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Subordinate executives' horizon and firm policies
Abstract
Motivated by the internal governance theory, we investigate the links between subordinate executives' horizon and firm policies. Using the number of years to retirement to capture subordinate executives' horizon inside the firm, we find that subordinates' horizon is positively associated with firm's risk-taking, long-term investments growth, and research and development productivity, but negatively related to the dividend decision and the payout ratio. We also find a positive relationship between subordinates' horizon and firm value. Our results are robust to controlling for alternative explanations including the pay gap between CEO and subordinate executives, executives' overconfidence, CEO's decision horizon, and other governance mechanisms. The results are also robust to alternative measures of subordinates' horizon, and after addressing potential endogeneity concerns.
... We find that key subordinate executives serve an important monitoring role and can effectively counterbalance the CEO's self-serving behavior. Our study builds on only a handful of studies dedicated to executive power distribution and the bottom-up monitoring of subordinate executives (e.g., Cheng et al. 2016;Jain et al. 2016;Li 2014;Mekhaimer, Abakah, Ibrahim, and Hussainey 2022;Xie, Chen, and Liu 2021). Specifically, we examine the role of subordinate executives in conservative accounting. ...
... Jain et al. (2016) show that internal governance is associated with lower information asymmetry and higher liquidity. Mekhaimer et al. (2022) find that subordinate executives' horizon motivates long-term investments growth. ...
... We utilize two instruments: (1) the industry-adjusted age difference (IndAdjDiff_Horizon) and (2) the industry-year median value of internal governance (IndYear_IG). Following Mekhaimer et al. (2022), we use the industry-adjusted age difference (IndAdjDiff_Horizon) between the CEO and key subordinate executives as the first instrument. This measure, detailed in Equation (7), compares the decision horizons of the CEO with the decision horizons of subordinate executives, relative to other executives in the industry. ...
Financial reporting decisions can be influenced by the distribution of executive decision-making power. We examine whether internal governance, the process through which the power to make decisions is distributed between CEOs and their subordinates, can influence the level of conservatism in such decisions. We show that firms with better internal governance are more conservative. We also find that the effect is more pronounced for firms with less powerful and older CEOs, those with subordinate executives who contribute more, and those who are more mature. We conduct various tests that confirm the robustness of our results. Unlike other studies that focus only on CEOs, we examine how the top management team as a group and the power distribution between CEOs and key subordinates shape financial reporting quality. Our study can inform various stakeholders, including firms aiming to appoint executives and strengthen their internal governance.
JEL Classifications: G34; M12; M41; M50.
... On one side, external market pressures push the CEO to focus on short-term performance and discourage risk-taking ( Edmans et al., 2017 ;Holmström, 1982 ). However, subordinate managers usually have an extended horizon in the firm and focus on the firm's longterm performance ( Cheng et al., 2016 ;Mekhaimer et al, 2022 ). Acharya et al. (2011) hypothesize that the difference in horizons inside the management team and subordinates' ability to withdraw their contributions to the firm can form an internal governance mechanism that influences the CEO to act in a more public-spirited and far-sighted way. ...
... Our work reveals an additional critical characteristic that determines the quality of the management team and their ability to promote innovation, namely, the difference in expected time horizon between a CEO and her executive subordinates. Our focus on executive subordinates is also closely connected to earlier theoretical ( Acharya, Myers, and Rajan, 2011 ;Landier, Sraer, and Thesmar, 2009 ) and empirical work ( Cheng, Lee, and Shevlin, 2016 ;Jain, Jiang, and Mekhaimer, 2016 ;Mekhaimer et al., 2022 ) that stress the important role of subordinate executives as a bottomup governance mechanism, that provides checks and balances in the organization to affect corporate decisions. ...
... Following Cheng et al. (2016) and Mekhaimer et al. (2022) , we define Sub. Rem. ...
We investigate the relationship between internal governance and firms’ innovation. We hypothesize that internal governance stemming from the difference in expected employment horizons between a CEO and her subordinate executives improves a firm’s innovation. Using the age difference between a CEO and her subordinate executives as the primary measure of internal governance, we find a strong positive relationship between internal governance and firms’ innovation output, and scientific and economic values. We show that the positive relation is causal and robust based on empirical tests including exogenous variation in internal governance resulting from non-forced CEO turnovers. We further show that the relationship between internal governance and innovation is more pronounced when external governance is weaker and when subordinate executives are expected to have more influence on the board. Cross- sectional analysis shows that internal governance spurs innovation in younger firms, firms led by generalist CEOs, and when the likelihood of insider successions is higher.
... We further include firm-fixed effects in our equations when appropriate to control for unobserved heterogeneity of a firm-specific and/or time-invariant nature. Thus, this addresses the concern that estimated coefficients are biased due to omitted variables, and time-invariant characteristics such as firm culture, attitudes and/or beliefs that might affect a firm's M&A choices and outcomes (Ahmed & Elshandidy, 2018;Faccio et al., 2016;Mekhaimer et al., 2022). ...
... Consistent with prior research (Adams et al., 2010;Farrell and Hersch, 2005;Hermalin & Weisbach, 1988), we employ a two-stage least squares (2SLS) statistical technique to address endogeneity concerns related to possible omitted variables. Following previous studies (e.g., Flabbi et al., 2019;Xing et al., 2021;Mekhaimer et al., 2022), we employ four instrumental variables: the regional trend in the percentage of female directors, the regional trend in the percentage of female executives, the multiplication of these two instruments, and province gross domestic product (GDP) growth. This procedure assumes that aggregate trends in the gender diversity on board at the regional level are unrelated to the time-varying firm-level heterogeneity that leads to endogeneity. ...
