Reduce Agency Conflicts Research Articles

CSR, agency costs and investment-cash flow sensitivity: a mediated moderation analysis

PurposeThe purpose of this paper is to document the relation between investment-cash flow sensitivity and a firm’s engagement in corporate social responsibility (CSR) activities in European context. Specifically, this paper aims to empirically examine how CSR moderates the sensitivity between investment spending and firm internal funds.Design/methodology/approachThe Euler equation technique approach is applied to test the sensitivity of investment to internally generated funds for a panel data set of 398 European companies listed in the STOXX Europe 600 during 2009-2014. Furthermore, a mediated moderation model is developed in order to examine the moderating role of CSR in the investment-cash flow sensitivity, as well as the mediating role of agency costs on the moderation effect of CSR.FindingsThe results show that CSR performance weakens the sensitivity of investment to internal funds; agency costs of free cash flow mediate the negative moderating effect of CSR on investment-cash flow sensitivity. Thus, this study demonstrates empirically that firms with socially responsible practices are better positioned to obtain financing in the capital markets through reducing market frictions as well as agency costs.Practical implicationsFirms are invited to engage more in CSR activities that reduce agency conflicts between management and shareholders.Originality/valueThe originality of this paper consists in proposing the establishment of both direct and indirect link between CSR and investment-cash flow sensitivity.

Equity-Based Compensation for Firm Performance

The paper finds evidence that the equity-based compensation is positively related to firm performance and risk-taking. Both stock price and operating performance as well as firm's risk-taking increase with incentives provided by CEO stock options and stock holdings. The pay-performance sensitivity can explain stock returns better as an additional factor to the Fama-French 3-factor model. When CEOs are compensated with the higher PPS, firms experiences the higher return on asset. The higher pay-volatility sensitivity also leads to the higher risk-taking. While CEO incentive compensation has been perceived mixed on its effectiveness, this study provides support to the equity-based CEO compensation in reducing agency conflicts between CEOs and shareholders.

Complex ownership structures, corporate governance and firm performance: The French context.

This study seeks to understand the leading role played by the blockholders and their true governance mechanism, in the French context, characterised by complex ownership structures. We focus on the role that second-tier shareholders can play in the optimal governance of companies and in their capacity to solve both principal/agent and principal/principal agency conflicts. Using a sample of 2118 observations between 2000 and 2009, we find that second-tier shareholders exercise effective additional monitoring when power is contestable but increase principal/principal agency costs in the presence of a controlling owner. We also show that shareholder homogeneity reduces agency conflicts. Our results demonstrate that the level of control contestability is essential in the understanding of governance mechanisms. Such contestability is to be found simultaneously at institutional level, at the level of the balance of power between blockholders, and according to the nature of the shareholders. Thus, the usual agency theory conclusions are debateable when the legal framework offers little protection of minority shareholders, and when ownership structure is complex and heterogeneous in nature. The study of corporate governance must therefore encompass a twofold analytical perspective, namely, an institutional and a socio-organisational one. The analysis and findings could be particularly useful in assessing corporate governance in the context of several European countries with a similar self-dealing legal environment to the French one, including Italy and Greece.

Corporate governance and cash holdings in MENA: Evidence from internal and external governance practices

This paper explores the impact of internal and external corporate governance practices on the decision to hold cash in MENA countries. Using430 non-financial firms in the MENA region for the period from 2000 to 2009, we find that both types of governance practices are important. We report a negative relationship between board size and cash holdings, evidence that firms hold less cash to reduce agency conflicts. Also, we detect that external governance activities are important in cash holding decisions, since we report that firms belonging to countries with international standards of securities law and bank supervision hold less cash. For our sub-sample of 85 firms, we report evidence that institutional owners are seen to be self-opportunistic and that they aim to maximize their own private benefits.

