Owning the board
Right on Schedule: CEO Option Grants and Opportunism
Robert Daines, Grant McQueen & Robert Schonlau
Journal of Financial and Quantitative Analysis, forthcoming
Abstract:
After the public outcry over backdating, many firms began scheduling option grants. This eliminates backdating but creates other agency problems: Chief executive officers (CEOs) aware of upcoming option grants have an incentive to temporarily depress stock prices to obtain lower strike prices. We show that some CEOs have manipulated stock prices to increase option compensation, documenting negative abnormal returns before scheduled option grants and positive abnormal returns afterward. These returns are explained by measures of CEOs’ incentives and ability to influence stock prices. We document several mechanisms used to lower stock price, including changing the substance and timing of disclosures.
What Makes the Bonding Stick? A Natural Experiment Testing the Legal Bonding Hypothesis
Amir Licht et al.
Journal of Financial Economics, forthcoming
Abstract:
We use a US Supreme Court case, Morrison v. National Australia Bank (2010), as a natural experiment to test the legal bonding hypothesis. By decreasing the potential liability of US-listed foreign firms, particularly due to class action lawsuits, Morrison arguably eroded their legal bonding to compliance with disclosure duties. Nevertheless, we find evidence of an increase or insignificant change in share values. Tests of longer-run effects of the legal event indicate that foreign firms’ disclosure quality and likelihood of facing enforcement actions remained stable, as did investors’ revealed preferences for trading on US markets. These results go against the legal bonding hypothesis but are consistent with reputational bonding and with market-based accounts of US cross-listing. Our results may contribute to ongoing debate about civil enforcement of securities laws through class actions.
Do Antitakeover Provisions Spur Corporate Innovation? A Regression Discontinuity Analysis
Thomas Chemmanur & Xuan Tian
Journal of Financial and Quantitative Analysis, forthcoming
Abstract:
We study the effect of antitakeover provisions (ATPs) on innovation. To establish causality, we use a regression discontinuity approach that relies on locally exogenous variation generated by shareholder proposal votes. We find a positive, causal effect of ATPs on innovation. This positive effect is more pronounced in firms that are subject to a larger degree of information asymmetry and operate in more competitive product markets. The evidence suggests that ATPs help nurture innovation by insulating managers from short-term pressures arising from equity markets. Finally, the number of ATPs contributes positively to firm value for firms involved in intensive innovation activities.
Is Regulatory Adoption Ceremonial? Evidence from Lead Director Appointments
Wei Shi & Brian Connelly
Strategic Management Journal, forthcoming
Abstract:
Regulatory bodies often wrestle with the thorny question of whether to mandate a governance practice or allow for organic adoption. While mandates afford rapid diffusion, we theorize that they also result in ceremonial adoptions. Leveraging a quasi‐natural experiment, we compare adoption outcomes for a governance practice – lead director adoption – that was mandated by the NYSE but not the NASDAQ. We find that NYSE firms are more likely than NASDAQ firms to have installed a lead director as a symbolic management tactic, so their lead directors are less effectual. We also find that transient institutional investors are deceived by this symbolic management, but dedicated institutional investors are not.
Organization Capital and Mergers and Acquisitions
Kai Li, Buhui Qiu & Rui Shen
Journal of Financial and Quantitative Analysis, forthcoming
Abstract:
Using a sample of completed U.S. acquisition deals over the period 1984–2014, we find that acquirer organization capital as measured by capitalized selling, general, and administrative (SG&A) expenses is associated with superior deal performance. We show that high organization-capital acquirers achieve significantly higher abnormal announcement period returns, and better post-merger operating and stock performance, than low organization-capital acquirers. Additional tests suggest a causal relation between acquirer organization capital and deal performance. We further show that post-merger, high organization-capital acquirers cut more on the cost of goods sold, invest more in SG&A expenses, and achieve greater asset turnover and innovative efficiency.
It pays to partner with a firm that writes annual reports well
Mufaddal Baxamusa, Abu Jalal & Anand Jha
Journal of Banking & Finance, July 2018, Pages 13-34
Abstract:
We use strategic alliances as a setting to examine whether the readability of a firm's partner's 10-K matters. We find that the increase in the cumulative abnormal return (CAR) around the announcement of an alliance is relatively lower when the firm's partner in a strategic alliance has a less readable 10-K report. Additional tests show that the impact of the readability of a partner's 10-K is much stronger when investors suspect insufficient due diligence before the alliance's formation, when the partner is from a different industry, and when the alliance occurs before the Sarbanes-Oxley Act. Overall, our results show that the readability of a partner's annual report matters — it pays to partner with a firm that writes these reports well.
