CEO Compensation and Stakeholders' Claims*

The traditional view that a corporation exists solely to serve the interests of the firm's shareholders has given way to a changing view that recognizes the importance of corporate constituents in addition to shareholders. Prior studies demonstrate a significant association between the sensitivity of CEO compensation and a firm's stock prices. However, the association between CEO compensation and the claim of other primary stakeholders (customers, employees, suppliers) has not been examined. The purpose of this study is to investigate whether the adoption of long‐term incentive plans aligns the interest of the CEO with the interest of the primary stakeholders in the firm. Using the fixed‐effect regression, our results indicate a significant association between the change in CEO compensation and the claims of the customers, shareholders, and employees. We contribute to the literature by demonstrating that the managers are accountable not only to the shareholders but also to primary stakeholders.     

Equity‐Based Compensation of Outside Directors and Corporate Disclosure Quality

We examine the relationship between a firm's disclosure quality and equity‐based compensation of independent members of the board of directors. The dimensions of disclosure quality we focus on are management's earnings guidance and information flowthrough financial analysts. Using both levels and changes specifications, we find the average ratio of equity‐based pay to total pay of independent board members to be positively related to a firm's disclosure quality. Our findings are robust to the inclusion of management's equity‐based compensation, other governance measures, and financial controls, and robust to instrumental variable tests of endogeneity. Furthermore, we find directors’ equity‐based compensation to be negatively associated with the firm's cost of equity capital. Our results are consistent with equity‐based compensation providing incentives to independent directors to push for better disclosure quality.     

Ill-intentioned or well-intentioned: earnings management and trade credit

The use of trade credit as important short-term financing for firms is increasing. This study explores the differential impact of firm earnings management on trade credit financing under different motives, using A-share listed firms in China from 2009 to 2020. The results show that accrued and real earnings management reduce a firm's trade credit. On the other hand, the classification shifting earnings management increases a firm's trade credit. Accrued and real earnings management are opportunistically motivated, while classification shifting earnings management is non-opportunistically motivated. Moreover, external audits weaken the negative effect of accrued and real earnings management on trade credit and enhance the positive effect of classification shifting earnings management on trade credit, indicating the ‘bilateral matching effect’ between external audits and firms. Finally, financing constraints weaken the impact of earnings management on trade credit.     

Trade Credit and Productive Efficiency in Developing Countries

In developing countries, credit shortages are often so severe as to impact a firm's day-to-day production decisions. Using firm-level data from five African countries, I show supplier credit is positively correlated with capacity utilization; the result continues to hold when credit access is instrumented using supplier characteristics. I claim that this is because firms lacking credit likely face inventory shortages, leading to lower rates of capacity utilization. This explanation yields several further predictions that are supported by the data: there is a positive relationship between supplier credit and inventory holdings; moreover, raw materials “stockouts” are positively correlated with capacity utilization, particularly in “inventory-intensive” industries.     

Promotions in the internal labor market: New evidence from China

Using unique personnel data from a firm in China, we analyze promotions in an internal labor market. Specifically, we explore the firm's hierarchy and promotion patterns as well as the relationship between promotions and compensation. Unlike previous works, we focus on promotions throughout the firm's hierarchy including rank-and-files and promotions across branches. By doing so, we hope to shed new light on the black box of a firm's internal hiring and promotion practices and improve understanding of the internal labor market.     

The Effect of Limited Liability on the Informativeness of Earnings: Evidence from the Stock and Bond Markets*

Previous empirical research on the informativeness of earnings has focused on stockholders, and has not examined differences in earnings' informativeness for stockholders and bondholders. Because stockholders are residual claimants and bondholders are fixed claimants, the informativeness of earnings should differ for these two types of investors. When a firm's default risk is low, changes in its financial condition should be of limited relevance to bondholders, but should be relevant to stockholders. In contrast, as the likelihood of financial distress increases, stockholders' limited liability allows them to abandon the firm to the bondholders (Fischer and Verrecchia 1997). Accordingly, as a firm's default risk increases, changes in its financial condition should be increasingly important to bondholders and less important to shareholders. Because earnings provide information on firm value, the stock return-earnings association should decrease as the firm's financial strength declines, while the bond return-earnings association should increase. We use two measures of a firm's financial strength: the firm's bond rating and its reporting of a loss. Consistent with our hypotheses, we find that the association between stock returns and changes in annual earnings decreases as bond ratings decline, while the association between bond returns and changes in annual earnings increases. These results suggest that as the company's financial condition deteriorates, earnings become less relevant for stock valuation and more relevant for bond valuation. When we partition firms based on their loss status, we find a stronger association between stock returns and annual earnings changes for firms with positive earnings (profit firms) than for firms with losses, consistent with earlier studies. In contrast, we find that the association between bond returns and earnings changes is greater for loss firms than for profit firms. These results suggest that losses reduce the informativeness of earnings for stockholders but increase informativeness for bondholders, suggesting that investors view losses as indicating increased credit risk.     

