What's wrong with strategy?

Why is it that successful strategies are rarely developed as a result of formal planning processes? What is wrong with the way most companies go about developing strategy? Andrew Campbell and Marcus Alexander take a common sense look at why the planning frameworks managers use so often yield disappointing results. Companies often fail to distinguish between purpose (what an organization exists to do) and constraints (what an organization must do in order to survive), the authors say. Many executives mistakenly believe, for example, that satisfying stakeholders is an objective that drives thinking about strategy. In fact, it's a constraint, not an objective. Companies that don't win the loyalty of stakeholders will go out of business. Strategy is not about plans but about insights, the authors add. Strategy development is the process of discovering and understanding insights and should not be confused with planning, which is about turning insights into action. Furthermore, because executives develop most of their insights while actually doing the real work of running a business, it is important for companies not to separate strategy development from implementation. Is there a better way? The answer is not new planning processes or more effort. Instead, managers must understand two fundamental points: the benefit of having a well-articulated, stable purpose and the importance of discovering, understanding, documenting, and exploiting insights about how to create value.     

Does executive compensation reflect corporate productivity?

Recent literature has given attention to the effect of CEO-specific productivity on the structure of CEO compensation. Our paper instead focuses on the effect of a different productivity factor—which we call “corporate productivity”—on CEO compensation. In particular, we show that corporate productivity affects the trade-off between incentive and risk in a non-monotonic fashion, which the literature has not yet recognized. Using various empirical proxies for corporate productivity, we show that our results are consistent with the non-monotonic relation and thus contribute to the debates in the incentive-risk trade-off literature. Second, our findings also contribute to the internal capital market literature by exploring the relation between the structure of CEO compensation and excess value.     

Does firm heterogeneity lead to differences in relative executive compensation?

Cost heterogeneity is an important source of performance disparity among firms. This heterogeneity conditions the strategic decisions that firms make in the product market and can lead to heterogeneity in the design of managerial compensation contracts. I investigate the effect of cost heterogeneity in a strategic product market environment where firms compete à la Cournot. The paper offers new predictions on how executive compensation contracts that account for relative performance must be adjusted for cost differences.     

A survey of executive compensation contracts in China’s listed companies

We analyze 228 executive compensation contracts voluntarily disclosed by Chinese listed firms and find that central-government-controlled companies disclose more information in executive compensation contracts than local-government-controlled and non-government-controlled companies. Cash-based payments are the main form of executive compensation, whereas equity-based payments are seldom used by Chinese listed companies. On average, there are no significant differences in the value of basic salaries and performance-based compensation in executive compensation contracts. But, compared with their counterparts in non-government-controlled companies, executives in government-controlled companies are given more incentive compensation. Accounting earnings are typically used in executive compensation contracts, with few firms using stock returns to evaluate their executives. However, the use of non-financial measures has increased significantly since 2007.     

Does executive compensation incentivize managers to create effective internal control systems?

We examine the relation between CFO compensation and the effectiveness of internal control structures under SOX, Section 404. Given the growing evidence of an uncoupling of pay from performance, we conduct our analysis using a two-stage regression. In our first stage model, we decompose compensation into its fitted (i.e., explained by firms’ economic characteristics) and residual (i.e., unexplained) components. In our second stage model, we estimate a logit regression of internal control effectiveness on both the fitted and residual components of compensation. Overall, we find that internal control effectiveness is related to the fitted components of compensation, but unrelated to the residual components. These relations exist for aggregate compensation, as well as its individual components (i.e., salary, bonus, equity-based). Our findings suggest that fitted compensation increases the probability of effective internal controls. Conversely, residual compensation does not affect this probability, suggesting that it reflects pay without performance. Our findings inform regulators and standard setters of the often unforeseen costs of increased regulation.     

