Trust is part of the foundation of public markets. Scandals at firms such as Enron and HealthSouth fractured this foundation and motivated market participants to ask why executives and other employees at these firms misled investors. Some regulators and experts conjecture that the roots of these scandals can be traced to the actions and attitudes of those at the very top of corporate leadership. In the words of Linda Chatman Thomsen (Director, Division of Enforcement, Securities and Exchange Commission) “Corporate character matters—and employees take their cues from the top. In our experience, the character of the CEO and other top officers is generally reflected in the character of the entire company.” In our paper, Suspect CEOs, Unethical Culture, and Corporate Misbehavior, forthcoming in the Journal of Financial Economics, we provide evidence consistent with this perspective by demonstrating an empirical link between CEOs’ revealed character and the misbehaviors of the firms they manage.
Archive for the ‘Empirical Research’ Category
Since World War II, Germany’s stock market has been mostly an after-thought, despite a highly successful economy. Why might this be the case? Explanations have included the power and influence of banks, the stakeholder-oriented nature of Germany’s economy and Germany’s civil law heritage. In Law, Politics and the Rise and Fall of German Stock Market Development, 1870-1938 we argue, based on statistical analysis of a hand-collected dataset of initial public offerings (IPOs), that a combination of law and politics during the late 19th and early 20th centuries played a significant role in the evolution of German equity markets. For most of this period Germany had, contrary to the present-day pattern, a stock market that was sizeable in comparative terms. The law helped to foster this trend but legal reforms during the Nazi era reversed matters in a way that had lasting consequences.
In recent years, the number of firms undertaking stock repurchases has increased dramatically, while the proportion of firms distributing value through cash dividends has declined. The popularity of share repurchases has not been mitigated even after the passage of the Jobs and Growth Tax Relief Act of 2003. In our paper, The Role of Institutional Investors in Open-Market Share Repurchase Programs, which was recently made publicly available on SSRN, we empirically analyze whether institutions have the ability to produce information about firms announcing open-market repurchase (OMR) programs, and how their information interacts with the private information held by firm insiders (which they may attempt to convey to the equity market through a repurchase program).
In our paper, The Impact of Whistleblowers on Financial Misrepresentation Enforcement Actions, which was recently made available on SSRN, we investigate the effect of employee whistleblowers on the consequences of financial misrepresentation enforcement actions by the Securities and Exchange Commission (SEC) and Department of Justice (DOJ). Whistleblowers are ostensibly a valuable resource to regulators investigating securities violations, but whether whistleblowers have any measurable impact on the outcomes of enforcement actions is unclear. Using the universe of SEC and DOJ enforcement actions for financial misrepresentation between 1978 and 2012 (Karpoff et al., 2008, 2014), we investigate whether whistleblower involvement is associated with more severe enforcement outcomes. Specifically, we examine the effects of whistleblower involvement on: (1) monetary penalties against targeted firms; (2) monetary penalties against culpable employees; and (3) the length of incarceration (prison sentences) imposed against employee respondents. In addition, we investigate the effect of whistleblowers on the duration of the violation, regulatory proceedings, and total enforcement periods. We examine the effects of whistleblowers conditional on the existence of a regulatory enforcement action. This distinction is important because our tests exploit variation in consequences to SEC or DOJ enforcement with and without whistleblower involvement; we do not measure the effects of whistleblower allegations for which there are no regulatory enforcement actions.
In our paper, Not Clawing the Hand that Feeds You: The Case of Co-opted Boards and Clawbacks, which was recently made publicly available on SSRN, we examine the impact of beholdenness of the directors to the CEO on the adoption and enforcement of clawbacks.
Clawbacks have been increasingly prevalent in recent years, and the aim of such provisions is to provide a punishment mechanism that links an executive’s compensation more closely to his or her financial reporting behavior. Clawbacks typically allow firms to recoup compensation from executives upon the occurrence of accounting restatements. Perhaps not surprisingly, the implementation and enforcement of clawbacks by companies is likely to create tensions between boards and executives because executives are unlikely to want to have a “Sword of Damocles” hanging over the compensation that is already in their pocket and are likely to resist attempts by boards to claw at this compensation when accounting restatements trigger a clawback. Hence, to better understand the use of clawbacks by firms, it is important to understand the type of boards that are more likely to implement clawbacks.
Illegal insider trading has become front-page news in recent years. High profile court cases have brought to light the extensive networks of insiders surrounding well-known hedge funds, such as the Galleon Group and SAC Capital. Yet, we have little systematic knowledge about these networks. Who are inside traders? How do they know each other? What type of information do they share, and how much money do they make? Answering these questions is important. Augustin, Brenner, and Subrahmanyam (2014) suggest that 25% of M&A announcements are preceded by illegal insider trading. Similarly, the U.S. Attorney for the Southern District of New York believes that insider trading is “rampant.”
