Powerful Independent Directors

Powerful Independent Directors

Kathy Fogel, Liping Ma, Randall Morck

NBER Working Paper No. 19809
Issued in January 2014
Shareholder valuations are economically and statistically positively correlated with more powerful independent directors, their power gauged by social network power centrality measures. Sudden deaths of powerful independent directors significantly reduce shareholder value, consistent with independent director power “causing” higher shareholder value. Further empirical tests associate more powerful independent directors with fewer value-destroying M&A bids, more high-powered CEO compensation and accountability for poor performance, and less earnings management. We posit that more powerful independent directors can better detect and counter managerial missteps because of their better access to information, their greater credibility in challenging errant top managers, or both.

Bad Corporate Marriages: Waking Up in Bed the Morning After

Bad Corporate Marriages: Waking Up in Bed the Morning After

Ye Cai Santa Clara University – Leavey School of Business

Hersh Shefrin Santa Clara University – Leavey School of Business; National Bureau of Economic Research (NBER)

December 27, 2013

Abstract: 
This paper examines corporate risk taking behavior in the wake of unsuccessful merger activities. We find that relative to other firms, firms that made bad acquisitions take both more systematic risk and more idiosyncratic risk. Moreover, higher risk is associated with greater value destruction and stronger corporate governance. The increased risk can be traced to increased cash flow volatility, increased leverage, decreased asset liquidity, more investment in R&D, and more equity-based executive compensation. These findings are in line with the behavioral approach suggesting that in the domain of losses, decision makers generally become more tolerant of risk.

Corporate Disclosure of Material Information: The Evolution—and the Need to Evolve Again

Corporate Disclosure of Material Information: The Evolution—and the Need to Evolve Again

Jean Rogers¹, Robert Herz²

Article first published online: 23 DEC 2013

Journal of Applied Corporate Finance

Volume 25, Issue 3, pages 50–55, Summer 2013

This article by the former chairman of the FASB and the founder and executive director of the new Sustainability Accounting Standards Board (SASB) presents the rationale for and mission of the SASB. As the authors point out, both the Securities and Exchange Commission, which was created in 1934, and the Financial Accounting Standards Board, set up in 1973, emerged during times of low investor confidence to restore trust in the capital markets. And the institutional changes brought about by the creation of both the SEC and the FASB succeeded in eliciting new information for investors and in raising the standards by which such information was reported.

How to Create Value Without Earnings: The Case of Amazon

Josh Tarasoff¹, John McCormack²

Article first published online: 23 DEC 2013

Journal of Applied Corporate Finance

Volume 25, Issue 3, pages 39–43, Summer 2013

Investors and commentators often equate GAAP accounting metrics, especially earnings per share, with financial success. The reality, however, is that there is no simple, linear relationship between GAAP earnings and intrinsic value, which is defined as the present value of expected future cash flows. And adjustments of GAAP metrics, though admittedly subjective, are often required to understand the economic reality of a business.

http://Amazon.com Inc. provides a case study that throws into sharp relief the need to look beyond GAAP in order to analyze underlying fundamentals and value. In this paper, the authors argue that Amazon has done a superb job of building shareholder wealth, all the while reporting low and declining operating and net income margins. The article provides a framework for thinking about Amazon’s underlying profitability that is based on the concept of return on capital in relation to the cost of capital, and shows how that profitability has been masked by GAAP accounting. The authors demonstrate that the company is now investing very large amounts of capital with the expectation of earning rates of return well above its cost of capital. And their analysis suggests that if such investment can continue over the long term, Amazon’s current market value of $140 billion can be readily justified.

But as the authors go on to argue, we now live in a different world, one in which the management of environmental, social, and governance issues is increasingly viewed as critical to the long-run value creation of companies. And because today’s corporate reporting fails to account in a systematic way for material non-financial issues, it’s time once again for the capital markets to evolve. The SASB aims to meet this need by creating sustainability accounting standards for use by public companies in disclosing a minimum set of material sustainability impacts for companies in over 80 different industries. As part of a natural evolution in disclosure, the SASB aims to achieve the same goal the SEC and FASB started with: to protect investors and the public.

Is Sell-Side Research More Valuable in Bad Times?

