Market efficiency,managerial compensation,and real efficiency

We examine how an exogenous improvement in market efficiency, which allows the stock market to obtain more precise information about the firm's intrinsic value, affects the shareholder–manager contracting problem, managerial incentives, and shareholder value. A key assumption in the model is that stock market investors do not observe the manager's pay-performance sensitivity ex ante. We show that an increase in market efficiency weakens managerial incentives by making the firm's stock price less sensitive to the firm's current performance. The impact on real efficiency and shareholder value varies depending on the composition of the firm's intrinsic value.     

Efficient management remuneration plan design: A consideration of specific human capital investments

This paper investigates the contractual relationship between the manager and the firm. The results indicate that cross-sectional variation in the components of management remuneration plans can be explained by variations in the specificity of both the manager's human capital investments and the firm's resources. Where the returns on the firm's resources are relatively more dependent upon (specific to) a particular manager, that manager is more likely to be able to negotiate his/her remuneration. The manager is also more likely to be paid on a long run contingent basis and to be offered deferred forfeitable remuneration. The results also indicate that the greater the firm-specificity of a manager's human capital investments the greater the likelihood that the manager is offered termination compensation as part of the remuneration package.     

Investment timing,agency, and information

This paper provides a model of investment timing by managers in a decentralized firm in the presence of agency conflicts and information asymmetries. When investment decisions are delegated to managers, contracts must be designed to provide incentives for managers to both extend effort and truthfully reveal private information. Using a real options approach, we show that an underlying option to invest can be decomposed into two components: a manager's option and an owner's option. The implied investment behavior differs significantly from that of the first-best no-agency solution. In particular, greater inertia occurs in investment, as the model predicts that the manager will have a more valuable option to wait than the owner.     

Information Production, Insider Trading, and the Role of Managerial Compensation

We analyze the information production decision of a manager who can trade on this information and whose compensation is increasing in the stock price. The amount of information produced increases with the stock's volatility and liquidity and decreases with the manager's pay-performance sensitivity. Insider trading regulations that symmetrically inhibit the manager's ability to buy and sell stock cause her to produce less information. But asymmetric insider trading regulations like the short sales prohibition have an ambiguous effect inducing her to produce more or less information depending on her pay-performance sensitivity. This contradicts the standard argument made by opponents of insider trading regulations that such regulations always reduce information production.     

Earnings vs. stock-price based incentives in managerial compensation contracts

We develop a theory of stock-price-based incentives even when the stock price does not contain information unknown to the firm. In our model, a manager must search for and decide on new investment projects when the market may have a difference of opinion about the quality of the firm’s investment opportunities. The firm optimally provides incentives based solely on realized earnings, leading to an efficient investment policy, when the market has congruent or pessimistic beliefs; however, the firm optimally introduces stock-price-based incentives, leading to an inefficient investment policy, when the market has optimistic beliefs. If the firm can raise equity capital on favorable terms, negative NPV projects from the perspective of the firm may be positive NPV projects from the perspective of current shareholders. The firm motivates the manager to take such projects by basing some compensation on the current stock price.     

The Value of Mandatory Certification: A Real Effects Perspective

We study the real effects of certification to demonstrate the value of mandatory certification over and above mandatory disclosure in enhancing investment efficiency. In our model, a firm's manager selects a project to maximize the firm's short-term stock price, which is a function of her certification and disclosure decisions about the outcome of the project. Although the manager might be either forthcoming or strategic with regard to the disclosure of her private information, she can strategically choose whether to incur a cost or not to certify her disclosure, unless mandated. The manager always selects the first-best project when both certification and disclosure are mandatory. However, when certification is voluntary, project selection is inefficient. In addition, mandating disclosure without mandating certification can lead to lower investment efficiency than mandating neither. In justifying why mandatory certification is beneficial for public firms, our results offer a note of caution regarding the contemplated regulatory moves for increased disclosures by public firms without corresponding certification requirements, for example, the recent SEC proposal requiring extensive climate-related disclosure.     

Dupes or Incompetents? An Examination of Management's Impact on Firm Distress

This article examines whether managers impact firm performance. We conservatively define managerial ability as the manager's capacity to deploy the firm's resources. We verify the validity of our metric using a manager–firm matched panel data set that allows us to track managers (CEOs) across different firms over time. We find managerial ability is inversely related to the amount of time a firm spends in distress, the likelihood of a firm's failure, and the cost of failure. These results suggest that the managers of failed firms are less skilled than their counterparts. But even within failed firms there is heterogeneity in the talents of managers.     

