Shareholder activism and firms’ performance

Increasing attention to activist campaigns raises the question of whether they lead to better performance. The impact of different motives, demands, and proposals is still unclear and, sometimes, contradictory. We used a unique dataset of activist campaigns targeting firms in the US from 2002 to 2017 and analysed the impact of activism on firm performance, considering their specific demands. Our results show that firms experience a decline in profitability almost immediately after campaigns, although the effect is unclear in the years subsequent to the intervention. Results also suggest that campaigns primarily focused on demanding a change in strategic direction or obtaining board control intensify the decline in profitability. Seeking board representation is the type of demand that effectively increases target firms’ profitability. Our analysis adds to research on shareholder governance and competitive dynamics by highlighting that the type of demand adopted in campaigns impacts differently on firms’ performance.     

Are good-news firms riskier than bad-news firms?

This paper examines the relative risk of good-news firms, i.e., those with high standardized unexpected earnings (SUE), and bad-news (low SUE) firms using a stochastic discount factor approach. We find that a stochastic discount factor constructed from a set of basis assets helps explain post-earnings-announcement drift (PEAD). The risk exposures on the pricing kernel increase monotonically from the lowest to highest SUE sorted portfolios. Specifically, good-news firms always have higher risk exposures than bad-news firms in both 10 SUE sorted portfolios and 25 size and SUE sorted portfolios. However, the estimated expected risk premium is too small to explain the observed magnitude of returns on the PEAD strategy. Our risk adjustment can explain only about one-fourth of the total magnitude of the average realized return to the PEAD strategy. As a result, the average risk-adjusted returns of earnings momentum strategies are mostly positive and significant. Overall, our results support the view that at least some portion of the returns to the earnings momentum strategies examined represent compensation for bearing increased risk.     

Do firms’ earnings management practices affect their equity liquidity?

This study investigates the relationship between earnings management and equity liquidity, positing that as incentives arise for the manipulation of firm performance through earnings management (due partly to conflicts of interest between firm insiders and outsiders), greater earnings management may signal higher adverse selection costs. If earnings manipulation reveals aggressive accounting practices, liquidity providers tend to widen bid-ask spreads to protect themselves. The empirical results indicate that companies with higher earnings management suffer lower equity liquidity.     

Are corporate governance attributes associated with accounting conservatism?

This article investigates the association between the board of directors, the audit committee and the external auditor (as well as an aggregate governance index) and the extent of conservatism evident in Australian firms’ financial reporting. Overall, the results provide only weak evidence that firms with certain governance characteristics report more conservatively. Evidence of any such link is restricted to measures of board composition and leadership, and even then the results are sensitive to the method used to measure the extent of conservatism in financial reporting.     

Are female CEOs associated with lower insolvency risk? Evidence from the US property-casualty insurance industry

This paper investigates the relationship between female CEOs and insolvency risk of US property-casualty insurance companies. We show that female CEOs are associated with lower insurer insolvency propensity, higher z-score, and lower standard deviation of return on assets. These findings are robust to alternative econometric specifications to address potential endogeneity concerns and self-selection issues, including propensity score matching, the instrumental variable approach, and the difference-in-difference approach. Furthermore, we find that the impact of female CEOs on insurer insolvency risk is moderated by firm capitalization, the presence of female directors, and political conservatism of insurers' home states.     

Are investors always compensated for information risk? Evidence from Chinese reverse-merger firms

Using a data sample of 93 Chinese reverse-merger (CRM) firms listed in the U.S. over the period from 2000 to 2011, we find supporting evidence of poorer financial reporting quality exhibited by CRM firms relative to their respective US counterparts. Our main result indicates that while poor financial reporting quality induces information risk/asymmetry, higher (lower) information risk fails to be associated with higher (lower) expected returns. In contrast with prior studies that document information risk as non-diversifiable and a priced risk factor, the value relevance of the CRM firms’ financial reporting quality, in terms of information asymmetry-based premiums, is found to be remote.

     

Do UK audit committees really engage with auditors on audit planning and performance?

In the wake of the financial crisis, regulators intend to increase the responsibilities of audit committees (ACs), yet little is known about how ACs discharge their existing responsibilities and interact with auditors and management. This study investigates the involvement of the AC, the AC chair (ACC), the audit partner (AP) and the chief financial officer (CFO) in relation to a range of audit-related matters in UK-listed companies in the 2007 regulatory environment, which remains fundamentally unchanged. The level of AC and ACC engagement in seven AC responsibilities set by the Combined Code is high (over 80%). However, only 50% of 16 audit planning, performance and finalisation matters are routinely discussed. The ACC acts without the full AC in 11% of discussions, while 25% involve only the CFO and AP without either the ACC or the AC. The extent of discussion and/or ACC involvement is influenced by background characteristics (company size, auditor size and ACC experience and qualifications). This evidence of less than full AC engagement with audit-related issues suggests that regulators may risk creating an AC expectations gap if AC duties under the extant model are significantly increased without structural change.     

Are fully independent audit committees really necessary?

