Taking ownership

Kevin Lewis

March 18, 2019

Does social capital mitigate agency problems? Evidence from Chief Executive Officer (CEO) compensation
Chun Keung (Stan) Hoi, Qiang Wu & Hao Zhang
Journal of Financial Economics, forthcoming


We find that social capital, as captured by secular norms and social networks surrounding corporate headquarters, is negatively associated with levels of CEO compensation. This relation holds in a range of robustness tests including those that address omitted variable bias and reverse causality. Additionally, social capital reduces the likelihood that firms make opportunistic option grant awards that unduly favor CEOs, including lucky awards, backdated awards, and unscheduled awards. Social capital also lessens the accretive effect of CEO power on CEO compensation. These findings indicate that social capital mitigates agency problems by restraining managerial rent extraction in CEO compensation.

The Value of Offshore Secrets: Evidence from the Panama Papers
James O'Donovan, Hannes Wagner & Stefan Zeume
Review of Financial Studies, forthcoming


We exploit one of the largest data leaks, to date, to study whether and how firms use secret offshore vehicles. From the leaked data, we identify 338 listed firms as users of secret offshore vehicles and document that these vehicles are used to finance corruption, avoid taxes, and expropriate shareholders. Overall, the leak erased $174 billion in market capitalization among implicated firms. Following the increased transparency brought about by the leak, implicated firms experience lower sales from perceptively corrupt countries and avoid less tax. We conservatively estimate that 1 in 7 firms have offshore secrets.

Gender and Geography in the Boardroom: What Really Matters for Board Decisions?
Zinat Alam et al.
Georgia State University Working Paper, December 2018


Recent literature has shown that gender diversity in the boardroom seems to influence key monitoring decisions of boards. In this paper, we examine whether the observed relation between gender diversity and board decisions is due to a confounding factor, namely, directors' geographic distance from headquarters. Using data on residential addresses for over 4,000 directors of S&P 1500 firms, we document that female directors cluster in large metropolitan areas and tend to live much farther away from headquarters compared to their male counterparts. We also reexamine prior findings in the literature on how boardroom gender diversity affects key board decisions. We use data on direct airline flights between U.S. locations to carry out an instrumental variables approach that exploits plausibly exogenous variation in both gender diversity and geographic distance. The results show that the effects of boardroom gender diversity on CEO compensation and CEO dismissal decisions found in the prior literature largely disappear when we account for geographic distance. Overall, our results support the view that gender-diverse boards are "tougher monitors" not because of gender differences per se, but rather because they are more geographically remote from headquarters and hence more reliant on hard information such as stock prices. The findings thus suggest that board gender policies, such as quotas, could have unintended consequences for some firms.

Strategic Reactions in Corporate Tax Planning
Christopher Armstrong, Stephen Glaeser & John Kepler
Journal of Accounting and Economics, forthcoming


We find that firms' tax planning exhibits strategic reactions: firms respond to changes in their industry-competitors' tax planning by changing their own tax planning in the same direction. We document evidence of these strategic reactions in two distinct research settings that entail an exogenous increase and decrease in competitors' tax planning. We also find evidence that strategic reactions stem from concerns about appearing more tax aggressive than industry competitors, some evidence that they stem from firms learning from the tax planning of their industry competitors, and no consistent evidence that they stem from leader-follower dynamics.

Independent executive directors: How distraction affects their advisory and monitoring roles
Luke Stein & Hong Zhao
Journal of Corporate Finance, June 2019, Pages 199-223


Active corporate executives are a popular source of independent directors. Although their knowledge, expertise, and network can bring value to firms on whose boards they sit, independent executive directors may be more likely to be distracted than other directors due to their outside executive roles. Using newly constructed data linking independent directors to their employers, we identify periods when employers' poor performance may distract them from board service. We find that firms with distracted independent executive directors have lower performance and value, higher CEO compensation, reduced CEO turnover-performance sensitivity, lower earnings quality, and lower M&A performance. These adverse effects are mainly driven by distracted directors who sit on relevant committees, and are stronger for small boards.

Distracted institutional shareholders and managerial myopia: Evidence from R&D expenses
Yueting Li, Jianling Wang & Xuan Wu
Finance Research Letters, June 2019, Pages 30-40


We explore how institutional shareholder attention affects firms' decisions to cut R&D expenses. Prior studies consider the attention distraction of institutional investors as a signal of firms' loosened monitoring constraints. Consistent with this view, we find that firms with distracted shareholders are more likely to engage in short-term behavior, namely, cutting R&D expenses. We further find that this effect is concentrated in firms with low information asymmetry, few product market competitive threats, few financial constraints, and low CEO ability. Our results suggest that attention is a key resource for institutional shareholders to effectively monitor firms and, hence, reduce managerial myopia.

The cash conversion cycle spread
Baolian Wang
Journal of Financial Economics, forthcoming


The cash conversion cycle (CCC) refers to the time span between the outlay of cash for purchases to the receipt of cash from sales. It is a widely used metric to gauge the effectiveness of a firm's management and intrinsic need for external financing. This paper shows that a zero-investment portfolio that buys the lowest CCC decile stocks and shorts the highest CCC decile stocks earns 5%-7% alphas per year. The CCC effect is prevalent across industries, remains even for large capitalization stocks, distinct from the known return predictors, and cannot be explained by the financial intermediary leverage risk.

