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Managers and corporate directors need to recognize two key behavioral impediments that obstruct the process of value maximization, one internal to the firm and the other external. I call the first obstruction behavioral costs. Behavioral costs, like agency costs, tend to prevent value creation. Behavioral costs are the costs associated with errors that people make because of cognitive imperfections and emotional influences. The second obstruction stems from behavioral errors on the part of analysts and investors. These errors can create gaps between fundamental values and market prices. When they do, managers may find themselves conflicted, unsure of how to factor the errors of analysts and investors into their own decisions. Proponents of value based management emphasize that with properly designed incentives, managers will maximize the value of the firms for which they work. As such, either they treat behavioral costs as simply another form of agency costs, or they deny the relevance of cognitive errors. In contrast, proponents of behavioral finance argue that behavioral costs are typically large, and cannot be addressed though incentives alone. This is not to say that incentives are immaterial. On the contrary, incentives are of critical importance. The point, however, is that there are limits to incentives. If employees have a distorted view of what is in their own self-interest, or if they have a mistaken view of what actions they need to take in order to maximize their self-interest, then incentive compatibility, although necessary for value maximization, will not be sufficient.

Merger and acquisition activity is extraordinarily prevalent in the United States and generates massive expenditures every year, but at its heart is a serious empirical puzzle. Despite many years of search, a range of empirical researchers have failed to find evidence that this activity generates benefits, either for the combining firms’ owners or for anyone else. While the problem is not unknown among academics, and the result is no longer very seriously contested, no one has any conclusive explanation for it. The law, for its part, ignores it entirely. This paper comprehensively reviews the empirical literature and the several confusing puzzles it raises, and works through the policy implications for the bodies of law it affects. The most important insights are two. First, the evidence casts doubt on the general confidence within corporations scholarship in the promise of oversight by robust market institutions, as an alternative to law and courts, especially the disciplinary power of the market for corporate control. Second, the less for antitrust law is simple. The fear of jeopardizing gains from merger, on which the antitrust law of mergers and acquisitions has been rendered largely inert, is no longer very defensible. The balance between false positive and false negative should be re-set.

We show that stock-based CEO compensation can create a "race to the bottom" among firms that escalates short-termist pressure. More informative stock prices reduce the agency cost of using stock-based compensation to incentivize managers. Also, shortening a firm's project maturity improves stock price informativeness by attracting informed investors, who prefer to invest in short-term assets. However, when informed trading is a scarce resource, this is a prisoners' dilemma game: competition for informed investors creates excessive short-termism that destroys shareholder value, while in equilibrium, price informativeness stays the same. More intense competition between firms sharpens incentives to shorten project maturity, deepening the "short-termism trap."

We investigate the impact of host-country shareholder rights protection on location and governance modes of Japanese foreign direct investment (JFDI). Agency theory predicts that strong shareholder rights protection in host countries should not increase location attractiveness nor impact entry and governance mode decisions, as foreign shareholders are outside the jurisdiction of host country laws. However, informal institutional mechanisms, including managerial bonding and isomorphic pressures, as predicted by institutional theory, may create indirect control over host country managers which reduces agency costs. Hence, we predict that higher shareholder rights protections will enhance a potential host country’s JFDI attractiveness, and that subsidiaries established in host countries with higher shareholder rights protection will employ fewer Japanese expatriates. We find support for our predictions based on a sample of JFDI established between 1986 and 2012.

This Article argues that the conventional wisdom about corporate raiders and activist hedge funds—raiders break things, and activists fix them—is wrong. Because activists have a higher risk of mistargeting—mistakenly shaking things up at firms that only appear to be underperforming—they are much more likely than raiders to destroy value and, ultimately, social wealth. As corporate outsiders who challenge the incompetence or disloyalty of incumbent management, raiders and activists play similar roles in reducing “agency costs” at target firms. The difference between them comes down to a simple observation about their business models: raiders buy entire companies, while activists take minority stakes. This means that raiders are less likely to mistarget firms underperforming by only a slight margin, and they are less able to shift the costs of their mistakes onto other shareholders. The differences in incentives between raiders and activists only increase after the acquisition of their stake. Raiders have unrestricted access to nonpublic information after acquiring ownership of a target company, which allows them to look under the hood to determine whether changing the target’s business strategy is truly warranted. Activists, by contrast, have limited information and face structural conflicts of interest that impair their ability to objectively evaluate what’s best for the target company. This insight has profound implications for corporate law and policy. Delaware and federal law alike have focused on building walls to keep raiders outside the gates, but they ignore the real threat—shareholder activists—that are already inside. We propose reforms to both state and federal law that would equalize the regulation of raiders and activists.

We examine the impact of internationalization on IPO underpricing in China. Our findings, which suggest that internationalization can reduce IPO underpricing, echo similar findings in the literature. However, we document that the transmission channel is not consistent with a diversification benefit documented in the literature. Instead, we find that internationalization: 1) serves as a good signal for investors and certifies the IPO is a quality investment due to lower information asymmetry; and 2) enhances corporate governance so that agency problems are less severe, thus leading to lower IPO underpricing. Overall, the underlying mechanisms differ between mature and emerging markets.

