Tag: Incentives

Management Philosophies and Styles in Family and Non-Family Firms

William Mullins is Assistant Professor of Finance at the University of Maryland and Antoinette Schoar is Professor of Finance at MIT. This post is based on an article authored by Professor Mullins and Professor Schoar.

A growing body of evidence supports the view that there are substantial differences in the management styles and skill sets of individual CEOs, and these differences seem to translate into effects on firm performance and how firms operate. However, we know little about what drives these differences in CEO behavior. In particular, we do not know if the management philosophies and styles of CEOs vary with the governance structure or ownership of the firm (for example, whether it is a family firm or widely held firm), or even across countries. One view is that the extent to which they take a stakeholder approach to management—in opposition to a shareholder focused approach—is an important determinant of CEO behavior. Family members as CEO might be more likely to adopt a stakeholder view, since they have a longer horizon and care about the reputation of the family beyond profit maximization. An alternative view holds that greater emphasis on stakeholder management is a feature of entire countries, evolving in response to aspects of the economy as a whole, rather than to firm-specific characteristics.

In our paper, How Do CEOs See Their Roles? Management Philosophies and Styles in Family and Non-Family Firms, forthcoming in the Journal of Financial Economics, we explore how the interplay of firm level and country level factors shape CEO management styles and beliefs regarding their roles.


Employee Rights and Acquisitions

Anzhela Knyazeva is a Financial Economist at the U.S. Securities and Exchange Commission. This post is based on an article authored by Dr. Knyazeva, Diana Knyazeva, Financial Economist at the Securities and Exchange Commission; and Kose John, Professor in Banking and Finance at New York University. The views expressed in this post are those of Dr. Knyazeva and do not necessarily reflect those of the Securities and Exchange Commission or its Staff.


In our paper, Employee Rights and Acquisitions, which was recently featured in the Journal of Financial Economics, we consider incentive conflicts involving employees, and how they may affect firms in the context of acquisitions. More specifically, we look at the effects of variation in employee protections on shareholder value, the choice of targets, and deal characteristics.  We focus on acquisitions since they are major firm investment decisions with the potential to substantially affect firm value.


On Secondary Buyouts

François Degeorge is Professor of Finance at the University of Lugano This post is based on an article authored by Professor Degeorge; Jens Martin, Assistant Professor of Finance at the University of Amsterdam; and Ludovic Phalippou, Associate Professor of Finance at Saïd Business School, Oxford University.

Twenty years ago, private equity (PE) firms seeking to exit sold their portfolio companies to another company in the same industry or organized an IPO. Nowadays, 40 percent of PE exits occur through secondary buyouts (SBOs), transactions in which a PE firm sells a portfolio company to another PE firm. The rise of SBOs has elicited concerns among PE investors (the limited partners with stakes in private equity funds): Does the rise of SBOs mean that PE firms have run out of investment ideas? Do SBOs create or destroy value for investors? Our paper, On Secondary Buyouts, forthcoming in the Journal of Financial Economics, provides answers to these questions.


The SEC Proposed Clawback Rule

Joseph E. Bachelder is special counsel in the Tax, Employee Benefits & Private Clients practice group at McCarter & English, LLP. The following post is based on an article by Mr. Bachelder which first appeared in the New York Law Journal. Andy Tsang, a senior financial analyst with the firm, assisted in the preparation of this column. The complete publication, including footnotes, is available here. Related research from the Program on Corporate Governance includes Excess-Pay Clawbacks by Jesse Fried and Nitzan Shilon (discussed on the Forum here).

On July 1, 2015, the Securities and Exchange Commission (SEC) issued Proposed Rule 10D-1 relating to so-called “clawbacks” pursuant to Section 10D of the Securities and Exchange Act of 1934 (the Exchange Act). Section 10D of the Exchange Act was added by Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank).

(On Aug. 5, 2015 the SEC issued its final rule requiring the disclosure of the ratio of the annual pay of the CEO to the median annual pay of all employees (excluding the CEO). Issuers subject to the rule must comply with it for the first fiscal year beginning on or after Jan. 1, 2017. The pay ratio rule will be the subject of a future post.)


Executive Overconfidence and Compensation Structure

Ling Lisic is Associate Professor of Accounting at George Mason University. This post is based on an article authored by Professor Lisic; Mark Humphery-Jenner, Senior Lecturer at UNSW Business School; Vikram Nanda, Professor of Finance and Managerial Economics at University of Texas at Dallas; and Sabatino Silveri, Assistant Professor of Finance at the University of Memphis. Related research from the Program on Corporate Governance includes The CEO Pay Slice by Lucian Bebchuk, Martijn Cremers and Urs Peyer (discussed on the Forum here).

In our paper “Executive Overconfidence and Compensation Structure,” forthcoming in the Journal of Financial Economics, we investigate whether overconfidence affects the compensation structure of CEOs and other senior executives. There is a burgeoning literature on the impact of CEO overconfidence on corporate policies. Overconfident CEOs are prone to overestimate returns to investments and to underestimate risks. Little is known, however, about the nature of incentive contracts offered to overconfident managers or even whether firms “fine-tune” compensation contracts to match a manager’s personality traits. We help fill this gap.


