Changes in bonus contracts in the post-Sarbanes–Oxley era

We examine whether the relation between earnings and bonuses changes after Sarbanes–Oxley. Theory predicts that, as the financial reporting system reduces the discretion allowed managers, firms will put more weight on earnings in compensation contracts to encourage effort. However, the increased risk imposed by Sarbanes–Oxley on executives may cause firms to temper this contracting outcome. We examine and find support for the joint hypothesis that the implementation of Sarbanes–Oxley and related reforms led to a decrease in earnings management and that firms responded by placing more weight on earnings in bonus contracts. We find no evidence that firms changed compensation contracts to compensate executives for assuming more risk.     

M&A Decisions and US Firms’ Voluntary Adoption of Clawback Provisions in Executive Compensation Contracts

We examine whether US firms’ M&A decisions influence the likelihood of voluntary adoption of clawback provisions in executive compensation contracts and whether clawback adoption improves subsequent M&A decisions. Because prior research finds that poor M&A decisions are associated with future earnings restatements, we predict that clawback adoption is more likely after these transactions. We further conjecture that M&A decisions will improve after clawback adoption, as its presence reduces executives’ willingness to manipulate post‐acquisition earnings. Consistent with our expectations, we find that (1) firms with more negative M&A announcement returns are more likely to adopt clawbacks; (2) firms that acquire targets with relatively poor accounting quality are more likely to adopt clawbacks; (3) clawbacks improve investor perception of M&A quality; and (4) executives are more responsive to the market when completing M&A deals if their compensation contracts include clawbacks. These results suggest that boards take a pro‐active approach and consider factors that may lead to restatements when adopting clawbacks. Our results have implications for US policymakers, as the Dodd‐Frank Act of 2010 requires mandatory adoption of clawbacks. Our results also suggest that non‐US firms can reduce managerial incentives to manipulate post‐takeover earnings by using clawbacks.     

Government contracts and trade credit

This study examines the association between government contracts and firms' use of trade credit. Firms with government contracts may demand less trade credit because of their lower operational risk, higher firm performance, stronger capacity to generate internal funds, and better access to other sources of financing. On the other hand, government contractors could receive more trade credit extensions from suppliers. We examine a sample of U.S. listed firms from 2000 to 2016 and find that firms with government contracts have a lower level of trade credit. We also find that government contractors make quicker payments for trade credit contracts than other firms. Moreover, we provide empirical evidence of government contractors' lower levels of operational risk and higher firm performance, which may enable government contractors to generate adequate internal funds for their operations or to obtain other forms of financing at a lower cost and thus lower their demand for trade credit. Incremental to prior research, our study suggests that having government contracts is one of the factors determining trade credit and firms' financing decisions.     

Overconfidence,Compensation Contracts,and Capital Budgeting

A risk‐averse manager's overconfidence makes him less conservative. As a result, it is cheaper for firms to motivate him to pursue valuable risky projects. When compensation endogenously adjusts to reflect outside opportunities, moderate levels of overconfidence lead firms to offer the manager flatter compensation contracts that make him better off. Overconfident managers are also more attractive to firms than their rational counterparts because overconfidence commits them to exert effort to learn about projects. Still, too much overconfidence is detrimental to the manager since it leads him to accept highly convex compensation contracts that expose him to excessive risk.     

Informationsmängel im deregulierten Kraftfahrzeugversicherungsmarkt?

Since 1994 the duty for the German insurers to file contracts by the supervisory authority was abolished. In automobile-, health- and life insurance the firms are now able to calculate tariffs without any restrictions. Especially in the motor vehicle insurance many insurers introduce their own rating systems. Practical experts fear that individuals are unable to find their best insurer. This paper analyzes what it means to choose the appropriate insurer. Secondly, I used this concept in an experiment with students who had to decide between 16 firms. Finally, I employed a Logit-model to evaluate the determinants of the appropriate decisions.     

