Showing papers on "Agency cost published in 2004"
TL;DR: In this paper, the authors discuss the different nature of agency costs in family and discuss the potential of family involvement in a business has the potential to both increase and decrease financial performance due to agency costs.
Abstract: Family involvement in a business has the potential to both increase and decrease financial performance due to agency costs In this article we discuss the different nature of agency costs in family
1,109 citations
TL;DR: In this paper, the authors present a conceptual framework for analyzing remuneration and incentives in organizations and discuss how well designed pay packages can mitigate the agency problems between managers and shareholders and between board members and shareholders.
Abstract: Currently, we are in the midst of a reexamination of chief executive officer (CEO) remuneration that has more than the usual amount of energy and substance. While much of the fury over CEO pay has been aimed at executives associated with accounting scandals and collapses in the prices of their company's shares, the controversies over GE CEO Jack Welch and NYSE CEO Richard Grasso signal a watershed. In their cases the competence and performance of both men were unquestioned: the issue seems to be the perception that they received "too much" and that there was inadequate disclosure.
We provide, history, analysis and over three dozen recommendations for reforming the system surrounding executive compensation.
Section I introduces a conceptual framework for analyzing remuneration and incentives in organizations. We then analyze the agency problems between managers and shareholders and between board members and shareholders, and discuss how well designed pay packages can mitigate the former while well designed corporate governance policies and processes can mitigate the latter. We say "mitigate" because no solutions will eliminate these agency problems completely. Since bad governance can easily lead to value destroying pay practices our discussion includes analyses of corporate governance as well as pay design. Because optimal remuneration policies cannot be designed and managed without consideration of the powerful relations and interactions between the financial markets and the firm, its top-level executives and the board, we devote significant space to these factors.
Section II offers a brief history of executive remuneration from 1970 to the present. Section III examines and explains the forces behind the US-led escalation in share options. We argue that boards and managers falsely perceive stock options to be inexpensive because of accounting and cash-flow considerations and, as a result, too many options have been awarded to too many people.
Section IV defines and discusses the agency costs of overvalued equity as the source of recent corporate scandals. Agency problems associated with overvalued equity are aggravated when managers have large holdings of stock or options. Because neither the market for corporate control or the usual incentive compensation systems can solve the agency problems of overvalued equity, they must be resolved by corporate governance systems. And few governance systems were strong enough to solve the problems. As the overvalued equity problem illustrates, while remuneration can be a solution to agency problems, it can also be a source of agency problems.
Section V discusses several widespread problems with pay processes and practices, and suggests changes in both corporate governance and pay design to mitigate such problems: including problems with the appointment and pay-setting process, problems with equity-based pay plans, and problems with the design of traditional bonus plans. We show how traditional plans encourage managers to ignore the cost of capital, manage earnings in ways that destroy value, and take actions to deceive investors and capital markets.
Section VI defines and analyzes a new concept: what we call the Strategic Value Accountability issue. This is the accountability for making the link between strategy formulation and choice and the value consequences of those choices - basically the link between internal managers and external capital markets. The critical importance of this accountability, its assignment, and its implications for performance measurement and remuneration have long been unrecognized and therefore ignored in most organizations.
Section VII analyzes the complex relationships between managers, analysts, and the capital market, the incentives firms have to manage earnings to meet or beat analyst forecasts, and shows how managers playing the earnings-management game systematically erode the integrity of their organization and destroy organizational value. We highlight the puzzling equilibrium in this market that seems to suggest collusion between analysts and managers at the expense of investors - an area that is ripe for further research.
764 citations
665 citations
TL;DR: In this article, the authors focus on emerging market firms for which pyramid ownership structures create potentially extreme managerial agency costs and conduct powerful new tests of whether debt can mitigate the effects of agency and information problems.
415 citations
TL;DR: In this article, the determinants of corporate cash holdings in EMU countries were investigated and it was shown that cash holdings are positively affected by the investment opportunity set and cash flows and negatively affected by asset's liquidity, leverage and size.
Abstract: This paper investigates the determinants of corporate cash holdings in EMU countries. Our results suggest that cash holdings are positively affected by the investment opportunity set and cash flows and negatively affected by asset’s liquidity, leverage and size. Bank debt and cash holdings are negatively related, which supports that a close relationship with banks allows the firm to hold less cash for precautionary reasons. Firms in countries with superior investor protection and concentrated ownership hold less cash, supporting the role of managerial discretion agency costs in explaining cash levels. Capital markets development has a negative impact on cash levels, contrary to the agency view.
397 citations
TL;DR: In this paper, the impact of managerial discretion and corporate control mechanisms on leverage and firm value within a contingent claims model where the manager derives perquisites from investment was analyzed and the model showed that manager-shareholder conflicts can explain the low debt levels observed in practice.
