Executive compensation in firms with concentrated control: The impact of dual class structure and family management

We examine how two distinct ownership forms of concentrated control affect executive compensation. We compare executive compensation in dual class firms with that in single class companies with concentrated control. Although both samples of companies have agency problems associated with concentrated control, dual class companies have additional problems associated with controlling shareholders holding smaller equity positions. We show that family members in executive positions in dual class companies are paid significantly more than those of single class companies with concentrated control. The excess is in the form of more incentive compensation (bonuses and stock options). This finding is consistent with optimal contract theory of executive compensation in that the higher compensation is given to prevent dual class executives from taking advantage of their higher voting leverage. Our results are robust to an alternative specification of voting leverage which uses the difference between voting and cash flow rights of controlling shareholders.     

Governance structure and the weighting of performance measures in CEO compensation

We empirically examine how governance structure affects the design of executive compensation contracts and in particular, the implicit weights of firm performance measures in CEO’s compensation. We find that compensation contracts in firms with higher takeover protection and where the CEO has more influence on governance decisions put more weight on accounting-based measures of performance (return on assets) compared to stock-based performance measures (market returns). In additional tests, we further find that CEO compensation in these firms has lower variance and a higher proportion of cash (versus stock-based) compensation. We further find that CEOs’ incentives (measured as changes in CEO annual wealth which includes expected changes in the value of the CEO’s equity holdings in addition to yearly compensation) do not vary across governance structures. These findings are consistent with CEOs in firms with high takeover protection and where they have more influence on governance negotiating different contracts.

Information Intermediary or De Facto Standard Setter? Field Evidence on the Indirect and Direct Influence of Proxy Advisors

We examine whether proxy advisory firms (PAs) serve primarily an information intermediary role by providing research and voting recommendations to shareholders, or directly influence executive compensation by exerting pressure on firms to adopt preferred pay practices. Through a field study, we find that PAs are perceived as both information intermediaries and agenda setters and that these roles provide leverage to enable PAs to exercise significant influence over executive pay practices. Boards feel, and sometimes yield to, pressure to conform to PA “best” practices despite their own preferred compensation philosophies, even in the absence of overt PA scrutiny or negative shareholder votes. We also find that PAs are susceptible to conflicts of interest and generally use a “one‐size‐fits‐all” approach to voting recommendations. Overall, however, PAs are viewed as improving compensation practices by increasing transparency and accountability and fostering dialogue between firms and their shareholders.     

Shareholder Votes and Proxy Advisors: Evidence from Say on Pay

We investigate the economic role of proxy advisors (PAs) in the context of mandatory “say on pay” votes, a novel and complex item requiring significant firm‐specific analysis. PAs are more likely to issue an Against recommendation at firms with poor performance and higher levels of CEO pay and do not appear to follow a “one‐size‐fits‐all” approach. PAs’ recommendations are the key determinant of voting outcome but the sensitivity of shareholder votes to these recommendations varies with the institutional ownership structure, and the rationale behind the recommendation, suggesting that at least some shareholders do not blindly follow these recommendations. More than half of the firms respond to the adverse shareholder vote triggered by a negative recommendation by engaging with investors and making changes to their compensation plan. However, we find no market reaction to the announcement of such changes, even when material enough to result in a favorable recommendation and vote the following year. Our findings suggest that, rather than identifying and promoting superior compensation practices, PAs' key economic role is processing a substantial amount of executive pay information on behalf of institutional investors, hence reducing their cost of making informed voting decisions. Our findings contribute to the literature on shareholder voting and the related policy debate.     

Separation of Ownership from Control and Acquiring Firm Performance: The Case of Family Ownership in Canada

Abstract:   This study investigates the relationship between ownership structure and acquiring firm performance. A large proportion of Canadian public companies have controlling shareholders (families) that often exercise control over voting rights while holding a small fraction of the cash flow rights. This is achieved through the concurrent use of dual class voting shares and stock pyramids. Many suggest that these ownership structures involve larger agency costs than those imposed by dispersed ownership structures and that they distort corporate decisions with respect to investment choices such as acquisitions. We find that average acquiring firm announcement period abnormal returns for our sample of 327 Canadian transactions are positive over the 1998–2002 period. Cash deals, acquisitions of unlisted targets and cross‐border deals have a positive impact on value creation. Governance mechanisms (outside block‐holders, unrelated directors and small board size) also have a positive influence on the acquiring firm performance. Further, the positive abnormal returns are greater for family firms. We do not find that separation of ownership and control has a negative impact on performance. These results suggest that, contrary to other jurisdictions offering poor minority shareholder protection or poor corporate governance, separation of control and ownership is not viewed as leading to value destroying mergers and acquisitions, i.e., market participants do not perceive families as using M&A to obtain private benefits at the expense of minority shareholders. We do find a non‐monotonic relationship between ownership level and acquiring firm abnormal returns. Ownership of a majority of the cash flow rights has a negative impact on announcement returns. This is consistent with the view that large shareholders may undertake less risky projects as their wealth invested in the firm increases.     

