Findings

For the shareholders

Kevin Lewis

February 22, 2017

When is good news bad and vice versa? The Fortune rankings of America's most admired companies

Yingmei Cheng et al.

Journal of Corporate Finance, April 2017, Pages 378–396

Abstract:
We use increases and decreases in the ranking scores of Fortune's Most Admired Companies to test the proposition that media shocks can increase (decrease) the value of a manager's reputational capital and, thus, enhance (diminish) his power to extract corporate resources for private benefit at the expense of shareholders. Consistent with the proposition increases (decreases) in scores are associated with stock price decreases (increases). And, CEOs whose firms experience increases (reductions) in scores experience increases (reductions) in compensation and in job tenure, and their firms undertake more (fewer) acquisitions and the acquisitions are less (more) value increasing.

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Ripple Effects of CEO Awards: Investigating the Acquisition Activities of Superstar CEOs’ Competitors

Wei Shi, Yan Zhang & Robert Hoskisson

Strategic Management Journal, forthcoming

Abstract:
This study proposes that CEOs may undertake intensive acquisition activities to increase their social recognition and status after witnessing their competitors’ winning CEO awards. Using a sample of U.S. S&P 1500 firm CEOs, we find that CEOs engage in more intensive acquisition activities in the period after their competitors won CEO awards (i.e., post-award period), compared to the pre-award period. Moreover, this effect is stronger when focal CEOs themselves had a high likelihood of winning CEO awards. Our findings also show that acquisitions by focal CEO firms in the post-award period realize lower announcement returns compared to acquisitions by the same CEOs in the pre-award period.

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Do exogenous changes in passive institutional ownership affect corporate governance and firm value?

Cornelius Schmidt & Rüdiger Fahlenbrach

Journal of Financial Economics, forthcoming

Abstract:
We investigate whether corporations and their executives react to an exogenous change in passive institutional ownership and alter their corporate governance structure. We find that exogenous increases in passive ownership lead to increases in CEO power and fewer new independent director appointments. Consistent with these changes not being beneficial for shareholders, we observe negative announcement returns to the appointments of new independent directors. We also show that firms carry out worse mergers and acquisitions after exogenous increases in passive ownership. These results suggest that the changed ownership structure causes higher agency costs.

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Tax Rates and Corporate Decision Making

John Graham et al.

Review of Financial Studies, forthcoming

Abstract:
We survey companies and find that many use incorrect tax rate inputs into important corporate decisions. Specifically, many companies use an average tax rate (the GAAP effective tax rate, ETR) to evaluate incremental decisions, rather than using the theoretically correct marginal tax rate. We find evidence consistent with behavioral biases (heuristics, salience) and managers’ educational backgrounds affecting these choices. We estimate the economic consequences of using the theoretically incorrect tax rate and find that using the ETR for capital structure decisions leads to suboptimal leverage choices and using the ETR in investment decisions makes firms less responsive to investment opportunities.

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Strategic Reactions in Corporate Tax Avoidance

Chris Armstrong, Stephen Glaeser & John Kepler

University of Pennsylvania Working Paper, December 2016

Abstract:
We find that the tax avoidance of firms in the same industry exhibit strategic complementarities: a change in a firm’s tax avoidance leads to a direct change in its industry-competitors’ tax avoidance, and vice versa. We document evidence of these strategic complementarities in several measures of corporate tax avoidance using multiple sources of exogenous variation in competitors’ tax avoidance. We also find evidence that firms’ strategic response to their competitors’ tax avoidance stems from concerns about appearing more tax aggressive than their industry competitors and drawing unwanted scrutiny as a result.

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Foreign Cash: Taxes, Internal Capital Markets, and Agency Problems

Jarrad Harford, Cong Wang & Kuo Zhang

Review of Financial Studies, forthcoming

Abstract:
When the fraction of a firm’s cash held overseas is greater, its shareholders value that cash lower. This goes beyond a pure tax effect: the repatriation tax friction disrupts the firm’s internal capital market, distorting its investment policy. Firms underinvest domestically and overinvest abroad. Our findings are more pronounced when firms are subject to higher repatriation tax rates, higher costs of borrowing, and more agency problems. Overall, our evidence suggests that a combination of taxes, financing frictions, and agency problems leads to a valuation discount for foreign cash and documents real effects of how foreign earnings are taxed.