Is Sell-Side Research More Valuable in Bad Times?

Roger K. Loh, René M. Stulz

NBER Working Paper No. 19778
Issued in January 2014
In bad times, uncertainty is high, so that investors find it more difficult to assess the prospects of the firms they invest in. Learning models suggest that in such times investors should, everything else equal, value informative signals such as analyst forecasts and recommendations more than in good times. However, the higher uncertainty in bad times and career concerns stemming from troubled employers may make the task of analysts harder, so that analyst output is noisier and hence less valuable in bad times. Consequently, whether analyst forecasts and recommendations are more valuable during bad times is an empirical matter. We examine a large sample of analyst output from 1983 to 2011. We find that analysts work harder in bad times, but their earnings forecasts accuracy is worse and that they disagree more. Despite more inaccurate earnings forecasts, revisions to earnings forecasts and stock recommendations have a more influential stock-price impact during bad times as predicted by a learning model.

Beauty is Wealth: CEO Appearance and Shareholder Value

Beauty is Wealth: CEO Appearance and Shareholder Value

Joseph Taylor Halford University of Wisconsin Milwaukee

Scott H. C. Hsu University of Wisconsin – Milwaukee

November 20, 2013

Abstract: 
This paper examines whether and how the appearance of chief executives officers (CEOs) affects shareholder value. We obtain a Facial Attractiveness Index of 677 CEOs from the S&P 500 companies based on their facial geometry. CEOs with a higher Facial Attractiveness Index are associated with better stock returns around their first days on the job and higher acquirer returns upon acquisition announcements. To mitigate endogeneity concerns, we compare stock returns surrounding CEO television news events with stock returns surrounding a matched sample of news article events. CEOs’ Facial Attractiveness Index positively affects the stock returns on the television news date, but not around the news article date. The findings suggest that CEO appearance matters for shareholder value and provide an explanation why more attractive CEOs receive “beauty premiums” in their compensation.

Study finds ‘beautiful’ CEOs boost stock prices

University research says attractive chief executives are paid better and their shares perform well when the boss goes on television

Yahoo!’s Marissa Mayer was cited as an example of an attractive chief executive who has boosted share prices Photo: Rex Features Read more of this post

Market Reactions to Tangible and Intangible Information Revisited

Market Reactions to Tangible and Intangible Information Revisited

Joseph Gerakos University of Chicago – Booth School of Business

Juhani T. Linnainmaa University of Chicago – Booth School of Business; National Bureau of Economic Research (NBER)

December 3, 2013
Chicago Booth Research Paper No. 13-82

Abstract: 
Daniel and Titman (2006) propose that the value premium is due to investors overreacting to intangible information. They therefore decompose changes in firms’ book-to-market ratios into stock returns and a proxy for tangible information based on accounting performance (“book returns”). Consistent with investors overreacting to intangible information, they find that only stock returns unrelated to “book returns” reverse. We show that their decomposition creates a “book return” polluted by past book-to-market ratios, stock returns, net issuances, and dividends. One-third of the variation in “book returns” is due to these factors. The Daniel and Titman (2006) result is fragile — a plausible alternative definition of tangible information reverses their conclusions.

Employee Spinouts, Social Networks, and Family Firms

Employee Spinouts, Social Networks, and Family Firms

James E. Rauch

NBER Working Paper No. 19727
Issued in December 2013
Recently collected data show that, within any manufacturing industry, vertically integrated firms tend to have larger, higher productivity plants, account for the bulk of sales, and also sell externally most of the inputs they produce. In a weak contracting environment characteristic of developing countries, vertically integrated firms are vulnerable to employee “spinouts”: managers of input divisions can start their own firms, making customized inputs formerly provided internally subject to hold-up and capturing the profits formerly made from external sales of generic inputs. This vulnerability is shown to lead to inefficiently low entry. Vertically integrated firms can fight back by hiring managers for their input divisions who are members of networks that informally sanction hold-ups or children who keep profits “in the family” even if they spin out. This is shown to predict the association of co-ethnic networks with high rates of entrepreneurship and the prominence of family-owned business groups in developing country manufacturing.

