Predictions Of Agency Theory Research Articles

Corporate ownership and market valuation in South Africa: uncovering the effects of shareholdings by different groups of corporate insiders and outsiders

This paper examines the connection between shareholdings by different groups of corporate officers (insiders and outsiders) and market valuation in South Africa. Specifically, we examine the effect of shareholdings by employees, chief executive officers (CEOs), chief financial officers (CFOs), other executive directors, and non-executive (outside) directors on market valuation. We find that total ownership by all corporate officers (insiders and outsiders) is positively related to market valuation. However, when we examine the link between ownership by individual groups of corporate officers and market valuation, our results suggest that firms with higher ownership by CEOs and other executive directors have lower market valuation, but we do not find any evidence that ownership by CFOs has any significant effect on market valuation. In contrast, we find that ownership by employees and non-executive outside) directors is positively related to market valuation. Our findings are generally consistent with the predictions of agency theory.

Affiliate Firm Performance in Large Family Business Groups: Reflection on Agency Theory

The predictions of classical agency theory and the principal-principal perspective on agency theory differ in their view of the level of family ownership in a firm. This study examines affiliate fi...

Top Executive Compensation: Implications and Recommendations for Reform

This article outlines the implications and recommendations that arise from the findings from a previous empirical research undertaken by the author. In general, the findings suggest that company performance is not a major determinant of top executive compensation. Rather, subjective measures and company size are likely to be the more important determinants of top executive compensation. The findings also suggest that under the condition of ownership concentration, the major role of the board of directors may not be monitoring top executives and setting their compensation. Instead, the major role of the board of directors may be to provide external links, expertise and advice to the company. The findings of the study further suggest that under the condition of ownership concentration, chief executives who hold the chair or vice-chair of the board are unlikely to use their power to benefit themselves. The findings suggest that the assumptions and predictions of agency theory should not be generalised to non–Anglo-American settings such as Hong Kong, and are unlikely to offer an explanation of top executive compensation—at least for the major listed companies in Hong Kong. Other theories such as stewardship theory may offer a better explanation of top executive compensation, especially in a business environment such as Hong Kong. The findings indicate that it may be wise for company shareholders and regulatory policy-makers in Hong Kong to consider Hong Kong’s unique institutional and cultural contexts as they reform compensation policies for Hong Kong’s top executives.

Optimal Compensation and Pay-Performance Sensitivity in a Continuous-Time Principal-Agent Model

This paper studies the optimal contract between risk-neutral shareholders and a constant relative risk-aversion manager in a continuous-time model. Several interesting results are obtained. First, the optimal compensation is increasing but concave in output value if the manager is more risk averse than a log-utility manager. Second, when the manager has a log utility, a linear contract is optimal when there is no explicit lower bound on the compensation, and an option contract is optimal when there is an explicit lower bound. Third, optimal effort is stochastic (state dependent). Fourth, consistent with empirical findings and contrary to standard agency theory predictions, the relationship between pay-performance sensitivity and firm performance and that between pay-performance sensitivity and firm risk can be nonmonotonic. This paper was accepted by Wei Xiong, finance.

