Conglomerate Firms, Internal Capital Markets and the Theory of the Firm

Conglomerate Firms, Internal Capital Markets and the Theory of the Firm

Vojislav Maksimovic University of Maryland – Robert H. Smith School of Business

Gordon M. Phillips University of Southern California; National Bureau of Economic Research (NBER)

August 3, 2013
Robert H. Smith School Research Paper

This article reviews the conglomerate literature with a focus on recent papers which have cast strong doubt on the hypothesis that conglomerate firms destroy value on average when compared to similar stand-alone firms. Recent work has shown that investment decisions by conglomerate firms are consistent with value maximization, that conglomerate firms trade at an average premium relative to single-segment firms when value weighting, and that the valuation premia and discounts, both for conglomerates and single-segment firms, are driven by differences in the production of unique differentiated products. A profit-maximizing theory of the firm that considers how firms select their organizational structure can explain these recent findings and much of the large variation in findings in the conglomerate literature. We also review the literature showing how market imperfections create additional benefits and costs of internal capital markets and a potential for managerial distortions.

CEO Interviews on CNBC

CEO Interviews on CNBC

Y. Han (Andy) Kim Nanyang Technological University (NTU)

Felix Meschke University of Kansas – Finance Area
October 9, 2013

We investigate whether media attention systematically affects stock prices through the trading of individual investors by exploiting the substantial discrepancy between perceived and actual information content of 6,937 CEO interviews on CNBC. The average cumulative abnormal stock return over the [-2, 0] trading day window is 1.62%, yet prices exhibit strong reversion of 1.08% over the following ten trading days. The magnitude of price response is positively correlated with the viewership as well as the language tone of the CEO. We find that individual investors are net buyers on the interview days, and that they keep on buying if the interview was both carried out by attractive anchorwoman and was watched by more male viewers. The price reversal is attributable to abnormal short-selling volume on interview day. Moreover, we find that the price run-up before the interviews is largely driven by individual investors that are excited even at the pre-announcement of the interview. We also find evidence of asymmetric attention cascade coming from CNBC interview upon the tone of media coverage of the firm, tilted towards the negative. Read more of this post

Unprofitable Affiliates and Income Shifting Behavior

Unprofitable Affiliates and Income Shifting Behavior

Lisa De Simone Stanford Graduate School of Business

Jeri K. Seidman University of Texas at Austin – McCombs School of Business

October 15, 2013
Rock Center for Corporate Governance at Stanford University Working Paper No. 157

Income shifting from high-tax jurisdictions to low-tax jurisdictions is commonly considered in the accounting, finance and economics literature as a method to reduce worldwide tax burdens of multinational firms. However, the presence of an unprofitable affiliate provides another potential tax-reducing recipient of shifted income. We develop an income prediction model that does not rely on the logarithm of profitability and thus can be applied to both profitable and unprofitable affiliates. After confirming prior results on a sample of profitable affiliates using our new model, we test whether unprofitable affiliates report lower losses than a matched sample of unprofitable stand-alone firms, and whether these differences in profitability are correlated with tax-related factors. Results are consistent with income shifting to unprofitable affiliates being an important transfer pricing consideration for multinational firms; however, we also find evidence of risk sharing within multinational groups. Overall, results suggest that risk sharing and a shift-to-loss income shifting strategy both influence the unexpected profitability of unprofitable affiliates.

The Downside of Legitimacy Building for a New Firm in a Nascent Industry

The Downside of Legitimacy Building for a New Firm in a Nascent Industry

Tiona Zuzul Harvard Business School

Amy C. Edmondson Harvard University – Technology & Operations Management Unit

October 24, 2013
Harvard Business School Technology & Operations Mgt. Unit Working Paper No. 11-099

This paper explores how entrepreneurs‘ efforts to legitimate a firm and a nascent industry at the same time affect the internal development of the firm. We analyze qualitative data from a three-year study of a new firm in the nascent smart cities industry, and find that firm leaders engaged in a set of legitimation activities intended to help external stakeholders understand and appreciate the firm and its industry. Our analysis uncovers three unintended cognitive consequences of legitimation activities for firm employees – constrained attention, overconfidence, and identity commitments – that affected the firm‘s ability to learn: that is, to attend to, reflect on, and dynamically respond to information and changes in its environment. Our longitudinal research thus reveals a downside of legitimacy building, contributes to the literature on behavioral strategy, and highlights unique challenges of starting a new firm in a nascent industry. Further, by identifying the mechanisms through which legitimation activities affect learning, we develop actionable propositions to help leaders and entrepreneurs manage the tension between the two sets of activities.

