Well-governed Firms Research Articles

Firm-level climate risk and accounting conservatism: International evidence

We examine the impact of climate-risk exposure on accounting conservatism, and document a significant positive association. Utilizing a firm-level climate-exposure measure (CRI) for a large international sample covering 46 countries from 2002 to 2021, we find that firms facing climate risk tend to adopt more conservative reporting practices. This effect is notably stronger during pivotal periods of climate awareness, such as that around the Paris Climate Agreement, and in jurisdictions governed by common law. Our results remain valid under a series of robustness tests and after addressing endogeneity concerns. Further analyses indicate that this positive association is more pronounced in well-governed firms and in firms with high levels of environmental and social performance, but less pronounced in firms with high degrees of complexity and information asymmetry. Additional tests reveal that firms in environmentally sensitive industries and those operating in developed countries adopt more conservative reporting than counterparts in non-environmentally sensitive industries or in developing countries. Our final analysis suggests that regulatory risks have a greater effect on accounting conservatism than physical risks. Our paper contributes to the ongoing discourse on climate change, documenting the ‘bright side’ of firms' exposure to climate risk.

ESG unpacked: Environmental, social, and governance pillars and the stock price reaction to the invasion of Ukraine

How do the individual pillars of environmental, social, and governance (ESG) factors perform in times of war? Focusing on euro area stocks around the Russian invasion of Ukraine in 2022, we investigate this question using an event study methodology. Our findings suggest that firms with higher governance scores experienced stronger abnormal positive stock returns, implying that investors particularly valued well-governed firms amidst the uncertainty and adversity. However, the importance of good governance was lower for countries with higher dependency on oil imports from Russia. In contrast, social and environmental considerations appeared to receive less attention from investors during this crisis period. Our study highlights the heterogeneous nature of ESG factors and underscores how their relevance can be context-dependent, especially in uncertain times marked by geopolitical conflicts.

The role of options markets in corporate social responsibility

We explore the relationship between options trading and corporate social responsibility (CSR). We find that options trading can enhance CSR by (i) fostering shareholder activism, as indicated by increased long-term and socially responsible institutional ownership and CSR proposals and (ii) intensifying product market competition, which spurs green innovation and product-related CSR initiatives. The positive effects are more pronounced in well-governed firms but diminished in firms with managerial entrenchment. Moreover, CSR improvements driven by options trading positively influence firm value, with notable enhancements in environmental performance. Our results underscore that options markets play a crucial role in promoting responsible corporate practices.

External financing, corporate governance and the value of cash holdings

This study investigates the role of corporate governance in the deployment of internal resources when access to credit is hampered and external financing is costly. The extant literature has focused on the rise in cash holdings amongst firms, but little is still known about when and under what conditions firms deploy and use accumulated internal resources. Using a panel data of 1,599 U.S firms for the period 2004 to 2016, the 2008 financial crisis as a quasi-natural experiment and a difference-in-difference estimation strategy, we examine how managers deploy and allocate cash reserves and excess cash. We find that the propensity to invest out of pre-crisis cash reserves is highest for weakly-governed firms and that these firms finance additional investment using short-term debt and allocate a higher fraction of post-crisis excess cash towards building up cash balances. Contrastingly, well-governed firms have a higher propensity to allocate excess cash towards increasing the value of pledgeable assets and deploy any accumulated cash balances to reduce short-term debt financing. Our findings are important as they reconcile the flexibility and the spending hypothesis of cash holdings, showing that well-governed firms trade-off the cost of cash holdings against the benefit of minimizing future demand for costly external financing; effectively hedging against foregoing profitable future investment opportunities.

Corporate governance and shareholder-employee risk-shifting: Evidence from corporate pension plan sponsors

This study examines how corporate governance affects pension plan sponsors’ conflicting motives—risk-shifting vs. risk management—and their future pension funding status, R&D investments, and shareholder values. We focus on managers’ discretionary choices of expected rates of return on plan assets and discount rates for pension liabilities to capture risk-shifting motives and measure corporate governance quality through foreign equity ownership (strong monitoring) and stable equity ownership (weak monitoring). The evidence shows that well-governed firms use managerial risk-shifting to finance R&D and increase shareholder values. Risk-shifting by poorly-governed firms results in larger pension underfunding without increasing shareholder values.

