Steering the Ship
CEO political preference and credit ratings
Avishek Bhandari & Joanna Golden
Journal of Corporate Finance, forthcoming
Abstract:
This study investigates whether a CEO's personal political ideology, as captured by his or her political contributions, is associated with a firm's credit ratings. Republican CEOs, we find, are associated with higher credit ratings, especially when their firms are headquartered in conservative areas. In addition, the link between political ideology and credit rating is more pronounced in firms that exhibit high financial distress or weak corporate governance. Changes in political ideology are associated with changes in credit rating. Our results support the behavior consistency, upper echelon, and social identity theories, as well as the risk acceptance hypothesis, and are robust to a number of alternative specifications as well as when alternate approaches and measures of credit risk are introduced. Using Republican CEOs as a proxy for conservative CEOs, our evidence implies that credit rating agencies justifiably view a CEO's political ideology and conservatism as indicative of corporate policies and, therefore, as an important determinant of the firm's credit ratings.
The Political Polarization of U.S. Firms
Vyacheslav Fos, Elisabeth Kempf & Margarita Tsoutsoura
University of Chicago Working Paper, February 2021
Abstract:
Executive teams in U.S. firms are becoming increasingly politically polarized. We establish this new fact using political affiliations from voter registration records for top executives of S&P 1500 firms between 2008 and 2018. The rise in political homogeneity is explained by both an increasing share of Republican executives and increased sorting by partisan executives into firms with like-minded individuals. We further document substantial heterogeneity across party lines in executives’ beliefs, as proxied by their trading of company stock around presidential elections, as well as in firms’ investment decisions.
Religiosity, Higher Purpose, and the Effectiveness of Intense Board Oversight
Todd Milbourn & Kingsley Wabara
Washington University in St. Louis Working Paper, March 2021
Abstract:
Using a novel measure, we study how the personal religiosity (or sense of higher purpose) of independent directors affects the effectiveness of their intense board oversight. We find that, relative to their non-religious counterparts, religious monitoring-intensive directors exhibit significantly lower sensitivity of CEO turnover to firm performance over a holding period of 1 year. However, for the more extended holding period of 2 years, this difference in sensitivity significantly switches direction, consistent with the “higher purpose, incentives, and economic performance” theory, which suggests that believers in higher purpose will tend to hold a longer-term perspective. We also find that religious monitoring-intensive directors further reduce both earnings management and excess total CEO compensation, especially when the lead independent director and/or a majority of the principal monitoring committee chairs are also religious. Overall, our findings show that religious monitoring-intensive directors differentially influence intense board oversight results and, thereby, help infuse or propagate a corporate culture consistent with an authentic organizational higher purpose.
Executive Network Centrality and Corporate Reporting
Jing He
Management Science, forthcoming
Abstract:
This paper investigates the association of corporate reporting and executive network centrality, which measures an executive’s relative position in a massive network consisting of outside corporate leaders. I find that high-centrality chief executive officers (CEOs) and chief financial officers (CFOs) are generally more likely to engage in financial misreporting than low-centrality CEOs and CFOs. I also find that the influence of CFO network centrality is greater than that of CEOs in financial misreporting. Further analyses show that the monitoring effect of internal governance mechanisms on high-centrality executives is very limited and that the discipline of the managerial labor market is weaker for high-centrality CFOs as well. My results hold for a subsample subject to exogenous shocks to CFO connectedness and are robust to a series of alternative specifications including using CFO fixed effects. Taken together, my findings suggest that corporate reporting can be influenced by executives’ social network position, with high-centrality CFOs using their social power to make adverse corporate reporting decisions to gain personal benefits.
The dark side of CEO social capital: Evidence from real earnings management and future operating performance
Paul Griffin et al.
Journal of Corporate Finance, forthcoming
Abstract:
We examine the role of CEO social capital as an important driver of the widespread practice of real earnings management (REM). Using the number of social connections to outside executives and directors to measure CEO social capital, we first find that well-connected CEOs associate with higher levels and volatilities of REM. The positive relation between REM and CEO network size is stronger when the CEO connects with more informed and influential persons, and when a more severe misalignment of interests can occur. Second, we find a contagion of REM among well-connected CEOs in an industry. Third, the level of REM induced by a large CEO social network associates negatively with future operating performance. This result is consistent with social capital circulating REM-related information ex-ante and increasing the power and influence for the CEO to deviate from optimal operating policies ex-post. Social capital shields the well-connected executive in the takeover and labor markets despite possible suboptimal future operating performance. While the prior literature finds that CEO social capital reduces accrual earnings management, our findings suggest a dark side of CEO social capital: it induces excessive levels and volatilities of REM costly to the firm in the long-run while imposing relatively low personal risk on the top executive.
Recruiting Dark Personalities for Earnings Management
Ling Harris et al.
Journal of Business Ethics, forthcoming
Abstract:
Prior research indicates that managers’ dark personality traits increase their tendency to engage in disruptive and unethical organizational behaviors including accounting earnings management. Other research suggests that the prevalence of dark personalities in management may represent an accidental byproduct of selecting managers with accompanying desirable attributes that fit the stereotype of a “strong leader.” Our paper posits that organizations may hire some managers who have dark personality traits because their willingness to push ethical boundaries aligns with organizational objectives, particularly in the accounting context where ethical considerations are especially important. Using several validation studies and experiments, we find that experienced executives and recruiting professionals favor hiring a candidate with dark personality traits into an accounting management position over an otherwise better-qualified candidate when the hiring organization faces pressure to manage earnings. Our results help to illuminate why individuals with dark personality traits may effectively compete for high-level accounting positions.
