Top dog
Poor performance and the value of corporate honesty
Don Chance, James Cicon & Stephen Ferris
Journal of Corporate Finance, August 2015, Pages 1-18
Abstract:
We examine a sample of companies that make announcements attributing blame for recent poor performance to either themselves or an external factor. We find that both groups of companies exhibit poor company-specific performance prior to the announcement, indicating that companies blaming external factors are not being truthful. Following the announcement, companies that blame themselves begin to perform better while those that blame others continue their weak performance. We find no differences in the financial and governance characteristics of these companies. Companies that blame themselves, however, provide more detailed information about the source of the problem, while those that blame others offer only vague generalizations. Our results suggest that managerial honesty and forthrightness have value to shareholders since they imply that the company is more likely to make the corrections necessary to achieve stronger future performance.
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The Long-Term Effects of Hedge Fund Activism
Lucian Bebchuk, Alon Brav & Wei Jiang
NBER Working Paper, June 2015
Abstract:
We test the empirical validity of a claim that has been playing a central role in debates on corporate governance - the claim that interventions by activist hedge funds have a negative effect on the long-term shareholder value and corporate performance. We subject this claim to a comprehensive empirical investigation, examining a long five-year window following activist interventions, and we find that the claim is not supported by the data. We find no evidence that activist interventions, including the investment-limiting and adversarial interventions that are most resisted and criticized, are followed by short-term gains in performance that come at the expense of long-term performance. We also find no evidence that the initial positive stock-price spike accompanying activist interventions tends to be followed by negative abnormal returns in the long term; to the contrary, the evidence is consistent with the initial spike reflecting correctly the intervention's long-term consequences. Similarly, we find no evidence for pump-and-dump patterns in which the exit of an activist is followed by abnormal long-term negative returns. Our findings have significant implications for ongoing policy debates.
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Restraining Overconfident CEOs through Improved Governance: Evidence from the Sarbanes-Oxley Act
Suman Banerjee, Mark Humphery-Jenner & Vikram Nanda
Review of Financial Studies, forthcoming
Abstract:
The literature posits that some CEO overconfidence benefits shareholders, though high levels may not. We argue that adequate controls and independent viewpoints provided by an independent board mitigates the costs of CEO overconfidence. We use the concurrent passage of the Sarbanes-Oxley Act and changes to the NYSE/NASDAQ listing rules (collectively, SOX) as natural experiments, to examine whether board independence improves decision making by overconfident CEOs. The results are strongly supportive: after SOX, overconfident CEOs reduce investment and risk exposure, increase dividends, improve postacquisition performance, and have better operating performance and market value. Importantly, these changes are absent for overconfident-CEO firms that were compliant prior to SOX.
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Judee Burgoon et al.
Journal of Language and Social Psychology, forthcoming
Abstract:
Quarterly conference calls where corporate executives discuss earnings that are later found to be misreported offer an excellent test bed for determining if automated linguistic and vocalic analysis tools can identify potentially fraudulent utterances in prepared versus unscripted remarks. Earnings conference calls from one company that restated their financial reports and were accused of making misleading statements were annotated as restatement-relevant (or not) and as prepared (presentation) or unprepared (Q&A) responses. We submitted more than 1,000 utterances to automated analysis to identify distinct linguistic and vocalic features that characterize various types of utterances. Restatement-related utterances differed significantly on many vocal and linguistic dimensions. These results support the value of language and vocal features in identifying potentially fraudulent utterances and suggest important interplay between utterances that are unscripted responses rather than rehearsed statements.
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Directors' and officers' liability insurance and the cost of equity
Zhihong Chen, Oliver Zhen Li & Hong Zou
Journal of Accounting and Economics, forthcoming
Abstract:
We examine whether directors' and officers' (D&O) liability insurance affects a firm's cost of equity. We find a positive association between D&O insurance and the cost of equity. Information quality and risk-taking appear to be two underlying channels through which D&O insurance affects the cost of equity. Further tests suggest that this positive association is not due to optimal risk-taking, as evidenced by a negative market reaction to an increase in D&O insurance coverage, a lack of improvement in firms' cash flow and a low valuation associated with D&O insurance. Overall, our evidence is consistent with the notion that D&O insurance weakens the disciplining effect of shareholder litigation, leading to an increase in the cost of equity.