What drives risk-taking incentives embedded in bank executive compensation? Some international evidence

This paper analyzes the country determinants of risk-taking incentives embedded in bank executive compensation using hand-collected international panel data on 135 publicly-traded banks in 26 countries. We exploit time-series changes in investor protection within a country and confirm that stronger protection leads to a higher vega. Moreover, the positive effect on vega is higher in countries where stronger bank competition and more extensive safety nets increase bank shareholders' risk-taking incentives. Our analysis controls for changes in bank regulation, systemic banking crises, and government bailouts. The results are robust to alternative specification models, alternative proxies for country determinants, and remain when we apply a more traditional cross-sectional analysis.     

What's the matter with business ethics?

The more business ethics secures its status in campuses across the country, the more bewildering it appears to actual managers. It's not that managers dislike the idea of doing the right thing. As University of Toronto Assistant Professor Andrew Stark argues, far too many business ethicists just haven't offered them the practical advice they need. Before business ethics became a formal discipline, advocates of corporate social responsibility claimed that the market would ultimately reward ethical behavior. But ethics and interests did not always intersect so fruitfully in the real world. And when they did not, managers were left in the dark to grope for the right ethical course. In the 1970s, the brand-new field of business ethics came onto the scene to address this issue. Critical of the "ethics pays" approach, academics held that ethics and interests can and do conflict. Still, scholars took an equally unrealistic line. To them, a manager's motivation could be either altruistic or self-interested, but never both. In short, ethicists still weren't addressing the difficult moral dilemmas that managers face on a day-to-day basis, and only recently have they begun to do so. After some initial stumbles, ethicists are getting their hands dirty and seriously considering the costs of doing the right thing. Finally, a new business ethics is emerging that acknowledges and accepts the messy world of mixed motives. As a result, novel concepts are springing up: moderation, pragmatism, minimalism, among others.(ABSTRACT TRUNCATED AT 250 WORDS)     

Does tunneling explain the sensitivity of executive compensation to other member firms’ performance?

This study examines how executive compensation is set when a firm is a business group member. Using Korea's unique setting of family-controlled business groups, we find that a member firm's executive cash compensation is positively linked to the stock performance of other member firms as well as its own. Further analyses reveal that this positive link is consistent with the hypothesis that corporate managers are rewarded for their decision to benefit the controlling family at the expense of the firm they manage. Specifically, we find that the sensitivity of executive pay to other member firms’ performance exists only in respect to firms in which the cash flow rights of the controlling family exceed those of the subject firm. We also find that this sensitivity is strengthened if the controlling family's control–ownership disparity in the subject firm is above the sample median.     

Are executive stock option exercises driven by private information?

In this study, we investigate the extent to which exercise of executive stock options is based upon private information. Contrary to popular belief, we find that shares are held more than 30 days following over a quarter of options exercised. Partitioning the data, we find weak evidence that decisions to exercise and sell immediately are prompted by bad news and stronger evidence that decisions to exercise and hold for at least 30 days are prompted by good news. Enhancing the power of our tests by considering several factors important to exercise decisions, we find that the higher the opportunity costs of early exercise as measured by the time-value of options, the greater the trading profits to executives. We also find that the greater the disguise provided by incentives to diversify and consume as measured by the depth of options in the money, the greater the trading profits to executives who exercise and sell. Turning to non-exercise decisions, we find that a strategy of holding options rather than shares to exploit good news yields positive abnormal returns consistent with theoretical predictions in the absence of dividends.

What is a fair amount of executive compensation? Outrage potential of two key stakeholder groups

The public discussion of executive compensation often centres on ‘fair’ and ‘unfair’ amounts and the public outrage over compensation that is deemed too high. The academic literature states that such outrage can lead to outrage costs, pressuring firms to adjust compensation levels. However, it is unclear what a ‘fair’ compensation is for various stakeholders and how their fairness concerns relate to outrage constraints. Based on surveys among two key stakeholder groups (representative eligible voters and investment professionals), we provide evidence that fairness is an important criterion for both groups but that opinions on how large a fair compensation amount should be are widely dispersed. Moreover, personality traits systematically influence fairness opinions through self‐serving interpretations of distributive justice and personal risk attitudes, indicating that a ‘fair’ amount of executive compensation may strongly depend on the involved stakeholders. Investigating thresholds for outrage, i.e., amounts above which compensation is judged ‘unfairly’ high, we show that even though investment professionals care for fairness as well, ‘capital market outrage’ might not equate to ‘public outrage’. Our paper contributes to the literature on outrage constraints by linking individual fairness concerns to outrage potential and has implications for transparency of executive compensation and research on shareholder activism.     