Entrenchment or efficiency? CEO‐to‐employee pay ratio and the cost of debt
Katsiaryna Bardos, Steven Kozlowski & Michael Puleo
Financial Review, forthcoming
Abstract:
Using new data on S&P 1500 firms’ chief executive officer (CEO)‐to‐employee pay ratios disclosed by mandate of Section 953(b) of the Dodd-Frank Act, we examine the effect of within‐firm pay inequality on bond yield spreads. We find a significant negative relation between industry‐adjusted CEO‐to‐employee pay ratio and yield spreads while controlling for covariates and endogeneity. This result is strongest in financially constrained, labor‐intensive, and small‐to‐medium‐sized firms. The evidence supports the incentive‐provision explanation of CEO‐to‐employee pay disparity, reflecting efficient CEO compensation rather than rent extraction. We also document selection bias in self‐reported pay ratios, highlighting the efficacy of the Dodd-Frank provisions.
Why Are Firms with Lower Performance More Volatile and Unpredictable? A Vulnerability Explanation of the Bowman Paradox
Manuel Becerra & Garen Markarian
Organization Science, forthcoming
Abstract:
This study investigates the negative relationship between firm risk and accounting performance known in the strategy field as the Bowman paradox, which has been generally attributed to differences across firms in their willingness to take risk. Most research to date relies on the behavioral theory of the firm to suggest that underperformers take greater risks to increase their performance to their reference point. As an alternative explanation, we suggest that the Bowman paradox may result from the inherent vulnerability of low performers to negative external shocks. Our panel analysis of 2,681 U.S. firms from 1980 to 2010 confirms that firms with lower performance within their industry are more affected by negative shocks to the economy. The asymmetric vulnerability of low performers to external events makes their overall accounting performance more volatile and difficult to predict by market analysts, even if all firms have a similar attitude toward risk taking and capabilities to manage change. Our vulnerability explanation is also supported by our empirical analysis of the 2008 global financial crisis as a natural experiment. Furthermore, we find strong evidence of a negative risk-return relationship using different methods to control for their endogeneity.
Competition for Flow and Short-Termism in Activism
Mike Burkart & Amil Dasgupta
Review of Corporate Finance Studies, March 2021, Pages 44-81
Abstract:
We develop a dual-layered agency model to study blockholder monitoring by activist funds competing for investor flow. Competition for flow affects the manner in which activist funds govern as blockholders. In particular, funds inflate their short-term performance by increasing payouts that are financed by higher (net) leverage. Doing so subsequently discourages value-creating interventions during economic downturns because of debt overhang. Our theory suggests a new channel via which asset manager incentives may foster economic fragility and links together the observed procyclicality of activist investments with the documented effect of such funds on the leverage of their target companies.
Investor Sentiment and Stock Option Vesting Terms
Shawn Huang, Sami Keskek & Juan Manuel Sanchez
Management Science, forthcoming
Abstract:
Using the details of vesting terms, we document that stock options granted in high-investor-sentiment periods tend to have shorter vesting periods and durations and are more likely to vest completely or have a significantly larger fraction vested within one year of the grant date, relative to low-sentiment periods. We further find that the sentiment effect on vesting terms is more pronounced when firms are largely held by investors with short investment horizons (e.g., transient institutions). Moreover, short vesting terms in high-sentiment periods are positively associated with future mergers-and-acquisitions activity and capital expenditures. Overall, our findings are consistent with theoretical predictions that, in a speculative market, shareholders incentivize managers with short-term-oriented compensation contracts to induce managers to pursue actions maintaining overvaluation.
Does the executive labor market discipline? Labor market incentives and earnings management
Qiyuan Peng & Sirui Yin
Journal of Empirical Finance, June 2021, Pages 62-86
Abstract:
This paper investigates the role of outside options in the executive labor market on earnings management decisions. To proxy for executives’ outside options, we use the number of times other firms cite the executive’s firm as a compensation peer. We find that executives with more citations conduct less earnings management. Exploiting the 2006 SEC requirement for compensation peer disclosure as a quasi-natural shock to executives’ awareness of outside options, we show that the executives who should be more responsive to outside options significantly reduce earnings management. Cross-sectional tests support a labor market discipline channel of outside options. Finally, we exploit state-level recognition of Inevitable Disclosure Doctrine and enforcement of non-compete agreements as cross-sectional restrictions on labor mobility and show that the impact of peer citations on reducing earnings management is stronger when there are fewer restrictions on mobility.
Institutional Investors and Hedge Fund Activism
Simi Kedia, Laura Starks & Xianjue Wang
Review of Corporate Finance Studies, March 2021, Pages 1-43
Abstract:
Hedge fund activists have ambiguous relationships with the institutional shareholders in their target firms. While some support their activities, others counter their actions. Due to their relatively small holdings in target firms, activists typically need the cooperation of other institutional shareholders that are willing to influence the activists’ campaign success. We find the presence of “activism-friendly” institutions as owners is associated with an increased probability of being a target, higher long-term stock returns, and higher operating performance. Overall, we provide evidence suggesting the composition of a firm’s ownership has significant effects on hedge fund activists’ decisions and outcomes.
The Fragility of Organization Capital
Oliver Boguth, David Newton & Mikhail Simutin
Journal of Financial and Quantitative Analysis, forthcoming
Abstract:
Firms with high levels of organization capital, a firm-specific production factor provided by key employees, are known to be risky and earn high stock returns. We argue that fragility of organization capital - its sensitivity to disruptions - is an independently important dimension of this risk. We proxy for fragility by the size of the top management team and show that firms with small teams outperform by 5% annually. The return spread increases with organization capital and correlates with outside options of top executives. Further supporting our interpretation, shocks to team composition from unexpected CEO deaths cause larger losses in smaller teams.