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High-Reputation Firms and Their Differential Acquisition Behaviors

Jerayr “John” Haleblian, Michael Pfarrer & Jason Kiley

Strategic Management Journal, forthcoming

Abstract:
Emerging reputation research suggests that high-reputation firms will act to maintain their reputations in the face of high expectations. Yet this research remains unclear on how high-reputation firms do so. We advance this research by exploring three questions related to high-reputation firms’ differential acquisition behaviors: Do high-reputation firms make more acquisitions than similar firms without this distinction? What kind of acquisitions do they make? How do investors react to high-reputation firms’ differential acquisition behaviors? We find that high-reputation firms make more acquisitions and more unrelated acquisitions than other firms. Yet we also find that investors bid down high-reputation firms’ stock more than other firms’ in response to acquisition announcements, suggesting that investors are skeptical of how high-reputation firms maintain their reputations.

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The impact of board gender composition on dividend payouts

Jie Chen, Woon Sau Leung & Marc Goergen

Journal of Corporate Finance, April 2017, Pages 86–105

Abstract:
This paper investigates whether female independent directors are more likely to impose high dividend payouts. We find evidence that firms with a larger fraction of female directors on their board have greater dividend payouts. This finding is robust to alternative econometric specifications, and alternative measures of dividend payouts and female board representation. The positive effect of board gender composition on dividends remains when we employ propensity score matching, the instrumental variable approach, and difference-in-differences approach to address potential endogeneity concerns. Furthermore, we find that board gender composition significantly increases the dividend payout only for firms with weak governance, suggesting that female directors use dividend payouts as a governance device.

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Private Equity, Layoffs, and Job Polarization

Martin Olsson & Joacim Täg

Journal of Labor Economics, forthcoming

Abstract:
Private equity firms are often criticized for laying off workers, but the evidence on who loses their jobs and why is scarce. This paper argues that explanations for job polarization also explain layoffs after private equity buyouts. Buyouts reduce agency problems, which triggers automation and offshoring. Using rich employer-employee data, we show that buyouts generally do not affect unemployment incidence. However, unemployment incidence doubles for workers in less productive firms who perform routine or offshorable job tasks. Job polarization is also much more marked among workers affected by buyouts than for the economy at large.

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Is There a ‘Dark Side’ to Monitoring? Board and Shareholder Monitoring Effects on M&A Performance Extremeness

Maria Goranova et al.

Strategic Management Journal, forthcoming

Abstract:
We investigate the effects of monitoring by boards of directors and institutional shareholders on merger and acquisition (M&A) performance extremeness using a sample of M&A deals from 1997–2006. Both governance research and legal reforms generally have espoused a ‘raise all boats’ view of monitoring. We instead investigate whether monitoring may serve as a double-edged sword that limits CEO discretion to undertake both value-destroying M&A deals and value-creating ones. Our findings indicate that the relationship between monitoring and M&A performance is more complex than previously believed. Rather than ‘raising all boats’ in a shift towards better M&A outcomes, monitoring instead is associated with lower M&A losses, but also with lower M&A gains.

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Compensation goals and firm performance

Ben Bennett et al.

Journal of Financial Economics, forthcoming

Abstract:
Using a large data set of performance goals employed in executive incentive contracts, we find that a disproportionately large number of firms exceed their goals by a small margin as compared to the number that fall short of the goal by a similar margin. This asymmetry is particularly acute for earnings goals, when compensation is contingent on a single goal, when the pay-performance relationship around the goal is concave-shaped, and for grants with non-equity-based payouts. Firms that exceed their compensation target by a small margin are more likely to beat the target the next period and CEOs of firms that miss their targets are more likely to experience a forced turnover. Firms that just exceed their Earnings Per Share (EPS) goals have higher abnormal accruals and lower Research and Development (R&D) expenditures, and firms that just exceed their profit goals have lower Selling, General & Administrative (SG&A) expenditures. Overall, our results highlight some of the costs of linking managerial compensation to specific compensation targets.

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Executive Suite Independence: Is It Related to Board Independence?

Han Kim

Management Science, forthcoming

Abstract:
The executive suite and the board are closely bound to each other through their fiduciary responsibility to the same shareholders. With chief executive officers’ (CEOs) prominent role in both governing bodies, their independence from CEOs’ self-serving behavior might be related to each other. We explore the interdependence using an external shock increasing board independence. The shock weakens executive suite independence by increasing CEO connectedness within executive suites through appointments and preexisting social ties. We also uncover interesting dynamics between the two governing bodies: (1) the spillover does not occur when treated firms increase CEO-independent director social ties, suggesting CEO-executive connections and CEO-director connections are substitutes; (2) consistent with theories of board independence, when an information environment calls for dependent boards, increasing CEO-executive connections, which helps negate the shock effect on the board, has positive marginal effects on firm performance. Our findings are not driven by the Sarbanes–Oxley Act and are robust to a battery of other tests. We conclude that independence in the board and executive suite are inversely related; inferring the overall independence from board independence alone can be highly misleading.