The market for audit services in Bangladesh

PurposeThe purpose of this paper is to provide a comprehensive analysis of the audit services market in Bangladesh. It explores the trend in audit fees over a period of 14 years and shows that in real terms audit fees have actually been declining although in nominal terms it appears otherwise. The study aims to expand the domain of audit fee literature by determining audit concentration in the market and thereby showing how the market is not dominated by the so‐called Big Four firms. The paper also examines the degree of inside ownership as a possible determinant of audit fees.Design/methodology/approachThe paper employs a multivariate analysis of estimating audit fees against mainly client‐specific attributes. It computes Helfindahl Index to measure audit concentration in the market.FindingsResults from the multivariate analysis show that the degree of inside ownership inversely affects audit fees. Client size and their multinational affiliation have a significant positive effect on audit fees. Firms in the financial sector also tend to pay significantly higher audit fees in Bangladesh. The reported inverse relationship between the audit fee and proportion of inside‐ownership in the auditee firm indicates, per agency theory prediction, that firms with more diverse ownership in Bangladesh pay more in audit fees. However, contrary to the findings in prior empirical studies, audit fee was reported to be significantly negatively related to audit complexity. As the audit complexity measure is revised, the variable ceases to be a significant driver of audit fees. This could be attributable to a methodological flaw in the traditional method of measuring audit fees as the ratio of inventory and receivables to total assets or to increased efficiency achieved by auditors via scale economies while auditing companies owned essentially by the same group of people.Research limitations/implicationsThe main limitation of the paper is that the closing period of the data is 2003, although there is no evidence to believe that the general determinants of audit fees have changed in Bangladesh since 2003.Practical implicationsA decline in real audit fees is a matter of concern for the quality of audit services because it may impede audit firms to invest in talent and other forms of audit technology essential to delivering a high quality audit. It may also have wider implications on the quality of financial reporting in the country.Social implicationsIf the audit fees do not increase keeping pace with general power, the profession would struggle to recruit talented individuals to the auditing profession. This may have longer‐term social implications as it may drive away potential graduates with little or no parental resources to support them to develop an accounting career with substantial dependence on family funds.Originality/valueThe current study is the first to introduce ownership structure based perspective, in a multivariate format, to explain what drives audit fees in a developing country setting. It also is the first to compute audit concentration in a developing country context. This is the first paper to present audit fee trend in real terms, i.e. inflation adjusted, client size adjusted, and so on.

Determinants of internal governance quality: evidence from Sweden

PurposeThe purpose of this paper is to assess whether ownership concentration, leverage and demand for equity financing is associated with internal corporate governance quality. The paper focuses on dimensions of governance quality that are related to financial reporting quality.Design/methodology/approachThe authors measure internal governance quality by an indicator variable that takes on higher values depending on whether a company has an audit committee, has a sufficient number of audit committee meetings during the year, has financial expertise on the audit committee, has an internal auditing function, a risk management function, a code of conduct and whistle blower provisions in the code of conduct. The sample consists of 91 Swedish listed companies of which 39 companies had to follow the Swedish Corporate Governance Code. The development of hypotheses is based on agency theory. Ordered logistic regressions are used to test the hypotheses.FindingsThe paper finds a strong negative association between leverage and the internal governance quality score for companies that do not have to follow the Corporate Governance Code. The paper also finds a positive association between the governance quality score and dispersed ownership among companies that have to follow the code.Research limitations/implicationsThe negative association between leverage and governance quality is opposite to the typical agency theory prediction. A number of other studies have also documented negative or insignificant associations with leverage in related settings. The research suggests there is a demand to develop theories related to leverage and the implementation of governance characteristics beyond the typical agency theory based predictions.Practical implicationsThe results raise the question whether lenders more actively directly or indirectly should influence the governance quality of borrowers.Originality/valueBased on the conjecture that governance quality increases with the number of governance elements, the paper studies a governance score that is built up by several elements of good corporate governance. Furthermore, the authors study a setting dominated by voluntary choices of governance quality, which makes it possible to study supply effects.

Board Task‐related Faultlines and Firm Performance: A Decade of Evidence

ABSTRACTManuscript Type: EmpiricalResearch Question/Issue: To what extent can group faultlines and their potential value‐destroying effects be detected on corporate boards? Task‐related attributes of the type of directorship, education, board tenure, and financial background of board members are considered as directors' characteristics that give rise to the faultline phenomenon. The impact of task‐related faultlines on firm performance as well as the moderating effects of busy boards, Chief Executive Officer (CEO) tenure, executive directors' (EDs) compensation structure, and the average non‐executive directors' (NEDs) involvement in board committees are examined.Research Findings/Insights: Using a panel of FTSE 350 companies from 1999 to 2008, we find a strong negative effect of task‐related faultlines on firm performance. Further exploration of the moderating effects demonstrates that the condition of a busy board and CEO tenure exacerbate the negative effects of faultlines. At the same time, the executive pay contingency is found to have a remedying effect on boardroom cohesiveness, whereas the involvement of NEDs in board committee work is not likely to make the adverse effects of board faultlines less pronounced.Theoretical/Academic Implications: Based on the arguments of social identity theory, this study shows that task‐related faultlines on corporate boards have strong negative value‐creating implications. The positive moderating impact of the executive compensation structure renders support to agency theory predictions about executive incentive alignment. This work also underlines the usefulness of the concept of faultlines in the corporate governance literature, because unitary boards, where NEDs and EDs share board responsibility, exhibit pre‐existing factions, similar to top management teams of family‐controlled firms and teams managing international joint‐ventures.Practitioner/Policy Implications: This research points to the importance of a careful selection process of directors by nomination committees. It also underlines the role for active leadership on boards, who should be aware of available strategies to ameliorate the negative consequences of board schisms, such as accentuating superordinate board identity and/ or informal meetings.

