In our paper, Looking in the Rear View Mirror: The Effect of Managers’ Professional Experience on Corporate Cash Holdings, which was recently made publicly available on SSRN, we study the role of managers’ professional experience in financial decision making, focusing on one of the most debated corporate policies in recent years – cash savings.

We focus our analysis on corporate cash policies because firms hold unprecedented, increasing levels of cash. In 1980, firms held $234.6 billion (in 2011 dollars) in cash, amounting to 12% of assets. By 2011, the amount of cash grew to $1,500 billion, or 22% of assets. The predominant approach to understanding corporate cash holdings is the precautionary savings motive. According to this motive, firms hold liquid assets to hedge against future states of nature in which adverse cash flow shocks, coupled with external finance frictions, may lead to underinvestment or default. While prior research shows that the precautionary savings motive explains much of the cash policy of firms, some suggest that managers are overly conservative in their decision to hold high levels of cash.

Motivated by psychological evidence, which shows that past experience affects individual decision-making, we argue that managers may behave conservatively because they experienced financial difficulties in their professional career. To test this hypothesis, we collect detailed data on managers’ employment histories and construct four measures of experience at firms that faced financial difficulties. These measures capture financial constraints and adverse shocks to cash flows and stock returns. To separate firm and CEO effects, the measures are based on prior employment at other firms.

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In the paper, Internal Governance and Real Earnings Management, which was recently made publicly available on SSRN, we examine whether key subordinate executives can restrain the extent of real earnings management. We focus on key subordinate executives, i.e., the top five executives with the highest compensation other than the CEO, because we hypothesize that they are the most likely group of employees that have both the incentives and the ability to influence the CEO in corporate decisions. As argued in Acharya et al. (2011), key subordinate executives have strong incentives not to increase short-term performance at the expense of long-term firm value. This tradeoff between current and future firm value is particularly salient in the case of real earnings management (as compared to accruals earnings management) because over production and cutting of R&D expenditures are costly and can reduce the long term value of the firm.

The motivation for the research question is twofold. First, the majority of the papers in the literature explicitly or implicitly assume that the CEO is the sole decision maker for financial reporting quality and the impact of other executives has been generally overlooked. Recent studies argue that subordinate executives usually have longer horizons and they can influence corporate decisions through various means. We hypothesize that differential preferences arising from differential horizons can affect the extent of real earnings management. Second, while there are studies focusing on the impact of external corporate governance (e.g., board independence and institutional ownership), little is known about whether there are checks and balances within the management team. This lack of knowledge is an important omission because control is not just imposed from the top-down or from the outside, but also from bottom-up (Fama 1980).

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In the paper, Managers Who Lack Style: Evidence from Exogenous CEO Changes, which was recently made publicly available on SSRN, we study managerial style effects in firm decisions by examining exogenous CEO changes in a panel of 8,615 Compustat firms from 1990 to 2007. The hypothesis that managers have varying preferences or traits that affect their corporate decisions has a great deal of intuitive appeal and is implicit in many discussions of leadership. Prior empirical evidence lends support to this general hypothesis and suggests that managerial style effects play a substantive role in firms’ investment and financing choices. This raises the possibility that much of the unexplained variation in these and related choices is driven by the identities of a firm’s leaders rather than more traditional factors such as various economic tradeoffs.

While prior research on this issue has generated many interesting findings, a major weakness arises from the fact that endogenous leadership changes are used to identify style effects. In this paper we overcome this weakness by identifying a large set of exogenous CEO changes arising from deaths, health concerns, and, in some parts of the analysis, natural retirements. Quite surprisingly, we find no significant evidence of abnormal changes in asset growth, investment intensity, leverage, or profitability subsequent to exogenous CEO changes.

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The widespread public criticism of boards of directors arising from the financial crisis, and the ensuing governance reform initiatives, should not have come as a surprise to those following trends in corporate governance. Instead, they should be seen as part of a series of developments in the evolving relationship between shareholders and their boards in the United States that has been underway for the past two decades. As the shareholder base has largely consolidated into the institutional investor community and those investors have become more organized and focused on exerting the influence inherent in their substantial ownership stakes, we have seen in recent years an accelerating shift in the “balance of authority” exercised by boards and shareholders in the corporate decision-making process.

There is no indication that this trend will reverse or even slow down significantly. Accordingly, directors should understand the origins and key drivers involved, and determine how they can most effectively adapt to this changing environment and secure the confidence and support of their companies’ shareholders.

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In the paper, Managerial Miscalibration, which was recently made publicly available on SSRN, we study whether top corporate executives are miscalibrated as well as the determinants of their miscalibration. Miscalibration is a form of overconfidence examined in psychology, economics, and law. Although it is often analyzed in lab experiments, there is scant evidence about the effects of miscalibration in practice.

Over the past nine years, we collected over 11,600 S&P 500 forecasts as well as 80% confidence intervals from Chief Financial Officers. The width of the confidence interval gives us a measure of miscalibration. Importantly, the CFOs are forecasting a common market-wide measure. This allows us to exploit cross-sectional heterogeneity in both optimism and miscalibration. By comparing forecasts to realizations over many periods, we also present a simple measure of miscalibration.

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In our paper Capital Allocation and Delegation of Decision-Making Authority within Firms, which was recently published on SSRN, we examine the allocation of capital and the delegation of decision-making authority within firms. Theoretical research examines how decision-making authority is delegated within groups. While the theoretical implications are far-ranging, there is a scarcity of empirical evidence about the delegation of authority within corporations (as noted by Prendergast (2002) and others). This paper provides some of the first empirical evidence that focuses on the delegation of decision-making authority with respect to major corporate policies. In particular, we study whether the chief executive makes decisions on her own versus delegating to lower-level executives and divisional managers.