Does pre-existing financial reporting quality play a role in mitigating market-driven takeover bids and enhancing investment efficiency? An exogenous buying pressure from mutual funds with extreme capital inflows affords us a quasi-experimental setting for testing the real effects of acquirers’ financial reporting quality. We find that financial reporting quality disciplines acquiring firm managers at the front-end of the acquisition process and averts value-destroying takeover stock bids. Our findings suggest that managers discipline themselves and offer takeover bids less frequently as a reaction to equity overvaluation when high-quality financial reporting facilitates an effective board oversight and managers rationally anticipate that the board will reject their market-driven stock bids. If managers inflate earnings proactively to prop up the stock price for their upcoming M&As, we will also observe an inverse relation between financial reporting quality and the likelihood of M&As. Our identification strategy on exogenous equity overvaluation helps in ruling out the reverse causality explanation of our findings. We contribute to the literature by investigating the effects of transparent financial reporting on mitigating managers’ sub-optimal investment decisions and unraveling the mechanisms underlying the real effects of financial reporting quality. Our falsification test result suggests the presence of tensions in our hypothesis.

There is ongoing academic interest in understanding share ownership and control dynamics in publicly listed companies, given the corporate governance and regulatory implications arising therefrom. This article presents a new dataset and analysis of shareholder information, focusing on the largest 50 publicly listed companies in Australia, filling a striking 12 year gap in the existing literature. Specifically, the following issues are addressed: 1. The level of institutional ownership within the largest 20 shareholders in each of the 50 companies; 2. The concentration of that ownership based on the percentage of issued capital owned by the largest three shareholders; 3. The control of that ownership, to determine whether ownership and control diverge; and 4. Where ownership and control diverge, substantial shareholding information is collected and analysed, in order to provide a more complete picture of share ownership patterns in the Australian context. The study findings provide a clear indication of the concentration of share capital in the hands of institutional shareholders in Australia. Yet, in relation to shareholder dispersion, all of the 20 largest publicly listed companies can be classified as widely held (versus 13 in the 1999 La Porta et al study) at the 20% level of control. Additionally, the results have a preliminary bearing on the relevance of common ownership theory within Australia. Regarding the ‘Big Three’ index funds, these institutions comprise 33.33% of the substantial shareholding positions across the ASX 50. Notably, 87.1% of these substantial holdings are in companies within the financial sector. The key implications arising from the findings are that managerial agency costs and the agency costs of institutional investors are of fundamental importance in the Australian context. Based on this understanding, there are two central messages for regulators and policy makers. First, corporate governance regulation must evolve in parallel to changes in share ownership and distribution. Second, there is a need for complementarity between shareholder patterns and regulation which incentivises potential governance actors and mitigates identified agency costs.

This study examines the impacts of minority investor protection mechanisms on agency costs in Vietnam. All relevant indicators of minority investor protection developed by the World Bank are employed with a panel data sample of 135 Vietnamese listed firms during the period from 2014-2018. It is found that the following mechanisms are effective in mitigating agency costs and hence agency problems at the firm level: i) extent of disclosure; ii) extent of director liability; iii) ease of shareholder suit; iv) shareholders’ rights in major corporate decisions; and v) corporate transparency. Interestingly, it is found that the board independence and controlling government shareholder do not play significant roles in addressing agency problems. To the best of the authors’ knowledge, this is one of the first attempts at testing for the impact of minority investor protection mechanisms developed by the World Bank on agency costs at the firm level. This study also provides policy implications for selecting effective mechanisms to mitigate agency conflicts between controlling shareholders and minority investors in order to promote the financial performance of the firm in an Asian emerging market.

The unobservability of the borrower's action is a major reason that smaller enterprises face high financing costs and credit rationing. We show that bank loans fully monitored by blockchain allow poor firms with low working capital to eliminate this agency cost. Interestingly, this is achieved by financing all production using fully monitored debt and leaving all internal capital unused; because the use of private, unmonitored internal capital creates unobservability whereas all-debt financing provides full transparency of operations. In contrast, rich firms find it costly to eliminate moral hazard via transparency and they prefer a mix of internal capital and unmonitored debt to finance production. We identify the working capital level at which a firm is indifferent between using all-debt or mixed financing for production. A poor firm with working capital below this indifference level strictly prefers all-debt financing and a rich firm above the level strictly prefers a debt-equity mix. We extend our results to a supply chain and show that the entire supply chain benefits from the use of monitored debt by an individual firm. The "inefficient" bankruptcy cost can create value under blockchain by mitigating the deadweight loss due to decentralization.

This article provides a comprehensive survey of the academic finance research on hedge fund activism. We review the development, current state, and potential future trends beginning with the institutional background in which hedge fund activists operate, activists’ objectives, tactics, and the selection of target companies. We also review the various outcomes, with a focus on the financial and operating performance of targeted firms, the dynamics of engagement with fellow investors, and the impact on other stakeholders. The evidence from the full body of the literature generally supports the view that hedge fund activism constitutes an important venue of corporate governance that is both influence-based and market-driven, placing activist hedge funds in a unique position to mitigate the agency costs which are fundamentally associated with the separation of ownership and control.

Purpose We contribute to the debate in the literature about generalist CEOs by exploring the effect of board governance on CEO general managerial ability, focusing on one of the most crucial aspects of the board of directors, board size. Prior research shows that smaller boards constitute a more effective governance mechanism and therefore are expected to reduce agency costs. Design/Methodology/Approach We estimate the effect of board size on CEO general managerial ability, using a fixed-effects regression analysis, propensity score matching, as well as an instrumental-variable analysis. These techniques mitigate endogeneity greatly and make our results much more likely to show causality. Findings Our results show that firms with smaller board size are more likely to hire generalist CEOs. Specifically, a decline in board size by one standard deviation raises CEO general managerial ability by 15.62%. A lack of diverse experiences in a small board with fewer directors makes it more necessary to hire a CEO with a broad range of professional experiences. Furthermore, the agency costs associated with generalist CEOs are greatly diminished in firms with a smaller board. Hence, firms with a smaller board are more inclined to hire generalist CEOs. Originality Although prior research has explored the effects of board size on various corporate outcomes, strategies, and policies, our study is the first to investigate the effect of board size on CEO general managerial ability. Our study contributes to the literature both in corporate governance and on CEO general managerial ability.

