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.     

Stock repurchasing and corporate social responsibility

Stock repurchases are controversial. Researchers often view the positive association between free cash flow and the volume of the stock repurchases to be in the shareholders’ interest and the positive association between executive options and stock repurchases to be in the managers’ interest. Using firms’ corporate social responsibility (CSR) ratings as a measure of ethical culture—one that increases the cost of self-serving behavior for managers— we examine whether a firm’s CSR rating is related to its stock repurchase decisions. Although the baseline regression shows a positive association between CSR and repurchases, we find that CSR amplifies the positive association between free cash flow and stock repurchases and lessens the positive association between executive options and stock repurchases. These results indicate that ethical culture might play a role in repurchase decisions: it may encourage repurchases aligned with shareholders’ interests and discourage those primarily in managers’ interest. Furthermore, we also find that high CSR firms are associated with a greater completion rate of announced repurchase programs and receive more favorable stock market reaction to their repurchase announcements.     

Managerial risk appetite and asymmetry cost behavior: evidence from China

Managerial risk preferences have considerable impacts on a firm’s cost management through committed resource adjustment decisions. We investigate whether a firm’s cost behaviour is influenced by managers’ risk appetite and find that cost stickiness increases with managers’ risk-seeking. The positive relationship between risk-seeking and cost stickiness is weaker for firms with higher levels of manager capacity. We further find that the moderating effect of managerial capacity is more pronounced in non-state-owned enterprises, in less competitive industries, and in areas with lower degrees of marketisation. These results suggest that managers’ personal characteristics are key factors that affect sticky cost behaviour.     

Managerial ability and firm risk-taking behavior

In this study, we show that managerial heterogeneity plays an important role in firm decisions. Our view is that in addition to the effects of previously examined determinants, firm decisions are affected not just by the managers’ explicit mandate to maximize firm value, but also by the ability of the manager in managing the firm. We find that high-ability managers and low-ability managers have opposite effects on firm behavior and firm value. High-ability managers are receptive to risk-taking whereas low-ability managers refrain from risk-taking. High-ability managers cut capital expenditures but spend significantly more on research and development projects; low-ability managers reduce both capital expenditures and research and development expenses significantly. High-ability managers are associated with higher levels of firm focus than low-ability managers. Managerial ability is negatively associated with firm leverage. In addition, our results show that high-ability managers are associated with increases in firm value whereas low-ability managers are associated with decreases in firm value.     

Managerial talent and managerial practices: Are they complements?

We examine the role of managerial talent and its interaction with managerial practices in determining firm performance. We build a matched firm-director panel dataset for the universe of limited liability companies in Italy, tracking directors across different firms over time. We define managerial talent as the individual contribution to the variation of the firms’ total factor productivity, estimated using a two-way fixed effects model. Combining the data with survey information on a representative sample of firms, we then document that our measure of talent correlates with ex-ante and ex-post indicators of ability, i.e. managers’ educational attainment and their forecast precision with respect to the firm’s future performance. Most important, we leverage information on the adoption of managerial practices within the firm to examine potential synergies between managerial talent and structured managerial practices, thus bridging two separate strands of the literature. While talent and structured practices are positively associated with firm productivity on their own, there is evidence of complementarities between the two. These findings hold both in a cross-sectional setting and in a panel analysis that accounts for time-invariant firm heterogeneity. Overall, our results indicate that the effectiveness of managerial practices varies with managers’ ability to implement them.     

Performance peer groups in CEO compensation contracts

How do firms choose performance peer groups used in chief executive officer (CEO) relative performance evaluation contracts? We find that while firms, for the most part, choose performance peers to better identify their CEOs’ impact on firm performance, they also tend to select underperforming peers. Dynamically, we find that peers that are added and retained every year are weaker than ones that were not chosen. These findings suggest managers may have some influence on the choice of performance peers. Finally, using a quasi-natural experiment, we find that enhanced disclosure did not affect the tendency of firms to select underperforming peers.     

Investor overlap and diffusion of disclosure practices

I develop and test an investor demand-driven explanation for why one firm’s change in voluntary disclosure behavior is emulated by some firms in the industry but not others. I focus on the overlap in institutional investor ownership between two firms as a mechanism by which a first-mover firm’s increase in disclosure prompts investors to seek a similar increase from a follower firm. Using 10-K market risk disclosures as my empirical setting, I find that a firm’s decision to follow a first mover in providing more quantitative information than is required by the SEC is positively associated with an increase in investor overlap from the prior year. I also find that the association is stronger for overlap in large institutional investors, consistent with their greater influence over managers, and for firms where investor uncertainty is high. This association is found after controlling for the herding effect documented in prior studies and after addressing potential endogeneity concerns. Overall, this evidence provides new insight into patterns of intra-industry disclosure behavior and highlights investor overlap as a communication channel and feedback mechanism that helps facilitate the diffusion of disclosure practices.     