This paper examines whether gender diversity influences foreign merger and acquisition (M&A) premiums and outcomes in China. Consistent with agency and resource dependence theories, we find that female directors significantly reduce the acquisition premium paid for foreign targets. We show that the market responds positively in the short-term (measured by cumulative abnormal returns) to the announcement of foreign acquisitions by firms with greater female representation in the boardroom. We further find significant evidence that acquirers’ boards comprising more female directors experience value creation and better operating synergies (measured by buy-and-hold abnormal returns and changes in return on assets) in the long-term following engagement in foreign M&A deals. Interestingly, after distinguishing between female independent and executive directors, we find that our previous finding on board gender diversity can be attributable to both the monitoring (independent directors) and supervisory (executive directors) roles played by female directors. We also find evidence accords with the argument of the critical mass of female directors’ representation in the boardroom. Our results are robust after controlling for endogeneity issues using instrumental variables (IV), propensity score matching (PSM), Heckman, and firm fixed-effects methods. Overall, our findings offer additional empirical support for the global concern by regulators for improving corporate governance practices by increasing female quotas in the boardroom.
... Mekhaimer, M. et al. based on the theory of internal governance incentives to explore the relationship between the horizon of the subordinate executives and the corporate policy, pointing out that the horizon of the executives and corporate policy is more important. The relationship is noted to be positive, with executives' horizons positively related to firm risk-taking, long-term investment growth, and R&D productivity, but negatively related to dividend decisions and payout ratios [15]. Chen, X. et al. examined how the operational risk of underwritten policies affects the insurer's role in dealing with portfolio investment risk. ...
... Peizhong Lu. Applied Mathematics and Nonlinear Sciences, 9(1) (2024)[1][2][3][4][5][6][7][8][9][10][11][12][13][14][15][16] ...
This paper introduces the GAS framework into the research problem of financial asset risk in the financial management of enterprises in the information age, gives the basic expression of the GAS framework model, improves based on the basic expression, and combines it with the traditional GARCH model to construct the GAS-GARCH-sst model. After that, the study of financial investment risk is extended further by constructing the GAS-factor Copula model, and when the parameters of the model are extrapolated, a two-step estimation method is used, i.e., the parameters of the marginal distribution and the parameters of the Copula model are extrapolated separately. Finally, with the help of the GAS-Factor Copula model, the financial investment risk analysis of ML Company can shows that the return on net assets, return on total assets and cost-expense margin of ML Company are lower than the industry average since 2020, and the growth rate of operating income has changed greatly, ranging from -354.88% to 54.3%. Cost-expense margin has been declining consistently since 50.1% in 2017, while cash inflow in investing activities is only 1.9%-17.57% of cash outflow in 2016-2021. This indicates that ML is facing the challenge of financial risk in various financial investments in the information age.
... We further employ a firm fixed effects regression model to account for any possible bias that would arise in the dependent variable due to unobserved heterogeneity of firm-specific and/or industry-specific effects; it also excludes the effects of time-invariant covariates (Elsayed & Elshandidy, 2021). 6 This also addresses any possible endogeneity concerns due to omitted variables (Mekhaimer et al., 2022). Table 8 reports results that are qualitatively consistent with our previous findings and further confirms that the relationship between faultline strength and ESD is not driven by firm-specific unobservable factors. ...
By creating a comprehensive corporate social- and environmental-related lexicon, this paper examines the extent to which board diversity impacts social and environmental disclosures. Contributing to diversity literature, we rely on the faultlines concept, postulated and developed by organizational research, which is hypothetical dividing lines that split a boardroom into relatively homogeneous subgroups based on directors’ diversified attributes. Employing a sample of FTSE All-share non-financial firms, our findings show that firms with higher faultline strength in the boardroom (i.e., relatively more homogeneous subgroups) exhibit significantly lower levels of both social and environmental disclosures in their narrative sections of annual reports. This implies that board diversity faultlines are likely to have a detrimental effect on corporate boards regarding reaching a consensus decision on disclosing information on social and environmental aspects. Our results remain robust after a battery of sensitivity tests and addressing potential endogeneity problems. Our results provide timely evidence-based insights into major recent structural reforms aiming at proposing remedies to corporate governance problems in the UK, specifically that interest should not be confined to board diversity per se but configurations (the extent of convergence) between the diversified attributes. Furthermore, the evidence provided by our paper should be of interest to the UK’s regulatory bodies (Financial Reporting Council) considering their increasing focus and pursuit to understand the underlying challenges of corporate social and environmental reporting.
... In Table 3, consistent with prior research, we address possible endogeneity concerns using various powerful econometric techniques. In column 1 of Table 3, we employ a firm-fixed effects regression to address the omitted variable concern and to control for unobserved heterogeneity of a firm-specific and/or time-invariant nature (Mekhaimer et al., 2022). In column 2 of Table 3, we address the possible simultaneity problem by using lagged independent variables, which technically works as a dynamic generalized method of moments estimation (Zalata & Abdelfattah, 2021). ...
The informativeness of textual risk disclosure (TRD) of financial firms is unexplored in the extant literature. Employing a sample of UK FTSE all-share financial firms, this paper fills this gap in the literature by providing the first empirical evidence on the relationship between TRD and market liquidity. Consistent with the convergence argument for TRD, we find that TRD decreases the financial firms' market liquidity. However, consistent with the divergence argument for TRD, our further analysis shows that TRD increases the market liquidity of large financial firms. Overall, our results suggest that financial firms' TRD is informative to market participants. In addition to the practical and policy implications of our results, this paper opens avenues for future research to use our textual method to measure the determinants and use risk information of financial firms in different contexts.
... The market has difficulty determining the true economic prospects of firms. However, the market can infer economic prospects from a firm's investment level (Bebchuk and Stole 1993;Bizjak et al. 1993;Trueman 1986), subordinates' horizon (Mekhaimer 2022), or by a specific project type (Hirshleifer et al. 2001). Investment decisions act as a signal to the market about the firm's economic state. ...
