Statistical Analysis with Missing Data

We provide evidence that the use of discretionary accruals to manipulate reported earnings is more pronounced at firms where the CEO's potential total compensation is more closely tied to the value of stock and option holdings. In addition, during years of high accruals, CEOs exercise unusually large amounts of options and CEOs and other insiders sell large quantities of shares.

CEO Incentives and Earnings Management

This paper provides an overview of the main theoretical elements and empirical underpinnings of a managerial power approach to executive compensation. Under this approach, the design of executive compensation is viewed not only as an instrument for addressing the agency problem between managers and shareholders but also as part of the agency problem itself. Boards of publicly traded companies with dispersed ownership, we argue, cannot be expected to bargain at arm's length with managers. As a result, managers wield substantial influence over their own pay arrangements, and they have an interest in reducing the saliency of the amount of their pay and the extent to which that pay is de-coupled from managers' performance. We show that the managerial power approach can explain many features of the executive compensation landscape, including ones that many researchers have long viewed as puzzling. Among other things, we discuss option plan design, stealth compensation, executive loans, payments to departing executives, retirement benefits, the use of compensation consultants, and the observed relationship between CEO power and pay. We also explain how managerial influence might lead to substantially inefficient arrangements that produce weak or even perverse incentives.

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Executive Compensation as an Agency Problem

Among financial economists, the dominant approach to the study of executive compensation views managers' pay arrangements as a (partial) remedy to the agency problem. Under this approach, which we label the “optimal contracting approach,” boards are assumed to design compensation schemes to provide managers with efficient incentives to maximize shareholder value. Financial economists have done substantial work within this optimal contracting model in an effort to understand executive compensation practices; recent surveys of this work include Murphy (1999) and Core, Guay and Larcker (2001). To some researchers working within the optimal contracting model, the main flaw with existing practices seems to be that, due to political limitations on how generously executives can be treated, compensation schemes are not sufficiently high-powered (Jensen and Murphy, 1990). Another approach to studying executive compensation focuses on a different link between the agency problem and executive compensation. Under this approach, which we label the “managerial power approach,” executive compensation is viewed not only as a potential instrument for addressing the agency problem but also as part of the agency problem itself. As a number of researchers have recognized, some features of pay arrangements seem to reflect managerial rent-seeking rather than the provision of efficient incentives (for example, Blanchard, Lopez-de-Silanes and Shleifer, 1994; Yermack, 1997; and Bertrand and Mullainathan, 2001). We seek to develop a full account of how managerial influence shapes the executive compensation landscape in a forthcoming book (Bebchuk and Fried, 2004) that builds substantially on a long article written jointly with David Walker (Bebchuk, Fried and Walker, 2002).

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This paper is a survey of the literature on boards of directors, with an emphasis on research done subsequent to the Benjamin E. Hermalin and Michael S. Weisbach (2003) survey. The two questions most asked about boards are what determines their makeup and what determines their actions? These questions are fundamentally intertwined, which complicates the study of boards because makeup and actions are jointly endogenous. A focus of this survey is how the literature, theoretical as well as empirical, deals—or on occasions fails to deal—with this complication. We suggest that many studies of boards can best be interpreted as joint statements about both the director-selection process and the effect of board composition on board actions and firm performance. ( JEL G34, L25)

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The Role of Boards of Directors in Corporate Governance: A Conceptual Framework and Survey

The primary goal of the Sarbanes-Oxley Act was to fix auditing of U.S. public companies, consistent with its full, official name: the Public Company Accounting Reform and Investor Protection Act of 2002. By consensus, auditing had been working poorly, and increasingly so. The most important, and most promising, part of Sarbanes-Oxley was the creation of a unique, quasi-public institution to oversee and regulate auditing, the Public Company Accounting Oversight Board (PCAOB). In controversial section 404, the law also created new disclosure-based incentives for firms to spend money on internal controls, above increases that would have occurred after the corporate scandals of the early 2000s. In exchange for these higher costs, which have already fallen substantially, Sarbanes-Oxley promises a variety of long-term benefits. Investors will face a lower risk of losses from fraud and theft, and benefit from more reliable financial reporting, greater transparency, and accountability. Public companies will pay a lower cost of capital, and the economy will benefit because of a better allocation of resources and faster growth. Sarbanes-Oxley remains a work in progress -- section 404 in particular was implemented too aggressively - but reformers should push for continued improvements in its implementation, by PCAOB, rather than for repeal of the legislation itself.