Impact of Outward Foreign Direct Investment on Domestic R&D Activity: Evidence from Taiwan's Multinational Enterprises in Low‐wage Countries

This paper theoretically and empirically investigates the home‐country effects of a firm's outward foreign direct investment (OFDI) activity, specifically OFDI motivated by lower labor costs in the host country. A two‐country imperfect competition model is developed, and the interaction between a firm's R&D spending and its OFDI is examined. It is found that the relationship between a firm's OFDI and its domestic R&D is indeterminate because there is a complementary effect as well as a substitution effect induced by OFDI activity. Panel data on Taiwanese manufacturing firms from 1992–2005 are applied to test the validity of the theoretical results. The propensity score matching method is used to construct a comparison group without selection bias. Our empirical evidence reveals that a Taiwanese firm's OFDI is positively related to its domestic R&D spending, particularly in R&D‐intensive industries.     

Employment-Based Health Insurance and the Effectiveness of Intrafirm Competition between Insurance Providers

This paper examines the effects of competition between insurers for the patronage of a firm's employees. Since for employment-based health insurance the employee choice of health insurance plans is often limited, the availability of competing plans in the market does not necessarily reflect competition within the firm. We utilize data from the 1987 National Medical Expenditures Survey (NMES) to examine the effect of intra firm competition in the employment-based health insurance market. Using switching regression models, we explore the process that sets premiums and the process that sets the net premium/medical cost margins. We find that greater choice results in higher margins and lower premiums. We also find significantly negative health maintenance organization choice effects on both premiums and margins.     

The Effect of Changes in Income Shifting on Affiliate Managers' Internal Reporting Decisions*†

This study examines the interplay between tax and internal reporting incentives among affiliates of multinational corporations (MNCs). MNCs face limited information flows that may prevent affiliates' performance metrics to be responsive immediately to changes in the firm's tax planning. Using granular data of affiliates belonging to MNCs from 21 European countries, our study provides new empirical evidence of affiliate internal reporting responses induced by changing tax plans. When high-tax-rate countries tighten income shifting rules, we first document that income shifting is reduced and low-tax-rate affiliates have less income. Second, we predict and document that managers of these low-tax-rate affiliates offset this decrease in profits by managing upwards a key performance metric: affiliate earnings. Our results are consistent with firms not quickly adjusting the affiliate managers' incentives in the face of changing tax planning strategies, and affiliates managing reported earnings to offset the effect of changes in the tax planning of the firm. Cross-sectional analyses provide further evidence consistent with the theory underlying the main tests. The results support the policy of tightening income shifting rules when the objective is to reduce income shifting, and firms' central management would benefit from considering the implications of changing tax plans on the assessment of local managers.     

The Effect of Competitive Bidding on Engagement Planning and Pricing*

This paper investigates how clients' choices regarding whether or not to engage in competitive bidding affect a bidding firm's decisions about planned engagement effort and pricing. Specifically, we investigate whether competitive bidding is associated with higher planned engagement effort and lower fees relative to noncompetitive bidding, and whether competitive bidding is associated with increased sensitivity of effort and fees to cost drivers and the components of service production. There is little available evidence regarding the effects of competitive versus noncompetitive bidding in the current market, and none that focuses on both quality and pricing effects associated with competitive bidding across a broad array of clients. We address these issues using data from a sample of one firm's evaluations of prospective clients, made during 1997‐98. During that period, about half of the firm's bids were competitive and half were noncompetitive, providing a unique opportunity to study how the bidding environment affects engagement planning and pricing. Our findings reveal that competitive bidding is associated with higher planned engagement effort and lower fees. In addition, we find that in competitive bidding situations there are stronger associations between cost drivers and planned engagement effort, and between the components of service production and fees.     

Discretion in Financial Reporting: The Voluntary Disclosure of Compensation Peer Groups in Proxy Statement Performance Graphs*

