Aboveboard
Corporate Jets and Private Meetings with Investors
Brian Bushee, Joseph Gerakos & Lian Fen Lee
University of Chicago Working Paper, November 2014
Abstract:
We examine whether corporate jet flight patterns can be used to identify private meetings between managers and investors that are ex ante unobservable to non-participants. We predict that such meetings enable select investors to supplement and trade on their private information, leading to price and volume reactions during the flight periods, as well as changes in local institutional investor ownership. Using a sample of almost 400,000 flights undertaken by 396 firms between 2007 and 2010, we proxy for private meetings with "road shows," which are three-day windows that include jet flights to multiple cities in which the firm has high institutional ownership. First, we find that the number of road show flights is significantly associated with a number of proxies for incentives to meet privately with investors. Second, we find that three-day windows including road show flights exhibit significantly greater abnormal market reactions than other flight windows. Finally, we show that flights to metro areas are positively associated with changes in local institutional ownership that anticipate future returns. Overall, our evidence suggests that these private meetings are an important information event for the participating investors, who potentially gain an advantage over non-participating investors who have no public notice of the meetings.
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Dispersed Information and CEO Incentives
Jan Schneemeier
University of Chicago Working Paper, November 2014
Abstract:
I measure the social cost of stock-based compensation schemes in a model in which the CEO learns from market prices. In my model all agents commit a small correlated error when forming their expectations about future productivity. The equilibrium stock price thus aggregates private information with noise. I show that a stock-based compensation scheme leads the CEO to overuse the price information by a factor of three, which in turn makes the excess return and investment growth excessively volatile. I calibrate a DSGE model that embeds this mechanism and estimate an implied welfare loss of 0.55% of permanent consumption. Surprisingly, if households were given the choice within this model of preserving the status quo or forcing the CEO to ignore all price information, they would choose the latter.
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The Costs of a (Nearly) Fully Independent Board
Olubunmi Faleye
Journal of Empirical Finance, forthcoming
Abstract:
A significant and growing percentage of U.S. firms now have boards where the CEO is the only employee director (hereinafter fully independent boards). This paper studies whether and how this practice impacts board effectiveness. I find that fully independent boards are associated with a significant reduction in firm performance. Further tests suggest two channels for this effect. First, full independence deprives the board of spontaneous and regular access to the firm-specific information of other senior executives. Second, full independence eliminates the first-hand exposure of future CEOs to board-level discussions of strategy, which steepens the learning curve for eventually promoted candidates.
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Agency Problems of Corporate Philanthropy
Ronald Masulis & Syed Walid Reza
Review of Financial Studies, February 2015, Pages 592-636
Abstract:
Evaluating agency theory and optimal contracting theory views of corporate philanthropy, we find that as corporate giving increases, shareholders reduce their valuation of firm cash holdings. Dividend increases following the 2003 Tax Reform Act are associated with reduced corporate giving. Using a natural experiment, we find that corporate giving is positively (negatively) associated with CEO charity preferences (CEO shareholdings and corporate governance quality). Evidence from CEO-affiliated charity donations, market reactions to insider-affiliated donations, its relation to CEO compensation, and firm contributions to director-affiliated charities indicates that corporate donations advance CEO interests and suggests misuses of corporate resources that reduce firm value.
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Executive Compensation, Organizational Performance, and Governance Quality in the Absence of Owners
Ashley Newton
Journal of Corporate Finance, forthcoming
Abstract:
I study the relationship between chief executive compensation, organizational performance, and governance quality in large U.S. nonprofits. Due in large part to the absence of shareholders, the nonprofit sector is characterized by weaker monitoring mechanisms and potentially more severe agency problems relative to their for-profit counterparts. As a result, there have been numerous instances of executive abuse, such as exorbitant pay for very little work. Despite the size of the nonprofit sector (5.5% of GDP and 9% of employment) and the obvious monitoring and legal responsibility concerns, governance issues at nonprofits have received much less attention than that at for-profits. Using recent IRS data on governance practices at nonprofits, I find that, after controlling for known determinants, both the CEO-to-employee relative pay ratio and the consumption of perquisites are significantly negatively related to an index of nonprofit governance quality. Furthermore, consistent with governance problems at nonprofits and inconsistent with the Pay-for-Performance Hypothesis, I find a significant negative relationship between CEO-to-employee relative pay and multiple measures of nonprofit performance. These results highlight the importance of strong governance mechanisms in mitigating high levels of relative pay to and poor performance by executives in organizations marred by severe agency conflicts and ineffective monitoring mechanisms.
