Connected transactions and firm value: Evidence from China-affiliated companies

This paper investigates tunneling through related-party transactions (RPT) using a unique dataset of listed Chinese companies in Hong Kong. While prior findings suggest that investors do not seem to systematically discount tunneling firms, we find that firm value (Tobin's q and market-to-book value) is significantly lower for firms undertaking potentially expropriating transactions. In addition, cumulative abnormal returns (CAR) are lower for RPTs with disclosure exemptions and are negatively related to some RPT types. Our results suggest that firms tunnel using RPTs with disclosure exemptions and that disclosure requirements matter for RPTs. These RPTs could signal firms' corporate-governance quality, as investors substantially discount firms that undertake potentially expropriating transactions.     

Non‐compliance in Executive Compensation Disclosure: the Brazilian Experience

We examine the determinants and consequences of firms’ choice not to comply with a new executive compensation disclosure regulation. We exploit a unique feature of Brazilian markets, where a change in the regulation of executive compensation disclosure could arguably lead to personal security‐related costs for executives. This major reform in executive compensation disclosure in Brazil became effective in December 2009. While some firms complied with the change in regulation, other firms explicitly refused to comply fully with the regulation by using a court injunction. After controlling for firm‐specific characteristics and both social and economic inequality measures, we find that the degree of criminality in the state in which the firm is headquartered (a proxy for security‐related costs) and the level of CEO compensation are important determinants of a firm's decision not to fully disclose executive compensation information. We also show that firms which do not fully comply with the regulation face costs in the form of higher bid‐ask spreads, suggesting investors are leery of the decision not to comply with the regulation. We discuss the potential implications of our results in the context of executive compensation disclosure reform.     

Not All Related Party Transactions (RPTs) Are the Same: Ex Ante Versus Ex Post RPTs

Related party transactions (RPTs) are potential means for insiders to expropriate outside shareholders via self‐dealing. There are, however, possible benefits to these arrangements for outside shareholders. We find that the overall volume of disclosed RPTs is generally not significantly associated with shareholder wealth as measured by operating profitability or Tobin's Q. However, the results for total RPT volume obscure that ex ante RPTs, transactions that predate a counterparty becoming a related party, are innocuous at worst in terms of their association with operating profitability and significantly positively associated with Tobin's Q whereas ex post RPTs, transactions initiated after a counterparty becomes a related party, are significantly negatively associated with operating profitability. Ex post RPTs also result in significant share price declines when first disclosed and are associated with an increased likelihood that a firm will enter financial distress or deregister its securities. These results are consistent with ex post RPTs serving as means for insiders to expropriate outside shareholders.     

Performance volatility,information availability,and disclosure reforms

Using the 2002 Sarbanes–Oxley reform as an exogenous disclosure shock, we find that high, relative to low, volatility firms opt for lower levels of information availability pre reform and experience increases in information availability, CEO turnover-to-performance sensitivity, myopic behavior, CEO compensation with a structure tilted towards more cash pay, and a reduction in firm value post the reform. Our findings suggest that mandating high levels of information availability across the board increases managerial evaluation risk and produces additional agency costs for firms with volatile performance.     

CFOs and CEOs: Who have the most influence on earnings management?

This study examines the association between chief financial officer (CFO) equity incentives and earnings management. Chief executive officer (CEO) equity incentives have been shown to be associated with accruals management and the likelihood of beating analyst forecasts (Bergstresser and Philippon, 2006; Cheng and Warfield, 2005). Because CFOs’ primary responsibility is financial reporting, CFO equity incentives should play a stronger role than those of the CEO in earnings management. We find that the magnitude of accruals and the likelihood of beating analyst forecasts are more sensitive to CFO equity incentives than to those of the CEO. Our evidence supports the Securities and Exchange Commission's (SEC) new disclosure requirement on CFO compensation.     

