Equity-based Compensation Research Articles

Environmental, social and governance (ESG) performance and abnormal positive tone

Purpose The purpose of this study is to explore the relationship between environmental, social and governance (ESG) performance and tone management in the annual report. This is based on the notion that managers, driven by personal interests, may use their ESG accomplishments by using an abnormal positive tone to enhance their reputation or career prospects. Design/methodology/approach Using panel data from Chinese listed companies from 2010 to 2022, this study first investigates the relationship between ESG performance and abnormal tone management. The study then uncovers this relationship is mediated through the mechanisms of equity-based incentive and analyst coverage. The conclusions of this paper hold even after a series of robustness tests, such as propensity score matching, Heckman two-stage method and two-stage least squares with instrumental variables. Findings This study finds a positive correlation between ESG performance and the presence of abnormal positive tone in annual reports. Furthermore, the mechanistic analysis reveals that managers in companies with strong ESG performance are motivated to use an overly positive tone, largely due to their vested interests in equity-based compensation. Moreover, in an effort to alleviate the pressure stemming from heightened financial analyst coverage and enhance the impression conveyed through analysts' reports, managers with superior ESG performance also tend to inflate the tone within their annual reports. Practical implications This study provides significant insights into the ongoing dialogue surrounding ESG-related equity incentives, which incentivize managerial manipulation of stock prices through the use of abnormal positive tone. The findings call upon investors to exercise greater vigilance in examining narrative information in annual reports, as abnormally positive tones may not always faithfully represent performance but rather reflect managerial self-interest. Social implications There is an emphasis on the importance of robust oversight mechanisms within corporate governance bodies to curb the manipulation of tone for managers’ personal gain. Originality/value This study enhances the theoretical foundation of ESG studies, offering a holistic perspective on the intricate interplay among ESG performance, managerial behavior and financial markets, with potential implications for researchers, investors and regulators.

Asset impairments surrounding chief financial officer turnover

We examine the effect of chief financial officer (CFO) turnover on the likelihood and size of asset impairments. Using Australian data, we find evidence consistent with incoming CFOs recording larger asset impairments, particularly when they are external hires with prior listed experience, or receive equity-based compensation. Our results also indicate that outgoing CFOs report higher profits in the year prior to their departure by reporting fewer and smaller asset impairments. This effect is larger when outgoing CFOs move to another listed firm or receive equity-based compensation, consistent with reputational and compensation incentives to maximise earnings. Overall, our results provide evidence of the independent influence CFOs have on financial reporting. JEL Classification: M41, G34, M40

Mergers and Acquisitions, CEO Compensation, and Corporate Governance in the Hospitality and Tourism Industry

Drawing on agency theory, we explore the relationship between mergers and acquisitions (M&As) and chief executive officer (CEO) compensation in the hospitality and tourism (HT) industry. Specifically, we investigate whether growth via acquisitions, a popular strategy in the HT industry, is influenced by CEO compensation. Using a sample of HT and non-HT firms for comparison from 1992 to 2019, we find that CEO compensation is significantly higher after acquisitions for both HT and non-HT firms. However, when controlling for common compensation determinants, CEO compensation is significantly higher in HT firms but not in non-HT firms. Surprisingly, in our sample, corporate governance is not significantly related to changes in CEO compensation post-acquisition. In addition, while the fraction of cash-based compensation is negatively related to M&A propensity in both HT and non-HT firms, the fraction of equity-based compensation is unrelated to M&A propensity in HT firms. Our study fills an important gap in the sparse literature on the link between M&A and CEO compensation in the HT industry, providing theoretical implications for future research and managerial implications for boards of directors to design compensation plans that align the interests of managers and shareholders.

The interaction between equity-based compensation and debt in managerial risk choices

This paper examines the risk incentives of traditional and non-traditional call options in the context of a levered firm where managers under-invest due to risk aversion. Our results contrast with those presented in the literature inasmuch as lookback calls do not always induce higher risk taking than regular calls, and managers always prefer a combination of regular calls and shares of stock in their compensation package as opposed to only company shares. We also show that Asian options outperform both plain-vanilla and other nonstandard options in inducing higher risk taking and, thereby, are a superior remedy for alleviating the agency costs of deviating from the optimal volatility level. Finally, we shed new insights that better clarify the incorrect arguments found in the literature regarding the delta of regular and lookback calls.

