How well-run boards make decisions

In the aftermath of seismic debacles like those that toppled Enron and WorldCom, corporate boards have been shaken up and made over. More directors are independent these days, for instance, and corporations now disclose directors' salaries and committee members' names. Research shows that most of the changes are having a positive effect on companies' performance. They are primarily structural, though, and don't go to the heart of a board's work: making the choices that shape a firm's future. Which decisions boards own and how those calls are made are largely hidden from the public. As a result, boards are often unable to learn from the best governance practices of their counterparts at other companies. This article pulls back the curtain and provides an inside look. Drawing on interviews with board members and executives at 31 companies, along with a close examination of three boardroom decisions, the author identifies several formal processes that can help companies improve their decision making: creating calendars that specify when the board and the standing committees will consider key items; drafting charters that define the decisions committees are responsible for; and developing decision protocols that divvy up responsibilities between directors and executives. The author also identifies a number of informal decision-making principles: Items that are strategically significant and touch on the firm's core values should go to the board. Large decisions should be divided into small pieces, so the board can devote sufficient attention to each one. Directors must remain vigilant to ensure that their decisions are effectively implemented. The CEO and either the nonexecutive chair or the lead director should engage in ongoing dialogue regarding which decisions to take to the full board and when. And directors should challenge assumptions before making yes-or-no decisions on management proposals.     

How SmithKline Beecham makes better resource-allocation decisions

Major resource-allocation decisions are never easy. For a pharmaceuticals company like SmithKline Beecham, the problem is this: How do you make good decisions in a high-risk, technically complex business when the information you need to make those decisions comes largely from the project champions who are competing against one another for resources? In 1993, the company experimented with ways of depoliticizing the process and improving the quality of decision making. In most resource-allocation processes, project advocates develop a single plan of action and present it as the only viable approach. In SB's new process, the company found an effective way to get around the all-or-nothing thinking that only reinforces the project-champion culture. Project teams were required--and helped--to create meaningful alternatives to current development plans. What would they do with more money? With less? With none at all? In another important departure from common practice, SB separated the discussion of project alternatives from their financial evaluations. In doing so, SB was able to avoid the premature evaluations that kill both creativity and the opportunity to improve decision making. The new process at SB has allowed the organization to spend less time arguing about how to value its R&D projects and more time figuring out how to make them more valuable. In the end, the company learned that by tackling the soft issues around resource allocation--such as information quality, credibility, and trust--it had also addressed the hard ones: how much to invest and where to invest it.     

How prior realized outcomes affect portfolio decisions

Investors have been shown to have particular preferences when it comes to the characteristics of stock they hold in their portfolios, while prior gains and losses have been shown to impact on individuals’ economic decisions, both in an investment context and more widely. This paper is the first to investigate how prior gains and losses affect investors’ preferences for particular stock characteristics and so shape their portfolio compositions. Using a rich dataset combination from China, we conclude that prior realized outcomes play an important role in shaping portfolio composition through their impact on the characteristics of stocks that investors choose to hold. We find that positive prior realized outcomes encourage investors to select stocks with a variety of characteristics broadly consistent with higher risk taking (for example, higher betas and higher levels of idiosyncratic risk), though there are some differences across investor classes. While our empirical results are in line with what one would expect from the existing literature on the disposition and house money effects, we also consider other possible interpretations of the results.     

How Managers' everyday decisions create or destroy your company's strategy

Senior executives have long been frustrated by the disconnection between the plans and strategies they devise and the actual behavior of the managers throughout the company. This article approaches the problem from the ground up, recognizing that every time a manager allocates resources, that decision moves the company either into or out of alignment with its announced strategy. A well-known story--Intel's exit from the memory business--illustrates this point. When discussing what businesses Intel should be in, Andy Grove asked Gordon Moore what they would do if Intel were a company that they had just acquired. When Moore answered, "Get out of memory," they decided to do just that. It turned out, though, that Intel's revenues from memory were by this time only 4% of total sales. Intel's lower-level managers had already exited the business. What Intel hadn't done was to shut down the flow of research funding into memory (which was still eating up one-third of all research expenditures); nor had the company announced its exit to the outside world. Because divisional and operating managers-as well as customers and capital markets-have such a powerful impact on the realized strategy of the firm, senior management might consider focusing less on the company's formal strategy and more on the processes by which the company allocates resources. Top managers must know the track record of the people who are making resource allocation proposals; recognize the strategic issues at stake; reach down to operational managers to work across division lines; frame resource questions to reflect the corporate perspective, especially when large sums of money are involved and conditions are highly uncertain; and create a new context that allows top executives to circumvent the regular resource allocation process when necessary.     

