Corporate veil
Religion and Stock Price Crash Risk
Jeffrey Callen & Xiaohua Fang
Journal of Financial and Quantitative Analysis, forthcoming
Abstract:
This study examines whether religiosity at the county level is associated with future stock price crash risk. We find robust evidence that firms headquartered in counties with higher levels of religiosity exhibit lower levels of future stock price crash risk. This finding is consistent with the view that religion, as a set of social norms, helps to curb bad news hoarding activities by managers. Our evidence further shows that the negative relation between religiosity and future crash risk is stronger for riskier firms and for firms with weaker governance mechanisms measured by shareholder takeover rights and dedicated institutional ownership.
----------------------
Efraim Benmelech & Carola Frydman
NBER Working Paper, January 2014
Abstract:
There is mounting evidence of the influence of personal characteristics of CEOs on corporate outcomes. In this paper we analyze the relation between military service of CEOs and managerial decisions, financial policies, and corporate outcomes. Exploiting exogenous variation in the propensity to serve in the military, we show that military service is associated with conservative corporate policies and ethical behavior. Military CEOs pursue lower corporate investment, are less likely to be involved in corporate fraudulent activity, and perform better during industry downturns. Taken together, our results show that military service has significant explanatory power for managerial decisions and firm outcomes.
----------------------
Nicholas Rule & Konstantin Tskhay
Leadership Quarterly, forthcoming
Abstract:
Inferences of leadership ability and personality from faces have been associated with leaders' efficacy across multiple domains. One influential factor that has only been scarcely explored, however, is the context in which leadership occurs. The present studies examined the effect of two such contextual variables: economic conditions across time and economic conditions across nations. In Study 1, inferences of leadership ability from the faces of American Chief Executive Officers (CEOs) predicted their companies' financial performance prior to the Financial Crisis of 2008 but not after. In Study 2, traits previously found to predict the success of American CEOs before the Financial Crisis (i.e., Power) predicted the success of CEOs in Germany in the year following the crisis but not in the US, consistent with the differential impact of the international recession in the two nations. These results suggest that economic events may affect the relationship between facial appearance and business leaders' success.
----------------------
Financial Crisis And Bank Executive Incentive Compensation
Sanjai Bhagat & Brian Bolton
Journal of Corporate Finance, April 2014, Pages 313–341
Abstract:
We study the executive compensation structure in 14 of the largest U.S. financial institutions during 2000–2008. We focus on the CEO’s purchases and sales of their bank’s stock, their salary and bonus, and the capital losses these CEOs incur due to the dramatic share price declines in 2008. We consider three measures of risk-taking by these banks. Our results are mostly consistent with and supportive of the findings of Bebchuk, Cohen and Spamann (2010), that is, managerial incentives matter - incentives generated by executive compensation programs are correlated with excessive risk-taking by banks. Also, our results are generally not supportive of the conclusions of Fahlenbrach and Stulz (2011) that the poor performance of banks during the crisis was the result of unforeseen risk. We recommend bank executive incentive compensation should only consist of restricted stock and restricted stock options – restricted in the sense that the executive cannot sell the shares or exercise the options for two to four years after their last day in office. The above incentive compensation proposal logically leads to a complementary proposal regarding a bank’s capital structure, namely, banks should be financed with considerably more equity than they are being financed currently.
----------------------
Right on Schedule: CEO Option Grants and Opportunism
Robert Daines, Grant Richard McQueen & Robert Schonlau
Stanford Working Paper, December 2013
Abstract:
In the wake of the backdating scandal, many firms began awarding options at the same time each year. These scheduled option grants eliminate backdating, but create other agency problems. CEOs that know the dates of upcoming scheduled option grants have an incentive to temporarily depress stock prices before the grant dates to obtain options with lower strike prices. We provide evidence that CEOs respond to this incentive and document negative abnormal returns before scheduled option grants and positive abnormal returns after the grants. These returns are explained by measures of a CEO's incentive and ability to influence stock price. We document several mechanisms CEOs use to lower the strike price, including changing the substance and timing of the firm’s disclosures.
