Table of contents(19 chapters)
Using a sample of 466 grants of stock options to executives of Japanese firms over the years 1997–2001, this study tests the managerial power theory of compensation design developed by Bebchuk, Fried, and Walker (2002) and Bebchuk and Fried (2004). This theory argues that managers of firms with weak corporate governance will use their “power” to design executive compensation that is “manager-advantageous.” Using our option grants sample, we test to determine if any of the firm's governance mechanisms are able to limit managerial self-dealing with respect to executive stock options. We find that smaller boards and a higher percentage of independent directors are important governance mechanisms for the control of managerial influences in the design of stock-option compensation. An alternative hypothesis, that firms elect to grant advantageously designed options to encourage risk taking by managers, is not supported by our empirical results. Finally, we determine that the market response to the announcements of such grants varies inversely with the extent to which the options are managerially advantageous. Overall, we conclude that managerial power effects are present in the design of executive stock options and that theory of managerial power advanced by Bebchuk et al. holds internationally.
We hypothesize that in a country with lax corporate governance rules Tobin's Q is maximized when controlholders’ vote approaches the supermajority level. In this holding range, controlholders do not possess extreme power (cannot pass supermajority decisions), nor do they feel a strong temptation to loot the firm (which largely belongs to them). Using a sample of 144 Israeli firms, we find that Tobin's Q is maximized when control group vote reaches 67%. This evidence is strong when ownership structure is treated as exogenous and weak when it is considered endogenous. Other ownership structure variables do not appear to have a significant valuation effect.
Corporate governance is regarded as a major issue during the post-financial crisis period in Asia. These countries have implemented corporate governance reforms to enhance the protection of shareholders and stakeholders interests. Such reforms have affected the conduct of business of all corporations in the region as it allows for greater monitoring especially by the shareholders. Unlike earlier studies which focused on non-financial firms, this study analyzes the corporate governance of listed banking firms in nine Asian emerging markets. Corporate governance mechanisms that serve to monitor the banking firms can be classified into Ownership Monitoring Mechanism, Internal Control Monitoring Mechanism, Regulatory Monitoring Mechanism, and Disclosure Monitoring Mechanism. This paper suggests that there are differences in the monitoring mechanisms of banking firms and non-bank firms.
On the Duty of Care of Institutional Investors: Evidence on Participation of Mutual Fund Managers in Shareholder Meetings in Israel
This paper analyzes Israeli mutual fund managers’ decisions regarding participation in shareholder meetings. The evidence suggests that the decision is affected by both the institution's and its beneficiaries’ interests. Consistent with the beneficiaries’ interest, the odds of attending are higher when the proposals to be voted upon could harm the fund's beneficiaries, than in other proposals, and the odds decrease with board independence. Consistent with the institution's interests, the odds that mutual funds managed by commercial banks will participate in shareholder meetings are found to be negatively related to the corporation's bank debt level. Surprisingly, despite their legal obligation, only 27% of the mutual fund managers expected to attend a meeting actually do so.
This model explains dividends as a component of a contract set up by an uninformed principal. I start from a well-documented empirical fact that there is a relation between dividends declared and executive compensation. I find that when hidden information is about the productivity of the agent then dividend – conditional on cash available – bears a negative relationship to managerial type. That is, for a given level of available cash, the lower type manager declares a higher dividend than that declared by a manager with higher productivity. The result is robust under different model extensions. I also discuss empirical implications of the model.
Our study examines CEO compensation for firms that announce layoffs during the 1993–2001 period. We find that overall there is a large increase in CEO equity-based compensation in the year prior to and the year of the downsizing. Our sample of downsizing firms has small improvements in operating performance following the announcement. However, these performance improvements manifest themselves in the low but not the high equity-based compensation firms. We find that the announcement period returns are higher for downsizing firms that are larger, hire a new CEO in the year prior to the downsizing, have higher leverage, and better operating performance.
Some commentators suggest that the Wall Street views family firms with scepticism. The appointment of independent directors to form a majority on a firm's board of directors should constitute a strong signal to the market of a family firm's willingness to be monitored objectively and thus should alleviate Wall Street's scepticism. This is likely to be more important for the newly public family firms than for mature family firms since outsider-domination on the board pre-dates the involvement of other outsiders, such as underwriters, financial analysts, or institutional investors. Whether the presence of an independent board alleviates the market's scepticism may be evident in the responses of various external monitoring entities to the newly public family and non-family firms. Using a hand-collected sample of newly public firms, we cast brand-new light on whether an independent board provides any advantage to the newly public family firms in underwriter reputation, analyst coverage, and investment by institutional investors over newly public non-family firms. We find that independence of board of directors is overall a positive signal and that while the independence of board is more important than the independence of management for underwriters and financial analysts, the reverse is the case for institutional investors.