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The Goals and Promise of the Sarbanes-Oxley Act

This article argues that effective staggered boards (ESBs) provide a powerful antitakeover defense, more powerful than is commonly recognized. We develop a theoretical account of how ESBs impede hostile bids by forcing bidders both to wait at least one year to gain control and to win two elections far apart in time rather than a one-time referendum on their offer. We then test our theory using a new data set of hostile bids during 1996-2000. We find that in this period:1) Not a single hostile bidder won a ballot box victory against an ESB;2) An ESB nearly doubled the odds of remaining independent for an average target in our data set;3) Shareholders of targets that remained independent were made worse off compared with accepting the bid;4) ESBs did not provide significant countervailing benefits in terms of increased premiums to offset the costs of remaining independent;5) Overall, during 1996-2000, ESBs reduced the returns to shareholders of hostile bid targets on the order of 8-10%; and6) Most ESBs were adopted before the developments in takeover jurisprudence that made ESBs.In view of these findings, we argue that courts should not permit managers of a target with an ESB to continue maintaining a pill after they lose one election conducted over an acquisition offer. This approach, we suggest, would best implement the basic proportionality principles underlying takeover doctrine.The Stanford Law Review is planning to publish a symposium with responses and reactions to this article. Participants will include Steve Bainbridge (UCLA), Mark Gordon (Wachtell, Lipton), Patrick McGurn (Institutional Shareholder Services), Lynn Stout (UCLA), and Leo Strine (Delaware Chancery Court). We are now in the process of writing for the symposium a paper that will respond to these five commentators and will further develop our analysis of staggered boards. Accordingly, comments or reactions on the article would be most welcome.

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The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence, and Policy

Staggered boards, which a majority of public companies now have, provide a powerful antitakeover defense, stronger than is commonly recognized. They provide antitakeover protection both by (i) forcing any hostile bidder, no matter when it emerges, to wait at least one year to gain control of the board and (ii) requiring such a bidder to win two elections far apart in time rather than a one-time referendum on its offer. Using a new data set of hostile bids in the five-year period 1996-2000, we find that not a single hostile bid won a ballot box victory against an "effective" staggered board (ESB). We also find that an ESB nearly doubled the odds of remaining independent for an average target in our data set, from 34% to 61%, halved the odds that a first bidder would be successful, from 34% to 14%, and reduced the odds of a sale to a white knight, from 32% to 25%. Furthermore, we find that the shareholders of targets that remained independent were made worse off compared with accepting the bid and that ESBs did not provide sufficient countervailing benefits in terms of increased premiums to offset the costs of remaining independent. Overall, we estimate that, in the period studied, ESBs reduced the returns of shareholders of hostile bid targets on the order of 8-10%. Finally, we show that most staggered boards were adopted before the developments in takeover doctrine that made ESBs such a potent defense. Our findings call for a reconsideration of takeover rules; in particular, we argue that, at least in the absence

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We review and assess research findings from 120 papers in accounting, finance, and law to evaluate the impact of the Sarbanes-Oxley Act. We describe significant developments in how the Act was implemented and find that despite severe criticism, the Act and institutions it created have survived almost intact since enactment. We report survey findings from informed parties that suggest that the Act has produced financial reporting benefits. While the direct costs of the Act were substantial and fell disproportionately on smaller companies, costs have fallen over time and in response to changes in its implementation. Research about indirect costs such as loss of risk taking in the U.S. is inconclusive. The evidence for and social welfare implications of claimed effects such as fewer IPOs or loss of foreign listings are unclear. Financial reporting quality appears to have gone up after SOX but research on causal attribution is weak. On balance, research on the Act's net social welfare remains inconclusive. We end by outlining challenges facing research in this area, and propose an agenda for better modeling costs and benefits of financial regulation.

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SOX after Ten Years: A Multidisciplinary Review

SYNOPSIS: We review and assess research findings from more than 120 papers in accounting, finance, and law to evaluate the impact of the Sarbanes-Oxley Act. We describe significant developments in how the Act was implemented and find that despite severe criticism, the Act and institutions it created have survived almost intact since enactment. We report survey findings from informed parties that suggest that the Act has produced financial reporting benefits. While the direct costs of the Act were substantial and fell disproportionately on smaller companies, costs have fallen over time and in response to changes in its implementation. Research about indirect costs such as loss of risk taking in the U.S. is inconclusive. The evidence for and social welfare implications of claimed effects such as fewer IPOs or loss of foreign listings are unclear. Financial reporting quality appears to have gone up after SOX but research on causal attribution is weak. On balance, research on the Act's net social welfare rem...

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John C. Coates

Papers

The Goals and Promise of the Sarbanes-Oxley Act

The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence, and Policy

The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence, and Policy

SOX after Ten Years: A Multidisciplinary Review

SOX after Ten Years: A Multidisciplinary Review