We examine the 49 Standard & Poor's (S&P) 500 firms that voluntarily disclosed in their 1993 proxy statements, the composition of the comparison group used by each board's compensation committee to set executive compensation policies. We hypothesize that the net benefits of this disclosure are largest when (1) there is a high degree of stakeholder concern about compensation, (2) compensation policies are defensible, and (3) corporate governance is strong. Consistent with our stakeholder concern prediction, disclosing firms have higher compensation levels and are more apt to have received prior shareholder proposals about executive compensation. Contrary to this prediction, we find a negative association between financial press coverage of compensation policies and the probability of disclosure. Additionally, the disclosure decision is unrelated to the defensibility of compensation policies and the firm's corporate governance profile. Industry-adjusted firm performance, managerial entrenchment, CEO tenure, institutional holdings, and compensation committee independence variables are insignificant. We also compare the financial performance and compensation practices of compensation peers to two yardsticks — performance and pay practices at the sample firms and the corresponding S&P industry index firms. The compensation levels of compensation peers exceed those of the firms in the corresponding S&P industry indexes. Because (1) compensation levels and performance sensitivities at sample firms are more similar to those at compensation peers than to those at S&P industry index firms, and (2) the superior financial performance and higher performance sensitivities of disclosing firms justify high pay, this evidence suggests that the compensation peers of disclosing firms are an appropriate comparison group.     

International Business Alliance under Asymmetric Information: Technology vis‐à‐vis Information Advantage

We study the relationship between a multinational corporation (MNC) and a domestic firm under demand uncertainty. The MNC possesses a superior production technology, but the domestic firm is better at predicting market demand. We examine the MNC's preference for, and the ownership structure of, an international alliance (IA) and find, inter alia, that binding borrowing constraints have serious implications for the results. Interestingly, a firm's preference for and profits in IA do not necessarily increase as its advantage in market information or production technology increases. We also consider a dynamic setting with technology spillover and show that whether technology spillover hinders or facilitates IA once again depends on the nature of the credit market.     

Determinants of Funding Strategies and Actuarial Choices for Defined-Benefit Pension Plans*

This paper examines the effects of firms' financial and pension profiles on their funding strategies and actuarial choices. The paper uses reports filed by individual pension plans with the Department of Labor under the requirements of the Employee Retirement Income Security Act of 1974 for the analysis. Evidence reported in the paper shows that as firms become overfunded, they make conservative actuarial choices to avoid visibility costs, and that as firms become underfunded, they make liberal actuarial choices to avoid visibility costs. As the annual contributions increase relative to the permissible contribution ranges, firms make conservative actuarial choices to minimize penalties and maximize tax benefits. As the annual contributions decrease relative to the permissible contribution ranges, firms make liberal actuarial choices to minimize penalties and maximize tax benefits. The larger the profitability, cash flow from operations, and tax liability, and the smaller the debt of a firm, the higher the likelihood that the firm's managers will make conservative actuarial choices to maximize contributions. Conversely, the smaller the profitability, cash flow from operations, and tax liability, and the larger the debt of a firm, the higher the likelihood that the firm's managers will make liberal actuarial choices to minimize contributions. This evidence, which is consistent with the hypothesis of funding management, can aid the Internal Revenue Service (IRS) in regulating the defined-benefit pension plans more effectively and help plan beneficiaries to manage their retirement portfolios more efficiently. The debiasing method developed in the paper can provide investors and creditors with the tools to identify the discretionary components of pension liabilities and thereby value firms more efficiently.     

Constraints in Access to and Demand for Rural Credit: Evidence from Uganda

Abstract: Like in most developing countries, Uganda's financial sector is largely underdeveloped and concentrated in urban areas, leaving the majority of the agricultural producers in the rural population with no access. However, agriculture forms a significant part of the lives of the rural households, who constitute about 85 per cent of the population. This study uses the Uganda household surveys conducted in 1992/93 and 1999/2000 to shed some light on access to, and the characteristics of demand for credit among the rural population. We employ the probit, tobit and multinomial logit model estimations and we analyse demand for credit and find that Uganda's credit market is highly segmented. The rural peasant producers are largely served by relatives/friends and self‐help credit associations and their loan applications are less likely to succeed, and of those that do, smaller loans are granted. The educated and the young are more likely to demand credit while women are less likely to, and to apply for smaller loans. Therefore, while government's agricultural modernization policy considers credit as an important input to its success and as the government plans to roll out the ‘wealth‐for‐all’ programme, more needs to be done to get credit to the sector and to ensure that it can be usefully utilized. Programmes to promote skills and vocational training to enhance production and training in appropriate use of credit are also needed.     

Private Information Production,Public Disclosure,and the Cost of Capital: Theory and Implications*

Both private information production by market traders and public disclosure by firms contribute to dissemination of financial information in the capital market. However, the motives and economic consequences of the two are quite different. In general, private information production is intended by investors to increase their trading profit, which has the effect of widening the information gap between informed and uninformed investors and increasing the firm's cost of capital. On the other hand, public disclosure can be used to narrow this information gap and to lower the cost of capital. This paper provides a theoretical model to examine the economic incentives behind these two forms of information dissemination and their consequences on the cost of capital. By simultaneously considering the firm's and the information traders' decisions, the paper derives an equilibrium in which the amount of private information production, the level of public disclosure, and the cost of capital are all linked to specific characteristics of the firm, of information traders, and of the market. In contrast to conventional beliefs, the paper predicts that, across firms, the cost of capital can be either positively or negatively related to the firm's disclosure level, depending on the specific factors that cause the variation within a particular sample. Similarly, the extent to which investors follow a firm and the firm's disclosure level can be either positively or negatively related to each other. Implications for empirical research are discussed.     