Does the contribution of dividend to firm value depend on controlling shareholders?

The aim of this paper is to investigate the effects of the degree of control of large shareholders on the relation between dividend payout and firm value creation. From the perspective of agency theory, dividend payout is highly appreciated for firms subject to highly agency problems. Using a sample of 275 firm-years listed on the Tunisian Stock Exchange over the period 1998–2007, our results show that contrary to agency theory predictions, dividend payout of Tunisian firms contributes more to value creation when the firm has low agency conflicts. We find a positive and highly coefficient for the payouts of firms with shared control and with majority financial institution control. These results may be interpreted through the trust assigned by Tunisian investors to firms that have low agency problems. Our results also indicate a strong positive relationship between the return on assets, the level of debt and firm value. Finally, we document a negative relationship between the financial business sector and firm value.

Corporate Governance and Performance in the Wake of the Financial Crisis: Evidence from US Commercial Banks

Manuscript Type: Empirical Research Question/Issue: Does corporate governance explain US bank performance during the period leading up to the financial crisis? We adopt the factor structure by Larcker, Richardson, and Tuna (2007) to measure multiple dimensions of corporate governance for 236 public commercial banks. Research Findings/Insights: Findings reveal corporate governance factors explain financial performance better than loan quality. We find strong support for a negative association between leverage and both financial performance and loan quality. CEO duality is negatively associated with financial performance. The extent of executive incentive pay is positively associated with financial performance but exhibits a negative association with loan quality in the long-run. We find a concave relationship between financial performance and both board size and average director age. We provide weak evidence of an association of anti-takeover devices, board meeting frequency, and affiliated nature of committees with financial performance. Theoretical/Academic Implications: We apply agency theory to the banking industry and expect that the governanceperformance linkage might differ due to the unique regulatory and business environment. Results extend Larcker et al. (2007), especially regarding the concave relationship between board size and performance, and the role of leverage. Given the lack of support for our agency theory predictions, we suggest that alternative theories are needed to understand the performance implications of corporate governance at banks. Practitioner/Policy Implications: We offer contributions to regulators, especially for ongoing financial reforms of capital requirements and executive compensation. Specifically, we show a consistent negative association between leverage and performance, which supports the current debate on Tier I capital limits for banks.

FDI, Export, and Capital Structure

This study investigates the impact of foreign direct investment (FDI) and export on capital structure for firms in emerging economies. The hypotheses are developed based on an agency theory perspective and are tested using a sample of 566 Taiwanese firms. We find that the behavior of multinational corporations (MNCs) with a high debt ratio is in line with agency theory predictions. Our findings show that: (1) MNCs in emerging economies, defined as those firms with at least one foreign subsidiary or some extent of FDI, have a higher level of debt than non-MNCs, which contrasts with the findings for MNCs based in developed countries; and (2) export intensity leads to a lower debt ratio, which has not received much attention in previous studies. We propose several factors related to the context of emerging economies to explain these contradictory findings. We also explore the interaction effect of the extent of FDI and export intensity on the capital structure of MNCs, and find that the impact is negative, which implies that both monitoring costs and agency costs rise dramatically for creditors when firms’ international operations become overly complicated.