----------------------
Peter Cebon & Benjamin Hermalin
University of California Working Paper, December 2013
Abstract:
We derive conditions under which state-imposed limits on executive compensation can enhance efficiency and benefit shareholders (but not executives). Having their hands tied in the future allows a board of directors to credibly enter into relational contracts with executives that are more efficient than performance-based contracts. This in turn can have implications for firm strategy and the ideal composition of the board. The analysis also offers insights into the political economy of executive-compensation reform.
----------------------
Political Connections and the Cost of Bank Loans
Joel Houston et al.
Journal of Accounting Research, March 2014, Pages 193–243
Abstract:
This paper analyzes whether the political connections of listed firms in the United States affect the cost and terms of loan contracts. Using a hand-collected data set of the political connections of S&P 500 companies over the 2003–2008 time period, we find that the cost of bank loans is significantly lower for companies that have board members with political ties. We consider two possible explanations for these findings: a Borrower Channel in which lenders charge lower rates because they recognize that connections enhance the borrower's credit worthiness and a Bank Channel in which banks assign greater value to connected loans to enhance their own relationships with key politicians. After employing a series of tests to distinguish between these two channels, we find strong support for the Borrower Channel but no direct evidence supporting the Bank Channel. Finally, we demonstrate that political connections reduce the likelihood of a capital expenditure restriction or liquidity requirement commanded by banks at the origination of the loan. Taken together, our results suggest that political connections increase the value of U.S. companies and reduce monitoring costs and credit risk faced by banks, which in turn, reduces the borrower's cost of debt.
----------------------
Executive Compensation and Board Governance in US Firms
Martin Conyon
Economic Journal, forthcoming
Abstract:
US executive compensation has increased significantly since the early 1990s. This growth has been associated with the use of more equity pay (such as stock options and restricted stock) and less reliance on fixed salaries. Critics assert that the growth in CEO pay reflects a fundamental governance failure. Weak or compliant boards have failed to reign in managerial 'excess’. In practice, compensation committees determine executive pay contracts. Using US data from 2007 to 2012 I show that boards and compensation committees have become increasingly independent. I find no evidence that boards or compensation committees containing affiliated (i.e. nonindependent directors) are associated with higher levels of executive pay. The causes of high US compensation seem to lie elsewhere - not with a failure of compensation committees. In addition, the study finds that on average executive pay is positively correlated to firm performance and firm size. Women executives are paid less than their male counterparts after controlling for other economic determinants of executive pay. The governance of executive pay is changing post Dodd Frank. I show that the market for compensation advice is dominated by relatively few compensation consultants who are generally engaged by the board and not management. I also show the outcomes of non-binding mandatory shareholder voting on executive compensation ('Say on Pay’). Typically, shareholders overwhelmingly endorse executive pay plans at S&P 500 firms. Less than 2% of executive pay resolutions fail.
----------------------
Board Changes and CEO Turnover: The Unanticipated Effects of the Sarbanes-Oxley Act
Mustafa Dah, Melissa Frye & Matthew Hurst
Journal of Banking & Finance, April 2014, Pages 97–108
Abstract:
The board independence requirements enacted in conjunction with the Sarbanes Oxley Act of 2002 (SOX) provided motivation for firms that were already compliant with the regulations to alter their board structure. We consider actual board changes made by compliant firms and how such changes affect the monitoring efficiency of the boards. We find that the majority of compliant firms (approximately 56%) add independent directors following SOX. However, we find a nontrivial number of firms (approximately 26%) actually decrease the number of independent directors to move closer to the stated 50% requirement. For firms that decrease independence, the CEO turnover performance sensitivity significantly decreases following SOX. We also find that large board independence changes seem to be most detrimental to the monitoring function of the board. Our results highlight that SOX may have had unintended consequences.