A Corporate Social Responsibility (CSR)-myopic firm is one that experiences greater-than-normal operating profits but scores worse in its CSR ‘strength’ or ‘concern’ rankings than is normally expected during the same year. We show that myopic behavior in CSR concerns (strengths) are positively (negatively) related to myopia in other conventional discretionary investments such as marketing, R&D, and capital expenditures. We find that large, highly leveraged firms are less likely to be myopic regarding CSR concerns and other discretionary investments; such firms are more likely to engage in myopic behaviors concerning CSR strength. Myopic firms tend to have lower contemporaneous and future risk-adjusted abnormal returns.
... techniques. In column 1 of Table 3, we employ a firm-fixed effects regression to address the omitted variable concern and to control for unobserved heterogeneity of a firm-specific and/or time-invariant nature (Mekhaimer et al., 2022). In column 2 of Table 3, we address the possible simultaneity problem by using lagged independent variables, which technically works as a dynamic generalized method of moments estimation (Zalata and Abdelfattah, 2021). ...
... Finally, we follow Mekhaimer et al. (2022) and Serfling (2014) and utilize the natural logarithm of average consumer price index (Ln CFO Birth CPI) that corresponds to the birth years of CFOs as the third instrument for CFO career concerns. 21 The CPI is on average increasing over time which satisfies the relevance condition as there is a positive association between CPI and the remaining horizon of CFO. ...
We find that firms led by Chief Financial Officers (CFOs) who are relatively more concerned about their future job prospects are less likely to take actions that result in poor discretionary quality reporting during an Initial Public Offering (IPO). In addition, our results show that CFOs with more serious career concerns are encouraged to undertake rightful actions among firms which are headquartered in the states that have stricter enforceability of non-compete clauses, when they face greater (reputation, litigation, and job status) penalties associated with distorted financial reports, or when they are subject to stringent monitoring. Finally, we document that CFOs with greater career concerns are associated with better post-IPO labor market outcomes. Overall, our findings indicate that career concerns play a disciplining role during IPOs and that CFOs exploit these high-visibility events to accelerate their career trajectory.
This study investigates the relationship between organization capital, dividends, and firm value across 61 countries. We find that firms with higher organization capital distribute more dividends. By exploiting changes in the stringency of national labor regulations, we demonstrate that this effect strengthens when labor markets become more flexible. Additionally, we document that the market places a premium on dividend payouts from firms with higher organization capital. Further analysis reveals that this premium differential and the positive organization capital-dividend payouts relationship, are more pronounced in firms and countries marked by substantial agency issues. The robustness of our evidence is affirmed through several endogeneity tests, supporting the agency view of organization capital.
Using executives' decision horizon as a measure of internal governance, this study examines the association between customer's internal governance and supplier's extension of trade credit. Suppliers may extend more trade credit to customers with strong internal governance because of their lower operational risk, higher firm performance, and better information environment. However, firms with better internal governance may have easier access to other sources of financing, and thus may need less trade credit. Using a sample of US listed firms between 1992 and 2021, we find that suppliers extend more trade credit to customers with strong internal governance. We also find that the association between internal governance and trade credit is more pronounced for financially, and informationally constrained firms. Our results are robust to alternative measures and specifications. Incremental to prior studies, we show that effectiveness of customers' internal governance affects suppliers' lending decisions.
Manuscript Type: Empirical
Research Question/Issue: The objective of this study is to examine whether the effectiveness of internal governance is associated with internal control material weaknesses. We employ the concept of internal governance as the checks-and-balances mechanism that subordinate executives apply to the chief executive officer (CEO). We predict that with long horizons and long-term interests aligned with firms’ long-term growth, subordinate executives may have the incentive to support a high-quality internal control system, which is an important factor contributing to firms’ long-term success.
Research Findings/Insights: Using data on CEOs’ and other highest-paid executives’ age and compensation to measure the effectiveness of internal governance, we empirically find consistent evidence that internal governance effectiveness is associated with higher internal control quality. In particular, we find that effective internal governance is related to a lower likelihood of firms reporting internal control material weaknesses, fewer material weaknesses in internal control (ICMWs), a lower chance of firms disclosing internal control weaknesses for multiple years, and a lower probability of firms reporting entity-level and/or account-level material weaknesses in internal control. We also show that among the two factors forming the internal governance measure, only subordinate executives’ horizon is associated with the probability of firms disclosing ICMWs. Our further analysis reveals that the probability of reporting ICMWs is lower for growth firms with effective internal governance.
Theoretical/Academic Implications: Our findings contribute to the literature on internal governance and internal control quality. The impact of the checks-and-balances mechanism inherent in internal governance on firms’ investment in the internal control system and thus the probability of disclosing ICMWs has not received sufficient attention from accounting researchers. While prior studies focus on individual members of the management team, our finding implies that the quality of the internal control system is a result of the joint effort of the whole management team. Unlike the extant literature that captures only certain aspects of reporting quality and information disclosures, our study emphasizes the role of the horizon dimension of internal governance in enhancing the reliability of financial reporting (measured as the quality of the internal control system).
Practitioner/Policy Implications: Our results shed light on the important role of subordinate executives in monitoring CEOs’ short-term interests.
This paper documents the existence of a CEO investment cycle, in which disinvestment decreases over a CEO's tenure, while investment increases, leading to “cyclical” firm growth in assets and employment. The estimated variation in investment rate over the CEO investment cycle is of the same order of magnitude as the differences caused by business cycles or financial constraints. Results from a number of tests generally support the view that the investment cycle is caused by agency problems, leading to increasing investment quantity and decreasing investment quality over time as the CEO gains more control over his board.
Received February 17, 2015; accepted October 1, 2015 by Editor David Denis.
The literature posits that some CEO overconfidence benefits shareholders, though high levels may not. We argue that adequate
controls and independent viewpoints provided by an independent board mitigates the costs of CEO overconfidence. We use the
concurrent passage of the Sarbanes-Oxley Act and changes to the NYSE/NASDAQ listing rules (collectively, SOX) as natural experiments,
to examine whether board independence improves decision making by overconfident CEOs. The results are strongly supportive:
after SOX, overconfident CEOs reduce investment and risk exposure, increase dividends, improve postacquisition performance,
and have better operating performance and market value. Importantly, these changes are absent for overconfident-CEO firms
that were compliant prior to SOX.
