Financial guarantors’ executive compensation,charter value and risk-taking

Financial guarantees have been extensively used recently as part of rescue packages to bail out troubled institutions and governments around the world. We propose a new incentive compensation model for studying agency conflict between the shareholders and the manager of a typical financial guarantor. In our model, the manager chooses the guarantor's risk level, with disutility to reduce risk (i.e., reducing the risk of the guarantor incurs a direct cost to the manager). Moral hazard causes the manager to select a level of risk that is higher than the level chosen in an otherwise first-best environment with no conflict of interest between the shareholders and the manager. However, in our proposed framework, charter value plays a self-disciplining role on the manager's appetite for risk, therefore it helps mitigate the extent of the deviation from first best with agency conflict found previously (e.g., 0055, 0015 and 0020). This suggests that researchers should study charter value, managerial compensation and risk decisions within a unified framework and not separately, as all studies have done in the past.     

Financial guarantors’ executive compensation,charter value and risk-taking

Financial guarantees have been extensively used recently as part of rescue packages to bail out troubled institutions and governments around the world. We propose a new incentive compensation model for studying agency conflict between the shareholders and the manager of a typical financial guarantor. In our model, the manager chooses the guarantor's risk level, with disutility to reduce risk (i.e., reducing the risk of the guarantor incurs a direct cost to the manager). Moral hazard causes the manager to select a level of risk that is higher than the level chosen in an otherwise first-best environment with no conflict of interest between the shareholders and the manager. However, in our proposed framework, charter value plays a self-disciplining role on the manager's appetite for risk, therefore it helps mitigate the extent of the deviation from first best with agency conflict found previously (e.g., Jensen and Meckling, 1976, Cadenillas et al., 2004, Cadenillas et al., 2007). This suggests that researchers should study charter value, managerial compensation and risk decisions within a unified framework and not separately, as all studies have done in the past.     

The evolution of pay premiums for managerial attributes

This paper proposes and estimates an interactive fixed effects model of executive compensation, which allows for time-variant pay premiums for unobserved manager attributes. We find that two managerial traits can explain executive compensation over time: talent and conservatism. The market premium for talent is higher in bull markets, as the higher marginal productivity of human capital during these periods increases the demand and thus the price for talents. Such pay premium is concentrated among top talented managers, who earn a premium about five times that of median talented managers. The pay premium for conservatism is linked to the equity market risk premium, with conservatism being discounted (compensated) during the low (high) risk premium periods. We show that risk-taking managers are rewarded during the early period of our sample. However, after the periods characterized by higher risk premium, such as the financial crisis, conservatism becomes a more desirable trait.     

Rethinking “Strength of Incentives” for Executives of Financial Institutions

The recent crisis has caused some finance theorists and practitioners to rethink the effects of managerial incentives on the total enterprise value of large financial institutions. This re-examination has identified and analyzed a number of potential problems with the use of equity-based compensation, including insufficiently long managerial time horizons as well as the temptation for excessive risk-taking provided by “asymmetric” payoff structures in which shareholders have virtually all the upside while debtholders bear most of the downside risk. In an attempt to address such problems, finance and governance scholars have increasingly explored the possible value of aligning managerial interests with those of not only shareholders, but other important corporate claimants such as debtholders and taxpayers. After reviewing the latest thinking about risk and managerial incentives at financial institutions, the authors come to the following conclusions:

• • The design of incentives for value maximization needs to reflect a healthy appreciation of downside risk as well as upside reward, and both senior and subordinated debt may be ideal instruments for establishing that balance. At the same time, most senior executives should continue to receive equity-linked compensation in addition to significant proportions of “inside debt.”
• • Since decision-makers below the highest level executives of large financial institutions collectively wield enormous power to assume and manage risks, this “upper-middle” tier of managers deserves special attention. Rather than rewarding these managers with stock or options, the authors suggest use of a combination of uncapped but “held-at-risk” bonuses denominated in subordinated inside debt as the best way of rewarding effort and competence while controlling opportunities for risk-shifting.