Ownership Structure, Financial Rent and Performance: Evidence from the Malaysian Manufacturing Sector
This paper addresses the interaction relationship between debt financing and ownership structure towards firms’ value in Malaysia. Two issues are addressed in this study. The study examines whether managers and controlling large shareholders pursue rent-seeking objective through excessive leverage in a firm. Second, the paper examines whether financial restraint policy is effective in enhancing corporate governance. The sample of the study covers a small economy – Malaysia where rent-seeking opportunities prevail. A total 256 manufacturing firms are examined. The hypotheses are set to examine whether rent seeking prevails in firms with high intangible asset and less competitive industries. The findings show that first, financial restraint policy is only effective when managerial equity interest is relatively low. Managers with a higher equity interest hinder the positive effects driven by financial restraint policy. Second, at a higher threshold of equity interest, the use of excessive leverage by managers leads to a lower firm value, confirming the presence of rent-seeking motive. The presence of the largest shareholder as directors also follows the same conjecture despite at a lower magnitude. Both findings could not be refuted in less competitive industries. Other findings from this paper conclude that a high industrial concentration industry increases firms’ value in this economy. Financial institutions can also exert corporate governance on firms in less competitive industries. It is, however, the agency problem mitigates the positive effects brought forth by financial rent in this emerging economy.
We examine the relationship between how mutual fund sponsors configure their board(s) of directors and the performance of the funds under a particular board's purview. Fund sponsors utilize either one board to oversee all the funds within a fund family or multiple boards that oversee one fund or a subset of the family's funds. Our results suggest that fund families – that is, sponsors – that use multiple boards have significantly higher objective-adjusted board-level weighted excess returns. But, there are no significant differences in the objective-adjusted board-level weighted excess expenses. These results are consistent with the argument that multiple boards provide superior monitoring.
This study provides evidence that Chinese initial public offerings (IPOs) report better operating performance than industry peers in the pre-IPO period, and worse performance in post-IPO period compared to the pre-IPO level. We find that related party transactions (RPTs) with controlling shareholders have significant effects on the long-run performance of IPO firms. Controlling shareholders structure a large percentage of operating (non-loan) RPTs to artificially boost revenues and/or profits of their IPO subsidiaries in the pre-IPO period. However, in the post-IPO period, controlling shareholders discontinue this RPT-based earnings manipulation practice and begin to expropriate IPO subsidiaries by obtaining a large percentage of cash loans, primarily in return for profits and/or resources transferred into the IPO subsidiaries in the pre-IPO period. Finally, we find that state-controlled IPO firms with a highly concentrated ownership structure and a less independent board of directors are more likely to be expropriated by controlling shareholders in the post-IPO period through related loans.
In some contexts, this illiquidity of executive stock options is referred to as non-transferability. In others, the problem is cast in terms of the highly concentrated portfolios that managers hold, an implication of which is that managers could not trade the options to diversify. The notion of option liquidity usually conjures up images of trading pits at the Chicago Board Options Exchange or other exchanges. The existence of an active trading pit gives a powerful visual image of liquidity, but, as evidenced by the success of electronic options exchanges such as New York's International Securities Exchange and Frankfurt's EUREX, a trading pit is hardly a requirement for liquidity. The existence of a guaranteed market for standardized options as implied by options exchanges (whether pit-based or electronic) further gives a misleading appearance of high liquidity. There is also a very large market for customized over-the-counter options. It is a misconception to think that these options are not liquid when they are simply not standardized. If an investor can create a highly customized long position in an option, that investor should be able to create a highly customized short position in the same option at a later date before expiration. If both options are created through the same dealer, they will usually be treated as an offset, as they would if they were standardized options clearing through a clearinghouse. If the two transactions are not with the same dealer, they would both remain alive, but the market risks would offset. Only the credit risk, a factor we ignore in this paper, would remain. Hence, these seemingly illiquid options are, for all practical purposes, liquid.2
This paper estimates the conditional hazard baseline (term-structure) of the hazard rate to default at the time of bonds’ issuance by using two hazard models–one ignoring and another allowing unobserved heterogeneity (UH) in the hazard rate. Following Diamond (1989) one can predict a declining hazard rate to default due to adverse selection and moral hazard. After controlling for UH caused by adverse selection and time-series shocks, the hazard rate shows to be increasing over time and hence the moral hazard effect cannot be confirmed.