Negative News and Investor Trust: The Role of $Firm and #CEO Twitter Use
Brooke Elliott, Stephanie Grant & Frank Hodge
Journal of Accounting Research, forthcoming
Abstract:
We examine how CEOs can facilitate the development of investor trust that helps mitigate the effects of negative information. Results from an experiment show that investors trust the CEO more and are more willing to invest in the firm when the CEO communicates firm news followed by a negative earnings surprise through a personal Twitter account than when the news and surprise comes from the CEO via a website or from the firm's Investor Relations Twitter account or website. A follow‐up experiment shows that repeating the negative news does not incrementally affect investors who received the news from the CEO's Twitter account, but does further negatively impact investors who received the news via other disclosure mediums, especially those who received the news via the Investor Relations Twitter account. Our results have implications for firms and executives considering the costs and benefits of communicating with investors via Twitter.
Director skill sets
Renée Adams, Ali Akyol & Patrick Verwijmeren
Journal of Financial Economics, forthcoming
Abstract:
Directors are not one-dimensional. We characterize their skill sets by exploiting Regulation S-K's 2009 requirement that U.S. firms must disclose the experience, qualifications, attributes, or skills that led the nominating committee to choose an individual as a director. We then examine how skills cluster on and across boards. Factor analysis indicates that the main dimension along which boards vary is in the diversity of skills of their directors. We find that firm performance increases when director skill sets exhibit more commonality.
Do Unlisted Targets Sell at Discounts?
Jeffrey Jaffe et al.
Journal of Financial and Quantitative Analysis, forthcoming
Abstract:
Academic literature, practitioners, courts, and regulators routinely assert that both private and subsidiary targets sell at discounts relative to public targets. However, the empirical evidence to support this conclusion is thin. Our work alters the methodology from prior research to avoid biases due to both one-sided sample truncation and Jensen’s inequality. Following these changes, we find no evidence that unlisted targets sell at discounts. Our results hold under a number of different approaches and after controlling for known determinants of acquisition pricing.
CEO Incentives and Corporate Innovation
Tu Nguyen
Financial Review, May 2018, Pages 255-300
Abstract:
Using scaled wealth‐performance sensitivity as my measure of Chief Executive Officer (CEO) incentives, and utilizing cross‐sectional variations in industry innovativeness, product market competition and firms’ degree of exposure to the market for corporate control for identification purposes, I find that higher long‐term incentives that stem from CEO holdings of unvested options are associated with greater subsequent corporate innovation in innovative industries, competitive product markets, and firms more exposed to the threat of hostile takeovers, that is, exactly where incentivizing innovation is a matter of necessity. I address the endogeneity concerns with systems of simultaneous equations estimated using three‐stage least squares. A possible channel for the observed relation between unvested options‐based incentives and subsequent corporate innovation is that these incentives encourage managers to undertake riskier projects to achieve long‐term economic benefits.
Skill or effort? Institutional ownership and managerial efficiency
Ghasan Baghdadi et al.
Journal of Banking & Finance, June 2018, Pages 19-33
Abstract:
Using a sample of U.S. firms during the 1989–2015 period, we study whether the efficiency with which managers generate revenue is sensitive to monitoring by institutional shareholders. We find that institutional ownership is positively related to managerial efficiency. Our identification relies on a discontinuity in ownership around the Russell 1000/2000 Index threshold and suggests that the positive effect of institutional ownership on managerial efficiency is causal. Furthermore, we document that monitoring by institutions helps improve managerial efficiency, and that an exogenous increase in institutional ownership leads to higher pay-for-performance sensitivity. Finally, we find consistent results after excluding from our sample forced CEO turnovers, suggesting that institutional shareholders force incumbent managers to exert greater effort rather than influence the replacement of less efficient CEOs. Taken together, our findings highlight the important role played by institutional shareholders in getting the most out of corporate executives.
The Effects of Proprietary Information on Corporate Disclosure and Transparency: Evidence from Trade Secrets
Stephen Glaeser
Journal of Accounting and Economics, forthcoming
Abstract:
I examine the effects of proprietary information on corporate transparency and voluntary disclosure. To do so, I develop and validate two measures of firms’ reliance on trade secrecy: one based on 10-K disclosures and one based on subsequent litigation outcomes. I complement these measures by using the staggered passage of the Uniform Trade Secrets Act as a shock to trade secrecy. I find that firms that begin to rely more heavily on trade secrecy substitute increased voluntary disclosure of nonproprietary information for decreased disclosure of proprietary information. The total effect of trade secrecy is a decrease in corporate transparency.
Director Networks and Credit Ratings
Bradley Benson et al.