Why are shareholders not paid to give up their voting privileges? Unique evidence from Italy

Dual-class share unifications have typically been argued to be beneficial for voting shareholders, who are usually compensated for the loss of their superior voting privileges. However, no covenants exist that make this compensation mandatory for voting shareholders. In this paper, we examine a subset of dual class share unifications from Italy where, in the main, voting shareholders are not offered any compensation in lieu of the loss of their superior voting rights. We present a simple model describing the conditions under which the controlling voting shareholder will choose not to offer compensation to minority voting shareholders as part of a share unification. Our empirical results support the model predictions.     

The Impact of Corporate Governance on Executive Compensation

This paper examines the relationship between the compensation of the top five executives at a set of over 400 publicly listed Canadian firms and various internal and external corporate governance‐related factors. The media is full of stories suggesting a relationship between large executive compensation packages and failures in governance at various levels within organisations, but there exists little formal analysis of many of these relationships. Our analysis provides empirical evidence supporting some of these assertions, refuting others and documenting new relationships. We find that variances in internal governance related to differences across firms in the characteristics of the CEO, compensation committee and board of directors do influence both the level and composition of executive compensation, especially for the CEO. Considering external measures of corporate governance, we find that different types of shareholders and competitive environments impact executive compensation. We do not find that either the internal or external governance characteristics dominate.     

European monetary arrangements: Implications for the dollar,exchange rate variability and credibility

This paper uses the recent history of the ERM to gain insights into what might happen to exchange rates on the road to EMU. to do this, the paper examines the variability of exchange rates, the transmission of monetary policy between countries, the role of the dollar in ERM exchange rate crises, and ERM members' credibility as measured by the realignment probabilities prior to the September 1992 crisis. We identify two factors that might have contributed to the September 1992 crisis: high German interest rates and weakness of the US dollar. We find that behaviour of exchange rates has changed over time and differs between ERM and non-ERM currencies. We also demonstrate that changes in German short-term interest rates influence interest rates in other ERM countries and vice versa.     

Cost behavior and executive bonus compensation

Prior literature provides compelling evidence of an asymmetric relation between executive bonus compensation and earnings performance. In particular, this literature reports that compensation committees assign greater weight to good (positive) earnings performance than poor (negative) earnings performance. Taken together, the prior literature provides strong support for critics who claim that compensation committees blindly protect executives from earnings underperformance. We further examine this issue by investigating whether a firm's cost behavior (i.e., the relation between expenses and sales) provides an explanation for the apparent inefficiency in executive compensation contracts. Our evidence suggests that executives are rewarded more for increases in ROA that arise from normal cost behavior than other increases in ROA consistent with these increases being perceived as more persistent. In contrast, we do not find such a relationship for decreases in ROA which suggests that executives are largely shielded from decreases in ROA that follow normal cost behavior. We examine two factors suggested by the prior literature, expected future sales and the extent of capacity utilization, which may provide an explanation for why executives are shielded from normal cost behavior decreases in ROA. When these additional factors are included in our empirical models, our evidence suggests that the asymmetric relation between changes in CEO bonus compensation and increases and decreases in earnings performance documented in prior literature goes away. That is, our results suggest that compensation committees do not blindly protect executives for earnings underperformance. On the contrary, our evidence suggests that these committees take into account other non-earnings information when deciding how much weight to give to a decrease in earnings and that executive compensation may not be as inefficient as suggested by prior research.     

