Predictions Of Agency Theory Research Articles

Management Ownership and Audit Firm Size*

AbstractThe finance literature identifies two agency problems between managers and outside shareholders. First, there is a divergence‐of‐interests problem as management ownership falls. Second, there is an offsetting entrenchment problem when management ownership increases within intermediate regions of ownership. Agency problems are mitigated through contracting, but contracts are often based on accounting numbers prepared by management. Because accounting numbers must be reliable for contracts to be enforced, agency theory predicts a demand for higher‐quality auditors when agency problems are more severe. However, extant studies find no significant or robust relation between management ownership and audit firm size. In contrast to extant research, this study samples unlisted companies rather than listed companies for two reasons. First, the monitoring value of auditing may be higher in unlisted companies because they are less vulnerable to takeover and they are required to disclose much less nonaccounting information to shareholders. Second, unlisted companies have greater variation in management ownership, which permits more powerful tests of the demand for auditing as ownership varies between 0 percent and 100 percent. Consistent with a divergence‐of‐interests effect, the association between management ownership and audit firm size is found to be significantly negative within low and high regions of management ownership. The association is flatter and slightly positive within intermediate regions of management ownership, suggesting the existence of an opposite entrenchment effect. The negative association and the nonlinearity is consistent with the finance literature and with the predictions of agency theory.

The Compensation of UK Executive Directors: Lots of Carrots but are There Any Sticks?

This article provides evidence on the level and composition of the pay of the top executives of a sample of UK public listed companies (PLCs). The study uses hand-collected data on the compensation for 698 CEO years and 2,609 other-executive years over the period 1995–2000. In order to focus on the consequences of exceptional performance the sample is stratified to include sub-samples of PLCs experiencing extreme positive and negative stock-price performance. With regard to management compensation clear differences are found in the treatment of executives across the three sub-samples. Consistent with standard contracting theory, the executives of exceptionally well performing firms fare better than the executives of mid-performing firms, who in turn fare better than the executives of poorly performing firms. In particular it appears the executives of exceptionally poorly performing firms experience mean cuts in their salaries and bonuses. That trend also applies to equity-based compensation. It should be mentioned, though, that a time-series investigation reveals increased participation and value in the equity-based schemes provided to CEOs and other executives of poorly performing firms. This is against the agency theory prediction that agents refrain from risk sharing in more volatile corporate environments. With regard to loss of tenure the finding, consistently with current literature, is that the CEOs of poorly performing firms are significantly more likely to be dismissed. This turnover, though, does not seem to directly affect the CEOs' emoluments during the year of departure. It is argued that the effect of turnover on CEOs' wealth depends on whether departure affects their ability to find an equally lucrative new job.

Effects of Accounting-Method Choices on Subjective Performance-Measure Weighting Decisions: Experimental Evidence on Precision and Error Covariance

Performance-measure weights for incentive compensation are often determined subjectively. Determining these weights is a cognitively difficult task, and archival research shows that observed performance-measure weights are only partially consistent with the predictions of agency theory. Ittner et al. (2003) have concluded that psychology theory can help to explain such inconsistencies. In an experimental setting based on Feltham and Xie (1994), we use psychology theories of reasoning to predict distinctive patterns of similarity and difference between optimal and actual subjective performance-measure weights. The following predictions are supported. First, in contrast to a number of prior studies, most individuals' decisions are significantly influenced by the performance measures' error variance (precision) and error covariance. Second, directional errors in the use of these measurement attributes are relatively frequent, resulting in a mean underreaction to an accounting change that alters performance measurement error. Third, individuals seem insufficiently aware that a change in the accounting for one measure has spillover effects on the optimal weighting of the other measure in a two-measure incentive system. In consequence, they make performance-measure weighting decisions that are likely to result in misallocations of agent effort.