Abstract: This article analyzes the impact of managerial discretion and corporate control mechanisms on leverage and firm value within a contingent claims model where the manager derives perquisites from investment. Optimal capital structure reflects both the tax advantage of debt less bankruptcy costs and the agency costs of managerial discretion. Actual capital structure reflects the trade-off made by the manager between his empire-building desires and the need to ensure sufficient efficiency to prevent control challenges. The model shows that manager-shareholder conflicts can explain the low debt levels observed in practice. It also examines the impact of these conflicts on the cross-sectional variation in capital structures.
259 citations
TL;DR: In this article, the authors provide evidence on the co-closet structure of corporate loan agreements, and show that firms that elect to issue private rather than public debt are smaller, have greater growth opportunities, less long-term debt, fewer tangible assets, more volatile cash flows and include more covenants in their debt agreements.
Abstract: We provide evidence on the covenant structure of corporate loan agreements. Building on the work of Jensen and Meckling (1976), Myers (1977) and Smith and Warner (1979), we summarize and test the implications for what we refer to as the Agency Theory of Covenants (ATC), using a large sample of privately placed corporate debt. Our results are consistent with many of the implications of the ATC, including a negative relation between the promised yield on corporate debt and the presence of covenants. We also find that borrower and lender characteristics, as well as macroeconomic factors, determine covenant structure. Loans are more likely to include protective covenants when the borrower is small, has high growth opportunities or is highly levered. Loans made by investment banks and syndicated loans are also more likely to include protective covenants, as are loans made during recessionary periods or when credit spreads are large. Finally, we show that consistent with the ATC, firms that elect to issue private rather than public debt are smaller, have greater growth opportunities, less long term debt, fewer tangible assets, more volatile cash flows and include more covenants in their debt agreements. An important byproduct of our analysis is to demonstrate empirically that covenant structure and the yield on corporate debt are determined simultaneously.
226 citations
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TL;DR: In this article, the authors discuss the incentive and organisational effects of stock overvaluation and the need for new language to enable managers and boards to deal with these issues, and conclude by considering how we solve this, where we go from here, and what's likely to happen.
Abstract: Keynote Address to the European Financial Management Association, London, June 2002 This paper received the European Financial Management Readers' Choice Best Paper Award for 2004 My intention today is to provide a way to understand some of what's currently happening in the world of finance and corporate governance at this time (June 2002). Few if any of us have discussed with our students the consequences of a company's stockprice becoming overvalued. Indeed I know of nowhere in the finance literature where the problems associated with overvaluation are discussed. We talked for a long time in the 1980s about the effects of under-valuation, and I will have a little to say about that below. But as things have progressed over the last half-dozen years overvaluation has come increasingly to occupy my thoughts. Indeed, understanding the incentive and organisational effects of stock overvaluation will help us understand much about the current malaise in corporate finance and corporate governance that surrounds the events at Enron, WorldCom, Xerox, and many other companies. I will review this situation briefly, and then move on to consider the agency costs of undervalued and overvalued equity. For the most part I'm going to concentrate on the latter, and examine the necessity for managers to manage stockprices down in situations where they become substantially overvalued, and the requirement for us to have new language to enable managers and boards to deal with these issues. I will conclude by considering how we solve this, where we go from here, and what's likely to happen?
181 citations
TL;DR: In this paper, the authors empirically investigate the effects of the adoption of Regulation Fair Disclosure (Reg FD) by the U.S. Securities and Exchange Commission in October 2000 and find that the adoption caused a significant reallocation of information-producing resources, resulting in a welfare loss for small firms, which now face a higher cost of capital.
Abstract: We empirically investigate the effects of the adoption of Regulation Fair Disclosure ( Reg FD') by the U.S. Securities and Exchange Commission in October 2000. This rule was intended to stop the practice of selective disclosure,' in which companies give material information only to a few analysts and institutional investors prior to disclosing it publicly. We find that the adoption of Reg FD caused a significant reallocation of information-producing resources, resulting in a welfare loss for small firms, which now face a higher cost of capital. The loss of the selective disclosure' channel for information flows could not be compensated for via other information transmission channels. This effect was more pronounced for firms communicating complex information and, consistent with the investor recognition hypothesis, for those losing analyst coverage. Moreover, we find no significant relationship of the different responses with litigation risks and agency costs. Our results suggest that Reg FD had unintended consequences and that information' in financial markets may be more complicated than current finance theory admits.
175 citations
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TL;DR: Kraakman et al. as discussed by the authors provided a comparative and functional analysis of corporate law in Europe, the U.S., and Japan, and identified five legal strategies that the law employs to address these problems.