Financial Sector Development and Sustainable Economic Growth in Regionally Co-Integrated Emerging Markets
This paper presents new evidence of the relationship between financial market development (banking sector) and economic growth for a set of seven Middle East and North African economies over the period 1965–2002. We find evidence that in six of the seven countries, banking-sector development Granger causes increases in economic growth. However, in three of those six countries, economic growth also Granger causes banking development. Our co-integration analysis reveals that there is a stable long-run equilibrium relationship between banking-sector development and economic growth for all our countries. However, based on vector error-correction models, there is limited evidence that banking-sector development boosts economic growth in the short run.
We examine whether systematic risk of the financial services industry (banks, finance, insurance, and real-estate sectors) declined after the passage of GLBA. This study differs from prior work in that we examine changes over a long period of time (5 years before and 5 years after the Act) and we use the Carhart (1997) four-factor model for assessing changes in risks. The study finds that banks, insurance, finance, and real-estate segments load on the market, size, and value factors before as well as after GLBA (the real-estate segment loads on the value factor only after GLBA). Except for finance companies, betas decline significantly for all the other segments after the GLBA. In the case of banks even their loadings on the size and value factors decline after the GLBA, while in the case of finance and real-estate companies the loadings on the momentum factor exhibits reduction in risk after the Act. Overall, the GLBA had a risk reducing impact on the financial services industry.
How do Small Firms in Developing Countries Raise Capital? Evidence from a Large-Scale Survey of Kenyan Micro and Small-Scale Enterprises
We utilize a unique comprehensive dataset, drawn from the 1999 baseline survey of some 2000 micro and small-scale enterprises (MSEs) in Kenya. We analyze the financing behavior of these enterprises within the framework of a heterodox model of debt-equity and gearing decisions. We also study determinants of the success rate of loan applications. Our results emphasize three major findings. First, MSEs in Kenya obtain debt from a wide variety of sources. Second, debt-equity and gearing decisions by MSEs and their success rates in loan applications can all be understood by relatively simple models which include a mixture of conventional and heterodox variables. Third, and in particular, measures of the tangibility of the owner's assets, and the owner's education and training have a significant positive impact on the probability of borrowing and of the gearing level. These findings have important policy implications for policy makers and entrepreneurs of MSEs in Kenya.
U.S. venture capital financings of U.S. entrepreneurial firms with up to 213 observations are consistent with the proposition that convertible preferred equity is the optimal form of venture capital finance. This paper introduces new evidence from 208 U.S. venture capital financings of Canadian entrepreneurial firms. In contrast to U.S. venture capital investments in U.S. entrepreneurial firms, U.S. venture capitalists finance Canadian entrepreneurial firms with a variety of forms of finance. The differences between domestic and international U.S. venture capitalist financing structures are not attributable to differences in the definition of the term ‘venture capital’. The data point to the importance of institutional determinants of venture capitalist capital structures within the U.S. and abroad. Among other things, the data indicate that U.S. venture capitalists often do not choose convertible preferred shares in the absence of tax considerations in favor of that financing vehicle.
Operational Hedges and Foreign-Exchange Exposure: The Experience of U.S. MNCs During the Asian Financial Crisis
This study provides evidence on the importance of operational hedges in foreign-exchange risk management, an issue that has been largely ignored in the literature. One possible reason for the absence of empirical evidence in the literature may be related to the difficulty in devising the appropriate measures of a firm's ability to construct operating hedges. We utilize measures of the structure of an MNC's foreign subsidiary network as proxies of the firm's ability to devise operational hedges and examine their relationship to exposure coefficients computed prior to and during the 1997–1998 Asian currency crisis. Our results show that the mean exposure during the Asian crisis period was significantly higher than the pre-crisis period. In addition, the mean of the absolute change in the exposure of MNCs that only operate in the Asian crisis region was significantly higher than that of MNCs without operations in the crisis region. We find a strong relationship between our proxies for ability to construct operating hedges and exchange-rate exposure measures both prior to the crisis and during the crisis. An even stronger association between exposure and measures of the MNC network structure is found for the sub-sample of MNCs that have some operations in the Asian crisis region. Similar results are obtained when the relationship is examined separately for “net importers” (MNCs with positive exposures) and “net exporters” (MNCs with negative exposures). Overall, our results are consistent with the notion that operational hedges significantly reduce a firm's exposure to foreign-exchange risk.
In this paper, we investigate the New Zealand stock market reactions to both on-market and off-market share repurchase programmes for the period 1995–2004. Share repurchases have become more frequent in New Zealand in recent years, though the size and the number of repurchases are still small by international standards. The main reason appears to be the presence of the dividend imputation system which diminishes the tax consequences of cash dividends compared to capital gains. On the whole, we observe that the market reacts positively and significantly to the share repurchase announcements. The magnitude of average abnormal returns for the on- and the off-market repurchases on the announcement day are 3.25 and 3.12% respectively. We further observe the reasons companies undertake stock repurchase are consistent with the investment and free cash flows agency hypotheses.