In our paper, The Effect of Audit Committee Industry Expertise on Monitoring the Financial Reporting Process, forthcoming in The Accounting Review, we examine the impact of audit committee (AC) industry expertise on the AC’s effectiveness in monitoring the financial reporting process. Despite the increased responsibilities, authority, independence, and financial expertise requirements placed on ACs by the Sarbanes-Oxley Act (SOX), ACs may, nonetheless, lack sufficient industry expertise to understand and thus properly monitor complex industry specific accounting issues. For instance, expertise in the retail industry may assist ACs to ensure that companies take an adequate write-down of inventory when their products face potential obsolescence. Similarly, revenue recognition, a prominent area of accounting manipulation (Beasley et al. 2000, 2010), entails an evaluation and understanding of the earnings process, which is tied to a company’s business processes that are often industry specific.
Archive for the ‘Academic Research’ Category
In the paper, International Corporate Governance Spillovers: Evidence from Cross-Border Mergers and Acquisitions, which was recently made publicly available on SSRN, we investigate whether the change in corporate control following a cross-border M&A leads to changes in corporate governance of non-target firms that operate in the same country and industry as the target firm. We focus on the strategic complementarity in governance choices between the target firm and its rival firms in the local market. We take the view that corporate governance is affected by the choice of other competing firms as in the models developed by Acharya and Volpin (2010), Cheng (2010), and Dicks (2012).
To provide guidance for our empirical analysis, we develop a simple industry oligopoly model, which captures the idea that rival firms operating in a given industry change their governance in response to competitive forces. The spillover effect occurs as firms in an industry recognize that corporate governance is used more efficiently by the target firm and therefore strengthen their own governance as a response. The model has two decision stages and builds on the work of Shleifer and Wolfenzon (2002) and Albuquerque and Wang (2008). In the first stage, outside shareholders choose firm-level governance (i.e., how much to monitor and limit of managerial private benefits), given the governance choices of other firms. In the second stage, firm managers choose output and the level of private benefits that they extract in the context of a symmetric oligopolistic industry. In the Nash equilibrium outcome, managers have an incentive to “overproduce” (because their private benefits increase with revenues) and industry-level profits are not maximized.
Recent events suggest that shareholders pay attention to matters involving the personal lives of CEOs and take this information into account when making investment decisions. In our paper, Separation Anxiety: The Impact of CEO Divorce on Shareholders, which was recently made publicly available on SSRN, we examine the impact that CEO divorce can have on a corporation.
There are at least three potential ways in which a CEO divorce might impact a corporation and its shareholders. The first is loss of control or influence. A CEO with a significant ownership stake in a company might be forced to sell or transfer a portion of this stake to satisfy the terms of a divorce settlement. This can reduce the influence that he or she has over the organization and impact decisions regarding corporate strategy, asset ownership, and board composition. Shareholder reaction to loss of control will vary, depending on the view that investors have of CEO performance and governance quality. If they view performance and governance quality favorably, they will react negatively to the news; if they view management as entrenched or a poor steward of assets, they will react positively. Shareholder reaction will also depend in part on what happens to divested shares, including whether they are transferred to the spouse, sold in a block to a third-party, or dispersed in the general market. Each of these can shape the future governance of a firm.
Last week the Securities and Exchange Commission released its regulatory agenda, and this agenda no longer includes rules requiring public companies to disclose their spending on politics. The agenda now includes only overdue rules that the SEC is required to develop under Dodd-Frank and the JOBS Act. While we are disappointed by the SEC’s decision to delay its consideration of rules requiring disclosure of corporate political spending, we hope that the SEC will consider such rules as soon as it is able to devote resources to rulemaking other than that required by Dodd-Frank and the JOBS Act. The submissions to the SEC over the past two years have clearly demonstrated the compelling case and large support for requiring such disclosure.
We co-chaired a committee of ten corporate and securities law professors that filed a rulemaking petition urging the SEC to develop rules requiring public companies to disclose their spending on politics. In the two years since the petition was submitted, the SEC has received more than 600,000 comment letters on our petition—more than on any other rulemaking project in the Commission’s history. The overwhelming majority of these comments—including letters from institutional investors and Members of Congress—have been supportive of the petition. At the end of 2012, the Director of the SEC’s Division of Corporate Finance acknowledged the widespread support for the petition, and the Commission placed the rulemaking petition on its regulatory agenda for 2013.
Corporate governance incentives at too-big-to-fail financial firms deserve systematic examination. For industrial conglomerates that have grown too large, internal and external corporate structural pressures push to re-size the firm. External activists press it to restructure to raise its stock market value. Inside the firm, boards and managers see that the too-big firm can be more efficient and more profitable if restructured via spin-offs and sales. But for large, too-big-to-fail financial firms (1) if the value captured by being too-big-to-fail lowers the firms’ financing costs enough and (2) if a resized firm or the spun-off entities would lose that funding benefit, then a major constraint on industrial firm over-expansion breaks down for too-big-to-fail finance.