Abstract: This article is the second chapter of a book authored by R. Kraakman, P. Davies, H. Hansmann, G. Hertig, K. Hopt, H. Kanda, and E. Rock, "The Anatomy of Corporate Law: A Comparative and Functional Approach," (Oxford University Press 2004). The book as a whole provides a functional analysis of corporate (or company) law in Europe, the U.S., and Japan. Its organization reflects the structure of corporate law across all jurisdictions, while individual chapters explore the diversity of jurisdictional approaches to the common problems of corporate law. "Agency Problems and Legal Strategies" establishes the analytical framework for the book as a whole. After further elaborating the agency problems that motivate corporate law, this chapter identifies five legal strategies that the law employs to address these problems. Describing these strategies allows us to more accurately map legal similarities and differences across jurisdictions. Some legal strategies are "regulatory" insofar as they directly constrain the actions of corporate actors: for example, a standard of behavior such as a director's duty of loyalty and care. Other legal strategies are "governance-based" insofar as they channel the distribution of power and payoffs within companies to reduce opportunism. For example, the law may accord direct decision rights to a vulnerable corporate constituency, as when it requires shareholder approval of mergers. Alternatively, the law may assign appointment rights over top managers to a vulnerable constituency, as when it accords shareholders - or in some jurisdictions, employees - the power to select corporate directors. Finally, the law may attempt to shape the incentives of managers or controlling shareholders, as when it regulates compensation or prescribes an equal treatment norm such as the rule that dividends must be paid out ratably. In addition to Chapter 2, Chapter 1 "What is Corporate Law" is available in full text on the SSRN at http://ssrn.com/abstract=568623. The abstracts for Chapter 3: The Basic Governance Structure; Chapter 4: Creditor protection (http://ssrn.com/abstract=568823); Chapter 5: Related Party Transactions; Chapter 6: Significant Corporate Actions; Chapter 7: Control Transactions; Chapter 8: Issuers and Investor Protection; Chapter 9: Beyond the Anatomy are also/will be available on the SSRN.
103 citations
TL;DR: In this article, the authors investigate the relation between corporate governance and the spinoff decision and find that larger firms with broader scope and investment patterns that appear inefficient are more likely to engage in a spinoff.
Abstract: Using a sample of 102 firms in the period 1981 to 1997, we investigate the relation between corporate governance and the spinoff decision. Larger firms with broader scope and investment patterns that appear inefficient are more likely to engage in a spinoff. Diversified firms conducting a spinoff have characteristics previously hypothesized to be associated with more effective corporate governance, such as greater ownership by outside board members, more heterogeneous boards, and fewer board members, in comparison to a set of peer firms. These findings are consistent with the view that agency problems are a contributing factor in firms maintaining value destroying diversification strategies.
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TL;DR: This article examined the effects of agency relationships on family firms and suggested the alternative influence of stewardship theory, which complements the agency framework in explaining entrepreneurial,organizationally-centered behaviors.
Abstract: Provides a reaction tothearticle"Comparing the agency costs of family and non-family firms:Conceptual issues and exploratory evidence," by Chrisman, Chua, and Litz inthe same issue of Entrepreneurship Theory and Practice. This commentaryexamines theeffects of agency relationships on family firms presented byChrisman et al, andsuggests the alternative influence of stewardshiptheory, which complements the agency framework in explaining entrepreneurial,organizationally-centered behaviors. The main thrust is to suggest that differences in organizational performanceare not driven by family involvement or its lack, but more by the existence ofagency or stewardship relationships within firms, regardless of the degree ofactual family involvement. Conclusions indicate that Chrisman et al.'s findingsmay be flawed because their study did not provide any significant performancedifferences between family and non-family firms. The differences may also varyby the types of businesses in which family firms are engaged. It is suggestedthat the issues of agency and stewardship relationships should be studied morecarefully and should avoid oversimple dichotomies such as family and non-familyfirms.(JSD)
TL;DR: In this article, a nonlinear relation between Tobin's $Q$ and REIT insider ownership was found consistent with the trade-off between the incentive alignment and the entrenchment effect of insider ownership.
Abstract: Real estate investment trust (REIT) provides a unique laboratory to study the relation between insider ownership and firm value. One, A REIT has to satisfy special regulations which weaken alternative mechanisms to control agency problems. Empirically, I find a significant and robust nonlinear relation between Tobin's $Q$ and REIT insider ownership that is consistent with the trade-off between the incentive alignment and the entrenchment effect of insider ownership. Two, many REITs are Umbrella Partnership REITs (UPREITs) which have dual ownership structure. They have both common shares and Operating Partnership Units (OP units). Property owners can contribute their properties to the UPREIT in exchange for OP units. Their capital gains taxes remain deferred as long as they hold onto their OP units and the UPREIT does not sell the properties they contributed. OP units owners are locked in with the firm and have incentive to monitor firm management, but their interests diverge from the common shareholders because their tax bases are much lower. Consistent with the trade-off between positive monitoring effect of OP units and tax-induced agency costs, I find that UPREIT's firm value increases with the fraction of OP units, but the effect is significantly weaker for the UPREITs where insiders hold OP units.
