Corporate masters
Yu Zhang & Javier Gimeno
Organization Science, March-April 2016, Pages 354-372
Abstract:
Recent research has shown that managers in publicly traded companies facing earnings pressure - the pressure to meet or beat securities analysts' earnings forecasts - may make business decisions to improve short-term earnings. Analysts' forward-looking performance forecasts can serve as powerful motivation for managers, but may also encourage them to undertake short-term actions detrimental to future competitiveness and performance. To identify whether managerial reactions to earnings pressure suggest evidence of intertemporal trade-offs, we explored how companies respond to earnings pressure under different conditions of corporate governance that shape the temporal orientations of managers. Using data on competitive decisions made by U.S. airlines under quarterly earnings pressure, we examined the effect of earnings pressure on competitive behavior under different ownership structures (ownership by long-term dedicated investors versus transient investors) and CEO incentives (unvested incentives that are restricted or unexercisable in the short term, versus vested incentives). The results suggest that companies with more long-term-oriented investors and long-term-aligned CEOs with unvested incentives are less likely to soften competitive behavior in response to earnings pressure, relative to companies with transient investors and CEOs with vested, immediately exercisable stock-based incentives. Using a difference-in-differences (DiD) specification for stronger identification, we also found that firms respond to their rivals' earnings pressure shocks by increasing capacity and prices, particularly when those rivals do not have long-term-oriented investors and CEO incentives. The evidence is more aligned with the view that the pursuit of short-term earnings as a result of earnings pressure may be detrimental to long-term competitiveness.
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CEO Political Preference and Corporate Tax Sheltering
Bill Francis et al.
Journal of Corporate Finance, June 2016, Pages 37-53
Abstract:
We show that firms led by politically partisan CEOs are associated with a higher level of corporate tax sheltering than firms led by nonpartisan CEOs. Specifically, Republican CEOs are associated with more corporate tax sheltering even when their wealth is not tied with that of shareholders and when corporate governance is weak, suggesting that their tax sheltering decisions could be driven by idiosyncratic factors such as their political ideology. We also show that Democratic CEOs are associated with more corporate tax sheltering only when their stock-based incentives are high, suggesting that their tax sheltering decisions are more likely to be driven by economic incentives. In sum, our results support the political connection hypothesis in general but highlight that the specific factors driving partisan CEOs' tax sheltering behaviors differ. Our results imply that it may cost firms more to motivate Democratic CEOs to engage in more tax sheltering activities because such decisions go against their political beliefs regarding tax policies.
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Do Executives Behave Better When Dishonesty is More Salient?
David Cicero & Mi Shen
University of Alabama Working Paper, March 2016
Abstract:
In behavioral experiments, individuals are less likely to cheat at a task when the saliency of dishonesty is increased [Mazar, Amir, and Ariely (2008), Gino, Ayal, and Ariely (2009)]. We test a similar hypothesis in a real world setting by treating news about high-profile political scandals as shocks to the salience of unethical/illegal behavior and its consequences. We find that local corporate insiders engage in fewer suspect behaviors in the year after a political scandal is revealed. Their stock sales are less profitable and they are less likely to sell stock ahead of large price declines, suggesting less illegal insider trading. These patterns vary predictably with the level of media attention to scandal-related events during the scandal years. Locally headquartered firms also appear to engage in less earnings management following the revelation of a political scandal. However, these changes in executives' behaviors appear to be largely transitory and the evidence of suspect behaviors resumes in following years.
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The Role of Managerial Ability in Corporate Tax Avoidance
Allison Koester, Terry Shevlin & Daniel Wangerin
Management Science, forthcoming
Abstract:
Most prior studies model tax avoidance as a function of firm-level characteristics and do not consider how individual executive characteristics affect tax avoidance. This paper investigates whether executives with superior ability to efficiently manage corporate resources engage in greater tax avoidance. Our results show that moving from the lower to upper quartile of managerial ability is associated with a 3.15 (2.50) percent reduction in a firm's one-year (five-year) cash effective tax rate (ETR). We examine how higher ability managers reduce income tax payments and find they engage in greater state tax planning activities, shift more income to foreign tax havens, make more R&D credit claims, and make greater investments in assets that generate accelerated depreciation deductions. Identifying a manager characteristic related to firms' tax policy decisions adds to our understanding of the factors that explain the substantial variation in corporate income tax payments across firms.
