In our paper, What Happens in Nevada? Self-Selecting into Lax Law, forthcoming in the Review of Financial Studies, we study the financial reporting behavior of firms that incorporate in Nevada, the second most popular state for out-of-state incorporations, after Delaware. Compared to Delaware, Nevada law has weak fiduciary requirements for corporate managers and board members. We find evidence consistent with the idea that lax shareholder protection under Nevada law induces firms prone to financial reporting errors to incorporate in Nevada, and that lax Nevada law may also cause firms to engage in risky reporting behavior.  In particular, we find that Nevada-incorporated firms are 30 – 40% more likely to report financial results that later require restatement than firms incorporated in other states, including Delaware. These results hold when we narrow our set of restatements to more serious infractions, including restatements that reduce reported earnings, and to restatements that raise suspicions of fraud or lead to regulatory investigations.
Archive for the ‘Empirical Research’ Category
In this summary of CFA Institute findings, we take a brief look at the history of proxy access, discuss the pertinent academic studies, examine the benefits and limits of cost–benefit analysis, analyze the use of proxy access in non-US jurisdictions, and draw some conclusions.
How We Got Here
Proxy access refers to the ability of shareowners to place their nominees for director on a company’s proxy ballot. This right is available in many markets, though not in the United States. Supporters of proxy access argue that it increases the accountability of corporate boards by allowing shareowners to nominate a limited number of board directors. Afraid that special-interest groups could hijack the process, opponents of proxy access are also concerned about its cost and are not convinced that proxy access would improve either company or board performance.
As a result of the Dodd-Frank Act of 2010, public firms must periodically hold advisory shareholder votes on executive compensation (“say on pay”). One of the main goals of the say-on-pay mandate is to increase shareholder scrutiny of executive pay, and thus alleviate perceived governance problems when boards decide on executive compensation. In our paper, Does Shareholder Scrutiny Affect Executive Compensation? Evidence from Say-on-Pay Voting, which was recently made publicly available on SSRN, we examine how firms change the structure and level of executive compensation depending on whether the firm will face a say-on-pay vote or not.
In 2013, CEOs in S&P 500 firms were paid, on average, over 200 times the average worker’s salary in their firms. To avoid or minimize public outrage, managers have a substantial incentive to obscure and try to legitimize their excessive compensation. One way of doing so is to have “independent” compensation consultants recommend higher pay to the board. However, prior literature has not been able to find significant evidence that hiring consultants leads to higher pay, partly because the information is only available after 2006 and most studies on this topic examine one or two years after 2006.
In response to the Global Financial Crisis of 2008-2009, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) in July 2010. Among its various provisions, Dodd-Frank outlines a series of broad reforms to the Credit Rating Agencies (CRA) market. Many observers believe that CRAs’ inflated ratings of structured finance products were partly to blame for the rapid growth and subsequent collapse of the shadow banking system. In response, Dodd-Frank’s CRA provisions significantly increase CRAs’ liability for issuing inaccurate ratings, and make it easier for the SEC to impose sanctions and bring claims against CRAs for material misstatements and fraud.
In our paper, Public Pressure and Corporate Tax Behavior, which was recently made publicly available on SSRN, we examine whether public scrutiny related to firms’ tax avoidance activities has a significant effect on their tax avoidance behavior. In contrast to U.S. regulations that only require disclosure of significant subsidiaries, the U.K.’s Companies Act of 2006 (“Companies Act”) requires firms to disclose the name and location of all subsidiaries, regardless of size or materiality. Although the U.K. law went into effect in 2006, in 2010, ActionAid International, a global non-profit dedicated to ending poverty worldwide, discovered that approximately half of the firms in the FTSE 100 were not disclosing the name and location of all subsidiaries. ActionAid’s finding was prima facie evidence that the Companies House was not enforcing the subsidiaries disclosure requirement. More importantly, the fact that some firms chose not to comply with the law suggests that the cost of disclosing detailed information on subsidiaries was greater than the benefit of a more complete information environment for the non-compliant firms.
The lack of gender parity in the governance of business corporations has ignited a heated global debate, leading policymakers to wrestle with difficult questions that lie at the intersection of market activity and social identity politics. In my new book, Challenging Boardroom Homogeneity: Corporate Law, Governance, and Diversity (Cambridge University Press, forthcoming in 2015), I draw on semi-structured interviews with corporate board directors in Norway and documentary content analysis of corporate securities filings in the United States to investigate empirically two distinct regulatory models designed to address diversity in the boardroom—quotas and disclosure.
In our paper, Executive Gatekeepers: Useful and Divertible Governance?, which was recently made publicly available on SSRN, we study the role of executive gatekeepers in preventing governance failures, and the counter-incentive effects created by equity compensation. Specifically, we examine the following two questions. First, do executive gatekeepers actually improve governance in the average firm? Second, does the effectiveness of gatekeepers in ensuring compliance and/or reducing corporate misconduct depend on their incentive contracts?
Whether mandatory disclosure regulation and insider ownership affect a firm’s cost of capital is an important question in financial economics. In our paper, Mandatory Disclosure Quality, Inside Ownership, and Cost of Capital, which was recently made publicly available on SSRN, we examine this question on a large global sample of more than 10,000 firms across 35 countries.
Theory predict that disclosure regulation is negatively related to the cost of capital due to two separate effects: (i) an information effect in which better disclosure improves investors’ prediction of future cash flows, or (ii) a stewardship effect in which better disclosure improves managerial alignment with shareholders and therefore increases expected cash flows. The stewardship effect is not unique to disclosure, but is also present in other governance mechanisms that increase managerial alignment such as inside ownership. As a result, these alternative alignment mechanisms potentially reinforce or substitute for the stewardship effect of disclosure. We test this argument by examining whether inside ownership is negatively associated with the cost of capital and how inside ownership affects the relation between disclosure and the cost of capital.
In our paper, Influence of Public Opinion on Investor Voting and Proxy Advisors, which was recently made publicly available on SSRN, we address the question of how public opinion influences the proxy voting process. We find strong influence of public opinion on the evolution in both investor voting behavior and proxy advisor recommendations. Therefore, our results suggest that an additional channel through which the public can communicate with corporate management (and potentially influence corporate behavior) is the proxy voting process. We provide new evidence that media coverage can also influence firm behavior through the voting channel. This channel is important because media coverage captures the attention of proxy advisors, institutional investors and individual investors, and is thus reflected in recommendations and votes.