Discussion of “Executive stock-based compensation and firms’ cash payout: the role of shareholders’ tax-related payout preferences”

Aboody and Kasznik (Rev Acc Stud, this issue, 2008) develop and test cross-sectional predictions about how firms might respond to the 2003 dividend tax cuts. My discussion suggests some alternative firm responses, a restructuring of the main tests to be consistent with the theory and predictions, and an interpretation of the magnitude of the observed associations. Overall, the paper addresses an interesting issue, recognizes that executive compensation is endogenous in this event, and adds to the long literature on dividend payout policy.     

Large shareholders’ power and the quality of corporate governance: An analysis of Brazilian firms

This paper analyzes the incentives of large shareholders to implement the corporate governance system that favors their interests within a framework of highly concentrated ownership and poor legal protection for investors. A metric for corporate governance based on the fulfillment of non-mandatory rules of good corporate governance is used. System GMM (Generalized Method of Moments) estimates for a balanced panel data of Brazilian firms reveal that the ownership concentration is detrimental to corporate governance quality and the quality of board composition. In accordance with the expropriation effect on principal-principal agency conflicts, by weakening the corporate governance system and board composition, large controlling shareholders may use private benefits of control. As proposed by the substitution effect, in a complementary way, controlling shareholders may renounce strong boards and directly perform management monitoring, mitigating agency conflicts with managers. Finally, the ability of large shareholders other than the main blockholder is not enough to contest his/her power to shape the corporate governance system. The work provides evidence of the prominence of the principal–principal agency problem in an emerging market, by analyzing the effect of ownership concentration over the quality of the corporate governance system, and also that other large non-controlling shareholders are not able to contest the power of the main blockholder.     

Risk-shifting and the regulation of bank CEOs’ compensation

This paper analyzes the effects of two regulatory mechanisms, namely a regulation of the structure of bank CEOs incentive pay and sanctions for the CEOs of failed banks, on bank risk shifting. We extend a standard model of CEO compensation by incorporating leverage and an investment decision. To the extent that bank depositors and creditors are even partially protected by public guarantees, we show that it is in the interests of bank shareholders to choose more risky investments than would be socially optimal, and therefore to design a CEO contract with excessive risk taking incentives. Thus, we argue that current corporate governance arrangements in the banking sector are not efficient. In this setting, we show that putting in place one of the aforementioned mechanisms could yield the socially optimal outcome at no cost. We also identify some limitations and potential perverse effects of these mechanisms.     

The asymmetry in firms’ mechanisms of cash holdings adjustments: evidence from the G-5 economies

Review of Quantitative Finance and Accounting - Using a G-5 country sample (France, Germany, Japan, the UK, and the US) from 1980 to 2007, I find new evidence of the asymmetry in firms’...     

How firms manage their cash flows: an examination of diversification’s effect

We extend recently documented evidence that diversified firms hold significantly less cash than specialized firms to consider differences in how diversified and specialized firms adjust their cash flows to achieve their target cash balance. We find that diversified firms have higher free cash flows as a result of equal operating cash flows and lower investment in comparison to specialized firms. Diversified firms save less cash by placing less reliance on external financing; by issuing less debt and equity, and distributing higher cash dividends. Our findings support the hypothesis that diversified firms are able to hold less precautionary cash as they are in better position to finance investment opportunities internally from operating cash flows.     

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.     

The spillover effect of focal firms’ cybersecurity breaches on rivals and the role of the CIO: Evidence from stock trading volume

This study investigates whether there is any spillover uncertainty regarding a rival firm’s future operations upon a focal firm’s announcement of cybersecurity breaches and whether the existence of a chief information officer (CIO) in rival firms can reduce this spillover uncertainty. Using abnormal trading volume to capture the change in investors’ expectations, we show that compared with the focal firms, rival firms experience an increase in abnormal trading volume following the focal firm’s announcement of a security breach. The findings suggest that the spillover effect generates even more uncertainties toward these nonbreached rival firms regarding the impact of the focal firm’s security breach. However, CIOs in nonbreached rival firms can play a shielding role in mitigating such effects. Our study contributes to the literature on the impact of cybersecurity and has policy implications for encouraging a strategic perspective when managing cybersecurity risks.     

