Corporate governance and capital allocations of diversified firms

We examine how various aspects of corporate governance structures affect the capital allocation inefficiency that drives the value discounts of diversified firms. Diversified firms with more effective internal or external governance mechanisms experience more efficient investment allocations at both the firm and segment levels and show less of a diversification discount. The efficiency of the investment allocation process is better for diversified firms with high board independence, low board busyness, high institutional ownership, high outside director ownership, high CEO equity-based pay, high audit quality, and strong shareholder rights. The results hold after controlling for other potential influences. Our evidence suggests that corporate governance considerations are important in assessing the relation between investment efficiency and firm value for diversified firms.     

CEO incentive compensation and stock price momentum

We document strong evidence that CEO incentive compensation can predict the significance of stock price momentum through discretionary accrual and real activities manipulation. The profit of momentum strategy increases with CEO pay-for-performance incentive, but decreases with CEO risk-taking incentive. It also evaluates the effects of information uncertainty on such relationship. The evidence is more significant for firms with older and longer tenured CEOs and firms with more informed traders. The relationship between the profit of momentum strategy and CEO pay-for-performance incentive is stronger among CEOs without the risk-taking incentive. Our results are robust for different sub-samples based on before and after Reg FD and Sarbanes–Oxley Act, even after controlling for the potential endogeneity. Further, our findings are consistent with the information diffusion explanation of momentum and the agency theory that incentivised CEOs tend to manipulate information by smoothing good news, concealing mildly bad news and accelerating the disclosure of extremely bad news.     

Does executive compensation reflect corporate productivity?

Recent literature has given attention to the effect of CEO-specific productivity on the structure of CEO compensation. Our paper instead focuses on the effect of a different productivity factor—which we call “corporate productivity”—on CEO compensation. In particular, we show that corporate productivity affects the trade-off between incentive and risk in a non-monotonic fashion, which the literature has not yet recognized. Using various empirical proxies for corporate productivity, we show that our results are consistent with the non-monotonic relation and thus contribute to the debates in the incentive-risk trade-off literature. Second, our findings also contribute to the internal capital market literature by exploring the relation between the structure of CEO compensation and excess value.     

Investor pricing of CEO equity incentives

The main purpose of this paper is to explore CEO compensation in the form of stock and options. The objective of CEO compensation is to better align CEO-shareholder interests by inducing CEOs to make more optimal (albeit risky) investment decisions. However, recent research suggests that these incentives have a significant down-side (i.e., they motivate executives to manipulate reported earnings and lower information quality). Given the conflict between the positive CEO-shareholder incentive alignment effect and the dysfunctional information quality effect, it is an open empirical question whether CEO equity incentives increase firm value. We examine whether CEO equity incentives are priced in the firm-specific ex ante equity risk premium over the 1992–2007 time period. Our analysis controls for two potential structural changes over this time period. The first is the 1995 Delaware Supreme Court ruling which increased protection from takeovers (and decreased risk) for Delaware incorporated firms. The second is the 2002 Sarbanes–Oxley Act which impacted corporate risk taking, equity incentives, and earnings management. Collectively, our findings suggest that CEO equity incentives, despite being associated with lower information quality, increase firm value through a cost of equity capital channel.     

CEO Stock Options and Equity Risk Incentives

Abstract:   We test the hypothesis that the risk incentive effects of CEO stock option grants motivate managers to take on more risk than they would otherwise. Using a sample of mergers we document that the ratio of post‐ to pre‐merger stock return variance is positively related to the risk incentive effect of CEO stock option compensation but this relationship is conditioned on firm size, with firm size having a moderating effect on the risk incentive effect of stock options. Using a broader time‐series cross‐sectional sample of firms we find a strong positive relationship between CEO risk incentive embedded in the stock options and subsequent equity return volatility. As in the case of the merger sample, this relationship is stronger for smaller firms.     