THE EFFECTS OF MUTUAL FUNDS ON M&A COMPENSATION

Motivated by shareholders’ interest in combating executive wealth expropriation through the merger and acqusition (M&A) process, we study how mutual funds influence firm behavior around an acquisition through votes against management proposals. We find that mutual funds reduce the chief executive officer's ability to extract rents during the M&A process by voting against management‐sponsored compensation proposals after the acquisition, thus lowering both excess compensation and increasing pay‐for‐performance sensitivity. Furthermore, mutual fund voting magnifies the impact on negatively performing firms and firms with a larger amount of the mutual fund's holdings in the firm.     

Labor Unions as Shareholder Activists: Champions or Detractors?

We examine the impact of labor union shareholder activism through the submission of shareholder proposals during the period 1988–2002. We examine the effect of labor union‐sponsored shareholder proposals on announcement period returns; on the corporate governance environment of the firm including shareholder rights, board composition, and CEO compensation; on changes in unionization rates and labor expense; and on long‐run shareholder wealth. We do not find any observable patterns for the overall sample of proposals. However, subsets of proposals associated with union presence at the target firm and shareholder voting support for the proposal are associated with significant effects surrounding and subsequent to targeting.     

The association between non-financial performance measures in executive compensation contracts and earnings management

Executive compensation, especially cash bonus compensation, has come under fire by the Securities and Exchange Commission (SEC), the US Federal government, and the media for its role in the current economic crisis. Specifically, the SEC has argued that some compensation packages provide incentives for risk-taking that may undermine shareholder value over the long-term. Short-term incentive payments to executives in the form of cash bonuses are mostly contingent on reaching targets of accounting-related measures or financial performance measures (FPMs). However, the incentives from these payments may lead to accrual manipulation and earnings management (EM). Alternative measures are non-financial performance measures (NFPMs). We expect that firms that employ NFPMs in bonus contracts will have a lower prevalence of EM, since these measures tend to focus executives on the long-term. In this paper, we examine the type of performance measures used by firms in the S&;P 500 index in their cash bonus compensation. We find that firms that use both FPMs and NFPMs have lower discretionary accruals compared to firms that use only FPMs, consistent with lower income-increasing EM. However, we do not find evidence of a reduction in EM behavior using the incidence of meeting or just beating analyst earnings benchmarks, another common EM proxy. In additional tests on a subset of firms with equity offerings, in which incentives for income-increasing manipulation are likely high, we find that firms with NFPMs have lower discretionary accruals. The implication is that NFPMs can be used in compensation contracts to reduce EM behavior and mitigate erroneous executive compensation. This is important to investors as well as regulators, especially in light of the recent debate on compensation reform.     

Firm performance and mutual fund voting

We employ a new comprehensive proxy voting records database to investigate whether mutual funds consider prior firm performance when they vote on a diverse range of management- and shareholder-sponsored proposals relating to governance, compensation, and director election. We argue that prior firm performance plays a role in the monitoring effort of mutual funds as they fulfill their fiduciary duties. Results show that voting is related to prior firm performance for selected management and shareholder proposals and that it is consistent with Institutional Shareholder Services’ recommendations. Mutual funds support management (shareholder) proposals less (more) when prior firm performance has been weak. Furthermore, even when mutual funds deviate from their fund family’s voting policies, they attach importance to prior firm performance, and their voting is, to a certain degree, affected by business ties.     

Equity‐based incentives and shareholder say‐on‐pay

We study the relationship between CEO pay‐performance sensitivity, pay‐risk sensitivity, and shareholder voting outcomes as part of the “say‐on‐pay” provision of the 2010 US Dodd‐Frank Act. Consistent with our hypothesis, we provide evidence that shareholders tend to approve of compensation packages that are more sensitive to changes in stock price (pay‐performance sensitivity). Our findings are consistent with theoretical predictions that outside owners approve of equity incentives as a means of aligning managers' interests with those of shareholders. We also document that future changes to equity‐based incentives are related to voting outcomes and that shareholders incorporate CFO incentives into their votes. Collectively, these results provide evidence of the importance of equity‐based incentives from the perspective of those most concerned with firm value and of the effectiveness of say‐on‐pay as a governance mechanism.     