Propositions (1) and (2) have both been true and, consequently, a major retardant to industrial firm over-expansion has been missing in the large financial firm. Debt cost savings from the implicit subsidy can amount to a good fraction of the big firms’ profits. Directors contemplating spin-offs at a too-big-to-fail financial firm accordingly face the problem that the spun-off, smaller firms would lose access to cheaper too-big-to-fail funding. Hence, they will be relatively more reluctant to push for break-up, for spin-offs, or for slowing expansion. They would get a better managed group of financial firms if their restructuring succeeded, but would lose the too-big-to-fail subsidy embedded in any lowered funding costs. Subtly but pervasively, internal corporate counterpressures that resist excessive bulk, size, and growth degrade.
Reputation concerns create strong incentives for independent directors to be viewed externally as capable monitors as well as to retain their most valuable directorships. In our paper, Reputation Incentives of Independent Directors: Impacts on Board Monitoring and Adverse Corporate Actions, which was recently made publicly available on SSRN, we extend this literature significantly by examining the effects of differential reputation incentives across firms that arise when a director holds multiple directorships.
Firms having boards composed of a greater portion of independent directors for whom this directorship represents one of their most prestigious are associated with firm actions known to reward directors and are negatively associated with firm actions known to be costly to director reputations. Specifically, they are associated with a lower likelihood of covenant violations, earnings management, earnings restatements, shareholder class action suits and dividend reductions. In addition, we also find they are positively associated with stock repurchases and dividend increases.
The global financial troubles of 2008-09, with whose debt-deflationary macroeconomic consequences  the world continues to struggle,  exposed weaknesses in many financial sector oversight regimes. Most of these had in common their focus on the safety and soundness of individual financial institutions to the exclusion of the stability of financial systems as wholes—wholes whose structural features render them more than mere sums of their institutional parts.
A number of academic, governmental, and other finance-regulatory authorities, myself included,  have accordingly concluded that an appropriately inclusive finance-regulatory oversight regime must concern itself as much with the identification and mitigation of systemic risk as with that of institutional risk. Once primarily ‘microprudential’ finance-regulatory oversight and policy instruments, in other words, are now understood to be in need of supplementation with ‘macroprudential’ finance-regulatory oversight and policy instruments.
Now because finance-regulatory policy in most jurisdictions is implemented through law, all of the weaknesses inherent in exclusively microprudential finance-regulatory regimes are, among other things, legal problems. They are weaknesses in what some non-American lawyers call existing ‘legal frameworks.’ Many countries in consequence are now looking to update their legal frameworks for finance-regulatory oversight, supplementing their traditional microprudential foci and methods with macroprudential counterparts.
Research on the composition and structure of the board of directors is a thriving subject in the aftermath of the financial crisis. The discussion thus far has assumed that finding the right board members is extremely important because they tend to enhance corporate strategy and decision-making. Consider the case of Apple’s board. Following Steve Jobs’ return to the firm in 1997, he understood well the important role of the board of directors to both improve company productivity and build relationships with its suppliers and customers. In order for the board of directors to become a competitive advantage and help carry Apple forward, its members needed to have a thorough understanding of the computer industry and the firm’s products. Accordingly, a change in the composition of the board of directors was arguably a necessary first step to bring back focus, relevance and interaction (with the outside world) to the company in its journey to introduce disruptive innovations and creative products to its customers. The result was impressive: Between August 6th, 1997 (the day the “new” board was introduced) and August 23rd, 2011 (the last day of Jobs as the CEO of Apple), the stock price soared from $25.25 to $360.30, increasing 1,327 per cent.
Nearly all U.S. regulatory agencies use benefit-cost analysis (BCA) to evaluate proposed regulations. The EPA, for example, uses BCA to evaluate regulations that require factories to reduce emissions. OSHA uses BCA to evaluate regulations that require workplaces to install safety devices for workers. NHTSA uses BCA to evaluate fuel economy standards. Yet a striking exception to this pattern occurs in the area of financial regulation. The major agencies with jurisdiction over financial activities—including the SEC, the CFTC, and the Fed—have almost never used formal BCA to evaluate financial regulations.
Yet there is no reason to believe that BCA would be appropriate for environmental or workplace regulation and not for financial regulation. Indeed, BCA would seem more appropriate for financial regulation where data are better and more reliable, and where regulators do not confront ideologically charged valuation problems like those concerning mortality risk and environmental harm. The benefits and costs of financial regulation are commensurable monetary gains and losses, and so can be easily compared.
In my paper, Zombie Boards: Board Tenure and Firm Performance, which was recently made publicly available on SSRN, I empirically investigate how board tenure is related to firm performance and corporate decisions, holding other firm, CEO, and board characteristics constant. I find that board tenure has an inverted U-shaped relation with firm value, and that this curvilinear relation is reflected in M&A performance, financial reporting quality, corporate strategies and innovation, executive compensation, and CEO replacement. The results indicate that, for firms with short-tenured boards, the marginal effect of board learning dominates entrenchment effects, whereas for firms that have long-tenured boards, the opposite is true.
The analysis relies on the assumption that some transaction costs prevent boards from fully adjusting to their optimal tenure level. But what are those transaction costs? For long-tenured boards, transaction costs could take the form of agency costs. For instance, board tenure choice may reflect the extent to which CEOs have influence over the board selection process (Hermalin and Weisbach, 1998). Further, firms with staggered boards can only replace a portion of board member each year, in which case the use of a staggered board itself introduces agency problems (Bebchuk and Cohen, 2005). For short-tenured boards, transaction costs could take the form of frictions in the labor market for directors.