The Valuation of Assets under Moral Hazard

The design of managerial incentive contracts is examined in a setting in which economic agents are risk averse, and the actions of managers can affect asset returns which contain both systematic and idiosyncratic risks. It is shown that in the absence of moral hazard, owners of assets will insure managers against idiosyncratic risks, but with moral hazard, contracts will depend on both systematic and idiosyncratic risks. The traditional recommendation of asset pricing models, namely, to focus only on systematic risks, is thus proved to be valid only when there is no moral hazard. The major empirically testable predictions of the model are (1) managerial incentive contracts will generally depend on systematic as well as idiosyncratic risks, (2) idiosyncratic risks will generally be important in investment decisions, (3) the managers of firms with relatively high levels of idiosyncratic risks will have compensations that are less dependent on their firms' excess returns, and (4) the compensations of managers of larger firms will be relatively more dependent on the excess returns of their firms.     

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.     

Boards,CEO entrenchment,and the cost of capital

Existing research on chief executive officer (CEO) turnover focuses on CEO ability. This paper argues that board ability is also important. Corporate boards are reluctant to replace CEOs, as this makes financing expensive by sending a negative signal about board ability. Entrenchment in this model does not result from CEO power, or from agency problems. Entrenchment is mitigated when there are more assets-in-place relative to investment opportunities. The paper also compares public and private equity. Private ownership eliminates CEO entrenchment, but market signals improve investment decisions. Finally, the model implies that board choice in publicly listed firms will be conservative.     

Seller Over-Pricing and Listing Contract Length: The Effects of Endogenous Listing Contracts on Housing Markets

This paper examines how seller pricing decisions influence listing contract length and how these decisions affect price and liquidity in housing markets. Because list price affects broker effort required to sell the property, brokers respond to seller overpricing by increasing the negotiated listing contract length. At the same time, sellers respond to longer listing contracts by adjusting their list price strategy. Both list price and length of marketing time affect broker sales effort and therefore a property’s realized selling price and liquidity. Analysis of house transaction data from Virginia indicates that greater over-pricing by sellers prompts brokers to pursue longer listing contracts, which subsequently lengthen marketing time but increase selling price. The results reveal a novel transmission mechanism from higher list price (which induces longer contracts) to selling price and liquidity.     

Political Connections and Allocative Distortions

Exploiting a unique institutional setting in Korea, this paper documents that politicians can increase the amount of government resources allocated through their social networks to the benefit of private firms connected to these networks. After winning the election, the new president appoints members of his networks as CEOs of state‐owned firms that act as intermediaries in allocating government contracts to private firms. In turn, these state firms allocate significantly more procurement contracts to private firms with a CEO from the same network. Contracts allocated to connected private firms are executed systematically worse and exhibit more frequent cost increases through renegotiations.     

Market power,price discrimination,and allocative efficiency in intermediate‐goods markets

We consider a monopolistic supplier's optimal choice of two‐part tariff contracts when downstream firms are asymmetric. We find that the optimal discriminatory contracts amplify differences in downstream firms' competitiveness. Firms that are larger—either because they are more efficient or because they sell a superior product—obtain a lower wholesale price than their rivals. This increases allocative efficiency by favoring the more productive firms. In contrast, we show that a ban on price discrimination reduces allocative efficiency and can lead to higher wholesale prices for all firms. As a result, consumer surplus, industry profits, and welfare are lower.     

Governance structure and the weighting of performance measures in CEO compensation

We empirically examine how governance structure affects the design of executive compensation contracts and in particular, the implicit weights of firm performance measures in CEO’s compensation. We find that compensation contracts in firms with higher takeover protection and where the CEO has more influence on governance decisions put more weight on accounting-based measures of performance (return on assets) compared to stock-based performance measures (market returns). In additional tests, we further find that CEO compensation in these firms has lower variance and a higher proportion of cash (versus stock-based) compensation. We further find that CEOs’ incentives (measured as changes in CEO annual wealth which includes expected changes in the value of the CEO’s equity holdings in addition to yearly compensation) do not vary across governance structures. These findings are consistent with CEOs in firms with high takeover protection and where they have more influence on governance negotiating different contracts.

