 2019
Abstract:
We examine thousands of U.S. private equity (PE) buyouts from 1980 to 2013, a period that saw huge swings in credit market tightness and GDP growth. Our results show striking, systematic differences in the real-side effects of PE buyouts, depending on buyout type and external conditions. Employment at target firms shrinks 13% over two years in buyouts of publicly listed firms but expands 13% in buyouts of privately held firms, both relative to contemporaneous outcomes at control firms. Labor productivity rises 8% at targets over two years post buyout (again, relative to controls), with large gains for both public-to-private and private-to-private buyouts. Target productivity gains are larger yet for deals executed amidst tight credit conditions. A post-buyout widening of credit spreads or slowdown in GDP growth lowers employment growth at targets and sharply curtails productivity gains in public-to-private and divisional buyouts. Average earnings per worker fall by 1.7% at target firms after buyouts, largely erasing a pre-buyout wage premium relative to controls. Wage effects are also heterogeneous. In these and other respects, the economic effects of private equity vary greatly by buyout type and with external conditions.
Do Director Networks Matter for Financial Reporting Quality? Evidence from Audit Committee Connectedness and Restatements
Thomas Omer, Marjorie Shelley & Frances Tice
Management Science, forthcoming
Abstract:
This study examines the effect of audit committee connectedness through director networks on financial reporting quality, specifically the misstatement of annual financial statements. Using network analysis, we examine multiple dimensions of connectedness and find that after controlling for operating performance and corporate governance characteristics, firms with well-connected audit committees are less likely to misstate annual financial statements. In addition, our study demonstrates that audit committee connectedness through director networks moderates the negative effect of board interlocks to misstating firms on financial reporting quality. We conduct several tests to address identification concerns and find similar results. Our findings suggest that firms with better-connected audit committees are less likely to adopt reporting practices that reduce financial reporting quality.
Getting Tired of Your Friends: The Dynamics of Venture Capital Relationships
Qianqian Du & Thomas Hellmann
NBER Working Paper, September 2019
Abstract:
Does doing more deals together always strengthen investor relationships? Based on the relationships of the top 50 US venture capital firms, this paper focuses on the strengths of relationships and their dynamic evolution. Empirical estimates indicate that having a deeper relationship leads to fewer, not more future coinvestments. Moreover, deeper relationships lead to lower exit performance, even after controlling for endogeneity. Interestingly, deeper relationships first lead to lower performance, and subsequently lead to a slowdown in the relationship intensity. Relationship effects are more negative for VC firms with less central network positions, and for deals made in “hot” investment markets.
Valuable Choices: Prominent Venture Capitalists’ Influence on Startup CEO Replacements
Annamaria Conti & Stuart Graham
Management Science, forthcoming
Abstract:
This paper explores how prominent venture capitalists (VCs) affect chief executive officer (CEO) replacement in startups. Defining prominence using eigenvector centrality, we use matching methods and instrumental variables to show that startup CEO replacement occurs more often and faster when prominent VCs participate. We further explore these VCs’ comparative advantage in managing CEO turnover, finding that the prominent VC effects increase as replacement costs rise, such as when incumbent CEOs are entrenched or possess specialized technology know-how, or when startups are in an early stage. When prominent VCs participate, replacement CEOs are disproportionately experienced outsiders - external hires who possess prior startup CEO experience. Our results reveal that CEO turnover is associated with increases in startups’ ex post innovation and survival performance, with experienced outsider CEO replacements showing the strongest survival rates.
Shareholder Governance and CEO Compensation: The Peer Effects of Say on Pay
Diane Denis, Torsten Jochem & Anjana Rajamani
Review of Financial Studies, forthcoming
Abstract:
We document that firms whose compensation peers experience weak say on pay votes reduce CEO compensation following those votes. Reductions reflect proxy adviser concerns about peers’ compensation contracts and are stronger when CEOs receive excess compensation, when they compete more closely with their weak-vote peers in the executive labor market, and when those peers perform well. Reductions occur following peers’ disclosures of revised pay and are proportional to those needed to retain firms’ relative positions in their peer groups. We conclude that the spillover effects of shareholder voting occur through both learning and compensation targeting channels.
Do Corporate Governance Ratings Change Investor Expectations? Evidence from Announcements by Institutional Shareholder Services
Paul Guest & Marco Nerino
Review of Finance, forthcoming
Abstract:
This paper examines empirically the announcement effect of commercial corporate governance ratings on share returns. Rating downgrades by Institutional Shareholder Services (ISS) are associated with negative returns of -1.14% over a 3-day announcement window. The returns are highly correlated with the proprietary analysis of ISS and are decreasing in agency costs, consistent with ratings providing independent information on underlying corporate governance quality. We thus show that the influence and impact of ISS extends beyond proxy recommendations and subsequent voting outcomes. Our findings contrast with the insignificant price impact of Daines, Gow, and Larcker (2010), whose analysis we replicate and successfully reconcile to ours by pooling upgrades and downgrades together.
Why Do Firms Hold Cash? Evidence from Demographic Demand Shifts
Igor Cunha & Joshua Pollet
Review of Financial Studies, forthcoming
Abstract:
We exploit variation in demand induced by demographics to provide causal evidence of the precautionary motive of cash holdings. We show that firms significantly increase their cash levels in response to exogenous increases in investment opportunities. We also provide novel evidence of the dynamics of accumulation and use of cash. Financially constrained firms build their cash reserves using internal sources. Consequently, they start saving earlier and keep high cash levels longer. Unconstrained firms rely on external financing to both invest and build cash reserves, requiring them to save less and allowing them to incur lower costs of carry.