Advances in Financial Economics: Volume 16

The change in CEO pay after their firms make large corporate investments is examined. Whether the change in CEO pay is a beneficial practice or harmful practice to firms is investigated.

A sample of firms that make large corporate investments is identified. For this sample, we identify the change in CEO pay before and after the investment, and we also measure the pay-for-size sensitivity of these investing firms.

For firms that make large corporate investments, CEOs get significantly more option grants when their firms’ stock returns are negative after the investments and these investing CEOs get more option grants than noninvesting CEOs.

The present study suggests that firms may have to increase CEO pay after large corporate investments to encourage investment. However, the results may also be consistent with an agency cost explanation. Future research should try to distinguish between the two explanations.

The study reveals a potential way to prevent CEOs from underinvesting.

The study provides important insights to shareholders on how to encourage CEOs to get their firms to invest, and on how to view CEO pay increases after their firms invest.

To explore the importance of the board of director nomination process (that is, who nominates a given director for a position on the firm’s board) for the voting outcomes, disciplining of management, and overall monitoring quality of the board of directors.

We exploit a recent regulation passed by the US Securities and Exchange Commission (SEC) requiring disclosure of the board nomination process. In particular, we focus on firms’ use of executive search firms versus allowing internal members (often simply the CEO) to nominate new directors to serve on the board of directors.

We show that companies that use search firms to find board members pay their CEOs significantly higher salaries and significantly higher total compensations. Further, companies with search firm-identified independent directors are significantly less likely to fire their CEOs following negative performance. In addition, companies with search firm-identified independent directors are significantly more likely to engage in mergers and acquisitions (M&A) and see abnormally low returns from this M&A activity. We instrument the endogenous choice of using an executive search through the varying geographic distance of companies to executive search firms. Using this instrumental variable framework, we show search firm-identified independent directors’ negative impact on firm performance, consistent with firm behavior and governance consequences we document.

Given the recent law passage, we are the first to directly analyze the nomination process, and show a surprisingly large predictive effect of seemingly arm’s-length nominations. This has clear implications for thinking carefully through how independence is defined in the director nomination process.

Exchange traded funds (ETFs) are one of the most innovative financial products listed on exchanges. As reflected by the size of the market, they have become popular among both retail and institutional investors. The original ETFs were simple and easy to understand; however, recent products, such as leveraged, inverse, and synthetic ETFs, are more complex and have additional dimensions of risk. The additional risks, complexity, and reduced transparency have resulted in heightened attention by regulators. This chapter aims to increase understanding of how ETFs function in the market and can potentially impact financial stability and market volatility.

We discuss the evolution of ETFs, growing regulatory concerns, and the various responses to these concerns.

We find that concerns related to systemic risk and excess volatility, suitability for retail investors, lack of transparency and liquidity, securities lending and counterparty exposure are being addressed by both market participants and policy makers. There has been a shift toward multiple counterparties, overcollateralization, disclosure of collateral holdings and index holdings.

The analysis contained in this chapter provides an understanding of the role of ETFs in the financial markets and the global economy that should be valuable to market participants, investors, and policy makers.

To determine what role overconfidence plays in the forced removal of CEOs internationally.

The study makes use of the Fortune Global 500 list.

We find that overconfident CEOs face significantly greater hazards of forced turnovers than their non-overconfident peers. Regardless of important differences in culture, law, and corporate governance across countries, overconfidence has a separate and distinct effect on CEO turnover. Overconfident CEOs appear to be at greater risk of dismissal regardless of where in the world they are located. We also discover that overconfident CEOs are disproportionately succeeded by other overconfident CEOs, regardless of whether they are forcibly removed or voluntarily leave office. Finally, we determine that the dismissal of overconfident CEOs is associated with improved market performance, but only limited enhancement in accounting returns.

This study is unique with its examination of overconfidence among global CEOs rather than being limited to U.S. chief executives. It also provides insight into how overconfidence is related to national cultures, legal systems and corporate governance mechanisms.

This study examines the director labor market to better understand which director attributes are important for board service.

Director level data, which includes proxies for both human and social capital, is analyzed to determine which characteristics increase the likelihood of gaining additional board appointments.

We find that general skills and director connections are valued in the marketplace. Among specific director characteristics, financial expertise, holding an MBA degree, and S&P 500 experience are positively associated with gaining new board appointments. Moreover, regardless of the director’s level of expertise, highly connected individuals are more likely to obtain new appointments. Finally, from a range of characteristics, only director connections mitigate the negative consequences of serving on the boards of firms that restate their financials.

While most research has analyzed the effectiveness of boards of directors as a whole, this study examines the value of individual director characteristics within the context of the labor market.

The chapter investigates three channels through which private benefits are hypothesized to be extracted in dual class companies: excess executive compensation, excess capital expenditures and excess cash holdings.

With a propensity score matched sample of S&P 1500 dual class and single class companies with concentrated control, the chapter analyzes the relationship between the valuation discount of dual class companies and measures of excess executive compensation, excess capital expenditure and excess cash holdings.

Executives in dual class firms earn greater compensation relative to their counterparts in single class firms. This excess compensation is more pronounced when the executive is a family member. The value of dual class shares is discounted most when cash holdings and executive compensation of dual class are excessive. Excess compensation is highest for executives who are family members of dual class companies. The dual class discount is not related to excess capital expenditures.

The research shows that the discount in the value of dual class shares in relation to the value of closely controlled single class company shares is directly related to the channels through which controlling shareholder-managers can extract private benefits.

Recent corporate scandals such as WorldCom, Enron, and others suggest a failure of corporate governance, that is, of the allocation of power and its lawful use and accountability within the corporation.

This chapter presents a game theoretic model for analyzing the power dynamics among the three groups responsible for oversight in the Anglo-American corporate model – namely the Board of Directors through its audit committee, corporate management, and the external auditors.

The chapter shows, among other findings, that the current governance structure results in an extreme imbalance of power among the three groups that not only permits but even induces management to conceal necessary financial data and often to ignore the long-term interests of the firm.

The chapter also derives changes in principles of governance that can right such imbalances and prevent defalcations from taking place through institutionalizing effective ex-ante checks and balances of power in addition to the ex post measures that come into play only after a wrong has been committed and which are the case with recent exchange rules and Congressional enactments.

None.

No prior analysis along these lines.