In my paper, Information Network: Evidence from Illegal Insider Trading Tips, which was recently made publicly available on SSRN, I analyze 183 insider trading networks to provide answers to these basic questions. I identify networks using hand-collected data from all of the insider trading cases filed by the Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) between 2009 and 2013. The case documents include biographical information on the insiders, descriptions of their social relationships, data on the information that is shared, and the amount and timing of insider trades. The data cover 1,139 insider tips shared by 622 insiders who made an aggregated $928 million in illegal profits. In sum, the data assembled for this paper provide an unprecedented view of how investors share material, nonpublic information through word-of-mouth communication.
Prior studies of corporate and securities law litigation have focused almost entirely on cases filed by shareholder plaintiffs. Bondholders are thought to play little role in holding corporations accountable for poor governance that leads to fraud. My article, Bondholders and Securities Class Actions, challenges that conventional view in light of new evidence that bond investors are increasingly recovering losses through securities class actions.
Drawing upon a data set of 1660 securities class actions filed from 1996 through 2005, I find that bondholder involvement in securities class actions is increasing. Bondholder recoveries were rare for the first five years covered by the data set, averaging about 3% of settlements from 1996 through 2000. The rate of bondholder recoveries increased to an average of 8% of settlements from 2001 through 2005. Bondholder recoveries have not only become more frequent, they are disproportionately represented in the largest settlements of securities class actions. For the period covered by the data set, bondholders recovered in 4 of the 5 largest settlements and 19 of the 30 largest settlements.
For at least 40 years, a large body of literature has debated the effects of state competition for corporate charters and the value of state corporate laws. The common assumption of these studies is that interstate competition affects the way state corporate laws respond to managerial moral hazard, i.e., the agency problem arising between shareholders and managers out of the separation of ownership from control (Jensen and Meckling, 1976). Nevertheless, scholars have been sharply divided about the importance of interstate competition, and particularly whether interstate competition fosters a “race to the top” that maximizes firm value (Winter, 1977; Easterbrook and Fischel, 1991; Romano, 1985, 1993) or a “race to the bottom” that pushes states to cater to managers at the expense of shareholders (Cary, 1974; Bebchuk, 1992; Bebchuk and Ferrell, 1999, 2001).
Across the world, difficulties in accessing external equity capital create a serious barrier to the development of new firms. In developed economies, this funding gap is bridged by angel investors and venture capitalists. In emerging economies however, contracting mechanisms and property rights protections are often insufficiently developed to support substantial venture capital activity. As a consequence, little is known about new venture funding in such economies and how external financing constraints are overcome.
In our paper titled “Does Group Affiliation Facilitate Access to External Financing? Evidence from IPOs by Family Business Groups,” which was recently made publicly available on SSRN, we investigate a major source of funding support for new firms—namely, internal equity investments by business groups, especially those controlled by families, and how this facilitates access to external equity markets. Our study is motivated by the pervasive nature of business group participation in international initial public offering (IPO) markets around the world: on average, 29 percent of new issue proceeds in each country is attributable to group-affiliated firms. This raises an important question regarding the role that business groups play in assisting new firms seeking to tap public equity markets. It also raises important questions about whether ignoring the existence of business groups creates serious biases in studies of international IPO activity.
In the paper Understanding Director Elections: Determinants and Consequences, which was recently made publicly available on SSRN, we provide an in-depth examination of uncontested director elections. Using a hand-collected and comprehensive sample for director elections held at S&P 500 firms over the 2003–2010 period, we examine the factors driving shareholder votes in uncontested director elections, the effect of these votes on firms’ actions and the impact of these actions on firm value. We make three contributions.
First, it is well known that recommendations by the proxy advisory firm Institutional Shareholder Services (ISS) play a key role in determining the voting outcome. Yet, the question of what factors drive ISS recommendations and, thus, shareholder votes in uncontested director elections remains largely unanswered. To fill this gap, we use the reports ISS releases to its clients ahead of the annual meeting and identify the specific reasons underlying negative ISS recommendations. We find that 38.1% of the negative recommendations target individual directors (reflecting concerns with independence, meeting attendance and number of directorships), 28.6% target an entire committee (usually the compensation committee), and the remaining 33.3% target the entire board (mostly for lack of responsiveness to shareholder proposals receiving a majority vote in the past). A withhold recommendation by ISS is associated with about 20% more votes withheld, in line with prior research. More relevant to our study, there is substantial variation in votes withheld from directors conditional on the underlying reason. A board-level ISS withhold recommendation is associated with 25.48% more votes withheld, versus 19.73% and 16.44%, respectively, for committee- and individual-level withhold recommendations. The sensitivity of shareholder votes to ISS withhold recommendations is higher when there are multiple reasons underlying the withhold recommendation for the director (a proxy for more severe concerns) and at firms with poorer governance structures. These results suggest that shareholders do not blindly follow ISS recommendations but seem to take into account their rationale, their severity and other contextual factors (e.g. governance of the firm). However, cases of high votes withheld without a negative proxy advisor recommendation are rare, suggesting that voting shareholders only focus on the issues singled out by proxy advisors, potentially at the expense of other value-relevant factors (e.g. directors’ skill set, expertise and experience) for which proxy advisors have not (yet) developed voting guidelines (perhaps due to lack of sophistication or the inherent complexity of the issue).