ESG-Linked Compensation, CEO Skills, and Shareholder Welfare

Abstract Executive compensation is increasingly being linked to ESG outcomes. This paper examines whether ESG targets are consistent with shareholder welfare. Using granular information on compensation contracts of Swedish CEOs, we show that ESG and financial targets are competing. ESG-linked compensation is 5 percentage points more common in well-governed firms and 6.3 percentage points more likely for CEOs with broader skill sets (generalist CEOs). ESG scores of well-governed firms improve when generalist CEOs have ESG-linked pay, but there is no effect on profitability. These results suggest that boards set ESG contracts because shareholders derive utility from ESG in addition to wealth, and ESG may not be produced without these incentives. (JEL M14, G14, D21, L21) Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

When and how are rule 10b5-1 plans used for insider stock sales?

SEC Rule10b5-1 plans are intended to limit the ability of insiders to trade opportunistically. We study insider stock sales by CEOs both under and outside of these plans. While both groups exhibit opportunism, this behavior is more limited in plan sales and non-plan sales in well-governed firms. Furthermore, opportunism in plan sales is greater for transactions representing a larger fraction of the CEO's firm-related wealth. CEOs can circumvent the intent of Rule 10b5-1 by exercising their discretion over financial reporting and real earnings management and appear to benefit from material nonpublic information by selectively cancelling plans or using limit orders.

Does corporate governance affect financial analysts' stock recommendations, target prices accuracy and earnings forecast characteristics? An empirical investigation of US companies.

This paper investigates how corporate governance quality affects the analyst’s stock recommendations, forecast efficiency and target price accuracy on New York Stock Exchange. In particular, as corporate governance is often uncertain and ambiguous to investors, expert financial advisors may use transparent corporate governance information to set their recommendations and improve the level of accuracy of their earnings forecasts. According to agency and signaling theories, good governance mechanisms aim to mitigate agency conflicts and boost corporate transparency. Thus, we argue that they can serve as mediators during the forecasting process and we expect a strong significant relationship between the effectiveness of corporate governance mechanisms and analyst activity. Five hypotheses are tested with a large sample of 154 US market firms over a 17-year period (2004–2020). Our empirical findings point out some special features of US stock markets. We find evidence that analysts tend to issue favorable recommendations, more accurate, less dispersed and more optimistic earnings forecasts for most well-governed firms. Furthermore, we show that higher-quality governance transparency is an important determinant of financial analysts’ behavior in the USA. The results also indicate that higher-quality governance appears valuable with financial analysts during pre- and post-crisis period, while it is not generally detected in COVID-19 times. However, we report the weakness of analysts’ outputs–governance quality for small firms. Thus, our findings cast doubts over the corporate governance-based analyst practices of US small and unaffiliated firms. The main implication of these findings is to improve understanding of how investors’ behavioral characteristics affect the transmission mechanism of information in money market and capital market prices. This paper has important implications for the decision making of financial analysts and investors by requesting firms to significantly improve their information environments in the good and bad times. It also offers insights into how firms establishing good corporate governance mechanisms can help the analysts to predict future stock prices.

Does institutional quality moderate the relationship between corporate governance and stock liquidity? Evidence from the emerging market of Pakistan.

The main aim of this study was to empirically analyze whether Institutional Quality moderates the relationship between corporate governance and stock liquidity through the light of agency and information asymmetry theory. To the best of our knowledge, this is the first finance study. The sample consists of 230 non-financial firms listed on the Pakistan stock exchange during the period of 2009–2019. We used an instrumental variable approach and our new Institutional Quality index composed of world governance indicators and a corporate governance index, developed via principal component analysis, to demonstrate a relationship between corporate governance and stock liquidity and check the moderating role of Institutional Quality by following the resources complementary phenomenon. Our results show a significant, positive relationship between the corporate governance index and stock liquidity, suggesting that well-governed firms have high liquidity. The results show that the Institutional Quality index has a positive moderating impact on the relationship between corporate governance and stock liquidity, suggesting that corporate governance in Pakistan is weak. Our results are robust to a series of endogeneity checks using alternative proxies of stock liquidity.

