External Monitoring Mechanisms Research Articles

Corporate tax avoidance and stock price crash risk: Firm-level analysis

Using a large sample of U.S. firms for the period 1995–2008, we provide strong and robust evidence that corporate tax avoidance is positively associated with firm-specific stock price crash risk. This finding is consistent with the following view: Tax avoidance facilitates managerial rent extraction and bad news hoarding activities for extended periods by providing tools, masks, and justifications for these opportunistic behaviors. The hoarding and accumulation of bad news for extended periods lead to stock price crashes when the accumulated hidden bad news crosses a tipping point, and thus comes out all at once. Moreover, we show that the positive relation between tax avoidance and crash risk is attenuated when firms have strong external monitoring mechanisms such as high institutional ownership, high analyst coverage, and greater takeover threat from corporate control markets.

Player and Referee Roles Held Jointly: The Effect of State Ownership on China’s Regulatory Enforcement Against Fraud

This paper examines the impact of the prevailing state ownership in the Chinese stock market on corporate governance and the financial regulatory system respectively as the internal and external monitoring mechanisms to deter corporate fraud and protect investors. In line with the literature that state ownership exaggerates the agency problem, we find that the retained state ownership in privatised firms increases the incidence of regulatory enforcements against fraud. For the state-owned enterprises (SOEs), however, larger state ownership is associated with a lower incidence of enforcement actions. This is attributed to the mutual political affiliation of the fraudulent SOEs and the regulatory commission. A new regulation “Solutions for Listed Firm Checks” promulgated in March 2001 has mitigated this effect by empowering the regulatory commission to increase the severity of regulatory conditions. Our evidence confirms the improvement in the regulatory environment and investor protection in the Chinese stock market brought about by the regulatory reform and development.

Player and Referee Roles Held Jointly: The Effect of State Ownership on China’s Regulatory Enforcement Against Fraud

This article examines the impact of the prevailing state ownership in the Chinese stock market on corporate governance and the financial regulatory system, respectively, as the internal and external monitoring mechanisms to deter corporate fraud and protect investors. In line with the literature that state ownership exaggerates the agency problem, we find that the retained state ownership in privatised firms increases the incidence of regulatory enforcements against fraud. For the state-owned enterprises (SOEs), however, larger state ownership is associated with a lower incidence of enforcement actions. This is attributed to the mutual political affiliation of the fraudulent SOEs and the regulatory commission. A new regulation “Solutions for Listed Firm Checks” promulgated in March 2001 has mitigated this effect by empowering the regulatory commission to increase the severity of regulatory conditions. Our evidence confirms the improvement in the regulatory environment and investor protection in the Chinese stock market brought about by the regulatory reform and development.

Takeover Immunity, Takeovers, and the Market for Nonexecutive Directors

We develop and test two competing hypotheses that relate the market for nonexecutive directors to the level of external monitoring mechanism of the firms they serve. The Reward for Discretion Hypothesis posits that directors are valued more when they display discretion concerning their choice of antitakeover provision (ATP) levels rather than follow a rule. Alternatively, the CEO Risk Aversion Hypothesis implies that CEOs seek directors with inclination for uniform and high ATP levels. We examine how changes in ATP levels and approval of value creating/destroying acquisitions affect the careers of nonexecutive directors. Our results, based on data from about 3,000 listed US companies during 1994‐2003, support the Reward for Discretion Hypothesis.

Regulation of Prison Conditions

Abstract Prisons in modern societies are complex bureaucracies that are subject to regulation through a range of external monitoring and internal inspection mechanisms. Internal inspections are closely connected to the bureaucracies that manage individual prison systems. External monitoring is conducted by international, regional, and national organizations. In theory, international monitoring by organs of the United Nations has a worldwide reach, but its impact in a particular country depends on whether the country has ratified the relevant international instrument and agreed to being monitored. Regional monitoring is particularly prominent in Europe. It is less prominent in other regions. The form that national external monitoring adopts varies greatly between countries. It may be done by a specially created inspectorate, human rights committee, or ombudsman. Local monitoring committees for individual prisons, complaints procedures, and court actions may all serve regulatory functions. These diverse bod...