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Directors' and officers' legal liability insurance and audit pricing
Hyeesoo (Sally) Chung, Stephen Hillegeist & Jinyoung Wynn
Journal of Accounting and Public Policy, forthcoming
Abstract:
Directors' and officers' (D&O) legal liability insurance is commonly provided to corporate executives and directors. Prior literature suggests managers are more willing to engage in opportunistic behaviors when their personal assets are more protected from litigation risk. Therefore, information about D&O policy details is potentially useful in assessing potential managerial opportunism. However, many countries, including the U.S., do not require firms to disclose this information. We provide evidence on whether mandatory D&O disclosures are likely to provide information about managerial opportunism that is incremental to that provided by other sources of information using a sample of Canadian firms, who are required to make D&O disclosures. We examine the association between excess D&O coverage limits and audit fees since auditors have extensive private information about the likelihood of managerial opportunism and strong incentives to incorporate this information into their audit fees. We find a positive association between excess D&O coverage limits and audit fees after controlling for numerous other audit fee determinants, including other proxies for managerial opportunism such as discretionary accruals and corporate governance variables. Additional analyses suggest auditors are more sensitive to potential managerial opportunism when managers are more likely to act on their opportunistic incentives. We also find a positive association between excess D&O coverage limits and the likelihood of future shareholder litigation. Our findings suggest that D&O insurance disclosures convey incremental information to shareholders and other capital market participants. As such, they suggest a beneficial role for mandatory D&O disclosures.
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Vyacheslav Fos, Kai Li & Margarita Tsoutsoura
University of Chicago Working Paper, May 2015
Abstract:
Using a hand-collected sample of more than 30,000 directors nominated for election over the period 2001-2010, we construct a novel measure of director proximity to elections - Closeness-to-election. We find that the closer a director is to her next election, the higher is CEO turnover-performance sensitivity. Each year closer to director elections is associated with a 23% increase in CEO turnover-performance sensitivity. Three tests support a causal interpretation of the results. First, when we require directors to have a minimum tenure of three years, there is no material change in the results, suggesting that the timing of when directors join their boards is unlikely to drive the results. Second, we find similar results when we use director Closeness-to-election on other boards as a measure of proximity to elections. Third, when we restrict the analysis to firms with unitary boards, there is no material change in the results, suggesting that director self-selection into firms with staggered boards does not drive the results. Cross-sectional tests suggest that, when other governance mechanisms are in place, CEO turnover-performance sensitivity is affected to a lesser extent by Closeness-to-election. We conclude that director elections have important implications for corporate governance.
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Auditor Conservatism, Incentive Compensation, and the Quality of Financial Reporting
Ravi Singh & Ian Larkin
Journal of Law, Economics, and Organization, forthcoming
Abstract:
This paper examines how performance-based compensation for managers influences their reporting behavior and the resulting stance auditors take when deciding whether to certify a manager's report. The paper makes endogenous the stance auditors take: with a more conservative stance, auditors are less likely to certify an inflated report, but are more likely to refuse to certify an accurate one. The auditor's tradeoff between these two error types, and the resulting interplay with the level of performance-based pay for managers, play a critical role in determining the level of managerial misreporting, investor welfare, and a number of other key variables. The paper finds that (1) strengthening the link between pay and reported performance can result in a weaker link between pay and actual performance and, consequently, lower managerial effort; (2) conservatism among auditors improves performance measurement; and (3) raising penalties on managers for overstating earnings can reduce audit quality and harm investors, while raising penalties on auditors for certifying overstated results does not harm investors.
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Leanne ten Brinke & Gabrielle Adams
Organizational Behavior and Human Decision Processes, September 2015, Pages 1-12
Abstract:
In the wake of corporate transgressions and scandals, how do apologizers' expressed emotions affect investors' perceptions of the organization in question? We analyzed the market effects of normative versus deviant facial affect expressed during apologies for corporate wrongdoing. Archival data revealed that the expression of deviant affect was associated with decreased investor confidence in the form of negative stock market returns; adverse financial effects persisted up to three months post-apology. Moreover, this effect was exacerbated when a company representative with greater responsibility within the organization delivered the apology. Experimental data further revealed that third parties interpreted deviant affect (smiling) as a signal of insincerity, which reduced their confidence in these representatives' organizations. Ultimately, we find that subtle emotion expressions are detected by stakeholders, signal insincerity, and have important consequences for organizations. We suggest that organizations must carefully consider the nonverbal behavior of apologetic representatives in the wake of transgressions.
