Posts Tagged ‘Agency costs’

Corporate Investment and Stock Market Listing: A Puzzle?

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Thursday November 20, 2014 at 9:18 am
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Editor’s Note: The following post comes to us from John Asker, Professor of Economics at UCLA; Joan Farre-Mensa of the Entrepreneurial Management Unit at Harvard Business School; and Alexander Ljungqvist, Professor of Finance at NYU.

Economists have long worried that a stock market listing can induce short-termist pressures that distort the investment decisions of public firms. Back in 1985 Narayanan wrote in the Journal of Finance that “American managers tend to make decisions that yield short-term gains at the expense of the long-term interests of the shareholders.” More recently, a growing number of commentators blame the sluggish performance of the U.S. economy since the 2008–2009 financial crisis on short-termism. For example, in a recent Harvard Business Review article, Barton and Wiseman, global managing director at McKinsey & Co. and CEO of the Canada Pension Plan Investment Board, respectively, argue that “the ongoing short-termism in the business world is undermining corporate investment, holding back economic growth.”

Yet, systematic empirical evidence of widespread short-termism has proved elusive, largely because identifying its effects is challenging. A chief challenge is the difficulty of finding a plausible counterfactual for how firms would invest absent short-termist pressures. In our paper, Corporate Investment and Stock Market Listing: A Puzzle?, which is forthcoming at the Review of Financial Studies, we address this difficulty by comparing the investment behavior of stock market-listed firms to that of comparable privately held firms, using a novel panel dataset of private U.S. firms covering more than 400,000 firm years over the period 2001–2011. Building on prior work, our key identification assumption is that, on average, private firms suffer from fewer agency problems and, in particular, are subject to fewer short-termist pressures than are their listed counterparts. This assumption is motivated by the fact that private firms are often owner managed and, even when not, are both illiquid and typically have highly concentrated ownership. These features encourage their owners to monitor management more closely to ensure long-term value is maximized.

…continue reading: Corporate Investment and Stock Market Listing: A Puzzle?

Executive Compensation in Controlled Companies

Posted by Kobi Kastiel, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Thursday November 13, 2014 at 9:12 am
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Editor’s Note: Kobi Kastiel is a fellow at the Harvard Law School Program on Corporate Governance. His article, Executive Compensation in Controlled Companies, is forthcoming in the January 2015 issue of Indiana Law Journal and available here. Additional work from the Program on Corporate Governance on executive compensation includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried, discussed on the Forum here.

More than a decade ago, Professors Lucian Bebchuk and Jesse Fried published the seminal work on the role and significance of managerial power theory in executive compensation. Their work cultivated a vivid debate on executive compensation in companies with dispersed ownership. The discourse on the optimality of executive pay in controlled companies, however, has been more monolithic. Conventional wisdom among corporate law theorists has long suggested that the presence of a controlling shareholder should alleviate the problem of managerial opportunism because such a controller has both the power and incentives to curb excessive executive pay.

My Article, Executive Compensation in Controlled Companies, forthcoming in the Indiana Law Journal, challenges that common understanding by proposing a different view that is based on an agency problem paradigm, and by presenting a comprehensive framework for understanding the relationship between concentrated ownership and executive pay. On the theoretical level, the Article shows that controlling shareholders often have incentives to overpay professional managers instead of having an arm’s-length contract with them, and therefore it suggests that compensation practices in a large number of controlled companies may have their own pathologies.

…continue reading: Executive Compensation in Controlled Companies

Buybacks Around the World

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday November 4, 2014 at 9:14 am
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Editor’s Note: The following post comes to us from Alberto Manconi of the Department of Finance at Tilburg University and Urs Peyer and Theo Vermaelen, both of the Finance Area at INSEAD.

Due to regulatory changes, share repurchases have become increasingly common around the world in the last 15 years. As such, in our paper, Buybacks Around the World, which was recently made publicly available on SSRN, we first examine whether the findings based on U.S. data hold up in an international setting, and whether examining non-U.S. data can change the way we think about buybacks. Second, we examine whether the original concerns about managers using buybacks to prop up the share price were somewhat warranted in countries outside the U.S.

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What Happens in Nevada? Self-Selecting into Lax Law

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday October 28, 2014 at 9:02 am
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Editor’s Note: The following post comes to us from Michal Barzuza, Professor of Law at the University of Virginia School of Law, and David Smith, Professor of Finance at the University of Virginia.

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. [1] 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.

…continue reading: What Happens in Nevada? Self-Selecting into Lax Law

Disclosure and Financial Market Regulation

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Sunday October 19, 2014 at 8:31 am
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Editor’s Note: The following post comes to us from Luca Enriques, Allen & Overy Professor of Corporate Law at University of Oxford, Faculty of Law, and Sergio Gilotta of University of Bologna.

In our recent paper, Disclosure and Financial Market Regulation, we provide a critical overview of the role of disclosure in financial market regulation.

We begin by discussing the goals of disclosure regulation, which we identify in investor protection, agency cost reduction and price accuracy enhancement. Disclosure protects investors because (a) it gives them the information that is needed in order to make correct investment decisions, (b) it prevents them from being “exploited” by traders having superior information, and (c) it constrains managers’ and controlling shareholders’ opportunistic behavior. In this last respect, the goal of investor protection equates that of agency cost reduction.