Board Structure, CEO Equity-Based Compensation, and Financial Performance: Evidence from MENA Countries

This paper investigates the association between board of director (BOD) structures and CEO equity-based compensation (long-term incentive) for commercial banks (conventional and Islamic banks) in MENA countries. Specifically, we take board size and board independence to measure the board structure. Furthermore, we investigate the influence of board structure on the association between CEO equity-based compensation and financial performance. Moreover, we compare conventional and Islamic banks in testing these relationships. Using a sample of 65 banks in MENA countries for the period between 2009 and 2020, we show a significant positive association between board size and CEO compensation. However, we find the same association between these variables for IBs, but the effect of board size on CEO compensation is less. We also show that board independence is negatively correlated with CEO compensation. Nevertheless, the relationship between board independence and CEO ownership is positive for IBs. For the moderating test, we find that effective board structure provides more incentives to the CEO, leading them to achieve higher financial performance. The Islamic bank’s business model (based on Shari’ah principles) contributes to the different influences of board structure on CEO compensation. Our results provide the insight that a strong and effective board is important for managing the executive’s compensation system. The findings of this study have implications for financial firms, policymakers, and regulators. Specifically, the study may help in understanding the benefits of different compensation structures relative to different types of financial firms.

Executive Equity-Based Compensation and Tournament Incentives

Executive Equity-Based Compensation and Tournament Incentives

CEO overconfidence, customer satisfaction, and firm value: An investigation of mediating and moderating effects

Drawing from the upper echelons theory and the balanced scorecard theory, this study investigates potential associations between CEO overconfidence, customer satisfaction, and firm value. Using a dataset of US public firms spanning from 1994 to 2019, we first examine the relationship between CEO overconfidence and customer satisfaction, focusing on the mediating role of R&D and advertising expenditures, and the moderating role of CEO equity-based compensation. We find that CEO overconfidence positively influences customer satisfaction, and this positive impact is partially mediated by R&D and advertising. In addition, moderated path analysis indicates that CEO equity-based compensation increases the indirect effect of CEO overconfidence on customer satisfaction. We next examine and document that CEO overconfidence moderates the positive impact of customer satisfaction on firm value. Our results contribute to the extant literature by highlighting that CEO overconfidence not only positively affects shareholder value, but also links to the consequences of strategic marketing decisions, such as customer satisfaction. Our study provides implications for boards of directors, who may need to align CEO and firm marketing spending decisions. It also raises shareholders’ awareness of the presence and impact of CEO overconfidence.

The Impact of General Manager’s Responsible Leadership and Executive Compensation Incentive on Enterprise ESG Performance

This paper takes 101 enterprises in high-tech industries as research samples to investigate the impact of a general manager’s responsible leadership on enterprise ESG performance. The results showed that (1) a general manager’s responsible leadership can promote enterprise ESG performance, and (2) organizational resilience has a mediating effect between general manager responsible leadership and enterprise ESG performance. These conclusions were still robust after a series of validity tests. Further analysis showed that a monetary compensation incentive for senior executives positively regulates the indirect effect of a general manager’s responsible leadership on enterprise ESG performance through organizational resilience; that is, when monetary incentive for senior executives is high, the positive impact of a general manager’s responsible leadership on enterprise ESG performance through organizational resilience is strong. However, the influence of executive equity-based compensation incentive on their relationship is not obvious. The conclusions of this study provide theoretical and practical enlightenment for improving enterprise ESG performance, enrich the research on the intermediary mechanism of organizational resilience on responsible leadership and enterprise ESG performance, and provide intervention and decision-making basis for enterprises, regulators, and other relevant departments. The limitations of this study pave the way for further research directions, incorporating equity-based compensation incentive on promoting responsible leadership to achieve high ESG performance, and allowing for a better evaluation assessment.