The Efficacy of Shareholder Voting: Evidence from Equity Compensation Plans

This study examines the effects of shareholder support for equity compensation plans on subsequent CEO compensation. Using cross‐sectional regression, instrumental variable, and regression discontinuity research designs, we find little evidence that either lower shareholder voting support for, or outright rejection of, proposed equity compensation plans leads to decreases in the level or composition of future CEO incentive compensation. We also find that, in cases where the equity compensation plan is rejected by shareholders, firms are more likely to propose, and shareholders are more likely to approve, a plan the following year. Our results suggest that shareholder votes for equity pay plans have little substantive impact on firms’ incentive compensation policies. Thus, recent regulatory efforts aimed at strengthening shareholder voting rights, particularly in the context of executive compensation, may have limited effect on firms’ compensation policies.     

Say on Pay: Is It Needed? Does It Work?

A leading compensation practitioner reviews “Say on Pay” rules, those corporate practices giving shareholders the right to vote on executive compensation. The assumption behind “Say on Pay” is that managers may be overpaid because directors fail to provide adequate oversight. O'Byrne questions this underlying assumption. He provides substantial evidence that directors do a poor job overseeing executive pay and that directors have weak incentives to pursue shareholder interests in executive pay. He also finds that “Say on Pay voting is sensitive to differences in pay for performance, but so forgiving that extraordinary pay premiums are required to elicit a majority ‘no’ vote”; and “that three quarters of institutional investors have lower SOP voting quality… than the average investor and almost all have a short‐term focus, with much greater vote sensitivity to current year grant date pay premiums than to long‐term pay alignment and cost.” The common corporate practice of providing competitive target compensation regardless of past performance leads to low alignment of pay and performance. Unfortunately, directors have little incentive to protect shareholder interests “because they are paid labor providers, just like management, not stewards of substantial personal capital.”     

Law and Executive Compensation: A Cross‐Country Study

Companies outside the U.S. use substantially less equity in their compensation mix than U.S. firms. But despite this consistent “cross‐sectional” difference, the pattern of changes in equity‐based pay of non‐U.S. companies over time appears to mirror changes in the pay of U.S. companies. The authors provide persuasive evidence that features of a nation's legal environment help explain major differences in compensation structure across countries. As a general rule, companies in countries that provide greater protection of shareholder rights use larger amounts of equity‐based compensation. And the equity mix also tends to be higher when a country's legal system ensures strict enforcement of the laws that are on the books. At the same time, since the equity mix varies considerably over time within the same legal environment, it is clear that factors other than the legal environment affect compensation structure. The authors report that, after controlling for legal factors, company‐specific variables that proxy for “agency” conflicts—not only between managers and shareholders, but between controlling and minority shareholders as well—also affect the compensation mix in fairly predictable ways. The bottom line of this study is that, although we may have a global market for talent, compensation structures across countries are not likely to converge unless and until the underlying legal protections afforded shareholders converge. At the same time, the effect of agency costs in compensation design for non‐U.S. firms appears to be partly conditioned by the nation's legal system and the entire set of regulatory and other institutions that are affected by it.     

A Wealth-Based Explanation for Earnings Conservatism

This study extends research on earnings conservatism – the degree to which the accounting system recognizes bad news regarding future cash flows in a more timely manner than good news – by arguing that heterogeneous executives' risk attitudes will influence the degree of conservatism. Prior research has demonstrated that differences in earnings conservatism are mainly the result of differences in institutional factors (Basu (1997) and Ball et al. (2000a)). We hypothesize that more risk-averse managers, who demand a risk premium that offsets the effects of the variance in their compensation, will report more conservative earnings. Earnings conservatism will temper expectations among stakeholders about the future cash flows to be distributed thereby diminishing the likelihood of disappointing outcomes and potential litigation or threats for executives of being fired. The more risk-averse manager would be more inclined to reduce such conflicts, since they will have a destabilizing effect on his future compensation. The empirical results for a sample of Dutch companies over the period of 1983 to 1995 confirm our hypothesis: more risk-averse managers report earnings more conservatively than do less risk-averse managers.     

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.     

What do dividends tell us about earnings quality?

Over the past 30 years, there have been significant changes in the distribution of earnings—cross-sectional variation has increased, with increasing left skewness—as well as in corporate payout policy, with many fewer firms paying dividends and the emergence of stock repurchases. We investigate whether the informativeness of payout policy with respect to earnings quality changes over this period. We find that the reported earnings of dividend-paying firms are more persistent than those of other firms and that this relation is remarkably stable over time. We also find that dividend payers are less likely to report losses and those losses that they do report tend to be transitory losses driven by special items. These results do not hold as strongly for stock repurchases, consistent with them representing less of a commitment than dividends.