Findings

Corporate control

Kevin Lewis

October 17, 2016

The Elephant (or Donkey) in the Boardroom: How Board Political Ideology Affects CEO Pay

Abhinav Gupta & Adam Wowak

Administrative Science Quarterly, forthcoming

Abstract:
We examine how directors’ political ideologies, specifically the board-level average of how conservative or liberal directors are, influence boards’ decisions about CEO compensation. Integrating research on corporate governance and political psychology, we theorize that conservative and liberal boards will differ in their prevailing beliefs about the appropriate amounts CEOs should be paid and, relatedly, the extent to which CEOs should be rewarded or penalized for recent firm performance. Using a donation-based index to measure the political ideologies of directors serving on S&P 1500 company boards, we test our ideas on a sample of over 4,000 CEOs from 1998 to 2013. Consistent with our predictions, we show that conservative boards pay CEOs more than liberal boards and that the relationship between recent firm performance and CEO pay is stronger for conservative boards than for liberal boards. We further demonstrate that these relationships are more pronounced when focusing specifically on the directors most heavily involved in designing CEO pay plans — members of compensation committees. By showing that board ideology manifests in CEO pay, we offer an initial demonstration of the potentially wide-ranging implications of political ideology for how corporations are governed.

---------------------

Socially responsible firms

Allen Ferrell, Hao Liang & Luc Renneboog

Journal of Financial Economics, forthcoming

Abstract:
In the corporate finance tradition, starting with Berle and Means (1932), corporations should generally be run to maximize shareholder value. The agency view of corporate social responsibility (CSR) considers CSR an agency problem and a waste of corporate resources. Given our identification strategy by means of an instrumental variable approach, we find that well-governed firms that suffer less from agency concerns (less cash abundance, positive pay-for-performance, small control wedge, strong minority protection) engage more in CSR. We also find that a positive relation exists between CSR and value and that CSR attenuates the negative relation between managerial entrenchment and value.

---------------------

Friends in the right places: The effect of political connections on corporate merger activity

Stephen Ferris, Reza Houston & David Javakhadze

Journal of Corporate Finance, December 2016, Pages 81–102

Abstract:
This study examines how the appointment of former politicians and regulators to boards of directors or management teams influences corporate acquisition activity and performance. We find that bidders with political connections are more likely to acquire targets and avoid regulatory delay or denial. The merger premium paid increases with political connectedness. The announcement period returns show that investors recognize that bids by politically connected acquirers are more likely to create firm value. Connected bidders make more bids and bid on larger targets. Connected acquirers also enjoy superior post-merger financial and operating performance.

---------------------

Distracted Shareholders and Corporate Actions

Elisabeth Kempf, Alberto Manconi & Oliver Spalt

Review of Financial Studies, forthcoming

Abstract:
Investor attention matters for corporate actions. Our new identification approach constructs firm-level shareholder “distraction” measures, by exploiting exogenous shocks to unrelated parts of institutional shareholders’ portfolios. Firms with “distracted” shareholders are more likely to announce diversifying, value-destroying, acquisitions. They are also more likely to grant opportunistically timed CEO stock options, more likely to cut dividends, and less likely to fire their CEO for bad performance. Firms with distracted shareholders have abnormally low stock returns. Combined, these patterns are consistent with a model in which the unrelated shock shifts investor attention, leading to a temporary loosening of monitoring constraints.

---------------------

The impact of firm prestige on executive compensation

Florens Focke, Ernst Maug & Alexandra Niessen-Ruenzi

Journal of Financial Economics, forthcoming

Abstract:
We show that chief executive officers (CEOs) of prestigious firms earn less. Total compensation is on average 8% lower for firms listed in Fortune’s ranking of America’s most admired companies. We suggest that CEOs are willing to trade off status and career benefits from working for a publicly admired company against additional monetary compensation. Our identification strategy is based on matched sample analyses, difference-in-differences regressions, and a regression discontinuity design. We perform several robustness checks and exclude many alternative explanations, including that firm prestige just proxies for better corporate governance or for increased exposure of the pay-setting process to media attention.

---------------------

Credit derivatives as a commitment device: Evidence from the cost of corporate debt

Gi Kim

Journal of Banking & Finance, December 2016, Pages 67–83

Abstract:
When a firm writes incomplete debt contracts, its limited ability to commit to not strategically default and renegotiate its debt requires the firm to pay higher yields to its creditors. Hedged by credit derivatives, creditors have stronger bargaining power in the case of debt renegotiation, which ex-ante demotivates the firm to default strategically. In this paper, I aim to investigate theoretically and empirically whether credit derivatives could help reduce the cost of debt contracting stemming from the possibility of strategic default. I find that firms with a priori high strategic default incentives experience a relatively large reduction in their corporate bond spreads after the introduction of credit default swaps (CDS) written on their debt. This result is robust to controlling for the endogeneity of CDS introduction. My finding is consistent with the presence of CDS reducing the strategic default-related cost of corporate debt, suggesting the beneficial role of credit derivatives as a commitment device for the borrower to repay the lender.

