Severe Agency Problems Research Articles

Firms’ performance following the initial resignation of independent directors: evidence from Taiwan

ABSTRACTThis study investigates the operating performance of firms listed on the Taiwan stock exchange following the initial resignation of independent directors. The results show that the firms’ operating performance following the resignation of these directors has not only deteriorated, but is also significantly below the industry average. In addition, firms with a relatively severe agency problem, including firms that have lower insider or institutional shareholdings, receive audit opinions other than unqualified opinions or change their auditors prior to the resignation of the independent directors, tend to perform more poorly following the resignation.

Dividend policy of firms listed on Casablanca Stock Exchange: a panel data analysis

This study attempts to identify the main determinants of dividend policy and evaluate the theories that better explain the dividend behaviour of Moroccan listed firms. Data consists of all non-financial firms listed on Casablanca Stock Exchange (CSE) between 2004 and 2015. This study employed panel data analysis to demonstrate that current profits, financial leverage, growth, liquidity, free cash flow, institutional stock holdings and economic conjuncture represent the main determinants of dividend policy of Moroccan listed firms. The results reveal that the level of expected earnings and past dividend patterns does not influence dividend policy. The findings offer analysts, investors and academicians a valuable tool to understand how CFOs, CEOs, and board of directors design dividend policy. Moreover, given the severity of agency problems in CSE and the role of dividend policy in reducing agency problems, understanding the factors influencing dividend policy is fundamental for investors trading in this market.

Dividend policy of firms listed on Casablanca Stock Exchange: a panel data analysis

This study attempts to identify the main determinants of dividend policy and evaluate the theories that better explain the dividend behaviour of Moroccan listed firms. Data consists of all non-financial firms listed on Casablanca Stock Exchange (CSE) between 2004 and 2015. This study employed panel data analysis to demonstrate that current profits, financial leverage, growth, liquidity, free cash flow, institutional stock holdings and economic conjuncture represent the main determinants of dividend policy of Moroccan listed firms. The results reveal that the level of expected earnings and past dividend patterns does not influence dividend policy. The findings offer analysts, investors and academicians a valuable tool to understand how CFOs, CEOs, and board of directors design dividend policy. Moreover, given the severity of agency problems in CSE and the role of dividend policy in reducing agency problems, understanding the factors influencing dividend policy is fundamental for investors trading in this market.

Political connections, institutional investors monitoring and stock price synchronicity

PurposeThe purpose of this paper is to examine the association between politically connected (POLCON) firms and stock price synchronicity, and whether this association can be attenuated by institutional investors.Design/methodology/approachThis paper uses an ordinary least square regression model to examine the association between POLCON firms and stock price synchronicity; institutional ownership and stock price synchronicity; the moderating role of institutional ownership on the association between POLCON firms and stock price synchronicity; institutional domiciles and stock price synchronicity; and the moderating role of institutional domiciles on the association between POLCON firms and stock price synchronicity.FindingsThe result shows that POLCON firms are positively associated with stock price synchronicity. Further, the author also finds that institutional monitoring, through higher ownership by local institutional investors is associated with lower stock price synchronicity. In addition, this study documents evidence that institutional investors, particularly local institutional investors can improve stock price informativeness in POLCON firms.Research limitations/implicationsThe results suggest that POLCON firms are plagued by severe agency problems, resulting in limited flow of firm-specific information to the capital markets. However, the author shows that POLCON firm’s agency problems can be attenuated through effective monitoring by institutional investors. Further, institutional domiciles are shown to be significantly associated with stock price synchronocity. However, effective monitoring is largely driven by local institutional investors, in line with the geographical proximity theory.Practical implicationsThe results suggest that regulators should increase their surveillance and monitoring effort, particularly on firms with close ties to the government. In particular, POLCON firms should be required to be more transparent in their corporate dealings. Additionally, auditors should intensify their audit efforts on POLCON firm to provide more reliable financial information to minority shareholders, investors and analysts. Finally, institutional investors should be incentivized by the Malaysian Securities Commission, via, the code of governance to play an effective monitoring role in Malaysian firms.Originality/valueThis study reveals that POLCON firms’ severe agency problems can be alleviated by effective institutional monitoring. Further result identifies institutional domiciles as a significant factor in influencing monitoring effectiveness in POLCON firms. This paper provides insights into the dynamic interaction between political connections, institutional monitoring, firm governance and capital markets behavior of an emerging market.