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How do Quasi-Random Option Grants Affect CEO Risk-Taking?

Kelly Shue & Richard Townsend

NBER Working Paper, January 2017

Abstract:
We examine how an increase in stock option grants affects CEO risk-taking. The overall net effect of option grants is theoretically ambiguous for risk-averse CEOs. To overcome the endogeneity of option grants, we exploit institutional features of multi-year compensation plans, which generate two distinct types of variation in the timing of when large increases in new at-the-money options are granted. We find that, given average grant levels during our sample period, a 10 percent increase in new options granted leads to a 2.8–4.2 percent increase in equity volatility. This increase in risk is driven largely by increased leverage.

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Offshore Expertise for Onshore Companies: Director Connections to Island Tax Havens and Corporate Tax Policy

Chao Jiang et al.

Management Science, forthcoming

Abstract:
Theory and recent empirical literature suggest that social and professional connections may influence corporate policy. However, inference may be biased by the possibility that firms who share peers also share unobserved characteristics that are correlated with observed policy. Using a novel identification strategy, we predict and find that director connections through well-known island tax havens have a significant effect on corporate tax policy. Specifically, we find that U.S. firms with directors who are connected to firms domiciled on the islands of the Bahamas, Bermuda, or the Caymans, exhibit significantly greater tax avoidance than other U.S. firms. The presence or arrival of an island director is associated with a reduction of between one and three percentage points in the firm's effective tax rate. We also observe a significant increase in the use of tax haven subsidiaries following the arrival of the island director.

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Do Voluntary Clawback Adoptions Curb Overinvestment?

Yu-Chun Lin

Corporate Governance, forthcoming

Research Question/Issue: This study tests whether the adoption of clawback provisions mitigates overinvestment. A clawback provision is a recoupment policy that allows certain bonuses previously paid to executives to be cancelled or “clawed back” if financial statements are restated.

Research Findings/Insights: This study focuses on 1,093 voluntary clawback adopters in the U.S. during 2006–2012 and uses propensity score matching to obtain a matched sample. We then perform a difference-in-differences analysis to assess pre- and post-adoption changes in overinvestment. The empirical results show that (i) clawback provisions mitigate overinvestment, and (ii) overinvestment decreases most for those executives identified as overconfident or receiving higher option compensation.

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Does index addition affect corporate tax avoidance?

Fariz Huseynov, Sabuhi Sardarli & Wei Zhang

Journal of Corporate Finance, April 2017, Pages 241–259

Abstract:
We examine corporate tax avoidance of firms around addition to the S&P 500 index. We find that corporate tax avoidance for firms at high levels of tax avoidance decreases after index addition, whereas tax avoidance for firms at low levels of tax avoidance increases after index addition. We disentangle the impact of changing governance practices from that of declining investment opportunities. Our findings indicate that the changes in tax avoidance can be attributed to improving governance practices, specifically higher institutional ownership and executive compensations, and this impact is above and beyond the changes in growth opportunities of index firms.

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Uncertainty in Managers’ Reporting Objectives and Investors’ Response to Earnings Reports: Evidence from the 2006 Executive Compensation Disclosures

Fabrizio Ferri, Ronghuo Zheng & Yuan Zou

Columbia University Working Paper, January 2017

Abstract:
We examine whether the information content of the earnings report, as captured by the earnings response coefficient (ERC), increases when investors’ uncertainty about the manager’s reporting objective decreases, using the 2006 compensation disclosures as an instrument to capture a decrease in investors’ uncertainty about managers’ incentives and reporting objectives. Using a difference-in-differences design and exploiting the staggered adoption of the new rules, we find a statistically and economically significant increase in ERC for treated firms relative to control firms. The effect is weaker in firms that received a comment letter from the SEC urging them to improve their compliance with the new rules (a proxy for firms less responsive to the new rules), and stronger in firms with more independent boards (a proxy for firms more responsive to the new rules). Our findings represent the first empirical evidence of a role of compensation disclosures in enhancing the information content of financial reports, consistent with the theoretical prediction in Fischer and Verrecchia (2000). As such, they may be of interest to both policy-makers and investors.