---------------------

Growth opportunities, short-term market pressure, and dual-class share structure

Bradford Jordan, Soohyung Kim & Mark Liu

Journal of Corporate Finance, forthcoming

Abstract:
We test the hypothesis that dual-class shares can help managers focus on the implementation of long-term projects while avoiding short-term market pressure. Consistent with this idea, we find that dual-class firms face lower short-term market pressure (fewer transient or short-term institutional holdings, a lower probability of being taken over, and lower analyst coverage) than propensity-matched single-class firms. Dual-class firms also tend to have more growth opportunities (higher sales growth and R&D intensity). The dual-class share structure increases the market valuation of high growth firms, in contrast to the finding in the literature that dual-class firms trade at lower valuations. To address endogeneity concerns, we evaluate a sample of dual-class share unifications and find that growth opportunities decline while short-term market pressure increases after share unifications.

---------------------

Good Monitoring, Bad Monitoring

Yaniv Grinstein & Stefano Rossi

Review of Finance, August 2016, Pages 1719-1768

Abstract:
Are courts effective monitors of corporate decisions? In a controversial landmark case, the Delaware Supreme Court held directors personally liable for breaching their fiduciary duties, signaling a sharp increase in Delaware’s scrutiny over corporate decisions. In our event study, low-growth Delaware firms outperformed matched non-Delaware firms by 1% in the three day event window. In contrast, high-growth Delaware firms under-performed by 1%. Contrary to previous literature, we conclude that court decisions can have large, significant and heterogeneous effects on firm value, and that rules insulating directors from court scrutiny benefit the fastest growing sectors of the economy.

---------------------

Incentives, termination payments, and CEO contracting

Stuart Gillan & Nga Nguyen

Journal of Corporate Finance, forthcoming

Abstract:
Many executives have compensation that is potentially forfeit conditioned on the circumstances surrounding their departure from the firm. We study firms' endogenous decisions to use such compensation “holdbacks” as a bonding device and find that firms with higher executive replacement costs, greater information asymmetry, more certain operating environments, and recent accounting concerns are more likely to have holdbacks. Additionally, holdbacks are negatively associated with incentive-based compensation, consistent with theoretical predictions that termination incentives can substitute for incentive pay. Further, holdbacks are positively associated with abnormal compensation, consistent with arguments that managers demand a premium to accept risky pay.

---------------------

The Value of International Income Shifting Opportunities to U.S. Multinational Firms

Paul Demere & Jeffrey Gramlich

University of Illinois Working Paper, August 2016

Abstract:
We examine the value of firms’ opportunities to reduce their corporate tax burden by shifting income from high- to low-tax jurisdictions. Prior literature shows that firms do engage in tax-motivated cross-jurisdictional income shifting; however, the contribution of such shifting to firm value has not been examined or quantified. We develop and validate a new measure of U.S. multinational firms’ tax-motivated income shifting opportunities. Using this measure, we find that income shifting opportunities are associated with a discount on firm value of 2.2 to 3.7 percent for a standard deviation increase in income shifting opportunities. We also find a positive association between changes in income shifting and returns that reverses in future periods, consistent with investors not immediately understanding the value consequences of income shifting. These negative value consequences are greater for firms with more intangible asset generating activities, consistent with tax-motivated income shifting opportunities facilitating managerial rent extraction, creating myopic investment behavior, or subjecting firms to significant compliance, regulatory, or reputational costs. Ultimately, we find evidence supporting the view that income shifting opportunities reduce firm value by increasing myopic investment behavior.

---------------------

The second wave of hedge fund activism: The importance of reputation, clout, and expertise

C.N.V. Krishnan, Frank Partnoy & Randall Thomas

Journal of Corporate Finance, October 2016, Pages 296–314

Abstract:
Using a large dataset of hand-collected information on activist interventions from 2008 to 2014, we examine why certain hedge funds succeed in the face of competition. We document that the top hedge funds succeed, not merely because of how they select targets, but because they acquire a reputation for what we label “clout and expertise.” These hedge funds do not intervene more frequently; to the contrary, activists with more interventions are associated with lower returns. Instead, top activists have a demonstrated ability to succeed in difficult interventions by targeting large firms, launching successful proxy fights, filing and winning lawsuits, pressuring target boards through the media, overcoming anti-takeover defenses, and replacing board members. These activists' successes appear to result more from board representation, improved performance, and monitoring management than from capital structure or dividend policy changes.