We survey more than 1,000 CEOs and CFOs around the world to determine who within the firm makes five different corporate decisions: capital allocation, capital structure, investment, mergers and acquisitions, and payout. Most of our analysis focuses on the 950 CEO and 525 CFO survey respondents who work in U.S.-based companies, though we also examine smaller samples of Asian and European executives. Knowing the job title of the corporate decision-maker is important, given recent evidence that executive-specific fixed effects appear to drive some corporate policies.

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In my paper Empire-Building or Bridge-Building? Evidence from New CEOs’ Internal Capital Allocation Decisions, which was recently accepted for publication in the Review of Financial Studies, I examine CEOs’ decision-making processes for capital allocation in the context of power and relationships within corporations by investigating whether the job histories of CEOs influence their capital allocation decisions when they preside over multi-divisional firms. I investigate the capital allocation decisions made by 265 new CEOs at 230 diversified firms after turnovers between 1993 and 2002. CEO turnovers provide a good opportunity for this study because CEOs are likely to be most vulnerable to political complications at work when they are new to the post. In particular, I focus on the 98 new CEOs in my sample who advanced through the ranks from certain, but not all, divisions in their firms. I call these CEOs specialists and separate the segments in their firms into two groups based on their affiliation with the CEOs: divisions that the CEOs advanced through the ranks from (labeled the in-group), and the rest of the divisions (labeled the out-group). The empirical analysis in the paper focuses on changes in segment capital expenditures around CEO turnovers to determine whether specialist CEOs treat the in-group and the out-group segments differently when allocating capital after succession, and if so, whether they favor the in-group (“empire-building”) or the out-group (“bridge-building”) in their allocation decisions.

My results are broadly consistent with the bridge-building hypothesis. I find that, on average, the out-group segments experience a significant increase in capital expenditures after CEO turnover relative to the in-group segments. The average change in segment investment ratio (capital expenditures over assets) after a specialist CEO takes office is 0.013 higher for the out-group than the in-group, statistically significant at the 5% level or better. This difference of 0.013 is economically meaningful as it represents more than 20% of the average pre-turnover investment ratio of 0.06. Moreover, these findings also hold for specialist CEOs hired from outside the firm and are robust to the inclusion of segment-level, firm-level, and turnover-related controls as well as changes in the test specifications including the definition of specialists, the measure for capital expenditures, the time frame around turnover, and the sample period. I further test for the bridge-building hypothesis by examining whether the in-group and out-group difference in capital allocation change around turnover is related to the specialist CEO’s relative bargaining power within the firm. I find that the difference is more pronounced if the specialist CEO does not hold a corporate-level executive title such as chief operating officer or president before succession or if the in-group segments and the out-group segments are not in related industries. The results from the finer tests are consistent with the prediction of the bridge-building hypothesis that a specialist CEO with less power should engage in more bridge-building efforts, which imply a more pronounced pattern of reverse-favoritism in capital allocation.

While my results are consistent with the bridge-building hypothesis, a key concern is the issue of endogeneity. CEOs are chosen by the board of directors, and the job histories of CEOs are observable by the board and may be an important selection criterion in the board’s choice for nomination. Even though the most obvious and natural endogeneity story is one that would lead to a bias that works in precisely the opposite direction to the empirical findings in this paper, I consider alternative versions of the endogeneity story in which the CEO might be chosen to grow the segments in the out-group or to reduce investments in the in-group, leading to the relative increase in the capital expenditures of the out-group segments observed in the data. I use two approaches to address this concern. First, I try to discriminate against this type of endogeneity story by identifying weak divisions in the firm based on segment cash flow and segment Q. I find that the in-group and the out-group segments experience differential capital allocation change regardless of segment operating performance and segment investment opportunity. The difference in capital expenditure change is significant and of the same magnitude even when one compares the strong segments in the in-group with the weak segments in the out-group, inconsistent with what the endogeneity story might suggest. Second, I estimate a segment’s propensity to be a member of the out-group based on pre-turnover segment characteristics, and use the propensity scores as a summary measure to match the out-group segments and the in-group segments. Again, I find a relative increase in the average change in capital expenditures for the out-group compared with those of the in-group after a specialist CEO takes office. The magnitude and significance level of the estimate are similar to those of the main results, further alleviating the concern that endogeneity might account for the findings.

Finally, I investigate whether having a specialist CEO affects segment investment efficiency by studying the changes in the sensitivity of segment investment to Q before and after the CEO turnover. My results show that the sensitivity of segment investment to Q increases significantly after CEO turnover in a generalist’s firm, indicating an improvement in investment efficiency. Segments under a specialist CEO, however, do not experience such improvements: the investment sensitivity to Q for these segments is virtually unchanged after the turnover. In addition, I examine the market’s reaction to the announcement of the appointment of specialist versus generalist CEOs and find that the cumulative abnormal returns around announcements are significantly higher for incoming CEOs who are generalists. The market’s response corroborates the finding that generalist CEOs are associated with improved segment investment efficiency after turnover and suggests that appointments of generalist CEOs are perceived by the market as positive news for the conglomerates.

Overall, my results suggest that the job histories of CEOs are an important determinant of their capital allocation decisions and that new specialist CEOs are affected by political concerns in the capital allocation process. New specialist CEOs use the capital budget as a bridge-building tool to elicit cooperation from powerful divisional managers in previously unaffiliated divisions.

The full paper is available for download here.