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Ready, AIM, acquire: Impression offsetting and acquisitions
Scott Graffin, Jerayr Haleblian & Jason Kiley
Academy of Management Journal, forthcoming
Abstract:
Drawing on expectancy violation theory, we explore the effects of anticipatory impression management in the context of acquisitions. We introduce impression offsetting, an anticipatory impression management technique organizational leaders employ when they expect a focal event will negatively violate the expectations of external stakeholders. Accordingly, in these situations, organizational leaders will announce the focal event contemporaneously with positive, but unrelated information. We predict impression offsetting will generally occur in the context of acquisitions, but also more frequently for specific acquiring firms and acquisitions that are more likely to lead to an expectancy violation. We also posit that offsetting will effectively inhibit observers' perceptions of events as negative expectancy violations by positively influencing shareholder reactions to acquisition announcements. Consistent with our hypotheses, in a sample of publicly traded acquisition targets, we find evidence for impression offsetting, in which characteristics of both acquirers and their announced acquisitions predict its frequency of use. We also find evidence that impression offsetting is efficacious; on average, it reduces the negative market reaction to acquisition announcements by over 40 percent, which translates into approximately $246 million in market capitalization.
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The effect of institutional ownership on firm transparency and information production
Audra Boone & Joshua White
Journal of Financial Economics, forthcoming
Abstract:
We examine the effects of institutional ownership on firms' information and trading environments using the annual Russell 1000/2000 index reconstitution. Characteristics of firms near the index cutoffs are similar, except that firms in the top of the Russell 2000 have discontinuously higher proportional institutional ownership than firms in the bottom of the Russell 1000 primarily due to indexing and benchmarking strategies. We find that higher institutional ownership is associated with greater management disclosure, analyst following, and liquidity, resulting in lower information asymmetry. Overall, indexing institutions' predilection for lower information asymmetries facilitates information production, which enhances monitoring and decreases trading costs.
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CEO Side-Payments in M&A Deals
Brian Broughman
Indiana University Working Paper, March 2015
Abstract:
In addition to golden parachutes, CEOs often negotiate for personal side-payments in connection with the sale of their firm. Side-payments differ from golden parachutes in that they are negotiated ex post in connection with a specific acquisition proposal, whereas golden parachutes are part of the executive's employment agreement negotiated when she is hired. While side-payments may benefit shareholders by countering managerial resistance to an efficient sale, they can also be used to redistribute merger proceeds to management. The current article highlights an overlooked distinction between pre-merger golden parachutes and merger side-payments. Similar to a legislative rider attached to a popular bill, management can bundle a side-payment with an acquisition that is desired by target shareholders. Thus, even if shareholders would not have approved the side-payment for purposes of ex ante incentives, it may receive shareholder support as part of a take-it-or-leave-it merger vote. Because side-payments are bundled into a merger transaction, voting rights cannot adequately protect shareholders against rent extraction. My analysis helps explain empirical results which show that target CEOs sometimes bargain away shareholder returns in exchange for personal side-payments. I conclude with legal reforms to help unbundle side-payments from the broader merger vote.
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Active Firms and Active Shareholders: Corporate Political Activity and Shareholder Proposals
Geeyoung Min & Hye Young You
University of Virginia Working Paper, April 2015
Abstract:
Corporate political activity has become one of shareholders' top concerns. We examine whether firms targeted by shareholder proposals show different campaign contributions and lobbying activities compared to non-targeted firms. We also ask whether different sponsors of shareholder proposals target different firms depending on the firms' partisan orientation. Using data on S&P 500 companies during the period between 2007 and 2013, we find that firms that spend more on campaign contributions and lobbying are more likely to be targeted by shareholder proposals. After controlling for firms' financial performance, governance characteristics and ownership structure, we also find that public pension funds and labor unions sponsors are more likely to target Republican-leaning firms, measured by the firms' campaign contributions. This finding suggests that increasing corporate political activity can intensify a tension between management and public pension fund and labor union shareholders and lead to more activism by these shareholders.