Political Connections and Earnings Quality: Evidence from India

Political Connections and Earnings Quality: Evidence from India

R. Narayanaswamy Indian Institute of Management (IIMB), Bangalore

November 25, 2013
IIM Bangalore Research Paper No. 433

Abstract: 
This paper investigates the association between political connections and earnings quality in Indian companies. Recent corporate scandals (e.g., 2G mobile phone licences, coal block allocations, iron ore and granite mining licences) have underlined the political connectedness of Indian business entities. The increasing role of the private corporate sector in the economy in the wake of the economic liberalization has strengthened the traditional links between business organizations and the political system. The involvement of politicians in business and of business organizations in politics, the participation of senior civil servants in political and business-related activities and the dependence of political parties on donations from business organizations for funding elections have contributed to the importance of political connections in business. We find that connected firms have lower earnings quality than non-connected firms and are more likely to engage Big Four auditors.

Do Chinese CEOs Consume Abnormal Perks Before Leaving Their Firms?

Do Chinese CEOs Consume Abnormal Perks Before Leaving Their Firms?

Martin J. Conyon University of Pennsylvania – The Wharton School; European Corporate Governance Institute (ECGI)

Junxiong Fang Sr.Fudan University – School of Management

Lerong He State University of New York (SUNY) College at Brockport; University of Pennsylvania – The Wharton School

November 16, 2013

Abstract: 
Economic success is driven by the optimal design of economic institutions. We investigate whether Chinese CEOs consume abnormal or ‘excess’ perks prior to leaving their firms. Agency models predict that CEO incentives and behavior might change in the years leading up to CEO turnover (the ‘horizon effect’). We predict that CEOs might consume excess perks at the expense of owners’ interests. Using data on Chinese publicly traded firms between 2003 and 2011 we find that abnormal perk consumption is significantly higher in the last two years of CEOs’ tenure compared to previous years. We also find that abnormal perk consumption is lower when the board is more independent, when the firm is privately controlled, and when the external auditor is more reputable. We find that perk consumption in CEOs’ terminal years vary with the type of CEO transition. Voluntary CEO turnover is associated with excess perks, whereas forced CEO turnovers are not. We find no evidence that abnormal perk consumption is associated with lower level of executive compensation, dispelling the idea that cash compensation and perks are substitutes. Instead, we document that abnormal perk consumption has a significant negative effect on firm performance. Overall, our results indicate that abnormal perk consumption and poor institutional design are correlated with managerial excess in China and there exists a horizon problem for Chinese executives.

Corporate Cash Holding in Asia

Corporate Cash Holding in Asia

Charles Y. Horioka, Akiko Terada-Hagiwara

NBER Working Paper No. 19688
Issued in December 2013
In this paper, we analyze the determinants of corporate saving in the form of changes in the stock of cash for 11 Asian economies using firm-level data from the Oriana Database for the 2002–2011 period. We find some evidence that cash flow has a positive impact on the change in the stock of cash, which suggests that Asian firms are borrowing constrained and that they save more when their cash flow increases so that they will be able to finance future investments. Moreover, we find in the developed economy sample that, as expected, cash flow has a positive impact on the change in the stock of cash only in the case of the smallest firms, which are more likely to be borrowing constrained, and find in the developing economy sample that, as expected, the positive impact of cash flow on the change in the stock of cash declines with firm size. In addition, we find that the cash flow sensitivity of cash declined after the global financial crisis. Finally, we find some evidence that Tobin’s q has a positive impact on the change in the stock of cash.

Deals Not Done: Sources of Failure in the Market for Ideas

Deals Not Done: Sources of Failure in the Market for Ideas

Ajay Agrawal University of Toronto – Rotman School of Management; National Bureau of Economic Research (NBER)

Iain M. Cockburn Boston University – Department of Finance & Economics; National Bureau of Economic Research (NBER)

Laurina Zhang University of Toronto

November 2013
NBER Working Paper No. w19679

Abstract: 
Using novel survey data on technology licensing, we report the first empirical evidence linking the three main sources of failure emphasized in the market design literature (lack of market thickness, congestion, lack of market safety) to deal outcomes. We disaggregate the licensing process into three stages and find that although lack of market thickness and deal failure are correlated in the first stage, they are not in the latter stages, underscoring the bilateral monopoly conditions under which negotiations over intellectual property often occur. In contrast, market safety is only salient in the final stage. Several commonly referenced bargaining frictions (congestion) are salient, particularly in the second stage. Also, universities and firms differ in the stage during which they are most likely to experience deal failure.