The Role of Management Ownership in Bank Governance: Evidence from Taiwan

The purpose of this paper is to investigate the relationships that banks’ managerial ownership has with financial performance and firm value. We use a sample of 35 Taiwan domestic banks for the period 2005-2014. In the pooled OLS regression analysis, we find that the banks’ performance and market value fall as the level of management ownership rises, supporting the managerial entrenchment hypothesis. Moreover, the results show that when the ratio of managerial ownership pledge increases, then financial performance decreases while firm value increases. We conjecture that the positive effect of managerial ownership pledge on market value may be caused by the price maintenance effect of stock pledges. In addition, the evidence shows that there is a higher nonperforming loan ratio in family-dominated banks, and this hints that their loan decisions may have more severe agency problems relative to non-family ones.

Social Networking and Corporate Innovation

This paper studies whether board connectedness affects corporate innovation. We find that well-connected boards have a positive impact on innovation activities and quality. The effect is stronger when firms have higher advising demand or face more severe agency problems. 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 from new exchange listing rules. We also provide evidence that types and relatedness of connections, as well as director characteristics, contribute to cross-sectional heterogeneity of the positive effect.

The impact of bank merger growth on CEO compensation

AbstractWe examine the impact of bank mergers on chief executive officer (CEO) compensation during the period 1992–2014, a period characterised by significant banking consolidation. We show that CEO compensation is positively related to both merger growth and non‐merger internal growth, with the former relationship being higher in magnitude. While CEO pay–risk sensitivity is not significantly related to merger growth, CEO pay–performance sensitivity is negatively and significantly related to merger growth. Collectively, our results suggest that, through bank mergers, CEOs can earn higher compensation and decouple personal wealth from bank performance. Furthermore, we document a more severe agency problem in CEO compensation as a consequence of bank mergers relative to mergers in industrial firms. Finally, we find that the post‐financial crisis regulatory reform of executive compensation in banks has limited effectiveness in curbing the merger–pay links.

The real effect of the initial enforcement of insider trading laws

Based on a difference-in-differences approach, we find strong evidence that the initial enforcement of insider trading laws improves capital allocation efficiency. The effect is concentrated in developed markets and manifests shortly after the enforcement year. Further analysis shows that the improvement is positively associated with the increase in liquidity around the enforcement year and the opaqueness of the information environment before the enforcement year. The improvement is more pronounced for firms operating in more competitive markets, being more financially constrained, and with more severe agency problems. Finally, we find increased accounting performance after the enforcement and the increase is positively associated with the improvement in capital allocation efficiency. Overall, our evidence suggests that the initial enforcement of insider trading laws improves capital allocation efficiency by providing more information to guide managerial decisions and by reducing market frictions arising from information asymmetry and agency problems.

Does the Agency Problem Exist in Bank Mergers?

This paper examines the effects of bank mergers on CEO compensation and incentives during 1992–2014, a period characterised by significant banking consolidation. The empirical results show that CEO compensation is positively related to both merger growth and non-merger internal growth, with the latter being significantly smaller in magnitude. While CEO vega is not significantly related to merger growth, CEO delta is negatively and significantly related to merger growth. Our results thus suggest that, through bank mergers, CEOs can earn higher compensation from their banks and decouple personal wealth from bank performance. Further, our results highlight a more severe agency problem as a consequence of bank mergers relative to mergers in industrial firms. Finally, our analysis of the global financial crisis suggests that the post-crisis regulatory reforms on executive compensation in banks have limited effectiveness in curbing the merger–pay links.