Why and how firms use operating cash flow in compensation**

This study considers the choice of operating cash flow (OCF) in contracts and further examines the sensitivity of the CFO's and CEO's compensation to OCF performance, conditional on our stylized indicator of the importance of working capital management (WCM). The analysis depicts OCF as conveying distinct information about WCM, and predicts that firms for which WCM is an important source of value are more likely to contract on OCF. The importance of WCM is instrumented by firm conditions that create strong demand for WCM, including large working capital, rapid growth in working capital, highly volatile working capital, and large debt relative to total assets. Using a sample of firms whose incentive plans explicitly include OCF measures and a control sample of firms without such plans, we show that all four indicators of the importance of WCM have positive association with the likelihood of contracting upon OCF, individually and collectively. In compensation regressions, we find that WCM importance has a pronounced positive effect on the weight of OCF, but muted effect on the weight of accrual earnings. The results suggest that firms include measures of OCF performance in contracts largely to provide incentives for WCM and internal cash generation.     

Colluding through suppliers

This article investigates downstream firms’ ability to collude in a repeated game of competition between supply chains. We show that downstream firms with buyer power can collude more easily in the output market if they also collude on their input supply contracts. More specifically, an implicit agreement on input supply contracts with above‐cost wholesale prices and negative fixed fees (that is, slotting fees) facilitates collusion on downstream prices. Banning information exchange about wholesale prices decreases the scope for collusion. Moreover, high downstream prices are more difficult to sustain if upstream rather than downstream firms make contract offers.     

New or used? Investment with credit constraints

Used capital is cheap up front but requires higher maintenance payments later on. We argue that the timing of these investment cash outflows makes used capital attractive to financially constrained firms, since it is cheap when evaluated using their discount factor. In contrast, it may be expensive from the vantage point of an unconstrained agent. We provide an overlapping generations model and determine the price of used capital in equilibrium. Agents with less internal funds are more credit constrained, invest in used capital, and start smaller firms. Empirically, we find that the fraction of investment in used capital is substantially higher for small firms and varies significantly with measures of financial constraints.     

Taxes and executive stock options

In the Sixties, the qualified stock option was the predominant form of long-term incentive compensation contract for major industrial firms in the U.S. In the early Seventies these same firms replaced their tax-qualified stock option plans with non-qualified sttock options and later modified these plans to include a variety of new contingent compensation arrangements, some of which were based on accounting numbers instead of stock prices. This paper develops the hypothesis that tax considerations play an important role in explaining the form of compensation contracts. The pattern and timing of changes in the compensation plans of the top 100 industrial firms provides evidence consistent with the tax hypothesis.     

Disclosure Decisions by Firms and the Competition for Price Efficiency

This paper develops a model of the relationship between investment decisions by firms and the efficiency of the market prices of their securities. It is shown that more efficient security prices can lead to more efficient investment decisions. This provides firms with the incentive to increase price efficiency by voluntarily disclosing information about the firm. Disclosure decisions are studied. It is shown that firms may expend more resources on disclosure than is socially optimal. This is in contrast to the concern implicit in mandatory disclosure rules that firms will expend too few resources on disclosure.     

CEO and board chair roles: To split or not to split?

We examine the performance and compensation implications of firms' decisions to combine the roles of CEO and board chairman (duality). We document that firms that split the CEO and chairman positions due to investor pressure have significantly lower announcement returns and subsequent performance, and lower contributions of investments to shareholder wealth. Further, these performance outcomes are more negative for firms with higher predicted probabilities of duality based on a model of economic determinants of board leadership structure. We also find that pay-performance sensitivity in CEO compensation contracts are significantly lower following a split in the CEO and chairman positions, and significantly higher following a combination in these positions. Our evidence suggests that on average, board leadership choices by firms and market responses are consistent with efficiency arguments, and recent proposals for all firms to separate the CEO and chairman roles warrant more careful consideration.     

Relational contracts with subjective peer evaluations

We study optimal dynamic contracting for a firm with multiple workers where compensation is based on public performance signals and privately reported peer evaluations. We show that if evaluation and effort provision are done by different workers (e.g., consider supervisor‐agent hierarchy), first‐best can be achieved even in a static setting. However, if each worker both exerts effort and reports peer evaluations (e.g., consider team setting), effort incentives cannot be decoupled from truth‐telling incentives. This makes the optimal static contract inefficient. Relational contracts based on public signals increase efficiency. Interestingly, the optimal contract may ignore signals that are informative about effort.