Sneak Preview: How ISS Dictates Equity Plan Design

Sneak Preview: How ISS Dictates Equity Plan Design

Ian D. Gow Harvard Business School

David F. Larcker Stanford University – Graduate School of Business

Allan L. McCall Stanford University – Graduate School of Business

Brian Tayan Stanford University – Graduate School of Business

October 23, 2013
Rock Center for Corporate Governance at Stanford University Closer Look Series: Topics, Issues and Controversies in Corporate Governance and Leadership No. CGRP-37

Proxy advisory firms are highly influential in the design and approval of equity compensation plans.
The largest proxy advisory firm — Institutional Shareholder Services — uses a variety of tests to determine its recommendation on equity plan proposals. Among these is a proprietary metric called Shareholder Value Transfer (SVT). ISS automatically recommends a vote against a company’s equity plan if its SVT exceeds a certain allowable cap that is determined by ISS. At the same time, ISS provides little transparency into the computation of this cap and instead sells companies access to this information.
A growing body of evidence suggests that companies pay significant attention to their SVT caps and rely on this information to design their equity plans.
We examine this issue in detail. We ask: Should market participants be concerned with ISS’s influence over equity plan design? Without transparent disclosure, how can shareholders be sure that ISS’s SVT allowable caps are “correct”? Does profit motive affect ISS’s incentive to be transparent about the computation and disclosure of SVT caps?
Topics, Issues and Controversies in Corporate Governance and Leadership: The Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important. Larcker and Tayan are co-authors of the books Corporate Governance Matters and A Real Look at Real World Corporate Governance.

Do Activist Investors Constrain Managerial Moral Hazard in Chapter 11?: Evidence from Junior Activist Investing

Do Activist Investors Constrain Managerial Moral Hazard in Chapter 11?: Evidence from Junior Activist Investing

Jared A. Ellias Stanford Law School

October 23, 2013
Rock Center for Corporate Governance at Stanford University Working Paper No. 155
Stanford Law and Economics Olin Working Paper No. 451

In recent years, hedge funds and other activist investors that specialize in bankruptcy investing have emerged as important players in virtually every large Chapter 11 case. These activist investors buy junior claims and deploy aggressive litigation tactics to gain influence in the restructuring process. The consensus among bankruptcy lawyers is that this behavior has had a negative effect on Chapter 11. Junior activists are considered by many to be out of the money rent seekers that try to extract hold-up value from senior creditors, increasing the administrative costs of bankruptcy and reducing the ultimate recovery of creditors. Junior activists, however, believe they counter the perverse incentives of managers of Chapter 11 debtors. Chapter 11 leaves managers in control of the bankruptcy process and requires them to maximize creditor recoveries. In performing this duty, managers face moral hazard. If the firm is reorganized in a transaction that is appraised at a discount to the firm’s true value, managers and senior creditors can profit at the expense of junior claimants. Junior activists claim they intervene to stop managers and senior creditors from extracting value from junior claimants. In this paper, I perform the first empirical study of junior activism. I develop a new methodology that measures junior activism and I use it to study a hand-collected dataset of large firms filing for Chapter 11 in 2009 and 2010. I find that junior activism is correlated with an increase in the appraised value of the restructuring transaction, supporting the view of junior activists that they constrain management’s ability to extract value from junior claimants by underappraising the firm. Although there is some evidence of cost increases associated with junior activism, these increases are small in relation to the potential benefits of junior activism. The results undermine the consensus view of junior activism and suggest that junior activists promote the bankruptcy policy goals of maximizing creditor recoveries and distributing the firm’s value in accordance with the absolute priority rule.