TL;DR: In this paper, the authors model earnings management as a consequence of the interaction among self-interested economic agents, namely, the managers, the shareholders, and the regulators, and show that various economic trade-offs give rise to endogenous earnings management.
Abstract: In this paper, we model earnings management as a consequence of the interaction among self-interested economic agents - namely, the managers, the shareholders, and the regulators. In our model, a manager controls a stochastic production technology and makes periodic accounting reports about his or her performance; an owner chooses a compensation contract to induce desirable managerial inputs and reporting choices by the manager; and a regulatory body selects and enforces accounting standards to achieve certain social objectives. We show that various economic trade-offs give rise to endogenous earnings management. Specifically, the owner may reduce agency costs by designing a compensation contract that tolerates some earnings management because such a contract allocates the compensation risk more efficiently. The earnings-management activity produces accounting reports that deviate from those prescribed by accounting standards. Given such reports, the valuation of the firm may be nonlinear and s-shaped, thereby recognizing the manager's reporting incentives. We also explore policy implications, noting that (1) the regulator may find enforcing a zero-tolerance policy - no earnings management allowed - economically undesirable; and (2) when selecting the optimal accounting standard, valuation concerns may conflict with stewardship concerns. We conclude that earnings management is better understood in a strategic context that involves various economic trade-offs.
TL;DR: In this paper, the authors employ a novel application of the Bertrand et al. insight to study the hypothesis that controlling shareholders use acquisitions to expropriate resources to their benefit, and do not allow them to reject the null hypothesis of proportional sharing of acquisition gains in favor of the alternative hypothesis of expropriation of bidder's minority shareholders.
Abstract: An important and growing literature in finance points to existence of considerable benefits to being a controlling shareholder, especially when legal protection of minority shareholders is weak, and when separation of ownership from control is high. At the same time, the substantial and well established literature on mergers often finds these key corporate events to be subject to agency costs. Relying on these two arguments, we employ a novel application of the Bertrand et al. (2002) insight to study the hypothesis that controlling shareholders use acquisitions to expropriate resources to their benefit. The findings do not allow us to reject the null hypothesis of proportional sharing of acquisition gains in favor of the alternative hypothesis of expropriation of bidder's minority shareholders.
01 Jan 2004
TL;DR: In this article, the authors define and analyze the agency costs of overvalued equity and propose a set of organizational forces that are extremely difficult to manage -forces that almost inevitably lead to the destruction of part or all of the core value of the firm.
Abstract: I define and analyze the agency costs of overvalued equity. They explain the dramatic increase in corporate scandals and value destruction in the last five years; costs that have totaled hundreds of billions of dollars. When a firm's equity becomes substantially overvalued it sets in motion a set of organizational forces that are extremely difficult to manage - forces that almost inevitably lead to destruction of part or all of the core value of the firm. WorldCom, Enron, Nortel, and eToys are only a few examples of what can happen when these forces go unmanaged. Because we currently have no simple solutions to the agency costs of overvalued equity this is a promising area for future research. The first step in managing these forces lies in understanding the incongruous proposition that managers should not let their stock price get too high. By too high I mean a level at which management will be unable to deliver the performance required to support the market's valuation. Once a firm's stock price becomes substantially overvalued managers who wish to eliminate it are faced with disappointing the capital markets. This value resetting (what I call the elimination of overvaluation) is not value destruction because the overvaluation would disappear anyway. The resulting stock price decline will generate substantial pain for shareholders, board members, managers and employees, and this makes it difficult for managers and boards to short circuit the forces leading to value destruction. And when boards and managers choose to defend the overvaluation they end up destroying part or all of the core value of the firm. WorldCom, Enron, Nortel, and eToys are only a few examples of what can happen if these forces go unmanaged. Control markets cannot solve the problem because you cannot buy up an overvalued firm, eliminate the overvaluation and make money. Equity-based compensation cannot solve the problem because it makes the problem worse, not better. While it is puzzling that short selling was unable to resolve the problem the evidence seems to be consistent with the Shleifer and Vishny (1997) arguments for the limits of arbitrage. It appears the solution to these problems lies in the board of directors and the governance system. But that is a problem because there is substantial evidence that weak governance systems have failed widely. It also appears that boards and audit committees would be well served by communicating with and carefully evaluating the information that could be provided by short sellers of the firm's securities.