Capital Structure, CEO Dominance, and Corporate Performance

We use agency theory to investigate the influence of CEO dominance on variation in capital structure. Due to agency conflicts, managers may not always adopt leverage choices that maximize shareholders’ value. Consistent with the prediction of agency theory, the evidence reveals that, when the CEO plays a more dominant role among top executives, the firm adopts significantly lower leverage, probably to evade the disciplinary mechanisms associated with debt financing. Our results are important as they demonstrate that CEO power matters to critical corporate outcomes such as capital structure decisions. In addition, we find that the impact of changes in capital structure on firm performance is more negative for firms with more powerful CEOs. Overall, the results are in agreement with prior literature, suggesting that strong CEO dominance appears to exacerbate agency costs and is thus detrimental to firm value.

Governance Thresholds, Managerial Ownership and Corporate Performance: Evidence from the UK

The paper examines the relationship between managerial share ownership and firm performance for British stock-exchange listed firms. We seek to establish a link between the predictions of agency theory and the corporate control environment using key governance and disclosure thresholds as determinants of the nonlinear relationship between managerial share ownership and performance. We also argue that the use of conventional accounting and market-based performance measures can be problematic in estimating managerial efficiency. The Clean Surplus Accounting Rate of Return is introduced as an alternative performance measure to Tobin’s Q and ROE.Our results indicate that relationships between managerial share ownership and corporate governance outcomes might be linked to key regulatory disclosure thresholds and minority shareholders rights of UK Company Law. We find that shareholder wealth is maximised when equity ownership by executive directors is below the 5% equity threshold of the Association of British Insurers’ dilution limit and sections 376 to 378 of Companies Act 1985 or above the 15% equity threshold of section 110 of Companies Act 1989 and section 127 of Companies Act 1985. Share ownership by executives between 5% and 15% is found to lead to declining firm performance.Our findings confirm the importance of testing thresholds based on corporate governance regulation rather than inductively deriving them from the data. We also show that it is desirable to decompose board ownership into executive and non-executive components. Our results further support the use of the Clean Surplus Accounting Rate of Return as an alternative performance variable.

Capital Structure, CEO Dominance, and Corporate Performance

We use agency theory to investigate the influence of CEO dominance on variation in capital structure. Due to agency conflicts, managers may not always adopt leverage choices that maximize shareholders’ value. Consistent with the prediction of agency theory, the evidence reveals that, when the CEO plays a more dominant role among top executives, the firm adopts significantly lower leverage, probably to evade the disciplinary mechanisms associated with debt financing. Our results are important as they demonstrate that CEO power matters to critical corporate outcomes such as capital structure decisions. In addition, we find that the impact of changes in capital structure on firm performance is more negative for firms with more powerful CEOs. Overall, the results are in agreement with prior literature, suggesting that strong CEO dominance appears to exacerbate agency costs and is thus detrimental to firm value.

Employees’ Pay-Performance Sensitivity and Firm Performance in the Uncertain and Competitive Environment: An Empirical Study of an Auto Dealership

Agency theory argues that pay-performance sensitivity to agents should be negatively associated with risk; however, some empirical evidence suggests the opposite. While analytical studies do not reach consensus on the relation between competition and pay-performance sensitivity, empirical evidence shows a positive relationship. This study uses a proprietary database of a major auto dealership in Taiwan to provide empirical evidence on how risk and competition affect sensitivity of employee pay to performance and how their congruence shapes firm performance. Our results support the prediction of agency theory that salespersons’ pay-performance sensitivity is negatively associated with risk (i.e., volatility of sales volume). Importantly, branches perform better when managers follow agency theory to adjust salespersons’ pay sensitivity to risk. Additionally, our results show that salespersons’ pay-performance sensitivity increases as competition intensifies; however, such relation does not produce higher firm performance.

Corporate Governance and Dividend Policy: Shareholders’ Protection or Expropriation?

Abstract: We investigate the relationship between corporate governance quality and dividend policy in Canada. Based on the agency theory predictions, we consider the effect of two conflicting hypotheses about the effect of corporate governance on dividend payouts: the outcome and substitution hypotheses. The effectiveness of firm‐level governance mechanisms is assessed through the Globe & Mail annual corporate governance index and four sub‐categories scores (board composition, shareholding and compensation issues, shareholder rights issues and corporate governance disclosure policy). Using a sample of 714 firm‐years listed on the Toronto Stock Exchange over the period 2002‐2005, our results show that firms with stronger corporate governance have higher dividend payouts. Among the four components of the corporate governance index, we document that board composition and shareholder rights’ policy are positively related to payout ratios. We also find a positive association between firm size, the level of free cash flows and dividend payouts. Finally, we document a negative relationship between firm risk, US cross‐listing and dividend payouts. Taken together our results are consistent with the outcome model of dividend policy.