Financial Attention; Account logins fall by over 11% after market declines. Investors also pay less attention when news media attention to the stock market is low and the VIX volatility index is high

Financial Attention

Nachum Sicherman Columbia University; Institute for the Study of Labor (IZA)

George Loewenstein Carnegie Mellon University – Department of Social and Decision Sciences

Duane J. Seppi Carnegie Mellon University – David A. Tepper School of Business

Stephen P. Utkus The Vanguard Group, Inc. – Center for Retirement Research

October 10, 2013

Novel panel data on daily online logins for a large sample of 401(k) retirement accounts let us identify causal drivers of investor attention to their personal portfolios. We find support for selective attention to portfolio information that seems unrelated to trading-based motivations and which is consistent with psychological motives. Account logins fall by over 11% after market declines. Investors also pay less attention when news media attention to the stock market is low and the VIX volatility index is high. The attention/return correlation and level of attention are strongly related to investor demographics (gender, age) and financial condition (wealth, holdings).

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

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.

Options on Initial Public Offerings

Options on Initial Public Offerings

Thomas J. Chemmanur Boston College – Carroll School of Management

Chayawat Ornthanalai University of Toronto – Rotman School of Management

Padmaja Kadiyala Pace University – Lubin School of Business

August 1, 2013
Rotman School of Management Working Paper No. 2311317

Using a sample of IPOs from 1996 to 2008, we examine, for the first time in the literature, the determinants and consequences of option listing on the equity of newly public firms. We explore four important issues. First, we study the determinants of the time to list options following the IPO and find that options are listed earlier on venture backed firms and those with larger IPO proceeds, but later on IPOs with higher reputation underwriters. Second, we analyze the effect of option listing on subsequent long-run stock returns and find significant under-performance persisting for more than a year after listing. This under-performance is greater for venture backed firms, but smaller for IPOs underwritten with higher reputation underwriters. Third, we test three hypotheses regarding the causes of equity under-performance post option listing and find the following: a significant increase in the short-interest ratio after option listing, indicating a relaxation of the short-sale constraint on the IPO firm equity; a significant decrease in insider equity holdings in the IPO firm in the months following option listing, indicating significant insider selling of the stock; and significantly higher put prices relative to call prices for several months following option listing, indicating that informed speculators are using put options to take short positions in the IPO firm stock during this period. Finally, we analyze the profitability of investment strategies in the newly listed options on IPO firm equity, and find significant excess returns from investing in long-maturity put options and holding them to maturity.

The Four Ways of Being that Create the Foundation for Great Leadership, a Great Organization, and a Great Personal Life

The Four Ways of Being that Create the Foundation for Great Leadership, a Great Organization, and a Great Personal Life

Werner Erhard Independent

Michael C. Jensen Harvard Business School; Social Science Electronic Publishing (SSEP), Inc.; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

October 10, 2013
Harvard Business School NOM Unit Working Paper No. 14-027
Barbados Group Working Paper No. 13-03

In this paper we argue that the four ways of being that we identify as constituting the foundation for being a leader and the effective exercise of leadership are also the foundations not only for great leadership, but also the foundations for an extraordinary organization and the foundations of a high quality personal life. One can also see this as a “value free” approach to values because each of the four foundations is a purely positive phenomena that has no inherent normative content. 1) authenticity is a purely positive phenomenon (being and acting consistent with who you hold yourself out to be for others and who you hold yourself to be for yourself). 2) being cause in the matter as a declaration of the stand you take for yourself regarding everything in your life is also a purely positive phenomenon. 3) being committed to something bigger than oneself is also a purely positive phenomenon (that says nothing about what that commitment should be other than it be bigger than oneself). And finally 4) integrity as we define it (being whole and complete by honoring your word) is also a purely positive phenomenon.