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Pay Me Now (and Later): Bonus Boosts Before Pension Freezes and Executive Departures
Irina Stefanescu, Kangzhen Xie & Jun Yang
Federal Reserve Working Paper, December 2014
Abstract:
We show that large public companies in the United States change the assumptions of the pension benefit formulas for their top executives in anticipation of defined benefit plan freezes and before executive retirements. In particular, top executives receive larger annual bonuses (an input of the pension benefit formula) before these events. Our findings are not driven by performance or other known determinants of annual bonuses and are not mirrored by increases in equity awards (which do not affect pension benefits). We document yet another mechanism through which top executives capture wealth at the expense of shareholders and regular employees.
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Litigation Risk and Agency Costs: Evidence from Nevada Corporate Law
Dain Donelson & Christopher Yust
Journal of Law and Economics, August 2014, Pages 747-780
Abstract:
In 2001, Nevada significantly limited the personal legal liability of corporate officers and directors. We use this exogenous shock to implement a differences-in-differences design that examines the impact of officer and director litigation risk on agency costs. We find decreased firm value, especially for firms with lower levels of investor protection and the highest expected agency costs. We also find that managerial incentives are reduced as measured by lower chief executive officers' pay-for-performance sensitivity. Finally, we find an adverse impact on operating performance and increased error-based restatements for Nevada firms subsequent to the change. Our findings emphasize that officer and director litigation risk is an important governance mechanism.
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The Effect of Repatriation Tax Costs on U.S. Multinational Investment
Michelle Hanlon, Rebecca Lester & Rodrigo Verdi
Journal of Financial Economics, forthcoming
Abstract:
This paper investigates whether the U.S. repatriation tax for U.S. multinational corporations affects foreign investment. Our results show that the locked-out cash due to repatriation tax costs is associated with a higher likelihood of foreign (but not domestic) acquisitions. We also find a negative association between tax-induced foreign cash holdings and the market reaction to foreign deals. This result suggests that the investment activity of firms with high repatriation tax costs is viewed by the market as less value-enhancing than that of firms with low tax costs, consistent with foreign investment of firms with high repatriation tax costs possibly reflecting agency-driven behavior.
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Pay-performance sensitivity before and after SOX
Hui Chen, Debra Jeter & Ya-Wen Yang
Journal of Accounting and Public Policy, forthcoming
Abstract:
The purpose of this paper is to investigate the impact on pay-performance sensitivity of the Sarbanes-Oxley Act (SOX), an effect that has been examined in prior research but with often conflicting findings. Using a more comprehensive sample of executives and of compensation components than in prior research, we compare managers' pay-performance sensitivity before and after 2001-2002, a period during which regulatory changes were initiated to increase scrutiny over managerial manipulation and improve financial reporting quality. Based on ExecuComp data from 1992 to 2005 (and excluding the years 2001 and 2002), our results show that pay-performance sensitivity using either market-based or accounting-based measures of performance increased significantly following these events. When we further decompose executive pay into its cash-based and equity-based components, we find evidence of an increase in the link between performance and executive compensation for five of six measures for each performance metric. Thus, in contrast to most prior studies on the impact of SOX on executive incentives and compensation, our evidence is consistent with an improvement rather than weakening in the alignment of managerial and shareholder interests.
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Do Corporate Managers Skimp on Shareholders' Dividends to Protect their Own Retirement Funds?
