Loopholes in Complex Contracts

An Empirical Analysis of Cost Outcomes of the Texas Medication Algorithm Project

Evidence shows that managers’ debt-like compensation (i.e., inside debt) aligns their incentives with lenders’, reducing the agency cost of debt. We examine how changes in the contracting environment affect the use of inside debt in debt contracting. We find evidence of reduced reliance on inside debt for debt contracting when borrowers have credit constraints, consistent with a shift in bargaining power to lenders, and when firms experience financial distress, consistent with increased agency costs when bankruptcy is more probable. We detect reduced reliance on inside debt for debt contracting during the financial crisis and during shocks to industry demand, two plausibly exogenous shocks to firms’ contracting environments. In total, the results suggest that the role of inside debt changes predictably with the contracting environment.

This study analyses the effectiveness of the series of post-2008 regulatory reforms in the banking industry. The paper aims to identify and classify new measures of agency costs. The results suggest that agency costs have increased in the post economic recession period. Agency costs have increased for all banks irrespective of sizes. A new theoretical framework on behavioural lines is proposed for the manifestation of agency costs. The study suggests that four types of behavioural factors result in agency costs – self-enrichment, complacency, cover-up and risk affinity. Agency costs originate due to the self-enrichment behavioural nature of managers. The study provides insights to the fact that management behaviour may adapt to both the external and internal environment to facilitate agency costs. The study suggests that the new regulatory measures may not have worked well on expected lines or may have provided adverse incentives which would have increased agency costs.

This study analyses the effectiveness of the series of post-2008 regulatory reforms in the banking industry. The paper aims to identify and classify new measures of agency costs. The results suggest that agency costs have increased in the post economic recession period. Agency costs have increased for all banks irrespective of sizes. A new theoretical framework on behavioural lines is proposed for the manifestation of agency costs. The study suggests that four types of behavioural factors result in agency costs – self-enrichment, complacency, cover-up and risk affinity. Agency costs originate due to the self-enrichment behavioural nature of managers. The study provides insights to the fact that management behaviour may adapt to both the external and internal environment to facilitate agency costs. The study suggests that the new regulatory measures may not have worked well on expected lines or may have provided adverse incentives which would have increased agency costs.

The economy is an essential factor in constructing a resilient city, and listed companies play a vital role in the local economy. From the microbehavior of corporate governance, we examine the relationship among corporate governance, agency costs, and corporate sustainable development for a panel sample of 690 state-owned firms in China during 2015–2019. We found that agency costs mediate the relationship between board size, management compensation, debt ratio, dividend policy, and corporate sustainable development. Specifically, decreasing the board size can reduce agency costs and enhance the company’s sustainable development capabilities. The existing compensation system is to the disadvantage of the sustainable development of the company. Increasing the salaries of managers will increase agency costs and reduce the company’s ability to develop sustainably. Although increasing liabilities can reduce agency costs, increasing liabilities will increase financial risks. The bankruptcy costs caused by increasing liabilities are more significant than agency costs, which leads to a decline in the company’s ability to develop sustainably. The implementation of cash dividend policies will help reduce agency costs, thereby increasing their sustainable development capabilities. This also provides new ideas for the Modigliani–Miller (MM) theory and agency cost theory.

PurposeThe purpose of this article is to analyze the effects of accruals-based earnings management (AEM), International Financial Reporting Standard (IFRS) adoption and stock market integration for firms that belong to Latin-American Integrated Market (MILA).Design/methodology/approachThe GMM estimator was used according to Arellano and Bover (1995) for panel data on a sample of 478 non-financial companies between 2000 and 2016. Multilevel mixed models was used for the robustness analysis.FindingsAEM practices significantly and dynamically reduce agency costs. This result suggests companies use positive discretionary accruals to hide true agency costs and avoid shareholders monitoring, while negative discretionary accruals are ways to expropriate wealth and increase agency costs. This result implies that firms use AEM as a predetermined strategy to weaken corporate governance. The IFRS adoption and MILA implementation reduced agency costs. However, only IFRS adoption had the capability to mitigate the effects of AEM on agency costs.Originality/valueThese results reveal AEM constitutes a practice that managers use to weaken firms’ corporate governance and expropriate wealth from shareholders. These practices have effects at short-run and long-run. However, the IFRS adoption and market integration represented by MILA are mitigating factors for agency costs. These results have relevant implications for firms’ corporate governance because they guide investors and shareholders to strengthen corporate control and monitoring on business decision-making. These results also are relevant to policymakers because they orient the financial policies design to strengthen the benefits of IFRS and MILA.

There is continuing uncertainty about whether family firms have lower agency costs. This paper proposes that a combination of family ownership and altruism affects agency costs in family firms. To begin with, family ownership can reduce agency costs through better aligning the interests of owners and managers. This is a ‘determining’ effect in the sense it independently mitigates one source of agency problems. However, altruism entangled with problems with self-control in the pattern of highly concentrated ownership often found in family firms can also increase agency costs. This is an ‘embedding’ effect as it is rooted in the personal relationships within the family firm. Using the Business Longitudinal Database compiled by the Australian Bureau of Statistics on small and medium-sized enterprises (SMEs), we find that for larger SMEs (those with 20–200 employees), the gains in lower agency costs arising from family ownership are almost completely offset by the losses from altruism and the problem of self-control.