Blockholders and Corporate Governance

Blockholders and Corporate Governance

Alex Edmans

NBER Working Paper No. 19573
Issued in October 2013
This paper reviews the theoretical and empirical literature on the different channels through which blockholders (large shareholders) engage in corporate governance. In classical models, blockholders exert governance through direct intervention in a firm’s operations, otherwise known as “voice.” These theories have motivated empirical research on the determinants and consequences of activism. More recent models show that blockholders can govern through the alternative mechanism of “exit” – selling their shares if the manager underperforms. These theories give rise to new empirical studies on the two-way relationship between blockholders and financial markets, linking corporate finance with asset pricing. Blockholders may also worsen governance by extracting private benefits of control or pursuing objectives other than firm value maximization. I highlight the empirical challenges in identifying causal effects of and on blockholders, and the typical strategies attempted to achieve identification. I close with directions for future research.

Home Bias and Local Contagion: Evidence from Funds of Hedge Funds

Home Bias and Local Contagion: Evidence from Funds of Hedge Funds

Clemens Sialm, Zheng Sun, Lu Zheng

NBER Working Paper No. 19570
Issued in October 2013
This paper analyzes the geographical preferences of hedge fund investors and the implication of these preferences for hedge fund performance. We find that funds of hedge funds overweight their investments in hedge funds located in the same geographical areas and that funds of funds with a stronger local bias exhibit superior performance. However, this local bias of funds of funds adversely impacts the hedge funds by creating excess comovement and local contagion. Overall, our results suggest that while local funds of funds benefit from local performance advantages, their local bias creates market segmentation that could destabilize financial markets.

The Value of Corporate Culture

The Value of Corporate Culture

Luigi Guiso, Paola Sapienza, Luigi Zingales

NBER Working Paper No. 19557
Issued in October 2013
We study which dimensions of corporate culture are related to a firm’s performance and why. We find that proclaimed values appear irrelevant. Yet, when employees perceive top managers as trustworthy and ethical, firm’s performance is stronger. We then study how different governance structures impact the ability to sustain integrity as a corporate value. We find that publicly traded firms are less able to sustain it. Traditional measures of corporate governance do not seem to have much of an impact.

Why Do Investors Favor Active Management … To the Extent They Do?

Why Do Investors Favor Active Management … To the Extent They Do?

Ron Bird  University of Technology, Sydney

Jack Gray University of Technology Sydney

Massimo Scotti University of Technology Sydney

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

Half a century of analysis has yet to fully answer why investors place such a large proportion of their funds with active equity managers, given the discouraging evidence on the latter’s ability to add net value. From the voluminous literature on manager performance we conclude that there is some, but limited, evidence that can rationally justify hiring active managers. The weakness of the evidence leads us to ask, Why do investors favor active equity management to the extent they do? To help answer this question, we conducted two online surveys, one of Chief Investment Officers of predominantly large Australian superannuation (i.e., pension) funds and another of asset consultants. The results confirmed that the industry is captive to a pervasive prior towards active management. The prior is reinforced by a competitive environment and supported by a complex mix of behavioral, agency, organizational, and cultural factors.

What’s to Know About the Credibility of Empirical Economics?

What’s to Know About the Credibility of Empirical Economics?

John Ioannidis Stanford University

Chris Doucouliagos Deakin University – School of Accounting, Economics and Finance

December 2013
Journal of Economic Surveys, Vol. 27, Issue 5, pp. 997-1004, 2013

The scientific credibility of economics is itself a scientific question that can be addressed with both theoretical speculations and empirical data. In this review, we examine the major parameters that are expected to affect the credibility of empirical economics: sample size, magnitude of pursued effects, number and pre‐selection of tested relationships, flexibility and lack of standardization in designs, definitions, outcomes and analyses, financial and other interests and prejudices, and the multiplicity and fragmentation of efforts. We summarize and discuss the empirical evidence on the lack of a robust reproducibility culture in economics and business research, the prevalence of potential publication and other selective reporting biases, and other failures and biases in the market of scientific information. Overall, the credibility of the economics literature is likely to be modest or even low.