EVIDENCE ON THE COMPENSATION OF PORTFOLIO MANAGERS

We surveyed 396 portfolio managers about the structure of their compensation. Overall, more compensation packages are subjective/discretionary than objective/formula based. Firm success factors such as firm profitability have more effect on bonuses than do client success factors such as investment performance. Differences in the structure of compensation across firms, clients, job types, and manager characteristics reflect likely differences in the underlying contracting environments, especially differences in the difficulty of monitoring performance and exerting control.     

The price of power: Valuing the controlling position of owner–managers in French IPO firms

Going public often creates an agency conflict between the owner–manager and minority shareholders. This problem is especially severe in countries with poor legal investor protection, such as France. We examine the controlling position of owner–managers in French initial public offering (IPO) firms. We find that investors anticipate the increased agency conflict associated with a lock on control and lower firm value when the owner–manager is more powerful. Shareholder agreements in which the owner–manager agrees to share control with other pre-IPO owners enhance firm value. We also report that higher cash flow ownership by the owner–manager is positively related to firm value when he is not in full control. Finally, we document that the large (non-pecuniary) private benefits of control in France may motivate owner–managers to retain control after the IPO.     

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.     

Why do managers avoid EPS dilution? Evidence from debt–equity choice

Survey evidence reveals that managers prefer to avoid dilution of earnings per share (EPS), though financial theory suggests it is irrelevant in firm valuation. We explore contracting and behavioral explanations for this apparent paradox using a large sample of debt–equity issuers. We first provide evidence that firms with greater agency conflicts between managers and shareholders are more likely to use EPS as a performance measure in bonus contracts. After controlling for possible endogeneity related to compensation contract design, we find that managers are more likely to avoid earnings dilution when their bonus compensation explicitly depends upon EPS performance. This effect is increasing in the magnitude of bonus compensation for this subset of firms; we document no such associations for the firms that do not use EPS in setting bonus pay. Additional tests of firms’ speed of adjustment to target leverage ratios and firms’ debt conservatism levels indicate that explicitly rewarding executives on EPS performance helps to resolve underleveraging problems. We also find that clientele effects are associated with managers’ aversion to earnings dilution. Our findings provide a deeper understanding of the factors that underlie the use of accounting performance in compensation contracts and new evidence on the implications of the contracting role of accounting in firm decision-making.     

Managers of Financially Distressed Firms: Villains or Scapegoats?

In this article, we provide evidence concerning the extent to which managers are to blame when their firms become bankrupt. We study a sample of firms that file for Chapter 11 and determine the actions taken by the firms' managers during the three-year period before the filing. We compare the sample with a control sample of firms that performed better. We suggest that the comparison provides evidence on the way managers act as their firms sink into financial trouble and whether financial distress is the result of incompetence or excessively self-serving managerial decisions or due to factors outside of management's control. We find that managers of the Chapter 11 firms and the control firms make very similar decisions and that, on average, neither set of managers is perceived to be taking value-reducing actions. These results do not change when we control for managerial turnover or managerial ownership. We also find that when managers are replaced in firms that eventually file for Chapter 11 protection, the market does not respond positively, regardless of whether the new managers are from inside or outside the firm. Our findings suggest that when managers are blamed for financial distress, they are serving as scapegoats.     

Propping by controlling shareholders,wealth transfer and firm performance: Evidence from Chinese listed companies

Propping acts by controlling shareholders are common in Chinese listed firms. In this paper, we use data on related-party transactions of all listed Chinese firms from 2002 to 2008 to investigate the motivation behind controlling shareholders’ propping acts and subsequent wealth-transfer behavior and how both affect firm performance. We find that such institutional motivators as the maintenance of shell resources and qualification for refinancing have a significant effect on the propping behavior of controlling shareholders of Chinese listed firms and that such behavior is often followed by more serious tunneling when shareholders are driven by these motivators. Compared with non-state-owned firms, state-owned firms with the motivation to qualify for refinancing exhibit more severe tunneling after engaging in propping behavior. We also find that while propping by controlling shareholders improves a firm’s current operating performance, in firms whose controlling shareholders’ are motivated by the desire to maintain shell resources or obtain a refinancing qualification their performance declines in the following year because of subsequent tunneling. The results presented in this paper provide us with a better understanding of the relationship between propping and tunneling, controlling shareholders’ engagement in both and the consequences of that behavior.     

Leading indicator variables and managerial incentives in a dynamic agency setting

This paper studies, in a dynamic agency setting, how incentives and contractual efficiency are affected by leading indicators of firms’ future financial performance. In our two-period model, a leading indicator variable provides a noisy forecast of the uncertain return from the manager’s long-term effort, and both contracting parties cannot refrain from renegotiating contract terms based on updated information. We find that the leading indicator can reduce the manager’s long-term effort incentive, as it allows the firm owner to capture more of the resulting return through renegotiated wages (i.e., the manager is held up). By reducing the uncertainty about future aggregate cash flows, the leading indicator also exacerbates the “ratchet” effect and discourages the manager’s short-term effort. In equilibrium, as the leading indicator becomes more accurate in forecasting future cash flows, the first-period contract attaches higher explicit weights to both the forward-looking leading indicator and backward-looking cash flow, and yet the manager may find it optimal to reduce both the short- and long-term efforts. We further show that with a more accurate leading indicator variable, the explicit incentive on the lagging cash flow may increase more than that on the leading indicator, and the equilibrium firm profit may decrease and diverge from the manager’s equilibrium efforts.     