Despite the mounting evidence that stock misvaluation affects takeover characteristics and outcomes at the deal level, there remains a prolonged debate over whether mispricing drives aggregate industry-level merger activity. We depart from the extant literature and investigate whether stock misvaluation drives industry-level merger waves by contrasting the effects of acquirer valuation during “stock” and “cash” merger waves, defined using pure stock or cash acquisitions during 1981-2015. Using the timing of stock waves, we find that acquirer valuation peaks during wave periods, and acquirers have low stock performance in the 5-year period after the merger bid, with especially acute underperformance for mergers announced during stock waves. There is little evidence of such patterns around cash merger waves. These results suggest that equity misvaluation drives stock merger waves, and agency costs associated with overvalued equity prevent acquirer shareholders from reaping gains from merger waves.

We examine the relation of active options market trading and the (in)efficiency of corporate investment in terms of deviation from optimal investment levels. Past research considers the volume of options trading as contributing to firms’ informational efficiency. Investment efficiency is partly driven by information asymmetries between firm managers and capital providers, aggravating moral hazard concerns. We test whether the enhancement in firms’ information environment associated with higher volume of options trading activity is positively related to optimizing investment at the firm level. Our results indicate that the volume of options trading by firms is positively and significantly associated with firm-level investment efficiency. This relation is associated with the enhancement in the firms’ information environment stemming from active options trading. Overall, our findings suggest that the managerial skills associated with active trading in derivatives markets also benefit firms’ investment decisions through enhancing the optimal allocation of firm resources and investment efficiency.

Analyzing the language styles of top executives using conference call transcripts, we find that the language style matching between the CEO and the CFO can predict CFO turnover. Using the CEO-CFO pair fixed effects, we find that the mimicry component of language style matching is negatively associated with CFO turnover. We also find that the effect is mitigated by better corporate governance mechanisms, suggesting that corporate decisions driven by social interactions could be a source of agency costs. The effect is also weaker for CFOs appointed by the current CEO.

This Article breaks new ground by using agency costs analysis to conceptualize the relationship between benefit plan sponsors and plan participants. The analysis provides normative insights on how governance mechanisms may mitigate agency costs. It also illuminates how those normative insights can be used to improve positive law. Courts, scholars, and policymakers have long tried to force employee benefit plan relationships into the pigeonholes used in donative trust law, and often bemoaned the results. Changing trends in benefit plan typology and importance have increased the disconnect between the relationships that exist in donative trusts and those in benefit plans. This Article argues that it is time to bring a new lens, agency costs analysis, to bear on the challenges in building governance mechanisms that enable American workers to accumulate the financial resources they need for a secure retirement and decrease the social safety net costs of supporting superannuated individuals.

We explore the role of female directors in mitigating CEO luck. CEOs are “lucky” when they receive stock option grants on days when the stock price is the lowest in the month of the grant, implying opportunistic timing. Our results show that board gender diversity significantly deters the opportunistic timing of option grants. The effect of board gender diversity is 17.19% stronger than that of board independence in reducing CEO luck. Board gender diversity plays an effective governance role, even more effective than board independence does. Our results support the benefits of board gender diversity in mitigating the agency cost.

Share repurchases have come under criticism as they may be used for earnings management and take capital away from productive investment. However, share repurchases can also reduce the agency costs of free cash flow and offset the dilution of current shareholders. Whether firms engage in good or manipulative share repurchases can crucially hinge on the quality of corporate governance. Using UK firm panel data, we study the effect of independent directors on repurchase policies. Our results indicate that board independence increases the propensity to engage in share repurchases. Moreover, board independence attenuates the harmful effect of manipulative share repurchases on employment growth. Our approach exploits the passage of a corporate governance reform which provided a unique opportunity to tease out the causal impact of independent directors on share repurchases. Our findings advocate in favor of more active involvement of independent directors in payout policies.

We examine the impact of foreign institutional investors on the prevalence of restrictive bond covenants using a sample of 959 Yankee bonds from 29 countries over the period 2001–2019. We find a significantly negative relation between foreign institutional ownership and debt cov-enants. This inverse relation is strongest for U.S. institutional ownership of foreign-issued Yan-kee bonds, and for covenants designed to mitigate such opportunistic behavior as claims dilu-tion and wealth transfers. We also show that the inverse relation between U.S. institutional ownership and restrictive debt covenants is moderated by country- and firm-level variables re-lated to corporate governance, information asymmetry, and agency costs of debt. Additional analyses show that U.S. institutional ownership has a significant pricing effect on Yankee bond investors by lowering the issuer’s cost of borrowing.