Accounting scandals and concerns about the quality of financial statements have led to many calls for improved audit committee effectiveness. Prior research indicates that audit committee independence is positively related to effective oversight of the financial reporting process. Unfortunately, prior research has not provided an answer as to how much independence on the audit committee is enough. This is an important unanswered question because while Section 301 of the Sarbanes-Oxley Act of 2002 (SOX) currently requires all listed companies to maintain an audit committee that is 100% independent there has been much debate regarding easing the SOX requirements for smaller and foreign companies. In this paper we examine whether the regulatory requirements of a completely independent audit committee are necessary to obtain the monitoring benefits related to audit committee independence that have been documented in prior literature. Our results suggest that the benefits of audit committee independence are consistently achieved only when the audit committee is completely independent. These results provide support for the SOX requirement of 100% independent audit committees.     

Are family firms more tax aggressive than non-family firms?

Taxes represent a significant cost to the firm and shareholders, and it is generally expected that shareholders prefer tax aggressiveness. However, this argument ignores potential non-tax costs that can accompany tax aggressiveness, especially those arising from agency problems. Firms owned/run by founding family members are characterized by a unique agency conflict between dominant and small shareholders. Using multiple measures to capture tax aggressiveness and founding family presence, we find that family firms are less tax aggressive than their non-family counterparts, ceteris paribus. This result suggests that family owners are willing to forgo tax benefits to avoid the non-tax cost of a potential price discount, which can arise from minority shareholders’ concern with family rent-seeking masked by tax avoidance activities [Desai and Dharmapala, 2006. Corporate tax avoidance and high-powered incentives. Journal of Financial Economics 79, 145–179]. Our result is also consistent with family owners being more concerned with the potential penalty and reputation damage from an IRS audit than non-family firms. We obtain similar inferences when using a small sample of tax shelter cases.     

Are insiders equal? Evidence from earnings management in closely held East Asian firms

In analyzing newly collected data on the ultimate ownership structure of publicly traded firms in nine East Asian economies, we contribute to international accounting research by providing evidence on earnings management in insider-controlled firms in this region. We find that family-controlled firms engage in less (more) accrual-based (real) earnings management than other insider-controlled firms. Our analysis suggests that controlling families, unlike other types of ultimate owners, tend to substitute real earnings management for accrual-based earnings management. To help empirically clarify the role that two incentives (entrenchment versus signaling) play in driving the substitution between real and accruals-based earnings management, we examine their valuation impact and find that both types negatively affect the future valuation of family firms. In another set of results consistent with expectations, we document that country-level investor protection and firm external financing demand shape the practice of earnings management in family-controlled firms.     

Are small family firms financially sophisticated?

We study the drivers of financial sophistication in small family firms. Sophistication is defined as the use of non-basic financial products such as options, swaps, debt restructuring, and mergers and acquisitions (M&A) advisory services. Our analysis is based on a unique dataset with detailed information on 187 Italian family firms. We find that the main drivers of financial sophistication are: (1) the generation that currently owns the firm; (2) the presence of a non-family CFO; and (3) the existence of a non-family shareholder. We analyze the impact of these factors on the following four classes of non-basic financial products: corporate finance, cash management, corporate lending and risk management. Our results can be used to determine the characteristics of financially sophisticated family firms and whether their corporate governance and ownership structure increase the use of non-basic financial products.     

Does environmental labeling exacerbate heavily polluting firms’ financial constraints? Evidence from China

The Chinese Ministry of Environmental Protection has enacted an environmental policy that restricts the investment activities of heavily polluting firms by increasing their financial constraints. In this paper, we examine the impact of environmental labeling on firms’ financial constraints. We document that the financial constraints of heavily polluting firms increase more than those of other firms after the issuance of environmental labeling. The debt and equity financing channels of heavily polluting firms are restricted, with smaller bank loans and less equity issuance in the future. The effect is stronger in firms that make a smaller contribution to the local government’s gross domestic product, receive greater media coverage, and are located in heavily polluted provinces. The environmental regulation is effective in increasing the environmentally friendly practices and decreasing the performance growth of heavily polluting firms. Our findings not only contribute to the growing literature on the factors influencing financial constraints, identifying the effects of non-monetary factors on financial constraints, but also provide more evidence for the underlying mechanism of efficient environmental policy. Our results also provide practical suggestions for investors and institutions on evaluating firms and for regulatory authorities on further implementing environmental policy.     

Is enterprise risk management real?

Moving from the growing relevance of the enterprise risk management (ERM) concept, this paper provides empirical evidence of ERM in practice. The paper presents ERM actual uses in a panel of nine Italian companies from different industrial fields and legislative settings and analyses the relationship between the uses and the characteristics of the ERM tool implemented in each case. The data analysis highlights the existence of different activities that are supported by the ERM tool and also different types of use (i.e. responsive, discoursive and prospective) corresponding to a different contribution of ERM to managerial action. These uses related to the specific characteristics of the tools generally indicated with the label ‘ERM’.     