Ownership structure and investment-cash flow sensitivity

This study investigates the effect of ownership structure on the use of cash flow in financing corporate investments—the investment-cash flow sensitivity—in a concentrated ownership context. Using a sample of 6797 French listed firms from 2000 to 2013, results show that investment-cash flow sensitivity decreases with the cash-flow rights of the controlling shareholder and increases with the separation of its cash-flow and control rights (excess control rights). Firms are, thus, less likely to use cash flow in investments when the interests of controlling shareholders are aligned with those of minority shareholders. However, they appear to use considerable internal funds for their investments when they have severe agency problems, driven by excess control rights of the controlling shareholders. Overall, our findings help advance the understanding of the role of agency relationship in shaping corporate financial policy.

The Value and Real Effects of Implicit Guarantees

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 SOEs experience 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.

The impact of the Sarbanes-Oxley Act on corporate innovation

We study the effect of the passage of the Sarbanes-Oxley Act (SOX) on corporate innovation. SOX dramatically changed corporate governance landscape of public firms in the U.S, especially in increasing monitoring from outside independent directors, which may have an impact on corporate innovation. The passage of SOX introduced an exogenous shock to the corporate governance structure, which enables us to establish causality between SOX and corporate innovation. Using patent and citation data from the NBER patent citation database, board of directors data from Institutional Shareholder Services (ISS) and a difference-in-difference regression technique, we find that SOX increases corporate innovation, as measured by the number of patents and the number of citations per patent. Moreover, we find that the effects are stronger for firms facing more severe agency problems, i.e., firms with more entrenched CEOs as proxied by a longer tenure, and firms with low institutional ownerships. The effect is also found to be stronger for firms operating in innovative industries.

Does the identity of multiple large shareholders affect the value of excess cash? Evidence from China

This paper examines the effect of ownership structure on the value of corporate excess cash holdings with consideration of the existence of multiple large shareholders (MLS) and the impact of the split share structure reform. The sample is comprised of information on Chinese listed companies from 2004 to 2011. The empirical results indicate that the presence of MLS increases the value of excess cash holdings, however, this effect exists only in OwnG group, where government is the controlling shareholder and the main MLS (the second largest shareholder) is a non-government entity (local institutional investor or foreign institutional investor). When the impact of the split share structure reform is taken into consideration, this reform enhances the monitoring of MLS in OwnG group and increases the value of excess cash holdings, especially when the contestability of control between the controlling shareholder and MLS becomes stronger. Our results imply that in this unique capital market of China, MLS play a valuable monitoring role in firms with more severe agency problems and when the contestability of control is stronger, especially after the split structure reform.

REIT Liquidity Management and Institutional Investors

We examine how institutional investors influence the liquidity choice between cash versus bank credit lines of real estate investment trusts (REITs). While cash offers REIT managers unconditional control rights, credit lines subject managers to bank monitoring. We find that REITs use more bank credit lines relative to cash under the oversight of institutional investors, especially independent and long-term institutions. These findings suggest that institutional investors attenuate the REIT managers' propensity to keep excessive cash relative to credit lines. Moreover, institutional investors delegate more agency monitoring to banks when their holding REITs are more risky and have more severe agency problems.

The Pathogen, Scapegoat, or a Miracle Drug? Short Selling and Stock Price Crash Risk

We identify the causality between short selling and stock price crash risk. Employing the difference-in-differences approach and a regulatory change from the Securities and Exchange Commission (SEC), Regulation SHO program, as an exogenous shock, we find that the lifting of short-sale constraints reduces the stock price crash risk, and the effect is stronger for the firms with more severe agency problems and greater information asymmetry. This study sheds light on the monitoring role of short selling in the equity market and its impact on corporate governance. In addition, our results have policy implications to security market regulators.

