Higher Firm Profitability Research Articles

Earnings Targets and Annual Bonus Incentives

ABSTRACT: We examine the extent to which firms use past performance as a basis for setting earnings targets in their bonus plans and assess the implications of such targets for managerial incentives. We find that high-profitability firms commonly decrease earnings targets when their managers fail to meet prior-year targets but rarely increase targets. Conversely, we find that low-profitability firms commonly increase earnings targets when their managers meet or exceed prior-year targets but rarely decrease targets. This target-revision process yields a serial correlation in target difficulty—targets remain relatively easy (or difficult) through time. We also find that firms are reluctant to revise earnings targets below zero, resulting in an unusually high frequency of zero earnings targets that are abnormally difficult to achieve. Collectively, our findings suggest that firms incorporate past performance information into targets, yet they do so only to a limited extent. This is consistent with theoretical arguments that highlight the benefits of contractual commitments. Data Availability: Data used in this study cannot be made public due to the confidentiality agreement with the sponsoring organization.

Four Pillars of Job Applicant Screening in China

Chinese employers practice extensive personal screening of job applicants. This study identifies four manifestations of this practice by motive – statistical, customer and employer taste-based, and regulatory – and evaluates their prevalence, economic determinants and implications for firms’ performance using simultaneous-equations models. Ordinary linear and Poisson regression specifications are estimated. Statistical screening is related positively to employers’ capital intensity, labor-market power and private ownership, and negatively to the supply of skills in provincial labor markets, as may be expected. Customer-taste screening is more prevalent in service and sales industries, as expected, and interestingly in wealthy first-tier cities. Employer-taste screening appears more prevalent at privately-owned firms, and surprisingly in skill-intensive industries and in first-tier cities, potentially reflecting difficulty at distinguishing it from customer-taste screening. Regulatory screening is related positively to firms’ market power, capital intensity and state ownership, as expected. Statistical and customer-taste screening is associated with higher firm profitability, particularly in skill-intensive industries and in service and sales industries, respectively, while employer-taste and regulatory screening is associated with lower profitability, as expected. These results jointly validate our identification of the four pillars of applicant screening.

Disclosure Quality and Executive Compensation

This paper studies the role of optimal managerial compensation in reducing uncertainty about a manager's reporting objective. I show that, paradoxically, firm owners allow managers with higher propensity to manipulate the short-term stock price to push for higher-powered and more short-term focused equity incentives. Such managers also work harder, and manipulate more, but may not generate higher firm profits. Consistent with existing empirical evidence on top manager pay, the model predicts a positive relationship between manipulation activity and both overall strength and short-term focus of equity incentives, but no relationship between firm value and equity incentives.

Do Labor Unions Affect a Firm’S Payout Policy? : Operating Leverage Versus Rent Extraction

While previous literature documents weak effects of unionization on payout policy on average, we find that this average relationship hides significant heterogeneous effects of unionization on payouts across firms that depend on firm profitability. The effect of unionization on payouts is negative for low-profitability firms but positive for high-profitability firms. We posit that labor unions (i) increase operating risk, which negatively affects payouts, but (ii) increase potential for rent extraction from unions, which could induce shareholders to demand positive payouts. Higher profitability mitigates the negative effect while strengthening the positive effect, making the relation between unionization and payouts less negative or more positive. We provide evidence consistent with both the negative and positive effects of unionization on payouts. Our empirical design mitigates endogeneity concerns. Further, an instrumental variable analysis and a cross-sectional test using right-to-work laws confirm that endogeneity is unlikely to drive our results.

The double-edged sword of CEO/chairperson duality in corporatized state-owned firms: evidence from top management turnover in China

This study examines how board leadership structure (CEO duality) affects the corporate governance of corporatized state-owned firms where the state shareholders use these firms to serve both profit and non-profit objectives. We propose that CEO duality will generate a positive (negative) significant impact on the firms’ corporate governance when state owners tend to monitor their CEOs on the basis of profit (non-profit) considerations. We test our hypotheses by examining the relations between CEO duality and CEO turnover in Chinese listed companies that are ultimately controlled by central or local governments. We find that CEO duality is negatively related to turnover in marginal profit-making firms where turnover would be value-enhancing. This suggests that CEO duality is detrimental to these firms’ corporate governance because it entrenches relatively poorly performing CEOs. Duality is also negatively related to turnover in high-profitability firms where turnover would be non-value-enhancing. This suggests that CEO duality might positively contribute to the corporate governance of these firms by reducing the occurrence of non-value enhancing turnover. Overall, our study suggests that CEO duality is a double-edged sword in corporatized state-owned firms.