Family firms and product recalls: an event study for the US automobile industry

PurposeThis study explores whether the unique organizational form of family firms helps to mitigate the negative effects caused by the announcement of product recalls.Design/methodology/approachThe authors use an event study, for a sample of 2,576 product recalls in the United States (US) automobile industry, between January 2010 and June 2021.FindingsThe authors found that stock market's reaction to a product recall announcement is less negative for family firms. This superior performance is partially driven by the family firms' long-term investment horizons and higher strategic emphasis on product quality. However, the relationship between family ownership and cumulative abnormal returns around product recall announcements is nonlinear as the impact of family ownership starts by being positive but becomes negative for higher levels of family ownership. The authors also find that family firm's chief executive officer (CEO) and managerial ownership influence positively the stock market reaction to product recall announcements.Practical implicationsThis work has several implications for family firms' management as well as for investors and financial analysts. First, as higher managerial ownership is associated with a greater emphasis on product quality, decreasing stock market losses when a product recall occurs, family firms should consider increasing equity-based compensation. Second, as there seems to exist an optimal proportion of family ownership, family firms should consider the risks of increasing too much their ownership share. Third, investors and financial analysts can use the results in the study to help them in their investment and trading decisions in the stock market.Originality/valueThe authors extend the knowledge of product recalls by studying the under-researched role of the flexible, internally focused culture of family businesses on the stock market reaction to product recalls.

The impact of accounting comparability on CEO incentive plans in an emerging economy: the moderating role of board independence

PurposeThe present study investigates the impact of accounting comparability on chief executive officer (CEO) incentive plans and the moderating role of board independence for companies listed in Tehran Stock Exchange (TSE).Design/methodology/approachThe information about 177 companies in 2014–2021 was examined. In this study, equity-based compensation and cash-based compensation were used as the CEO incentive plans. The equity-based compensation was calculated through the ownership of the CEO shares.FindingsThe results suggest that the higher accounting comparability increases not only CEO equity-based compensation, but also cash-based compensation. Board independence also strengthens the relationship between accounting comparability and CEO compensation. Hypothesis testing based on robustness checks confirmed these results.Originality/valueThe paper is pioneering, to the authors' knowledge, in identifying how board independence moderates the impact of accounting comparability on CEO compensation. The findings provide insights into economic consequences to the firm related to accounting comparability and board monitoring. The results have important practical implications for international investors to evaluate accounting comparability, corporate governance mechanisms and CEO incentives.

IMMIGRANT-FOUNDER FIRM, LAYOFF, AND FIRM PERFORMANCE

ABSTRACT This study examines the impact of layoff announcement on firm performance for immigrant-founder firms. Specifically, I examine the difference of financial performance between immigrant-founder companies and non-immigrant-founder companies over the three-year period surrounding layoffs. The study documents that immigrant-founder companies announcing downsizing, on average, perform better than non-immigrant-founder companies prior to and in the year of employee layoff announcement, but perform worse after the year of layoff announcement. Market responds positively to value-enhancing layoff announcements from both immigrant-founder and non-immigrant-founder companies. It implies that companies, especially immigrant-founder companies with deteriorating financial performance, are more likely to implement value-enhancing layoffs to avoid eliciting a negative stock price response that leads to decreased executive equity-based compensation. Keywords Layoff, Immigrant-founder firms, Firm Performance.

Outside directors' equity incentives and strategic alliance decisions

This study examines whether the proportion of equity-based compensation in outside director compensation is associated with corporate strategic alliances. We hypothesize that equity incentives provided to outside directors mitigate potential agency conflicts between outside directors and shareholders that arise from the strategic alliance decision-making process, thus resulting in more alliance activities. Our empirical evidence indicates that the percentage of equity in outside director compensation is positively associated with the incidence and the number of strategic alliance activities. Additionally, when the proportion of outside directors' equity in total compensation is higher, firms with strategic alliances generate better future stock returns. Overall, our findings suggest that providing equity incentives in outside director compensation mitigates the agency problems inherent in corporate strategic alliance decisions and enhances the quality of alliance activities.

CEO duality, CEO compensation, and earnings management: Evidence from China

This paper investigates whether chief executive officer (CEO) duality and CEO compensation influence earnings management. We obtain the data of the A-shares companies listed in both the Shanghai Stock Exchange (SSE) and Shenzhen Stock Exchange (SZSE) from the Chinese Securities Market and Accounting Research (CSMAR) database. Using a sample of 8,419 firm-year observations of 881 unique listed companies in China from 2011–2022, we find that the firms with CEO duality exhibit a higher level of earnings management, through both discretionary accruals and real activities. In addition, CEOs with higher cash-based compensation are more likely to engage in earnings management, while CEOs with higher equity-based incentives are less likely to engage in real earnings management. We further examine the moderating role of CEO duality and find that CEOs who also chair the board are more likely to engage in real earnings management. Additional analysis shows that state-owned companies are less likely to engage in earnings management activities. However, equity-based compensation provides incremental incentives for the CEOs of state-owned companies to manage earnings through accruals rather than real activities.

