Severe Agency Problems Research Articles

The Real Effects of Implicit Government Guarantee: Evidence from Chinese State-Owned Enterprise Defaults

We study the effects of implicit government guarantee (IGG) on Chinese state-owned enterprises (SOEs). We find that SOEs reduce their investments by 2.4% of book assets, on average, relative to matched non-SOEs after the first SOE default in China’s onshore bond markets in 2015. The investment reduction concentrates among SOEs that are financially constrained, yet SOEs financed by large state banks are hardly affected. Bondholders require more stringent default protection in newly issued SOE bonds. We also find that the investment reduction is more pronounced for SOEs with severe agency problems and that SOEs experienced more positive market reactions to acquisition announcements after 2015. Our results suggest that the reduction in IGG has confounding effects on Chinese firms. Although the weakening of IGG may help mitigate overinvestment, it exacerbates financial constraints of those with limited access to alternative sources of financing. This paper was accepted by Lucas Schmid, finance. Funding: Z. Zhang acknowledges the funding support by Research Grants Council of Hong Kong [Project 11503318]. Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2022.4483 .

Acquiring firms’ transparency and their returns around M&A announcements: Evidence from China

This study empirically examines the effects of the information transparency of acquiring firms on their stock returns around merger and acquisition (M&A) announcements in China. We find that acquiring firms’ information transparency is positively associated with their returns within M&A announcement windows. Our cross-sectional analyses show that such associations are more significant for acquiring firms from regions with an underdeveloped market institution, with lower institutional investor shareholdings, and that are state-owned, suggesting that acquiring firms’ information transparency is a critical determinant of perceived M&A benefits in environments with severe agency problems. We expect our results to be relevant to other emerging markets with institutional characteristics similar to those of China, such as significant agency problems and weak investor protection.

Institutional quality and dark side of product market competition: a cross-country study

PurposeThe authors examine the joint effect of the country-wide legal institutions and product market competition on stock crash risk in a large sample of international firms.Design/methodology/approachIn the study, the authors examine whether the country-level institutional factors affect product market competition's impact on stock crash risk. Specifically, the authors characterize country-wide institutional quality with individual governance indices developed in earlier studies and also adopt the worldwide board reforms as a proxy for the change in firms' governance environment.FindingsThe authors find that strong institutions mitigate the positive relationship between product market competition and stock crash risk in the international setting. In addition, the authors find that institutional quality moderates the effect of product market competition on stock crash risk via the information channel, i.e. although firms in competitive industries manage and report earnings more aggressively, strong institutions or board reforms, curtail managers' incentive to do so.Originality/valueThe authors’ findings lend support to the dark side of product market competition with a broader sample from 35 countries. In light of this, when earlier studies consider firms from competitive (concentrated) industries as having less (more) severe agency problems, future studies should consider the agency costs associated with product market competition for both the US firms and non-US firms. Furthermore, when it is debatable that regulators are self-interested, captured, uninformed and thus the regulations and institutions may not be fully effective as a result, this study demonstrates the effectiveness of institutions in ex ante mitigating agency conflicts associated with product market competition.

Board Gender Diversity and Cash Holdings: Empirical Evidence from the European Sport and Leisure Sector

The scope of this study is to examine the impact of board gender diversity on corporate cash-holding decisions within the European sport and leisure sector. A sample of 125 unique firms was selected for the period from 2008 to 2019, and analysis was performed using panel fixed-effects regressions. Empirical evidence documented that the higher the number of women serving on the board of directors, the higher the level of cash the firm holds. This result is attributed to the critical mass theory of governance, suggesting that boards having at least two women directors are associated with higher cash holdings compared to firms with one or no women directors. Additionally, gender diversity leads to increased cash holdings for firms with lower governance quality, suggesting that women on boards perform a monitoring role within those firms with the most severe agency problems. The results remain robust after several sensitivity tests controlling for potential endogeneity among the variables and the model’s functional form.

Female directors’ monitoring and earnings quality: the moderating effect of political connections and family ownership

PurposeThis study aims to examine whether the monitoring effectiveness of female directors in corporate boards is moderated by political connections and family ownership.Design/methodology/approachThis study employs a Malaysian dataset of listed firms from 2005 to 2015. The ordinary least squares model (OLS) is used to test all the research questions.FindingsThe authors find that female directors' monitoring is associated with higher earnings quality. This implies effective monitoring by female board directors. However, the monitoring effectiveness by female directors is attenuated by political connections; consistent with the argument that politically connected firms (PCFs) are plagued by severe agency problems. On the other hand, the association between female directors and higher earnings quality is strengthened by family ownership, indicating less severe type 1 agency problem.Originality/valueThis study is the first to show that the monitoring capability of female board directors is significantly influenced by a country's institutional setting. Although prior studies find that higher proportion of female directors is associated with higher earnings quality; the findings suggest that institutional setting such as political connections (family ownership) attenuate (strengthen) the monitoring effectiveness of female directors in the corporate board.

