The impact of performance-based compensation on misreporting

This paper examines the effect of CEO compensation contracts on misreporting. We find that the sensitivity of the CEO's option portfolio to stock price is significantly positively related to the propensity to misreport. We do not find that the sensitivity of other components of CEO compensation, i.e., equity, restricted stock, long-term incentive payouts, and salary plus bonus have any significant impact on the propensity to misreport. Relative to other components of compensation, stock options are associated with stronger incentives to misreport because convexity in CEO wealth introduced by stock options limits the downside risk on detection of the misreporting.     

Affiliated firms and financial support: Evidence from Indian business groups

We investigate the functioning of internal capital markets in Indian Business Groups. We document that intragroup loans are an important means of transferring cash across group firms and are typically used to support financially weaker firms. Evidence suggests that an important reason for providing support may be to avoid default by a group firm and consequent negative spillovers to the rest of the group. Consistent with such spillovers, the first bankruptcy in a group is followed by significant drops in external financing, investments and profits of other firms in the group and an increase in their bankruptcy probability.     

Managerial attitudes and corporate actions

We administer psychometric tests to senior executives to obtain evidence on their underlying psychological traits and attitudes. We find US CEOs differ significantly from non-US CEOs in terms of their underlying attitudes. In addition, we find that CEOs are significantly more optimistic and risk-tolerant than the lay population. We provide evidence that CEOs' behavioral traits such as optimism and managerial risk-aversion are related to corporate financial policies. Further, we provide new empirical evidence that CEO traits such as risk-aversion and time preference are related to their compensation.     

Corporate cash holdings and CEO compensation incentives

We examine the effect of chief executive officer (CEO) compensation incentives on corporate cash holdings and the value of cash to better understand how compensation incentives designed to enhance the alignment of manager and shareholder interests could influence stockholder-bondholder conflicts. We find a positive relation between CEO risk-taking (vega) incentives and cash holdings, and we find a negative relation between vega and the value of cash to shareholders. The negative effect of vega on the value of cash is robust after controlling for corporate governance, is stronger in firms with high leverage, is reversed for unlevered firms, and is not present in financially constrained firms. We also find that the likelihood of liquidity covenants in new bank loans is increasing in CEO vega incentives. Our evidence primarily supports the costly contracting hypothesis, which asserts that bondholders anticipate greater risk-taking in high vega firms and, therefore, require greater liquidity.     

Corporate governance and the value of cash holdings

We investigate how corporate governance impacts firm value by comparing the value and use of cash holdings in poorly and well-governed firms. We show that governance has a substantial impact on value through its impact on cash: $1.00 of cash in a poorly governed firm is valued at only $0.42 to $0.88. Good governance approximately doubles this value. Furthermore, we show that firms with poor corporate governance dissipate cash quickly in ways that significantly reduce operating performance. This negative impact of large cash holdings on future operating performance is cancelled out if the firm is well governed.     

Geographic diversification and firm value in the financial services industry

This paper investigates whether geographic diversification is value-enhancing or value-destroying in the financial services sector, broadly defined. Our dataset comprises approximately 3579 observations over the period from 1985 to 2004 and covers the entire range of U.S. financial intermediaries — commercial banks, investment banks, insurance companies, asset managers, and financial infrastructure services firms. We use two alternative measures of geographic diversification: (1) a dummy variable whether the firm reports more than one geographic segment and (2) the percentage of sales from non-domestic operations. Our results indicate that geographic diversification is not associated with a significant valuation discount in financial intermediaries. However, when accounting for the firms' main activity-areas, we find evidence of a significant discount associated with geographic diversification in securities firms and a premium in credit intermediaries and insurance companies. All these results are robust after taking into account functional diversification of the firms, a potential endogeneity of both functional and geographic diversification, and a potential value transfer from equity to debt holders by using estimates of the market value of debt.     