----------------------
CEO Ownership, Stock Market Performance, and Managerial Discretion
Ulf von Lilienfeld-Toal & Stefan Ruenzi
Journal of Finance, forthcoming
Abstract:
We examine the relationship between CEO ownership and stock market performance. A strategy based on public information about managerial ownership delivers annual abnormal returns of 4% to 10%. The effect is strongest among firms with weak external governance, weak product market competition, and large managerial discretion, suggesting that CEO ownership can reverse the negative impact of weak governance. Furthermore, owner-CEOs are value increasing: they reduce empire building and run their firms more efficiently. Overall, our findings indicate that the market does not correctly price the incentive effects of managerial ownership, suggesting interesting feedback effects between corporate finance and asset pricing.
----------------------
Powerful Independent Directors
Kathy Fogel, Liping Ma & Randall Morck
NBER Working Paper, January 2014
Abstract:
Shareholder valuations are economically and statistically positively correlated with more powerful independent directors, their power gauged by social network power centrality measures. Sudden deaths of powerful independent directors significantly reduce shareholder value, consistent with independent director power “causing” higher shareholder value. Further empirical tests associate more powerful independent directors with fewer value-destroying M&A bids, more high-powered CEO compensation and accountability for poor performance, and less earnings management. We posit that more powerful independent directors can better detect and counter managerial missteps because of their better access to information, their greater credibility in challenging errant top managers, or both.
----------------------
Public Equity and Audit Pricing in the U.S.
Brad Badertscher et al.
Journal of Accounting Research, forthcoming
Abstract:
To what degree are audit fees for U.S. firms with publicly traded equity higher than fees for otherwise similar firms with private equity? The answer is potentially important for evaluating regulatory regime design efficiency and for understanding audit demand and production economics. For U.S. firms with publicly-traded debt, we hold constant the regulatory regime, including mandated issuer reporting and auditor responsibilities. We vary equity ownership and thus public securities market contextual factors, including any related public firm audit fees from increased audit effort to reduce audit litigation risk and/or pure litigation risk premium (litigation channel effects). In cross-section, we find that audit fees for public equity firms are 20% to 22% higher than fees for otherwise similar private equity firms. Time-series comparisons for firms that change ownership status yield larger percentage fee increases (decreases) for those going public (private). Results are consistent with litigation channel effects giving rise to substantial incremental audit fees for U.S. firms with public equity ownership.
----------------------
CEO Age and the Riskiness of Corporate Policies
Matthew Serfling
Journal of Corporate Finance, April 2014, Pages 251–273
Abstract:
Prior theoretical work generates conflicting predictions with respect to how CEO age impacts risk-taking behavior. Consistent with the prediction that risk-taking behavior decreases as CEOs become older, I document a negative relation between CEO age and stock return volatility. Further analyses reveal that older CEOs reduce firm risk through less risky investment policies. Specifically, older CEOs invest less in research and development, make more diversifying acquisitions, manage firms with more diversified operations, and maintain lower operating leverage. Further, firm risk and the riskiness of corporate policies are lowest when both the CEO and the next most influential executive are older and highest when both of these managers are younger. Although older CEOs prefer less risky investment policies, I document results suggesting that CEO and firm risk preferences tend to be aligned. Lastly, I find that a trading strategy that goes long in a portfolio of stocks consisting of firms managed by younger CEOs and short in a portfolio of stocks comprised of firms led by older CEOs would generate positive risk-adjusted returns. Overall, my results imply that CEO age can have a significant impact on risk-taking behavior and firm performance.
----------------------
The Impact of Targets’ Social Performance on Acquisition Premiums
Mahfuja Malik
Boston University Working Paper, January 2014
Abstract:
This paper examines whether the corporate social responsibility (CSR) performance of target firms influences the acquisition premiums paid by the acquirers. Using U.S. public merger and acquisition (M&A) deals, I find that acquisition premiums increase in the targets’ perceived CSR quality, an effect incremental to previously-documented drivers of such premiums. These findings are also robust to (1) using different proxies for CSR measures and acquisition premiums, and (2) considering various dimensions of CSR (environment, community, employee, product, and diversity). Additional analysis reveals that the positive association between target firms’ CSR quality and acquisition premiums is stronger for high-CSR acquirers and larger targets. Overall, I combine the CSR and M&A literature by demonstrating that superior quality CSR performance affects acquisition premiums positively and thus expand our understanding of the value-driven role of CSR initiatives in a unique way.