Auctioning Class Action Representation

Abstract Class actions feature severe agency problems, resulting from the divergence of interests between class members and the class attorney. This article proposes a novel mechanism for selecting the class attorney and aligning her interests with those of the represented class. The mechanism applies a combined percentage and hourly litigation fee structure, suggested by Polinsky, Mitchell A., and Daniel L. Rubinfeld. 2003. “Aligning the Interests of Lawyers and Clients,” 5 Am Law Econ Rev 165, in which lawyers earn a percentage of the class’ common fund, and bear the same percentage over their time investment. To maximize the expected payoff for the class, we supplement this fee structure with a preliminary two stages auction, in which the role of the lawyer is tendered using competitive bidding. We prove that the proposed auction approximates the highest possible net payoff for the class as the number of lawyers who compete for the right to represent the class increases. The percentage taken by the lawyer would be the lowest possible, and the winning lawyer would be the one who produces the highest expected net payoff for the class. We then extend the model to cases where the attorney files the class action is compensated for her pre-filing investment, and to settlements (JEL K41, K22)

Accounting Frauds and Main-Bank Monitoring in Japanese Corporations

This study examines whether the delegated monitoring of main banks effectively decreases severe agency problems. For example, this includes accounting fraud in bank-dominated corporate governance. In this context, the fraud triangle specifies the three main factors of opportunity, incentive, and rationalization. Main banks may reduce the factor of opportunity through actions such as monitoring, which plays a moderating role by reducing the potential for managerial misconduct, whereas, the incentive factor may be enhanced through the subsequent pressure that influences managers to force turnover when they do not repay debts. The potential influence that the main banks have on the fraud rationalization factor may be stronger in firms that are more dependent on main-bank borrowing. This study analyzed data from publicly listed firms in Japan for the period between 2008 and 2016 to determine how main-bank relationships affected accounting fraud, thus allowing an assessment of delegated monitoring practices. Findings showed that main-bank relationships were helpful for reducing accounting fraud, suggesting its overall effectiveness in delegated monitoring. Results also showed that large audit firms did not necessarily prevent accounting fraud, which implies that main banks can employ their own monitoring as a substitute for the roles typically played by these firms. Here, the main policy implication is that main-bank relationships may strengthen business ethics in the context of bank-dominated corporate governance. In conclusion, the continued analysis of bank monitoring may benefit stakeholders while strengthening business ethics in bank-centered economies.

Corporate sustainability performance in the emerging market of Turkey: the role of accounting information quality and firm risk

PurposeThe purpose of this study is to investigate the effect of accounting information quality (AIQ) and firm risk on the corporate sustainability performance (CSP) of Turkish listed firms.Design/methodology/approachThis study used data of 70 firms listed on Istanbul Stock Exchange during the period 2014–2019. Binary and ordinal logistic regression models are used to examine the factors affecting CSP as proxied by the membership to BIST Sustainability Index.FindingsThe results of this research indicate that AIQ is negatively related to CSP in firms with severe agency problem. The results also show a significant negative relationship between accounting earnings volatility and CSP. However, the effect of stock return volatility on CSP is not significant. Furthermore, the findings reveal that the possibility of being a member of Turkish sustainability index is higher for larger firms, firms that are included in BIST Corporate Governance Index and firms with high leverage, more research and development (R&D) intensity and high brand value.Practical implicationsThe results of this study provide implications for policymakers, investors and firms about the role of firm characteristics in determining CSP.Originality/valueTo the author's knowledge, this study is the first to explore the effect of AIQ and firm risk on CSP in the Turkish context.

Stock liquidity and corporate debt maturity structure: Evidences from Indian firms

The study examines the relationship between stock liquidity and the firms' use of short‐term debt. In addition, this study examines the impact of agency costs on this relationship and also documents whether large shareholding acts as a transmission channel through which stock liquidity may influence the use of short‐term debt. The study is based on secondary financial data of non‐financial Indian companies obtained from Center for Monitoring of Indian Economy Prowess database, pertaining to a period of 18 years (2000–2018). This study employs two‐step generalized method of moments (GMM) techniques to arrive at results. Results of the study confirm that firms' use of short‐term debt is negatively associated with stock liquidity. Additionally, we found that this relation is more pronounced for firms subjected to severe agency problems. We also find that large shareholding acts as a transmission channel through which stock market liquidity may influence the use of short‐term debt.