To control risk-related incentive problems, equity holders are expected to manage both the convexity and slope of the relation between firm performance and managers’ wealth. I find stock options, but not common stockholdings, significantly increase the sensitivity of CEOs’ wealth to equity risk. Cross-sectionally, this sensitivity is positively related to firms’ investment opportunities. This result is consistent with managers receiving incentives to invest in risky projects when the potential loss from underinvestment in valuable risk-increasing projects is greatest. Firms’ stock-return volatility is positively related to the convexity provided to managers, suggesting convex incentive schemes influence investing and financing decisions.
This study examines aspects of pay and promotion in corporate hierarchies in the context of tournament theory. Evidence supports the tournament perspective in that most positions are filled through promotion and pay rises strongly with hierarchical level. Furthermore, the winner's prize in the CEO tournament increases with the number of competitors for the CEO position. Not all evidence is supportive: the square of the number of competitors is negatively associated with the CEO prize. Additionally, firms do not appear to maintain short-term promotion incentives, as lengthier time in position prior to a promotion reduces the pay increase from the promotion. Copyright 2001 by University of Chicago Press.
We show that the incentive for managers to build their reputations distorts firms’ investment policies in favor of relatively
safe projects, thereby aligning managers’ interests with those of bondholders, even though managers are hired and fired by
shareholders. This effect opposes the familiar agency problem of risky debt that is imperfectly covenant-protected, wherein
shareholders are tempted to favor excessively risky projects in order to expropriate bondholders. Consequently, when managerial
concern for reputation results in conservatism, it can actually make shareholders better off ex ante by allowing the firm
to issue more debt. We examine how the optimal choice of leverage from the shareholders’ standpoint is influenced by takeover
activity, and how the adoption of antitakeover measures affects a firm’s investment policy and leverage choice.
This study analyzes how promotion-based tournament incentives for non-CEO senior executives affect corporate innovation. We measure tournament incentives using the pay gap between a CEO and the next layer of senior executives. We find that tournament incentives are positively related to innovative efficiency, as measured by the number of patents and patent citations generated per million dollars of R&D expense. Our main finding holds in an instrumental-variable analysis and regressions using alternative innovation measures, including patent generality and originality indices and stock market reactions to patent grants. Consistent with prior theories, the positive effect of tournament incentives is found to be particularly pronounced during the period prior to CEO turnovers.
Research Summary
Combining studies on real options theory and economic short‐termism, we propose that, depending on CEOs’ career horizons, CEOs have heterogeneous interests in strategic flexibility and, thus, have different incentives to make real options investments. We argue that compared to CEOs with longer career horizons, CEOs with shorter career horizons will be less inclined to make real options investments because they may not fully reap the rewards during their tenure. In addition, we argue that long‐term incentives and institutional ownership will mitigate the relationship between CEOs’ career horizons and real options investments. U.S. public firms as an empirical setting produced consistent evidence for our predictions. Our study is the first to theoretically explain and empirically show that a CEO’s self‐seeking behavior will impact real options investments.
Managerial Summary
This paper helps to explain how a CEO’s self seeking‐behavior may shape a firm’s real option investment, which could result in different level of strategic flexibility. We argue that CEOs with short career horizons have less time to exercise their firms’ real options, which should lower the investments in the firms’ real options portfolios relative to CEOs with long career horizons. We study a sample of U.S. public firms and find strong evidence that a CEO’s expected tenure in the firm is positively related to the real options investments at the firm level. We find that this agency issue can be mitigated by adopting appropriate corporate governance mechanisms such as long‐term incentives and institutional investors.
We show that firms with chief executive officers (CEOs) who gain general managerial skills over their lifetime of work experience produce more patents. We address the potential endogenous CEO–firm matching bias using firm–CEO fixed effects and variation in the enforceability of noncompete agreements across states and over time during the CEO’s career. Our findings suggest that generalist CEOs spur innovation because they acquire knowledge beyond the firm’s current technological domain, and they have skills that can be applied elsewhere should innovation projects fail. We conclude that an efficient labor market for executives can promote innovation by providing a mechanism of tolerance for failure.
The Internet appendix is available at https://doi.org/10.1287/mnsc.2017.2828 .
This paper was accepted by Gustavo Manso, finance.
We investigate the effect of top managers' myopia on firms' market valuation. We devise a measure of expected CEO tenure as a proxy for the length of CEO decision horizon. After accounting for the endogenous nature of CEO horizon, our empirical tests show that shorter CEO horizon is associated with more agency costs, lower firm valuation and higher levels of information risk. The results are consistent with the notion that a short CEO decision horizon is indicative of preference for investments that offer relatively faster paybacks at the expense of long-term value creation.
We examine whether internal governance affects the extent of real earnings management in U.S. corporations. Internal governance refers to the process through which key subordinate executives provide checks and balances in the organization and affect corporate decisions. Using the number of years to retirement to capture key subordinate executives' horizon incentives and using their compensation relative to CEO compensation to capture their influence within the firm, we find that the extent of real earnings management decreases with key subordinate executives' horizon and influence. The results are robust to alternative measures of internal governance and to various approaches used to address potential endogeneity, including a difference-in-differences approach. In cross-sectional analyses, we find that the effect of internal governance is stronger for firms with more complex operations where key subordinate executives' contribution is higher, is enhanced when CEOs are less powerful, is weaker when the capital markets benefit of meeting or beating earnings benchmarks is higher, and is stronger in the post-SOX period. This paper contributes to the literature by examining how internal governance affects the extent of real earnings management and by shedding light on how the members of the management team work together in shaping financial reporting quality.