----------------------
Do Overvaluation-driven Stock Acquisitions Really Benefit Acquirer Shareholders?
Mehmet Akbulut
Journal of Financial and Quantitative Analysis, August 2013, Pages 1025-1055
Abstract:
I study the effects of overvalued equity on acquisition activity and shareholder wealth, using managers’ insider trades to measure overvaluation. I find that overvalued equity drives managers to make stock acquisitions, and such acquisitions destroy value for acquirer shareholders. Overvalued stock acquirers earn negative and lower returns in the short run and substantially underperform similarly overvalued non-acquirer firms in the long run. My results do not support the idea that managers can benefit shareholders by converting overvalued equity into real assets through stock acquisitions.
----------------------
Jason Ridge, Federico Aime & Margaret White
Strategic Management Journal, forthcoming
Abstract:
We integrate the seemingly contradictory theoretical predictions of behavioral and economic perspectives about the relationship between pay disparity and firm performance and show that tournament and social comparison theories are more supplementary than contradictory in nature. Our results show that high levels of firm performance will be found around either meaningfully low or meaningfully high levels of pay disparity. Additional findings indicate that this curvilinear relationship is weakened in the presence of both an heir apparent and high CEO power, and strengthened when top management team members are more eligible as CEOs. These findings suggest that factors that increase or inhibit social comparison or tournament perceptions among TMT members play a role in the strength of the curvilinear relationship between pay disparity and firm performance.
----------------------
Thirty Years of Shareholder Rights and Firm Value
Martijn Cremers & Allen Ferrell
Journal of Finance, forthcoming
Abstract:
This paper introduces a new hand-collected data set that tracks restrictions on shareholder rights at approximately 1,000 firms from 1978 to 1989. In conjunction with the 1990 to 2006 IRRC data, we track shareholder rights over 30 years. Most governance changes occurred during the 1980s. We find a robustly negative association between restrictions on shareholder rights (using G-Index as a proxy) and Tobin's Q. The negative association only appears after judicial approval of antitakeover defenses in the 1985 landmark Delaware Supreme Court decision of Moran v. Household. This decision was an unanticipated exogenous shock that increased the importance of shareholder rights.
----------------------
Board composition and CEO power
Tim Baldenius, Nahum Melumad & Xiaojing Meng
Journal of Financial Economics, forthcoming
Abstract:
We study the optimal composition of corporate boards. Directors can be either monitoring or advisory types. Monitoring constrains the empire-building tendency of chief executive officers (CEOs). If shareholders control the board nomination process, a non-monotonic relation ensues between agency problems and board composition. To preempt CEO entrenchment, shareholders may assemble an adviser-heavy board. If a powerful CEO influences the nomination process, this may result in a more monitor-heavy board. Regulations strengthening the monitoring role of boards can be harmful in precisely those cases in which agency problems are severe or in which CEO entrenchment is a threat to corporate governance.
----------------------
Director Human Capital, Information Processing Demands, and Board Effectiveness
Poonam Khanna, Carla Jones & Steven Boivie
Journal of Management, February 2014, Pages 557-585
Abstract:
Research on human capital as a source of competitive advantage has focused largely on firm employees. In this article, we argue that outside directors’ general human capital can also be a source of competitive advantage. Firm performance is likely to benefit from directors’ human capital — that is, their prior experience and education — because such human capital is likely to make them more effective at monitoring management and providing advice. Drawing on insights from research on individuals’ cognitive limitations, we further argue that the extent to which the firm is able to benefit from this human capital can be severely limited by the demands for information processing that directors face from their other board positions. Consequently, we find that the benefit of directors’ human capital is contingent upon the information processing load placed upon them from their other board appointments. We find support for our hypotheses using data on over 5,700 directors from 650 firms sampled from the Fortune 1000. This study extends the nascent literature on board human capital by showing that in addition to specific expertise in relevant areas, directors’ general human capital can also help firms create competitive advantage. The theory developed in this article also contributes to the literature on strategic human capital by incorporating the concept of information processing demands, suggesting that not only do such demands leave limited cognitive capacity for directors to focus on the focal firm but also that they can severely diminish the beneficial effects of directors’ general human capital.