This article explores a series of rent-seeking behaviors and fiduciary deficits that are playing a role in the “growth” and demise of U.S. companies. Start-up financing occurs through exemptions that remove disclosure obligations required in public markets, assuming that private ordering suffices. The exemptive-privilege premise is that parties to financing rounds will be faithful agents, i.e., fiduciaries, to their sources of capital. Where there are conflicts of interest, fiduciary deficits will arise unless either the threat of litigation for breaches of duty sufficiently deters the resulting opportunism or the sources of capital are themselves sufficiently watchful and savvy to combat the opportunism. As private capital sources become more numerous and diverse, the latter may not happen so reliably. We examine this territory through a business-school like case study of WeWork, one of the most recent examples of failed private ordering and one where the prescribed corporate governance mechanisms failed to fill the gaps. WeWork’s extraordinary growth over eight rounds of financing both strengthened the hand of its CEO, Adam Neumann and concealed danger signs. Indeed, in the absence of required disclosure, fiduciary duties take on extra significance. Yet, the WeWork board exhibited multiple fiduciary deficits resulting in what is a cautionary story about governance failure and a warning to those who are focused on expanding “access” to these funding rounds In short, the funding and governance systems are not designed for long-term “startup” governance, and WeWork reveals the systemic slack and flaws. Our exploration of the motivations, incentives and opportunities in start-up financing reveals an accumulating set of deficits that makes the current state of affairs more problematic than the conventional account would suggest. From founder control enabling self-centered, biased and risky behaviors, to funders with diverse incentives and capital sources, to start-up market “valuations” issues, the result is failed information-forcing systems and governance safeguards and directors who focus on constituent protections and not on their fiduciary duties.

Private equity investing and the relationship between the general partner and the limited partners are plagued with the risk of information asymmetries and agency costs, so the markets have developed several mechanisms to align the incentives of the funds and the investors, most importantly through disclosure requirements and protections in limited partnership agreements. However, such agreements may not always deal with the most important asymmetries or agency conflicts, especially the hidden effort problem. From the fund’s perspective, there are also other relationships that affect its internal dynamics. They are the need for interest alignment between the fund (and the general partner) and the managers of the portfolio companies, the risk of financial agency costs and the risk of strategic creditor actions. All of these relationships are regulated primarily by contracts. In this paper, I evaluate the game-theoretical framework, Investment Game, based on the analysis of the general-limited partner investment-effort relationship supported by a brief analysis of the other relationships. I argue that, in most cases, the limited partners are able to solve the general partner effort maximisation problem, making part of the fund regulation unnecessary. However, private ordering may not work in some cases. Despite these situations, the Investment Game enables, even when the limited partners cannot affect the fund terms, an analysis of the general partner effort level and the level of undisclosed private benefits. Therefore, the Investment Game also sets a framework for a data analysis of private equity investing.

Auditors of foreign cross listed firms face liability arising from the nature of the institutional monitoring framework of legal claims that can potentially be brought against the auditor in both the home country and the US. This paper is the first to document the relationship between auditor liability and auditor pricing of excess cash holdings for foreign firms cross-listed in the US. Our findings indicate that auditors demand a fee premium for foreign incorporated clients with greater excess cash holdings, consistent with auditors recognizing the potential for legal exposure to agency conflict arising from foreign listed US traded clients. Furthermore, we examine aspects of foreign capital market protections, such as disclosure requirements, the strength of legal enforcement, and the strength of shareholder rights to better understand auditor perception of the liability they incur due to the agency costs associated with excess cash holdings. We find that there is a significant positive association between audit fees and excess cash holdings for firms where the country of incorporation permits greater liability of auditors in criminal and civil litigation. In addition, auditors assign higher audit fees to firms holding greater excess cash incorporated in countries with greater required accounting disclosure, stronger legal enforcement and stronger shareholder rights.

Three-party situations are problematic due to the agency, information and administrative costs involved. This includes the substitution of parties in relationships characterized as choses in action, which is why we see them as property transfers even if that is not fully accurate. We also create separate personality to help compress the number of parties involved in a transaction but that still contains separate layers within an artificial entity. It is not possible to fully avoid the use of intermediary analysis once there are dealings with the outside world in situations of coownership of property or co-sharing of power and so the goal is to keep costs low. The problem is not with agency costs as principals are well protected today. But that then shifts informational costs to third parties, particularly if objective standards are imposed on them. This lowers the administrative costs of adjudication but if so we need to get those standards right in order to minimize total costs. At the moment much of the work is done through the doctrine of notice and burden of proof, which could turn on how a case is pleaded. This may be too onerous for third parties and could in fact increase transactional costs if principals are not incentivized to control agency costs. There needs to more notice-creating mechanisms and perhaps more principled ways to apportion losses.

Internationalization of an MNE often involves succession of entries, divestments and re-investments in the host country. However, the extant literature rarely analyses these sequential processes. By relying on a broad agency model, we argue that these processes are shaped by MNEs’ organizational learning, which in turn depends on their internal headquarters-subsidiary configuration. Specifically, we compare investment-divestment-reinvestment sequences undertaken by family MNEs vs. non-family MNEs. Due to specific agency problems affecting their internal configuration, and to lower levels of self-interest and bounded rationality in overseas subsidiaries, family MNEs incur lower agency costs than non-family MNEs in running businesses abroad, and present a learning model that allows them to more effectively memorize and value past events experienced at the subsidiary level. As a result, while family MNEs and non-family MNEs do not differ in their propensity to divest foreign subsidiaries, after divestment occurs, the former will be more incline to re-invest in the same host country, and the likelihood increases with the depth of their local presence there. Our empirical analyses, conducted on a large sample of foreign investment-divestment-reinvestment initiatives by Italian companies, in the period 2000-2015, support our hypotheses, thus advancing our knowledge on a topic underexplored so far.

The study explores and contrasts the earning management and its nature of the non-rent seeking and rent seeking prone firms followed by their respective valuation implication in the light of agency problem (cost) in India, where rent seeking is central to the economy. The empirical results suggest that the cash flow management by the non-rent seeking firms having lesser agency cost, is likely to be beneficial from equity valuation point as the same might aid in addressing information asymmetry as to superior operating cash flow and cash flow growth. Accrual management is considered detrimental from valuation perspective for these firms- may be due to information risk of accruals. For rent seeking prone firms where agency cost is documented to be higher, both cash flow management and cost of production management are opportunistic because they are likely to be aimed at reaping private benefit, as such, both have an inverse relation with the equity value.