Can management-sponsored non-binding remuneration votes shape the executive compensation structure? Evidence from Say-on-Pay votes in Germany

In this paper, a hand-selected sample of 1676 annual general meetings with 268 management-sponsored Say-on-Pay votes in 164 different companies between 2010 and 2015 in the German two-tier system was analysed. The analysis focused on the structure, rather than the level, of executive compensation by applying a sample-selection model and panel data regression. Consistent with our hypotheses, shareholders favour long-term stock and stock option plans but oppose short-term cash-bonus payments. However, the positive effect of equity compensation decreases as the share of the total remuneration increases, suggesting that the alignment effect is limited. The negative effect of bonus payments on the voting results is stronger in cases in which the voting approval of the supervisory board is low. Thus, investors who are discontent with the bonus payments eventually punish the supervisory board in charge of negotiating the contract. The supervisory board reacts to such cases by reducing the bonuses and increasing the equity payments in the following year, but the total compensation or fixed annual salary is unaffected. Hence, Say-on-Pay in Germany affects the structure but not the level of compensation. The results show that shareholders assess the entire compensation structure and prefer a particular compensation mix. However, non-binding Say-on-Pay votes help to establish compensation schemes that are favoured by shareholders.     

Are CFO debt-like compensation incentives associated with financial reporting quality?

We investigate whether CFO debt-like compensation incentives and their alignment with CEO debt-like compensation incentives are associated with financial reporting quality. He (2015) finds that CEO debt-like compensation incentives are associated with higher financial reporting quality. Consistent with agency theory, we extend He (2015) by considering CFO debt-like compensation incentives. Overall, we find that CFO debt-like compensation incentives are associated with better financial reporting quality while controlling for CEO debt-like compensation incentives. These effects are present when the CEO and CFO compensation incentives are aligned with the same party. Further, the CFO effect dominates that of the CEO when examining discretionary accruals, and complements the CEO effect for accrual quality. However, we are unable to find any evidence of an incremental joint effect from the alignment of the CEO and CFO debt-like compensation incentives.     

What’s wrong with Pittsburgh? Delegated investors and liquidity concentration

What makes an asset institutional quality? This paper proposes that one reason is the existing concentration of delegated investors in a market through a liquidity channel. Consistent with this intuition, it documents differences in investor composition across US cities and shows that delegated investors concentrate their investments in cities with higher turnover. It then estimates a search model showing how heterogeneity in liquidity preferences makes some markets more liquid, even when assets have identical cash flows. The paper provides evidence for clientele equilibria arising in frictional asset markets and suggests that a liquidity channel may explain divergent paths in city development.     

What's it worth? A general manager's guide to valuation

Behind every major resource-allocation decision a company makes lies some calculation of what that move is worth. So it is not surprising that valuation is the financial analytical skill general managers want to learn more than any other. Managers whose formal training is more than a few years old, however, are likely to have learned approaches that are becoming obsolete. What do generalists need in an updated valuation tool kit? In the 1970s, discounted-cash-flow analysis (DCF) emerged as best practice for valuing corporate assets. And one version of DCF-using the weighted-average cost of capital (WACC)-became the standard. Over the years, WACC has been used by most companies as a one-size-fits-all valuation tool. Today the WACC standard is insufficient. Improvements in computers and new theoretical insights have given rise to tools that outperform WACC in the three basic types of valuation problems managers face. Timothy Luehrman presents an overview of the three tools, explaining how they work and when to use them. For valuing operations, the DCF methodology of adjusted present value allows managers to break a problem into pieces that make managerial sense. For valuing opportunities, option pricing captures the contingent nature of investments in areas such as R&D and marketing. And for valuing ownership claims, the tool of equity cash flows helps managers value their company's stake in a joint venture, a strategic alliance, or an investment that uses project financing.     

