Recent Technical Papers on Corporate Governance

Abstract

During 2004, the Social Science Research Network (SSRN) posted nearly 200 draft and pre-published articles examining aspects of corporate governance on its website. This cluster of new work exceeded by scale that on the telecom collapse, the stock bubble, the overvalued dollar, and the Irish economic renaissance. The question is whether it is evidence that social science research follows what gets media attention, or whether it forms an organic whole attempting to advance towards a solution to the governance crisis. We develop an overview of that part of year 2004’s corporate governance research that answers partially that question. Articles were evaluated on six factors: intent, hypothesis, sources, methodology, relevance and importance, on a score between zero and one for each factor, providing for a score between zero and six for each article. The articles were then clustered into four categories: 1) the role of the board in explaining the corporate governance crisis 2) the relationship of executive and director compensation and corporate governance 3) the effect of governance indices on firm performance 4) the market for corporate control. In order to test for the “organic whole” of this stream of literature we evaluated each cluster using the factors as common metrics. In our judgment, a small number of articles (30% of those with scores of six) made contributions to understanding and thus improving governance in 2004. In the first set of articles Uzun et al. found less fraud if boards are smaller and have a lower percentage of non-independent inside directors; public firms having independent directors on nominating and audit committees experience lower levels of fraud (those in the sample tested [1978-2001 period] were not subject to the current requirements of the Sarbanes-Oxley Act of 2002 [SOX] of an independent director to chair the audit committee; thus the results are somewhat dated). Agrawal and Chadha found that boards having independent directors with financial expertise (on the board or audit committee) were less likely to experience a “shock” (defined by the authors as a significant accounting restatement). Brown and Caylor found that seven of the metrics utilized by Institutional Shareholder Services (ISS), principally those related to director performance and senior management stock options, had an effect on firm performance. On the second set, Shi found that CEO compensation structure was related to the type of risk (general, industry, and firm specific) that management can be held accountable for. Kadan and Yang found a relationship between executive stock options and earnings management. Datta et al. argue that there is a relationship between managerial stock ownership and corporate debt maturity (shorter debt maturity subjects the firm to greater monitoring by the debt capital markets). Cohen et al. found that subsequent to the passage of the Sarbanes-Oxley Act of 2002 (SOX), firms increased the fixed portion of executive compensation packages to compensate CEOs for the additional liability imposed on them by SOX. Moreover, CEO’s in the post-SOX environment were less likely to invest in RD well governed firms recognize write-offs earlier. On the fourth cluster of articles, Qiu found that when public pension ownership in a firm is high, corporate (post merger) performance in stronger. Wang found that block and higher institutional stock ownership (a governance mechanism) reduces corporate fraud and increases fraud detection. Bebchuk et al. find that the entrenchment index (developed from six ISS corporate governance variables) improves firm performance. Bebchuk et al. argue that internal barriers developed by management with the approval of the board constrain outside market governance forces. We also note two governance articles developed in 2004 that are based more on the extensive prior research by authors, rather than new empirical research. We refer to these as Type II articles in this paper. One article of interest by Jensen et al. posits a refinement of executive compensation that they believe will result in an improved performance metric to evaluate management. Shareholder value related to management performance should be measured by changes in earnings, incorporating cost of capital, rather than being measured solely by share price. The authors argue for the creation of bonus banks that allow for negative bonuses, thus holding management accountable for poor performance. Romano found that the development of SOX and derivative governance reforms was not grounded in empirical research. Romano argues that policy makers developed SOX rapidly in response to pressure from the public and media that was amplified by an election cycle. In our view, the articles by Jensen et al. and Romano provide the greatest contribution to our understanding of corporate governance. We believe that while many of the Type I (based on empirical research) articles provide answers to individual corporate governance factors (or sets of factors), they address only partial elements of a multivariate equation, rather than an organic whole, that would offer a solution to strengthen corporate governance.