     

AGENCY CONFLICTS IN DELEGATED PORTFOLIO MANAGEMENT: EVIDENCE FROM NAMESAKE MUTUAL FUNDS

Namesake funds provide a unique sample for studying the two agency conflicts that exist within a mutual fund. The first is between the fund management company and fund shareholders, and the second is between the fund management company and the fund manager. A typical namesake fund manager sits on his or her fund's board, frequently as the chairman, is the majority owner of the fund management company, and has significant investments in the fund he or she manages. Our results indicate that namesake funds charge higher fees, suggesting that the boards of namesake funds are less effective. We find that namesake funds are more tax efficient, consistent with the idea that managerial ownership helps align the interests of managers with those of shareholders. Because of fewer career concerns, namesake fund managers herd less while assuming greater unsystematic risk. We find weak evidence that namesake fund managers outperform their benchmarks and peers. Finally, we observe that namesake funds attract higher levels of investor cash flow.     

Optimal compensation contracts when managers can hedge

This paper examines optimal compensation contracts when executives can hedge their personal portfolios. In a simple principal-agent framework, I predict that the Chief Executive Officer's (CEO's) pay-performance sensitivity decreases with the executive-hedging cost. Empirically, I find evidence supporting the model's prediction. Providing further support for the theory, I show that shareholders also impose a high sensitivity of CEO wealth to stock volatility and increase financial leverage to resolve the executive-hedging problem. Moreover, executives with lower hedging costs hold more exercisable in-the-money options, have weaker incentives to cut dividends, and pursue fewer corporate diversification initiatives. Overall, the manager's ability to hedge the firm's risk affects governance mechanisms and managerial actions.     

The effects of management compensation on firm hedging: Does SFAS 133 matter?

This paper analyzes whether executive compensation in the form of options or stocks affects a firm's decision to hedge. In particular, we investigate whether SFAS 133, a regulation designed to increase transparency of derivative reporting, alters the relationship between managerial compensation and derivative use. We demonstrate that when management is compensated with options, the firm uses less derivatives to hedge interest rate and currency risk. Whereas, compensation of management with shares increases a firm's hedging activity. Results thus highlight the importance of agency conflict in the payment of managerial options and the firm's use of hedging instruments. Passage of SFAS 133 significantly affects derivative use and agency conflict.     

Insider trading and managerial incentives

We derive conditions under which permitting manager “insiders” to trade on personal account increases the equilibrium level of output and the welfare of shareholders. These increases are produced by two effects of insider trading. First, insider trading impounds information about hidden managerial actions into asset prices. This impounding of information allows shareholders to make better personal portfolio-allocation decisions. Second, allowing insider trading can induce managers to increase, on average, the correlation between their personal wealth and firm value beyond the level dictated by the employment relationship alone. This increased correlation increases managerial incentives. When these two effects are only weakly present, permitting insider trading harms shareholders, because insider trading reduces shareholder control over the performance–compensation relationship. In addition, when managerial effort incentives are high and corporate governance costs are low, managers may prefer insider-trading restrictions because such restrictions force shareholders to offer them a larger fraction of output through the employment relationship.     

论基金管理人的股东化转型

在传统的基金治理结构中,基金管理人大多采用经理型模式,基金管理人的道德风险的发生难以避免。对基民与基金管理人的委托—代理合同进行优化,重激励、轻约束,不能从根本上消除基金管理人的道德风险。要消除基金管理人的道德风险,必须实现基金管理人从经理型向股东型的彻底转变,将基民与基金管理人的关系由传统的基金运行模式中的股东与经理的关系改造为优先股东与普通股东的关系。基金管理人的股东化转型,相对于经理型基金管理人而言,至少有两大功能:对基金管理人的机会主义行为的矫治功能;对基金管理人能力的甄别功能。     

Managerial Ownership and Corporate Hedging

Abstract:  Using information on 443 UK non-financial companies, this work provides evidence supporting the hypothesis that managerial risk aversion is an incentive to deviate from the optimal hedging position. Conflicts of interest between shareholders and managers are at the centre of the decision about the firm's risk profile but are not relevant as determinants of the decision to hedge. This is rather associated with factors enhancing the firm's expected value (underinvestment, scale economies, tax savings).     