Effects of Accounting-Method Choices on Subjective Performance-Measure Weighting: Experimental Evidence on Precision and Error Covariance

Performance-measure weights for incentive compensation are often determined subjectively. Determining these weights is a cognitively difficult task, and archival research shows that observed performance-measure weights are only partially consistent with the predictions of agency theory. Ittner, Larcker and Meyer (2003) have concluded that psychology theory can help to explain such inconsistencies. In an experimental setting based on Feltham and Xie (1994), we use psychology theories of reasoning to predict distinctive patterns of similarity and difference between optimal and actual subjective performance-measure weights. The following predictions are supported. First, most individuals in our setting use the measures' error variance (precision) and error covariance to determine performance-measure weights. Second, directional errors in the use of these measurement attributes are relatively frequent, resulting in a mean under-reaction to the accounting-method change. Third, individuals seem insufficiently aware that a change in the accounting for one measure has spillover effects on the optimal weighting of the other measure in a two-measure incentive system, and in consequence, they make performance-measure weighting choices that are likely to result in misallocations of agent effort.

Reflections on the generalization of agency theory: Cross-cultural considerations

Agency theory assumes that employees and employers have different goals, act in a self-interested manner, and are willing to assume varying degrees of risk. In this paper, we argue that cultural differences may attenuate those assumptions and thereby temper agency theory predictions. Culture may align goals between employers and employees, change a company's preference for behavior- versus outcome-based pay, require higher incentives before employees will accept outcome-based pay, and lower the moral hazard concerns associated with outcome-based pay. Based on those arguments, we develop propositions that can be tested empirically.

Management Buyouts and Human Resource Management

AbstractThis paper reports the findings from a survey of the effects of management buyouts on human resource management (HRM). Buyouts resulted in increased employment, the adoption of new reward systems, and expanded employee involvement. These developments support the resource‐based view that buyouts develop internal assets over agency theory predictions that managers will adopt a cost reduction approach. The type of buyout influences the subsequent development of HRM. Buyouts report more commitment‐orientated employment policies where employees own shares, and where the buyout pursues a ‘buy and build’ corporate strategy and adopts a business strategy of enhancing customer service and developing markets.

Subsidiary Staffing in Multinational Enterprises: Agency, Resources, and Performance

How likely are multinational enterprises (MNEs) to use expatriate parent country nationals to staff culturally distant subsidiaries? How does their employment affect subsidiary performance? The agency theory prediction is that MNEs will rely more heavily on parent country nationals as cultural distance increases and that this reliance will weaken over time. Both agency theory and the “resource-based view” suggest that a positive effect of expatriate staffing on subsidiary performance increases with cultural distance but decreases over time. Results largely supported the predictions in data on Japanese foreign subsidiaries.

Asset size management by small private firms in response to the mandatory audit requirement in Korea

We investigate whether small private firms manage assets downward to avoid the mandatory audit required by the. Audit Requirement Law in Korea. The law requires that firms with assets larger than 6 billion won file audited financial statements regardless of the listing status. Since most private firms in Korea have concentrated ownership by individual owners who are also managers, the agency problem for these firms is small and, therefore, external audits are less likely to be beneficial, as the agency theory suggests. Consequently, small private firms may have little incentive to have external audits. Using both univariate and multivariate analyses, we find evidence that small private firms manage assets downward to avoid the regulation. Our finding is consistent with the predictions of agency theory that external audits are more beneficial when information asymmetry is large. © City University of Hong Kong.

Corporate Governance and Board Effectiveness in Maritime Firms

This paper examines the financial performance effect of three corporate governance mechanisms: (i) founding family CEO, (ii) board ownership, and (iii) board independence. The developed hypotheses are tested using multivariate ordinary least-squares regression on a 3-year sample of 32 publicly traded maritime firms from Norway and Sweden, and compared to the results of the same hypotheses tested on a sample of 96 manufacturing firms. This study concludes that maritime firms with a founding family CEO have better financial performance than maritime firms with a non-founding family CEO. Support was also found for the hypothesis that a high level of board independence enhances profitability in maritime firms. Contrary to agency theory predictions, no significant relation was found between the level of board ownership and firm profitability in maritime firms, although board ownership control was significant in the sample of manufacturing firms.

The Fit Between CEO Compensation Design and Firm Risk

We examined the effects of unsystematic and systematic firm risk on CEO compensation risk bearing and total pay. Both the proportion of variable pay in CEO pay packages and their magnitude are curvilinearly related to unsystematic firm risk—that is, they are highest under conditions of moderate firm-specific risk. Our results are consistent with agency theory predictions that both performance-contingent pay and the greater earnings potential associated with that form of pay are highest when an agent has greater control over performance outcomes.

THE FIT BETWEEN CEO COMPENSATION DESIGN AND FIRM RISK.

