Corporate executives pay considerable attention to secondary market prices and they have strong incentives to maintain or increase the level of their firms’ stock prices. The accounting literature has long recognized that managers can make strategic financial reporting or disclosure choices to influence stock prices. A large body of empirical research examines whether and how corporate disclosures affect stock prices. The literature, however, provides little directional evidence on whether the behavior of stock prices has a causal effect on managerial strategic disclosure decisions. The difficulty in establishing causality stems largely from the endogenous nature of stock prices. In the paper, Short Selling Pressure, Stock Price Behavior, and Management Forecast Precision: Evidence from a Natural Experiment, which is forthcoming in Journal of Accounting Research, we use a randomized experiment, the Regulation SHO pilot program, to examine the causal effect of stock price behavior on managers’ voluntary disclosure choices.
Posts Tagged ‘Stock performance’
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.
In our paper, Employee Satisfaction, Labor Market Flexibility, and Stock Returns Around The World, which was recently made publicly available on SSRN at, we study the relationship between employee satisfaction and abnormal stock returns around the world, using lists of the “Best Companies to Work For” in 14 countries.
Theory provides conflicting predictions as to whether employee satisfaction is beneficial or harmful to firm value. On the one hand, employee welfare can be a valuable tool for recruitment, retention, and motivation. For the typical 20th-century firm, the bulk of its value stemmed from its physical capital. In contrast, most modern firms’ key assets are their workers. Employee-friendly policies can attract high-quality workers to a firm and ensure that they remain within the firm, to form a source of sustainable competitive advantage.
The quality of the top management team of a firm is an important determinant of its performance. This is an obvious statement to many. Yet, there is little evidence that relates top management team quality to firm performance in a causal manner. Part of the challenge in doing so stems from assigning a measure to the quality of the top management team. There are, after all, various aspects of top managers that contribute to their performance, including their education, their connections and prior experience. Another reason that relating management quality to firm performance is hard is that one can argue that the best managers can simply select into the best firms to work in. This makes making causal statements extremely hard in this context. As a result, while one can point toward anecdotal evidence relating good managers to good performance (e.g., Steve Jobs of Apple), systematic evidence is lacking in the academic literature on this issue. The relation between management quality and firm performance is important in more than just an academic context. For instance, analysts frequently cite top management quality as a reason to invest in a stock. Thus, one needs to ask what they mean by “quality,” and does it really impact the future performance of the firm.
In our paper, In Short Supply: Equity Overvaluation and Short Selling, which was recently made publicly available on SSRN, we use detailed equity lending data to examine the role of constraints on equity prices. We find that constrained stocks underperform, the short interest ratio (SIR) has a nonlinear association with constraints, constrained stocks have negative returns regardless of short interest ratio, high short interest yet unconstrained stocks do not underperform, yet low short interest unconstrained stocks outperform. Moreover, we show that limited supply is a key feature distinguishing constrained and unconstrained stocks, and that among constrained stocks, those with the lowest supply have the strongest negative returns. Our findings confirm that supply varies across firms (in contrast to SIR, which assumes supply is 100 percent of outstanding shares for all stocks) and short supply in the equity lending market has implications for the informational efficiency of equity prices.
The State Board of Administration (SBA) sponsored an executive compensation research study by Farient Advisors LLC, covering 1,800 companies, 24 Industry groups, and fourteen years of data (from 1998-2011). The research project identifies the primary metrics used in executive compensation plans, overall and by industry, company size, and valuation premiums, and then tests these metrics to determine whether the metrics being used have the highest impact on total stock returns.
The study provides the most definitive answer to date on a critical question—are companies choosing their long-term incentive metrics wisely for the most sustainable benefit to shareowners?
Economic trends are sometimes more closely related to one another than news reports make them seem. For example, one regularly encounters reports of governments’ financial troubles, like the “fiscal cliff” in the United States and the debt crisis in Europe. And much attention has been devoted, often in nearby opinion pieces, to the view that hyperactive equities markets, particularly in the US and the United Kingdom, push large corporations to focus disproportionately on short-term financial results at the expense of long-term investments in their countries’ economies.
The two are not unconnected. And examining that connection provides a good opportunity to assess the weaknesses and ambiguities of the longstanding argument that a furiously high-volume stock-market trading shortens corporate time horizons.
In June 2011, the Secretary of State for Business, Innovation and Skills asked me to review activity in UK equity markets and its impact on the long-term performance and governance of UK quoted companies. The Review’s principal concern has been to ask how well equity markets are achieving their core purposes: to enhance the performance of UK companies and to enable savers to benefit from the activity of these businesses through returns to direct and indirect ownership of shares in UK companies. More detail on the background to the Review, including its terms of reference and the Interim Report, can be found at www.bis.gov.uk/kayreview.
This final report details the findings of the Review. Overall we conclude that short-termism is a problem in UK equity markets, and that the principal causes are the decline of trust and the misalignment of incentives throughout the equity investment chain. These themes of trust and incentives are central to this report. We set out principles that are designed to provide a foundation for a long-term perspective in UK equity markets and describe the directions in which regulatory policy and market practice should move. These high level statements are supported by specific recommendations that are aimed at providing the first steps towards the re-establishment of equity markets that work well for their users.
On June 28, 2012, the European Court of Justice (“ECJ”) issued an important judgment that will have a significant impact on the disclosure of non-public, price-sensitive information (so-called “inside information”) by public companies listed on stock exchanges in the European Union (“EU”). The decision clarifies the definition of inside information in cases where the circumstances relevant to the disclosure develop over time, potentially involving several intermediate steps. The ruling is the latest in a string of court decisions concerning the spectacular departure of Daimler’s CEO in summer 2005 and the company’s allegedly late disclosure of this event.
The issue before the ECJ was whether Daimler had met its obligation to timely disclose inside information. Under EU and German law, each issuer of securities is obliged to disclose inside information if (i) the information is sufficiently precise, (ii) relates to circumstances which are not publicly known, (iii) relates to one or more issuers of securities (or the securities themselves) and (iv) the information would likely have a significant effect on the price of the securities if it became publicly known. Future circumstances may also constitute inside information if they are sufficiently likely to occur. Issuers can temporarily delay disclosure if certain conditions are met.
The recent court decisions in United States v. Anthony Cuti et al. and United States v. Ferguson et al. highlight the increasing importance of correctly analyzing loss causation in criminal cases. In United States v. Cuti, a New York federal judge applied considerably shorter prison sentences than were recommended by prosecutors for two former executives of Duane Reade Inc. convicted of securities fraud. 
In United States v. Ferguson, the U.S. Court of Appeals for the Second Circuit overturned criminal convictions of four former General Re Corporation (Gen Re) executives and a former American International Group Inc. (AIG) executive.  Both court decisions were driven by conclusions that prosecutors failed to properly connect the alleged fraud to any actual losses.