---------------------

Standing on the Shoulders of Giants: The Effect of Passive Investors on Activism

Ian Appel, Todd Gormley & Donald Keim

NBER Working Paper, September 2016

Abstract:
We analyze whether the growing importance of passive investors has influenced the campaigns, tactics, and successes of activists. We find activists are more likely to pursue changes to corporate control or influence (e.g., via board representation) and to forego more incremental changes to corporate policies when a larger share of the target company’s stock is held by passively managed mutual funds. Furthermore, higher passive ownership is associated with increased use of proxy fights and a higher likelihood the activist obtains board representation or the sale of the targeted company. Overall, our findings suggest that the increasingly large ownership stakes of passive institutional investors mitigate free-rider problems associated with certain forms of intervention and ultimately increase the likelihood of success by activists.

---------------------

Market Valuation of Anticipated Governance Changes: Evidence from Contentious Shareholder Meetings

Francois Brochet, Fabrizio Ferri & Gregory Miller

Columbia University Working Paper, July 2016

Abstract:
We define annual shareholder meetings as contentious if one or more ballot items are likely to obtain sufficient shareholder votes to induce a firm to implement governance changes. Using a sample of almost 28,000 meetings between 2003 and 2012, we find that abnormal stock returns over the 40-day period prior to contentious meetings are significantly positive and higher than prior to non-contentious meetings. These higher abnormal returns persist after controlling for firm-specific news and proxies for risk factors and are more pronounced in firms with poor past performance. Our results are consistent with investors viewing an increase in the probability of shareholder vote-induced governance changes as value creating, on average.

---------------------

Can Staggered Boards Improve Value? Evidence from the Massachusetts Natural Experiment

Robert Daines, Shelley Xin Li & Charles Wang

Harvard Working Paper, September 2016

Abstract:
We study the effect of staggered boards on long-run firm value, using a natural experiment: a 1990 law that imposed a staggered board on all firms incorporated in Massachusetts. We find a significant and positive average increase in Tobin's Q among the Massachusetts treated firms, suggesting that staggered boards can be beneficial for early-life-cycle firms, which exhibit greater information asymmetries between insiders and investors. These results are validated using a larger sample of firms from the Investor Responsibility Research Center. In exploring possible channels for these effects, we find that the effects are stronger among innovating Massachusetts firms, particularly those facing greater Wall Street scrutiny. The evidence is consistent with staggered boards improving managers' incentives to make long-term investments.

---------------------

Actual Share Repurchases, Price Efficiency, and the Information Content of Stock Prices

Pascal Busch & Stefan Obernberger

Review of Financial Studies, forthcoming

Abstract:
We examine the impact of actual share repurchases on stock prices using several measures of price efficiency and manually collected data on U.S. repurchases. We find that share repurchases make prices more efficient and reduce idiosyncratic risk. Further analyses reveal that the effects are primarily driven by repurchases in down markets. We conclude that share repurchases help to maintain accurate stock prices by providing price support at fundamental values. We find no evidence that managers use share repurchases to manipulate stock prices when selling their equity holdings or exercising stock options.

---------------------

Analyst coverage and corporate tax aggressiveness

Arthur Allen et al.

Journal of Banking & Finance, December 2016, Pages 84–98

Abstract:
We examine the impact of analyst coverage on corporate tax aggressiveness. To address endogeneity concerns, we perform a difference-in-differences analysis using a setting which causes exogenous decreases in analyst coverage. Our tests identify a negative causal effect of analyst coverage on tax aggressiveness, suggesting that higher analyst coverage constrains corporate tax aggressiveness. Further cross-sectional variation tests find that this constraining effect on tax aggressiveness is more pronounced in firms with lower investor recognition and firms with more opaque information environments. Our results are consistent with the notion that higher analyst coverage increases the visibility of aggressive tax planning behavior as well as heightens analysts’ demand for more transparent information, which in turn reduces tax aggressiveness.

---------------------

Causal effect of analyst following on corporate social responsibility

Binay Adhikari

Journal of Corporate Finance, December 2016, Pages 201–216

Abstract:
I examine the influence of sell-side financial analysts on corporate social responsibility (CSR), and find that firms with greater analyst coverage tend to be less socially responsible. To establish causality, I employ a difference-in-differences (DiD) technique, using brokerage closures and mergers as exogenous shocks to analyst coverage, as well as an instrumental variables approach. Both identification strategies suggest that analyst coverage has a negative causal effect on CSR. My findings are consistent with the view that spending on CSR is a manifestation of an agency problem, and that financial analysts curb such discretionary spending by disciplining managers.