Hedging, hedge accounting, and speculation in a rational expectations equilibrium

This paper explains corporate hedging and speculation in a two period rational expectations model. A risk averse manager represents a firm that is priced in a risk neutral market. The manager enters into a cash flow hedge of a forecast transaction by taking a short position in the futures market. When the futures position is chosen, the manager possesses private information regarding the firm’s production capacity. Mandatory disclosure of the futures position in the financial statements allows the market to draw inferences over the manager’s information. These inferences affect the market’s pricing decision and in turn the manager’s hedging decision. The futures position taken is chosen not only to reduce price risk exposure but to signal some capacity level. In equilibrium, however, the market anticipates the manager’s strategy and is not fooled.Considering varying managerial preferences, we analyze three settings. In the basic setting speculation occurs whenever the manager prefers high market values in both periods. In the second setting we add transaction costs and find that speculation is less likely. Finally, we introduce uncertainty regarding the manager’s preferences. If the market needs to determine prices based on expected preferences, incentives to speculate are mitigated in equilibrium but still present.     

Moral Hazard, Effort Sensitivity and Compensation in Asset-Backed Securitization

One interesting explanation for asset securitization is the managerial agency theory—where securitization of cash flows that are relatively insensitive to managerial effort reduces the noise for cash flows that are sensitive to managerial effort (Iacobucci and Winter, 2005). This paper extends this concept in several ways. First, we differentiate the effects of noise and effort sensitivity on managerial effort and compensation, underscoring the importance of a less noisy environment. We also carefully delineate the conditions under which asset securitization would improve the welfare of managers and shareholders of the originating company. Second, we relax the assumptions regarding the expected income-producing function and the income variance, and further take into consideration the change of the marginal production of income with respect to effort before and after securitization. Third, under a multitask principal-agent model framework, we explore how the relationship between managerial activities on different assets affects the incentive compensation for the manager of the originating company and the joint surplus for shareholder and manager. This is particularly relevant when entire buildings are securitized as opposed to pools of income-generating assets. Finally, we examine the role of the third-party servicer.     

OPTIMAL BIDDING FOR TENDER OFFERS

By modeling tender offers as auctions in which bidders arrive sequentially, I show that the first bidder includes a high premium in its opening bid in an attempt to freeze out potential competitors. When expected competition goes up, the premium offered increases as does target shareholder welfare, while bidders suffer. Also, total synergy gains generated increase with competition. Including a premium in the opening bid remains optimal for the first bidder when target management is permitted to resist. Target management's ability to resist, though, benefits target shareholders even when resistance is not actually observed. When agency costs are introduced, the effect of managerial resistance on target shareholder welfare becomes ambiguous.     

Risk aversion,prudence, and compensation

In a standard principal-agent setting, we use a comparative approach to study the incentives provided by different types of compensation contracts, and their valuation by managers with utility function u who are risk averse (u″<0) and prudent (u″′>0). We show that concave contracts tend to provide more incentives to risk averse managers, while convex contracts tend to be more valued by prudent managers. This is because concave contracts concentrate incentives where the marginal utility of risk averse managers is highest, while convex contracts protect against downside risk. Thus, managerial prudence can contribute to explain the prevalence of stock-options in executive compensation. However, convex contracts are not optimal when the principal is sufficiently prudent relative to the manager.     