Is success a sin? A conversation with the reverend Peter J. Gomes. Interview by David A. Light

The difficult task of achieving worldly success while also storing up spiritual treasure is perennially with us, in good times and in bad. Today, however, as the economy has cooled and companies have demonstrated their mortality, questions about meaning and value appear more relevant, even urgent. HBR associate editor David A. Light recently spoke with the Reverend Peter J. Gomes, one of the nation's best-known preachers and the minister at Harvard University's Memorial Church, about why and how it is both possible and necessary to reconcile a life of success with a life of faith. To do so, says Gomes, you must first "get used to it"--come to terms with the age-old tension between being rich in spirit and rich in worldly goods. Second, you should "get over it"--arrive at an understanding of the value and responsibilities associated with power and wealth. Finally, "get on with it"--figure out how you can live your life spiritually while continuing to lead in the business world. For those wondering how to get on with spiritual development, Gomes cites the growing phenomenon of senior executives gathering with peers--out of shared need, not shared accomplishment--to pray, study sacred texts, and share their religious life together. He counsels that it's never too late to get on with it: We can amend life at any time, whether we're 35, 45, or 75. Gomes concludes that business will continue to be one of the most significant forces in American culture, but it will always struggle against people's need for a perspective that is beyond this world's.     

Does top executive gender diversity affect earnings quality? A large sample analysis of Chinese listed firms

Using a large sample of Chinese listed firms, this paper examines whether the gender of top executives affects earnings quality. Unlike the findings documented in developed markets such as the U.S., our results show that earnings quality proxies, including earnings persistence, the accuracy of current earnings in forecasting future cash flows, the association between earnings and stock returns, and the absolute magnitude of discretionary accruals do not display significant differences for firms with female and male top executives. This study is the first to examine the relationship between gender and earnings quality in emerging markets such as China that offers managerial and policy implications.     

Has European corporatism delivered? A survey with preliminary evidence

I ask whether European firms' investments in stakeholder welfare come at the cost of lower shareholder value. Focusing on the largest 50 public firms in four European countries, I find a valuation discount in the Tobin's Q of continental European firms relative to matched US firms. The valuation discount is correlated with presence of large block holders in European firms but not with the poorer disclosure record of US firms on the environmental (E) and social (S) dimensions. In sum, poorer governance (G) in continental Europe appears to destroy more shareholder value than better E and S disclosure can add.     

Does loan renegotiation differ by securitization status? A transition probability study

This paper examines whether securitization has an ex-post effect on residential loan renegotiation. It makes two main contributions to the existing literature. First, this paper evaluates the re-default and self-cure rates of loans using bank-reported loan renegotiation data. Second, it conducts a transition probability study to better understand the re-default and self-cure dynamics by time and previous loan state. I find that previously delinquent portfolio loans are less likely to re-default and more likely to self-cure than comparable securitized loans during the intermediate time frame, but the difference diminishes afterwards. For previously cured loans, portfolio loans and securitized loans have generally similar re-default and self-cure rates over time. This paper emphasizes that it is important to understand the dynamic transition behavior of mortgage loans.     

What's in a “China” Name? A Test of Investor Attention Hypothesis

We study whether a firm's name affects investor attention and firm valuation. Some Chinese firms listed on US stock exchanges have the word “China” included in their company names (“China‐name stocks”), while others do not (“non‐China‐name stocks”). During the 2007 China stock market boom, we find that China‐name stocks significantly outperform non‐China‐name stocks. This is not due to differences in firm characteristics, risk, or liquidity. The “China‐name effect” is largely consistent with the investor attention hypothesis that price pressure caused by increased investor attention on China‐name stocks during the boom period drives up China‐name stocks more than non‐China‐name stocks.