A review of corporate governance effectiveness: Developed vs emerging markets

In recent years, a thriving academic debate evaluating the trend of convergence in corporate governance regulations around the world (Samanta, 2020) has taken place. Academics and practitioners question the transplantation of corporate governance regulatory environment, typically from the developed world to emerging countries, without much consideration for local economic and business environment and culture. Based on a review of empirical studies published in high-quality journals from 2001 to 2021, we synthesize evidence related to the effectiveness of corporate governance mechanisms in developed markets compared to emerging markets. We focus on benefits accruing from these mechanisms in reducing agency costs of firms in terms of improved accounting performance, market valuation, and financial reporting quality of firms. We find that only a few governance mechanisms, for example, board diversity, family management, and equity-based compensation for top management are effective in reducing agency conflicts and promoting good governance. Other governance-improving tools seem to vary in terms of the degree of effectiveness in developed and emerging markets. The analysis suggests that cultural, political, economic, and legal features of an economy should be considered carefully by policy makers and regulators while adapting corporate governance regulations from developed economies in emerging markets.

Does adopting voluntary ESG practices affect executive compensation?

The Equator Principles (EP) is a voluntary framework of environmental guidelines for financial institutions in project financing. This paper examines the impact of an EP adoption on executive compensation. Compared to a matched sample of non-adopting banks, we find that total compensation significantly increased in banks that adopted the EP. The increase was driven by larger grants of equity-based compensation. This effect of EP adoption on executive pay does not depend on the risk management framework of the bank or on the timing of the adoption. Lastly, we do not find evidence of a change in the adopting banks’ performance.

Does social capital influence executive risk-taking incentives?

We examine the impact of social capital at the US county level on managerial risk-taking incentives. We hypothesize that corporate executives in counties with higher social capital would accept lower equity-based compensation then faithfully behave in terms of efforts and risks following the shareholder trust or restrain themselves from rent-seeking which may harm shareholders. Our main test results with firm fixed effects are consistent with our hypothesis. Additional robustness checks—propensity score matching, instrumental variable, and difference-in-differences analyses—corroborate our main findings. Thus, it is highly likely that social capital has a curbing effect on executive risk-taking incentives.

An analysis of net-outcome contracting with applications to equity-based compensation

Options, restricted stock, bonuses tied to total shareholder return, and similar equity-based compensation contracts stipulate payments that depend on stock price. Any such contract is a function of shareholder value net of the compensation payment, because stock price (1) is proportional to this net value or “net outcome” and (2) anticipates compensation-related payments and dilution. The net outcome, in turn, is reduced by the payment and so depends on the contract. Standard moral hazard analyses, wherein contractual payments are based on the gross outcome before any payment to the agent, overlook this dependency. We characterize the optimal net-outcome contract, describe its shape and pay-for-performance sensitivity, contrast it with the optimal gross-outcome contract, and discuss implications for equity-based compensation arrangements.

SEC Ruling, Investor Confidence and Firm Valuation

Prior studies suggest that a firm is valued higher when the shareholders are better protected. By examining the firms’ responses to the SEC Order No. 4-460, we find significant positive abnormal returns to those firms with correct certification. Those firms with timely certification are rewarded with higher valuation. Consistent with the notion that large outside blockholders have strong incentive to monitor managers, we find that outside blockholders play an important role in ensuring the accuracy and timeliness of financial reports. The equity-based compensation package may align the managerial interest with shareholders’ as a whole, but not necessarily with outside shareholders’.

Does equity-based compensation motivate executives to build strong brands?

ABSTRACT To defeat myopic brand management, we need to understand better what motivates executives to invest in brand building. Drawing from agency theory, we argue that a better alignment of executivesʻ and shareholdersʻ interests can help. Tests using longitudinal compensation data of chief executive officers (CEO) from 123 public firms suggest that decreasing the sensitivity of CEOʻs Equity-Based Compensation (EBC) to the firmʻs stock price and increasing its sensitivity to the firmʻs stock return volatility are associated with higher brand equity. Weak governance somewhat offsets these effects. Moreover, we find that the impact of EBC on brand equity is partially mediated through the firmʻs strategic emphasis. Our research highlights the importance of understanding managerial incentives as drivers of brand equity.

Mediating Effects of Accounting Conservatism on The Relationship Between Corporate Governance and Cost of Capital

Mediating Effects of Accounting Conservatism on The Relationship Between Corporate Governance and Cost of Capital