Dividend Policy, Corporate Governance and the Managerial Entrenchment Hypothesis: An Empirical Analysis

This paper analyses the agency explanation for the cross-sectional variation of corporate dividend policy in the UK by looking at the managerial entrenchment hypothesis drawn from the agency literature. Consistent with predictions, a significant U-shaped relationship between dividend payout ratios and insider ownership is observed for a large (exceeding 600 firms) sample of UK companies and two distinct periods. These results strongly suggest the possibility of managerial entrenchment when insider ownership reaches a threshold of around 30%. Evidence is also presented that non-beneficial holdings by insiders can lead to entrenchment in conjunction with shares held beneficially.     

Officers’ fiduciary duties and acquisition outcomes

Using a Delaware case law that recognized officers’ distinct fiduciary duties for the first time in 2009, I examine the effect of officers' fiduciary duties (OFDs) on corporate acquisitions. I find that firms with entrenched officers prior to 2009 experienced increased announcement-period abnormal stock returns, mainly because their acquisitions created more synergies and reduced officers’ incentives to preserve control. These firms increased liability insurance premium expenditures, but reduced value-decreasing acquisition frequencies. Furthermore, the effect of OFDs is more pronounced in firms where officers are not directors, have wealth risk, face less product market competition, are insulated from the market for corporate control, or are able to avoid board monitoring. Overall, OFDs are a critical corporate governance mechanism that works in tandem with other disciplinary mechanisms.     

Contracts Between Firms and Shareholders

Theory predicts the existence of explicit bilateral contracts between firms and expert shareholders. I assemble and analyze a large-scale data set of these contracts. Using block investments from 1996 to 2018, I find that these contracts involve mainly corporate owners and activist owners, and often specify covenants pertaining to financing, trading, directorships, dividends, joint ventures, corporate investment, financial reporting, and information access. I also find that some of the contract covenants are stated in terms of accounting information, and that the prevalence of these contracts is significantly positively associated with measures of information asymmetry between managers and shareholders. Overall, this study provides some of the first systematic evidence on explicit bilateral contracts between firms and shareholders.     

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.     

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.     

Do shareholder protection and creditor rights have distinct effects on the association between debt maturity and ownership structure?

This study examines the effects of the firm's ownership concentration and its institutional environment on corporate debt maturity choices. As ownership concentration and debt maturity are alternative governance mechanisms, we theorize and investigate whether their association is influenced by country-level governance factors that enhance outside monitoring by minority shareholders and debtholders. Our investigation is based on a dataset of 50,599 firm-year observations from 38 countries. We use a propensity-score matching approach and find that the effect of ownership concentration on debt maturity is conditional to country-level governance attributes. Ownership concentration has a negative effect on debt maturity in countries where both shareholder protection and creditor rights are weak. Ownership concentration, however, tends to lengthen debt maturity as protection increases, and this positive effect on the length of debt maturity is stronger in countries enhancing protection towards debtholders (instead of shareholders). We also explore other characteristics of ownership structure, such as the identity and presence of controlling shareholders. These results corroborate the view that entrenched shareholders may use debt maturity opportunistically. Our study provides new insights into the interplay between firm- and country-level governance mechanisms and a deeper understanding of cross-country differences in the association between ownership structure and debt financing.     

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.     

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.