Shareholder Activism and Voluntary Disclosure

Jordan Schoenfeld is Assistant Professor of Accounting at the University of Utah. This post is based on an article authored by Professor Schoenfeld and Thomas Bourveau, Assistant Professor of Accounting at the Hong Kong University of Science and Technology. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here), The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here), The Law and Economics of Blockholder Disclosure by Lucian Bebchuk and Robert J. Jackson Jr. (discussed on the Forum here), and Pre-Disclosure Accumulations by Activist Investors: Evidence and Policy by Lucian Bebchuk, Alon Brav, Robert J. Jackson Jr., and Wei Jiang.

Information is the foundation on which traders form their beliefs about a company and ultimately their investment decisions. In empirical settings, information often arrives in the form of a company disclosure. Since managers have significant discretion over disclosure, researchers have extensively studied the relation between disclosure and trading via the price system. In our paper, Shareholder Activism and Voluntary Disclosure, which was recently made available on SSRN, we study the relation between disclosure and a specific class of traders, shareholder activists. The activism literature has only indirectly explored the link between company disclosures and activism. For example, several papers include financial statement variables as regressors in their empirical models of activist targeting (e.g., Brav, Jiang, Partnoy, and Thomas, 2008). We extend this literature by looking at disclosure explicitly.


The Limits of Using TSR as an Incentive Measure

David N. Swinford is the President and Chief Executive Officer of Pearl Meyer & Partners, LLC. This post relates to research conducted by Pearl Meyer and the Cornell University ILR School’s Institute for Compensation Studies.

The widespread and growing use of total shareholder return (TSR) as an incentive measure is not the panacea many believe it to be. To test our point of view we wanted to explore one critical question: Does the inclusion of TSR measures in long-term incentive plans result in improved firm performance?

To find out the answer, Pearl Meyer collaborated with the Cornell University ILR School’s Institute for Compensation Studies to conduct original research on the use of TSR by S&P 500 companies over a ten year period.


The Failure of Liability in Modern Markets

Yesha Yadav is an Associate Professor of Law of Vanderbilt Law School. This post is based on an article authored by Professor Yadav.

In April 2015, the Justice Department indicted Navinder Sarao—a 36 year-old trader operating out of his parents’ basement—for actions resulting in the Flash Crash in May 2010. [1] According to the complaint, Sarao’s use of fake or “spoof” orders was damaging enough to precipitate a near 1000-point plunge in in the Dow Jones Index. It is telling that, today, a single trader can stand accused of contributing to this extraordinary drop in the value of the stock market. The complaint draws into relief the central challenge facing securities trading. With markets approaching ever-fuller levels of automation and driven by complex algorithms, even small-time traders like Sarao can create costs far in excess of either the seriousness of their conduct—or their capacity to pay for what they do. As I argue in The Failure of Liability in Modern Markets, to be published in the Virginia Law Review, the liability framework anchoring modern, algorithmic markets struggles to both control harmful risks and to punish them satisfactorily. Where instances of mistake, carelessness and fraud can neither be reliably controlled nor adequately punished, the law’s capacity to create a fair, richly informed marketplace must come under serious doubt.


The Effect of Relative Performance Evaluation

Frances M. Tice is Assistant Professor of Accounting at the University of Colorado at Boulder. This post is based on an article authored by Ms. Tice.

In the paper, The Effect of Relative Performance Evaluation on Investment Efficiency and Firm Performance, which was recently made publicly available on SSRN, I examine the effect of explicit relative performance evaluation (RPE) on managers’ investment decisions and firm performance. Principal-agent theory suggests that firms can motivate managers to act in shareholders’ interest by linking their compensation to firm performance. However, firm performance is often affected by exogenous factors, and as a result, performance-based compensation may expose managers to common risk that they cannot directly control. In such cases, RPE enables the principal to compensate managers on their effort and events under their control by removing the effect of common shocks from measured performance, thus improving risk sharing and incentive alignment. However, RPE use as implemented in practice may not be effective in addressing agency costs because of potential peer group issues, such as availability of firms with common risk or a self-serving bias in peer selection. In addition, prior research also suggests that a large gap in ability between the RPE firm and peers (“superstar effect”) may actually reduce managers’ effort because the probability of winning is low. Therefore, the question of whether explicit RPE use in executive compensation does indeed reduce agency costs remains unanswered in the empirical literature.


Is Institutional Investor Stewardship Still Elusive?

Simon C.Y. Wong is an adjunct professor of law at the Northwestern University School of Law, and a visiting fellow at the London School of Economics and Political Science. This post is based on an article that recently appeared in the Butterworths Journal of International Banking and Financial Law.


The idea that institutional investors should behave as active, long-term oriented “stewards” has caught on globally. Five years after the launch of the landmark UK Stewardship Code, counterparts can be found on four continents (see Figure 1).

When the UK code was promulgated, I argued that institutional investor stewardship was an elusive quest due to, inter alia: ––

  • Inappropriate performance metrics and financial arrangements that promote trading and a short-term focus;
  • ––Excessive portfolio diversification that makes monitoring of investee companies challenging; ––
  • Lengthening chain of ownership that weakens an ownership mindset; ––
  • Passive/index funds that pay scant attention to corporate governance; and ––
  • Pervasive conflicts of interest among asset managers.

The fifth anniversary of the UK code provides an opportune moment to examine the notable achievements and continuing challenges in the drive to encourage institutional investors to be informed and engaged owners.


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