Mandatory vs. Voluntary Management Earnings Forecasts in China

Mandatory vs. Voluntary Management Earnings Forecasts in China

Xiaobei Huang University of International Business and Economics – Business School

Xi Li Temple University – Fox School of Business and Management

Senyo Y. Tse Texas A&M University – Lowry Mays College & Graduate School of Business

Jenny Wu Tucker University of Florida – Warrington College of Business Administration

May 2, 2013
Mays Business School Research Paper No. 2012-82

Capital-market regulators face the question of whether mandating management earnings forecasts would improve the information environment or be counterproductive. We examine the efficacy of a forecast regulation in the emerging market of China, which mandates management earnings forecasts in certain performance regions such as anticipated losses, turning profit, and large changes in earnings from the previous year and allows voluntary forecasts in other circumstances. We examine the quantity, quality, and usefulness of mandatory forecasts by comparing firms’ forecast behavior under the mandatory vs. voluntary regime in China. Our results suggest that the Chinese mandate substantially increases the quantity of information available to investors, particularly by state-owned enterprises (SOEs) — firms that play a major role in the economy but are reluctant to provide forecasts voluntarily. Firms that issue mandatory forecasts are more likely to issue voluntary forecasts in the subsequent year. Yet mandatory forecasts are less timely and less precise than voluntary forecasts, suggesting that mandatory forecasts are of lower quality than voluntary forecasts. On balance, investors react to mandatory forecasts as if they are useful. One unintended consequence of the mandate is that firms appear to manage their reported earnings to avoid the bright-line threshold for mandatory forecasts of large earnings decreases. Overall, our evidence provides guidance to regulators in emerging markets and feedback to regulators in developed economies.

The Vicarious Wisdom of Crowds: Toward a Behavioral Perspective on Investor Reactions to Acquisition Announcements

The Vicarious Wisdom of Crowds: Toward a Behavioral Perspective on Investor Reactions to Acquisition Announcements

Mario Schijven Texas A&M University – Department of Management

Michael A. Hitt Texas A&M University – Department of Management

Strat. Mgmt. J. (2012)
Mays Business School Research Paper No. 2012-17

Although event-study methodology is invaluable to strategic management research, we argue that the traditional financial economic rationale on which it is based has led scholars to assume away the behavioral mechanisms underlying investor reactions. Building on behavioral theory from management, psychology, and economics, we set out to develop a behavioral perspective on investor reactions to acquisition announcements — one that relaxes the assumption of investors making objective, rational-deductive calculations. Given the information asymmetry they face, we theorize that investors (1) infer management’s perception of an acquisition’s synergistic potential from the premium it pays, and (2) draw on additional public information to assess the reliability of that perception. Using a multi-industry sample of acquisitions by North American firms, we find considerable support for our behavioral framework.

The Bag of Stars: High-Speed Idea Filtering for Open Innovation

The Bag of Stars: High-Speed Idea Filtering for Open Innovation

Ana Cristina Bicharra Garcia Universidade Federal Fluminense; Massachusetts Institute of Technology (MIT) – Sloan School of Management

Mark Klein Massachusetts Institute of Technology (MIT) – Sloan School of Management

September 26, 2013
MIT Sloan Research Paper No. 5031-13

Open innovation platforms (web sites where crowds post ideas in a shared space) enable us to elicit huge volumes of potentially valuable solutions for problems we care about, but identifying the best ideas in these collections can be prohibitively time-consuming and expensive. This paper presents an approach, called the “bag of stars”, which enables crowd to filter ideas with (our experiments show) accuracy comparable to standard (Lichert scale) rating approaches, but in only a fraction of the time.

The Quality of Expertise: we should expect experts to be systematically biased, potentially to the point that they are less reliable sources of information than non-experts

The Quality of Expertise

Edward Dickersin Van Wesep Vanderbilt University – Owen Graduate School of Management

May 7, 2013
Vanderbilt Owen Graduate School of Management Research Paper No. 2257995

Policy-makers and managers often turn to experts when in need of information: because they are more informed than others of the content and quality of current and past research, they should provide the best advice. I show, however, that we should expect experts to be systematically biased, potentially to the point that they are less reliable sources of information than non-experts. This is because the decision to research a question implies a belief that research will be fruitful. If priors about the impact of current work are correct, on average, then those who select into researching a question are optimistic about the quality of current work. In areas that are new, or feature new research technologies (e.g., data sources, technical methods, or paradigms), the selection problem is less important than the benefit of greater knowledge: experts will indeed be experts. In areas that are old and lack new research technologies, there will be significant bias. Furthermore, consistent with a large body of empirical research, this selection problem implies that experts who express greater confidence in their beliefs will be, on average, less accurate. This paper provides many empirical implications for expert accuracy, as well as mechanism design implications for hiring, task assignment, and referee assignment.