ABSTRACTRecently, Chinese administrative authorities have introduced administrative penalties, specifically targeting violations of adopting digital technology innovations and applications (termed administrative penalties toward digital technology companies, APDTs). These penalties have significantly heightened operational pressure on Chinese enterprises. This study explores the impact of APDTs on the agency costs between owners and managers. Through a combination of theoretical analysis and empirical testing utilizing Chinese city data and samples of listed companies from 2008 to 2020, we investigate the intricate mechanisms underlying this impact. The findings reveal that, first, APDTs exacerbate the agency conflict between owners and managers, resulting in increased agency costs. Second, the operational mechanism involves the elevation of firms’ debt capital and the reduction of their equity capital, consequently intensifying the agency costs between owners and managers. Lastly, the impact of APDTs on agency costs displays heterogeneity, diminishing as firms’ investment opportunities increase.

Given the continuing uncertainty about whether family firms enjoy lower agency costs, this article hypothesizes that a combination of the effects of family ownership, altruism and self-control is instead at play. To begin with, family ownership can indeed reduce agency costs through better aligning the interests of owners and managers. This is a ‘determining’ effect in that it independently mitigates one source of agency problems. However, altruism combined with self-control problems arising from the highly concentrated ownership often found in family firms can also increase agency costs. This is an ‘embedding’ effect as it is rooted in the personal relationships within the family firm. Using the Business Longitudinal Database compiled by the Australian Bureau of Statistics on small- and medium-sized enterprises (SMEs), we find that for larger SMEs (those with 20–200 employees), the gains in lower agency costs arising from family ownership are almost completely offset by the losses from altruism and the lack of self-control.

Some authors argue that the integration of stock options as well as restricted stocks into executive compensation may reduce the conflicts between shareholders and management but may at the same time give rise to other agency problems connected to debt. While this line of argument may hold some merit, the structure of executive compensation packages, has over the years, focused less on stock options and more on restricted stocks. A classic example of this trend is Microsoft, who in 2003, switched from using stock options to restricted stock.Compensating executives through restricted stocks has recently come under scrutiny due to the fact that some of these executives receive dividend equivalents on restricted stocks even before the vesting period. One recent example of a company that has received such criticism is CA. Inc. CA’s executives received as much as $19,530 apiece on dividend equivalents from stock that they do not own. The relevant question that follows is whether executives are extracting additional compensation from shareholders using dividend equivalents or are dividend equivalents appropriate incentives to executives.This paper will examine the concept of restricted stocks as part of executive compensation and the motivation of companies in using this compensation policy to address the agency costs problem. I will also examine practical examples of CEO’s who have received dividend equivalent payments on restricted stocks, variations of corporate treatment of dividend equivalent rights and the motivation of some companies who chose to defer payment on dividend equivalents until an executive earns the shares.This paper will further examine, whether there are agency cost benefits of dividend equivalent rights, which merit a strong case for its use. I conclude that there are a quite a number of significant agency cost benefits of dividend equivalent rights, one of which includes the fact that it helps executives focus on, and rewards them for managing the business to produce cash that is capable of being distributed to shareholders in the form of a dividend.I will also look at some of the criticisms that have been asserted by shareholder activist groups as to how dividend equivalent rights reduce firm value, increase agency costs, and fails to achieve the objectives of adopting restricted stocks as a performance enhancing compensation package. I will describe the criticisms with a view to determining the basis of the criticisms and I conclude that while the criticisms are well founded, calling for complete elimination of dividend equivalent rights is not an appropriate solution to the agency cost problem. Finally, I will put forward my recommendations for policy reforms.

How do dividend taxes affect stock volatility? If a risk-averse executive faces price risk through his incentive contract, changes in stock volatility due to dividend taxes may increase agency costs and therefore decrease overall welfare. In this paper, I use a decrease in dividend taxes as a natural experiment to identify their effect on the firm’s idiosyncratic stock return volatility. Stock volatility decreased after the tax cut for firms at which executives have larger sensitivity to stock price in their incentive compensation package relative to firms at which executives have a smaller sensitivity. Therefore, with risk-averse executives and risk-neutral shareholders, dividend taxes may exacerbate agency costs. The increase in agency costs will decrease shareholder welfare, which can be partially offset by the use of options in the employment contract.

This article examines the hedge fund and hedge fund manager characteristics that lead certain hedge fund managers to select quality auditors. Specifically, using a unique measure of audit quality, the author tests whether hedge fund managers with long histories choose lower-quality auditors, given that the effects of initially selecting a quality auditor lessen over time. Consistent with prior research, the author finds a negative relationship between manager tenure and the choice of a quality auditor. Further, under the theory that agency costs increase as hedge fund size increases, the author tests whether hedge funds with higher agency costs choose higher-quality auditors. Again consistent with prior research, the author’s findings indicate that increased agency costs are positively associated with the selection of higher-quality auditors.

This exploratory study is intended to analyze how a combination of the resources-based view and agency theory can provide a better understanding of the internal dynamic of the family business and its evolution. Our evidence seems to suggest that the desire to keep family control produces specific sources of value and conditions the firm's financial capacity to acquire resources. These peculiarities change between first and following generations. During the first generation, we find that less severe agency costs balance the negative effect of scarce financial structure on the family firm's value. After descendants join the firm, the increasing agency costs are compensated by the enlargement of the firm's financial structure.

How do dividend taxes affect stock volatility? If a risk-averse executive faces price risk through his incentive contract, changes in stock volatility due to dividend taxes may increase agency costs and therefore decrease overall welfare. In this paper, I use a decrease in dividend taxes as a natural experiment to identify their effect on the firm’s idiosyncratic stock return volatility. Stock volatility decreased after the tax cut for firms at which executives have larger sensitivity to stock price in their incentive compensation package relative to firms at which executives have a smaller sensitivity. Therefore, with risk-averse executives and risk-neutral shareholders, dividend taxes may exacerbate agency costs. The increase in agency costs will decrease shareholder welfare, which can be partially offset by the use of options in the employment contract.

The agency costs of free cash flow: acquisition activity and equity issues