The problem of managerial short-termism has long preoccupied policymakers, researchers, and practitioners. These groups have given much less attention, however, to the converse problem of managerial long-termism. Michal Barzuza and Eric Talley fill this gap in their pioneering article, Long-Term Bias. Relying on the behavioral finance and psychology literatures, the authors provide a novel and thought-provoking analysis of managerial long-term bias, which may be just as detrimental as the more widely condemned short-term bias. This invited Comment to Barzuza and Talley’s article advances three claims. First, it argues that proper incentives—created by executive compensation, heightened risk of early termination, market responses and shareholder pressures—are likely to turn most managers more realistic and thus to mitigate their long-term biases. Second, it explains how, in reality, it could be almost impossible to distinguish between long-term bias and traditional agency theories of empire building and pet projects. Ultimately, both long-termist and self-interested managers systematically harm shareholders; both choose to ignore shareholder interests and waste free cash flow on inferior business investments. This also explains why the cure to both long-term bias and agency costs is similar: reducing the relative insulation of the board from shareholders’ disciplinary power. Finally, this Comment expresses strong support for most of Barzuza and Talley’s normative conclusions, with one important exception: their acceptance of the use of dual-class stock. With a perpetual lock on control and a limited equity stake, corporate leaders will be immune to any “institutional brake” on all forms of long-termist overinvestment. If anything, the analysis of Barzuza and Talley provides an additional strong justification to oppose the use of perpetual dual-class stock.

We contend that the decision between public and private ownership can be understood in a cost-benefit framework where firms trade-off the governance benefits of private ownership with the potentially lower capital costs of public ownership. Consequently, ownership structure can be understood by examining the governance model that maximizes firm value. We discuss the conditions under which firms maximally benefit from private ownership, and argue that the “governance engineering” by private equity sponsors can ultimately explain the continued rise of private markets to the detriment of public markets.

Evidence shows that managers’ debt-like compensation (i.e., inside debt) aligns their incentives with lenders’, reducing the agency cost of debt. We examine how changes in the contracting environment affect the use of inside debt in debt contracting. We find evidence of reduced reliance on inside debt for debt contracting when borrowers have credit constraints, consistent with a shift in bargaining power to lenders, and when firms experience financial distress, consistent with increased agency costs when bankruptcy is more probable. We detect reduced reliance on inside debt for debt contracting during the financial crisis and during shocks to industry demand, two plausibly exogenous shocks to firms’ contracting environments. In total, the results suggest that the role of inside debt changes predictably with the contracting environment.

We study the mandated introduction of an auction (and its subsequent supervision) for the pri-mary bond market in China. These regulatory interventions significantly reduce the cost of debt for Chinese issuers. While this reduction is partly driven by reduced information asymmetry, we show the majority of the benefits flow from reduced agency conflict between underwriters and issuers. Using unique bidder-level data from a lead underwriter, we develop replicable tools and techniques to identify collusive bidding behavior that results in artificial (and economically costly) increases in bond yields. Such evidence can benefit global regulators, issuers and investors currently using unsupervised auction mechanisms.

Using the universe of Business Development Companies for the period 2006-17, we analyze the effects of fund management structure on managerial decisions and fund premiums. We show that externally managed funds trade at significantly higher discounts relative to their internally managed counterparts and they are 74% (67%) less likely to announce (execute) value enhancing share repurchase programs. We further find a significantly higher positive market reaction to share repurchase announcements of externally relative to internally managed funds. Overall, we show the benefits of internal management structure in avoiding agency costs associated with the dependence of managerial compensation on total assets.

In Japan, since 2013, Japanese corporate governance reform has been developed by Japanese Government initiatives. This paper provides a theoretical framework for understanding what Japanese corporate governance reform means for Japanese companies by an application of agency theory. Corporate governance is a structure which determines how shareholders delegate corporate control to managers and monitor managers’ business executions. Debates on corporate governance finally end in how we should resolve agency problems which decide what is the best measures to maximize corporate value by reducing agency costs deriving from an agency relationship between shareholders and managers. New Japanese reform further develops previously introduced measures for improving corporate governance in order to reduce agency costs. Now some changes in corporate financial results are recognized in stewardship reports by institutional investors. This reform is facilitated by an introduction of Japanese Stewardship Code and leveraged by a collaboration between Corporate Governance Code and Japanese Stewardship Code to seek a long-term corporate growth. Key to success to a corporate governance reform is a synchronized collaboration between these two codes, which puts burdens of execution on institutional investors who take stewardship activities effectuating a governance reform. Agency theory focused on principal costs provides us with interpretation of the reform and implication of possible changes in corporate governance and their solutions. One possible hint for solutions is disclosure of stewardship activities including engagement activities by institutional investors.

