Corporate Orientation
Executive compensation: The trend toward one-size-fits-all
Felipe Cabezon
Journal of Accounting and Economics, forthcoming
Abstract:
I report and analyze a recent "one-size-fits-all" trend in the structure of executive compensation plans. Since 2006, 24% of the variation in the distribution of CEO compensation across pay components -- salary, bonus, stock awards, options, non-equity incentives, pensions, and perquisites -- disappeared. This uniformity might come at the expense of optimal incentives, as increases in pay structure similarity translate into lower shareholder value. Using panel data regressions and plausibly exogenous shocks, I find that institutional investors' influence, proxy advisors' recommendations, and expanded compensation disclosure are salient drivers of this standardization. The findings highlight an unintended consequence of recent regulations enhancing shareholders' participation and expanding compensation disclosure.
Firms' Perceived Cost of Capital
Niels Joachim Gormsen & Kilian Huber
NBER Working Paper, June 2024
Abstract:
We study hand-collected data on firms' perceptions of their cost of capital. Firms with higher perceived cost of capital earn higher returns on invested capital and invest less, suggesting that the perceived cost of capital shapes long-run capital allocation. The perceived cost of capital is partially related to the true cost of capital, which is determined by risk premia and interest rates, but there are also large deviations between the perceived and true cost of capital. Only 20% of the variation in the perceived cost of capital is justified by variation in the true cost of capital. The remaining 80% reflects deviations that are consistent with managers making mistakes. These deviations lead to misallocation of capital that lowers long-run aggregate productivity by 5% in a benchmark model. Forcing all firms to apply the same cost of capital would improve the allocation of capital relative to current corporate practice. The deviations in the perceived cost of capital challenge standard models, in particular the production-based asset pricing paradigm, and lead us to reject the "Investment CAPM." We describe actionable methods that allow firms to improve their perceptions and capital allocation.
The real impacts of public short campaigns: Evidence from stakeholders
Claire Liu, Angie Low & Talis Putnins
Journal of Corporate Finance, forthcoming
Abstract:
Using a novel dataset of firm product introductions, we examine whether public short campaigns (PSCs) have real impacts on targets. Targets introduce fewer new products and experience declines in productivity and product quality relative to matched firms following PSCs. These declines in product outcomes are partly attributed to the withdrawal of support from key stakeholders, resulting in reduced access to external capital, decreased employee commitment, and weakened customer relationships. Our results suggest that the public nature of PSCs has distinctive impacts on target firms compared to traditional short selling, primarily through their impact on the firm's stakeholders.
Complexity of CEO compensation packages
Ana Albuquerque et al.
Journal of Accounting and Economics, forthcoming
Abstract:
This paper examines complexity in CEO compensation contracts. We develop a measure of compensation complexity and provide empirical evidence that complexity has increased substantially over time. We document that complexity results not only from factors reflecting efficient contracting, but also from external pressures from compensation consultants, institutional investors, proxy advisors, and attempts to benchmark to peers, with these external factors having greater impact in more recent years. Examining consequences of contract complexity, we find an association with lower future firm performance that is related to the influence of external factors on compensation design. We further find this relation is partially mitigated when a contract's performance metrics are more highly correlated, consistent with information processing costs hampering decision-making. Collectively, these findings confirm concerns raised by investors and the media regarding compensation complexity and can inform boards in their design of CEO pay packages.
Private Equity and Digital Transformation
Brian Baik, Wilbur Chen & Suraj Srinivasan
Harvard Working Paper, April 2024
Abstract:
We study the role which private equity (PE) plays in digital transformation. We find that PE investment is associated with greater investments into portfolio firm's digital technologies, as measured by IT expenditures and the hiring demand for AI skills. This relationship is more pronounced for growth equity investments, and portfolio firms invested by PE investors with greater exposure and expertise in digital technology. Consistent with the broad range of applications for digital technologies, non-IT portfolio companies also significantly increase their digital investments post PE investment. Lastly, we study the potential benefits from digital investments, and find that an increase in these investments after PE entry, is associated with stronger portfolio firm sales/employee growth and innovation. Overall, our results highlight that PE investors increasingly drive value creation using digital technologies in their portfolio companies.
Corporate insider purchases and the options market: Competition among informed investors
Byounghyun Jeon & Johan Sulaeman
Journal of Corporate Finance, August 2024
Abstract:
Corporate insiders have superior access to information; their trades, particularly purchases, should be informative. However, the extent of their informational advantage may be limited by the presence of other informed market participants. We document less frequent insider purchases in stocks with relatively high options trading activity. These purchases are followed by negligible abnormal returns. In contrast, stocks with less active options trading experience more frequent insider purchases, which yield positive abnormal returns over the subsequent six months. Our novel approach highlights the options market's role in screening uninformed insider trades, which ultimately contributes to more efficient stock market price formation.
Auditor Political Connections and SEC Oversight
Jagan Krishnan, Meng Li & Hyun Jong Park
Temple University Working Paper, February 2024
Abstract:
We examine whether auditor political connections are associated with the Securities and Exchange Commission's (SEC) oversight of audit clients. Specifically, we test whether auditors' Political Action Committee (PAC) contributions are associated with three SEC oversight actions: comment letters, investigations, and Accounting and Auditing Enforcement Releases (AAERs). Consistent with higher political connections inducing heightened scrutiny from the SEC, we find that the clients of auditors with higher political connections are more likely to receive comment letters and face SEC investigations. However, conditional on SEC investigation, we find no association between auditor political connections and the issuance of AAERs. We consider heightened attention from investors and analysts towards audit clients as one possible mechanism leading to increased scrutiny because auditor political connections could be perceived as a red flag by market participants. Using EDGAR downloads and the number of earnings forecast revisions, we document evidence consistent with the existence of such a mechanism. These findings add to our understanding of how auditor political connections could influence SEC oversight over audit clients.
Investor-Paid Credit Ratings and Managerial Information Disclosure
Wei Li
Management Science, forthcoming
Abstract:
Unlike issuer-paid credit rating agencies (CRAs), investor-paid CRAs are compensated by investors for providing rating services. Exploiting the staggered timing of rating initiation by an investor-paid rating agency (the Egan Jones Ratings (EJR)), I document that the coverage by EJR increases rated firm managers' voluntary disclosure of negative news. Consistent with EJR's rating coverage deterring managerial bad news hoarding by informing investors of downside risks, I find that the effect of EJR coverage is more pronounced when issuer-paid CRAs tend to assign inflated ratings and when rated firms' managers have a stronger incentive to conceal bad news. I also document that firms unwind upward earnings management after being covered by EJR. In contrast, coverage by an issuer-paid CRA (Standard & Poor's) is not associated with changes in managerial information disclosure. I conclude that investor-paid CRAs function as a type of effective information intermediary to discipline firm managers and improve corporate transparency.