Does Internal Control Over Financial Reporting Curb Corporate Corruption? Evidence from China

We examine whether internal control over financial reporting (internal control) reduces the expropriation of resources from the firm by managers and controlling shareholders. Although we have ample evidence from prior literature that internal controls reduce errors in financial reports, it is less clear that they can curb resource extraction, as management may simply override these controls. We exploit a rich Chinese dataset to distinguish between the design and implementation of internal controls. On average we find some evidence that internal controls curb resource extraction, but further investigation reveals that many firms with documented internal controls fail to implement these controls, or simply override them (i.e., form over substance), and these firms’ controls do not curb resource extraction. We find that internal controls are most likely to be form over substance when they are policy-driven instead of voluntarily adopted, and also when there are more severe agency problems (and thus an increased likelihood of control override). Although the analysis is conducted with Chinese data, the spirit of our findings should generalize to all settings. In particular, our findings suggest that management can use the “form” of internal control procedures while still engaging in the undesirable behavior.

Segment Disclosure Transparency and Internal Capital Market Efficiency: Evidence from SFAS No. 131

ABSTRACTUsing the adoption of SFAS 131, I examine the effect of segment disclosure transparency on internal capital market efficiency. SFAS 131 requires firms to define segments as internally viewed by managers, thereby improving the transparency of managerial actions in internal capital allocation. I find that diversified firms that improved segment disclosure transparency by changing segment definitions upon adoption of SFAS 131 experienced an improvement in capital allocation efficiency in internal capital markets after the adoption of SFAS 131. In addition, I find that the improvement in internal capital market efficiency was greater for firms that suffered more severe agency problems before the adoption of SFAS 131 and also for firms whose managers faced stronger incentives to improve efficiency after the adoption of SFAS 131. My results suggest that more transparent segment information can help resolve agency conflicts in the internal capital markets of diversified firms, thus improving investment efficiency.

Endogenous Agency Problems and the Dynamics of Rents

Agents choose to acquire skills ranging from simple and transparent tasks to complex and opaque ones. While potentially more productive, the latter generate more severe agency problems. In our overlapping generations model, agents compete with their predecessors. With dynamic contracts, long horizons help principals incentivize agents. Agents with short horizons are more difficult to incentivize than agents with long horizons. Hence, old agents are imperfect substitutes for young ones. This reduces competition between generations. As a result, young managers can opt for more opaque and complex technologies, and therefore larger rents, than their predecessors. Thus, in equilibrium, complexity and rents rise over time. Our theoretical results are in line with the increase in complexity and rents observed in the finance sector.

Executive compensation, organizational performance, and governance quality in the absence of owners

I study the relationship between chief executive compensation, organizational performance, and governance quality in large U.S. nonprofits. Due in large part to the absence of shareholders, the nonprofit sector is characterized by weaker monitoring mechanisms and potentially more severe agency problems relative to their for-profit counterparts. As a result, there have been numerous instances of executive abuse, such as exorbitant pay for very little work. Despite the size of the nonprofit sector (5.5% of GDP and 9% of employment) and the obvious monitoring and legal responsibility concerns, governance issues at nonprofits have received much less attention than that at for-profits. Using recent IRS data on governance practices at nonprofits, I find that, after controlling for known determinants, both the CEO-to-employee relative pay ratio and the consumption of perquisites are significantly negatively related to an index of nonprofit governance quality. Furthermore, consistent with governance problems at nonprofits and inconsistent with the Pay-for-Performance Hypothesis, I find a significantly negative relationship between CEO-to-employee relative pay and multiple measures of nonprofit performance. These results highlight the importance of strong governance mechanisms in mitigating high levels of relative pay to and poor performance by executives in organizations marred by severe agency conflicts and ineffective monitoring mechanisms.

Post-IFRS Revaluation Adjustments and Executive Compensation

International Financial Reporting Standards (IFRS) allow firms to record adjustments (gains or losses) from the revaluation of investment properties in their income statements. After Hong Kong converged to IFRS in 2005, property companies were required to move their revaluation gains and losses (RGL) from equity to income. We find RGL to be a significant determinant of executive compensation in these firms after 2005, but not before. We further find evidence that the RGL-compensation association is consistent with the prediction of management opportunism. First, the level of compensation is not penalized by revaluation losses. Second, the RGL-compensation association is significant among firms with more severe agency problems, such as firms in which the controlling shareholders own a relatively small percentage of shares, firms in which the controlling shareholders have control rights that exceed ownership rights, and firms that are no longer run by their founders.