Ownership Structure and Dividend Policy of Listed Deposit Money Banks in Nigeria: A Tobit Regression Analysis

Free cash flow hypothesis posit that regular paying of dividend can reduce agency conflict and through this, the range of future probable misuse of resources by management reduces. Ownership structure has been identified to have relationship with dividend policy of a firm. Though the relationship is different for different class of owners and at different level; it does not influence dividend policy uniformly. Although, the linkage between the two has been monitored by many researchers, yet empirical researches do not provide consensus as to the direction of the relationships. Thus, the paper investigates the likelihood impact of ownership structure on dividend policy in the context of agency relation while using managerial ownership, institutional ownership, ownership concentration and foreign ownershipon dividend policy in the listed Deposit Money Banks (DMBs)in Nigeria. The research designs are Correlational and ex-post facto using secondary data extracted from the sampled companies’ annual financial reports for the period 2010-2014. Maximum likelihood (panel data tobit regression) is adopted as a technique of analysis for the study, using a sample of ten (10) out of seventeen (17) listed DMBs in Nigeria that served as population. The result shows that managerial ownership and ownership concentration are likely to have significant negative impact on dividend policy of listed DMBsin Nigeria, while institutional ownership is found to have likely significant positive impact on dividend policy of listed DMBs in Nigeria. But foreign ownership is found not to have likely significant impact on dividend policyof listed DMBsin Nigeria. Based on the findings, it is recommended among others that policy makers (Security and Exchange Commission and Corporate Affairs Commission) to design future policies where dividend payment could be facilitated and the diverse range of shareholders to be satisfied most especially minority shareholders. And that a limit should be set for managers on the proportion of shares to be held as this can facilitate dividend payment.

Did the Sarbanes-Oxley Act Have the Desired Effect? Evidence from the Marginal Value of Corporate Cash Holdings

We examine whether passage of the Sarbanes-Oxley Act (SOX) in 2002 did in fact have the intended effect of reducing agency conflicts or did it alter managerial incentives in ways that could be detrimental to firm value. Our findings for the full sample suggest a decrease in firm value and the marginal value of cash collectively suggesting that either the provisions imposed by SOX resulted in significant compliance costs and/or lead to an increase in risk aversion of managers resulting in costs of lost opportunity. There is, however, evidence of a significant variation in the ability of the various provisions to constrain incentives of managers with some leading to reduced agency conflicts while others having the perverse effect of increasing both managerial risk aversion as well as imposing excessive costs of compliance.

Reducing Agency Conflict through Bank Dividend Payout Decisions: The Role of Opacity and Ownership Structure

We empirically examine whether banks’ dividend decisions are influenced by their degree of opacity and ownership structure. We find that banks with concentrated ownership structure pay lower dividends when they have high degrees of opacity, in line with the hypothesis that majority shareholders pay lower dividends to extract higher levels of private benefits. We do not observe such opportunist behavior for widely held banks. These results suggest that there exist other corporate mechanisms in widely held banks that can induce insiders to select payout policies that reduce agency conflict in a context of high degrees of opacity. Nevertheless, the effectiveness of these mechanisms is reduced in banks with controlling shareholders. Further analysis shows that higher levels of shareholder protection and stronger supervisory regimes help to constrain opportunistic behavior of majority shareholders. Our findings have critical policy implications for the Basel 3 implementation of restrictions on dividend payouts.

Investment and financing for SMEs with a partial guarantee and jump risk

We consider a small- and medium-sized enterprise (SME) with a funding gap intending to invest in a project, of which the cash flow follows a double exponential jump-diffusion process. In contrast to traditional corporate finance theory, we assume the SME is unable to get a loan directly from a bank and hence it enters into a partial guarantee agreement with an insurer and a lender. Utilizing a real options approach, we develop an investment and financing model with a partial guarantee. We explicitly derive the pricing and timing of the option to invest. We find that if the funding gap rises, the option value decreases but its investment threshold first declines and then increases. The larger the guarantee level, the lower the option value and the later the investment. The optimal coupon rate decreases with project risk and a growth of the guarantee level can effectively reduce agency conflicts.

Culture, Marketization, and Owner-Manager Agency Costs: A Case of Merchant Guild Culture in China

This study explores cultural influence on corporate behavior employing the case of merchant guild culture in China and further the moderating role of Marketization. Using hand-collected data on merchant guild culture, we find that merchant guild culture is significantly negatively associated with owner-manager agency costs, suggesting that merchant guild culture in ancient China still has its continuous and remarkable effects on managerial behavior in contemporary corporations. This finding also implies that merchant guild culture motivates managers to upgrade the efficiency of controlling operating costs, reduces agency conflicts between management and shareholders, and eventually mitigates owner-manager agency costs. Moreover, provincial Marketization level attenuates the negative association between merchant guild culture and owner-manager agency costs. Above results are robust to a variety of alternative measures of merchant guild culture and owner-manager agency costs. Furthermore, our findings are still valid after controlling for the potential endogeneity between merchant guild culture and owner-manager agency costs.