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TL;DR: In this article, the authors investigated whether lockup agreements in France and Germany mitigate problems of agency and asymmetric information, and found that lockup agreement are not only highly diverse across firms but also across the different shareholders of a single firm as most firms have different agreements in place for executives, non-executives and venture capitalists.
Abstract: This paper investigates whether shareholder lockup agreements in France and Germany mitigate problems of agency and asymmetric information. Despite minimum requirements in terms of the length and percentage of shares locked up, lockup agreements are not only highly diverse across firms but also across the different shareholders of a single firm as most firms have different agreements in place for executives, non-executives and venture capitalists. The diversity across firms and types of shareholders can be explained by firm characteristics - such as the level of uncertainty - as well as the type and importance of each shareholder within the firm.
TL;DR: In this article, a news vendor model is used to make optimal production decisions in the presence of financial constraints and managerial incentives, and the relationship between operating conditions and financial leverage is explored.
Abstract: While firm growth critically depends on financing ability and access to external capital, the operations management literature seldom considers the effects of financial constraints on the firms' operational decisions. Another critical assumption in traditional operations models is that corporate managers always act in the firm owners' best interests. Managers are, however, agents of the owners of the company, whose interests are often not aligned with those of equity-holders or debt-holders; hence, managers may make major decisions that are suboptimal from the firm owners' point of view. This paper builds on a news vendor model to make optimal production decisions in the presence of financial constraints and managerial incentives. We explore the relationship between operating conditions and financial leverage and observe that financial leverage can increase as margins reach either low or high extremes. We also provide some empirical support for this observation. We further extend our model to consider the effects of agency costs on the firm's production decision and debt choice by including performance-based bonuses in the manager's compensation. Our analyses show how managerial incentives may drive a manager to deviate from firm-optimal decisions and that low-margin producers face significant risk from this agency cost while high-margin producers face relatively low risk in using such compensation.
01 Jan 2004
TL;DR: This paper examined the effects of agency relationships on family firms and suggested the alternative influence of stewardship theory, which complements the agency framework in explaining entrepreneurial,organizationally-centered behaviors.
Abstract: Provides a reaction tothearticle"Comparing the agency costs of family and non-family firms:Conceptual issues and exploratory evidence," by Chrisman, Chua, and Litz inthe same issue of Entrepreneurship Theory and Practice. This commentaryexamines theeffects of agency relationships on family firms presented byChrisman et al, andsuggests the alternative influence of stewardshiptheory, which complements the agency framework in explaining entrepreneurial,organizationally-centered behaviors. The main thrust is to suggest that differences in organizational performanceare not driven by family involvement or its lack, but more by the existence ofagency or stewardship relationships within firms, regardless of the degree ofactual family involvement. Conclusions indicate that Chrisman et al.'s findingsmay be flawed because their study did not provide any significant performancedifferences between family and non-family firms. The differences may also varyby the types of businesses in which family firms are engaged. It is suggestedthat the issues of agency and stewardship relationships should be studied morecarefully and should avoid oversimple dichotomies such as family and non-familyfirms.(JSD)
Posted Content•
TL;DR: In this article, the authors developed and tested a model of how country characteristics, such as legal protections for minority investors, and the level of economic and financial development, influence firms' costs and benefits in implementing measures to improve their own governance and transparency.
Abstract: This paper develops and tests a model of how country characteristics, such as legal protections for minority investors, and the level of economic and financial development, influence firms’ costs and benefits in implementing measures to improve their own governance and transparency. The model focuses on an entrepreneur who needs to raise funds to finance the firm's investment opportunities and who decides whether or not to invest in better firm-level governance mechanisms to reduce agency costs. We show that, for a given level of country investor protection, the incentives to adopt better governance mechanisms at the firm level increase with a country’s financial and economic development. When economic and financial development is poor, the incentives to improve firm-level governance are low because outside finance is expensive and the adoption of better governance mechanisms is expensive. Using firm-level data on international corporate governance and transparency ratings for a large sample of firms from around the world, we find evidence consistent with this prediction. Specifically, we show that (1) almost all of the variation in governance ratings across firms in less developed countries is attributable to country characteristics rather than firm characteristics typically used to explain governance choices, (2) firm characteristics explain more of the variation in governance ratings in more developed countries, and (3) access to global capital markets sharpens firm incentives for better governance, but decreases the importance of home-country legal protections of minority investors.
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01 Jan 2004
TL;DR: The authors developed a quantitative, monetary business cycle model in which agency problems affect both the relationship between banks and firms as well as that linking banks to their depositors, and showed that bank capital and entrepreneurial net worth jointly determine aggregate investment, and help propagate over time shocks affecting the economy.