Debt covenants and asset versus equity acquisitions

AbstractWe examine whether the presence of loan covenants leads firms to choose either an asset or equity acquisitions. Asset acquisitions involve the selective purchase of a target company's assets, and equity acquisitions involve acquisitions of common stocks. We document that firms with loan covenants are more likely to engage in asset acquisitions as opposed to equity acquisitions. Our results are robust to alternative measures of loan covenants and to endogeneity concerns. Furthermore, the association between loan covenants and asset acquisitions is stronger among firms with greater debt covenant intensity, more severe agency problems, and lower profitability. Acquirers facing more intense competition within their industries are also likely to choose asset acquisitions. Our findings suggest that acquirers' incentives to avoid wealth transfer at the expense of debtholders drive the relation between debt covenants and choice of acquisition structure.

Financial Intermediaries and Agency Problems With and Without Vertical Incentives

I study agency problems between brokers and investors in the retail bond market. The presence of suitability or fiduciary regulations, which govern transactions in this setting, can lead to tensions for brokers between maximizing their own profit and acting in the best interests of their customers. This paper measures the degree to which these conflicting incentives influence brokers by examining the U.S. reverse convertible bond market. While brokers do consider the profits of investors when making decisions, I estimate that their own profits are roughly three times more important, suggesting the existence of severe agency problems that reduce consumer welfare.

Related-Party Transactions, Chaebol Affiliations, and the Value of Cash Holdings

This study examines whether related-party transactions (RPTs) impact the value of firms’ cash holdings. Using a 2011–2018 sample of Korean public firms, we find that greater RPTs lead to lower cash holdings value. In particular, this decline is more pronounced in Korean chaebol firms than in non-chaebol firms. Our findings suggest that a unique and complex corporate governance structure of chaebol firms makes it difficult for outside investors to monitor firms’ internal cash management decisions, resulting in a negative valuation of cash holdings. This study contributes to the extant literature by providing additional evidence that RPTs in chaebol firms with severe agency problems may lower the value of cash holdings.

Institutional investment horizons, corporate governance, and credit ratings: International evidence

Using a comprehensive set of firms from 57 countries over the 2000–2016 period, we examine the relation between institutional investor horizons and firm-level credit ratings. Controlling for firm- and country-specific factors, as well as for firm fixed effects, we find that larger long-term (short-term) institutional ownership is associated with higher (lower) credit ratings. This finding is robust to sample composition, alternative estimation methods, and endogeneity concerns. Long-term institutional ownership affects ratings more during times of higher expropriation risk, for firms with weaker internal corporate governance, and for those in countries with lower-quality institutional environments. Additional analysis shows that long-term investors facilitate access to debt markets for firms facing severe agency problems. These findings suggest that, unlike their short-term counterparts, long-term investors improve a firm's credit risk profile through effective monitoring.

Employment Protection, Corporate Governance, and Labor Productivity around the World

Consistent with the existing evidence from a single country study, our differences-in-differences estimation finds a negative effect of employment protection legislation (EPL) provisions on labor productivity in a sample of OECD countries. Our study is distinct, however, in that we provide empirical evidence on why EPL reduces labor productivity, which has different practical implications. While the negative effect is more pronounced among firms domiciled in countries with weaker investor protection, less developed takeover markets, and weaker employee incentives to work hard, in industries with less intense competition, and in firms suffering from more severe agency problems and firms with lower pay-for-performance sensitives, our results suggest that the firm-employee agency conflict is the channel through which employment protection legislation hurts labor productivity.

BOARD CHARACTERISTICS, CORPORATE GOVERNANCE AND AGENCY PROBLEMS IN INDIAN COMPANIES

This research paper explores how the board characteristics and other external governance mechanisms mitigate the agency conflicts prevailing in the Indian corporate sector based on panel data of 315 companies drawn from the BSE 500 index (Bombay Stock Exchange) during the period 2008-2018. Utilising the panel OLS regression methodology, this research paper has derived two alternative econometric models based on the proxies of agency cost (operating ratio and Tobin's Q) as dependent variables and the independent variables as the board size, independent directors, CEO-Chairperson separation, audit committee, nomination, and remuneration committee, stakeholders' relationship committee, promoters' holdings, leverage, bank debt, and firm size. The descriptive statistics establish that the Indian companies are subjected to severe agency problems. The multivariate regression results reveal that the board characteristics as governance mechanisms are not successful in mitigating agency conflict in Indian companies. However, Indian companies have been gradually assimilating corporate governance mechanisms.