Reputation Repair after a Serious Restatement

Reputation Repair after a Serious Restatement

Jivas Chakravarthy Emory University – Goizueta Business School

Ed DeHaan Stanford Graduate School of Business

Shivaram Rajgopal Emory University – Goizueta Business School

November 7, 2013
Rock Center for Corporate Governance at Stanford University Working Paper No. 163

Abstract: 
How do firms repair their reputations after a serious accounting restatement? To answer this question, we review firms’ press releases and identify 1,765 reputation-building actions taken by: (i) 94 restating firms in the periods before and after their restatement; and (ii) a set of matched control firms during contemporaneous periods. We posit that firms have incentives to target multiple stakeholders in a reputation repair strategy — including capital providers, customers, employees, and geographic communities — and that actions targeting each group generate positive market returns as reputation capital is repaired. Consistent with our predictions, the frequency of, and stock returns to, reputation-building actions are greater for restating firms in the period after their restatement than for the control groups. In addition, firm characteristics predict the types of stakeholders targeted by firms. Finally, actions targeted at both capital providers and other stakeholders are associated with improvements in the restating firm’s financial reporting credibility.

News versus Sentiment: Comparing Textual Processing Approaches for Predicting Stock Returns

News versus Sentiment: Comparing Textual Processing Approaches for Predicting Stock Returns

Steven L. Heston University of Maryland – Department of Finance

Nitish Ranjan Sinha Board of Governers of the Federal Reserve System

September 4, 2013
Robert H. Smith School Research Paper

Abstract: 
This paper uses a dataset of over 900,000 news stories to test whether news can predict stock returns. It finds that firms with no news have distinctly different average future returns than firms with news. We measure sentiment with the Harvard psychosocial dictionary used by Tetlock, Saar-Tsechansky, and Macskassy (2008), the financial dictionary of Loughran and McDonald (2011), and a proprietary Thomson-Reuters neural network. Simpler processing techniques predict short-term returns that are quickly reversed, while more sophisticated techniques predict larger and more persistent returns. Conforming previous research, daily news predicts stock returns for only 1-2 days. But weekly news predicts stock returns for a quarter year. Positive news stories increase stock returns quickly, but negative stories have a long-delayed reaction.

Competition for Talent Under Performance Manipulation: CEOs on Steroids

Competition for Talent Under Performance Manipulation: CEOs on Steroids

Ivan Marinovic Stanford Graduate School of Business

Paul Povel University of Houston – Department of Finance, C.T. Bauer College of Business

October 22, 2013
Rock Center for Corporate Governance at Stanford University Working Paper No. 160

Abstract: 
We study how competition for talent affects CEO compensation, taking into consideration that CEO decisions are not contractible, CEO skills or talent are not observable, and CEOs can manipulate performance as measured by outsiders. Firms compete to appoint a CEO by offering contracts that generate large rents for the CEO. However, the incentive problems restrict how such rents can be created. We derive the equilibrium compensation contract offered by the firms, and we describe how the outcome is affected. Competition for talent leads to excessively high-powered performance compensation. Competition for talent can thus explain the increase in pay-performance sensitivity over the last few decades, and the extremely high-powered compensation packages observed in some markets. Given the high-powered incentive compensation, CEOs exert inefficiently high levels of effort and also distort the performance measure excessively. If the cost of manipulating performance is low, competition for talent may reduce the overall surplus, compared with a setup in which one firm negotiates with one potential CEO (and the firm extracts the rents). We discuss possible remedies, including regulatory limits to incentive compensation.