Assaf Eisdorfer, Carmelo Giaccotto & Reilly White
Journal of Corporate Finance, forthcoming
Abstract:
What is the impact of long-term executive compensation, particularly large pension payouts, on the firm's current dividend policy? We argue that managers with high pension holdings are less likely to adopt a high dividend policy that can risk their future pension payouts. Using a hand-collected actuarial pension dataset we show that (i) dividend payments are significantly lower when manager compensation relies more heavily on pension payouts; (ii) higher compensation leverage and inside debt have a significant negative effect on dividend payments net of stock repurchases; and (iii) the negative effect of pension on dividend is significantly weaker when pensions are protected in a pre-funding rabbi trust. We show further that this agency behavior reduces firm performance.
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CEO Tenure and Earnings Management
Ashiq Ali & Weining Zhang
Journal of Accounting and Economics, February 2015, Pages 60-79
Abstract:
This study examines changes in CEOs' incentive to manage their firms' reported earnings during their tenure. Earnings overstatement is greater in the early years than in the later years of CEOs' service, and this relation is less pronounced for firms with greater external and internal monitoring. These results suggest that new CEOs try to favorably influence the market's perception of their ability in their early years of service, when the market is more uncertain. Also, consistent with the horizon problem, earnings overstatement is greater in the CEOs' final year, but this result obtains only after controlling for earnings overstatement in their early years of service.
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Managerial Attitudes and Takeover Outcomes: Evidence From Corporate Filings
Shan Yan
Journal of International Financial Markets, Institutions and Money, forthcoming
Abstract:
We examine the textual content of merger and acquisition related SEC filings in an effort to understand the role of managerial attitudes and beliefs in merger negotiations and outcomes. Using a textual algorithm to identify the degree to which filings of bidders and targets exhibit negative/cautious tones vs. positive/optimistic tones, we find that bidders employing the most optimistic language in their filings actually experience the worst long-run performance following the transactions. In contrast, bidding managers who appear to acknowledge and understand the risks of the transactions experience relatively better post-merger performance. Thus our analysis of the textual content of merger filings appears to give us a new method for investigating the role of bidder and target attitudes and beliefs on merger outcomes.
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Is Tone at the Top Associated with Financial Reporting Aggressiveness?
Lorenzo Patelli & Matteo Pedrini
Journal of Business Ethics, January 2015, Pages 3-19
Abstract:
The discussion about the relationship between tone at the top and financial reporting practices has been primarily focused on the oversight role played by the board of directors and other structural elements of corporate governance. Another relevant determinant of tone at the top is the corporate narrative language, since it is a fundamental way in which the chief executive officer (CEO) enacts leadership. In this study, we empirically explore the association between financial reporting aggressiveness and five thematic indicators capturing different traits of ethical leadership from 535 annual letters to shareholders. We find that aggressive financial reporting is positively associated with CEO letters using a language which is resolute, complex, and not engaging. Our empirical findings highlight the importance of examining discretionary corporate narratives for the auditing process and the role of tone at the top in influencing accounting practices.
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Evidence on the Outcome of Say-On-Pay Votes: How Managers, Directors, and Shareholders Respond
Kelly Brunarski, Colin Campbell & Yvette Harman
Journal of Corporate Finance, February 2015, Pages 132-149
Abstract:
The economic value of the Say-on-Pay (SOP) provision of the Dodd-Frank Act has been a subject of debate. Proponents of this provision suggest these votes benefit shareholders by increasing investor influence over managerial compensation. Opponents of the SOP provision believe compensation contracting is better done by well-informed and unobstructed boards of directors. Our study provides direct evidence on the impact of the shareholder SOP votes by examining responses to the vote. We find that overcompensated managers with low SOP support tend to react by increasing dividends, decreasing leverage and increasing corporate investment. However, we find no evidence that management's response to the vote affects subsequent vote outcomes, nor do we find a subsequent change in firm value. Finally, we find excess compensation increases for managers that were substantially overpaid prior to the SOP vote, regardless of the outcome of the vote. Thus, it does not appear that the SOP legislation has had the intended effect of improving executive contracting.