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The determinants of effective corporate lobbying
Richard Borghesi & Kiyoung Chang
Journal of Economics and Finance, July 2015, Pages 606-624
Abstract:
In this paper we study whether capital markets view lobbying activities to be value enhancing by examining the effects of lobbying on excess returns and stock return volatility. We undertake our analysis cautious that there are significant differences between the characteristics of lobbying and non-lobbying firms. Specifically, firm size, free cash flows, and R&D intensity are critically important factors that may drive results of our and other lobbying research. We show that once properly accounting for the effects of firm size, a managerial agency problem in lobbying is apparent. Initially we find that shareholders experience either no discernible or else negative excess returns in response to firm lobbing efforts. Results are even stronger when corrections are made for endogeneity issues. Further, evidence presented suggests that lobbying firms have higher volatility of stock returns, and we show that volatility is greater for firms that lobby more intensely. However, for R&D-intensive firms, and for those firms with low agency problems, lobbying does contribute to the long-term benefit of shareholders. Overall, results suggest that lobbying leads to positive excess returns when agency problems are low and R&D is high, and leads to negative excess returns otherwise.
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The Power of Shareholder Votes: Evidence from Director Elections
Reena Aggarwal, Sandeep Dahiya & Nagpurnanand Prabhala
University of Maryland Working Paper, May 2015
Abstract:
In the U.S., votes in director elections are advisory but are often used by shareholders to express dissent. We examine whether these non-binding votes have consequences for directors and report affirmative evidence. Directors facing dissent are more likely to depart boards, especially if they are not lead directors or chairs of important committees. Directors facing dissent who do not leave are moved to less prominent positions in boards. These effects are more pronounced in firms with greater ownership by institutional investors who pose exit threats. Finally, we find evidence that directors facing dissent face reduced opportunities in the market for directors, consistent with the Fama and Jensen (1983) view of the disciplining role of the market for directors. We show that contrary to popular belief, shareholder votes have power and result in negative consequences for directors. We also find that the effects of dissent votes go beyond those of proxy advisor recommendations.
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Social learning and corporate peer effects
Markku Kaustia & Ville Rantala
Journal of Financial Economics, forthcoming
Abstract:
We find that firms are more likely to split their stock if their peer firms have recently done so. The effect is comparable to an increase of 40-50% in the share price. Splitting probability is also increasing in the announcement returns of peer splits. These results are consistent with social learning from peers' actions and outcomes. The unique features of the setting and various further tests render alternative explanations unlikely. We find no clear benefit in following successful peer splitters. Firms are sometimes suspected to succumb to imitation, and the effect we show could be a case in point.
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Susan Albring et al.
Management Science, forthcoming
Abstract:
Extant theory claims a firm's information environment impacts the choice between debt and equity financing. However, empirical evidence supporting this contention is limited. We evaluate this relation within the context of Regulation Fair Disclosure (Reg FD), which prohibited the use of selective disclosure. We find that firms with high proprietary costs of public disclosure are more likely to resort to debt financing following the passage of Reg FD. This relation is not sensitive to whether a firm has relied on selective disclosure in the pre-Reg FD regime. We also evaluate changes in firm disclosure policy and find that firms that adopted an expansive public disclosure policy are more likely to turn to equity financing. Overall, our evidence is consistent with the pecking order theory: firms with deteriorated firm information environments increase their use of less information-sensitive debt, whereas firms with improved information environments favor the use of equity financing.
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Insider sales and the effectiveness of clawback adoptions in mitigating fraud risk
Simon Yu Kit Fung et al.
Journal of Accounting and Public Policy, forthcoming
Abstract:
In recent years, firms (and lawmakers) have sought to mitigate the dysfunctional effects of incentive-based executive compensation by adopting clawbacks. However, extant clawbacks (whether firm-initiated or as mandated by the 2010 Dodd-Frank Act) do not go far enough in that they seem to allow executives to retain trading profits linked to sales of their own companies' shares at a time of inflated earnings (Fried and Shilon, 2011). In this paper, we examine the moderating effect of insider sales on the relation between firm-initiated clawback-adoptions and fraud risk. Our results indicate that clawback-adopting firms experience a decrease in fraud risk following adoption relative to non-adopters during the same time period. However, this decrease in fraud risk for the clawback-adopting firms is materially weakened in the presence of insider trading. At this time (July 2014), the SEC is still working on rules for implementing clawbacks (one of nearly half of the rules yet to be completed under Dodd-Frank). Our findings suggest that clawback rules (as and when issued by the SEC) need to address insider sales for clawbacks to be fully effective in mitigating the risk of fraudulent financial reporting.