Compensation discussion and analysis (CD&A): Readability and management obfuscation

This paper examines the relationship between the readability of the CD&A section in proxy statements and management motives to obfuscate executive compensation disclosures. Using the CD&As in the 2007 and 2008 proxy statements, we examine whether the CD&A readability is associated with the proportion of CEO pay not related to the economic determinants of compensation. We note that the average CD&A is difficult to read. We find that firms with CEO pay exceeding the benchmark pay have a more difficult to read CD&A in the 2007 proxy season. The result suggests that, in its first CD&A report, top management tends to cloak its compensation practices when the practices are not tied to the economic determinants of pay. However, we also find those firms with CEO pay exceeding the benchmark pay improve the readability of their CD&As in the 2008 proxy season, suggesting that executive compensation disclosure improves under regulatory oversight and public pressure.     

Value relevance of disclosed related party transactions

Several recent North American corporate scandals have brought attention to the potential for accounting manipulations associated with related party transactions (RPTs), which have lead to a decline in perceived earnings quality. We examine the value relevance of disclosed RPTs in Chinese corporations. We focus on two types of RPTs: sales of goods and sales of assets. From 1997 to 2000, we find that the reported earnings of firms selling goods or assets to related parties exhibit a lower valuation coefficient than those of firms in China without such transactions. This result is not observed during 2001-2003 after a new fair value measurement rule for RPTs came into effect. Our evidence suggests that the new RPT regulation in China is perceived to be effective at reducing the potential misuse of RPTs for earnings management purposes. Since RPTs have been the subject of numerous scandals in North America, our evidence from the Chinese stock markets suggests that new RPT accounting standards could prove an efficient solution to this issue.     

The impact of board governance on director compensation in West African IPO firms

This paper undertakes a unique study of the determinants of corporate governance in the West African developing region and their impact on director compensation. A new measure of director total remuneration is constructed providing a conservative estimate of expropriation of private benefits of control. Using a hand-collected sample of 51 West African IPO firms from 2000 to 2011 we find evidence that increased presence of true independent nonexecutives that are unconnected to CEO or dominant insider groups within firm and nominally independent board level committees are highly associated with expropriation inferring that firm's with directors engaging in this behaviour are more likely to adopt measures indicative of governance best practice.     

Executive pensions,disclosure quality,and rent extraction

We argue that vague disclosure of supplemental executive retirement plans (SERPs) may impede effective shareholder monitoring over this compensation form. Hence, CEOs with power over the board may view SERP benefits as an attractive mechanism to increase their own pay, thereby extracting rents. Our results provide empirical support of the hypothesis. Many of the variables proxying for CEO power are significant in explaining the incidence and magnitude of CEO SERP benefits. In contrast, we find little association between CEO power and cash pay, a well disclosed and monitored compensation form. The results indicate that rent extraction depends on the quality of compensation disclosure.     

CEO compensation,director compensation,and firm performance: Evidence of cronyism?

We model CEO and director compensation using firm characteristics, CEO characteristics, and governance variables. After controlling for monitoring proxies, we find a significant positive relationship between CEO and director compensation. We hypothesize that this relationship could be due to unobserved firm complexity (omitted variables), and/or to excess compensation of directors and managers. We also find evidence that excess compensation (both director and CEO) is associated with firm underperformance. We therefore conclude that the evidence is consistent with excessive compensation due to mutual back scratching or cronyism. The evidence suggests that excessive compensation has an effect on firm performance that is independent of the poor governance variables discussed by previous studies.     

The impact of bank merger growth on CEO compensation

We examine the impact of bank mergers on chief executive officer (CEO) compensation during the period 1992–2014, a period characterised by significant banking consolidation. We show that CEO compensation is positively related to both merger growth and non‐merger internal growth, with the former relationship being higher in magnitude. While CEO pay–risk sensitivity is not significantly related to merger growth, CEO pay–performance sensitivity is negatively and significantly related to merger growth. Collectively, our results suggest that, through bank mergers, CEOs can earn higher compensation and decouple personal wealth from bank performance. Furthermore, we document a more severe agency problem in CEO compensation as a consequence of bank mergers relative to mergers in industrial firms. Finally, we find that the post‐financial crisis regulatory reform of executive compensation in banks has limited effectiveness in curbing the merger–pay links.     