In this article, we examine whether internal governance, the process through which subordinate managers effectively monitor the chief executive officer (CEO), can improve a firm’s liquidity. Using the difference in horizons between a CEO and his immediate subordinates to measure internal governance, we show that firms with better internal governance have lower information asymmetry and higher liquidity. Further, we show that internal governance is effective in enhancing liquidity for firms with CEOs close to retirement, firms that require higher firm-specific skills, and firms with experienced subordinate managers. Our results are robust to inclusion of conventional governance measures, alternative model specifications, and different measures of internal governance and liquidity.
This analysis considers the impact of the top managers in an organization on the organization's outcomes, specifically strategic choices and performance levels. The focus is not on the chief executive alone, but rather on the entire top management team. Using a macro view, these organizational outcomes are perceived to be related to the values and cognitive bases of those high-power individuals in the organization. In developing the model, emphasis is on the background characteristics of the top managers as opposed to the psychological dimensions. A series of propositions that should be tested to support the upper echelons theory are presented. The topics of these propositions include age, functional track, other career experiences, education, socioeconomic roots, financial position, and group characteristics. The creation of this model is just the beginning of the work that is necessary to evaluate and understand the upper echelons theory. Further input is needed from areas such as the executive recruiting industry. Additionally, clinical and statistical studies are both necessary to fully develop this theory. (SRD)
This article empirically relates the internal organization of a firm with decision making quality and corporate performance.
We call “independent from the CEO” a top executive who joined the firm before the current CEO was appointed. In a very robust way, firms with a smaller fraction of independent executives exhibit (1)
a lower level of profitability and (2) lower shareholder returns following large acquisitions. These results are unaffected
when we control for traditional governance measures such as board independence or other well-studied shareholder friendly
provisions. One interpretation is that “independently minded” top ranking executives act as a counter-power imposing strong
discipline on their CEO, even though they are formally under his authority.
We study CEOs with a career background in finance. Firms with financial expert CEOs hold less cash, more debt, and engage in more share repurchases. Financial expert CEOs are more financially sophisticated: they are less likely to use one companywide discount rate instead of a project-specific one, they manage financial policies more actively, and their firm investments are less sensitive to cash flows. Financial expert CEOs are able to raise external funds even when credit conditions are tight, and they were more responsive to the dividend and capital gains tax cuts in 2003. Analyzing CEO-firm matching based on financial experience, we find that financial expert CEOs tend to be hired by more mature firms. Our results are consistent with employment histories of CEOs being relevant for corporate policies. However, we cannot formally rule out that our findings are partly explained by endogenous CEO-firm matching.
We examine the impact of overconfidence on compensation structure. Our findings support the exploitation hypothesis: firms offer incentive-heavy compensation contracts to overconfident Chief Executive Officers (CEOs) to exploit their positively biased views of firm prospects. Overconfident CEOs receive more option-intensive compensation and this relation increases with CEO bargaining power. Exogenous shocks (Sarbanes-Oxley Act of 2002 (SOX) and Financial Accounting Standard (FAS) 123R) provide additional support for the findings. Overconfident non-CEO executives also receive more incentive-based pay, independent of CEO overconfidence, buttressing the notion that firms tailor compensation contracts to individual behavioral traits such as overconfidence.
I demonstrate that acquisitions are accompanied by large, permanent increases in Chief Executive Officer (CEO) compensation, which create strong financial incentives for CEOs to pursue acquisitions earlier in their career. Accordingly, I document that a firm's acquisition propensity is decreasing in the age of its CEO: a firm with a CEO who is 20 years older is ∼30%∼30% less likely to announce an acquisition. This negative effect of CEO age on acquisitions is strongest among firms where CEOs likely anticipate or can influence high post-acquisition compensation, and is absent for other investment decisions that are not rewarded with permanent compensation gains. The age effect cannot be explained by the selection of young CEOs by acquisition-prone firms, nor by a story of declining overconfidence with age. This paper underscores the relevance of CEO personal characteristics and CEO-level variation in agency problems for corporate decisions.
Prior theoretical work generates conflicting predictions with respect to how CEO age impacts risk-taking behavior. Consistent with the prediction that risk-taking behavior decreases as CEOs become older, I document a negative relation between CEO age and stock return volatility. Further analyses reveal that older CEOs reduce firm risk through less risky investment policies. Specifically, older CEOs invest less in research and development, make more diversifying acquisitions, manage firms with more diversified operations, and maintain lower operating leverage. Further, firm risk and the riskiness of corporate policies are lowest when both the CEO and the next most influential executive are older and highest when both of these managers are younger. Although older CEOs prefer less risky investment policies, I document results suggesting that CEO and firm risk preferences tend to be aligned. Lastly, I find that a trading strategy that goes long in a portfolio of stocks consisting of firms managed by younger CEOs and short in a portfolio of stocks comprised of firms led by older CEOs would generate positive risk-adjusted returns. Overall, my results imply that CEO age can have a significant impact on risk-taking behavior and firm performance.
Based on 134 CEO succession events in nondiversified, manufacturing firms, this study examines the relationships between industry structure and the characteristics of CEO successors. The paper also explores the performance implications of the fit between industry structure and CEO successors. Results indicate that industry structure plays an important, but not pervasive, role in explaining variations in newly selected CEOs. Specifically, the higher the level of industry product differentiation, the lower the organizational tenure, the higher the educational level and the greater the likelihood of a nonthroughput background in the CEO successor; the higher the industry growth rate, the lower the organizational tenure and age of the CEO successor. However, findings provide very limited support for the normative view that firms which match CEO successor characteristics to industry structure realize better postsuccession performance than those with lower levels of fit. © 1998 John Wiley & Sons, Ltd.
This paper utilizes information collected on more than eighty British companies and on about 800 senior managers working in them. It is in two parts. Part I starts by outlining problems involved in identifying influences on company performance. It then describes the sources of data analysed in the paper. The remainder of Part I examines the view that certain managerial and organizational attributes will tend to raise levels of performance whatever the type of company and its operating circumstances. Another approach takes the view that what makes for good performance is contingent upon the type of company and the prevailing situation. This is examined against our data in Part II of the paper. Part II concludes with an assessment of present knowledge on the managerial and organizational concomitants of company performance and the practical implicatons to be drawn from it.
