Findings

Shell games

Kevin Lewis

January 04, 2016

Are offshore firms worth more?

Art Durnev, TieMei Li & Michel Magnan
Journal of Corporate Finance, February 2016, Pages 131–156

Abstract:
We examine how firms’ reliance on Offshore Financial Centers (OFCs), either by registering or setting up subsidiaries in OFCs, affects their financial performance. Using multilevel mixed (fixed and random) effects regressions, we provide evidence that is consistent with the agency costs of tax avoidance. Information asymmetry and lax legal environments in OFCs offset tax benefits, especially for firms directly registered in OFCs. Firms directly registered in OFCs are valued 14% lower than onshore firms, while firms with subsidiaries in OFCs enjoy an 11% higher valuation than onshore firms. However, it appears that investors do not fully appreciate the extent of the agency costs due to increased information asymmetry of firms that set up subsidiaries in OFCs. We argue that the assessment of firm value must encompass the registration status of its subsidiaries rather than the parent company’s origin.

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Discipline or Disruption? Stakeholder Relationships and the Effect of Takeover Threat

Ling Cen, Sudipto Dasgupta & Rik Sen
Management Science, forthcoming

Abstract:
Although a sizable literature suggests that firms benefit from vulnerability to takeovers because it reduces agency problems, the threat of takeovers can also impose ex ante costs on firms by adversely affecting relationships with important stakeholders, such as major customers. We find that when firms have corporate customers as important stakeholders, an exogenous reduction in the threat of takeovers increases their ability to attract new customers and strengthens their relationships with existing customers, resulting in improvement in operating performance. The positive effect on operating performance is greater for suppliers that are likely to offer unique and durable products to their customers. Our results suggest a beneficial aspect of protection from takeovers when stakeholder relationships are important.

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The Shareholder Value of Empowered Boards

Martijn Cremers & Simone Sepe
Stanford Law Review, forthcoming

Abstract:
In the last decade, the balance of power between shareholders and boards has shifted dramatically. Changes in both the marketplace and the legal landscape governing it have turned the call for empowered shareholders into a new reality. Correspondingly, the authority that boards of directors have historically held in U.S. corporate law has been eroded. Empirical studies associating staggered boards with lower firm value have been interpreted to favor this shift of authority, supporting the view that protecting boards from shareholder pressure is detrimental to shareholder interests. This Article presents new empirical evidence on staggered boards that not only exposes the limitations of prior empirical studies, but also, and more importantly, suggests the opposite conclusion. Employing a unique and comprehensive dataset covering thirty-four years of board staggering and destaggering decisions — from 1978 to 2011 — we show that staggered boards are associated with a statistically and economically significant increase in firm value. In light of these novel empirical results, we then show theoretically that a corporate model with staggered boards emerges as a rational institutional response to market imperfections that are more complex and more significant than shareholder advocates have realized. Boards that retain their historical authority — empowered boards — benefit, rather than hurt, shareholders. This Article concludes with a normative proposal to revitalize the authority of U.S. boards.

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Do aircraft perquisites cause CEOs to withhold bad news?

Chia-Wei Huang & Chih-Yen Lin
North American Journal of Economics and Finance, January 2016, Pages 189–202

Abstract:
This paper explores the relation between management forecasts and expensive perquisites. We investigate Yermack's (2006) conjecture that managers withhold bad news in order to receive expensive perquisites. We provide direct evidence supporting Yermack's (2006) conjecture. The frequency and magnitude of bad news release is greater than that of good news after the chief executive officer (CEO) first discloses aircraft perks. In addition, managers with greater numbers of disclosed perks are more inclined to withhold bad news. Additional subsample analyses provide further support for managerial bad news withholding behavior.

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Do External Labor Market Incentives Motivate CEOs to Adopt More Aggressive Corporate Tax Reporting Preferences?

Thomas Kubick & Brandon Lockhart
Journal of Corporate Finance, forthcoming

Abstract:
Building on recent theory, we find strong and robust evidence that external labor market incentives motivate CEOs to adopt more aggressive tax policies in order to improve firm performance and their own labor market value. In addition, we find that the tax aggressiveness-labor market incentives relation varies in the cross-section consistently with theory. We find that the relation is attenuated in industries for which the CEO has more outside employment options, and we find it to be amplified in industries for which competition for CEO talent is likely greatest, and also among CEOs estimated to have greater ability. Overall, our results suggest that the market for CEOs – an incentive device external to the firm – has a meaningful impact on corporate tax policy.

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Are Corporate Inversions Good for Shareholders?