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Group judgment and advice-taking: The social context underlying CEO compensation decisions
Bryan Bonner & Brian Cadman
Group Dynamics, December 2014, Pages 302-317
Abstract:
Groups are often tasked with making important organizational decisions. For example, CEO compensation judgments are made by groups of decision makers with no specialized compensation training who receive advice from a third party with a potential bias. This study seeks to understand the effects of this challenging context on decision making. We explore whether and how decision makers adjust their judgments, considering the potential for advisor bias. This is an essential issue in CEO compensation that is difficult to assess through traditional archival research based on publicly available data. Our study explores how decision makers, in the context of compensation committees, process and use advice provided by external parties. Our findings illustrate that individuals adjust for known conflicts of interest in the information provided to them. However, we do not find that individuals discount lavish advice to a greater extent than more modest advice, and the group decision-making process fails to correct for this tendency.
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Pandej Chintrakarn et al.
Applied Economics Letters, Winter 2015, Pages 312-317
Abstract:
We examine the impact of corporate governance quality on the extent of analyst coverage. The evidence based on nearly 3000 firms indicates that more analysts are likely to cover firms with weaker corporate governance. In particular, as corporate governance quality falls by one SD, analyst following increases by 11.40%. Our evidence is consistent with the notion that poor governance results in a wider divergence between the stock's market price and the fundamental value. Analysts prefer to cover companies with poor governance because it allows them to generate trading commissions by offering shareholders a particularly compelling story about why a stock's fundamental value and the current price differ.
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The Impact of Personal Attributes on Corporate Insider Trading
David Hillier, Adriana Korczak & Piotr Korczak
Journal of Corporate Finance, February 2015, Pages 150-167
Abstract:
We analyze the importance of personal attributes in explaining the performance of reported share transactions by corporate insiders. While prior literature has focused on observable firm and trade characteristics, little effort has been made to understand how individual attributes, such as skills, abilities, or personality, impact upon post-trade abnormal returns. We document that personal attributes explain up to a third of the variability in insider trading performance and dominate unobservable and observable firm and trade characteristics by a sizeable margin. Personal attributes are correlated with the insider's year of birth, education and gender, and matter more in companies with greater information asymmetry and when outsiders are inattentive to public information. We shed also new light on the significance of executive hierarchy and regulations in explaining insider trading performance and highlight the importance of controlling for individual fixed effects in insider trading research to avoid omitted variable bias in estimated regression coefficients.
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Corporate General Counsel and Financial Reporting Quality
Justin Hopkins, Edward Maydew & Mohan Venkatachalam
Management Science, forthcoming
Abstract:
We examine the role of general counsel (GC) in firms' financial reporting quality. GCs have a broad oversight role within the firm, including keeping the firm in compliance with laws and regulations and dealing with potential violations with respect to financial reporting. Several high-profile U.S. Securities and Exchange Commission (SEC) investigations have resulted in lawsuits or indictments against GCs for perpetrating financial fraud and caused many to ask: where were the gatekeepers? As such, we examine the conditions under which GCs may stray from their primary role as gatekeepers. Mainly, we empirically investigate claims that compensation can impair the independence or compromise the professional judgment of a GC. We measure the level of compensation using the GC's presence or absence in the top five officers of the firm by compensation. Results are consistent with GCs straying from their role as gatekeepers, to some extent, when highly compensated in a manner similar to the CEO and CFO. In particular, firms with highly compensated GCs have lower financial reporting quality and more aggressive accounting practices, including management of the litigation reserve. However, the results also show that highly compensated GCs play an important gatekeeping role in keeping the firm in compliance with generally accepted accounting principles. Thus, highly compensated GCs appear to tolerate moderately aggressive behavior but constrain it such that it would not result in violation of securities laws and jeopardize their standing within the firm.
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Strategic silence, insider selling and litigation risk
Mary Brooke Billings & Matthew Cedergren
Journal of Accounting and Economics, forthcoming
Abstract:
Prior work finds that managers beneficially time their purchases, but not sales, prior to forecasts. Focusing on if (as opposed to when) a forecast is given, we link insider selling to silence in advance of earnings disappointments. This raises the question of whether the absence of incriminating trading drives reductions in litigation risk potentially attributed to warnings. We find that the absence of a warning combined with the presence of selling exacerbates the consequences associated with the individual behaviors. Yet, selling prior to a warning typically does not offset all of the warning's benefit. In so doing, we supply the first robust evidence of a litigation benefit associated with warning.