No Appealing Future For High Growth – Low Profitability Firms: Evidence from Turkey’s Top 1000

The view that profitability, not growth, is the main driving force behind the firm performance, and unprofitable high growth can not lead to financial success has often been discussed in the literature. In this study, I tested this hypothesis on Turkey’s top 1000 data using an extended version of the method of Davidson et al. (2009). My sample strongly supports the hypothesis that controlling for leverage, low growth-high profitability firms (profit-focused firms) outperform high growth-low profitability firms (growth-focused firms) regarding both directions of their transition to an upper (i.e., high growth-high profitability) state and a lower (i.e., low growth-low profitability) state in subsequent periods. The hypothesis that controlling for firm type (growth-focused or profit-focused), leverage matters with respect to firm’s future performance is weakly supported by 3-year transition data.

Downsizing the Labor Force by Low and High Profit Firms - An Experimental Analysis

We theoretically and experimentally employ a principal-agent setting to capture the effects of downsizing the labor force. One of the two main treatments features a large increase of the principal's profit and another one a rather low increase. Our main experimental findings are that downsizing often is avoided and that its frequency does not depend on its profitability. There is evidence that agents spend more effort when downsizing is more profitable what might explain that downsizing frequencies hardly depend on the profitability.

An Experimental Examination of Perceptions of Fairness on Transfer Pricing Decisions and Firm Profit

Transfer pricing is an important managerial decision in a decentralized firm. Analytical research has proposed that different transfer pricing methods are better for different information circumstances in a firm. For example, when information asymmetry is high, the information advantage of the negotiated method generates higher firm profits than the cost-based method. But, when information asymmetry is low, the cost-based method provides more firm profits. Yet so far little empirical evidence exists that identifies when a particular scheme performs better than others in practice. The main challenge remains that it is difficult to apply analytical prescriptions without proper considerations of managerial behavior issues. For example, perceptions of fairness may influence a manager’s decisions, willingness to trade and thus the firm’s performance. This study develops a model that examines the potential influences on willingness to trade (transfer pricing method, information asymmetry and perceived fairness) and then the influence of willingness to trade on company profit. Overall, we find that transfer pricing methods, information asymmetry and perceived fairness influence willingness to trade and that willingness to trade is positively associated with company profit. Finally, perceived fairness was a significant variable when perceptions of fairness, willingness to trade, transfer pricing method and information asymmetry were regressed on firm profits, indicating that perceptions of fairness had the most significant influence on firm profits in this study.

Investment Growth and the Relation between Equity Value, Earnings, and Equity Book Value

Abstract: Using Zhang (2000) as the theoretical basis, we predict and empirically test the effect of investment growth on the relation between equity value and accounting variables. We find that (1) growth increases the slope in the value-earnings relation for high-profitability firms (consistent with growth having positive NPV), but has an insignificant or negative effect on the slope for lower-profitability firms (consistent with growth having non-positive NPV); (2) given earnings, growth increases the (positive) slope of the relation between equity value and equity book value for low-profitability firms, but reduces this slope and causes equity value to decrease with book value for high-profitability firms; and (3) given profitability (ROE), equity value uniformly increases with book value, and growth increases the slope of this relation. We also examine the valuation impact of past investment activities that arises from accounting conservatism. We find that the earnings coefficient is greater in the years following faster investment increases (which cause earnings to be more conservatively stated).

The power of intangibles in high-profitability firms

The paper identifies which intangible management features distinguish high-profitability firms. Based on the resource-based theory of the firm, we argue that high-profitability firms focus on the management of intangible resources linked to human, structural, and relational factors. We test two groups of 246 and 250 companies, in two different periods. Results confirm that high-profitability firms are strongly focused on their management of intangibles, and especially on factors that tend to strengthen employees productivity, innovation activities, and business relationships.

The effect of CEO pay deviations on CEO withdrawal, firm size, and firm profits

AbstractWe build upon previous work on the effects of deviations in CEO pay from labor markets to assess how overcompensation or undercompensation affects subsequent voluntary CEO withdrawal, firm size, and firm profitability, taking into account the moderating effect of firm ownership structure. We find that CEO underpayment is related to changes in firm size and CEO withdrawal, and that the relationship between CEO underpayment and CEO withdrawal is stronger in owner‐controlled firms. We also show that when CEOs are overpaid, there is higher firm profitability; a relationship that is weaker among manager‐controlled firms. We then discuss the implications that these findings have for future research. Copyright © 2010 John Wiley & Sons, Ltd.