Anton Babkin, Brent Glover & Oliver Levine

University of Wisconsin Working Paper, December 2015

Abstract:
In 2014 alone, U.S. firms worth over half a trillion dollars announced their intention to expatriate to a foreign country -- a corporate inversion -- in order to reduce corporate income taxes. To discourage expatriation, U.S. law requires shareholders of inverting firms to realize a personal capital gains tax liability at the completion of the transaction. Thus, while reduced corporate taxes benefit all shareholders equally, a corporate inversion results in a personal tax cost that depends on the individual investor's tax basis and standing. We develop a model to value the net benefits of inversion and we show that the private returns to investors varies widely across individuals. We find that the benefits of inversion disproportionately accrue to the CEO, foreign shareholders, and short-term investors, while many long-term investors suffer a net loss.

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Antitakeover Statutes and Internal Corporate Governance

Choonsik Lee & Kee Chung
Corporate Governance, forthcoming

Research Question/Issue: This paper examines the relation between internal corporate governance and the market for corporate control by analyzing how firms' internal governance mechanisms are related to states' antitakeover statutes (ATS). Specifically, we test two competing hypotheses concerning the effect of ATS on internal governance: the substitution hypothesis and the complementarity hypothesis.

Research Findings/Insights: We provide evidence that is consistent with the complementarity hypothesis that exposure to a possible takeover increases rather than decreases the need for better internal governance mechanisms. Specifically, firms that are exposed to takeover threats (i.e., firms in states without ATS or firms that opt out of states' ATS) have stronger internal governance mechanisms (i.e., adopt a greater number of governance standards) than do firms that are not exposed to takeover threats (i.e., firms in states with ATS). In a similar vein, firms adopt more internal governance standards when states abolish existing ATS.

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Do Nonexecutive Employees Have Valuable Information? Evidence from Employee Stock Purchase Plans

Ilona Babenko & Rik Sen
Management Science, forthcoming

Abstract:
Using novel data on employee stock purchase plans (ESPPs), we show that aggregate purchases of company stock by lower-level employees predict future stock returns. Firms in the top quartile of ESPP purchases outperform those in the bottom quartile by 10% in the year after purchase. The relation between ESPP purchases and future stock returns is stronger for firms with high information asymmetry. Furthermore, we find that high ESPP purchases are associated with a lower likelihood of breaks in strings of consecutive earnings increases, as well as higher future sales growth and more innovation. These findings support the hypothesis that lower-level employees have information about future firm performance. We examine and reject a number of alternative explanations. Our results have implications for firms using employees as a source of capital, accounting issues related to expensing of equity-based compensation, and disclosure policy.

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The Throne vs. the Kingdom: Founder Control and Value Creation in Startups

Noam Wasserman
Strategic Management Journal, forthcoming

Abstract:
Does the degree to which founders keep control of their startups affect company value? I argue that founders face a “control dilemma” in which a startup's resource dependence drives a wedge between the startup's value and the founder's ability to retain control of decision making. I develop hypotheses about this tradeoff and test the hypotheses on a unique dataset of 6,130 American startups. I find that startups in which the founder is still in control of the board of directors and/or the CEO position are significantly less valuable than those in which the founder has given up control. On average, each additional level of founder control (i.e., controlling the board and/or the CEO position) reduces the pre-money valuation of the startup by 17.1%-22.0%.

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Managers set the tone: Equity incentives and the tone of earnings press releases

Özgür Arslan-Ayaydin & Kris Boudt & James Thewissen

Journal of Banking & Finance, forthcoming

Abstract:
Earnings press releases, as a timely vehicle for communicating a firm’s performance to third parties, can be used by managers to influence the perception of the firm’s achievements. Taking the stock price reaction to the tone of earnings press releases at earnings announcements into account, we argue that equity-based incentives induce managers to inflate the tone. We further posit that the impact of tone on the abnormal stock returns at the earnings announcements depends on the magnitude of the equity-based incentives. Based on over 26,000 earnings press releases of S&P1500 firms between 2004Q4 and 2012Q4, we find that the tone of earnings press releases tends to be more positive when the managerial portfolio value is more closely tied to the firm’s stock price. We also find that investors react proportionally less to the tone as managers’ equity incentives increase.

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The global corporate elite after the financial crisis: Evidence from the transnational network of interlocking directorates

Eelke Heemskerk, Meindert Fennema & William Carroll

Global Networks, January 2016, Pages 68–88

Abstract:
What impact did the recent financial crisis have on the corporate elite's international network? Has corporate governance taken on an essentially national structure or have transnational networks remained robust? We investigate this issue by comparing the networks of interlocking directorates among the 176 largest corporations in the world economy in 1976, 1996, 2006 and 2013. We find that corporate elites have not retrenched into their national business communities: the transnational network increased in relative importance and remained largely intact during the crisis lasting from 2006 to 2013. However, this network does not depend – as it used to do – on a small number of big linkers but on a growing number of single linkers. The network has become less hierarchical. As a group, the corporate elite has become more transnational in character. We see this as indicative of a recomposition of the corporate elite from a national to a transnational orientation.