Cost-benefit analysis (“CBA”) is widely used in agency decisionmaking, summarizing the impacts of an agency’s chosen policy. As agency rulemakings have increased in quantity and importance, there has been renewed interest in improving transparency in decisionmaking, especially with respect to the models and data that underlie CBA. Recent proposals have been highly controversial. At least some of the controversy can be attributed to limited information about the usefulness of this type of transparency. This Article contributes to this debate by evaluating the current level of transparency in CBA and proposing incremental improvements. First, it suggests a new framework for thinking about transparency in CBA that includes two key dimensions: process transparency and policy transparency. A CBA that scores well on these two dimensions would allow interested parties to scrutinize agency action and hold decisionmakers more accountable. Second, it objectively evaluates the process transparency and policy transparency of a comprehensive set of CBAs for significant rules issued between October 2015 and September 2018. It uses a scorecard methodology, which scores whether a particular CBA met a number of different criteria related to transparency. The Article finds that many agency CBAs lack basic process transparency, meaning that their creation and role in the decisionmaking process is not clear. In addition, most CBAs continue to lack transparency about policy impacts, often failing to quantify and monetize costs and benefits. Among CBAs that do monetize at least some costs and benefits, most do not make their data, models, and underlying sources readily available online. In light of the results, the Article provides low-cost recommendations for improving transparency in CBA that could do more good than harm. In particular, while models used in the CBA and their inputs should be adequately described and made publicly available, it is premature to require that all underlying data from studies used in the CBA be made available. In line with this incremental approach to improving CBA transparency, we argue that the move toward adopting an “open policy framework” in government policy analysis should consider both the costs and the benefits carefully.

Purpose This 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/approach The present study uses univariate analysis, multi-variate regression analysis and 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/value 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.

This paper investigates the effects of the Sarbanes-Oxley Act (SOX) on CEO compensation, using panel data constructed for the S&P 1500 firms on CEO compensation, financial returns, and reported accounting income. Empirically SOX (i) changes the relationship between a firm’s abnormal returns and CEO compensation, (ii) changes the underlying distribution of abnormal returns, and (iii) significantly raises the expected CEO compensation in the primary sector. We develop and estimate a dynamic principal agent model of hidden information and hidden actions to explain these regularities. We find that SOX (i) increased the administrative burden of compliance in the primary sector, but reduce this burden in the service sector, (ii) increased agency costs in most categories of the firms, and (iii) reduced the off-equilibrium loss from the CEO shirking.

We examine the impact of strategic deviance on corporate cash holdings and find that firms with strategies that deviate from their industry peers hold more cash. This pattern can be consistent with an agency motive, a precautionary motive, or both. We show that the value of cash holdings decreases with strategic deviance and that the cash effect of strategic deviance increases with agency costs but not with financial constraints, consistent with an agency motive. Finally, we find that strategically deviant firms pay lower dividends and avoid more taxes, both of which can potentially contribute to cash holdings. We conclude that strategically deviant firms hold more cash due to an agency motive.

This paper examines whether debt renegotiation mitigates the agency costs of asset substitution. Inspired by the studies of Mella-Barral and Perraudin (1997) and Leland (1998), we have developed an analytical continuous time model of a firm that has the option to switch to a higher risk activity and renegotiate the terms of the debt. Our model creates a trade-off between increasing firm volatility and decreasing growth rate which characterizes the potential for asset substitution. Our findings indicate that, in most cases, debt renegotiation substantially reduces agency costs of asset substitution, whereas non-renegotiable debt is optimal when equity holders have a weak bargaining position and the opportunity cost of their risk-taking incentives is high. Several testable empirical implications regarding the design of debt contracts are developed.

This chapter introduces the Research Handbook on Comparative Corporate Governance and surveys several of the central themes addressed in the book. Most corporate governance research deals with the interaction between board members, officers, and shareholders, primarily in large, publicly traded corporations. Considerable volumes of literature thus are preoccupied with reducing conflicts of interest between shareholders and management, and consequently minimizing agency cost, thus vindicating the narrow finance perspective. Given the predominance of controlling shareholders around the globe, the literature increasingly focuses acutely on conflicts between controlling and minority shareholders. In a comparative or international context, research also often addresses all groups whose interests are affected by corporate activities and who have some degree of influence on corporations, such as creditors and employees. The book attempts to take a broad perspective. It deals with interactions between boards and shareholders, as well as minority and controlling shareholders. We cover legal duties and their enforcement, as well as the balance of powers generated by the institutional setup. Nevertheless, the interests of other “stakeholders” are very much present. The authors also explore corporate purpose, including short-termism, corporate social responsibility (CSR) and environmental, social and governance (ESG) issues. In addition, the book tackles key debates in the field, including the significance of legal origins for the development of corporate law, convergence in corporate governance, and the appropriate choice of research methods in comparative corporate governance scholarship.

The notion of stock-market-driven short-termism relentlessly whittling away at the American economy’s foundations is widely accepted and highly salient. Presidential candidates state as much. Senators introduce bills assuming as much. Corporate interests argue as much to the Securities and Exchange Commission and the corporate law courts. Yet the academic evidence as to the problem’s severity is no more than mixed. What explains this gap between widespread belief and weak evidence? This Article explores the role of narrative power. Some ideas are better at being popular than others. The concept of pernicious stock market short-termism has three strong qualities that make its narrative power formidable: (1) connotation — the words themselves tell us what is good (reliable long-term commitment) and what is not (unreliable short-termism); (2) category confusion — disparate types of corporate misbehavior, such as environmental degradation and employee mistreatment, are mislabeled as being truly and primarily short-termism phenomena emanating from truncated corporate time horizons (when they in fact emanate from other misalignments), thereby making us view short-termism as even more rampant and pernicious than it is; and (3) confirmation — the idea is regularly repeated, because it is easy to communicate, and often boosted by powerful agenda-setters who benefit from its repetition. The Article then highlights the real-world implications of narrative power — powerful narratives can be more certain than the underlying evidence, thereby leading policymakers astray. For example, a favorite remedy for stock-market-driven short-termism is to insulate executives from stock market pressure. If lawmakers believe that short-termism is a primary cause of environmental degradation, anemic research and development, employee mistreatment, and financial crises — as many do — then they are likely to focus on further insulating corporate executives from stock-market accountability. Doing so may, however, do little to alleviate the underlying problems, which would be better handled by, say, stronger environmental regulation and more astute financial regulation. Powerful narratives can drive out good policymaking.