The Effects of Inter-Firm Cost Correlation, IT Investment, and Product Cost Accuracy on Production Decisions and Firm Profitability

ABSTRACT: Using analytical and simulation techniques, we investigate the effect of inter-firm cost correlation, IT investment, and product cost accuracy on production decisions, and ultimately firm profitability in an imperfectly competitive market. Along with an unprecedented growth in investments in information technology (IT) over the last two decades, firms have made significant investments in IT to increase product cost accuracy. Yet, a variety of studies present mixed evidence as to the linkage between IT investment, product cost accuracy, and organizational performance. Further, while previous research has shown that IT may contribute to the improvement of organizational performance, contextual factors are important. We reexamine this issue in an imperfectly competitive market and product cost setting. We assert that knowledge of inter-firm cost correlation may be used to reduce the IT investment needed to achieve product cost accuracy and thereby optimize production and ultimately firm profit. To motivate our hypotheses, we develop and analyze an analytical model which incorporates IT investment, a costly, endogenous, imprecise product cost report, and inter-firm cost correlation. Using simulation techniques, we illustrate that production decisions informed by inter-firm cost correlation require less IT investment and result in higher firm profitability. Our emphasis on the initial design of product costing systems and the related IT requirements definition phase suggest that our result could be helpful to firm managers in establishing the optimal levels of IT investment and product cost accuracy in their specific product market setting.

Are special items informative about future profit margins?

Most proponents of using profit margins in forecasting models suggest that unusual items be removed from income to create a core profit margin. We investigate the appropriateness of this assumption over short and long horizons. Specifically, we explore the association between profit margins and special items over windows of increasing length, from one to five years. We find that the association between past special items and future profit margins differs markedly between firms with low and high core profitability. For low profitability firms, past special items have no association with future profit margins, even over windows of five years. In sharp contrast, for high profitability firms, negative special items are associated with lower future profit margins. This suggests that some firms maintain high core profitability by becoming serial chargers and special items differ from core earnings only to the extent that the allocation process induces timing errors in reported earnings.

The Persistence of Special Items

Prior research shows that negative special items are less persistent than core earnings. However, the allocation of special items to periodic earnings entails significant measurement error which may induce the observed lower persistence. In this paper, we control for this measurement error by aggregating core earnings and special items over periods of one to five years, and testing whether the differential persistence is robust to longer aggregation periods. We find lower persistence of special items only for firms with low core (pre-special items) profitability. For these firms, negative special items have no association with future bottom line earnings for all aggregation periods. In contrast, for high core profitability firms, negative special items exhibit significant persistence, and the persistence increases with the aggregation period. In particular, when earnings are aggregated over five years, we find no difference in the persistence of negative special items and core earnings.

A Re-examination of Dividend Policy: A Dynamic Panel Data Analysis

Through a cross sectional analysis of 48 firms, over a seven-year period, from 1996 to 2002, we try to shed some light into two sides. First of all, we research whether managers smooth their dividend policies or not. Besides, we outline the main determinants that may influence the dividend policy pattern. Specifically, we attempt to find answers to the following questions: Do Tunisian firms follow stable dividend policies or not? Do dividend yields differ across industries? What are the main factors that determine the dividend policy making? In the first section, Lintner's model is applied. Our results show that Tunisian firms rely on both current earnings and past dividends. However, it seems that dividends tend to be more sensitive to current earnings than prior dividends. Any variability in the earnings of the corporation is directly reflected in the level of dividends. However, dividend policy does vary across financial and non-financial industries. Our results uncover a low target payout ratio of respectively 16% and 27% for non-financial and financial firms while the adjustment speed respectively ranges from 0.68 to 1.56. Non-financial institutions adopt therefore a more smoothing dividend policy. Secondly, through a fully developed model, we highlight some factors that may influence the dividend policy pattern. First, riskier firms with high financial leverage pay out fewer dividends and have lower dividend yields. Furthermore, high-profitability firms with more stable earnings can also afford more dividends. However, larger investment opportunities deprive firms from higher dividends. Similarly, growing firms distribute fewer dividends. Additionally, dividends serve to reduce agency costs between the shareholders themselves only whereas the conflicts between insiders and outsiders seem to be not resolved with dividends. This matter holds true only in non-financial firms. In this vein, it should be noted that our analysis does show significant differences throughout financial versus non-financial industries. Finally, the size of Tunisian corporations has a systematic negative effect on dividend policy.