We examined the effects of unsystematic and systematic firm risk on CEO compensation risk bearing and total pay. Both the proportion of variable pay in CEO pay packages and their magnitude are curvilinearly related to unsystematic firm risk—that is, they are highest under conditions of moderate firm-specific risk. Our results are consistent with agency theory predictions that both performance-contingent pay and the greater earnings potential associated with that form of pay are highest when an agent has greater control over performance outcomes.

Corporate restructuring and performance: An agency perspective on the complete buyout cycle

Leveraged buyouts are an accepted method of restructuring, but a substantial percentage of these privately held buyouts eventually return to public trading, thus defining a public–private–public cycle of ownership. Arguments supporting buyouts have pointed to positive performance changes that occur while the firm is privately held. Such improvements, according to agency theory, are the result of changes in ownership when the firm is bought out. Since ownership patterns change substantially over the buyout cycle, performance implications of the complete cycle of changes must be considered before the true value of the buyout phenomenon can be assessed. With agency theory as a foundation for hypothesis development, we examined the performance and restructuring of 39 firms over the complete buyout cycle and found that agency theory explanations of performance are generally valid throughout the buyout cycle; i.e., increased managerial ownership leads to better firm performance. Moreover, when firms reversed buyouts and returned to public trading, we again found support for agency theory explanations. Qualitative content analysis also supported the agency theory's prediction of restructuring emphases associated with a buyout. Overall, these results suggest that agency theory is an appropriate theoretical base for explaining managerial choices during the buyout cycle. Unexpectedly, however, agency costs that were eliminated or minimized during the private buyout period did not reappear immediately following a reverse buyout. It took several years for the predicted performance declines associated with the agency costs of public ownership to reemerge.

Strategic Change, Multi-Task Managers and Executive Compensation

There is consensus that executive compensation is strongly tied to firm size and much less so to financial performance. Observed strategic change in corporations can affect these results. Based on multi-task theoretical considerations, the evidence for German industrial firms shows that elasticities in pay decrease only for large firms as they change from growth to downsizing strategies. Furthermore, pay-for-performance elasticities are contrary to predictions of agency theory. Both results support the belief that compensation contracts in public corporations are imperfectly aligned with firm performance and managers’ tasks.

The Determinants of Compensation Committee Membership

This study extends the work of Kesner (1988) and Bilimoria and Piderit (1994) in examining the determinants of compensation committee composition. Consistent with their findings, my results suggest that the likelihood of compensation committee membership is significantly related to director type (i.e., outside vs. inside), length of board tenure, and the number of other directorships held. In addition, my results suggest that committee membership also depends on director age, and the number of other committee memberships served. Importantly, in contrast to the predictions of agency theory, I find that committee membership is only marginally related to director affiliation, and unrelated to outside director stock ownership. Together, these results provide mixed, somewhat weak evidence that firms staff their compensation committees with directors that are likely to protect shareholder interests.

Incentive Pay and the Market for CEOs: An Analysis of Pay-For-Performance Sensitivity

Significant increases in CEO compensation in recent years have coincided with an unprecedented bull market for stocks. They have also coincided with increasingly frequent arguments from academics and practitioners that CEO pay is excessive. Academics in particular point to departures from relative performance evaluation as a major puzzle. Observing that the sensitivity of CEO compensation to market returns is inconsistent with the predictions of principal-agent theory; they have increasingly been tempted to resort to political explanations to explain the compensation of CEOs. The sensitivity of CEO compensation to market returns is not so puzzling, however, when one recognizes the special feature of the labor market for CEOs. The combination talent sorting of CEOs among firms and aggregate shocks that affect the marginal value of CEO services to the firm predicts a positive relationship between CEO pay and aggregate stock market returns. We argue that the supply of highly skilled CEOs capable of running large, complex corporations is relatively inelastic, so shocks to aggregate demand for CEOs simultaneously raise firm value and raise the marginal value of CEO services to the firm. In equilibrium, such shocks bid up the value of their compensation packages. This phenomenon makes it appear as if (some) firms are violating relative performance evaluation. Using Standard and Poor's Execucomp data for a large panel of U.S. firms, we show that the empirical failure of RPE is systematically restricted to the CEOs of certain types of firms. In our data, there is less of a puzzle for the firms in the bottom quartile of the size distribution. The behavior of these firms is in closer accordance with the predictions of agency theory. We interpret this as evidence that the supply of CEOs sufficiently skilled to manage such firms is relatively elastic. The compensation packages for the CEOs of larger, more complex firms, however, require highly skilled CEOs. Empirically, the compensation packages for the CEOs of these firms are more sensitive to aggregate shocks, which we interpret as evidence that the supply of highly skilled CEOs is relatively inelastic. These results are robust to robustness checks against alternative hypothesis such as skimming and strategic considerations. Finally, the paper's findings suggest three extensions to i) analysis rent sharing between CEOs and firms, ii) comparisons of pay-performance sensitivities of CEOs and divisional managers, and iii) studies of cyclical patterns in earnings inequality.