Effect of mandatory pro forma earnings disclosure on the relation between CEO share bonuses and firm performance

This paper examines the effect of mandatory pro forma earnings disclosure on the alignment of CEO share bonuses and firm performance (i.e., annual stock returns). Using 6,583 executive-level observations from 986 non-financial firms in Taiwan over the period 1999–2004, we find a significant shift in the CEO share bonus pay-earnings relation caused by a marked reduction in bonus shares after the new disclosure rule becomes effective. The change in CEO compensation structure in turn leads to a closer link between CEO stock bonuses and annual stock returns. The result suggests that a more transparent earnings disclosure could positively affect board choices regarding compensation arrangements, thus inducing a better convergence of manager and shareholder interests.     

Extreme Uncertainty and Forward‐looking Disclosure Properties

This study investigates the effect of extreme uncertainty on disclosure behaviour by analyzing the quality and quantity of forward‐looking disclosures during the global financial crisis and pre‐crisis periods, controlling for other determinants of disclosure behaviour. Prior research has struggled to distinguish between the quality and quantity dimensions of forward‐looking disclosures. Also, the impact of the recent financial crisis on these forward‐looking disclosure attributes has not yet been examined systematically. We address this gap by exploiting the unique setting of German publicly traded firms. These firms must provide forward‐looking information within their audited financial statements, although relevant regulation is sufficiently vague to allow great variation in the quality, scope and quantity of forward‐looking disclosures actually observed. Using hand‐collected data from 2005 to 2009, we provide evidence of a significantly negative association between crisis and disclosure quality. This finding is robust to several different disclosure quality proxies and regression specifications. In contrast, we find no negative significant relation between crisis and disclosure quantity; rather, there is evidence that reported volume increases during the crisis. Our results are consistent with extreme uncertainty, as occurring during times of crisis, negatively affecting the quality of voluntary disclosures, while firms maintain or increase disclosure quantity, ultimately diluting the information density of forward‐looking disclosures.     

Length of Board Tenure and Outside Director Independence

I posit and test two competing views on the significance of outside director tenure lengths; the expertise hypothesis suggesting that extended board service time is a sign of director commitment, experience, and competence and the management‐friendliness hypothesis suggesting that extended board service time marks directors who befriend management at the expense of shareholders. I find evidence that Senior directors, defined as directors with twenty or more years of board service, are almost twice as likely to occupy a 'management‐affiliated' profession compared to the rest, and that they are also more likely to staff the firm's nominating and compensation committees. Senior director participation in the compensation committee is associated with higher pay for the CEO, especially when the CEO is more powerful in the firm. These results are consistent with the management‐friendliness hypothesis, and highlight a need for setting term limits for directors.     

CEO Compensation and Fair Value Accounting: Evidence from Purchase Price Allocation

This study investigates the impact of CEO compensation structure on post‐acquisition purchase price allocation, an accounting procedure that involves fair value estimation of various assets and liabilities. We find that CEOs whose compensation packages rely more on earnings‐based bonuses are more likely to overallocate the purchase price to goodwill, the largest asset recorded post‐acquisition. Because goodwill is not amortized, the overallocation likely increases post‐acquisition earnings and bonuses. We also find that, when the acquirer's CEO bonus plan includes performance measures that are not affected, or are less affected, by the overstatement of goodwill, such as cash flows, sales, or earnings growth, the overallocation to goodwill motivated by bonus plans diminishes.     