Behaving Like an Owner: Plugging Investment Chain Leakages

Behaving Like an Owner: Plugging Investment Chain Leakages

Jane Ambachtsheer Mercer Investments

Richard Fuller Mercer Investments

Divyesh Hindocha Mercer Investments

September 24, 2013
Rotman International Journal of Pension Management, Vol. 6, No. 2, 2013

Abstract: 
The theme of investing for the long term through engaged ownership is gaining profile. This article explores the implications of “behaving like an owner” and estimates its financial benefits. We follow the journey of $100 over 20 years under four different “leakage” scenarios. Downstream leakages are active management fees, manager transition costs, and excessive trading; upstream leakages are unwarranted M&A activity and misaligned incentive structures. We find that fixing these leakages can increase the size of savings pots by as much as 25% over a 20-year accumulation period. We also address the behavioral question, “If this is so self-evident, then why do presumably rational investors keep doing these irrational things?” We close with some thoughts on the behavioral changes needed to get institutional investors behaving as owners.

An Analysis of Related-Party Transactions in India

An Analysis of Related-Party Transactions in India

Padmini Srinivasan Indian Institute of Management Bangalore

September 30, 2013
IIM Bangalore Research Paper No. 402

Abstract: 
Related-party transactions (RPTs) refer to transactions between a company and its related entities such as subsidiaries, associates, joint ventures, substantial shareholders, executives, directors and their relatives, or entities owned or controlled by its executives, directors, and their families. RPTs are widespread and are part of every business group activity. RPTs have come under close scrutiny in recent years as they have been misused by companies as revealed in various corporate scandals. The study analyses Indian companies for three years between 2009 and 2011 and finds that RPTs were widespread and present in almost all companies during this period. Further, companies with high RPTs related to sales and income were found to report lower performance compared to companies with low RPTs. While ownership structure failed to offer any explanation for the magnitude of RPTs, RPTs were found to be lower in companies where big audit firms were statutory auditors.

Business Groups in the United States: A Revised History of Corporate Ownership, Pyramids and Regulation, 1930-1950

Business Groups in the United States: A Revised History of Corporate Ownership, Pyramids and Regulation, 1930-1950

Eugene Kandel Hebrew University of Jerusalem – Department of Economics; Centre for Economic Policy Research (CEPR)

Konstantin Kosenko Bank of Israel

Randall Morck University of Alberta – Department of Finance and Statistical Analysis; National Bureau of Economic Research (NBER)

Yishay Yafeh Hebrew University of Jerusalem – Jerusalem School of Business Administration; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

November 2013
CEPR Discussion Paper No. DP9759

Abstract: 
The extent to which business groups ever existed in the United States and, if they did exist, the reasons for their disappearance are poorly understood. In this paper we use hitherto unexplored historical sources to construct a comprehensive data set to address this issue. We find that (1) business groups, often organized as pyramids, existed at least as early as the turn of the twentieth century and became a common corporate form in the 1930s and 1940s, mostly in public utilities (e.g., electricity, gas and transportation) but also in manufacturing; (2) In contrast with modern business groups in emerging markets that are typically diversified and tightly controlled, many US groups were focused in a single sector and controlled by apex firms with dispersed ownership; (3) The disappearance of US business groups was largely complete only in 1950, about 15 years after the major anti-group policy measures of the mid-1930s; (4) Chronologically, the demise of business groups preceded the emergence of conglomerates in the United States by about two decades and the sharp increase in stock market valuation by about a decade, so that a causal link between these events is hard to establish, although there may well be a connection between them. We conclude that the prevalence of business groups is not inconsistent with high levels of investor protection; that US corporate ownership as we know it today evolved gradually over several decades; and that policy makers should not expect policies that restrict business groups to have an immediate effect on corporate ownership.

The Sovereign Wealth Fund Discount: Evidence from Public Equity Investments

The Sovereign Wealth Fund Discount: Evidence from Public Equity Investments

Bernardo Bortolotti Università di Torino

Veljko Fotak SUNY Buffalo; Bocconi University – BAFFI Center on International Markets, Money, and Regulation

William L. Megginson University of Oklahoma

September 17, 2013
Baffi Center Research Paper No. 2013-140
FEEM Working Paper No. 22.2009

Abstract: 
Using a sample of 1,018 Sovereign Wealth Fund (SWF) equity investments in publicly traded firms and a control sample of 5,975 transactions by private-sector financial institutions over 1980-2012, we find that announcement-period abnormal returns of SWF investments are positive, but lower than those of comparable private-sector investments by approximately 2.67 percentage points. We do not find evidence of long-term stock price performance of SWF investment targets differing from that of private-sector investment targets. We do find, however, significant differences among SWFs which are only partially captured by the short-term market reaction: firms acquired by passive funds tend to underperform over the following three years, while positive abnormal returns are associated with actively monitoring SWFs. We conclude that SWFs’ corporate governance role tends to affect the value of the firm.