Ownership structure and financial constraints: Evidence from a structural estimation

This article examines the impact of the divergence between corporate insiders' control rights and cash-flow rights on firms' external finance constraints via generalized method of moments estimation of an investment Euler equation. Using a large sample of U.S. firms during the 1994-2002 period, we find that the shadow value of external funds is significantly higher for companies with a wider insider control-ownership divergence, suggesting that companies whose corporate insiders have larger excess control rights are more financially constrained. The effect of insider excess control rights on external finance constraints is more pronounced for firms with higher degrees of informational opacity and for firms with financial misreporting, and is moderated by institutional ownership. The results show that the agency problems associated with the control-ownership divergence can have a real impact on corporate financial and investment outcomes.     

CAPITAL STRUCTURE,SHAREHOLDER RIGHTS,AND CORPORATE GOVERNANCE

We show how capital structure is influenced by the strength of shareholder rights. Our empirical evidence shows an inverse relation between leverage and shareholder rights, suggesting that firms adopt higher debt ratios where shareholder rights are more restricted. This is consistent with agency theory, which predicts that leverage helps alleviate agency problems. This negative relation, however, is not found in regulated firms (i.e., utilities). We contend that this is because regulation already helps alleviate agency conflicts and, hence, mitigates the role of leverage in controlling agency costs.     

Compensation committee governance quality,chief executive officer stock option grants,and future firm performance

This paper examines whether the relationship between future firm performance and chief executive officer (CEO) stock option grants is affected by the quality of the compensation committee. Compensation committee quality is measured using six committee characteristics – the proportion of directors appointed during the tenure of the incumbent CEO, the proportion of directors with at least ten years’ board service, the proportion of directors who are CEOs at other companies, the aggregate shareholding of directors on the compensation committee, the proportion of directors with three or more additional board seats, and compensation committee size. We find that future firm performance is more positively associated with stock option grants as compensation committee quality increases.     

Incentive and entrenchment effects in European ownership

In a large sample of European firms we analyze the value discount associated with disproportional ownership structures first documented by Claessens et al. (2002). Consistent with a theoretical model of incentive and entrenchment effects, we find higher value discount in family firms, in firms with low cash flow concentration, and in industries with higher amenity value. Furthermore, the discount is higher in countries with good investor protection and higher for dual class shares than for pyramids. We find no impact on operating performance, likelihood of bankruptcy, dividend policy, or growth. Finally, we discuss policy implications of these findings.     

Governance quality and privately negotiated stock repurchases: Evidence of agency conflict

This study examines the impact of shareholder rights on the wealth effects of privately negotiated stock repurchases. Our results show that wealth gains are lower when shareholder rights are more suppressed. We also find that the premium paid for shares is inversely related to the strength of shareholder rights, and this suggests that managers pay higher premiums when shareholder rights are more restricted. These findings imply that managers use shareholders’ funds to eliminate blockholders who are more likely to monitor them when shareholder rights are relatively weak, thereby entrench themselves. Consistent with this view, we further show that significant positive abnormal long-run returns after private stock repurchases are limited to firms with stronger shareholder protection. Overall, the evidence is consistent with the predictions of agency theory.     

Risk management,corporate governance,and bank performance in the financial crisis

The recent financial crisis has raised several questions with respect to the corporate governance of financial institutions. This paper investigates whether risk management-related corporate governance mechanisms, such as for example the presence of a chief risk officer (CRO) in a bank’s executive board and whether the CRO reports to the CEO or directly to the board of directors, are associated with a better bank performance during the financial crisis of 2007/2008. We measure bank performance by buy-and-hold returns and ROE and we control for standard corporate governance variables such as CEO ownership, board size, and board independence. Most importantly, our results indicate that banks, in which the CRO directly reports to the board of directors and not to the CEO (or other corporate entities), exhibit significantly higher (i.e., less negative) stock returns and ROE during the crisis. In contrast, standard corporate governance variables are mostly insignificantly or even negatively related to the banks’ performance during the crisis.     

Corporate misreporting and bank loan contracting

This paper is the first to study the effect of financial restatement on bank loan contracting. Compared with loans initiated before restatement, loans initiated after restatement have significantly higher spreads, shorter maturities, higher likelihood of being secured, and more covenant restrictions. The increase in loan spread is significantly larger for fraudulent restating firms than other restating firms. We also find that after restatement, the number of lenders per loan declines and firms pay higher upfront and annual fees. These results are consistent with banks using tighter loan contract terms to overcome risk and information problems arising from financial restatements.     