The Dark Side of Internal Capital Markets: Divisional Rent-Seeking and Inefficient Investment

We develop a two-tiered agency model that shows how rent-seeking behavior on the part of division managers can subvert the workings of an internal capital market. By rent-seeking, division managers can raise their bargaining power and extract greater overall compensation from the CEO. And because the CEO is herself an agent of outside investors, this extra compensation may take the form not of cash wages, but rather of preferential capital budgeting allocations. One interesting feature of our model is that it implies a kind of "socialism" in internal capital allocation, whereby weaker divisions get subsidized by stronger ones.     

高管团队内部治理与企业资本结构调整——基于非CEO高管独立性的视角

本文以2001-2017年A股上市公司为研究样本,实证检验了高管团队内部治理对企业资本结构的影响。研究发现:当企业负债不足时,高管团队内部治理效应能够显著提高企业(尤其是非国有企业)的负债水平,降低企业实际资本结构与目标资本结构的偏离程度。这种高管团队内部治理效应在第一类委托代理问题比较严重以及非CEO高管监督动机较强的企业中更加显著。作用机制分析表明,高管团队内部治理效应能够通过降低第一类代理成本来降低企业资本结构与目标资本结构的偏离程度。本文的研究结论为改善我国上市公司治理提供了新的思路,对于优化企业融资结构、深化金融供给侧结构性改革具有一定的启示意义。     

Promotion Tournaments and Capital Rationing

We analyze capital allocation in a conglomerate where divisionalmanagers with uncertain abilities compete for promotion to CEO.A manager can sometimes gain by unobservably adding varianceto divisional performance. Capital rationing can limit thisdistortion, increase productive efficiency, and allow the ownerto make more accurate promotion decisions. Firms for which CEOtalent is more important for firm performance are more likelyto ration capital. A rationed manager is more likely to be promotedeven though all managers are identical ex ante. When the tournamentpayoff is relatively small, offering an incentive wage can bemore efficient than rationing capital; however, when tournamentincentives are paramount, rationing is more efficient.     

The Subjective Valuation of Indexed Stock Options and Their Incentive Effects

We analyze the potential role of indexed stock options in future pay‐for‐performance executive compensation contracts. We present a unified framework for index‐linked stock options, discuss their incentive effects, argue that indexation schemes based on the capital‐asset pricing model (CAPM) are the most suitable for executive compensation, and derive a subjective pricing model for the class of CAPM‐based indexed stock options. Contrary to earlier work, executives would not be motivated to take on investment projects with high idiosyncratic risk once their lack of wealth diversification and degree of risk aversion are factored into the analysis.     

Investors’ perception of CEO overconfidence: evidence from the cost of equity capital

Prior literature documents that CEO overconfidence plays an important role in corporate financial reporting and accounting decisions. However, an unexplored issue is how investors perceive the risks associated with CEO overconfidence. This study examines the effect of CEO overconfidence on the cost of equity capital. We find that the association between CEO overconfidence and the cost of equity is nonlinear: a moderate level of CEO overconfidence results in the lowest cost of equity capital after controlling for other known determinants of the cost of equity. We also find an inverted nonlinear relation between CEO overconfidence and equity issuance, which corroborates our main conclusion of the nonlinear effect of CEO overconfidence on the cost of equity. Our results are robust to alternative overconfidence measures, cost of equity measures, and change analysis.     

Diversification,corporate governance and firm value in small markets: evidence from New Zealand

We find that diversified firms in New Zealand are associated with a value discount of 19–42 per cent relative to single‐segment (undiversified) firms. Although several competing explanations have been offered in the literature, we find that the strength of corporate governance explains between 15–21 per cent of this discount. Specifically, board size, busyness of directors, CEO ownership and whether or not compensation of directors includes equity‐based components collectively explain a large part of the reported discount. Our results from companies trading in New Zealand complement recent findings in the US by not only confirming the existence of a diversification discount but also emphasizing the role of poor governance in destroying shareholder wealth by pursuing a value‐destroying corporate strategy. All our results hold after controlling for potential endogeneity in the decision to diversify and the choice of corporate governance structure by employing two‐way fixed‐effects and dynamic‐panel generalized method of moments regression techniques.     