New product introduction with costly search

In the usual model of product market search, a low search cost can turn out to have detrimental incentives on new product introduction as the low search cost erodes firms’ market power, attenuating the profit from innovation. This paper studies a model of monopolistic competition with costly search, where the point of departure is that of a fixed cost of initiating search. In this environment, a low search cost could turn out to be favorable to innovation. At a low search cost, more consumers may decide to start searching, possibly resulting in higher profits for firms in the larger market, despite the erosion of market power.

An Experimental Comparison of Transfer Pricing Methods Under High and Low Private Information

Transfer pricing is an important managerial decision in a decentralized firm. When there is no competitive market for an internally traded good or service, a fair transfer price must be established for the buying and selling divisions in the firm. Analytical research has proposed different transfer pricing methods for different information circumstances in a firm. For example, when information asymmetry is high, the information advantage of the negotiated method generates higher firm profits that the cost-based method. But, when information asymmetry is low, the cost-based method provides more firm profits because there is no information advantage through negotiation. Yet so far little empirical evidence exists that identifies when a particular scheme performs better than others in practice. The main challenge remains that it is difficult to apply analytical prescriptions without proper considerations of managerial behavior issues. Behavioral studies on transfer pricing indicate that perceptions of fairness influences manager's decisions, willingness to trade and thus the firm's performance. This study conducts a laboratory experiment based on the results of analytical and behavioral research to compare three transfer-pricing methods (cost-based equal profit distribution, cost-based equitable cost distribution, negotiated). We experimentally investigate which method provides higher perceived fairness, more truthful cost reporting, willingness to trade and thus higher firm profits under conditions of high/low private information asymmetry. We first test the analytical prescriptions regarding whether high/low information asymmetry is a key factor in determining the preferred transfer pricing methods. We then further test our hypotheses with considerations of behavioral factors such as perceived fairness, truthful reporting, and willingness to trade in transfer pricing decisions. Overall, we find that when information asymmetry is high, firm profit is similar across transfer pricing methods, inconsistent with prior analytical studies. Conversely, when information asymmetry was low, both cost-based methods provided more firm profit than the negotiated transfer pricing method, consistent with prior analytical studies. In addition, firm profits were higher overall when information asymmetry was high than when it was low. Further, we found that perceptions of fairness significantly influenced participant's truthful reporting, willingness to trade, and firm profit. Finally, perceptions of fairness was a significant variable when perceptions of fairness, truthful reporting, willingness to trade and transfer pricing method was regressed on firm profit, indicating that perceptions of fairness had the most significant influence on firm profit in this study.

What risks are Chinese people concerned about?

The aim of this study is to investigate public perceived risk on various issues in present-day China. Two surveys were conducted in urban China in 1996 and 1998. In the first survey, risk perceptions of different occupational groups are compared. Gender differences within each occupational group are also analyzed. In the second survey, participants with diverse employment status were recruited. The overall risk rankings of both surveys indicate great concern with risks that threaten national stability and economic development, and less concern with high-technology risk such as threat from a nuclear power plant. It is also found that employees from high-profit firms are more concerned about macroscopic catastrophic risks, whereas laid-off workers and employees from money-losing enterprises are more concerned about daily life or self-concerned risks. The importance of actual exposure to risk, mass media coverage, culture, and psychometric dimensions are discussed.

Competitive strategies and business performance: evidence from the adhesives and sealants industry

Synthesizes the contributions of a number of scholars on competitive strategies. Discusses several imperfections in the literature. Submits three propositions for empirical testing in a fragmented industry ‐ the adhesives and sealants industry. The results of the investigation suggest that business units which compete with the low cost strategy and differentiation strategy have higher ROIs than enterprises which compete with low costs only or differentiation only. As a group, however, the high profit firms are not significantly larger in size than the groups of low profit companies studied. Thus, what is elaborated is that competing with both strategies may involve benefits that are not based on advantages of larger market shares and scale economies.

RURAL RETAILERS: USING A BANKRUPTCY MODEL TO PREDICT HIGH PROFIT VERSUS LOW PROFIT FIRMS

ABSTRACT Bankruptcy models are used to predict business failure. These models are based on key financial indicators. The same key ratios might serve as anticipatory indicators of business success. Retailers in rural communities from twelve states took part in the study. The model developed by Miller and Miller to predict business failure is based on five key ratios. Our results show the model is a useful tool in predicting financial success (p<.001; 97.65% correct classification using logistical regression). Two of the five ratios were highly significant. Our ratio measures the influence of financial leverage on return on equity. Higher profit firms had higher return on total assets than did low profit firms. This ratio was the single best predictor of business success. Net Sales to Total Assets is also a significant predictor of profit. This ratio affects all major elements of the income statement and the balance. High profit firms in this study had a lower ratio. Generally low Net Sales to Total Assets ...