Abstract: Evidence suggests that banks, like firms, face financial frictions when raising funds. In this paper, we develop a quantitative, monetary business cycle model in which agency problems affect both the relationship between banks and firms as well as that linking banks to their depositors. As a result, bank capital and entrepreneurial net worth jointly determine aggregate investment,and help propagate over time shocks affecting the economy. Our findings are as follows. First, we find that the effects of monetary policy and technology shocks are dampened but more persistent in our environment, relative to an economy where the information friction facing banks is reduced or eliminated. Second, after documenting that the bank capital-asset ratio is countercyclical in the data, we show that our model, in which movements in the bank capital-asset ratio are market-determined, replicates that feature
TL;DR: This paper argued that controlling shareholders will tend to prefer poor firm transparency, to protect their private benefits of control, even if the presence of a demanding disclosure regime would have the socially desirable effect of increasing competition in the capital and product markets and reducing the agency costs associated with concentrated ownership structures.
Abstract: The desirability of mandatory disclosure requirements in securities regulation has been the subject of a longstanding debate among corporate law scholars and economists. The debate has largely focused on the desirability of mandatory disclosure requirements in the United States, a country characterized by dispersed ownership structures. This article argues that there are strong theoretical reasons to believe that mandatory disclosure requirements can play a socially useful role in countries with concentrated ownership structures. Controlling shareholders will tend to prefer poor firm transparency, to protect their private benefits of control, even if the presence of a demanding disclosure regime would have the socially desirable effect of increasing competition in the capital and product markets and reducing the agency costs associated with concentrated ownership structures. Recent empirical work is consistent with mandatory disclosure requirements fulfilling the valuable role of enhancing competition and reducing agency costs.
TL;DR: The authors examines the problems of agentification using a principal-agent framework, and attempts to explain the choices made between problems of commitment and problems of agency, and examines the degree of autonomy possible within a broader framework of political control of policy.
Abstract: This article focuses on problems of institutional design from a political perspective. It examines the problems of agentification using a principal–agent framework, and attempts to explain the choices made between problems of commitment and problems of agency. The fundamental problem addressed is the degree of autonomy possible within a broader framework of political control of policy. Copyright © 2004 John Wiley & Sons, Ltd.
Journal Article•
TL;DR: In this paper, the authors provided the largest empirical study of shareholder litigation to date, examining more than 1000 fiduciary duty suits filed in Delaware in a two-year period and found that more than 80 percent of these cases are class actions against public companies challenging one type of director decision-whether or not to participate in a corporate acquisition.
Abstract: Shareholder litigation, as illustrated by derivative lawsuits and federal securities class actions, has generated a long-running debate that sets its possible governance benefit in monitoring corporate management against the fears of its misuse by self-selected clients and attorneys. This article provides the largest empirical study of shareholder litigation to date, examining more than 1000 fiduciary duty suits filed in Delaware in a two-year period. It finds that more than 80 percent of these cases are class actions against public companies challenging one type of director decision-whether or not to participate in a corporate acquisition. These acquisition-oriented suits are now the dominant form of corporate litigation, outnumbering by a wide margin derivative suits, the traditional shareholder litigation that is the staple of corporate law casebooks. The acquisition-oriented class actions are a previously unstudied category of representative litigation, which permits us to shed new light on prior studies of state derivative suits and federal securities fraud class actions. These suits provide management agency costs reductions in some cases through substantial monetary settlements. The settlements leading to relief in an acquisition setting are not spread across all acquisitions complaints (including hostile, second bidder acquisitions etc.), but rather concentrated where there is a majority shareholder who is attempting to cash-out the minority interest held by public shareholders on terms that have been picked by the majority. And, within this subset, monetary settlement is more likely to occur where the initial takeover premiums was lower. The acquisition-oriented class action suits do have many of the characteristics that have been identified in other contexts as indicators of agency costs (e.g. suits filed quickly, many suits per transaction). Yet, these litigation agency costs are lower than the level of perceived costs that spurred securities fraud legislation. Placing these findings in the historical context of the debate over the value of representative shareholder litigation, this article suggests there are positive management agency costs reducing effects of acquisition-oriented class actions, while the litigation agency costs they create do not appear excessive. Shareholder litigation is the most frequently maligned legal check on managerial misconduct within corporations.1 Derivative lawsuits and federal securities class actions are portrayed as slackers in debates over how best to control the managerial agency costs created by the separation of ownership and control in the modern corporation.2 In each instance, early hopes that these suits would effectively monitor managerial misconduct have been replaced with concerns about the size of the litigation agency costs of such representative litigation. Such litigation agency costs can arise when a self-selected plaintiffs attorney and her client are appointed to pursue the claims of an entire class of shareholders and have interests that may differ from those of the class.3 Now, however, a new form of shareholder litigation has emerged that is distinct from derivative or securities fraud claims: class action lawsuits filed under state law challenging director conduct in mergers and acquisitions. The empirical data reported in this article show that these acquisition-oriented suits are now the dominant form of corporate litigation and outnumber derivative suits by a wide margin. Are these acquisition-oriented class actions just another deadbeat in the corporate governance debate? Should policymakers take action to cut back on the development of this new form of shareholder litigation? In this paper, we argue that, just as with derivative suits and securities fraud class actions, good policy must balance the positive managerial agency cost reducing effects of these acquisition-oriented shareholder suits against their litigation agency costs. …
TL;DR: This paper examined if non-management pay packages are set in ways consistent with the optimal contracting theory and found that significantly positive links exist between the ratio of current stock option grants to total compensation and seven future investment, risk and firm performance variables.