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Huaizhi Chen, Lauren Cohen & Dong Lou
Review of Financial Studies, forthcoming
Abstract:
We explore a new mechanism by which investors take correlated shortcuts and present evidence that managers - using sales management - take advantage of these shortcuts. Specifically, we exploit a regulatory provision wherein a firm's primary industry is determined by the highest sales segment. Exploiting this regulation, we provide evidence that investors classify operationally nearly identical firms as starkly different depending on their placement around this sales cutoff. Moreover, managers appear to exploit this by manipulating sales to be just over the cutoff in favorable industries. Further evidence suggests that managers engage in activities to realize large, tangible benefits from this opportunistic action.
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CEO confidence and stock returns
Rakesh Bharati, Thomas Doellman & Xudong Fu
Journal of Contemporary Accounting & Economics, April 2016, Pages 89-110
Abstract:
Consistent with the theoretical predictions of Goel and Thakor (2008), we find that overconfident CEOs create significant value for the firm through superior stock return performance and take more risk, compared to their non-overconfident counterparts. We also differentiate between innovative and non-innovative industries and find for each subsample that overconfident CEOs create firm value. We find these results even when we control for founder CEOs as they add value and make similar corporate policy decisions as overconfident CEOs. Finally, consistent with the predictions of Goel and Thakor (2008), we find that overconfident CEOs are hired less frequently, take less risk, and add less value after the enactment of the Sarbanes-Oxley Act in 2002, which put in place strict penalties for poor quality information disclosures by corporations. This finding has significant implications for empirical study as this paper provides evidence of the important impact the Sarbanes-Oxley Act has on the relation between CEO overconfidence and firm policies.
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Excess Pay and Deficient Performance
Mary Ellen Carter et al.
Review of Financial Economics, forthcoming
Abstract:
We investigate the link between abnormal CEO compensation and firm performance, asking whether high unexplained compensation relative to several benchmarks is a sign of hard-to-measure but desirable executive attributes or is instead a symptom of unsolved agency problems. We find that abnormally high CEO pay predicts worse future firm performance. Abnormally high compensation that is performance contingent is a less ominous signal about the future success of the firm. But abnormal levels of even performance-contingent compensation predict worse future performance. We conclude that abnormally high CEO pay can be useful as an independent indicator of agency problems.
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Ending Executive Manipulations of Incentive Compensation
Sureyya Burcu Avci, Cindy Schipani & Nejat Seyhun
Journal of Corporation Law, forthcoming
Abstract:
In this article, we analyze whether the manipulation of stock options still continues to this day. Our evidence shows that executives continue to employ a variety of manipulative devices to increase their compensation, including backdating, bullet-dodging, and spring-loading. Overall, we find that as a result of these manipulative devices executives are able to increase their compensation by about 6%. We suggest a simple new rule to end all dating games in executive compensation. We propose that all grants of stock options in executive compensation be awarded on a daily pro-rata basis and priced accordingly. This proposal would leave no incentive to game option grant dates or manipulate information flow.
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Can Changes in the Cost of Carry Explain the Dynamics of Corporate "Cash" Holdings?
José Azar, Jean-François Kagy & Martin Schmalz
Review of Financial Studies, forthcoming
Abstract:
Firms until recently were effectively constrained to hold liquid assets in non-interest-bearing accounts. As a result, the cost of capital of firms' liquid-assets portfolios exceeded the return, especially when the risk-free interest rate was high. The spread between cost and return is the cost of carry. Changes in the cost of carry explain the dynamics of corporate "cash" holdings both in the United States and abroad, and the level of cost of carry explains the level of liquid-asset holdings across countries. We conclude that current US corporate cash holdings are not abnormal in a historical or international comparison.