Disclosure incentives when competing firms have common ownership
Jihwon Park et al.
Journal of Accounting and Economics, forthcoming


This paper examines whether common ownership - i.e., instances where investors simultaneously own significant stakes in competing firms - affects voluntary disclosure. We argue that common ownership (i) reduces proprietary cost concerns of disclosure, and (ii) incentivizes firms to "internalize" the externality benefits of their disclosure for co-owned peer firms. Accordingly, we find a positive relation between common ownership and disclosure. Evidence from cross-sectional tests and a quasi-natural experiment based on financial institution mergers help mitigate concerns that our results are explained by an omitted variable bias or reverse causality. Finally, we find that common ownership is associated with increased market liquidity.

Who's Paying Attention? Measuring Common Ownership and Its Impact on Managerial Incentives
Erik Gilje, Todd Gormley & Doron Levit
NBER Working Paper, March 2019


We derive a measure that captures the extent to which overlapping ownership structures shift managers' incentives to internalize externalities. A key feature of the measure is that it allows for the possibility that not all investors are attentive to whether a manager's actions benefit the investor's overall portfolio. Empirically, we show that potential drivers of ownership overlap, including mergers in the asset management industry and the growth of indexing, could in fact diminish managerial motives. Our findings illustrate the importance of accounting for investor inattention and cast doubt on the possibility that the growth of common ownership has had a significant impact on managerial incentives.

Do investors perceive a change in audit quality following the rotation of the engagement partner?
Gopal Krishnan & Jing Zhang
Journal of Accounting and Public Policy, forthcoming


Though Section 203 of the Sarbanes-Oxley Act (SOX) calls for the rotation of the audit partner every five years, we do not know whether investors value audit partner rotation. This is an important issue since many in the auditing profession believe that mandatory rotation of the audit partner is unnecessary and may in fact impair audit quality. We identify a sample of firms that disclosed changes in the engagement partner in the proxy statement and examine whether equity investors perceive a change in audit quality following the partner rotation. We find a significant increase in earnings informativeness following audit partner rotation. We also find that short sellers regard earnings in the post-rotation to be of higher quality than earnings prior to the rotation. Finally, cost of equity capital is lower following partner rotation. Our findings have important implications for the regulators, auditors, and investors.

The Role of Executive Cash Bonuses in Providing Individual and Team Incentives
Wayne Guay, John Kepler & David Tsui
Journal of Financial Economics, forthcoming


Given CEOs' substantial equity portfolios, much recent literature on CEO incentives regards cash-based bonus plans as largely irrelevant, begging the question of why nearly all CEO compensation plans include such bonuses. We develop a new measure of bonus plan incentives and show that performance sensitivities are much greater than prior estimates. We also test hypotheses regarding the role of bonuses in providing executives with individualized and team incentives. We find little evidence supporting the individualized incentives hypotheses but find consistent evidence that bonus plans appear to be used to encourage mutual monitoring and to facilitate coordination across the top management team as a whole.

The Corporate Restructuring Imperative: Performance, Strategy, and CEO Dismissal in the Shareholder Value Era
Shoonchul Shin
Social Forces, forthcoming


This paper proposes that CEO dismissal is a form of penalty that CEOs incur for their record of deviation from historically prevailing norms of appropriate behavior during performance downturns. To verify this argument, I examine CEO dismissal and post-dismissal strategic change in large U.S. companies between 1984 and 2007, when the field in which these firms were embedded was characterized by the prominence of the norms of corporate restructuring for shareholders. My findings are three-fold. First, the effect of performance declines on CEO dismissal was intensified by the extent to which CEOs held a record of deviation from the norms of restructuring - i.e., that of increasing assets, employees, and unrelated diversification. Second, new CEOs were more inclined to engage in restructuring when they took office following the dismissal of predecessors with a record of deviation. Finally, those patterns of CEO dismissal and post-dismissal restructuring became more evident over time as the norms developed. Meanwhile, the findings did not apply prior to the shareholder value era. Consequently, this paper suggests that institutional norms act as interpretive frameworks that enable a board of directors to make sense of performance problems and evaluate managerial competence to resolve those problems. Implications for the literatures on institutional theory and upper echelon research are discussed.

The Effect of Financial Reporting Quality on Corporate Investment Efficiency: Evidence from the Adoption of SFAS No. 123R
Yiwei Dou, Franco Wong & Baohua Xin
Management Science, forthcoming


We test for changes in investment efficiency around a shock to financial reporting quality - the adoption of SFAS No. 123R, which requires that employee stock option (ESO) costs be recognized rather than disclosed at fair value. We predict and find a reduction in underinvestment for firms heavily affected by the new standard, and these firms exhibit a decrease in the bid-ask spread and an increase in new capital raised in the post-SFAS No. 123R period. The reduction in underinvestment is more pronounced for firms whose ESO estimates are more unreliable before SFAS No. 123R, for firms that are financially constrained, and for firms with more entrenched managers. These findings are consistent with recognition of ESO costs at fair value improving financial reporting quality, which, in turn, enhances investment efficiency through the mitigation of the adverse selection problem for underinvesting firms.

Why do institutions like corporate social responsibility investments? Evidence from horizon heterogeneity
Xudong Fu, Tian Tang & Xinyan Yan
Journal of Empirical Finance, March 2019, Pages 44-63


Why do institutional investors improve firms' engagement in corporate social responsibility (CSR) investments? We show that CSR activities are driven by institutional investors with long investment horizons, and that this is due to the reputation insurance that CSR spending provides. Specifically, longer horizon investors benefit more from such insurance, and so do their agents, the investment managers that interact with portfolio firms. Additional tests show that this positive relationship between shareholder horizons and CSR is enhanced by market myopia, managerial agency risks, and motivated investors. We address the endogeneity concerns by employing Russell 1000/2000 index switches as sources of exogenous variation in shareholder investment horizons. The influence of shareholder horizons on CSR is also related to social norms. Our main results hold for all but one category of CSR and appear to be driven by CSR strengths.


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