Abstract: This paper examines if non-management director pay packages are set in ways consistent with the optimal contracting theory. Under this theory, directors issue stock option grants as a means for providing non-management directors incentives to monitor adequately the risk-taking and investment opportunities that managers of the firm undertake. Our results are consistent with this theory. Using a sample of over 5,200 observations between 1997 and 2002, we find that (1) agency costs differ substantially across our sample, (2) boards systematically set their compensation contracts to address these agency costs, and (3) significantly positive links exist between the ratio of current stock option grants-to-total compensation and seven future investment, risk and firm performance variables. The investment variables are next period's change in research and development expenditures and change in capital expenditures. The risk variable is next year's stock return volatility. The firm performance variables are next period's Tobin's Q ratio, return on assets (ROA), a market return on current investments, and this period's stock return. Our results are incremental to board characteristics, CEO stock option grants, and economic, firm-specific, yearly, and industry control factors.
TL;DR: The authors found that more than 80% of these cases are class actions against public companies challenging one type of director decision - whether or not to participate in a corporate acquisition, where there is a majority shareholder who is attempting to cash-out the minority interest held by public shareholders on terms that have been picked by the majority.
Abstract: Shareholder litigation is the most frequently maligned legal check on managerial misconduct within corporations. Derivative lawsuits and federal securities class actions are portrayed as slackers in debates over how best to control the managerial agency costs created by the separation of ownership and control in the modern corporation. In each instance, early hopes these suits would effectively monitor managerial misconduct have been replaced with concerns about the size of the litigation agency costs of such representative litigation, which can arise when a self-selected plaintiff's attorney and her client that are appointed to pursue the claims of an entire class of shareholders have interests that may differ from those of the class. Now, however, a new form of shareholder litigation has emerged that is distinct from derivative or securities fraud claims: class action lawsuits filed under state law challenging director conduct in mergers and acquisitions. The empirical data reported in this article show that these acquisition-oriented suits are now the dominant form of corporate litigation, outnumbering derivative suits by a wide margin. Are these acquisition-oriented class actions just another deadbeat in the corporate governance debate? Should policymakers take action to cut back on the development of this new form of shareholder litigation? In this paper, we argue that, just as with derivative suits and securities fraud class actions, good policy must balance the positive management agency cost reducing effects of these acquisition-oriented shareholder suits against their litigation agency costs. This new breed of suits has positive management agency cost reducing effects that may offset the litigation agency costs that accompany them. Our data set of all 1000 corporate fiduciary duty cases filed in Delaware in 1999 and 2000 is the largest empirical study of shareholder litigation. We find that more than 80% of these cases are class actions against public companies challenging one type of director decision - whether or not to participate in a corporate acquisition. By contrast, derivative suits, the traditional shareholder litigation that is the staple of corporate law casebooks, make up only about 14% of all fiduciary duty suits. The acquisition-oriented class actions are a new, previously unstudied category of representative litigation, an area long dominated by studies of state derivative suits and federal securities fraud class actions. We find these suits do provide some management agency costs reductions, but these are concentrated in only one subset of the suits that are brought. Settlements leading to relief in an acquisition setting are not spread across all acquisitions complaints (including hostile, second bidder acquisitions, etc.), but rather concentrated where there is a majority shareholder who is attempting to cash-out the minority interest held by public shareholders on terms that have been picked by the majority. On the opposite side of the equation - whether these suits possess high litigation agency costs - we find conflicting evidence. The acquisition-oriented class action suits have many characteristics that have been identified in other contexts as indicators of agency costs (e.g., suits filed quickly, many suits per transaction). Yet, these litigation agency costs are below the level of perceived costs that spurred securities fraud legislation. Placing our findings in the historical context of the debate over the value of representative shareholder litigation, we believe that the positive management agency cost reducing effects of acquisition-oriented class actions are substantial, while the litigation agency costs they create do not appear excessive. For these suits, we therefore disagree with earlier studies that have claimed that all representative shareholder litigation has little, if any, effect in reducing management agency costs and should be evaluated solely in terms of its litigation agency costs.