This Article is the first academic study to systematically analyze the overall sensitivity of executive compensation to stock buybacks. Specifically, my analysis of executive compensation arrangements of CEOs included in the S&P 500 Index reveals that buybacks can enhance a record high portion of incentive compensation, corresponding, on average, to one-third of total CEO pay. I further show that, despite the focus of financial economists on the ability of buybacks to mechanically improve per share performance measures that determine executives’ annual bonuses, repurchases can, in addition and to a much greater extent, boost performance measures that decide executives’ long-term incentive awards. I argue, first, that because a buyback can increase pay even when it would destroy firm value, executives are motivated to conduct buybacks excessively. Second, I explain that this potential motivates executives to game their incentive compensation arrangements and turn them from pay for performance into pay for manipulation. Third, I find that the impacts of buybacks on executive pay are camouflaged in firms’ public filings. These distorted incentives and the lack of transparency are likely to lead firms to underinvest in productive capabilities, disguise poor financial performance, and contribute to the creation of a market bubble that increases the likelihood of another financial crisis. Borrowing from dividend protection, which safeguards executive stock and option awards from the automatic decline in the stock price that dividends trigger, I suggest applying buyback protection, which would shield executive pay from the mechanical performance improvement that stock buybacks stimulate. Because I do not expect a mandatory rule requiring firms to adopt buyback protection to be effective I propose a novel regulatory reform to make the impact of stock buybacks on executive pay transparent. Transparency can be expected to push boards, shareholders, and proxy advisors to pressure firms to adopt buyback protection.

In July 2020, the European Commission published the “Study on directors’ duties and sustainable corporate governance” by EY. The Report purports to find evidence of debilitating short-termism in EU corporate governance and recommends many changes to support sustainable corporate governance. In this paper, we point out deep flaws in the Report’s evidence and analysis. We recently submitted the content of this paper in response to the European Commission’s call for feedback. First, the Report defines the corporate governance problem as one of pernicious short-termism that damages the environment, the climate, and stakeholders. But the Report mistakenly conflates time-horizon problems with externalities and distributional concerns. Cures for one are not cures for the others and a cure for one may well exacerbate the others. Second, the Report’s main ostensible evidence for an increase in corporate short-termism is rising gross payouts to shareholders (dividends and stock repurchases). However, the more relevant payout measure to assess corporations’ ability to fund long-term investment is net payouts (gross payouts minus equity issuances), which is much lower and has left plenty of funds available for long-term and short-term investment. Third, when the Report turns to other evidence for short-termism, it selectively picks academic studies that support its views on short-termism, while failing to engage substantial contrary literature. Significant studies fail to detect short-termism and some substantial studies show excessive long-termism. Conceptually, some short-termism is an unfortunate but an inevitable side effect of effective corporate governance and may not be a first-order problem warranting wholesale reform. Finally, the Report touts cures whose effectiveness has little evidentiary support and, for some, there is real evidence that the cures could be counterproductive and costly.

Prior research finds that firms pay special dividends before a dividend tax increase. We examine the funding sources and real effects of these tax-motivated special dividends, finding that firms incur costs – reducing investment and repurchases – to pay them. The funding sources, and related real effects, vary with shareholders’ tax incentives. When tax-insensitive institutional investors likely influence the dividend to benefit firms’ taxable shareholders other than insiders, firms reduce repurchases and capital expenditures. Conversely, when taxable insiders likely influence the dividend, and their tax incentives are misaligned with firms’ primarily tax-insensitive shareholder base, firms reduce R&D, consistent with misaligned payouts signaling managerial myopia which erodes shareholder value. Tests using both market responses to, and total factor productivity changes around, tax-motivated special dividends support these conclusions. These findings add to our understanding of tax-based agency issues influencing real corporate decisions and identify a previously unexplored cost of dividend tax increases.

Legal systems around the world apply various strategies to mitigating agency costs between controlling and minority shareholders. A systematic review of the transnational law on controlling shareholder's loyalty and care obligations reveals variant doctrinal choices. This study aims to uncover the evolution of these choices by employing a law-in-context methodology. Accordingly, it seeks to explain the differences in governance selections by exploring the cultural, historical, and socio-economic backgrounds of a particular legal system in which organizations and decisions are embodied. I conduct a macro-level inquiry that focuses on the cultural environment and business history development to understand the different doctrinal designs. In particular, I argue that those dissimilarities result from unique cultural-non-formal norms of corporate governance regarding the protection afforded to shareholders' interests, and they correspond to the historical development of the law of corporate groups across nations. As the macro-level investigation indicates, any initiative to globally converge corporate law and governance should be carried out with caution because it may distort the delicate normative equilibrium represented in a given jurisdiction.

Much of the literature develops theory using audits of publicly owned companies with agency costs that create demand for audit quality. In contrast, I study auditor size and industry specialization in the broker-dealer (BD) industry, where entities have weak incentives to demand and supply high audit quality. Using proprietary data, I test whether larger firms and industry specialists provide better audit quality, as proxied by audit adjustments. Consistent with theory, I find that larger firms provide higher audit quality. In contrast, industry specialists perform worse than non-specialists; industry specialist partners in small firms drive this result. These findings suggest that clients with weak demand for auditing hire low quality auditors, who in turn gain market share in the industry. Overall, my findings illustrate the importance of considering clients’ demand for auditing when evaluating audit quality and industry specialization.