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Does Corporate Governance Matter More for High Financial Slack Firms?
Kose John, Yuanzhi Li & Jiaren Pang
Management Science, forthcoming
Abstract:
The effect of corporate governance may depend on a firm's financial slack. On one hand, financial slack may be spent by managers for their private benefits; a high level is likely associated with severe agency conflicts. Thus corporate governance matters more for high financial slack firms (i.e., the wasteful spending hypothesis). On the other hand, financial slack provides insurance against future uncertainties; a low level may signal deviations from the best interests of shareholders. Then corporate governance is more effective for low financial slack firms (i.e., the precautionary needs hypothesis). We differentiate the two hypotheses using the passage of antitakeover laws to identify exogenous variation in governance. Consistent with the wasteful spending hypothesis, the laws' passage has a larger negative impact on the operating and stock market performance of high financial slack firms. Further analysis shows that these firms do not invest more but become less efficient at cost management after the laws' passage.
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Proxy Advisory Firms: The Economics of Selling Information to Voters
Andrey Malenko & Nadya Malenko
MIT Working Paper, March 2016
Abstract:
Proxy advisors play an important role by providing investors with research and recommendations on how to vote their shares. This paper examines how proxy advisors affect the quality of corporate decision-making. We analyze a model in which a monopolistic advisor offers to sell information to shareholders, who decide whether to acquire private information and/or buy the advisor's recommendation, and how to cast their votes. We show that the proxy advisor's presence can decrease the quality of decision-making, even if its information is more precise than shareholders' information and no party has a conflict of interest. This is because there is a wedge between privately optimal and socially optimal information acquisition decisions, leading to inefficient crowding out of private information production. We also evaluate several existing proposals on regulating proxy advisors and show that some suggested policies, such as reducing proxy advisors' market power or increasing the transparency of their methodologies, can have a negative effect.
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CEO Narcissism and the Takeover Process: From Private Initiation to Deal Completion
Nihat Aktas et al.
Journal of Financial and Quantitative Analysis, February 2016, Pages 113-137
Abstract:
Chief executive officer (CEO) narcissism affects the takeover process. Acquirer shareholders react less favorably to a takeover announcement when the target CEO is more narcissistic. Narcissistic acquiring CEOs negotiate faster. They are also marginally more likely to initiate deals. Acquirer CEO narcissism and target CEO narcissism are associated with a lower probability of deal completion and reduce the likelihood that the target CEO will be employed by the merged firm. Our findings highlight the importance of both acquirer and target CEO psychological characteristics throughout the takeover process.
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Are Founder CEOs more Overconfident than Professional CEOs? Evidence from S&P 1500 Companies
Joon Mahn Lee, Byoung-Hyoun Hwang & Hailiang Chen
Strategic Management Journal, forthcoming
Abstract:
We provide evidence that founder CEOs of large S&P 1500 companies are more overconfident than their non-founder counterparts ("professional CEOs"). We measure overconfidence via tone of CEO tweets, tone of CEO statements during earnings conference calls, management earnings forecasts, and CEO option-exercise behavior. Compared with professional CEOs, founder CEOs use more optimistic language on Twitter and during earnings conference calls. In addition, founder CEOs are more likely to issue earnings forecasts that are too high; they are also more likely to perceive their firms to be undervalued, as implied by their option-exercise behavior. We provide evidence that, to date, investors appear unaware of this "overconfidence bias" among founders.
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Passive Investors, Not Passive Owners
Ian Appel, Todd Gormley & Donald Keim
Journal of Financial Economics, forthcoming
Abstract:
Passive institutional investors are an increasingly important component of U.S. stock ownership. To examine whether and by which mechanisms passive investors influence firms' governance, we exploit variation in ownership by passive mutual funds associated with stock assignments to the Russell 1000 and 2000 indexes. Our findings suggest that passive mutual funds influence firms' governance choices, resulting in more independent directors, removal of takeover defenses, and more equal voting rights. Passive investors appear to exert influence through their large voting blocs, and consistent with the observed governance differences increasing firm value, passive ownership is associated with improvements in firms' longer-term performance.