Impact of Retained Ownership, CEO-Chair Duality, and Foreign Equity Participation on Auditor Choice of IPO Firms: Evidence from an Emerging Market

In this paper we study the impact of corporate governance characteristics on IPO firms’ auditor choice in an emerging market setting. We use three corporate governance attributes – CEO-Chair duality, retained ownership, and foreign equity participation to test the impact of ownership structure on auditor choice of 129 Bangladeshi firms that went public during the period 1990 to 2005. Our findings from logistic regression suggest that CEO-Chair duality and the degree of foreign equity participation are significant determinants of auditor choice while proportion of board ownership is not. In addition, issuer size and whether the issuer is a green field operation also influence auditor choice while the length of a firm’s operating history does not seem to matter. Our findings support agency theory prediction that (at least one category of) principals (foreign shareholders in this case), are likely to trade-off higher monitoring costs (of hiring a higher quality auditor) with agency costs arising from asymmetric information, primarily borne by absentee owners. It also supports the signaling role managers of green field operations play by hiring higher quality auditors to mitigate the uncertainties associated with their offerings.

Testing the effects of capital structure on entrepreneurial effort

Do entrepreneurs work less or harder when they borrow more? This article tests how entrepreneurial effort is affected by the firm's financing choice. In line with the typical agency theory prediction, entrepreneurial effort is negatively related to the magnitude of the equity financing. Furthermore, accounting for firm and entrepreneur heterogeneities, I find that entrepreneurs work less when they use more debt financing, and higher firm risk leads to greater entrepreneurial effort reductions.

Remuneration Committee, Ownership Structure and Pay-for-Performance: Evidence from Malaysia

We examine the association between remuneration committee and ownership structures on pay-for-performance. We find that appropriately structured remuneration committee and institutional shareholders enhance the pay-for-performance elasticity which lends credence to their monitoring role. We also find that pay-for-performance relationship is weaker at high level of managerial ownership, consistent with agency theory prediction. However, we also show that among pay-without-performance firms, executives earn higher pay as managerial ownership increases, which suggests that rent extraction through overcompensation is likely, in tandem with managerial power theory. The evidence shows that both the principal-agent and managerial power views are relevant in explaining executive pay in Malaysia.

Employee Compensation Contracts and Firm Performance in Uncertain Environments Empirical Evidence for Adjusting Pay-Performance Sensitivity

Agency theory argues that pay-performance sensitivity should be negatively associated with risk. Yet, empirical studies have reported mixed findings on this relationship, which may be attributable to such confounding factors as different levels of delegation and monitoring costs. Extending prior research, we use data from the proprietary database of a major car dealership in Taiwan to examine the relationships among risk, employee compensation contract design, and firm performance. Results show that pay-performance sensitivity (incentive) for salespersons is negatively associated with risk (i.e., volatility of sales volume), which supports the prediction of agency theory. Importantly, findings indicate that branch managers who adjust salespersons’ pay-performance sensitivity consistent with the suggestion of agency theory perform better than those who do not make prompt or sufficient adjustments.

Agency Theory and Participative Budgeting Experiments

ABSTRACT: A series of participative budgeting experiments has examined the effect of incentive structures and/or information environments on employees' reporting and production decisions. We analyze the previous experiments in terms of the insights they offer regarding agency theory. We expand the previous analyses of the incentive contracting experiments in three ways. First, we classify the earliest set of participative budgeting experiments based on the type of incentive and information structures examined in each study. Second, from the 21 papers we review, we identify eight specific cases for which the experimental evidence contradicts an agency theory prediction (i.e., anomalies). Third, we develop a classification scheme that can be used to organize hypotheses in terms of whether they rely on an agency theory prediction, a competing behavioral prediction, or a combination of the two. We use this classification to illustrate why we believe that studies that test both an agency theory prediction and a competing behavioral prediction are more likely to advance the development of theory than those that do not.