Do better-governed firms enhance shareholders’ value? A study of corporate governance index firms

Malaysia has taken various actions to improve the corporate governance (CG) mechanisms and practices for all listed firms. In 2011, the Malaysian Corporate Governance Index (MCGI) was released, and before that, in 2009, the blueprint of MCGI was introduced. As a result, MCGI released annually the top 100 listed Malaysian firms that have been classified and ranked as the well-governed firms from its corporate governance compliance and disclosure. This study examines the efficacy of MCGI on shareholders’ value over the 12-year periods from 2008 to 2019 and compares pre- and post-CG Blueprint. A generalized least square (GLS) method is employed as it fits the data characteristics in this study, and robust results are yielded. The results reveal that MCGI, firm size, ROA, and female directors exhibit a significant impact on shareholders’ value while leverage and growth yield non-significant effects on shareholders’ value. Overall, firms tend to use external financing rather than internal financing as the preferred option. This supports the contention that trade-off theory was adopted in the Malaysian context for the study period. However, this result is unstable over time; therefore, an up-to-date investigation of its relationship is necessary.

Corporate governance and investment sensitivity to policy uncertainty in Brazil

In this study, I investigate the role of corporate governance on the relationship between investment and economic policy uncertainty (EPU). Exploring the Brazilian context of poor investor protection, high private benefits of control and premium listing segments, I provide evidence that the negative impact of EPU on investment is stronger for well-governed firms. The moderating effect of corporate governance on investment-EPU sensitivity is present in companies with different levels of financial constraints and investment irreversibility. My findings support the view that controlling owners prefer riskier investments when expropriating minority shareholders and stricter governance practices may mitigate such an opportunistic behavior.

Role of Corporate Governance and Lifecycle in Determining Payout Precommitment in an Emerging Economy

We analyze the role of firm-level corporate governance in determining the precommitment payout policy of emerging market firms and investigate if there is a precommitment lifecycle effect. Unlike previous studies for the U.S. firms, we only find evidence of precommitment among relatively well-governed firms, who combine good governance with large dividend payouts to shareholders and large debt-related repayments to creditors. We also document a strong precommitment lifecycle effect. Firms in the growth and mature stages of their lifecycle tend to use both debt and dividends to precommit to investors, with an increasing proportion of dividends in total payout measures. Our results are robust to an array of control variables, alternate payout proxies and market setting, firm-level corporate governance and addresses any potential endogeneity concerns in the sample.

The effect of sovereign wealth funds on corporations: Evidence of cash policies in Singapore

This paper studies the monitoring role of sovereign wealth funds (SWFs). By using unique dataset from one of the largest SWF: Temasek holdings, we find that SWF’s presence has a positive effect on cash holdings of portfolio companies. The effect is more pronounced for well-governed firms, indicating that Temasek increases corporate cash holdings through its active role in corporate governance. We further find supportive evidence that Temasek ownership affects cash holdings by hoarding excess cash and reducing capital expenditure, especially within firms with good governance. Temasek’s discerning effect on cash policies highlights the effective monitoring role of sovereign wealth funds.

Managerial Ability and External Financing

This research examines the link between managerial ability and firms’ external financing. Our findings show that firms with more able managers tend to mitigate information risk by reducing their loan financing and increasing equity financing. These findings are more prominent for financially unconstrained and well-governed firms, suggesting that high-ability managers are more apt to use equity financing as a financial source in firms with better financial and governance quality. To address potential endogeneity problems, we document that the impact of managerial ability on external financing remains unchanged after we employ yearly regression, change analysis, quantile regression, and the instrumental variable approach.

Do analysts’ recommendations reflect co-opted boards?