How universal health care would influence decisions about work and retirement

The current U.S. health care system distorts individual decisions about work and retirement. After a brief explanation of how the current health care system works, this article reviews those distortions and considers how individuals would respond to the implementation of a universal health care system. The author argues that the likely adverse impacts of an employer health insurance mandate on low-skilled workers could be more than offset by a well-designed system of government subsidies.     

The effect on stock performance of executives' emotions during IPO roadshows

This paper describes the correlation between executives' emotions expressed at IPO online roadshows and post-IPO stock performance in the Chinese stock market. The executives' emotion is quantified by face recognition models used for analyzing facial expressions during the IPO roadshows. Our results show that the more negative emotions are expressed by executives at the roadshow, the lower the short-term stock returns after IPO, and this finding is stronger for firms with limited information disclosure. These results are robust to the implementation of an instrumental variable strategy using Air Quality Index or Comfort Index of Human Body as the instrumental variable, various measures of management emotions, and the subsample analysis in which the financial firms and industries has the limited number of firms are excluded.     

How information systems influence user decisions: a research framework and literature review

Technology has created new information alternatives that may influence the way information system users make decisions. This paper proposes a research framework for examining how features of an information system affect the decision-making process. The framework is synthesized by merging frameworks from the accounting information systems (AIS) literature and the human information processing (HIP) literature. The framework is then used to organize a literature review of 15 journals from 1987 through mid-1999, which identified 57 decision-making studies. Findings indicate that a wide range of opportunities is available for information systems research on issues of contemporary importance. This discussion includes changes in the decision process initiated by implementing enterprise resource planning (ERP) systems, data warehouses, electronic commerce, virtual organizations, on-line financial reporting, and disaggregated financial statement information.     

CEO optimism and the board's choice of successor

Research suggests that boards of directors select CEOs using signals of ability. However, little is known about how boards determine the combination of attributes that constitute a ‘good’ CEO, especially attributes without an ex ante clear impact on managerial quality, such as CEO optimism. I argue that boards will learn the optimal level of such attributes more quickly from past success, and empirical results support this. Boards, particularly those with high reputation/independence, are significantly more likely to select a moderately optimistic (optimal) successor following a moderately optimistic CEO departure. Robustness checks rule out alternate explanations and support this conclusion.     

Transformational change and the vacuum of performance measurement: How a story of success became a failure

Some local government organisations stand out in terms of their capability to adopt and use management accounting innovations and become a model for those struggling with issues such as performance measurement (PM). But what happens to the innovations if the organisation is forced into transformational change? This longitudinal case study is based on the theory that the use and impact of PM is influenced by (a) its contractibility and (b) how the performance management systems in place are configured and used. One conclusion is that transformational change can result in a vacuum of PM, even with a high degree of contractibility.     

Investment decisions with financial constraints. Evidence from Spanish firms

This paper analyses to what extent the rejection of the investment dynamics implied by the Euler equation model with quadratic and symmetric adjustment costs can be attributed to the fact that the investment behavior of some firms in some periods is financially constrained by the availability of internal funds. I use a hierarchy of finance model which assumes that internally generated finance for investment is available at a lower cost than external finance, and implies the existence of distinct financial regimes depending on the firm’s financial policy. I estimate the empirical investment equation derived from the model using GMM, taking into account the endogeneity of the selection and allowing for debt finance, imperfect competition and the existence of a possible measurement error in the user cost of capital. The empirical results suggest that the Euler equation model is not seriously misspecified for a sub-sample of firms pursuing a particular financial policy.     

Predictors of unrealistic optimism: a study of Norwegian risk takers

In areas of voluntary risk behaviour, as with other kinds of risk, people tend to be overly optimistic regarding not being injured. A study of risk perception and causal explanations of injury assessments was conducted on 199 respondents from three different sub‐groups in Norway; skydivers (n?=?88), fire fighters (n?=?73) and soldiers (n?=?38). Unrealistic optimism was studied by means of four demographic variables: the background of the subject (sub‐sample), gender, age, and education. In addition, three predictors of unrealistic optimism were taken into account—safety attitudes, control, and anxiety. These predictors were included in an Analysis of Linear Structural Relationship (LISREL) analysis. The results showed that optimism differed between the sub‐groups, and that different factors influenced risk perception depending on the group and depending on whether the assessment was of oneself or of others. These findings offers additional information that will help explain the inconsistent findings in the current literature of unrealistic optimism. Of the predictors investigated, safety attitudes were found to be the most important, which may be because respondents preoccupied with safety are more aware of potential dangers and thereby less optimistic.     