Why do bank-dependent firms bear interest-rate risk?

I document that floating-rate loans from banks, particularly important for bank-dependent firms, drive most variation in firms’ exposure to interest rates. I argue that banks prefer to supply floating-rate loans, due to their finite ability to transform short-duration deposit liabilities into long duration assets. Three key findings support this argument: banks with more floating-rate liabilities make more floating-rate loans, hold more floating-rate securities, and quote lower prices for floating-rate loans. Intermediary funding structures therefore help determine what types of contracts non-financial firms use. Banks transmit rising policy rates to firms by contractually raising interest rates on existing loans, not just by reducing the supply of new loans.     

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.     

Are interim management statements redundant?

In 2004 the Transparency Directive increased the reporting frequency by mandating the Interim Management Statement (IMS). However, only nine years later, the EU announced that it was making quarterly reporting voluntary again, arguing that IMSs are redundant as they are unlikely to contain any additional information not already required by the Market Abuse Directive (MAD). The current paper tests this argument empirically. For that it collects data on trading statements from a post-MAD pre-IMS year and uses these statements to predict which IMSs are genuinely incremental firm announcements (‘incremental IMSs’) and not simply substitutes for otherwise disclosed trading statements (‘non-incremental IMSs’). It then calculates three-day abnormal return variability and abnormal trading volume associated with incremental and non-incremental IMSs and it makes three observations. First, the introduction of IMSs coincided with a substantial reduction in other trading statements consistent with a large substitution effect between IMSs and non-periodic trading statements. Second, incremental third-quarter IMSs, but not incremental first-quarter IMSs, exhibit significantly positive abnormal return variability and abnormal trading volume, suggesting that the withdrawal of IMSs will involve the loss of some relevant information. Third, higher abnormal return variability and trading volume for non-incremental IMSs, relative to incremental IMSs, are consistent with the argument that a MAD-only regime will ensure the release of most relevant information.     

Are both managerial morality and talent important to firm performance? Evidence from Chinese public firms

Morality and talent are two important factors to consider when selecting managers. This study examines the relation among managerial morality, talent, and firm performance by manually collecting morality data in a sample of non-financial Chinese public firms during 2008–2018. We find that both managerial morality and talent are important to firm performance. In particular, managerial morality is positively associated with firm performance regardless of ownership or legal environment, but managerial talent is associated with better firm performance only in non-state-owned enterprises and in a strong legal environment. On the other hand, managerial talent cannot improve or may even harm firm performance when managerial morality is low, but managerial talent can improve firm performance when managerial morality is high.     

Are performance measures equally stable?

Managed portfolio performance evaluation is an important issue from both academics’ and investors’ points of view. One important aspect concerns the choice of the measure used to assess performance, because each index offers a different perspective about the trade-off between return level and risk exposure. A related crucial issue is the stability of measures over time and, hence, their predictive power about future results. In this work, we address the problem of evaluating of the stability of a performance measure. First, we discuss the use of alternative criteria to measure stability and propose a stability index based on changes of ranks over several periods of time. We also propose a statistical test to evaluate the homogeneity of the stability of alternative performance measures. Second, we suggest a composite performance measure, built as a linear combination of various indexes, specifically conceived to be maximally stable over time while preserving information about risk-adjusted return behavior. An application to a set of US mutual funds belonging to the Large Blend category shows how these methods work.     

Are zombie firms more incentivized to financialize?

This paper investigates whether zombie firms demonstrate a tendency to invest in the financial sector, a practice we term financialization strategy. Unlike those in the United States, Japan, and Europe, we find that zombie firms in China are not necessarily small and that they rely heavily on government subsidies in addition to bank loans for survival. In addition, we document that zombie firms in China experience limited investment opportunities in their core businesses. This combination of readily available funding and limited investment opportunities jointly motivate the financialization of firms with zombie status. We further find that financialization is preferred by non-state-owned firms and by those located in regions with less developed markets. Finally, we suggest that a contagion effect can occur in terms of financialization in provinces that have a high percentage of zombie firms. This research sheds light on the effects of a triangular relationship among firms, government agencies, and financial institutions on both the operations of individual firms and overall market efficiency.     

Is assurance on risk management systems relevant for bankers’ decisions?

Risk management systems (RMS) are an essential element of corporate governance and support companies in managing the omnipresent internal and external risks. Assurance on such systems can support such efforts and add further benefits. This study investigates the impact of RMS assurance on the perceptions and decisions of German bankers, and analyzes whether the assurance provider and the assurance level are relevant to them. We conducted an experiment with 145 bankers, using ANOVA to analyze their reliance on the hypothetical company’s RMS and their decisions regarding lending, recommending investments, and investing in stocks. A 2×2+1 between-subjects design was chosen, and we manipulated the assurance provider (audit firm vs. third-party provider) and the assurance level (limited vs. reasonable), and added a control condition with no assurance. Our results indicate that RMS assurance positively influences banker perceptions and decisions, whereas the assurance provider and assurance level has no statistically significant impact on them.