Regulatory Incentives for Earnings Management through Asset Impairment Reversals in China

While asset impairment reversals are practiced in many jurisdictions, empirical evidence is rare. China provides us with a unique opportunity to examine both the determinants and consequences of impairment reversals resulting from recent developments in standard-setting and its specific performance-based listing requirements. Based on a sample of reversal firms in China, we report the following findings: First, Chinese-listed companies are motivated by regulatory incentives to reverse asset impairments to reduce or avoid the possibility of trading suspension or de-listing. Second, we provide some evidence that the value-relevance of reversal information appears to be negatively affected by the regulatory-motivated earnings management. Third, favorable internal and external monitoring mechanisms play a role in constraining this type of earnings management. Taken together, we conclude that while the intention of granting reversal discretion is for managers to reveal private value recovery information, our findings suggest that a seemingly improved accounting standard does not necessarily lead to its intended consequence in financial reporting.

Takeover Immunity, Takeovers and the Market for Non-Executive Directors

Using a database that covers close to 3,000 listed companies in the United States during a ten year period from 1994 to 2003, we characterize non-executive directors' preference for ATP levels; examine the effect on their careers for changes in ATP levels and approval of acquisitions that create or destroy value. We develop and test two competing hypotheses that relate market for non-executive directors to the level of external monitoring mechanism of the firms they serve. Reward for Hypothesis would predict that directors are valued more when they display discretion with regard to their choice of ATP levels rather than following a rule. On the other hand, CEO Risk Aversion Hypothesis would predict that CEOs seek directors with high ATP inclination and who also display uniformity in their choice of ATP levels. Our results suggest that non-executive directors serving in high ATP firms experience greater turnover in board seats. High ATP preference directors with no variation in their choice of ATP level are more likely to lose board seats, whereas high ATP preference directors with variation in their choice of ATP levels obtain additional board seats more often. Therefore, with regard to choice of ATP levels, Reward for Hypothesis dominates. The results with changes in ATP level as well as for M&A deals also support the Reward for Discretion hypothesis. The labor market appears to prefer directors who show variation in ATP level choices rather than simply prefer a high or low ATP level.

Which Monitors Monitor the Most? Dual-Stock Structure, Analyst Following, and Corporate Governance

We examine the effects of internal and external corporate governance and monitoring mechanisms on the choice of dual-class status and the firm performance of dual-class firms. Employing 736 dual-class firms and 7,027 single-class firms during the period 1996-2002, we find that dual-class firms tend to be larger, and have higher director ownership, higher institutional ownership, lower blockholdings, and a smaller fraction of independent, outside directors on their boards than single-class firms. In addition, we observe that dual-class firms are followed by a smaller number of security analysts. After correcting for endogeneity bias, our regression results show that not only firms with higher analyst coverage, but also firms with higher analyst following and a lower wedge, measured as the difference between voting rights and cash flow rights, or lower managerial entrenchment are strongly associated with Tobin's q. In contrast, blockholders' ownership, board independence, and institutional ownership play a relatively insignificant role in enhancing Tobin's q. We interpret these results to mean that security analysts are the most effective monitoring mechanism that influence both the dual-class choice and firm performance. Our results are not attributed either to the difference in firm size or to an industry effect.

Business Groups: An Integrated Model to Focus Future Research

abstract Business groups are the primary form of managing large business organizations outside North America. This paper provides a systematic and integrative framework for understanding business groups. We argue that existing theoretical perspectives of business groups pay attention to four critical external contexts, each of which draws from a specific theoretical perspective: market conditions (transaction cost theory), social relationships (relational perspective), political factors (political economy perspective), and external monitoring mechanisms (agency theory). Business groups adapt to these external forces by deploying various internal mechanisms along two key dimensions: one focuses on the distinctive roles of the group affiliates (horizontal connectedness) and the other focuses on coupling and order between the parent firm and its affiliates (vertical linkages). Based on these two dimensions, a typology of business group forms is developed: network (N‐form), club (C‐form), holding (H‐form), and multidivisional (M‐form). Utilizing this model we provide research questions which facilitate an improved future research agenda.