This paper tests the proposition that higher tournament incentives will result in greater risk taking by senior managers in order to increase their chance of promotion to the rank of CEO. Measuring tournament incentives as the pay gap between the CEO and the next layer of senior managers, we find a significantly positive relation between firm risk and tournament incentives. Further, we find that greater tournament incentives lead to higher R&D intensity, firm focus, and leverage but lower capital expenditures intensity. Our results support the hypothesis that option-like features of intra-organizational CEO promotion tournaments provide incentives to senior executives to increase firm risk by following riskier policies. Finally, the compensation levels and structures of executives of financial institutions have received a great deal of scrutiny after the financial crisis. In a separate examination of financial firms, we again find a significantly positive relation between firm risk and tournament incentives. for helpful comments. We are particularly indebted to Lalitha Naveen for her help in handling the transition in ExecuComp due to accounting changes imposed by the Financial Accounting Standards Board (FAS123R). We are also grateful to an anonymous referee whose comments enabled us to significantly improve the paper. We thank Bunyamin Onal for providing excellent research assistance. Ryan Williams acknowledges research support from the Center for the Economic Analysis of Risk (CEAR) at Georgia State University, the Max Burns Fellowship, and the Steven Smith Fellowship. The usual disclaimer applies.
CEO inside debt holdings (pension benefits and deferred compensation) are generally unsecured and unfunded liabilities of the firm. Because these characteristics of inside debt expose the CEO to default risk similar to that faced by outside creditors, theory predicts that CEOs with large inside debt holdings will display lower levels of risk-seeking behavior (Jensen and Meckling, 1976). Consistent with the theoretical predictions, we find a negative association between CEO inside debt holdings and the volatility of future firm stock returns, R&D expenditures, and financial leverage and a positive association between CEO inside debt holdings and the extent of diversification and asset liquidity. Collectively, our results provide empirical evidence suggesting that CEOs with large inside debt holdings prefer investment and financial policies that are less risky.
We show that measurable managerial characteristics have significant explanatory power for corporate financing decisions beyond traditional capital-structure determinants. First, managers who believe that their firm is undervalued view external financing as overpriced, especially equity. Such overconfident managers use less external finance and, conditional on accessing risky capital, issue less equity than their peers. Second, CEOs with Depression experience are averse to debt and lean excessively on internal finance. Third, CEOs with military experience pursue more aggressive policies, including heightened leverage. Complementary measures of CEO traits based on press portrayals confirm the results.
While CEO job tenure is seen as influencing firm performance, the intervening mechanisms that govern this influence have remained largely unexplored. Given that individuals in the firm most closely influenced by the CEO are members of the top management team (TMT), we focus on the CEO-TMT interface as one important intervening mechanism. Specifically, our tested model suggests that CEO tenure indirectly influences performance through its direct influences on TMT risk-taking propensity and the firm's pursuit of entrepreneurial initiatives. Results from structural equation modeling are consistent with this model and support its associated hypotheses. In the discussion, we trace the implications of our study for research and practice. Copyright © 2007 John Wiley & Sons, Ltd.
We develop a model of internal governance where the self-serving actions of top management are limited by the potential reaction of subordinates. Internal governance can mitigate agency problems and ensure that firms have substantial value, even with little or no external governance by investors. External governance, even if crude and uninformed, can complement internal governance and improve efficiency. This leads to a theory of investment and dividend policy, in which dividends are paid by self-interested CEOs to maintain a balance between internal and external control.
We investigate the relation between the CEO Pay Slice (CPS)--the fraction of the aggregate compensation of the top-five executive team captured by the Chief Executive Officer--and the value, performance, and behavior of public firms. The CPS could reflect the relative importance of the CEO as well as the extent to which the CEO is able to extracts rents. We find that, controlling for all standard controls, CPS is negatively associated with firm value as measured by industry-adjusted Tobin's q. CPS also has a rich set of relations with firms' behavior and performance. In particular, CPS is correlated with lower (industry-adjusted) accounting profitability, lower stock returns accompanying acquisitions announced by the firm and higher likelihood of a negative stock return accompanying such announcements, higher odds of the CEO receiving a lucky option grant at the lowest price of the month, lower performance sensitivity of CEO turnover, and lower stock market returns accompanying the filing of proxy statements for periods when CPS increases. Taken together, our results are consistent with the hypothesis that higher CPS is associated with agency problems and indicate that CPS can provide a useful tool for studying the performance and behavior of firms.
Entrepreneurs are more susceptible to certain cognitive biases than are managers who are not entrepreneurs, but it is not clear why. In an effort to help explain why, I examine differences in the degree to which entrepreneurs exhibit the overconfidence bias. Results show that individual age, firm decision comprehensiveness and external equity funding affect the degree to which entrepreneurs are overconfident. In addition, founder-managers are shown to be more overconfident than are new-venture managers who did not found their firms. The results suggest that entrepreneurs' cognitive biases are a function of both individual and contextual factors.
We investigate the effect of top managers' myopia on firms' market valuation. We devise a measure of expected CEO tenure as a proxy for the length of CEO decision horizon. After accounting for the endogenous nature of CEO horizon, our empirical tests show that shorter CEO horizon is associated with more agency costs, lower firm valuation and higher levels of information risk. The results are consistent with the notion that a short CEO decision horizon is indicative of preference for investments that offer relatively faster paybacks at the expense of long-term value creation.
Estimates of the cost of equity for industries are imprecise. Standard errors of more than 3.0% per year are typical for both the CAPM and the three-factor model of Fama and French (1993). These large standard errors are the result of(i) uncertainty about true factor risk premiums and (ii) imp ecise estimates of the loadings of industries on the risk factors. Estimates of the cost of equity for firms and projects are surely even less precise.