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Extreme CEO pay cuts and audit fees
David Bryan & Terry Mason
Advances in Accounting, forthcoming
Abstract:
This study investigates whether sudden and severe reductions in total CEO compensation affect auditor perceptions of risk. We argue that extreme CEO pay cuts can incentivize the CEO to manipulate the financial reports or make risky operational decisions in a desperate attempt to improve firm performance. This incentive, in turn, is likely to impact auditor assessments of audit risk and auditor business risk, leading to higher audit fees. Consistent with our hypothesis, we find evidence of a positive and highly significant association between extreme CEO pay cuts and audit fees. The results suggest that audit fees are 4.6% higher when there is an extreme CEO pay cut, which corresponds to an audit fee that is $111,458 higher for the average firm-year observation in our sample.
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Economic Uncertainty and Earnings Management
Luke Stein & Charles Wang
Harvard Working Paper, March 2016
Abstract:
We document that firms report more negative discretionary accruals when financial markets are less certain about their future prospects. Stock-price responses to earnings surprises are moderated when firm-level uncertainty is high, consistent with performance being attributed more to luck, which can create incentives to shift earnings toward lower-uncertainty periods. We show that the resulting opportunistic earnings management is concentrated in CEOs, firms, and periods where such incentives are likely to be strongest: (1) where CEO wealth is sensitive to change in the share price, (2) where announced earnings are particularly likely to be an important source of information about managerial ability and effort, and (3) before implementation of Sarbanes-Oxley made opportunistic earnings management more challenging. Our evidence highlights a novel channel through which firm-level uncertainty affects managerial decision making.
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Credit risk and governance: Evidence from credit default swap spreads
Evrim Akdoğu & Aysun Alp
Finance Research Letters, forthcoming
Abstract:
In this paper, we examine the effect of shareholder governance mechanisms on the firms' credit risk through credit default swap spreads. Our results suggest that higher antitakeover provisions decrease the price of debt. We find that on average, addition of one antitakeover provision lowers the CDS spread by 3.46 basis points. In addition, we find that this effect is more pronounced for smaller, highly levered, low-rated, and less profitable firms. Since these firms arguably carry a higher financial distress risk, it appears that bondholders favor weaker shareholder governance when the conflict of interest between the shareholders and the bondholders peak.
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The Disciplinary Effects of Proxy Contests
Vyacheslav Fos
Management Science, forthcoming
Abstract:
Using a manually collected data set of all proxy contests from 1994 through 2012, I show that proxy contests play an important role in hostile corporate governance. Target shareholders benefit from proxy contests: the average abnormal returns reach 6.5% around proxy contest announcements. Proxy contests that address firms' business strategies and undervaluation are most beneficial for shareholders. By contrast, proxy contests that aim at changing capital structure and governance do not lead to higher firm values. Relative to matching firms, future targets are smaller, they have higher stock liquidity, higher institutional and activist ownership, lower leverage and market valuation, and higher investments. Whereas most of these characteristics predict proxy contests in time series, prior to proxy contests, targets also experience poor stock performance, decreases in investments, increases in cash reserves and payouts to shareholders, and increases in management's entrenchment. These changes in corporate policies are consistent with targets' attempts to affect the probability of a proxy contest.
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The Labor Market for Directors and Externalities in Corporate Governance
Doron Levit & Nadya Malenko
Journal of Finance, April 2016, Pages 775-808
Abstract:
This paper studies how directors' reputational concerns affect board structure, corporate governance, and firm value. In our setting, directors affect their firms' governance, and governance in turn affects firms' demand for new directors. Whether the labor market rewards a shareholder-friendly or management-friendly reputation is determined in equilibrium and depends on aggregate governance. We show that directors' desire to be invited to other boards creates strategic complementarity of corporate governance across firms. Directors' reputational concerns amplify the governance system: strong systems become stronger and weak systems become weaker. We derive implications for multiple directorships, board size, transparency, and board independence.