The effects of executive compensation and outside monitoring on firms’ pre-repurchase disclosure behavior and post-repurchase performance

Review of Quantitative Finance and Accounting - We show that corporate governance mechanisms play an important role in controlling managers’ opportunistic behavior. Low executive equity...     

Beating market expectations and the pricing of firms’ probability of default

This study explores the impact of beating analysts' forecasts on investors' perceptions about firms' default probability. The information contained in analysts’ forecasts, both earnings and revenues, provides additional information to investors in pricing CDSs. While previous research has focused on the impact of beating analysts’ earnings forecasts, this study shows that firms that beat analysts' revenue forecasts also experience, on average, a decrease in the CDS premium around the earnings announcement date. This study also documents that the effect is stronger when firms beat/miss both earnings and revenue forecasts. When firms beat (miss) earnings and miss (beat) revenues, the effect of earnings is the dominant signal. These effects are stronger for firms with high levels of default risk.     

Regulation FD and analysts’ vs. investors’ weightings of the cash components of earnings

This paper investigates whether investors’ bias in processing the information contained in the cash components of annual earnings has been reduced, and whether the difference in bias between financial analysts and investors has decreased subsequent to Regulation Fair Disclosure (hereafter, Reg FD). We compare analysts’ and investors’ weightings of the three cash flow components of earnings, defined by Dechow, Richardson, and Sloan (2008), from 1985 to 2008, using historical weightings as benchmarks. Our results show that, in the post Reg FD period, the magnitude of investors’ (analysts’) mis-weightings has decreased (increased), and the differences between analysts’ and investors’ mis-weightings have become smaller. Overall, these results suggest that financial analysts’ information advantages over investors declined after Reg FD took effect, and that investors consequently are less biased in assessing the persistence of the cash flow components of earnings following the implementation of Reg FD.     

The effect of unionization on firms’ earnings management and employee compensation: Evidence from a regression discontinuity design

This study examines the effect of unionization on US firms’ accruals-based earnings management and future employee compensation expenses by employing a research design that overcomes the inherent endogeneity issue of the relationship between unionization and earnings management. First, by comparing firms that just pass unionization by a small number of votes to those that just barely lose elections, the regression discontinuity design estimations document significant downward accruals earnings management for firms that barely pass unionization, compared to those that barely fail to pass unionization. Second, the association between unionization and earnings management is only significant in US states without right-to-work legislation, where unions are more powerful. These findings are consistent with recently unionized firms’ incentives to report lower earnings in order to mitigate unions’ demands for greater employee compensation. Further, for firms that barely pass unionization, we find that: (1) unions cannot fully “undo” the effects of earnings management, that is, downward managed earnings depress future compensation expenses, and (2) firms cannot fully “undo” the effects of unionization, that is, compensation expenses increase after unionization despite the downward earnings management.     

The effect of chief financial officers’ accounting expertise on corporate tax avoidance: the role of compensation design

Review of Quantitative Finance and Accounting - Accounting expertise is closely related to corporate tax planning, and hence, corporate chief financial officers (CFOs) with accounting expertise may...     

Firms cash management,adjustment cost and its impact on firms’ speed of adjustment: a cross country analysis

Review of Quantitative Finance and Accounting - We investigate the firms’ specific attributes that determine the difference in speed of adjustment (SOA) towards the cash holdings target in...     

State ownership,soft-budget constraints,and cash holdings: Evidence from China’s privatized firms

We study the relation between state ownership and cash holdings in China’s share-issue privatized firms from 2000 to 2012. We find that the level of cash holdings increases as state ownership declines. For the average firm in our sample, a 10 percentage-point decline in state ownership leads to an increase of about RMB 55 million in cash holdings. This negative relation can be attributable to the soft-budget constraint (SBC) inherent in state ownership. The Chinese financial system is dominated by the state-owned banks, an environment very conducive for the SBC effect. We further examine and quantify the effect of state ownership on the value of cash and find that the marginal value of cash increases as state ownership declines. The next RMB added to cash reserves of the average firm is valued at RMB 0.96 by the market. The marginal value of cash in firms with zero state ownership is RMB 0.36 higher than in firms with majority state ownership. The SBC effect exacerbates agency problems inherent in state-controlled enterprises, contributing to their lower value of cash.     