Agency theory and Japanese corporate governance

Agency theory has been used to predict managerial strategic behavior in the past. However, critics have commented that this theory, in its applications, has been too Anglo-American specific. Research in non-Anglo-American settings has been scarce. Recent changes in the Japan Commercial Code and moves by Japanese corporations to access global equity markets allow us to test the veracity of this criticism by examining how Japanese firms respond strategically to the increased requirement for disclosure and transparency; whether they behave in ways congruent with agency theory predictions. Agency theory states that managers who are held accountable for their use of corporate resources will deploy them in ways to enhance stockholder value rather than increase their shares of the economic residual. Thus, we would expect to observe a difference in Japanese managerial behavior accompanying an increased exposure to global capital markets. Using data from Japanese firms, we found some support for the usefulness of agency theory to non-Anglo-American settings when the rules of capital market discipline are allowed to operate.

Corporate Restructuring, Downsizing and Managerial Compensation

There is common consensus that managerial compensation is strongly tied to firm size and much less so to financial performance. One suspects that observed restructuring and downsizing in corporations in recent years may have an effect on these results. Based on multi-task theoretical considerations, our evidence for German industrial firms shows that pay for firm size elasticities decrease only for large firms as they change their strategy from growth to downsizing strategies. Furthermore, pay for performance elasticities are contrary to predictions of agency theory. Both results provide further support to the common belief that compensation contracts in public corporations seem imperfectly tied to firm performance and managers' tasks.

The effects of corporate antitakeover provisions on long-term investment: empirical evidence

This paper’s empirical results indicate that the average effect of antitakeover provisions on subsequent long-term investment is negative. The interpretation of these results depends on whether one thinks that there was too much, too little, or just the right amount of longterm investment prior to the antitakeover provision adoption. We use agency theory to devise more refined empirical tests of the effects of antitakeover provision adoption by managers in firms with different incentive and monitoring structures. Governance variables (e.g. percentage of outsiders on corporate boards, and separate CEO/chairperson positions) have an insignificant impact on subsequent long-term investment behavior. However, consistent with agency theory predictions, managers in firms with better economic incentives (higher insider ownership) tend to cut subsequent long-term investment less than managers in firms with less incentive alignment. Furthermore, managers in firms with greater external monitoring (due to higher institutional ownership) also tend to cut subsequent long-term investment less than managers in firms with less external monitoring. Thus, the decrease in subsequent long-term investment is significantly less for firms where the managers have greater incentives to act in shareholders’ interests. Finally, there are interesting effects of the control variables. First, high book equity/ market equity firms cut total long-term investment more. Second, firms that were takeover targets or rumored to be takeover targets cut long-term investment more. These results suggest that inefficient firms cut long-term investment more when an antitakeover provision is adopted. # 1997 John Wiley & Sons, Ltd.

The Rationality of Honesty in Debt Markets

The Rationality of Honesty in Debt Markets

Monitoring versus Bonding: Shareholder Rights and Management Compensation

Using a sample of nearly 700 firms, we documented a significant level of substitution between monitoring efforts by shareholders and bonding of Chief Executive Officers' (CEO)compensation with shareholder wealth. Direct shareholder monitoring effectiveness is measured by various dimensions of voting rights, e.g., equal voting, cumulative voting, and confidential voting. Indirect monitoring is measured by the degree of independence of the board of directors. Bonding of CEO compensation with shareholder wealth is gauged by a new pay-performance sensitivity measure that incorporates volatility in firm value. The results are consistent with prediction of agency theory that compensation contracts are designed to reduce the owner-manager conflict.