Corporate cash flow and dividends smoothing: a panel data analysis at Bursa Malaysia

Purpose – The purpose of this paper is to contribute to the debate and find out the impact of cash flow on changes in dividend payout decisions among non-financial firms quoted at Bursa Malaysia as compared to earnings. There has been renewed debate in recent finance and accounting literature concerning the key determinants of changes in dividends payout policy decisions in some jurisdictions. The conclusion in some is that firms base their dividend decisions on cash flows rather than published earnings. Design/methodology/approach – The research made use of panel data from 1999 to 2012 at Bursa Malaysia, using generalized method of moments as the main method of analysis. Findings – The research finds that Malaysia non-financial firms consider current earnings more important than current cash flow while making dividends payout decisions, and prior year cash flows are considered more important in dividends decisions than prior year earnings. We also found support for Jensen (1986) in Malaysia on agency theory, that managers of firms pay dividends from free cash flow to reduce agency conflicts. Practical implications – The research concludes that Malaysian non-financial firms use current earnings and less of current cash flow in making changes in dividends policy. The policy implication is that current earnings are dividends smoothing agents, and the more they are considered in dividends payout decisions, the less of dividends smoothing. Social implications – If dividends smoothing is encouraged, it could lead to dividends-based earnings management. Originality/value – The research is our novel contribution of assisting investors and government in making informed decisions regarding dividends policy in Malaysia.

The Determinants of Intellectual Capital Disclosure: Evidence from French stock exchange

The objective of this paper is to identify the determinants of voluntary intellectual capital disclosure (ICD) by analyzing a panel of French listed companies observed over the period 2006-2010. The results confirm that ownership structure, size, debts and the weight of activated goodwill are the determinants of voluntary ICD which allows managers to reduce agency conflicts and solve the inadequacy of financial reporting by disclosing relevant information (signals) for investors. However, our results disprove that voluntary ICD could be a process of legitimizing targeting other stakeholders.

Institutional Investment Horizons and Labor Investment Efficiency

We investigate how the investment horizon of a firm’s institutional shareholders affects the efficiency of its labor investments. We argue that long-term investors have greater incentives to engage in effective monitoring, which reduces agency conflicts in labor investment choices. Consistent with this argument, we find that abnormal net hiring, measured as the absolute deviation from net hiring predicted by economic fundamentals, decreases in the presence of institutional investors with longer investment horizons. Firms dominated by long-term shareholders reduce both over-investment (over-hiring and under-firing) and under-investment in labor (under-hiring). The monitoring role of long-term investors is more pronounced for firms facing higher labor adjustment costs. These results are robust to alternative model specifications and variable definitions, as well as to tests controlling for the endogeneity in the institutional shareholders’ investment decisions. Overall, our findings suggest that institutional investors play an important role in firm-level employment decisions.

Executive Remuneration, Financial Crisis and ‘Say on Pay’ Rule

Among the alternatives to reduce agency conflict, executive remuneration has commonly been perceived as the best possible solution. Financial meltdown is commonly attributed to the large portion of remuneration rewarded to the executives. As a response, ‘say on pay’ rule, introduced in 2011which provides shareholders right to vote for or against executives remuneration package. Proponents of this new rule argue that reforms will fortify the association between the shareholders and the executives of the board, will ensure that board members execute fiduciary duty placed upon them. However, the critics think this new rule will be unsuccessful in monitor directors’ remuneration, and contemplate it to be backward-looking rather than forward-looking. Despite the importance of these issues, contextual analyses of executives’ remuneration and company performance in the Australian context are still limited. This paper, using sample from top 200 Australian listed companies, aims to study the relationship between executive remuneration and companies’ performance during the financial crisis in 20062009. Methodology of this research is based on two approaches: firstly, we investigate the pay-for-performance relationship during the global financial crisis; secondly, identify cause and effects relationships through lead and lag analysis. Overall, this research concludes that Australia’s reward system is quite effective and reflects market based performance, specially in respect to Earnings per Share and Dividend Yield. Therefore, the introduction of ‘say on pay’ rule is appropriate in Australian context.