Do Firms Issue More Equity When Markets Are More Liquid?

Do Firms Issue More Equity When Markets Are More Liquid?

Rene M. Stulz Ohio State University (OSU) – Department of Finance; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Dimitrios Vagias Erasmus University Rotterdam (EUR) – Rotterdam School of Management (RSM)

Mathijs A. Van Dijk Erasmus University – Rotterdam School of Management; Erasmus Research Institute of Management (ERIM)

July 9, 2013
Fisher College of Business Working Paper No. 2013-03-10
Charles A. Dice Center Working Paper No. 2013-10

Abstract: 
This paper investigates how public equity issuance is related to stock market liquidity. Using quarterly data on IPOs and SEOs in 36 countries over the period 1995-2008, we show that equity issuance is significantly and positively related to contemporaneous and lagged innovations in aggregate local market liquidity. This relation survives the inclusion of proxies for market timing, capital market conditions, growth prospects, asymmetric information, and investor sentiment. Liquidity considerations are as important in explaining equity issuance as market timing considerations. The relation between liquidity and issuance is driven by the quarters with the greatest deterioration in liquidity and is stronger for IPOs than for SEOs. Firms are more likely to carry out private instead of public equity issues and to postpone public equity issues when market liquidity worsens. Overall, we interpret our findings as supportive of the view that market liquidity is an important determinant of equity issuance that is distinct from other determinants examined to date.

The Financialization of Commodity Markets

The Financialization of Commodity Markets

Ing-Haw Cheng Dartmouth College – Tuck School of Business

Wei Xiong Princeton University – Department of Economics; National Bureau of Economic Research (NBER)

October 1, 2013

Abstract: 
The large inflow of investment capital to commodity futures markets in the last decade has generated a heated debate about whether financialization distorts commodity prices. Rather than focusing on the opposing views concerning whether investment flows either did or did not cause a price bubble, we critically review academic studies through the perspective of how financial investors affect risk sharing and information discovery in commodity markets. We argue that financialization has substantially changed commodity markets through these mechanisms.

What Shapes the Gatekeepers? Evidence from Global Supply Chain Auditors

What Shapes the Gatekeepers? Evidence from Global Supply Chain Auditors

Jodi L. Short UC Hastings College of Law

Michael W. Toffel Harvard Business School (HBS) – Technology & Operations Management Unit

Andrea Hugill Harvard Business School

October 22, 2013
Harvard Business School Technology & Operations Mgt. Unit Working Paper No. 14-032

Abstract: 
Private gatekeeping institutions, from credit rating agencies to supply-chain auditors, are important players in contemporary regulatory regimes. Yet little is known about what influences the decisions of the individual accountants, auditors, analysts, and attorneys who interpret and apply the rules embodied in the regulatory schemes they help to implement. Drawing on insights from the literatures on street-level bureaucracy and on regulatory and audit design, we theorize and investigate the economic incentives and social institutions that shape the gatekeeping decisions of private supply-chain auditors. We find evidence to support the argument that auditors’ decisions are influenced by financial conflicts of interest. But we also find evidence that their decisions are shaped by social factors, including an auditor’s experience, gender, and professional training; ongoing relationships between auditors and audited factories; and gender diversity on audit teams. By demonstrating the contributions of both economic incentives and social institutions to gatekeeping decisions, our research significantly extends the gatekeeping literature’s narrow focus on economic incentives. By providing the first comprehensive and systematic findings on supply-chain auditing practices, our study also suggests strategies for designing private regulatory regimes that will more effectively detect and prevent corporate wrongdoing.