Pay inequalities and managerial turnover

We study how pay inequalities affect (i) a firm's rate of voluntary non-CEO manager (VP) VP resignations, and (ii) the likelihood that an individual VP will voluntarily resign. We consider pay inequalities that a VP faces relative to (i) the CEO in her own firm, (ii) other VPs in the firm, and (iii) VPs in benchmark firms. We use a unique hand-collected dataset of over 1000 voluntary managerial resignations and find that pay inequality is an important determinant of managerial turnover. We find that managers are more likely to resign when their pay relative to their peers in the firm and outside the firm is lower; and firms with greater levels of pay inequality and greater pay inequality relative to benchmark firms experience higher VP turnover.     

Auditor reporting and earnings management: some additional evidence

This paper investigates the reasons that lead to modification of auditors’ opinions. We revisit the conclusions of prior US‐based research on whether a modification highlights likely earnings management activities. Extending this research, we consider an alternate explanation that managers adjust accruals to report earnings that better predict future firm performance, which has the side‐effect of placing them in conflict with their auditors. Our study sample comprises all firms listed on the Australian Stock Exchange over the period 1999–2003. Consistent with prior research, there is no evidence of earnings management leading to an audit opinion modification. However, we do show that firms receiving inherent uncertainty modifications (other than going concern) have greater persistence of earnings (accruals) relative to other firms. This is consistent with the proposition that managers have made policy choices in reporting current earnings, with which their auditors disagree, that will likely result in a greater ability to forecast the firm's future earnings.     

CEO tenure and the performance-turnover relation

In a broad cross-section of US firms, we document that the likelihood of a CEO’s performance-related dismissal declines in his tenure. This finding is consistent with both firm performance revealing information about a CEO’s uncertain executive ability and CEO tenure reflecting weak firm governance choices that reduce the likelihood of performance-related dismissal. In a sample of CEOs who begin their appointment during our sample period, we find evidence more broadly in favor of the former explanation. Specifically, we find that (1) CEO survival is associated with superior firm performance, (2) this relation is unaffected by firm governance choices, (3) the intensity with which a firm monitors its CEO declines over his tenure, and (4) firms’ monitoring intensity increases following CEO turnover. Collectively, our results suggest that periodic performance reports increasingly resolve uncertainty regarding executive ability, thereby lowering firm owners’ demand for monitoring their CEO over his tenure.     

‘Managerialism’, ‘ownerism’ and risk

This paper proposes that managers, having the value of their human capital dependent on the performance of the firm they manage, and being unable to diversify away this risk, are expected to attempt to reduce their employment risk internally by project selection or by income smoothing, intended to stabilize the firm's income stream. An empirical investigation shows that manager-controlled firms exercise ‘income smoothing’ to a greater extent than owner-controlled firms, have relatively lower unsystematic risk and perhaps lower systematic risk.     

Governance and firm value: The effect of a recession

This paper examines the relationship between the firm's governance structure and its value during different economic conditions. We show that both relative industry turnover and CEO entrenchment increase during economic downturns. We also find that relative industry turnover and managerial entrenchment have opposite impacts on the value of the firm throughout the recessionary period. While industry turnover leads to an appreciation in firm value, managerial entrenchment reduces shareholders’ wealth. The negative impact of managerial entrenchment on firm value, however, outweighs the positive impact of industry turnover. Accordingly, we propose that a recession provides managers with a good opportunity to camouflage their behavior and extract more private benefits and, thus, blame the poor performance on bad economic conditions.     

Does international experience of managers bring financing benefits? Evidence from the cost of equity capital

Using a sample of Chinese firms, this study examines whether and how managers’ overseas experience affects a firm’s cost of equity capital. We document a negative association between managers’ overseas experience and the cost of equity capital. Mechanism analyses indicate that companies with returnee managers have better information quality and lower systematic risk; more institutional investors, media reports, and analysts following; and higher stock liquidity, all of which lead to a lower cost of equity capital. Further analyses show that chief executive officers (CEOs) with foreign experience have a more significant impact on the cost of capital than non-CEO managers with foreign experience and that managers’ overseas work experience has a more significant impact on the cost of capital than their overseas education. We also find that the impact of managers’ overseas experience is more pronounced when that experience is gained in common law countries compared to code law countries but weaker for state-owned enterprises and firms that are cross-listed or have foreign institutional investors. Overall, the results suggest that managers’ knowledge, skills, and ethical values imprinted from overseas experience, plus eyeball effects from media and analyst attention, can reduce the cost of equity capital.