https://sites.temple.edu/lnaveen/files/2014/05/JFE_risktaking_2006.pdf

Managerial incentives and risk-taking ☆

This book provides a detailed account of how structural flaws in corporate governance have enabled managers to influence their own pay and produced widespread distortions in pay arrangements. The book also examines how these flaws and distortions can best be addressed. Part I of the book (titled The Official View and its Limits) critically examines the arm's length contracting view, which underlies much of the academic research on executive compensation as well as the law's approach to it. We show that boards have not been operating at arm's length from the executives whose pay they set. While recent reforms can improve matters, they cannot be expected to eliminate significant deviations from arm's length contracting. We also show that the constraints imposed by market forces and shareholders' power to intervene are not tight enough to prevent such deviations. Part II of the book (titled Power and Pay) shows how an understanding of the role of managerial power can help explain executive compensation practices. We provide a framework for assessing whether pay arrangements are a product of managerial influence. We discuss managers' interest in camouflaging the amount and the performance-insensitivity of their pay. Applying our framework, we discuss how managerial influence can help explain, among other things, the evidence on the relationship between managerial pay and managerial power; the use of retirement benefits and other compensation arrangements to provide stealth compensation; and the ability of departing managers to obtain more than their contractual entitlement. Part III of the book (titled Decoupling Pay from Performance) examines how managerial influence has operated to reduce the performance-sensitivity of executive pay. Among other things, we examine the structure of non-equity compensation, the design of conventional option plans, the use of restricted stock grants, and managers' freedom to unload options and shares. Part IV of the book (titled Going Forward) discusses how executive compensation - and corporate governance more generally - can be improved. We examine the extent to which pay arrangements can be improved by adopting board process rules, imposing shareholder approval requirements, and making pay more transparent. We conclude that problems with compensation arrangements cannot be fully addressed without ensuring that directors focus on shareholder interests and operate at arm's length from the executives whose compensation they set. To achieve this result, we argue, it is not sufficient to make directors independent of executives as recent reforms has sought to do; it is also necessary to make directors dependent on shareholders by changing the legal arrangements that insulate boards from shareholders.

/pdf/pay-without-performance-the-unfulfilled-promise-of-executive-2jxhdecmc3.pdf

Pay without Performance: The Unfulfilled Promise of Executive Compensation

https://dspace.mit.edu/bitstream/handle/1721.1/99175/Hanlon_A%20review%20of%20tax%20research.pdf;sequence=1

A review of tax research

Opaque financial reports, R2, and crash risk

This paper contains a draft of Part III of our forthcoming book, Pay without Performance: The Unfulfilled Promise of Executive Compensation (Harvard University Press, September 2004). The book provides a detailed account of how structural flaws in corporate governance have enabled managers to influence their own pay and produced widespread distortions in pay arrangements. The book also examines how these flaws and distortions can best be addressed. Part III of the book examines how managerial influence has operated to reduce the performance-sensitivity of executive pay. Among other things, we examine the structure of non-equity compensation, the design of conventional option plans, the use of restricted stock grants, and managers’ freedom to unload options and shares.

/pdf/pay-without-performance-the-unfulfilled-promise-of-executive-2s8l63codl.pdf

Pay without Performance, The Unfulfilled Promise of Executive Compensation, Part III: The Decoupling of Pay from Performance

R2 around the world: New theory and new tests

CEO compensation, diversification, and incentives

Morck, Yeung and Yu (2000) show that R and other measures of stock market synchronicity are higher in countries with less developed financial systems and poorer corporate governance. We develop a model that explains these results and generates additional testable hypotheses. The model shows how control rights and information affect the division of risk bearing between inside managers and outside investors. Insiders capture part of the firm’s operating cash flows. The limits to capture are based on outside investors’ perception of the value of the firm. The firm is not completely transparent, however. Lack of transparency shifts firm-specific risk to insiders and reduces the amount of firm-specific risk absorbed by outside investors. Our model also predicts that “opaque” stocks are more likely to crash, that is, to deliver large negative returns. Crashes occur when insiders have to absorb too much firm-specific bad news and decide to give up. We test these predictions using stock returns from 40 stock markets from 1990 to 2001. We find strong positive relations between R and several measures of opaqueness. These measures also explain the frequency and magnitude of large negative returns. JEL classification: G12, G14, G15, G38, N20

R Around the World: New Theory and New Tests

This paper examines the empirical question of whether systematic equity risk of US firms as measured by beta from the capital asset pricing model reflects the risk of their pension plans. There are a number of reasons to suspect that it might not. Chief among them is the opaque set of accounting rules used to report pension assets, liabilities, and expenses. Pension plan assets and liabilities are off-balance sheet and are often viewed as segregated from the rest of the firm, with its own trustees. Pension accounting rules are complicated. Furthermore, the role of the Pension Benefit Guaranty Corporation clouds the real relation between pension plan risk and firm equity risk. The empirical findings in this paper are consistent with the hypothesis that equity risk does reflect the risk of the firm's pension plan despite arcane accounting rules for pensions. This finding is consistent with informational efficiency of the capital markets. It also has implications for corporate finance practice in the determination of the cost of capital for capital budgeting. Standard procedure uses de-leveraged equity return betas to infer the cost of capital for operating assets. But the de-leveraged betas are not adjusted for the risk of the pension assets and liabilities. Failure to make this adjustment typically biases upward estimates of the discount rate for capital budgeting. The magnitude of the bias is shown here to be large for a number of well-known US companies. This bias can result in positive net present value projects being rejected.

/pdf/do-a-firm-s-equity-returns-reflect-the-risk-of-its-pension-97qqcm2gmq.pdf

Do a Firm's Equity Returns Reflect the Risk of Its Pension Plan?

This paper employs heterogeneity in institutional shareholder tax characteristics to identify the relationship between firm payout policy and tax incentives. Analysis of a panel of firms matched with the tax characteristics of the clients of their institutional shareholders indicates that "dividend-averse" institutions are significantly less likely to hold shares in firms with larger dividend payouts. This relationship between the tax preferences of institutional shareholders and firm payout policy could reflect dividend-averse institutions gravitating to low dividend paying firms or managers adapting their payout policies to the interests of their institutional shareholders. Evidence is provided that both effects are operative. Instrumental variables analysis indicates that plausibly exogenous changes in payout policy result in shifting institutional ownership patterns. Similarly, exogenous changes in the tax code indicate that as the tax cost of paying dividends changes, managers alter their dividend policy to serve their institutional shareholders.

/pdf/institutional-tax-clienteles-and-payout-policy-2nlit5cdkv.pdf

Li Jin

Papers

R2 around the world: New theory and new tests

CEO compensation, diversification, and incentives

R Around the World: New Theory and New Tests

Do a Firm's Equity Returns Reflect the Risk of Its Pension Plan?

Institutional Tax Clienteles and Payout Policy