Cross-Border Reverse Mergers: Causes and Consequences

Cross-Border Reverse Mergers: Causes and Consequences

Jordan I. Siegel Harvard Business School

Yanbo Wang Boston University School of Management

September 24, 2013
Harvard Business School Strategy Unit Working Paper No. 12-089

Abstract: 
We study non-U.S. companies that have used reverse mergers as a means to adopt U.S. corporate law (and sometimes U.S. securities law as well). Early adopters of cross-border reverse mergers and those firms that hired a Big Four auditor exhibited superior corporate governance outcomes. Later adopters of cross-border reverse mergers were likely to strategically mimic the early entrants only to gain access to U.S. capital markets — that is, they took some governance actions but not others — and are shown to be likely to have worse corporate governance outcomes over time. Firm-level origins in China initially appears to be a significant negative determinant of at least some corporate governance outcomes, but the variable loses its statistical power when examining the most comprehensive data set on cross-border reverse mergers yet assembled and when including a battery of relevant control variables. Adoption of Nevada’s corporate law is associated with some of the most serious restatements involving real corporate governance and data manipulation problems. In summary, the evidence supports the existence of strategic mimicry, which the capital market did not fully discern for many years. It also supports the explanatory power of reputational bonding to explain the fact that adoption of U.S. institutions can be used either to build reputation or to exploit relatively weak U.S. cross-border law enforcement.

Independent Directors’ Dissent on Boards: Evidence from Listed Companies in China

Independent Directors’ Dissent on Boards: Evidence from Listed Companies in China

Juan Ma Harvard Business School

Tarun Khanna Harvard University – Strategy Unit

October 24, 2013
Harvard Business School Strategy Unit Working Paper No. 13-089

Abstract: 
In this paper, we examine the circumstances under which so-called “independent” directors voice their independent views on public boards in a sample of Chinese firms. First, we ask why independent directors dissent, i.e. how they justify such dissent to public investors. We find that when independent directors dissent, they tend to offer mild, subjective justifications. Overt criticism of the management is rare. Next, we ask when an independent director is more likely to dissent and who is more likely to dissent. Controlling for firm and board characteristics, we find that dissent is significantly correlated with breakdown of social ties between the independent director and the board chair who locates at the center of the board bureaucracy in China. Dissent is more likely to occur when the board chair who appointed the independent director has left the board. Dissent also tends to occur at the end of board “games”, defined as a 60-day window prior to departure of the board chair or departure of the independent director herself. The endgame effect is particularly strong, seeing 27% of the dissent issued at board “endgames” which represents only 4% of independent directors’ average tenure. While directors with foreign experience are more likely to dissent, we do not find that academics, accountants and lawyers are significantly more active in voicing dissent. Lastly, we show that dissent is consequential to both the director and the firm. For directors, dissent significantly increases one’s likelihood of exiting the director labor market, which translates to a more-than-10% estimated loss of annual income. For firms, we document an economically and statistically significant cumulative abnormal return of -0.97% around announcement of dissent. Although the literature has suggested that dissent might be reflective of diverse viewpoints, and perhaps beneficial in and of itself through reduction of firm variability, we do not find this offsetting beneficial effect to be strong.

Managers and Market Capitalism

Managers and Market Capitalism

Rebecca M. Henderson Harvard Business School; NBER

Karthik Ramanna Harvard University – Harvard Business School

November 9, 2013
Harvard Business School Accounting & Management Unit Working Paper No. 13-075
Harvard Business School Strategy Unit Working Paper No. 13-075
Harvard Business School General Management Unit Working Paper No. 13-075

Abstract: 
In a capitalist system based on free markets, do managers have responsibilities to the system itself? If they do, should these responsibilities shape their behavior when they are engaging in the political process in an attempt to structure the institutions of capitalism? The prevailing view — perhaps most eloquently argued by Milton Friedman — is that the first duty of managers is to maximize shareholder value, and thus that they should take every opportunity (within the bounds of the law) to structure market institutions so as to increase profitability. We maintain here that this shareholder-return view of political engagement applies in cases where the political process is sufficiently ‘thick,’ in that diverse views are well-represented and sufficiently detailed information about the issues is widely available. However, we draw on a series of detailed examples in the context of the determination of corporate accounting standards to argue that when the political process of determining institutions of capitalism is ‘thin,’ in that managers find themselves with specialized technical knowledge unavailable to outsiders and with little political resistance from the general interest, then managers have a responsibility to market institutions themselves, even if this entails acting at the expense of corporate profits. We make this argument on grounds that this behavior is both in managers’ long-run self-interest and, expanding on Friedman’s core contention, that it is managers’ moral duty. We provide a framework for future research to explore and develop these arguments.

