Top dollar
Executive Compensation, Fat Cats, and Best Athletes
Jerry Kim, Bruce Kogut & Jae-Suk Yang
American Sociological Review, forthcoming
Abstract:
Income gains in the top 1 percent are the primary cause for the rapid growth in U.S. inequality since the late 1970s. Managers and executives of firms account for a large proportion of these top earners. Chief executive officers (CEOs), in particular, have seen their compensation increase faster than the growth in firm size. We propose that changes in the macro patterns of the distribution of CEO compensation resulted from a process of diffusion within localized networks, propagating higher pay among corporate executives. We compare three possible explanations for diffusion: director board interlocks, peer groups, and educational networks. The statistical results indicate that corporate director networks facilitate social comparisons that generate the observed pay patterns. Peer and education network effects do not survive a novel endogeneity test that we execute. A key implication is that local diffusion through executive network structures partially explains the changes in macro patterns of income distribution found in the inequality data.
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Caroline Flammer
Management Science, forthcoming
Abstract:
This study examines the effect of shareholder proposals related to corporate social responsibility (CSR) on financial performance. Specifically, I focus on CSR proposals that pass or fail by a small margin of votes. The passage of such “close call” proposals is akin to a random assignment of CSR to companies and hence provides a quasi-experiment to study the effect of CSR on performance. I find that the adoption of close call CSR proposals leads to positive announcement returns and superior accounting performance, implying that these proposals are value enhancing. When I examine the channels through which companies benefit from CSR, I find that labor productivity and sales growth increase after the vote. Finally, I document that close call CSR proposals differ from non-close proposals along several dimensions. Accordingly, although my results imply that adopting close call CSR proposals is beneficial to companies, they do not necessarily imply that CSR proposals are beneficial in general.
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Market (In)Attention and Earnings Announcement Timing
Ed DeHaan, Terry Shevlin & Jacob Thornock
Stanford Working Paper, October 2014
Abstract:
We revisit a long-standing question: do managers “hide” bad news by announcing earnings during periods of low market attention? Or conversely, do managers “highlight” good news by reporting during periods of higher attention? We posit three necessary conditions for an effective hiding/highlighting strategy: (i) managers must change their earnings announcement timing frequently enough that to do so would not attract unwanted attention to bad news; (ii) there must be ex-ante predictable variation in market attention; and (iii) we must observe that managers tend to release more negative (positive) earnings news during periods of lower (higher) expected attention. The first and second conditions have not been directly examined. Prior studies examining the third condition have produced mixed results. We examine three times during which prior research has speculated that market attention is lower: after trading hours, on Fridays, and on “busy” days when numerous other firms are reporting earnings. We find that earnings announcement timing are highly variable, which supports the first necessary condition. Using four measures of market attention, we find that attention does appear to be lower after hours and on busy reporting days. However, we find that attention is the same or even higher on Fridays, which is inconsistent with the second condition. Finally, we find that unexpected earnings are lower in all three settings. In additional tests, we find negative returns around the scheduling of a forthcoming earnings announcement for a Friday, which is consistent with investors inferring that earnings news tends to be worse on Fridays. In sum, the results are consistent with managers strategically reporting bad news during times when they expect that attention is limited, and conversely, reporting good news in periods of higher attention. However, given that attention is the same or higher on Fridays than other days, it is unlikely that managers are able to effectively hide bad news by reporting immediately prior to the weekend. Instead, the preponderance of strategically reporting bad news on Fridays is possibly due to managers incorrectly perceiving attention as lower on Friday.
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Evidence on Contagion in Earnings Management
Simi Kedia, Kevin Koh & Shivaram Rajgopal
Accounting Review, forthcoming
Abstract:
We examine contagion in earnings management using 2,376 restatements announced during the years 1997-2008. Controlling for industry and firm characteristics, firms are more likely to begin managing earnings after the public announcement of a restatement by another firm in their industry or neighborhood. Such contagion is absent when the restating firm is disciplined by the SEC or class action lawsuits, suggesting deterrent effects of enforcement activity. Contagion among peers is observed (i) in the same account as the one restated by the target firm; or (ii) when larger target firms restate or the restatement in prominently disclosed; or (iii) when the target firm's restatement is less severe. Contagion stops during the years 2003-2005, possibly due to the enforcement associated with the Sarbanes-Oxley (SOX) Act but reappears during 2006-2008, perhaps because the sting associated with SOX has worn off. In sum, peers' actions appear to affect a firm's earnings management decisions.