PurposeThis study aims to examine whether co-opted directors influence analysts’ recommendations. As information intermediaries, financial analysts should incorporate the quality of corporate governance into their valuation because well-governed firms are associated with lower agency costs and better performance. Co-opted directors are those appointed after the incumbent chief executive officer assumes office. The authors investigate whether board co-option has an effect on analyst recommendations.Design/methodology/approachThe present study uses univariate analysis, multi-variate regression analysis and conduct a natural experiment using the Sarbanes-Oxley as an exogenous shock.FindingsThe results show that firms with fewer co-opted directors tend to receive more favorable recommendations, suggesting that analysts favor firms with strong corporate governance. The results hold even after controlling for various firm characteristics, including the traditional measures of board quality, i.e. board size and independent directors.Originality/valueThe paper is the first of its kind and offers evidence on the effect of co-opted directors on analyst recommendations. The results contribute to the literature both in corporate governance and in financial intermediaries, where analysts play a crucial role in providing information to the various participants in financial markets.

Do Analysts’ Recommendations Reflect Co-Opted Boards?

Purpose: This study examines whether co-opted directors influence analysts’ recommendations. As information intermediaries, financial analysts should incorporate the quality of corporate governance into their valuation because well-governed firms are associated with lower agency costs and better performance. Co-opted directors are those appointed after the incumbent CEO assumes office. Design/methodology/approach: The present study uses univariate analysis, multi-variate regression analysis, as well as conduct a natural experiment using the Sarbanes-Oxley as an exogenous shock. Findings: The results show that firms with fewer co-opted directors tend to receive more favorable recommendations, suggesting that analysts favor firms with strong corporate governance. The results hold even after controlling for various firm characteristics, including the traditional measures of board quality, i.e. board size and independent directors. Originality: The paper is the first of its kind and offers evidence on the effect of co-opted directors on analyst recommendations. The results contribute to the literature both in corporate governance and in financial intermediaries, where analysts play a crucial role in providing information to the various participants in financial markets.

Project-Level Disclosure and Investment Efficiency: Evidence From China

Different from studies that use rough proxies for aggregate accounting information quality to investigate its impact on investment efficiency, we construct a project-level measure of disclosures pertaining specifically to firms’ ongoing and future investments, using a large sample of Chinese listed firms. We first validate this measurement of project-level investment disclosure, finding that more detailed investment disclosures are associated with stronger market reactions, particularly among strong-governance firms. Furthermore, we find that project-level disclosure is associated with higher future investment efficiency for strong-governance firms, but not for weak-governance firms. Investigations into underlying channels reveal that well-governed firms with more investment disclosures face less financial constraints and are more likely to abandon poorly performing investments. Cross-sectional analyses suggest that project-level disclosure and governance play a more important role in settings where firms have stronger incentives for opportunistic disclosure. Overall, our evidence indicates that project-level disclosure interacts with corporate governance to impact investment efficiency. The results have implications for disclosure regulation and practice.

CSR-contingent executive compensation contracts

Firms have increasingly started tying their executives’ compensation to CSR-related objectives. In this paper, we attempt to understand why firms offer CSR-contingent compensation and the conditions under which such compensation improves corporate social performance. Using hand-collected data from proxy statements, we find that this emerging compensation practice varies significantly across industries and across different CSR categories. Further, well-governed firms are more likely to offer CSR-contingent compensation, and such compensation does lead to higher corporate social standing. Such firms are more likely to offer formula-based, Objective CSR-contingent compensation. However, our results suggest that non-formulaic, Subjective CSR-contingent compensation also helps improve companies’ social performance when firm outcomes are more volatile and unpredictable, and therefore executives’ effort and performance are harder to evaluate, and when firms have better corporate governance.

The impact of married couples on firm innovation: Evidence from Chinese family firms

This paper investigates whether family firms controlled by married couples have better innovation performance. Based on the Chinese patent data during 2008∼2016, I find that married couples have positive impacts on firm innovation output for family firms in China. My identification strategy is based on matched sample analysis. I further find that this positive effect is more pronounced in well-governed firms.

Discouraging Corporate Savings

We study whether corporate cash holdings are optimal or excessive by exploiting a Korean tax reform that imposes a new tax on earnings not paid out to shareholders or reinvested. Firms treated by the reform reduce cash savings, and market participants react favorably. Increases in value are concentrated among firms subject to memories from the 1997 Asian financial crisis and among well-governed firms, and these firms spend more on payouts. By contrast, no value increases are observed among poorly governed firms, and these firms instead spend more on investments. Overall, our results are consistent with excessive savings before the reform.