Vertical integration to mitigate internal capital market inefficiencies

We argue that vertical integration creates operational links between divisions in a conglomerate, which aligns divisional interests, thereby reducing internal competition between divisions. As a result, vertical integration improves the capital allocation efficiency of the internal capital market (ICM). We measure ICM efficiency by innovation output and capital expenditure (CAPX) deviation, and present evidence that higher levels of vertical integration are associated with higher ICM efficiency. Our results are robust to a number of endogeneity tests and the use of alternative measures of vertical integration and ICM efficiency.     

CEO Compensation and Firm Performance: an Empirical Investigation of UK Panel Data

This paper examines the link between CEO pay and performance employing a unique, hand‐collected panel data set of 390 UK non‐financial firms from the FTSE All Share Index for the period 1999–2005. We include both cash (salary and bonus) and equity‐based (stock options and long‐term incentive plans) components of CEO compensation, and CEO wealth based on share holdings, stock option and stock awards holdings in our analysis. In addition, we control for a comprehensive set of corporate governance variables. The empirical results show that in comparison to the previous findings for US CEOs, pay‐performance elasticity for UK CEOs seems to be lower; pay‐performance elasticity for UK CEOs is 0.075 (0.095) for cash compensation (total direct compensation), indicating that a ten percentage increase in shareholder return corresponds to an increase of 0.75% (0.95%) in cash (total direct) compensation. We also find that both the median share holdings and stock‐based pay‐performance sensitivity are lower for UK CEOs when we compare our findings with the previous findings for US CEOs. Thus, our results suggest that corporate governance reports in the UK, such as the Greenbury Report (1995) that proposed CEO compensation be more closely linked to performance, have not been totally effective. Our findings also indicate that institutional ownership has a positive and significant influence on CEO pay‐performance sensitivity of option grants. Finally, we find that longer CEO tenure is associated with lower pay‐performance sensitivity of option grants suggesting the entrenchment effect of CEO tenure.     

Internal control and internal capital allocation: evidence from internal capital markets of multi-segment firms

We investigate the impact of internal control over financial reporting on management decisions in directing corporate resources to alternative investment projects in multi-segment firms. Results from cross-sectional and inter-temporal analyses indicate that internal control weaknesses (ICWs) are associated with distortionary internal capital allocations. The adverse impact on internal capital markets is more pronounced for firms with company-level ICWs. Our analyses also show that firms with weak existing governance mechanisms benefit more from maintaining effective internal control. We further document that the negative impact of ICWs on firms’ internal capital transfers manifests in a lower excess value of diversification.     

The Young and the Restless: A Study of Age and Acquisition Propensity of CEOs of UK Firms

Using a large sample of CEOs of UK firms, we show that CEO age is a key determinant of acquisition activity. We find that younger CEOs are more likely to acquire another firm and spend more on large capital expenditures. We argue that while younger CEOs of both UK and US firms undertake more acquisitions than their older peers, their motivations for acquisitions might differ. We find that the stock market perceives acquisitions by younger CEOs to be of a higher quality. Following previous studies, we use CEO tenure as a proxy for reputation, and find that large acquisitions enhance CEO reputation, especially for younger CEOs. In contrast to the previous findings for CEOs of US firms, we determine that the compensation of CEOs in the UK does not increase after acquisitions. This absence of a compensation incentive for CEOs of UK firms is consistent with the idea that the UK compensation structure is more restrictive and has a smaller equity‐based component. Our evidence is also inconsistent with an overconfidence effect. Overall, our results provide consistent evidence of executive signaling by younger CEOs of UK firms eager to distinguish themselves.     