Peter Phillips: Unit Roots in Life — A Graduate Student Story

Unit Roots in Life — A Graduate Student Story

Peter C. B. Phillips Yale University – Cowles Foundation; University of Auckland; University of Southampton; Singapore Management University – School of Economics

January 5, 2013
Cowles Foundation Discussion Paper No. 1913

This is a graduate student story. It mixes personal reflections with recollections of the extraordinary New Zealanders who shaped my thinking as a graduate student and beginning researcher — people who have had an enduring impact on my work and career as an econometrician. The story traces out these human initial conditions and unit roots that figure in my early life of teaching and research.

Strategic Risk Management – The Beanstalk Syndrome

Strategic Risk Management – The Beanstalk Syndrome

Patrick J. McConnell Macquarie University, Applied Finance Centre

September 19, 2013
Journal of Risk Management in Financial Institutions, Vol. 6, No 3, September 2013

Growth can be good – but can also be dangerous! When firms grow with superior products and services, then directors, executives, staff, shareholders, customers, suppliers and the general economy benefit. But delivering on a ‘growth strategy’ is notoriously difficult, as such a strategy often involves committing all of the firm’s resources to achieve growth targets. If such a strategy succeeds, riches can follow but, if not, the outcome can be catastrophic.This paper looks at several examples of large financial institutions that adopted some form of aggressive growth strategy only to have it blow up when the Global Financial Crisis (GFC) hit. All of the banks considered in this paper had adopted strategies that were built on significantly growing their balance sheets but they failed to manage the risks inherent in these strategies, in particular the need to manage their leverage and their liquidity. Their Boards and management were, this paper argues, bedazzled by a type of ‘Beanstalk Syndrome’, where they believed they could, like the mythical Jack, plant some ‘magic beans’ that would somehow grow into a constant supply of profits. Prudence was abandoned as each firm discovered a ‘golden goose’ that could seemingly produce profits forever. Unlike Jack, however, the beanstalk came crashing down, killing not the giant but the bank itself. This paper argues that these cases illustrate a lack of proper Strategic Risk Management (SRM), or the proactive management of the risks to corporate strategies. It further argues that regulators have a responsibility to ensure that Boards of Systemically Important Banks (SIBs) that adopt risky strategies, put in place the necessary risk management policies to ensure that taxpayers do not have to bail the companies out if/when the strategies fail.

Separation Anxiety: The Impact of CEO Divorce on Shareholders

Separation Anxiety: The Impact of CEO Divorce on Shareholders

David F. Larcker Stanford University – Graduate School of Business

Allan L. McCall Stanford University – Graduate School of Business

Brian Tayan Stanford University – Graduate School of Business

October 1, 2013
Rock Center for Corporate Governance at Stanford University Closer Look Series: Topics, Issues and Controversies in Corporate Governance and Leadership No. CGRP-36

There are at least three potential ways in which a CEO divorce might impact a corporation and its shareholders. First, it might reduce the executive’s control or influence over the organization. Second, it might affect his or her productivity, concentration, and energy levels. Third, it can influence attitudes toward risk. We examine these in detail, and ask: Should shareholders and boards be concerned when a CEO and spouse separate? Should the board make the CEO “whole” in order to restore equity incentives to where they were prior to divorce? Is divorce a private matter, or should companies disclose this information to shareholders?
Topics, Issues and Controversies in Corporate Governance and Leadership: The Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important. Larcker and Tayan are co-authors of the books Corporate Governance Matters and A Real Look at Real World Corporate Governance.