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CEO Network Centrality and Merger Performance
Rwan El-Khatib, Kathy Fogel & Tomas Jandik
Journal of Financial Economics, forthcoming
Abstract:
We study the effects on M&A outcomes of CEO network centrality, which measures the extent and strength of a CEO's personal connections. High network centrality can allow CEOs to efficiently gather and control private information, facilitating value-creating acquisition decisions. We show, however, that M&A deals initiated by high-centrality CEOs, in addition to being more frequent, carry greater value losses to both the acquirer and the combined entity than deals initiated by low-centrality CEOs. We also document that high-centrality CEOs are capable of avoiding the discipline of the markets for corporate control and the executive labor market, and that the mitigating effect of internal governance on CEO actions is limited. Our evidence suggests that corporate decisions can be influenced by a CEO's position in the social hierarchy, with high-centrality CEOs using their power and influence to increase entrenchment and reap private benefits.
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Board interlocking network and the design of executive compensation packages
Ling Heng Henry Wong, André Gygax & Peng Wang
Social Networks, forthcoming
Abstract:
The standard approach used to model interlocks in the business and management literature is to treat each interlock of a network as an independent data point. However, such an approach ignores the complex inter-dependencies among the common director interlocks. We propose that an interlocking board network is an important inter-corporate setting that has bearing on how company boards make corporate decisions. Using a sample of 725 large U.S.-based public companies over the period 2007–2010, board member information, executive compensation information, and exponential random graph modeling (ERGM) techniques for social networks, we present evidence that board interlocks are positively linked with similarities in the design of executive compensation packages in interlocked firms, particularly the proportions of the options component. We also find evidence that board interlocks are positively linked with similarities in a number of board characteristics.
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Tax Rates and Corporate Decision Making
John Graham et al.
MIT Working Paper, January 2015
Abstract:
It has long been suspected that managers use short-cuts (e.g., heuristics) to make many decisions and that their decisions are affected by behavioral biases such as a tendency to overly rely on ‘salient’ or vivid metrics/information. We document that managers do indeed exhibit these behavioral biases when incorporating taxes into their decision processes. For example, we find that many firms employ the more salient average tax rate (i.e., the GAAP effective tax rate) to evaluate incremental decisions rather than the more theoretically correct marginal tax rate. We estimate that behavioral biases that influence firms to use the average tax rate for decision-making lead to deadweight losses that average $10 million for poor capital structure decisions and $25 million for suboptimal acquisitions, and also reduce the responsiveness of corporate investment to growth opportunities.
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The Benefits of Selective Disclosure: Evidence from Private Firms
Joan Farre-Mensa
Harvard Working Paper, January 2015
Abstract:
I investigate an unexplored benefit of being privately-held: Non-SEC-filing private firms’ ability to disclose confidential information to selected investors minimizes the scope for information asymmetry between the firms and their investors. This decreases private firms’ exposure to misvaluation and leads them to hold lower levels of precautionary cash than similar-sized public firms, as private firms do not need to optimize the timing of their equity issues. Consistent with these predictions, I use a unique panel of non-SEC-filing private U.S. firms to show that the average public firm holds twice as much cash as the average private firm. This cash gap is driven by small- and medium-sized public firms, which are most equity dependent, and is larger in industries with higher exposure to misvaluation shocks.
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Dynamics of CEO Compensation: Old is Gold
Hari Adhikari et al.
Quarterly Review of Economics and Finance, forthcoming
Abstract:
There is an ongoing debate regarding the hiring and compensation of younger versus older employees. In this paper, we examine this question for Chief Executive Officers (CEOs) in the context of the Sarbanes-Oxley Act (SOX) of 2002. We argue that the increased complexities in the post-SOX era (regulatory, technological, and the ever-changing business environment) have forced corporate boards to incentivize top executives for the increased burden. We contend that older CEOs are perceived as more reliable, efficient, and trustworthy (to fulfill the regulatory requirements demanded by SOX) than their younger counterparts. Consistent with our contention, we find that the total compensation of CEOs of U.S. firms has increased significantly for older CEOs as compared to their younger counterparts after the introduction of SOX. Our results are robust to sophisticated econometric techniques and also consistent with the logic that in order to motivate older CEOs (who would have raised substantial personal wealth over time) to keep working rather than retiring or moving to a competitor, their compensation package must be highly competitive.