Overconfidence and optimism: The effect of national culture on capital structure

This study assesses whether variations in capital structure across countries can be explained by cultural traits. We analyze capital structure choices of firms in 42 countries and provide evidence that these decisions are affected by the degree of individualism of the country where the firm is located. We assert that managers in countries with high level of individualism exhibit strong optimism and overconfidence which cause an upward bias in perception of supportable debt ratios. Our results are robust to controlling for other firm- and country specific determinants of capital structure choices and to using alternative model specifications and estimation techniques.     

Disclosure of internal control material weaknesses and optimism in analyst earnings forecasts

This paper investigates how analyst forecast optimism is associated with disclosures of internal control material weaknesses (ICMWs) and their remediation under Section 404 of the Sarbanes–Oxley Act (SOX). Drawing on agency theory, I hypothesize that analysts are likely to issue earnings forecasts that are more optimistic for firms with ICMW disclosures than for those without ICMW disclosures. Using a sample of 20,875 firm-year observations with 10-K (10-Q) reports from 2004 to 2018, I find a positive association between ICMW disclosures and analyst forecast optimism. This positive association is partially driven by investors’ inability to unravel analyst forecast bias and analysts’ intentions to curry favor with management for private information. In addition, analysts are found to issue less optimistic forecasts for firms with ICMW remediation disclosures compared with those without ICMW remediation disclosures. A series of propensity score matching and regression analyses are conducted to test the robustness of my inferences. Overall, the paper suggests that analysts have incentives to take the opportunity of firms disclosing ICMWs to bias their forecasts upward for self-interest. The findings have the potential to assist regulators in guiding analyst behavior and educating investors to unravel positive bias in analyst forecasts.     

The financing decisions of innovative firms

The paper examines the relation between forms of financing and the level of expenditure on research and development (R&D). The paper shows that the probability of issuing new equity rises monotonically with the level of expenditure on R&D, whilst the use of debt finance follows an inverted U curve, rising and then falling as R&D expenditure rises. The analysis confirms ‘control rights’ theories of financing, in which firms follow an established hierarchy of preferences for modes of financing, with debt preferred to equity since it involves less loss of control rights. The mode of financing is linked to characteristic types of innovation, with debt financing associated with incremental innovation and equity funding with R&D intensive innovation, as in pharmaceuticals. The paper concludes by suggesting a linkage between modes of financing, types of innovation and business systems, with the UK's innovation pattern linked to market financing contrasting with the relationship financing of bank oriented systems such as Germany.     

Good decisions,bad decisions: the interaction of process and outcome in evaluations of decision quality

Process‐based considerations are generally accepted by experts and analysts as being the fundamental drivers of decision quality. However, little work has been done to account for the role of a risk management decision’s outcome as a key driver of the public judgments about decision quality. To this end, the objective of the research reported here was straightforward to determine – via an experiment – the relative importance of decision‐making process and the associated outcome in lay evaluations of decision quality. Our results demonstrate that people seem to have a difficult time unpacking decision‐making processes, even ones they strongly prefer, from their associated outcomes when evaluating decision quality. From a practical standpoint, our results cast doubt on the generally accepted belief that participatory and deliberative decision‐making processes (e.g., for risk management) will – on their own – contribute to positive evaluations of decision quality.     

Active timing decisions of equity mutual funds

In this paper we examine an aspect of professional investment management which has not been adequately documented and studied; the extent to which equity mutual fund managers actively adjust their portfolio's equity risk exposure over time. Estimates of a portfolio's quarter-end beta are developed using the actual stock holdings of the portfolio at the quarter-end. Changes in these beta estimates from one quarter to the next are shown to arise from both passive and active asset allocation. We find that active risk adjustment dominates passive rebalancing and that equity risk exposure is quite variable over time. Thus, individual investors who estimate the equity risk inherent in a portfolio based on a single time series return beta might seriously misestimate the portfolio's current equity risk. We also test whether active risk management is better characterized as anticipatory of future market events or reactive to past market events.     

Information, speed vs. cost trade-offs, and order routing decisions in U.S. equity markets

Prior research indicates that both execution speed and cost are important to traders, but that these two dimensions of execution quality are negatively related across U.S. equity markets. In our paper, we examine how U.S. equity traders, who are (un)informed about future price changes, trade-off between speed and cost in their order-routing decisions. We find that informed traders are more likely to choose trading systems that allow them to trade-off lower cost for faster speed; whereas, uninformed traders are more likely to choose trading systems that allow them to sacrifice speed for lower costs. Our results indicate that traders have varying preferences for the different dimensions of execution quality based on their information levels. These differences subsequently influence order-routing decisions.