CFO role and CFO compensation: An empirical analysis of their implications

Given concerns over CFO pay, especially incentives, and considering the tension between a CFO’s fiduciary responsibility and being a key member of the firm’s executive team, we examine the determinants and effects of CFO compensation amount, incentive intensity, and proximity to CEO compensation in a sample of European companies (FTE 500, 2005–2009). First, we focus on the CFO role as a determinant of CFO compensation. Like prior work, we proxy for CFO roles by using hand-collected public data on education and past professional experience, but we supplement these proxies with proprietary data to more directly capture the firm-specific nature of the CFO job in term of its similarity with that of the CEO. We thus argue how CFOs can have varied roles characterized by different levels of financial expertise and CEO-likeness, and document that it is this latter aspect that is associated with CFO compensation. Second, we study the effects of CFO compensation design on outcomes in the CFO’s realm related to financial reporting. We find that CFO financial expertise is positively associated with financial reporting quality, while a CFO’s pay long-term incentive intensity and a CFO’s incentive compensation proximity with the CEO are negatively associated with financial reporting quality. Overall, then, our results suggest that CFOs get rewarded for their CEO-likeness, and particularly for their being similar to the CEO in terms of tasks and decision making authority. But it is their financial expertise that is positively related to financial reporting quality. At the same time, using compensation that is more incentive intensive and more similar to that of the CEO appears to be potentially detrimental to the quality of financial reporting. These results are relevant for boards involved in selecting highly expert CFOs, and their compensation committees charged with defining subsequently effective incentive compensation plans for those CFOs.     

The effect of supplier industry competition on pay-for-performance incentive intensity

We examine how supplier industry competition affects CEO incentive intensity in procuring firms. Using Bureau of Economic Analysis data to compute a weighted supplier industry competition measure, we predict and find that higher supplier competition is associated with stronger CEO pay-for-performance incentive intensity. This effect is incremental to that of the firm's own industry competition previously documented and is robust to alternative measures of supplier competition and to exogenous shocks to competition. Importantly, we show that performance risk and product margin act as mediating variables in the relation between supplier competition and CEO incentive intensity providing support for the theory underpinning our finding. We document that CEO compensation contracts are used as a mechanism to exploit the market dynamics of upstream industries to a firm's benefit. Our findings are economically important as suppliers provide, on average, 45 percent of the value delivered by procuring firms to the market (BEA, 2016).     

The impact of performance-based compensation on misreporting

This paper examines the effect of CEO compensation contracts on misreporting. We find that the sensitivity of the CEO's option portfolio to stock price is significantly positively related to the propensity to misreport. We do not find that the sensitivity of other components of CEO compensation, i.e., equity, restricted stock, long-term incentive payouts, and salary plus bonus have any significant impact on the propensity to misreport. Relative to other components of compensation, stock options are associated with stronger incentives to misreport because convexity in CEO wealth introduced by stock options limits the downside risk on detection of the misreporting.     

Emerging Derivatives Markets: The Case of Chile

We compare the performance of firms affiliated with diversified business groups with the performance of unaffiliated firms in Turkey, an emerging market. We address the question of whether group-affiliated firms create internal capital markets or control large cash flows. Our findings indicate that group affiliation improves a firm's accounting performance, but not stock market performance. Deviation of cash-flow rights from voting rights has a negative but insignificant effect on accounting performance, but a significant effect on market performance. We also find that a firm's accounting, but not stock market, performance increases with the level of group diversification. Our results show that internal capital markets play an important role for the existence of business groups in an emerging market context.     

The implied cost of equity capital,corporate investment and chief executive officer turnover

This study investigates how the cost of equity capital, along with corporate investment, affects chief executive officer (CEO) turnover decisions. We hypothesize that the cost of equity conveys information about firm performance uncertainty that is informative of CEO talent. Consistently, our empirical results show that the likelihood of CEO turnover is positively associated with the implied cost of equity, after controlling for earnings and stock performance measures and risk factors. Additional analysis of reverse causality supports the causal effect of the high cost of equity on CEO dismissals. We also find that the positive association is more pronounced for firms that are more likely to suffer from underinvestment problems. These results suggest that the cost of equity plays a more important role in assessing CEO performance when the firm needs more external equity capital to pursue investment opportunities.