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Silverback CEOs: Age, Experience, and Firm Value

Brandon Cline & Adam Yore
Journal of Empirical Finance, January 2016, Pages 169–188

Abstract:
Approximately half of S&P 1500 firms have adopted policies mandating retirement based on age. This study investigates the merits of CEO mandatory retirement policies (MRPs) using a sample of 12,610 firm-year observations from 2,143 unique firms. It also addresses the question of whether CEO age is relevant to the success of an organization. We fail to find consistent evidence that MRPs are intended to limit CEO entrenchment. MRPs are, however, positively associated with CEO age and negatively associated with firm-specific human capital. Further analysis reveals that CEO age is significantly negatively related to firm value, operating performance, and corporate deal-making activity. Splitting our sample according to whether an MRP is in place, we observe that the negative impact of age exists only for those firms which do not have MRPs. We therefore conclude that MRPs represent an effective form of firm governance designed to mitigate the underperformance of older CEOs.

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The impact of say-on-pay on executive compensation

Steven Balsam et al.
Journal of Accounting and Public Policy, forthcoming

Abstract:
We investigate the impact of say-on-pay on 2010 executive compensation, finding that affected firms reduced compensation and made it more performance-based in advance of the initial 2011 vote, with the decrease being greater for firms that previously overpaid their CEOs. We also find that the percentage of votes cast against executive pay is lower when the firm reduced executive compensation in advance of that initial say-on-pay vote, but higher when the firm pays higher total compensation, has a large increase in compensation, has a larger amount of compensation that cannot be explained by economic factors, or has a higher amount of “other compensation,” a category which includes perquisites. Last, but not least, we find that the tone and prominence of the Compensation Discussion and Analysis (CD&A) are associated with the vote, as is the recommendation of Institutional Shareholders Services.

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Local Economic Consequences of Stock Market Listings

Alexander Butler, Larry Fauver & Ioannis Spyridopoulos

Rice University Working Paper, November 2015

Abstract:
When a firm goes public there is, on average, a positive spillover effect on the local economy where the firm’s headquarters is. This effect is an incremental 2% growth in local per capita income over the next year and is twice as large for high-proceeds IPOs. We mitigate concerns about unobserved heterogeneity with MSA fixed effects and a matching procedure. We provide evidence that our result is not due to reverse causality, and show that it is the listing decision, rather than raising capital, that induces the growth. The channel for the growth effect appears to be through employment.

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Director Liability Protection, Earnings Management, and Audit Pricing

Sarfraz Khan & John Wald
Journal of Empirical Legal Studies, December 2015, Pages 781–814

Abstract:
We examine how a firm's director liability protection is related to earnings management and audit pricing. Firms whose directors are protected from litigation either by state laws or through clauses in the firm's charter have significantly more accruals management. This relation is significant after the passage of the Sarbanes-Oxley Act but not before. We also find evidence of a positive association between director protection and auditor fees. The results are robust to a number of alternative specifications, including one that instruments for director liability protection.

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Cheap talk? Strategy presentations as a form of chief executive officer impression management

Richard Whittington, Basak Yakis-Douglas & Kwangwon Ahn

Strategic Management Journal, forthcoming

Abstract:
We develop and test a set of hypotheses on investors’ reactions to a specific form of impression management, public presentations of overall strategy by Chief Executive Officers (CEOs). Contrary to expectations from a ‘cheap talk’ perspective, we suggest that such strategy presentations convey valuable information to investors, especially in conditions of heightened information asymmetry associated with varying types of new CEOs. Broad empirical support for our theoretical arguments is shown in a sample of strategy presentations carried out by NYSE and NASDAQ listed organizations over 10 years. Our research contributes to literature on new CEOs and impression management. We draw out implications both for management and for further research.

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Examining the Role of the Media in Influencing Corporate Tax Avoidance and Disclosure

Shannon Chen, Kathleen Powers & Bridget Stomberg

University of Texas Working Paper, September 2015

Abstract:
We examine the determinants of negative media coverage of corporate taxes as well as whether and how firms respond to media scrutiny. Prior literature demonstrates that the business press can act as an information intermediary and/or an entertainment provider. We test which of these roles the media primarily serve in their coverage of corporate income taxes by developing a selection model to identify which firm characteristics increase the probability of negative coverage. Our analysis reveals that negative media coverage is increasing in firms’ tax aggressiveness and in the extent of firms’ foreign operations, which suggests the media serve at least some role as information intermediaries. We find no evidence that firms reduce their level of tax avoidance following negative media attention but do find they report smaller reserves for uncertain tax positions. We also test for changes in disclosure quality and document an increase in passive voice and ambiguous language in income tax footnote disclosures. Thus, it appears firms’ primary response to negative media coverage is a decrease in disclosure readability rather than a change in economic activity. Our findings suggest that the media do not influence firms’ tax avoidance activity, which should be of interest to boards and shareholders.


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