Much corporate finance research is concerned with causation—does a change in some input cause a change in some output? Does corporate governance affect firm performance? Does capital structure affect firm investments? How do corporate acquisitions affect the value of the acquirer, or the acquirer and target together? Without a causal link, we lack a strong basis for recommending that firms change their behavior or that governments adopt specific reforms. Consider, for example, corporate governance research. Decisionmakers—corporate boards, investors, and regulators—need to know whether governance causes value, before they decide to change the governance of a firm (or all firms in a country) with the goal of increasing firm value or improving other firm or market outcomes. If researchers provide evidence only on association between governance and outcomes, decisionmakers may adopt changes based on flawed data that may lead to adverse consequences for particular firms.
Posts Tagged ‘Firm performance’
As the fallout from the financial crisis recedes and both institutional investors and corporate boards gain experience with expanded corporate governance regulation, the coming year holds some promise of decreased tensions in board-shareholder relations. With governance settling in to a “new normal,” influential shareholders and boards should refocus their attention on the fundamental aspects of their roles as they relate to the creation of long-term value.
Institutional investors and their beneficiaries, and society at large, have a decided interest in the long-term health of the corporation and in the effectiveness of its governing body. Corporate governance is likely to work best in supporting the creation of value when the decision rights and responsibilities of shareholders and boards set out in state corporate law are effectuated.
In our paper, Distracted Directors: Does Board Busyness Hurt Shareholder Value?, which was recently accepted for publication in the Journal of Financial Economics, we examine the impact of independent director busyness on firm value in a setting that addresses a key challenge that the board of directors is an endogenously determined institution. A large number of publicly-traded firms in the U.S. have recently limited the number of multiple directorships held by their board members. For example, a recent survey shows that 74 percent of S&P 500 firms impose restrictions on the number of corporate directorships held by their independent directors, up from 27 percent in 2006, and the Institutional Shareholder Services recommends restrictions on the number of multiple directorships. Although such shareholder initiatives are consistent with standard theoretical considerations (e.g., Holmstrom and Milgrom, 1992), the empirical evidence on whether director busyness has any effect on the firm is thus far mixed. While several studies find that busy directors are associated with lower firm valuations and less effective monitoring (e.g., Fich and Shivdasani, 2006; Core, Holthausen and Larcker, 1999) others either do not, or provide mixed evidence (e.g., Ferris, Jagannathan and Pritchard, 2003; Field, Lowry, and Mkrtchyan, 2013).
The JP Morgan Chase board of directors has vexed the world with its terse announcement in a recent 8-K filing that CEO Jamie Dimon would receive a big pay raise—$20 million in total pay for 2013, up from $11.5 million for 2012, a 74 percent increase.
Not surprisingly, the news sparked strong reactions, from indignant critique to justification and support. Dimon’s raise obviously has special resonance because JP Morgan’s legal woes were one of the top business stories last year as it agreed to $20 billion in payments to settle a variety of cases involving the bank’s conduct since 2005 when Dimon became JPM CEO. But the ultimate question that gets fuzzed-over in the filing and response is one of culture and accountability—whether a long-serving CEO is accountable for a corporate culture that has spawned major regulatory inquiries and settlements across a broad range of legal issues, even though the firm has otherwise performed well commercially.
It is often argued that venture capital (VC) plays an important role in promoting innovation and growth. Consistent with this belief, governments around the world have pursued a number of policies aimed at fostering local venture capital activity. The goal of these policies has been to replicate the success of regions like Silicon Valley in the United States. However, there remains scarce evidence that the activities of venture capitalists actually play a causal role in stimulating the creation of innovative and successful companies. Indeed, venture capitalists may simply select companies that are poised to innovate and succeed, even absent their involvement. In this case, efforts by policy-makers to foster local venture capital activity would be misguided. In our paper, The Impact of Venture Capital Monitoring: Evidence from a Natural Experiment, which was recently made publicly available on SSRN, we examine whether the activities of venture capitalists do indeed affect portfolio company outcomes.
In our recent NBER working paper, The Value of Corporate Culture, we study which dimensions of corporate culture are related to a firm’s performance and why. Resigning from Goldman Sachs, vice president Greg Smith wrote in a very controversial New York Times op-ed: “Culture was always a vital part of Goldman Sachs’s success. It revolved around teamwork, integrity, a spirit of humility, and always doing right by our clients. The culture was the secret sauce that made this place great and allowed us to earn our clients’ trust for 143 years.” He then adds “I am sad to say that I look around today and see virtually no trace of the culture that made me love working for this firm for many years.” In his follow-up book, Greg Smith seems to blame the demise of Goldman Sachs’s culture to its transformation from a partnership to a publicly traded company.
While highly disputed by the company, Greg Smith’s remarks raise several important questions. What constitutes a firm’s culture? How can we measure it? Does this culture—however defined and measured—impact a firm’s success? If so, why? And how can different governance structures enable or curtail the formation and preservation of a value-enhancing culture? In this paper we try to answer these questions.
In the past two decades, private equity buyout transactions have grown from a niche phenomenon to a ubiquitous form of corporate ownership (e.g., Strömberg, 2008). Traditionally buyouts have involved private equity funds buying companies or divisions from families or conglomerates: such transactions are known as primary buyouts (PBOs). A major trend accompanying the growth of private equity has been the rise of secondary buyouts (SBOs): transactions in which a private equity fund buys a company from another private equity fund. In our paper, The Performance of Secondary Buyouts, which was recently made publicly available on SSRN, we compare buyer returns in SBOs and PBOs.
Directors have two complementary functions in a firm: that of monitoring and offering strategic advice. Directors with current expertise in the firm’s own industry have the requisite information and therefore are clearly suited to perform these functions effectively. However, antitrust laws prohibit firms from having directors from other firms that compete in the same product market. Given these constraints, “directors from related industries” (DRIs) are well-positioned to perform these critical functions, particularly when firms face a severe information gap vis-à-vis their related upstream and downstream industries. For instance, DRIs can improve a firm’s ability to respond to demand/supply shocks or forecast trends in related upstream/downstream industries. They can also help shrink the information gap between the firm’s board and its managers regarding conditions in related industries, thereby enhancing the board’s ability to monitor managerial performance.
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.
In our paper, Determinants and Trading Performance of Equity Deferral Choices by Corporate Outside Directors, which was recently made publicly available on SSRN, we investigate the determinants and trading performance of outside directors’ “equity deferrals,” which represent the choice to convert part or all of the current cash compensation into deferred company stock. Director equity deferrals are interesting for two reasons. First, by deferring, the directors give up a sure amount of cash today for firm stock with an uncertain future value, while at the same time substantially increasing the proportion of their compensation that is tied to future firm performance. Second, the equity deferrals can become a form of insider trading, because directors can use these options as a tax-advantaged alternative to open-market purchases of the firm’s stock.
We examine director equity deferrals using a hand-collected sample of U.S. firms that allowed outside board members to defer their cash compensation into equity between 1999 and 2003. We first focus on the factors affecting director equity deferral choices. Consistent with a certainty equivalent story, we find that directors are more likely to defer cash into equity when they receive higher cash compensation levels and when the plans offer premiums for deferrals made into equity. Deferral likelihood also increases with the size of the taxes that are deferred.