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The Structure of Voluntary Disclosure Narratives: Evidence from Tone Dispersion
Kristian Allee & Matthew DeAngelis
Journal of Accounting Research, forthcoming
Abstract:
We examine tone dispersion, or the degree to which tone words are spread evenly within a narrative, to evaluate whether narrative structure provides insight into managers’ voluntary disclosures and users’ responses to those disclosures. We find that positive and negative tone dispersion are associated with current aggregate and disaggregated performance and future performance, managers’ financial reporting decisions and managers’ incentives and actions to manage perceptions. Furthermore, we find that tone dispersion is associated with analysts’ and investors’ responses to conference call narratives. Our results suggest that tone dispersion both reflects and affects the information that managers convey through their narratives.
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Managerial Ownership and Earnings Management: Evidence from Stock Ownership Plans
Phillip Quinn
University of Washington Working Paper, December 2014
Abstract:
Stock ownership plans require executives to hold a minimum level of stock. I exploit the changes in stock ownership following plan adoptions to examine the relation between managerial ownership and earnings management. In contrast to prior work that suggests equity incentives induce opportunistic earnings management, I find evidence of a reduction in earnings management for adoption firms relative to a propensity-matched control sample. Splitting adopters into firms with plans that required increases in ownership and firms with plans that did not, I find the reductions in earnings management are concentrated in firms that required increases in managerial ownership. Thus, I document evidence that mandatory managerial ownership increases lead to a reduction in earnings management.
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The market response to corporate scandals involving CEOs
Surendranath Jory et al.
Applied Economics, Spring 2015, Pages 1723-1738
Abstract:
This article examines corporate scandals of both a financial and nonfinancial nature between 1993 and 2011 which is expressly linked to a firm’s CEO. Findings suggest that in the short run, investors react adversely to such events and that recalcitrant CEOs end up costing their shareholders dearly. Such scandals are more likely to occur among large firms, firms with insiders on the board and where the value of options granted to a firm’s managers is substantial. However, firms with more cash flows are less likely to be mired in such scandals, and their stock returns are less likely to be affected. There is an increase in stock price volatility of affected firms in the days following the announcement of the scandal. A point of respite for investors is the damage being confined to the short run. The stock price performance of the firms affected by the scandals matches the performance of control firms in the long run post-announcement. However, the operating performance of the sample firms is better than their matched counterparts in the years after the scandal. We contribute to the extant literature by considering corporate scandal events that are the doings of a firm’s CEO and not necessarily financially motivated.
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Which Skills Matter in the Market for CEOs? Evidence from Pay for CEO Credentials
Antonio Falato, Dan Li & Todd Milbourn
Management Science, forthcoming
Abstract:
Market-based theories predict that differences in CEO skills lead to potentially large differences in pay, but it is challenging to quantify the CEO skill premium in pay. In a first step toward overcoming this empirical challenge, we code detailed biographical information for a large sample of CEOs for a panel of S&P 1500 firms between 1993 and 2005 to identify specific reputational, career, and educational credentials that are indicative of skills. Newly appointed CEOs earn up to a 5% or $280,000 total pay premium per credential decile, which is concentrated among CEOs with better reputational and career credentials, those with the very best credentials, and those who run large firms. Consistent with the unique economic mechanism of market-based theories, CEO credentials have a positive impact on firm performance. The performance differential for newly appointed CEOs is up to 0.5% per credential decile and is also concentrated among CEOs with better reputational and career credentials and those at large firms. Credentials are positively correlated with unobserved CEO heterogeneity in pay and performance, which further validates our hypothesis that boards use them as publicly observable signals of otherwise hard-to-gauge CEO skills. In all, our results offer direct evidence in support of market-based explanations of the overall rise in CEO pay.