Collaboration, Stars, and the Changing Organization of Science: Evidence from Evolutionary Biology

Collaboration, Stars, and the Changing Organization of Science: Evidence from Evolutionary Biology

Ajay Agrawal, John McHale, Alexander Oettl

NBER Working Paper No. 19653
Issued in November 2013

We report a puzzling pair of facts concerning the organization of science. The concentration of research output is declining at the department level but increasing at the individual level. For example, in evolutionary biology, over the period 1980 to 2000, the fraction of citation-weighted publications produced by the top 20% of departments falls from approximately 75% to 60% but over the same period rises for the top 20% of individual scientists from 70% to 80%. We speculate that this may be due to changing patterns of collaboration, perhaps caused by the rising burden of knowledge and the falling cost of communication, both of which increase the returns to collaboration. Indeed, we report evidence that the propensity to collaborate is rising over time. Furthermore, the nature of collaboration is also changing. For example, the geographic distance as well as the difference in institution rank between collaborators is increasing over time. Moreover, the relative size of the pool of potential distant collaborators for star versus non-star scientists is rising over time. We develop a simple model based on star advantage in terms of the opportunities for collaboration that provides a unified explanation for these facts. Finally, considering the effect of individual location decisions of stars on the overall distribution of human capital, we speculate on the efficiency of the emerging distribution of scientific activity, given the localized externalities generated by stars on the one hand and the increasing returns to distant collaboration on the other.

The Economics of China: Successes and Challenges

The Economics of China: Successes and Challenges

Shenggen Fan, Ravi Kanbur, Shang-Jin Wei, Xiaobo Zhang

NBER Working Paper No. 19648
Issued in November 2013

This paper is the first chapter in the Oxford Companion to the Economics of China (Oxford University Press, forthcoming). Rather than trying to summarize other contributors’ views, we provide our own perspectives on the Economics of China—the past experience and the future prospects. Our reading of China’s economic development over the past 35 years raises two major sets of issues, one of which is inward looking, and the other of which is outward looking. While Chinese aggregate development is impressive, it has raised the question of whether the growth is sustainable, and has led to a set of distributional issues and well-being concerns. We argue that these internal issues combine with those raised by China’s rapid integration and ever growing presence in the international arena, to jointly frame the challenges faced by China in the next 35 years, as it approaches the 100th anniversary of the People’s Republic in 2049.

Why Has Japan’s Massive Government Debt Not Wreaked Havoc (Yet)?

Why Has Japan’s Massive Government Debt Not Wreaked Havoc (Yet)?

Charles Y. Horioka, Takaaki Nomoto, Akiko Terada-Hagiwara

NBER Working Paper No. 19596
Issued in October 2013
In this paper, we present data on trends over time in government debt financing in Japan since 2010 with emphasis on the importance of foreign holders and speculate about the determinants of those trends. We find that Japanese government securities were held primarily by domestic holders until recently because robust domestic saving (combined with strong home bias) made it possible for domestic investors to absorb most of the government debt but that foreign holdings of Japanese government securities have increased sharply in recent years, especially in the case of short-term government securities. We show that trends in foreign holdings of Japanese government securities can be explained by conventional economic factors such returns and risks and that the recent surge in foreign holdings of short-term Japanese government securities is attributable to foreign investors in search of a safe haven for their funds in the face of the Global Financial Crisis of 2008-09 precipitated by the Lehman crisis. Our analysis suggests that the surge in foreign holdings of Japanese government securities will subside (in fact, it already has), and this, combined with the projected decline in domestic saving (especially household saving) caused by population aging, will create increasing pressures for fiscal adjustment to reduce her massive government debt. Thus, Japan’s massive government debt has not resulted in high economic costs in the past because of robust domestic saving and a temporary inflow of foreign capital caused by the Global Financial Crisis, but it may have substantial costs in the future as both of these factors become less applicable unless the government debt can be brought under control.