Executive compensation,supervisory board,and China’s governance reform: a legal approach perspective

China’s corporate governance system implements both American and German style mechanisms, but the supervisory board, a typical feature of German style governance is generally considered dysfunctional. After 2006, the newly amended Chinese Corporate Law significantly enhances the role played by supervisory boards. Our study examines if the new Corporate Law improves supervisory board’s monitoring over executive compensation, which becomes one of the main agency concerns in China’s emerging market, thus providing a quasi-experimental testing of the legal approach of governance (La Porta et al. in J Financ Econ 58:3–27, 2000). We examine the effects of both size and meeting frequency of supervisory boards on executive compensations in Chinese listed companies, by using data before and after the new Corporate Law became effective in 2006. We find that before the new Corporate Law became effective, supervisory boards did not affect executive compensation, although their role after that became significant; both supervisory board size and meeting frequency affect total executive compensation, and supervisory board size also influences pay-performance sensitivity. Furthermore, we find that there exists a non-linear effect of supervisory board meeting frequency on executive pay, and an optimal range exists. Policy implications are discussed.     

Does CEO inside debt compensation benefit both shareholders and debtholders?

Review of Quantitative Finance and Accounting - We examine whether the proportion of CEO inside debt holdings (pension and deferred compensation) to stock holdings benefit both shareholders and...     

Are long-tenured CEOs rent seekers? Analysis of cash compensation and post disposal performance

Are typical long-tenured CEOs rent-seekers? Do compensation committees consider undiversified risk for veteran executives and design their cash pay to limit their risk exposure? Because an exit decision requires board approval, discontinued operations provide a unique setting to analyze intervention by compensation committees. Seasoned managers should require less oversight because their ability has been revealed over time. However, as CEOs advance in their careers, they are more likely to acquire power to influence board decisions. They are also more risk averse and potentially more myopic than younger CEOs because they hold a large undiversified portfolio. Lucrative labor markets for talented retired executives can incentivize long-tenured CEOs to maintain a solid reputation. I reexamine the previously reported differential sensitivity of CEO cash compensation to positive or negative-valued disposal decisions, which can be viewed as rent-seeking. I show that cash pay for veteran CEOs are shielded from the effect of both negative and positive-valued discontinued operations, suggesting that compensation committees alter their cash pay. This evidence does not support rent-seeking. I also find strong evidence that long-tenured CEOs make better exit decisions to improve future firm performance than less experienced executives.     

Australia’s ‘two-strikes’ rule and the pay-performance link: Are shareholders judicious?

To improve accountability of executive compensation, Australia introduced the ‘say-on-pay’ legislation in 2011, which is widely known as the ‘two-strikes’ rule. We investigate the consequences of this new rule for the pay-performance link in Australian firms. Employing a matched-pair design, we find that pay changes of the chief executive officer and the key management personnel were not significantly positively related to the stock returns of the firms that registered a ‘first strike’ in 2011 under the ‘two-strikes’ rule. However, the relations improved significantly in 2012. Our results also suggest that the shareholders of the ‘first-strike’ firms may have been over-enthusiastic about their voting power in 2011 but exercised this power more judiciously in 2012. Our findings provide important insights for the global debate on governance of executive compensation.     

The cost of firms’ debt financing and the global financial crisis

We provide an assessment of the determinants of the risk premium paid by non-financial corporations on long-term bonds. By looking at 5500 issues over the period 2005–2012, we find that in recent years the sovereign debt market turbulence has been a major driver of corporate risk. Compared with the three-year period 2005–2007 before the global financial crisis, in the years 2010–2012 Italian, Spanish and Portuguese firms paid on average between 70 and 120 basis points of additional premium due to the negative spillovers from the sovereign debt crisis, while German firms received a discount of 40 basis points.