---------------------

Are Activist Investors Good or Bad for Business? Evidence from Capital Market Prices, Informed Traders, and Firm Fundamentals

Edward Swanson & Glen Young

Texas A&M University Working Paper, August 2016

Abstract:
We provide new evidence on the important and contentious question of whether interventions by activist investors add value to the targeted companies. Our large sample covers two decades and includes interventions in which the five-percent-ownership threshold for filing SEC Schedule 13D requires too much capital. We find that short-window returns around the public announcement are significantly positive and do not reverse in the post-intervention period; analyst recommendations decline prior to the intervention but increase significantly afterward; and short interest declines significantly in the post-intervention period. These favorable reactions are supported by significant improvements in target firms’ accounting fundamentals. Finally, ownership by long-term (“dedicated”) institutional investors increases after the intervention, and ownership by short-term (“transient”) investors decreases. Taken together, actions by informed market participants and accounting fundamentals provide consistent, strong evidence that investor activism strengthens the prospects of target firms.

---------------------

Say Pays! Shareholder Voice and Firm Performance

Vicente Cuñat, Mireia Giné & Maria Guadalupe

Review of Finance, August 2016, Pages 1799-1834

Abstract:
This article estimates the effects of Say-on-Pay (SoP), a policy that increases shareholder “voice” by providing shareholders with a regular vote on executive pay. We apply a regression discontinuity design to the votes on shareholder-sponsored SoP proposals. Adopting SoP leads to large increases in market value (5%) and to improvements in long-term profitability. In contrast, it has limited effects on pay levels and structure. Taken together our results suggest that SoP can be seen as a repeated regular vote of confidence on the CEO and that it serves as a disciplining device.

---------------------

CEO Pay Disparity: Efficient Contracting or Managerial Power?

Jean Canil

Journal of Corporate Finance, forthcoming

Abstract:
This paper investigates whether CEO pay disparity reflects efficient contracting or managerial power by exploiting a quasi-natural experiment which mandated option expensing, FASB ASC 718. We find supportive evidence for the managerial power hypothesis. Relative to low pay disparity firms, firms characterized by high pay disparity exhibit a significantly larger decline in options pre- versus post-expensing. Further, high pay disparity firms are found to replenish their compensation with cash-based rather than other equity-based pay. Our findings suggest CEOs in high pay disparity firms exploited the free accounting cost of options to inflate their pay rather than for their incentive properties.

---------------------

Managerial Response to Constitutional Constraints on Shareholder Power

Brian Connelly, Wei Shi & Jinyong Zyung

Strategic Management Journal, forthcoming

Abstract:
We examine whether top managers engage in misconduct, such as illegal insider trading, illegal stock option backdating, bribery, and financial manipulation, in response to the presence, or absence, of governance provisions that impose constitutional constraints on shareholder power. Within the agency framework, shareholders typically oppose governance provisions that limit their power because those provisions could undermine shareholder influence and increase agency costs. However, when shareholders support provisions that constrain their power, managers could respond positively by refraining from self-interested behavior in the form of managerial misconduct. We find this to be especially true in industries where these governance provisions are particularly relevant to managers and in scenarios where CEOs do not also serve as board chair.

---------------------

Playing it safe? Managerial preferences, risk, and agency conflicts

Todd Gormley & David Matsa

Journal of Financial Economics, forthcoming

Abstract:
This article examines managers’ incentive to play it safe. We find that, after managers are insulated by the adoption of an antitakeover law, they take value-destroying actions that reduce their firms’ stock volatility and risk of distress. To illustrate one such action, we show that managers undertake diversifying acquisitions that target firms likely to reduce risk, have negative announcement returns, and are concentrated among firms with managers who gain the most from reducing risk. Our findings suggest that instruments typically used to motivate managers, such as greater financial leverage and larger ownership stakes, exacerbate risk-related agency challenges.

---------------------

The Role of Proxy Advisory Firms: Evidence from a Regression-Discontinuity Design

Nadya Malenko & Yao Shen

Review of Financial Studies, forthcoming

Abstract:
Proxy advisory firms have become important players in corporate governance, but the extent of their influence over shareholder votes is debated. We estimate the effect of Institutional Shareholder Services (ISS) recommendations on voting outcomes by exploiting exogenous variation in ISS recommendations generated by a cutoff rule in ISS voting guidelines. Using a regression discontinuity design, we find that from 2010 to 2011, a negative ISS recommendation on a say-on-pay proposal leads to a 25 percentage point reduction in say-on-pay voting support, suggesting a strong influence over shareholder votes. We also use our setting to examine the informational role of ISS recommendations.


Sign-in to your National Affairs subscriber account.


Already a subscriber? Activate your account.


subscribe

Unlimited access to intelligent essays on the nation’s affairs.

SUBSCRIBE
Subscribe to National Affairs.