Executive Stock Options: Early Exercise Provisions and Risk-taking Incentives

Traditional executive stock option plans allow fixed numbers of options to vest peri‐odically, independent of stock price performance. Because such options may climb deep in‐the‐money long before the manager can exercise them, they can exacerbate risk aversion in project selection. Making the proportion of options that vest a gradually increasing function of the stock price can ensure that appropriate numbers of options are retained while they provide risk‐taking incentives, but are exercised once they have lost their convexity. “Progressive performance vesting” can allow the firm more efficiently to rebalance the manager's risk‐taking incentives.     

Comment on Forward Markets,Stock Markets,and the Theory of the Firm

In a recent article, MacMinn [5] argues that the presence of forward markets eliminates the incentives of the firm's manager to choose production levels that maximize firm value. In this comment, we show that his results do not depend on the presence of forward markets. The critical assumptions are that the manager is endowed with money rather than stock in the firm and that there is no competitive labor market for managers. In addition, his results require time-inconsistent behavior on the part of the firm's manager.     

A Theory of Noise Trading in Securities Markets

In a recent article, Black 1 introduces a type of trading that he terms noise trading. He asserts that noise trading, which he defines as trading on noise as if it were information, must be a significant factor in securities markets. However, he does not provide an explanation of why any investors would rationally want to engage in noise trading. The goal of this paper is to provide such an explanation for one type of investor, managers of investment funds. As shown here, the incentive for a manager to engage in noise trading arises because of the positive signal that the level of the manager's trading provides about his or her ability to collect private information concerning current and potential investments. If the manager's compensation is directly related to investors' perceptions of his or her ability, the manager will then trade more frequently than is justified on the basis of his or her private information. In addition to providing this explanation for noise trading, the results of this analysis may also be useful for further empirical exploration of the relation between investment fund portfolio turnover and subsequent performance.     

DOES IT PAY TO DISCLOSE MANAGERIAL EARNINGS INFORMATION EARLY?

Does it pay to voluntarily disclose the manager's private information about the firm's earnings prospects before the mandatory announcement date? This question has been a subject of much debate because prior research establishes both benefits and costs of early information disclosure. We provide evidence on the net effect of such disclosure by examining its impact on firm value. Using a large sample and correcting for self‐selection bias, we find that early disclosure of the manager's private earnings information enhances the end‐of‐period value of the firm.     

Motivating Management to Reveal Inside Information

This paper develops incentive schemes which motivate a manager to release private information that he has concerning the probabilities of occurrence of the various output levels of his firm. It is shown that, in the context of a pure-exchange economy, a complete prohibition on the manager's trading in his firm's stock is sufficient to motivate him to truthfully release his private information. When the setting is extended to that of a production-exchange economy, the manager must also be allowed to choose the production plan that he most prefers in order for him to be motivated to release his information truthfully. In fact, no incentive scheme in a general production-exchange economy can be guaranteed to motivate the manager to release his information truthfully if he is not allowed to choose the production plan freely. However, when more structure is placed on the economy, such an incentive scheme can be developed as described in the latter part of this paper.     

Stock-based managerial compensation,price informativeness,and the incentive to overinvest

This paper investigates the relationship among a firm's managerial incentive scheme, the informativeness of its stock price, and its investment policy. It shows that the shareholders' concerns about the effectiveness of stock-based compensation can lead to overinvestment. However, unlike other explanations in the literature, our results are neither caused by suboptimal incentive contracts nor do they rely on the assumption that managers are “empire builders.” Rather, overinvestment serves to induce information production by outside investors. By accepting positive and negative NPV projects, a firm effectively increases the market's uncertainty about its cash flow, thereby giving traders more incentives to become informed.     

Temporal resolution of uncertainty,disclosure policy,and corporate debt yields

In this paper, we study how risk-shifting incentives and the design of debt covenants are affected by the pattern of temporal resolution of uncertainty (TRU) in the underlying technology of the firm. We show that the extent of risk-shifting as well as the yield demanded on corporate debt are larger the later the resolution of uncertainty (thus providing one explanation for the empirical evidence of Reisz and Perlich (2006)). We allow for contracting based on verifiable information disclosed by the manager. In this context, we characterize optimal covenants restricting investment. The effects of these covenants on the firm's investment policy and corporate bond yields under different disclosure policies and patterns of TRU are studied. Empirical implications are derived and discussed.     