Determinants and Consequences of Proxy Voting By Mutual Funds on Shareholder Proposals

We analyze mutual funds' proxy voting records on shareholder proposals and investigate the following three issues. First, we study the determinants of mutual funds' voting policies across firms. Next, we examine the incentive structure of mutual funds that could act as a motivational force for them to undertake an activist role in their proxy voting behavior. Last, we investigate the trading behavior of mutual funds surrounding proposal meeting date and voting record release date and investigate whether mutual funds engage in Wall Street Walk, that is, sell off their shares when dissatisfied with firms' management. Our results indicate that mutual funds support shareholder proposals and vote against management for proposals that are likely to increase shareholders' wealth and rights, in firms with weaker external monitoring mechanisms and in firms with entrenched management. The level of insider voting rights and the internal governance mechanism through blockholder ownership also influence funds' voting decisions. Moreover, mutual funds' motivation to take on an activist role does not come from their ownership concentration, but rather from their long-term investment goal. The results further indicate that there is a positive reputational effect for the funds undertaking a monitoring role in their voting strategies. The trading behavior of mutual funds suggests that funds reduce holdings when they disapprove of managements' policy, but before doing so they take on an activist role by supporting shareholder proposals.

A matter of trust: The search for accountability in Italian politics, 1990–2000

During the Nineties Italian politics underwent major changes. Following the uncovering of systemic corruption, the current political establishment was wiped out. The system of representation at both the national and local level underwent a significant transformation that improved voters’ control over their elected representatives. We argue that both events were the consequence of citizens’ demand for greater accountability of public officers. We model the relationship between voters and politicians as a repeated Trust game. In such game, cooperation can be attained by means of external or internal controls. Whereas judicial investigation is an external monitoring mechanism, the electoral reform provides controls internal to the political system. We explain the Italian transition between these different modes of control and show under which conditions a cooperative equilibrium can be established in which voters trust their representatives who in turn act in the public interest.

Ownership structure, managerial behavior and corporate value

The nonlinear relationship between corporate value and managerial ownership is well documented. This has been attributed to the onset of managerial entrenchment, which results in a decrease of corporate value for increasing levels of managerial holdings. We propose a new structure for this relationship that accounts for the effect of conflicting managerial incentives, and external and internal disciplinary monitoring mechanisms. Using this specification as the basis for our analysis, we provide evidence that the managerial ownership–corporate value relationship is co-deterministic. This finding is at odds with recent work which reports that corporate value determines managerial ownership but not vice-versa.

Ownership Structure, Managerial Behavior and Corporate Value

The nonlinear relationship between corporate value (Tobin's Q) and managerial ownership is well documented. This has been attributed to the onset of managerial entrenchment, which results in a decrease of corporate value for increasing levels of insider holdings. We propose a new structure for the corporate value - managerial ownership function that accounts for the effect of conflicting managerial incentives, and external and internal disciplinary monitoring mechanisms. Using this specification as the basis for our analysis, we provide evidence that the managerial ownership - corporate value relationship is co-deterministic. This finding is at odds with recent work by Cho (1998) and Himmelberg et al. (1999) who report that corporate value determines insider ownership but not vice-versa. Keywords: Insider Ownership, Capital Expenditure, Corporate Value, Tobin's Q

The Power of Monitoring

The corporation celebrates its 400th birthday. What Adam Smith treated sceptically in his home country, has become the dominant organizational form all over the world. Closely related with the history of the corporation is the separation of ownership (shareholders) and control (management). As the managers do not necessarily behave as shareholders want them to, internal and external monitoring mechanisms developed over time, but different within the two legal systems of Common and Civil Law. In this contribution theoretical and empirical literature concerning internal and external monitoring devices is substantially reviewed. We find that in Common Law and Civil law countries as well monitoring systems are established to align the managers' interests with those of the external capital providers. But neither system is perfect. Although monitoring turns out to be a necessity providing a second-best solution to the inherent principal-agent situation between owner and managers of a firm there are inevitable weaknesses which one should be aware of.