…continue reading: Disclosure and Financial Market Regulation

Agency Problems of Corporate Philanthropy

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday July 1, 2014 at 9:04 am
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Editor’s Note: The following post comes to us from Ronald Masulis, Professor of Finance at the Australian School of Business, and Syed Reza of the Finance Area at Queensland University of Technology.

While corporate charitable contributions are frequent and often substantial, there is no clear evidence in the literature on whether these expenditures have positive effects on firm revenues or performance or on shareholder wealth. In our paper, Agency Problems of Corporate Philanthropy, which was recently accepted at the Review of Financial Studies, we use contributions of American Fortune 500 firms during 1997-2006 and find in a variety of tests that corporate donations advance CEO interests and suggest that misuses of corporate resources that reduce firm value.

…continue reading: Agency Problems of Corporate Philanthropy

Shareholder Governance through Disclosure

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Thursday May 15, 2014 at 9:17 am
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Editor’s Note: The following post comes to us from Jordan Schoenfeld of the Department of Accounting at the University of Michigan.

Index fund sponsors today oversee about 18% of all mutual fund and ETF assets (or $2.3 trillion), but their ability to govern is hampered by a pressing need to keep expense ratios low (ICI, 2013). Thus traditional governance channels, such as evaluating and guiding project selection by managers (intervention), are foreclosed to them. Neither can these fund sponsors strategically trade in response to private information, because they must hold the index. Nonetheless, index fund sponsors would still like to govern their portfolio companies, because high index returns mean more inflows into their funds and fees. In my paper, Shareholder Governance through Disclosure, which was recently made publicly available on SSRN, I conjecture that index fund sponsors govern by asking management of firms to disclose more about their activities. These disclosures can facilitate the monitoring activities of all stakeholders and increase firm value, thus benefiting the index fund sponsor. For example, more disclosure enhances other blockholders’ monitoring activities and makes stock prices more informative about management’s actions. In addition, eliciting such disclosures about current projects undertaken by management does not require the index fund sponsor to invest in and acquire specific skills about how to run the business. This feature of disclosure makes it particularly attractive to index fund sponsors, who compete by keeping their expenses low.

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The Use and Abuse of Labor’s Capital

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday April 7, 2014 at 9:23 am
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Editor’s Note: The following post comes to us from David H. Webber of Boston University Law School.

Across the country, public employee retirement systems are investing in companies that privatize public employee jobs. Such investments lead to reduced working hours and often job losses for current employees. [1] Although, in some circumstances, pension fund participants and beneficiaries may benefit from these investments, their actual economic interests might also be harmed by them, once the negative jobs impact is taken into account. But that impact is almost never taken into account. That’s because under the ascendant view of the fiduciary duty of loyalty, pension trustees owe their allegiance to the fund first, rather than to the fund’s participants and beneficiaries. Notwithstanding the fact that ERISA and state pension codes command trustees to invest, “solely in the interests of participants and beneficiaries and for the exclusive purpose of providing benefits,” the United States Department of Labor declared in 2008 that the plain text of the quoted language means that the interests of the plan come first. [2] Under this view, plan trustees should de facto ignore the potentially negative jobs impact of privatizing investments because that impact harms plan members, and not, purportedly, the plan itself. Thus, in the name of the duty of loyalty, the actual economic interests of plan members in plan investments are subverted to the interests of the plan itself (or, at a minimum, to an unduly constrained version of the plan’s interests that excludes lost employer and employee contributions). As a result, public pension plans make investments that harm the economic interests of their members. This turns the duty of loyalty on its head.

…continue reading: The Use and Abuse of Labor’s Capital

The Corporate Governance Movement, Banks and the Financial Crisis

Editor’s Note: Brian Cheffins is a Professor of Corporate Law at the University of Cambridge.

The primary function of corporate governance in the United States has been to address the managerial agency cost problem that afflicts publicly traded companies with dispersed share ownership. Berle and Means threw the spotlight on this type of agency cost problem—using different nomenclature—in their famous 1932 book The Modern Corporation and Private Property. Nevertheless, it was only in the 1970s that the now ubiquitous corporate governance movement began. Why did the corporate governance movement gain momentum in the U.S. when it did? And given its belated arrival, why did it flourish during ensuing decades?

…continue reading: The Corporate Governance Movement, Banks and the Financial Crisis

Fact and Fiction in Corporate Law and Governance

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday November 18, 2013 at 9:39 am
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Editor’s Note: The following post comes to us from Michael Klausner, Nancy and Charles Munger Professor of Business and Professor of Law at Stanford Law School.

In a recent article, entitled Fact and Fiction in Corporate Law and Governance, I evaluate two broad elements of corporate governance scholarship—one conceptual and the other methodological. The conceptual element is the “contractarian” framework within which legal academics have analyzed corporate law since the 1980s. My evaluation is not aimed at the characterization of a corporation as a nexus of voluntary associations—a characterization that I think most of us share—but rather at the belief among some legal scholars that market forces lead to optimal governance arrangements within firms, and that a market dynamic leads states to compete to provide value-maximizing corporate law rules. The methodological element that I address is the use of corporate governance indices in empirical studies of corporate governance, an approach that dates back to the 1990s but that became widespread following Gompers, Ishii and Metrick’s development of the G Index in 2003.

…continue reading: Fact and Fiction in Corporate Law and Governance

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