Buybacks Around the World

Buybacks Around the World

Alberto Manconi Tilburg University

Urs Peyer INSEAD – Finance

Theo Vermaelen INSEAD – Finance

September 2, 2013
INSEAD Working Paper No. 2013/101/FIN

This paper documents that outside the U.S. short-term returns around share repurchase announcements are positive, although only about half the size as in the U.S. Long-run abnormal returns after buyback announcements follow the same pattern in non-U.S. firms as document by prior literature for U.S. firms extending the buyback puzzle to the global level. Cross-country differences in corporate governance quality and regulatory differences can explain variation in the short- and long-run abnormal returns. Globally, long-run abnormal returns are related to an undervaluation index (Peyer and Vermaelen, 2009, RFS) consistent with the interpretation that managers are able to time the market.

Analyst Forecasts: It Pays to Be Off!

Analyst Forecasts: It Pays to Be Off!

Gilles Hilary INSEAD

Charles Hsu Hong Kong University of Science & Technology

August 27, 2013
Journal of Investment Management, Forthcoming
INSEAD Working Paper No. 2013/92/AC

We show that analysts who display more consistent forecast errors have a greater effect on stock prices than analysts who provide more accurate but less consistent forecasts. This result leads to three implications. First, consistent analysts are less likely to be demoted to a less prestigious brokerage house and are more likely to be named All Star analysts. Second, analysts strategically “lowball” (that is, deliver downward-biased forecasts) to increase their consistency. This is because lowballing gives management an easier target to beat and, in turn, management grants analysts greater access to company information. Finally, the benefits of both consistency and lowballing increase while those of accuracy decrease when institutional/sophisticated investors are more of a presence in the analyst’s audience.

On the Effectiveness of Patenting Strategies in Innovation Races

On the Effectiveness of Patenting Strategies in Innovation Races

Jurgen Mihm INSEAD

Fabian J. Sting Erasmus University – Rotterdam School of Management

Tan Wang Independent

July 19, 2013
INSEAD Working Paper No. 2013/88/TOM

Which inventions should a company patent? Should it patent at all? Many companies engaged in an innovation race seek a patenting strategy that will protect their intellectual property, but not much is known about factors that determine the best strategy. Although scholars in various management, economics, and engineering disciplines have conducted research on patents, little work has addressed the normative issues pertaining to formation of an appropriate patenting strategy. We develop an inventory of patenting strategies and integrate them into a framework accommodating the contingencies that influuence their selection. Our simulation model characterizes the optimal patenting choices for different settings, and it captures the dynamics between firms that compete via strategic interactions. We identify those competitive dynamics driven by the choice of R&D strategy as the most salient determinant of the firm’s optimal patenting strategy. Thus our research contributes to establishing a contingency theory of patenting strategies.

Managing Merger Risk During the Post-Selection Phase

Managing Merger Risk During the Post-Selection Phase

Robert Heller Georgia State University

Pamela Ellen Georgia State University

September 20, 2013
Third Annual International Conference on Engaged Management Scholarship, Atlanta, Georgia. September 19-22, 2013. Paper 9.1


Mergers and acquisitions are an important part of many companies’ strategic plans, yet they often fail to meet expectations. This may be due in part to a lack of understanding of the risks and the failure to apply a practical framework for managing them. Risk management techniques or frameworks have been developed for use in projects involving mergers and acquisitions (M&A), and many other company projects. Here we identify risks present and the risk resolutions available at this stage of the M&A process via a review of the literature and interviews with experienced managers of mergers and acquisitions. We develop a practical framework for managing post-selection phase risks in M&A. We analyzed published case studies to evaluate the framework. This research contributes to the literature by identifying and classifying the risks and risk resolutions in the post-selection phase of the M&A process and providing a practical framework for managing risks.