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M&A Negotiations and Lawyer Expertise
Christel Karsten, Ulrike Malmendier & Zacharias Sautner
University of California Working Paper, September 2014
Abstract:
We shed light on the effects of lawyer expertise on contract design in the context of M&A negotiations. Using proprietary data on 151 private transactions, we document that lawyer expertise significantly affects contract design. More lawyer expertise is associated with more beneficial contractual outcomes in terms of warranties, implicit risk-shifting, and in terms of length of the negotiation among other outcomes. In order to address concerns about the endogenous allocation of lawyers to deals or clients, we exploit firms’ inclination to work with the same lawyer (“house lawyer”) on subsequent deals and restrict the analysis to repeated deals. We also perform lawyer fixed-effect and client fixed-effect analyses. Our results help explain the importance of league table rankings and the variation in legal fees within the legal M&A services industry.
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Does Takeover Activity Cause Managerial Discipline? Evidence from International M&A Laws
Ugur Lel & Darius Miller
Review of Financial Studies, forthcoming
Abstract:
This paper exploits the staggered initiation of takeover laws across countries to examine whether the threat of takeover enhances managerial discipline. We show that following the passage of takeover laws, poorly performing firms experience more frequent takeovers; the propensity to replace poorly performing CEOs increases, especially in countries with weak investor protection; and directors of targeted firms are more likely to lose board seats following corporate-control events. Our findings suggest that the threat of takeover causes managerial discipline through the incentives that the market for corporate control provides to boards to monitor managers.
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Gender Diversity and Securities Fraud
Douglas Cumming, Tak Leung & Oliver Rui
Academy of Management Journal, forthcoming
Abstract:
We formulate theory on the effect of board of director gender diversity on the broad spectrum of securities fraud and generate three main insights. First, based on ethicality, risk aversion, and diversity, we hypothesize that gender diversity on boards can operate as a significant moderator for the frequency of fraud. Second, we hypothesize that the stock market response to fraud from a more gender-diverse board is significantly less pronounced. Third, we hypothesize that women are more effective in male-dominated industries in reducing both the frequency and severity of fraud. Our first-ever empirical tests, based on data from a large sample of Chinese firms that committed securities fraud, are largely consistent with each of these hypotheses.
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Rob Bauer, Frank Moers & Michael Viehs
Corporate Governance, forthcoming
Research Question/Issue: We study more than 12,000 shareholder proposals that were filed to S&P1500 companies from 1997 to 2009, and investigate the determinants of proposal withdrawal by the sponsoring shareholder. We also study the effectiveness of withdrawn proposals as a corporate governance device.
Research Findings/Insights: We find that proposals filed by influential investors are more likely to be withdrawn than proposals filed by private investors. Our empirical results show that institutional ownership (in particular by long-term, passively investing institutions) is positively related to a proposal's withdrawal likelihood if the sponsoring shareholder is an institutional investor. We also document a negative relation between CEO ownership and the withdrawal likelihood. This effect is most pronounced for corporate governance proposals. We also show that withdrawn proposals on executive compensation change subsequent corporate pay practices.
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Board Independence and Corporate Investments
Jun Lu & Wei Wang
Review of Financial Economics, January 2015, Pages 52–64
Abstract:
This research investigates whether and how board independence influences corporate investment decisions in a Seemingly Unrelated Regression (SUR) framework, where the capital investment and the research and development (R&D) investment are examined simultaneously. We argue that the free cash flow problem primarily inflicts capital investments, while the managerial conservatism mainly undercuts the more risky R&D investments. Consistent with independent board mitigating both agency problems, we find that firms with a higher degree of board independence is negatively associated with capital investments but positively associated with R&D investments, after controlling for common determinants of investments. We address the endogeneity of board independence by exploiting an exogenous change in board structure brought about by the Sarbanes-Oxley Act (SOX) and continue to find consistent results.
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Out-of-the-Money CEOs: How Do Proxy Contests Affect Insider Option Exercises
Vyacheslav Fos & Wei Jiang
Columbia University Working Paper, June 2014
Abstract:
When a proxy contest is looming, the rate at which CEOs exercise options in order to sell (hold) the resulting shares slows down by 80% (accelerates by 60%), consistent with their desire to maintain or strengthen voting rights when facing control challenges. Such deviations are closely aligned with features unique to proxy contests, e.g., the record dates and nomination status. Moreover, a contest triples the probability that an insider exercises options out-of-the-money, an irrational strategy under conventional models. The various distortions suggest that incumbents (with private benefits of control) value their stocks 5% – 20% higher than the market price.