Insider Trading in Financial Signaling Models

We study the impact of voluntary trade by the manager. We find that, in contrast to standard signaling models, an action is good news for some firms and bad news for others, depending on observable characteristics of the firm, its managers, and their compensation plans. Further, voluntary trade eliminates separating equilibria and thus the possibility of exactly inferring the manager's private information. This may cause the manager to take inefficient actions so as to earn trading profits. Such undesirable behavior can be more effectively constrained by compensation contracts based on phantom shares or nontradeable options instead of large stockholdings.     

The Effect of Personnel Characteristics in the Internal Accounting Control System on Discretionary Tax Accruals: Evidence from Korea

This study examines whether the characteristics of personnel in a firm's internal accounting control system (IACS) and auditor characteristics control managers’ discretionary behaviour for tax planning. The study uses a sample of 4210 firm‐year observations from 2006 to 2014. The results show that managers’ discretionary tax planning cannot be controlled when the personnel in charge of internal accounting control are at an optimum level or higher. On the other hand, when a CPA is included among the personnel, the manager's discretionary behaviour is somewhat controlled. Moreover, the results show that firms audited by a large accounting firm also control the manager's discretionary tax planning to some extent. Unlike previous studies that examine the effects of IACS on discretionary accruals mostly in terms of book income, this study's contribution is an examination of the effects of the characteristics of personnel in IACS on the relationship between discretionary book‐tax conformity accruals and discretionary book‐only accruals that can be used when the manager establishes a tax plan. Additionally, this study also provides indirect evidence that the characteristics of auditors and personnel in charge of internal accounting perform a monitoring role that controls the manager's opportunistic behaviour.     

Unobservable transfer price exceeds marginal cost when the manager is evaluated using a balanced scorecard

This study investigates the optimal level of transfer prices chosen by managers in a divisionalized firm when they are evaluated based on a balanced scorecard. A unique assumption of our model is that transfer prices are unobservable to a competing firm's managers. In contrast to the findings in several studies that examine strategic transfer pricing, this research shows that a manager who is evaluated using a balanced scorecard chooses a transfer price that exceeds marginal cost given a market competitor in a specific economic environment. This result is caused mainly by our model's assumption that a manager considers the competitor's profit in his/her in decision-making when the objective is to maximize long-term profit. This study makes a significant contribution to the strategic transfer pricing literature by showing that even if the transfer price is unobservable to rivals, the optimal transfer price exceeds marginal cost when the final product market is characterized by price competition, something not shown in previous analytical accounting research.     

Dividend Policy under Asymmetric Information

We extend the standard finance model of the firm's dividend/investment/financing decisions by allowing the firm's managers to know more than outside investors about the true state of the firm's current earnings. The extension endogenizes the dividend (and financing) announcement effects amply documented in recent research. But once trading of shares is admitted to the model along with asymmetric information, the familiar Fisherian criterion for optimal investment becomes time inconsistent: the market's belief that the firm is following the Fisher rule creates incentives to violate the rule. We show that an informationally consistent signalling equilibrium exists under asymmetric information and the trading of shares that restores the time consistency of investment policy, but leads in general to lower levels of investment than the optimum achievable under full information and/or no trading. Contractual provisions that change the information asymmetry or the possibility of profiting from it could eliminate both the time inconsistency and the inefficiency in investment policies, but these contractual provisions too are likely to involve dead-weight costs. Establishing which route or combination of routes serves in practice to maintain consistency remains for future research.     

Disclosing a Random Walk

We examine a dynamic disclosure model in which the value of a firm follows a random walk. Every period, with some probability, the manager learns the firm's value and decides whether to disclose it. The manager maximizes the market perception of the firm's value, which is based on disclosed information. In equilibrium, the manager follows a threshold strategy with thresholds below current prices. He sometimes reveals pessimistic information that reduces the market perception of the firm's value. He does so to reduce future market uncertainty, which is valuable even under risk-neutrality.     

Discretionary Accounting Choices: A Debt covenants Based Signalling Approach

This paper seeks to explain the discretionary accounting choices made by managers in a world characterised by asymmetric information between managers and investors. It considers a firm whose capital structure consists of both debt and equity, a manager who protects the interests of the firm's existing shareholders, and a financial market. The manager is committed to engage in an investment opportunity and needs to raise some equity to finance it. He is furthermore endowed with some private information about his firm's future earnings. The paper shows how, under certain conditions, the manager may credibly communicate his private information to investors through his accounting choices. In this equilibrium, the selection of balance sheet strengthening and income increasing accounting choices signals unfavourable information while the use of balance-sheet weakening and income- decreasing accounting choices signals favourable private information. The latter firms should thus experience positive abnormal returns around the announcement dates of their accounting choices.