Does analyst following restrain tunneling? Evidence from brokerage closures and mergers

We examine the impact of analyst following on tunneling using a sample of Chinese firms. Our findings suggest that, after brokerage closures and mergers, tunneling increases for firms with reduced analyst following. Additional analyses suggest that when a firm has severe agency problems (in terms of a large divergence of ownership and control or more related-party transactions) or a poor information environment (in terms of high earnings management), the impact of a reduction of analyst following on the increase in tunneling is more salient.

An Auditor's Perspective of Executive Incentive Pay and Dividend Payouts in Family Firms

In family firms, where the family and the business domains are intertwined, conflicts from one domain can spill over to the other. Agency conflicts in the business domain can spread to the family domain and ruin the well-being of the families. Agency theorists suggest that corporate governance tools such as performance-based incentive pay and dividend payouts can be used to mitigate agency conflicts in widely-held firms. Previous studies in family firms, however, show inconclusive results. This paper aims to investigate whether incentive pay and dividend payouts alleviate agency conflicts in family firms, from an auditor’s perspective. Audit research shows that audit fees are higher for firms (auditees) with more severe agency problems. Thus, an audit fee premium (discount) can be a proxy for the severity (mildness) of agency conflicts. If a governance tool exacerbates (mitigates) agency conflicts in a family firm, it is expected to lead to an audit fee premium (discount). Using data from 150 largest listed companies in Hong Kong, the analyses show that the impacts of incentive pay and dividend payouts on audit fees are not uniform. Auditors view the governance tools as effective in mitigating agency conflicts only in some settings. This implies that the owning families should be cautious when implementing a governance tool. In some situations, a governance tool may aggravate agency conflicts in the business domain, which then can spill over to the family domain and adversely affect the family welfare.

The Effect of State Antitakeover Laws on Corporate Tax Avoidance

We examine the implications of enhanced managerial control afforded by state anti-takeover laws for tax avoidance and find the strength of anti-takeover statutes in a state is negatively related to tax avoidance of firms incorporated in that state. In testing underlying mechanisms, we find that the empirical results support the price discount concern hypothesis (i.e., managers refrain from tax avoidance activities to prevent potential stock price discounts induced by heightened investor perception of tax-related rent extraction in firms with severe agency problems). By contrast, the results are inconsistent with the quiet life hypothesis (i.e., managers entrenched by state anti-takeover protection enjoy the quiet life by under-investing in tax planning opportunities). Our findings are generally consistent with the takeover market phenomenon that one of managers' concerns lies in their inability to re-contract away the adverse consequences of perceived agency problems arising from state anti-takeover protection.

The Effects of Stewardship Code on the Exercise of Voting Rights by Institutional Investors at Shareholders’ Meetings

Based on the sample firms listed on the Korea Stock Exchange, this study analyzes the characteristics of institutional investors who adopted the Korea stewardship code. The changes in their voting patterns at annual shareholders’ meetings and the characteristics of firms that led to such changes after the stewardship code was introduced in December 2016 are also analyzed. Empirical analyses reveal that the institutional investors who belong to a financial group, invest a larger amount of money in stocks, pay more dividends in cash, belong to foreign institutional investors, and showed a higher level of negative votes before code participation tend to participate more actively in the stewardship code. We also find that the institutional investors who have introduced the code tend to show a higher level of negative voting, especially when invested firms have more severe agency problems such that the invested companies pay less dividends in cash but hold relatively more cash, and have low shares of foreign investors as effective monitors of the firms. These results suggest that the introduction of the stewardship code tends to lead domestic institutional investors to more actively monitor the invested companies, which would eventually help improve the corporate governance of listed firms in Korea.

Board Networks and Corporate Innovation

This paper studies whether board connectedness affects corporate innovation. We find that well-connected boards have a positive effect on innovation activities and quality. The effect is stronger when firms have higher demand for advising or face more severe agency problems. Firms with greater needs for external finance benefit more from board connections with bankers. We show that the positive relation is causal and robust based on a battery of empirical tests including exogenous variation in board connectedness resulting from death and retirement of directors and from a regulatory shock under new exchange listing rules. Evidence indicates that types and relatedness of connections as well as director characteristics contribute to cross-sectional heterogeneity of the positive effect. This paper was accepted by Gustavo Manso, finance.