Mind the gap: CEO–employee pay ratios and shareholder say‐on‐pay votes

We examine the Securities and Exchange Commission's assertion in the pay ratio disclosure rule that the ratio of Chief Executive Officer to employee pay is useful to shareholders for say‐on‐pay (SOP) voting decisions. Using an estimated pay ratio for a broad panel of commercial banks from 2010 to 2017, we find that voting dissent on SOP proposals is significantly higher in the top pay ratio decile, particularly when institutional ownership is high. Results are robust to controlling for a number of other determinants of voting dissent, including proxy advisor recommendations and executive compensation. Additionally, inferences using the first year of disclosed pay ratios in 2017 for S&P 1500 firms are consistent. However, we do not find similar results in the other deciles of the pay ratio in either sample, calling into question whether a cost‐benefit analysis would support the disclosure requirement imposed by Dodd‐Frank and implemented by the SEC.     

Independent directors and the propensity to pay dividends

Using data from 944 public companies in 2006, I examine how a firm's propensity to pay dividends is related to (i) board independence and (ii) independent directors' tenure, number of board seats (busy) and equity incentive compensation. After controlling for the effects of traditional economic, CEO entrenchment and ownership determinants of the propensity to pay dividends, I find evidence of a positive association between the propensity to pay and (i) board independence and (ii) director tenure, and a negative association between the propensity to pay and (i) busy directors and (ii) greater equity incentive compensation in the director pay structure. I find consistent results when the decision is to pay cash dividends or repurchase shares. In further tests, I find that equity incentive compensation in the independent director pay structure is the most pervasive determinant across other dividend measures such as dividend payout, total payout and repurchases. Overall, the findings suggest that the characteristics of independent directors are important determinants of the payout policy. The results also suggest that future corporate governance research could benefit from incorporating characteristics of independent directors rather than limiting governance measures to board independence especially when recent empirical evidence (Linck et al., 2008, 2009) shows convergence, and therefore, narrowing variation in the proportion of outsiders and insiders on a board.     

Increased Disclosure Requirements and Corporate Governance Decisions: Evidence from Chief Financial Officers in the Pre‐ and Post–Sarbanes‐Oxley Periods

I study how increased internal control disclosure requirements mandated by the Sarbanes‐Oxley Act (SOX) affect annual corporate governance decisions regarding CFOs. Using non‐CEO, non‐COO executive officers as a control group, I find that CFOs of firms with weak internal controls receive lower compensation and experience higher forced turnover rates after the passage of SOX. In contrast, CFOs of firms with strong internal controls receive higher compensation and do not experience significant changes in forced turnover rates. These results are consistent with the “disclosure of type” hypothesis, which suggests that the mandatory internal control disclosures under SOX are a credible mechanism that effectively distinguishes good CFOs from bad ones by revealing the firm's internal control quality. The empirical evidence thus supports the notion that mandated increases in disclosure reduce information asymmetry in the executive labor market.     

CEO equity incentives and the remediation of material weaknesses in internal control

This study examines how CEO equity incentives affect the remediation of material weaknesses (MWs) in internal control disclosed pursuant to the Sarbanes‐Oxley Act (SOX). We find that the sensitivity of CEO equity portfolios to stock price (CEO price sensitivity, or delta) has a positive impact on firm promptness in remedying MWs, whereas the sensitivity of CEO equity portfolios to stock return volatility (CEO volatility sensitivity, or vega) has a negative impact on firm promptness in remedying MWs. In addition, we provide evidence that effective boards of directors mitigate the undesirable, negative effect of CEO volatility sensitivity on remediation of MWs. Our results shed light on the effects of equity compensation structures on internal control quality in the more transparent, post‐SOX environment.     

How Firms Use Director Networks in Setting CEO Pay

We examine how firms use the network of overlapping directorships to determine chief executive officer (CEO) compensation. We contribute to related work by empirically exploring two competing hypotheses. In the first hypothesis, networks propagate relevant information used to establish good pay practices. In the second hypothesis, director networks are used opportunistically to benefit the CEO. The empirical findings are generally consistent with the first hypothesis. Yet, the importance of director networks is reduced when the CEO is entrenched and when management hires a compensation consultant. The latter finding is especially pronounced when director networks predict a reduction in CEO pay.