We report the results of experiments on economic decisions with two populations, one of healthy elderly individuals (average age 82) and one of younger students (average age 20). We examine confidence, decisions under uncertainty, differences between willingness to pay and willingness to accept and the theory of mind (strategic thinking). Our findings indicate that the older adults’ decision behavior is similar to that of young adults, contrary to the notion that economic decision making is impaired with age. Moreover, some of the demonstrated decision behaviors suggest that the elderly individuals are less biased than the younger individuals.
We provide empirical evidence of a strong causal relation between managerial compensation and investment policy, debt policy, and firm risk. Controlling for CEO pay-performance sensitivity (delta) and the feedback effects of firm policy and risk on the managerial compensation scheme, we find that higher sensitivity of CEO wealth to stock volatility (vega) implements riskier policy choices, including relatively more investment in R&D, less investment in PPE, more focus, and higher leverage. We also find that riskier policy choices generally lead to compensation structures with higher vega and lower delta. Stock-return volatility has a positive effect on both vega and delta.
We model an organization as a two-agent hierarchy: an informed Decision Maker in charge of selecting projects and a (possibly)
uninformed Implementer in charge of their execution. Both have intrinsic preferences over projects. This paper models the
costs and benefits of divergence between their preferences, that is, dissent within the organization. Dissent is useful to
(1) foster the use of objective (and sometimes private) information in decision making and (2) give credibility to the Decision
Maker's choices. However, dissent comes at the cost of hurting the Implementer's intrinsic motivation, thereby impairing organizational
efficiency. We show that dissent can be optimal, in particular, when information is useful and uncertainty is high. Moreover,
dissent remains an optimal organizational form even when Implementers can choose their employer or when Decision Makers have
real authority over hiring decisions.
We study the effect of the recent financial crisis on corporate investment. The crisis represents an unexplored negative shock to the supply of external finance for non-financial firms. Corporate investment declines significantly following the onset of the crisis, controlling for firm fixed effects and time-varying measures of investment opportunities. Consistent with a causal effect of a supply shock, the decline is greatest for firms that have low cash reserves or high net short-term debt, are financially constrained, or operate in industries dependent on external finance. To address endogeneity concerns, we measure firms' financial positions as much as four years prior to the crisis, and confirm that similar results do not follow placebo crises in the summers of 2003-2006. Nor do similar results follow the negative demand shock caused by September 11, 2001. The effects weaken considerably beginning in the third quarter of 2008, when the demand-side effects of the crisis became apparent. Additional analysis suggests an important precautionary savings motive for seemingly excess cash that is generally overlooked in the literature.
This paper examines the familiar argument that takeover pressure can be damaging because i t leads managers to sacrifice long-term interests in order to boost c urrent profits. If stockholders are imperfectly informed, temporarily low earnings may cause the stock to become undervalued, increasing t he likelihood of a takeover at an unfavorable price; hence the manage rial concern with current bottom line. The magnitude of the problem d epends on a variety of factors, including the attitudes and beliefs o f shareholders, the extent to which corporate raiders have inside inf ormation, and the degree to which managers are concerned with retaini ng control of their firms. Copyright 1988 by University of Chicago Press.
Economists have long been concerned with the incentive problems that arise when decision making in a firm is the province of managers who are not the firm's security holders. One outcome has been the development of “behavioral” and “managerial” theories of the firm which reject the classical model of an entrepreneur, or owner-manager, who single-mindedly operates the firm to maximize profits, in favor of theories that focus more on the motivations of a manager who controls but does not own and who has little resemblance to the classical “economic man.” Examples of this approach are Baumol (1959), Simon (1959), Cyert and March (1963), and Williamson (1964b). More recently the literature has moved toward theories that reject the classical model of the firm but assume classical forms of economic behavior on the part of agents within the firm. The firm is viewed as a set of contracts among factors of production, with each factor motivated by its self-interest. Because of its emphasis on the importance of rights in the organization established by contracts, this literature is characterized under the rubric “property rights.” Alchian and Demsetz (1972) and Jensen and Meckling (1976b) are the best examples. The antecedents of their work are in Coase (1937, 1960). The striking insight of Alchian and Demsetz (1972) and Jensen and Meckling (1976b) is in viewing the firm as a set of contracts among factors of production.
Much of our understanding of corporations builds on the idea that managers, when they are not closely monitored, will pursue goals that are not in shareholders' interests. But what goals would managers pursue? This paper uses variation in corporate governance generated by state adoption of antitakeover laws to empirically map out managerial preferences. We use plant-level data and exploit a unique feature of corporate law that allows us to deal with possible biases associated with the timing of the laws. We find that when managers are insulated from takeovers, worker wages (especially those of white-collar workers) rise. The destruction of old plants falls, but the creation of new plants also falls. Finally, overall productivity and profitability decline in response to these laws. Our results suggest that active empire building may not be the norm and that managers may instead prefer to enjoy the quiet life.
This paper examines individual decision making when decisions reflect on people's ability to learn. The authors address this problem in the context of a manager making investment decisions on a project over time. They show that, in an effort to appear as a fast learner, the manager will exaggerate his own information but ultimately he becomes too conservative, being unwilling to change his investments on the basis of new information. The authors' results arise purely from learning about competence rather than concavity or convexity of the rewards functions. They relate their results to the existing psychology literature concerning cognitive dissonance reduction. Copyright 1996 by University of Chicago Press.
This paper develops a model of inefficient managerial behavior in the face of a rational stock market In an effort to mislead
the market about their firms' worth, managers forsake good investments so as to boost current earnings. In equilibrium the
market is efficient and is not fooled: it correctly conjectures that there will be earnings inflation, and adjusts for this
in making inferences. Nonetheless, managers, who take the market's conjectures as fixed, continue to behave myopically. The
model is useful in assessing evidence that has been presented in che “myopia” debate. It also yields some novel implications
regarding firm structure and the limits of intergation.