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Did Family Firms Perform Better during the Financial Crisis? New Insights from the S&P 500 Firms

Haoyong Zhou, Fan He & Yangbo Wang

Global Finance Journal, forthcoming

Abstract:
This paper provides new evidence on whether family firms performed better during the global financial crisis (2008–2010). Using the dataset of the S&P 500 nonfinancial firms during the period 2006–2010, we find that family firms outperformed nonfamily firms during the crisis. Among family firms, the ones that contributed to the outperformance were those where the founder was still present. We also find that during the global financial crisis, founder firms invested significantly less and had better access to the credit market than nonfamily firms. Our analysis suggests that the superior performance of founder firms is largely caused by their having less incentive to overinvest in order to boost short-term earnings during the crisis.

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Higher Highs and Lower Lows: The Role of Corporate Social Responsibility in CEO Dismissal

Timothy Hubbard, Dane Christensen & Scott Graffin

Strategic Management Journal, forthcoming

Abstract:
Investing a firm's resources in Corporate Social Responsibility (CSR) initiatives remains a contentious issue. While research suggests firm financial performance is the primary driver of CEO dismissal, we propose that CSR will provide important additional context when interpreting a firm's financial performance. Consistent with this prediction, our results suggest that past CSR decisions amplify the negative relationship between financial performance and CEO dismissal. Specifically, we find that greater prior investments in CSR appear to expose CEOs of firms with poor financial performance to a greater risk of dismissal. In contrast, greater past investments in CSR appear to help shield CEOs of firms with good financial performance from dismissal. These findings provide novel insight into how CEOs’ career outcomes may be affected by earlier CSR decisions.

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Is the Market Grossed out by Gross-Ups? An Investigation of Firms that Pay Their CEOs' Taxes

Jeffrey Hoopes, Xiaoli (Shaolee) Tian & Ryan Wilson

Ohio State University Working Paper, January 2017

Abstract:
This study provides evidence on whether investors value tax gross-up provisions for executives, and how the elimination of these provisions changes executive compensation. We examine the market response to tax gross-up eliminations and find investors react favorably to the removal of these provisions, suggesting that on average, investors perceived these agreements as a bad compensation practice that destroyed firm value. Next, we examine whether firms respond to these eliminations by increasing other forms of executive compensation. We find firms eliminating tax gross-up provisions increase bonus but not salary. Broadly, we provide evidence that some features of compensation contracts are not valued by shareholders, and that the elimination of these features can lead to increased firm value.

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On the Foundations of Corporate Social Responsibility

Hao Liang & Luc Renneboog

Journal of Finance, forthcoming

Abstract:
Using CSR ratings for 23,000 companies from 114 countries, we find that a firm's corporate social responsibility (CSR) rating and its country's legal origin are strongly correlated. Legal origin is a stronger explanation than “doing good by doing well” factors or firm and country characteristics (ownership concentration, political institutions, and globalization): firms from common law countries have lower CSR than companies from civil law countries, with Scandinavian civil law firms having the highest CSR ratings. Evidence from quasi-natural experiments such as scandals and natural disasters suggests that civil law firms are more responsive to CSR shocks than common law firms.

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Organized Labor and Loan Pricing: A Regression Discontinuity Design Analysis

Yue Qiu & Tao Shen

Journal of Corporate Finance, forthcoming

Abstract:
This paper provides new evidence on the effect of unionization on the cost of bank loans. By using a regression discontinuity design, we establish a causal relation between new unionization and bank loan pricing. Relative to firms in which unions barely lose elections, firms in which unions barely win elections experience an increase in the spread of the newly originated loans. Further tests suggest that the effect of labor unions on the loan spread arises through the channel of reducing the recovery rate of banks in bankruptcy rather than increasing firms’ default risk.

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The Effects of Short-Selling Threats on Incentive Contracts: Evidence from an Experiment

David De Angelis, Gustavo Grullon & Sébastien Michenaud

Review of Financial Studies, forthcoming

Abstract:
This paper examines the effects of a shock to the stock-price formation process on the design of executive incentive contracts. We find that an exogenous removal of short-selling constraints causes firms to convexify compensation payoffs by granting relatively more stock options to their managers. We also find that treated firms adopt new antitakeover provisions. These results suggest that when firms face the threat of bear raids, they incentivize managers to take actions that mitigate the adverse effects of unrestrained short selling. Overall, this paper provides causal evidence that financial markets affect incentive contract design.


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