Employee Representation and Financial Leverage

We analyze how direct employee voice affects financial leverage. German law mandates that firms' supervisory boards consist of an equal number of employees' and owners' representatives. This requirement, however, applies only to firms with over 2,000 domestic employees. We exploit this discontinuity and the law's introduction in 1976 for identification and find that direct employee power increases financial leverage. This is explained by a supply side effect: as banks' interests are similar to those of employees, higher employee power reduces agency conflicts with debt providers, leading to better financing conditions. These findings reveal a novel mechanism of direct employee influence.

How do Informational Frictions Affect the Firm's Choice of Asset Liquidity? The Effect of SOX Section 404

Although existing theories predict a causal link between informational frictions in financial markets and a firm's choice of asset liquidity, the lack of an exogenous and clean measure of informational frictions hinders the precise identification of this link. Using the discontinuous requirement of financial reporting introduced by Section 404 of the Sarbanes-Oxley Act, we identify a causal effect of informational frictions on the holding of liquid assets. By employing the cash ratio as a measure of corporate liquidity, we show that firms that comply with Section 404 and provide more reliable information to the financial markets reduce their holding of liquid assets compared to observationally similar firms. In the cross-section, the reduction in the cash ratio is more pronounced among firms that face financial constraints and have weaker governance. This is consistent with the fact that such firms incur a high opportunity cost for funds and is consistent with the view that SOX reduces agency conflicts through increased controls. Finally, firms that comply with Section 404 and hold less cash exhibit higher R&D expenditures relative to non-compliant firms. This difference sheds light on the opportunity costs of holding cash.

Reducing Agency Conflicts with Target Debt Ratios

We show how target debt ratios in book value terms applied to new investment can improve alignment of investment incentives in firms when they have risky debt outstanding and asymmetric information. While wealth transfer from both agency conflicts can reduce the value of existing equity, new debt offsets the value loss to old shareholders. New debt set by the target debt ratio naturally reflects key factors such as the NPV and size of the new project and offsets wealth transfers. Numerical examples show that both agency conflicts can be eliminated both in structural models and in binomial models.

Reducing agency conflicts with target debt ratios

Reducing agency conflicts with target debt ratios

Voluntary disclosure reduces agency conflicts: an empirical analysis of Italian listed companies with substantial intangible assets

R&D assets cause information asymmetries between shareholders and managers. In order to reduce such information asymmetries, our aim is to learn what typologies of additional information managers find it opportune to disclosure voluntarily in annual reports. We consider voluntary information which can be disclosed about strategy as well as that about R&D assets. Our analysis, which is conducted on a panel of 195 observations, shows that information about R&D is more useful to investors than information about strategy, but companies obtain greater benefits from providing information about strategy because they are more useful to other important stakeholders, such as lenders, bondholders, suppliers and others. For firms whose value is largely composed of assets such as R&D, management faces higher future uncertainty in transforming firm assets into revenues. This increases the utility for investors and other stakeholders of knowing the strategy management intends to anticipate and deal with eventual changes in the environment.

Portfolio selection: does corporate governance matter?

PurposeThe purpose of this paper is to examine whether corporate governance has an impact on portfolio selection within the usual mean‐variance framework, the idea being that by reducing agency conflicts, corporate governance increases the value of the firm.Design/methodology/approachUsing a sample of 460 American firms between 1995 and 2004, the authors first determine the optimal mean‐variance portfolio. The authors then test whether governance characteristics explain the optimal portfolio weights.FindingsThe results show that the optimal portfolio weights are sensitive to internal control mechanisms, ownership concentration, managerial entrenchment and incentive compensation.Originality/valueThe results are relevant to academicians and investors concerned with portfolio selection. In fact, they underline the importance of including governance characteristics in their portfolio selection.

Executive Compensation and the Covenant Structure of Debt

I examine how the debt covenant structure of a firm varies with managerial risk-taking incentives via CEO compensation sensitivities to stock return volatility (Vega). I build a comprehensive firm debt covenant index by including both public and private debt issues. I find a robust negative relation between CEO compensation Vegas and firms’ debt covenant structures, even after considering alternative estimation procedures and endogeneity. I also find that a firm’s debt maturity is decreasing in Vega, and the cost of debt induced by Vega is reduced by the presence of a covenant. Taken together, my results suggest that managers with high Vegas preserve their financing and investment flexibility by using few covenants, and that they use short-term debt and/or the higher cost of debt to reduce agency conflicts with creditors.