Explaining CEO retention in misreporting firms

We propose a framework that advances our understanding of Chief Executive Officer (CEO) retention decisions in misreporting firms. Consistent with economic intuition, outside directors are more likely to fire (retain) CEOs when retention (replacement) costs are high relative to replacement (retention) costs. When the decision is ambiguous because neither cost dominates, outside directors are more likely to retain the CEO when they both benefit from selling stock in the misreporting period. We show that joint abnormal selling captures director–CEO alignment incrementally to biographical overlap. This new proxy operationalizes information sharing and trust, making it useful for studying economic decision-making embedded in social relationships.     

Executive overconfidence and the slippery slope to financial misreporting

A detailed analysis of 49 firms subject to AAERs suggests that approximately one-quarter of the misstatements meet the legal standards of intent. In the remaining three quarters, the initial misstatement reflects an optimistic bias that is not necessarily intentional. Because of the bias, however, in subsequent periods these firms are more likely to be in a position in which they are compelled to intentionally misstate earnings. Overconfident executives are more likely to exhibit an optimistic bias and thus are more likely to start down a slippery slope of growing intentional misstatements. Evidence from a high-tech sample and a larger and more general sample support the overconfidence explanation for this path to misstatements and AAERs.     

The risk appetite of private equity sponsors

Using a unique proprietary data set of 460 realized buyouts completed between 1990 and 2005, we examine the risk appetite of private equity (PE) sponsors in different states of the PE market and analyze key determinants of deal-level equity risk. We develop a new approach to mathematically model PE investment equity risk based on the Black-Cox default model. We find higher equity volatilities during boom periods. Further, deals conducted by more reputed PE sponsors have lower equity volatilities as they are unwilling to imperil their reputation by taking excessive risks. In addition, we find that PE sponsors' risk appetite is negatively related to the ownership stake in the buyout target company.     

Stock option grants to target CEOs during private merger negotiations

Unscheduled stock options to target chief executive officers (CEOs) are a nontrivial phenomenon during private merger negotiations. In 920 acquisition bids during 1999-2007, over 13% of targets grant them. These options substitute for golden parachutes and compensate target CEOs for the benefits they forfeit because of the merger. Targets granting unscheduled options are more likely to be acquired but they earn lower premiums. Consequently, deal value drops by $62 for every dollar target CEOs receive from unscheduled options. Conversely, acquirers of targets offering these awards experience higher returns. Therefore, deals involving unscheduled grants exhibit a transfer of wealth from target shareholders to bidder shareholders.     

Brand perception,cash flow stability,and financial policy

This paper demonstrates that intangible assets play an important role in financial policy. Using a proprietary database of consumer brand evaluation, I show that positive consumer attitude toward a firm's products alleviates financial frictions and provides additional net debt capacity, as measured by higher leverage and lower cash holdings. Brand perception affects financial policy through reducing overall firm riskiness, as strong consumer evaluations translate into lower future cash flow volatility as well as higher credit ratings for potentially volatile firms. The impact of brand is stronger among small firms, contradicting a number of reverse causality and omitted variables explanations.     

The impact of investor protection law on corporate policy and performance: Evidence from the blue sky laws

Recent studies have debated the impact of investor protection law on corporate behavior and value. I exploit the staggered passage of state securities fraud statutes (“blue sky laws”) in the United States to estimate the causal effects of investor protection law on firm financing decisions and investment activity. The statutes induce firms to increase dividends, issue equity, and grow in size. The laws also facilitate improvements in operating performance and market valuations. Overall, the evidence is strongly supportive of theoretical models that predict investor protection law has a significant impact on corporate policy and performance.     

Executive compensation and the cost of debt

This study examines how different components of executive compensation affect the cost of debt. We find that debt-like and equity-like pay components have differing effects: an increase in defined benefit pensions is associated with lower bond yield spread, while higher share holdings lead to higher spreads. In addition, we find that stock options have a mixed impact on the cost of debt whereas cash bonus has no significant impact. Overall, our results indicate that corporate bondholders are fully aware of both risk-taking and risk-avoiding incentives created by various executive pay components.