----------------------
A Structural Estimation of the Cost of Suboptimal Matching in the CEO Labor Market
Jordan Nickerson
University of Texas Working Paper, November 2013
Abstract:
Using a structural model, I examine the distortionary effects of frictions in the CEO labor market. Firms experience productivity shocks over time and either outgrow or underutilize their incumbent CEO's talent, but keep their manager to avoid a switching cost. The decision to replace a manager depends on the magnitude of the cost and dispersion of CEO talent. I find CEO talent to be quite heterogeneous. Additionally, I estimate the switching cost to be 20% of the median firm's annual earnings. While reduced-form estimates of the switching cost serve as a lower bound on the reduction in firm value, they underestimate the overall effect which also includes the resulting inefficient firm-CEO matches. Using counterfactual analysis, the switching cost is estimated to decrease the median firm's value by 4.8%, four times larger than the reduced-form estimate. While firms experience an observable decrease in earnings when finally replacing CEOs, I find evidence of a considerable unobservable cost associated with the inability of firms and managers to be optimally matched in the cross-section.
----------------------
Staggered Boards and Firm Value, Revisited
Martijn Cremers, Lubomir Litov & Simone Sepe
University of Notre Dame Working Paper, December 2013
Abstract:
This paper revisits the association between firm value (as proxied by Tobin’s Q) and whether the firm has a staggered board. As is well known, in the cross-section firms with a staggered board tend to have a lower value. Using a comprehensive sample for 1978-2011, we show an opposite result in the time series: firms that adopt a staggered board increase in firm value, while de-staggering is associated with a decrease in firm value. We further show that the decision to adopt a staggered board seems endogenous, and related to an ex ante lower firm value, which helps reconciling the existing cross-sectional results to our novel time series results. To explain our new results, we explore potential incentive problems in the shareholder-manager relationship. Short-term oriented shareholders may generate myopic incentives for the firm to underinvest in risky long-term projects. In this case, a staggered board may helpfully insulate the board from opportunistic shareholder pressure. Consistent with this, we find that the adoption of a staggered board has a stronger positive association with firm value for firms where such incentive problems are likely more severe: firms with more R&D, more intangible assets, more innovative and larger and thus likely more complex firms.
----------------------
Do Target CEOs Trade Premiums for Personal Benefits?
Buhui Qiu, Svetoslav Trapkov & Fadi Yakoub
Journal of Banking & Finance, forthcoming
Abstract:
Using a sample of 2,198 completed M&A transactions between 1994 and 2010 in which both target and acquirer are public US firms supplemented with hand-collected data for target CEO retention, we uncover a significantly negative relation between target CEO retention and takeover premiums received by target shareholders. Further, when the target CEO was not retained, we document a significantly negative relation between the relative importance of the severance pay received by the target CEO and takeover premium. Taken together, our findings, which hold in various robustness tests, suggest that target CEOs bargain shareholder value for personal benefits during corporate takeovers. Our findings have important policy implications for takeover disclosures.
----------------------
Dalida Kadyrzhanova & Matthew Rhodes-Kropf
NBER Working Paper, January 2014
Abstract:
Equity overvaluation is thought to create the potential for managerial misbehavior, while monitoring and corporate governance curb misbehavior. We combine these two insights from the literatures on misvaluation and governance to ask 'when does governance matter?' Examining firms with standard long-run measures of corporate governance as they are shocked by plausible misvaluation, we provide consistent evidence that firm performance is impacted by governance when firms become overvalued – overvaluation causes weaker performance in poorly governed firms. Our findings imply that firm oversight is important during market booms, just when stock prices suggest all is well.