THE DETERMINANTS OF SELECTIVE EXCHANGE RISK MANAGEMENT–EVIDENCE FROM GERMAN NON-FINANCIAL CORPORATIONS

Survey studies of both corporate exchange risk management and the corporate use of derivatives in general have shown considerable variation in managerial practices. Some firms do not hedge open positions at all, and some hedge their exposures completely. Most companies, however, hedge only those positions on which they expect a currency loss, while leaving open positions on which they expect a currency gain—a practice known as “selective hedging.” Finally, there is a small minority of firms that engage in outright speculation, deliberately creating risk exposures in addition to those arising from their normal business operations. Such findings are consistent with survey studies that suggest that a majority of corporate financial managers appear to believe that they are able to “beat the market”—a belief that, of course, is inconsistent with efficient markets theory. So why do some companies follow selective risk management strategies while other firms hedge open positions without recourse to exchange rate forecasts? In an attempt to answer this question, the author surveyed 74 German non‐financial companies about their exchange risk management practices. He found that highly levered firms were less likely to take bets in the currency markets, while bank‐controlled firms were more likely to use a selective risk management strategy. There was a negative relationship between profitability and the use of selective hedging—a finding that could be interpreted as suggesting that selective hedging does not generally benefit the firm's shareholders. Finally, there was a weak tendency for larger firms to be more inclined to use forecasts in their foreign exchange risk management.     

Agency,Firm Growth,and Managerial Turnover

We study managerial incentive provision under moral hazard when growth opportunities arrive stochastically and pursuing them requires a change in management. A trade‐off arises between the benefit of always having the “right” manager and the cost of incentive provision. The prospect of growth‐induced turnover limits the firm's ability to rely on deferred pay, resulting in more front‐loaded compensation. The optimal contract may insulate managers from the risk of growth‐induced dismissal after periods of good performance. The evidence for the United States broadly supports the model's predictions: Firms with better growth prospects experience higher CEO turnover and use more front‐loaded compensation.     

Corporate Governance When Managers Set Their Own Pay

This paper presents a model of the firm in which the manager has discretion over his own compensation, constrained only by the threat of shareholder intervention. The model addresses two main questions. How does shareholder power affect managers' compensation and their incentives to maximise firm value? And what is the optimal level of shareholder power? Expectedly, the model shows that increasing shareholder power leads to lower managerial pay. Greater shareholder power, however, also weakens the manager's incentives to maximise value and may even lead to lower profits for shareholders. There might, thus, be too much, as well as too little, shareholder power. The model characterises the optimal level of shareholder power and yields predictions about the relation between shareholder power, managerial pay, performance and firm characteristics.     

MANAGERIAL INCENTIVES AND THE USE OF FOREIGN‐EXCHANGE DERIVATIVES BY BANKS

We examine the effect of managerial compensation and ownership on the use of foreign‐exchange derivatives by U.S. bank holding companies. We focus on derivatives used for purposes other than trading to investigate derivative use in a hedging framework. We use instrumental variables probit and sample‐selection models to estimate the effects of endogenous and exogenous factors on the probability and extent of foreign‐exchange derivatives used. We find that the use of derivatives is inversely related to option awards but positively related to managerial ownership. Finally, our results suggest that ownership by large institutional shareholders provides incentive for managers to hedge.     

Corporate social responsibility as a common risk factor

This article challenges factor models widely used to explain stock returns. For European firms involved in corporate social responsibility (CSR) actions, we find a risk premium associated with extra-financial ratings priced by the market (that is, environmental, social, and governance [ESG] ratings). This premium is calculated as the excess return of low-rated firms compared to high-rated firms. To describe rated firms' returns, we propose a parsimonious two-factor model that includes both the market factor and this premium. Unlike the CAPM, three-, or five-factor models, our model is validated by the Gibbons, Ross and Shanken (1989) test. Our results lead to many managerial implications related to portfolio management, asset pricing, and corporate financial and investing decisions.     

CEO Age,Risk Incentives,and Hedging Strategy

We test whether managerial preferences explain how firms hedge, using hand‐collected data on derivative portfolios in the oil and gas industry. How firms hedge involves choosing between linear contracts and put options, and deciding whether to finance these hedging positions with cash on hand or by selling call options. The likelihood of being a hedger increases with chief executive officer (CEO) age, and near‐retirement CEOs prefer linear hedging instruments. The predictions of the managerial risk incentives theory of hedging strategy, according to which managers with convex compensation schemes avoid hedging strategies that cap upside potential, find no support in the data.