Financial Review, May 2018, Pages 301-336
Abstract:
We explore the effect of director social capital, directors with large and influential networks, on credit ratings. Using a sample of 11,172 firm‐year observations from 1999 to 2011, we find that larger board networks are associated with higher credit ratings than both firm financial data and probabilities of default predict. Near‐investment grade firms improve their forward‐looking ratings when their board is more connected. Last, we find that larger director networks are more beneficial during recessions, and times of increased financial uncertainty. Our results are robust to controls for endogeneity. Tests confirm that causality runs from connected boards to credit ratings.
Recruiting the CEO from the Board: Determinants and Consequences
Udi Hoitash & Anahit Mkrtchyan
Journal of Financial and Quantitative Analysis, forthcoming
Abstract:
We investigate an increasingly prevalent CEO succession strategy: recruiting CEOs from the board of directors (director–CEOs). Director–CEOs might be hired in a planned succession because they combine outsiders’ new perspectives with insiders’ firm-specific knowledge. Alternatively, directors may be recruited when the board is unprepared for a leadership change. We find that unplanned successions, in which director–CEOs are appointed as a “quick-fix” solution, result in a negative market reaction, deterioration in performance, and ill-fitting candidates with shorter tenures. Conversely, firms recruiting director–CEOs in planned successions perform similarly to other firms. We find no evidence that poor firm quality drives these results.
Financial Misreporting: Hiding in the Shadows or in Plain Sight?
Delphine Samuels, Daniel Taylor & Robert Verrecchia
University of Pennsylvania Working Paper, April 2018
Abstract:
This paper examines how the quality of a firm’s information environment influences a manager’s subsequent decision to misreport. The conventional wisdom is that high-quality information facilitates monitoring and increases the cost of misreporting, suggesting a negative relation between the quality of the information environment and misreporting. However, high-quality information also increases the weight that investors place on earnings in valuing the firm. This in turn increases the benefit of misreporting, suggesting a positive relation. We formalize these two countervailing forces –– “monitoring” and “valuation” –– in the context of a parsimonious model of misreporting. We show that the combination of these two forces leads to a unimodal relation. Specifically, as the quality of the information environment improves, misreporting first increases, reaches an inflection point, and then decreases. We find evidence of such a relation in multiple empirical measures of misreporting. Misreporting is greatest in a medium-quality environment and least in both high- and low-quality environments.
Predicting Accounting Misconduct: The Role of Firm-Level Investor Optimism
Shantaram Hegde & Tingyu Zhou
Journal of Business Ethics, forthcoming
Abstract:
Motivated by a large literature on how firm-specific resources (such as leadership and management skills, strategies, organizational capabilities and intellectual properties) drive firm performance, we propose and find that heterogeneity in investor optimism regarding firm-specific attributes plays a very important role in influencing the managerial propensity to manipulate financial statements. When firm-level investor optimism is moderate, the incidence of accounting misconduct increases, but it decreases when investors are highly optimistic. Further, market reaction to the announcement of financial restatements is more negative when investors held more optimistic firm-specific beliefs at the time of initial misstatement. These findings are robust to alternative firm-specific optimism measures linked to analysts, general investors and unsophisticated individual investors, controls for market-wide consumer sentiment unexplained by macroeconomic factors, economy-wide and industry-level optimism, potential selection bias and reverse causality. Our analysis highlights the importance of firm-level investor optimism in predicting, preventing and detecting accounting misconduct.
Industry Expert Directors
Wolfgang Drobetz et al.
Journal of Banking & Finance, forthcoming
Abstract:
We analyze the valuation effect of board industry experience and channels through which industry experience of outside directors relates to firm value. Our analysis shows that firms with more experienced outside directors are valued at a premium compared to firms with less experienced outside directors. Additional analyses, including a quasi-experimental setting based on director deaths, mitigate endogeneity concerns. The association between having directors with more industry experience and higher firm value is more pronounced for firms with larger investment programs, larger cash reserves, and during crises. In contrast, it is weaker in more dynamic industries, i.e., industries that rank high in terms of sales growth, R&D expenditures, merger activities, competitive threat, and product market changes, where the value of previously acquired experience is likely to be diminished. Overall, our findings are consistent with board industry experience being a valuable corporate governance mechanism.
Market Sentiment and Innovation Activities
Tri Vi Dang & Zhaoxia Xu
Journal of Financial and Quantitative Analysis, forthcoming
Abstract:
We investigate potential mechanisms through which market-wide sentiment affects firms’ innovation activities. We provide evidence for the financing channel by showing that financially constrained firms are more likely to issue equity and invest more in research and development (R&D) than financially unconstrained firms at high market sentiment. Using time-varying manager sentiment measures, we find suggestive evidence for a sentiment spillover channel whereby market sentiment affects R&D investments through influencing manager sentiment. Furthermore, better patent portfolios are produced from R&D investments stimulated by high market sentiment. Market sentiment has a stronger impact on R&D than the capital expenditures of financially constrained firms.