----------------------
CEO Turnover and the Reduction of Price Sensitivity
Michael Alderson, Naresh Bansal & Brian Betker
Journal of Corporate Finance, April 2014, Pages 376–386
Abstract:
We examine managerial compensation and wealth sensitivities around CEO changes. The average new CEO is incentivized to increase the risk of the firm primarily because he holds significantly less stock than his predecessor, and in fact riskier policy choices are subsequently implemented. Similar results are obtained in a subsample of CEO changes that are due to retirements and deaths, which alleviates concerns about endogeneity. Our findings indicate that firms seem to be limited in their ability to mitigate the risk-averse behavior caused by large CEO shareholdings.
----------------------
Technological Change, Job Tasks, and CEO Pay
Jason Kotter
University of Michigan Working Paper, November 2013
Abstract:
This paper examines how changes in the composition of the human capital of the workforce impact the CEO. Over the last fifty years, technological change has caused the tasks workers perform to shift from routine to nonroutine work. I estimate that these changes in the workforce caused CEO pay to double over the last thirty years, explaining roughly one-third of the aggregate increase in CEO pay. Consistent with this effect being caused by synergies between CEOs and nonroutine workers, I use text analysis of 10-K statements to show that managers of nonroutine workforces focus relatively more on employees and that this focus leads to large increases in firm value and profitability. Together, these results suggest that a substantial portion of the increase in CEO pay over the past three decades represents an optimal response to technological change.
----------------------
Adam Kolasinski & Xu Li
Journal of Financial and Quantitative Analysis, August 2013, Pages 1173-1206
Abstract:
Little evidence exists on whether boards help managers make better decisions. We provide evidence that strong and independent boards help overconfident CEOs avoid honest mistakes when they seek to acquire other companies. In addition, we find that once-overconfident CEOs make better acquisition decisions after they experience personal stock trading losses, providing evidence that a manager’s recent personal experience, and not just educational and early career experience, influences firm investment policy. Finally, we develop and validate a new CEO overconfidence measure that is easily constructed from machine-readable insider trading data, unlike previously-used measures.
----------------------
R&D and the High Cash Holdings in the U.S.
Zhaozhao He
University of Kansas Working Paper, October 2013
Abstract:
This paper re-examines the factors that have contributed to the dramatic increase in the average cash-to-assets ratio in U.S. firms since 1980. The analysis first shows that this increase is driven almost entirely by the increase in cash-to-assets ratio of R&D intensive firms. Further, the results suggest that the biggest increase in cash holdings over the last three decades has been in financially constrained R&D intensive firms in competitive industries with volatile cash flows. Since 1980 there has been a fundamental shift in how firms finance R&D, and these findings suggest that R&D intensive firms are increasingly using their cash holdings to overcome the increased volatility of major financing sources: cash flow and stock issues. Finally, the data reveals strong evidence that intensified competition contributes to the increased cash holdings of R&D firms using exogenous variation in competition.
----------------------
The impact of SOX on opportunistic management behavior
François Aubert & Gary Grudnitski
International Review of Financial Analysis, forthcoming
Abstract:
An innovative aspect of this study is the use of a relatively new metric to capture opportunistic earnings management behavior. We define opportunistic earnings management as the difference between a firm’s US-GAAP earnings and ex post earnings consensus derived from forecasts of financial analysts who follow that firm. Using over 24,500 quarterly reports of over 2,500 publicly-traded companies spanning two, three-year periods, and controlling for factors previously linked to having an effect on earnings management and analysts forecast effort, we find statistical evidence supporting the proposition that, in the aggregate, the Sarbanes-Oxley Act (SOX) has served as a constraint on curbing opportunistic earnings management behavior, and thus should be considered as an effective means to improve the quality of financial reporting information.