Analyst Report Readability

Analyst Report Readability

Gus De Franco University of Toronto – Rotman School of Management

Ole-Kristian Hope University of Toronto – Rotman School of Management

Dushyantkumar Vyas University of Toronto – Rotman School of Management; University of Toronto at Mississauga

Yibin Zhou University of Texas at Dallas – School of Management

June 21, 2013
Contemporary Accounting Research, Forthcoming
Rotman School of Management Working Paper No. 2283265

Using an extensive database of 356,463 sell-side equity analysts’ reports from 2002 to 2009, this study is one of the first to analyze the readability of analysts’ reports. We first examine the determinants of variations in analyst report readability. Using several proxies for ability, we show that reports are more readable when issued by analysts with higher ability. Second, we test the relation between analysts’ report readability and stock trading volume reactions. We find that trading volume reactions increase with the readability of analysts’ text, consistent with theoretical models that predict that more precise information (and hence more informative signals) results in investors’ initiating trades. These results support the view that the readability of analysts’ reports is important to analysts and capital market participants.

Executive Hubris: The Case of a Bank CEO

Executive Hubris: The Case of a Bank CEO

Niamh M. Brennan University College Dublin (UCD) – Quinn School of Business

John P. Conroy Independent

2013 Accounting, Auditing and Accountability, Vol. 26, No. 2, 2013

Purpose – Can personality traits of Chief Executive Officers (CEOs) be detected at-a-distance? Following newspaper speculation that the banking crisis of 2008 was partly caused by CEO hubris, this paper analyses the CEO letters to shareholders of a single bank over ten years for evidence of CEO personality traits, including: (i) narcissism (a contributor to hubris), (ii) hubris, (iii) overconfidence and (iv) CEO-attribution. Following predictions that hubris increases the longer individuals occupy positions of power, the research examines whether hubristic characteristics intensify over time.

Design/methodology/approach – This paper takes concepts of hubris from the clinical psychology literature and applies them to discourses in CEO letters to shareholders in annual reports. The research comprises a longitudinal study of the discretionary narrative disclosures in the CEO letters to shareholders in eight annual reports, benchmarked against disclosures in the CEO letters to shareholders of the previous and subsequent CEOs of the same organisation.

Findings – Results point to evidence of narcissism and hubris in the personality of the Bank CEO. Over half the sentences analysed were found to contain narcissistic-speak. In 45% of narcissistic-speak sentences, there were three of more symptoms of hubris – what Owen and Davison (2009) describe as extreme hubristic behavior. In relation to CEO overconfidence, only seven (2%) sentences contained bad news. More than half of the good news was attributed to the CEO and all the bad news was attributed externally. The research thus finds evidence of hubris in the CEO letters to shareholders, which became more pronounced the longer the CEO served.

Research limitations/implications – The analysis of CEO discourse is highly subjective, and difficult to replicate.

Originality/value – The primary contribution of this research is the adaptation of the 14 clinical symptoms of hubris from clinical psychology to the analysis of narratives in CEO letters to shareholders in annual reports to reveal signs of CEO hubris.

Making 1 1=1: The Central Role of Identity in Merger Math

Making 1 1=1: The Central Role of Identity in Merger Math

Hamid Bouchikhi ESSEC Business School

John Kimberly University of Pennsylvania – Management Department

June 13, 2012
ESSEC Working Paper 1204

When trying to pull off a successful deal many senior executives focus their attention on economic synergies (1 1>2) and ignore that psychological synergies (1 1=1) are required to reap the financial benefits of mergers and acquisitions. The authors discuss common mistakes firms make in the management of identity issues and offer four approaches that managers can follow to achieve identity integration.

Playing Favorites: How Firms Prevent the Revelation of Bad News

Playing Favorites: How Firms Prevent the Revelation of Bad News

Lauren Cohen, Dong Lou, Christopher Malloy

NBER Working Paper No. 19429
Issued in September 2013
We explore a subtle but important mechanism through which firms manipulate their information environments. We show that firms control information flow to the market through their specific organization and choreographing of earnings conference calls. Firms that “cast” their conference calls by disproportionately calling on bullish analysts tend to underperform in the future. Firms that call on more favorable analysts experience more negative future earnings surprises and more future earnings restatements. A long-short portfolio that exploits this differential firm behavior earns abnormal returns of up to 101 basis points per month. Further, firms that cast their calls have higher accruals leading up to call, barely exceed/meet earnings forecasts on the call that they cast, and in the quarter directly following their casting tend to issue equity and have significantly more insider selling. Read more of this post

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