TL;DR: In this paper, the authors explore the implications of the free cash flow hypothesis concerning the disciplinary role of ownership structure in corporate capital structure policy, and show that the sensitivity of the ownership structure to leverage depends on growth opportunities and free-cash flow.
Abstract: This paper, using 833 observations of listed Japanese firms between the years 1992 to 2000, explore the implications of the free cash flow hypothesis concerning the disciplinary role of ownership structure in corporate capital structure policy. The results show (1) the sensitivity of ownership structure to leverage depends on growth opportunities and free cash flow. (2) Keiretsu classification affects relations between ownership structure and leverage. Overall, the results generally support the free cash flow hypothesis.
TL;DR: In this paper, the authors consider agency costs in determining the optimal staffing/ outsourcing balance, and propose a strategy to reduce the cost of outsourced business functions to focus on core competencies and cut operating expenses.
Abstract: Firms outsource business functions to focus on core competencies and cut operating expenses. However, companies must consider agency costs in determining the optimal staffing/ outsourcing balance. ...
Journal Article•
TL;DR: In this article, the authors argue that the absence of globally valid rules for organizational design and management means that public administration will be more of an art than a science, and that most good solutions to public administration problems, while having certain common features of institutional design, will not be clear-cut "best practices" because they will have to incorporate a great deal of context-specific information.
Abstract: Is public administration a science or an art? The answer to this question matters greatly to state building, because good public administration is key to effective governance. If public administration--the organization and management of individual public agencies--is a science, then presumably it can be transferred to developing countries much like knowledge of how to maintain jet aircraft or operate a factory. On the other hand, if it is more of an art, then teaching good public administration and setting up competent public agencies will be much more problematic. This article will argue that there is no optimal form of organization, either in the private sector or among public sector agencies. The absence of globally valid rules for organizational design and management means that public administration will be more of an art than a science. This implies that most good solutions to public administration problems, while having certain common features of institutional design, will not be clear-cut "best practices" because they will have to incorporate a great deal of context-specific information. Theorizing about organizational design has been dominated by economists in recent years, who have sought to incorporate organizations into broader microeconomic theory. This effort has yielded certain important and useful insights into public sector reform. But in the end, the behavioral assumptions on which neoclassical economics rests--in particular, the assumption that people in organizations are motivated primarily by individual self-interest--are too limited to provide understanding of key aspects of organizational behavior. This line of thought has eclipsed earlier, more sociological understandings of organizations and has obscured some important insights of that tradition. INSTITUTIONAL ECONOMICS AND THE THEORY OF ORGANIZATIONS For all of its richness and complexity, a huge amount of organizational theory revolves around a single, central problem: that of delegated discretion. The conundrum of organization theory is that while efficiency requires the delegation of discretion in decision-making and authority the very act of delegation creates problems of control and supervision. Observes one leading organization theorist, Because all information cannot be moved to a central decision maker, whether a central planner in an economy or the CEO in a firm, most decision rights must be delegated to those people who have the relevant information. The cost of moving information between people creates the necessity for decentralizing some decision rights in organizations and the economy. This decentralization in turn leads to systems to mitigate the control problem that results from the fact that self-interested people (with their own self-control problems) who exercise decision rights as agents on behalf of others will not behave as perfect agents. (1) The problem of delegated discretion is currently conceptualized by economists under the rubric of "principal-agent" relationships, something that has become the overarching framework for understanding governance problems. Berle and Means recognized long ago that the divorce of ownership from management in modern corporations created significant corporate governance problems. (2) The owners, or principals, designate managers, or agents, to look after their interests, but the agents often face individual incentives that differ sharply from those of the principals. This is a problem with all forms of hierarchical organization, and can exist at multiple levels of the hierarchy simultaneously. Jensen and Meckling introduced the concept of agency costs, which were the costs that principals had to pay to ensure that agents did their bidding. (3) These costs included the costs of monitoring agent behavior, bonding the agent and the residual losses that occurred when the agent acted in ways contrary to the interests of the firm. …
01 Jan 2004
TL;DR: In this paper, the authors test hypotheses about the structure of corporate debt ownership and the use of bank debt by firms in a civil-law country, Spain, focusing on bank debt effects in the presence of information asymmetries and agency costs, and on efficient versus inefficient firm liquidation.
Abstract: We test hypotheses about the structure of corporate debt ownership and the use of bank debt by firms in a civil-law country, Spain. We focus on bank debt effects in the presence of information asymmetries and agency costs, and on efficient versus inefficient firm liquidation. We find that the relation between growth opportunities and bank financing is not as strong as the one found in common-law countries, that there is a positive relation between firm size and the proportion of bank debt used, and that firms closer to bankruptcy and highly leveraged are more likely to use bank debt.