Top managers' power plays a key role in strategic decision making. However, although numerous scholars have recognized its importance, very few have attempted to measure the phenomenon. In this article, I present a set of dimensions measuring top managers' power and suggest a measurement methodology to facilitate empirical inquiry. Data from a group of 1,763 top managers in three industries were used to assess the validity and reliability of the power dimensions in three studies. Results demonstrate strong support for the proposed power dimensions.
The U.S. system of allocating investment capital is failing, putting American companies at a serious disadvantage and threatening the long-term growth of the nation's economy. The problem, says Michael Porter, goes beyond the usual formulation of the issue: accusations of "short-termism" by U.S. managers, ineffective corporate governance by directors, or a high cost of capital. The problem involves the external capital allocation system by which capital is provided to companies, as well as the system by which companies allocate capital internally. America's system is marked by fluid capital and a financial focus. Other countries--notably Japan and Germany--have systems with dedicated capital and a focus on corporate position. In global competition, where investment increasingly determines a company's capacity to upgrade and innovate, the U.S. system does not measure up. These conclusions come out of a two-year research project sponsored by the Harvard Business School and the Council on Competitiveness. Porter recommends five far-reaching reforms to make the U.S. system superior to Japan's and Germany's: 1. Improve the present macroeconomic environment. 2. Expand true ownership throughout the system so that directors, managers, employees, and even customers and suppliers hold positions as owners. 3. Align the goals of capital providers, corporations, directors, managers, employees, customers, suppliers, and society. 4. Improve the information used in decision making. 5. Foster more productive modes of interaction and influence among capital providers, corporations, and business units.
This article presents a model of optimal control of corporate boards of directors. We determine when one would expect inside
versus outside directors to control the board, when the controlling party will delegate decision-making to the other party, the
extent of communication between the parties, and the number of outside directors. We show that shareholders can sometimes
be better off with an insider-controlled board. We derive endogenous relationships among profits, board control, and the number
of outside directors that call into question the usual interpretation of some documented empirical regularities. (JEL G34)
This paper studies managerial decisions about investment in long-run projects in the presence of imperfect information (the market knows less about such investments than the firm's managers) and short-term managerial objectives (the managers are concerned about the short-term stock price as well as the long-term stock price). Prior work has suggested that imperfect information and short-term managerial objectives induce managers to underinvest in long-run projects. We show that either underinvestment or overinvestment is possible, and we identify the connection between the type of informational imperfection present and the direction of the distortion. When investors cannot observe the level of investment in long-run projects, suboptimal investment will be induced. When investors can observe investment but not its productivity, however, an excessive level of investment will be induced.
The authors examine managerial investment decisions in the presence of imperfect information and short-term managerial objectives. Prior research has argued that such an environment induces managers to underinvest in long-run projects. The authors show that short-term objectives and imperfect information may also lead to overinvestment and they identify how the direction of the distortion depends upon the type of informational imperfection present. When investors cannot observe the level of investment in the long-run project, suboptimal investment will be induced. When investors can observe investment but not its productivity, however, overinvestment will occur. Copyright 1993 by American Finance Association.
By combining (i) the economic theory of rational expectation bubbles, (ii) behavioral finance on imitation and herding of investors and traders and (iii) the mathematical and statistical physics of bifurcations and phase transitions, the log-periodic power law (LPPL) model has been developed as a flexible tool to detect bubbles. The LPPL model considers the faster-than-exponential (power law with finite-time singularity) increase in asset prices decorated by accelerating oscillations as the main diagnostic of bubbles. It embodies a positive feedback loop of higher return anticipations competing with negative feedback spirals of crash expectations. We use the LPPL model in one of its incarnations to analyze two bubbles and subsequent market crashes in two important indexes in the Chinese stock markets between May 2005 and July 2009. Both the Shanghai Stock Exchange Composite index (US ticker symbol SSEC) and Shenzhen Stock Exchange Component index (SZSC) exhibited such behavior in two distinct time periods: 1) from mid-2005, bursting in October 2007 and 2) from November 2008, bursting in the beginning of August 2009. We successfully predicted time windows for both crashes in advance (Sornette, 2007; Bastiaensen et al., 2009) with the same methods used to successfully predict the peak in mid-2006 of the US housing bubble (Zhou and Sornette, 2006b) and the peak in July 2008 of the global oil bubble (Sornette et al., 2009). The more recent bubble in the Chinese indexes was detected and its end or change of regime was predicted independently by two groups with similar results, showing that the model has been well-documented and can be replicated by industrial practitioners. Here we present more detailed analysis of the individual Chinese index predictions and of the methods used to make and test them. We complement the detection of log-periodic behavior with Lomb spectral analysis of detrended residuals and -derivative of logarithmic indexes for both bubbles. We
This paper provides an overview of the existing theoretical and empirical work on the provision of incentives. It reviews the costs and benefits of many types of pay-for-performance, such as piece rates, promotions, and long-term incentives. The main conclusions are (i) while there is considerable evidence that individuals respond to pay-for-performance, there is less evidence that contracts are designed as predicted by the theory, (ii) there has been little progress made in distinguishing amongst plausible theories, and (iii) we still know little about how incentives are provided to workers whose output is difficult to measure.
The paper studies how a person's concern for a future career may influence his or her incentives to put in effort or make
decisions on the job. In the model, the person's productive abilities are revealed over time through observations of performance.
There are no explicit output-contingent contracts, but since the wage in each period is based on expected output and expected
output depends on assessed ability, an “implicit contract” links today's performance to future wages. An incentive problem
arises from the person's ability and desire to influence the learning process, and therefore the wage process, by taking unobserved
actions that affect today's performance. The fundamental incongruity in preferences is between the individual's concern for
human capital returns and the firm's concern for financial returns. The two need be only weakly related. It is shown that
career motives can be beneficial as well as detrimental, depending on how well the two kinds of capital returns are aligned.