We study the corporate governance implications of the "beta anomaly," generated by the fact that major equity investors overweight their portfolios toward high-beta stocks because of leverage constraints. We hypothesize that the resulting higher portfolio concentration will increase the monitoring incentives of "leverage-constrained" investors and reduce the agency costs of the firms they own. We test this hypothesis by quantifying a measure of leverage constraint of mutual funds and relating it to their monitoring behavior and the portfolio firms' governance quality. We find that leverage-constrained funds monitor more actively – vote more often against management in contentious proposals and are more likely to induce CEO turnovers. Consequently, the portfolio firms have a higher value of cash holdings, lower need to alleviate agency problems through payouts, and higher investment efficiency. These effects are more pronounced as the beta anomaly becomes more acute, i.e., when the security market line gets flattened. We identify a causal effect using extreme fund outflows and the number of nearby banks as instruments for fund leverage constraints.

We examine whether the Securities Exchange Act of 1934 increased the information content of corporate earnings disclosures. Prior research questions whether the Act improved disclosure quality but generally relies on long-window tests and yields mixed results. We focus on whether the Act increased earnings informativeness, improving upon prior designs by focusing on short earnings announcement windows and employing a difference-in-differences design to control for potential contemporaneous structural changes. We document an increase in earnings informativeness following the Act, which is larger for treatment firms (which withheld disclosure before the Act) than for control firms. The increase in informativeness is more pronounced for small firms (consistent with a relatively larger change in enforcement), profitable firms that do not pay dividends (consistent with higher agency costs), and firms reporting good news (which suggests that the Act increased conservatism).

A recent reform in China, the Shanghai-Hong Kong Stock Connect program, made a subset of Chinese stocks investable for foreign investors, thus partially opening China’s stock market. We use this reform to examine the quantity and quality effects of stock market liberalization on corporate investment and address some of the data and methodological concerns raised in previous studies. Our difference-in-differences analysis shows that the reform boosts the investment of investable firms relative to non-investable firms. It also makes the investable firms’ investment more responsive to growth opportunities, increases their total factor productivity, and improves their operating performance. Further analysis finds that the reform increases equity issuance, reduces agency costs, and mitigates earnings management, which helps explain its quantity and quality effects on corporate investment.

Despite some advantages over traditional (offline) labor markets – such as lower search costs, better matching and improved monitoring – online labor markets (OLMs) have not taken off as initially expected. In this paper, we study the factors that limit perceived project success on OLMs. Using psychological contract theory, we theorize how common OLM features including contracts with virtual monitoring, multi-freelancer projects, and simultaneous projects by a client trigger the perception of psychological contract breach among OLM participants and reduce perceived project success for both participants. We test these hypotheses using an extensive dataset with more than 143,000 transactions on the world’s largest freelancing platform, Upwork, and find that – contrary to predictions from agency theory – projects equipped with strict freelancer monitoring (hourly-pay contracts) and projects enabling peer comparison (multi-freelancer projects or multiple simultaneous projects), lead to lower perceived project success both from the freelancer’s and the client’s perspective. Our work implies that transactions on online labor markets should not be viewed solely as agency relations, and that some features that supposedly reduce agency costs and improve efficiency on OLMs come at the cost of triggering the perception of psychological contract breach.

Japanese corporate governance reform is implemented by an introduction of corporate governance code and stewardship code, in which stewardship activities by institutional investors play an important role in terms of reduction of agency cost. In this report, stewardship activities are focused based upon the idea that agency theory, newly introduced as principal cost theory, could support a conceptual framework of governance reform and analyzed that as an important function for agency cost reduction. In order to make governance reform more effective, I make several proposals, cost sharing of stewardship activities by asset owners and full disclosure of those activities based on investment strategies, such as actively managed strategies and/or passively managed ones, for stewardship activities of both engagement and proxy voting, especially by index fund managers.

International tax planning strategies, by their very nature, increase firms’ free cash flows, which could improve companies’ creditworthiness. However, these strategies also bring information and agency problems, which may reduce their creditworthiness. To understand which of these effects dominates, this study examines the effect of international tax planning on credit ratings. We find that credit analysts incorporate information related to international tax planning when analyzing a firm’s credit risk and that high international tax planning is associated with less favorable credit ratings. We also find that this effect is mitigated by a higher conflict of interest for the bond rating agencies. Furthermore, we find that the effect of international tax planning operates through the channels of future cash flow effects, agency costs, and information risk. Our results are robust to a difference-in-differences research design using The American Jobs Creation Act of 2004 as an exogenous shock to the benefits from international tax planning, and we document that the effect of international tax planning is different from and incremental to overall tax avoidance.

Using a sample of 22,442 firm-year observations for 3,721 U.S. listed firms, we show that family firms, on average, issue annual reports with higher readability than do nonfamily firms. Higher readability could occur due to lower obfuscation or less information conveyance. By controlling for complexity and choosing readability measures linked to obfuscation, we attribute the higher readability to lower obfuscation. We argue that family insiders’ long-term horizon, incentive to maintain family reputation, and a desire to pass on the firm to family successors, drive the lower obfuscation. We conduct several tests to control endogeneity and test the robustness of our result. Specifically, we use state-level succession tax cuts as an exogenous shock to support the attribution of the higher readability to the family’s increased incentive for succession. Further, we find that the higher readability in family firms is associated with higher informativeness, and is weaker for firms with more earnings manipulation, weaker board governance, and dual-class shares.