Tests of a Deferred Tax Explanation of the Negative Association between the LIFO Reserve and Firm Value*

Guenther and Trombley (1994) and Jennings, Simko, and Thompson (1996) document a negative association between a firm's last-in, first-out (LIFO) reserve and the market value of its equity. In this paper, we test a deferred tax explanation of this negative association. Specifically, we argue that investors, conditional on adjusting inventory to as-if first-in, first-out (FIFO), estimate a firm's future LIFO liquidation tax burden as its LIFO reserve multiplied by the appropriate corporate tax rate and include this tax-adjusted LIFO reserve in the valuation of a LIFO firm's net assets. On the basis of this argument, the tax-adjusted LIFO reserve is in effect an estimate of an off-balance-sheet deferred tax liability and, as a result, we predict a negative association between the tax-adjusted LIFO reserve and market value of equity. We test our deferred tax explanation by estimating a valuation model in which a firm's market value of equity is expressed as a function of the firm's assets, liabilities, deferred tax liability, and tax-adjusted LIFO reserve; the model is estimated separately in years preceding and following the reduction of tax rates mandated by the US Tax Reform Act of 1986. Test results provide strong support for the deferred tax explanation of the negative association between a firm's LIFO reserve and the market value of its equity.     

The minimum wage and the financialization of firms: Evidence from China

This paper utilizes China's A-listed firm data to investigate whether increasing the minimum wage promotes the financialization of firms. We apply instrumental variable estimation and various robustness tests to address measurement errors and potential endogeneity. We find robust and consistent evidence that exposure to higher minimum wages increases a firm's investment in financial assets. Furthermore, we explore the effects of moderators, such as increased employment stickiness, intensification of financial constraints, and reduced innovation activities as potential explanations for the positive effect of increasing minimum wages. Moreover, firms located in non-coastal cities with relatively higher equity concentration and lower market competition are substantially more incentivized to increase investment in financial assets. Overall, this paper provides new insights into understanding the effects of increasing labor costs on firms' asset allocation in emerging market economies.     

Express Yourself: Why Managers' Disclosure Tone Varies Across Time and What Investors Learn from It

We argue that volatility in a manager's disclosure tone across time should be a function of two components: (i) the firm's innate operating risk and (ii) the extent to which the manager's disclosure transparently reflects that risk. Consistent with this argument, we find that both operating risk and disclosure transparency are important determinants of disclosure tone volatility. We then examine whether investors incorporate the incremental information provided by disclosure tone volatility into their assessments of firm risk. If disclosure tone volatility primarily provides investors with incremental information about a firm's operating risk, we should find a positive association between tone volatility and market-based assessments of risk. On the other hand, if disclosure tone volatility primarily provides investors with incremental information about a manager's disclosure transparency, we should find a negative association between tone volatility and market-based assessments of risk. Consistent with an operating risk explanation, we find a positive association between disclosure tone volatility and market-based assessments of firm risk after controlling for a comprehensive set of proxies for operating risk and transparency. We find little support for an information risk explanation, even when we examine multiple measures specifically designed to capture information risk. Taken together, our results suggest that although disclosure tone volatility is a function of both a firm's operating risk and a manager's disclosure transparency, investors appear to respond as if disclosure tone volatility only provides incremental information about a firm's operating risk.     

Information Quality and Endogenous Project Outcomes

In this study, we show that when a firm needs external financing, information quality has real effects via financing contracts on the firm's input to influence its operational outcome. Interestingly, we find that higher information quality decreases overall efficiency. Our analysis highlights the importance of considering the role of information quality in the presence of the firm's input decision upon financing contracts. In particular, information quality has a feedforward effect on the firm's real input decision via financing contracts, which in turn has a feedback effect on financing contracts and overall efficiency.     

Intra‐Industry Information Transfers and the Post‐Earnings Announcement Drift

This study examines the role of intra‐industry information transfers in the analyst forecast‐based post‐earnings announcement drift. I find that subsequent same‐industry‐peer earnings announcements influence a firm's post‐earnings announcement drift if these subsequent announcements confirm the firm's initial earnings surprise and the firm's industry exhibits ex ante positive (common effect) intra‐industry information transfers. The results suggest that underreaction to industry‐specific information contributes to analyst forecast‐based post‐earnings announcement drift.