Showing papers on "Agency cost published in 2008"

Managerial Empire Building and Firm Disclosure

Abstract: This study tests the agency cost hypothesis in the context of geographic earnings disclosures. The agency cost hypothesis predicts that managers, when not monitored by shareholders, make self-maximizing decisions that may not necessarily be in the best interest of shareholders. These decisions include aggressively growing the firm, which reduces profitability and destroys firm value. Geographic earnings disclosures provide an interesting context to examine this issue. Beginning with Statement of Financial Accounting Standards No. 131 (SFAS 131), most U.S. multinational firms are no longer required to disclose earnings by geographic area (e.g., net income in Mexico or net income in East Asia). Such nondisclosure potentially reduces the ability of shareholders to monitor managers' decisions related to foreign operations. Using a sample of U.S. multinationals with substantial foreign operations, we find that nondisclosing firms, relative to firms that continue to disclose geographic earnings, experience greater expansion of foreign sales, produce lower foreign profit margins, and have lower firm value in the post–SFAS 131 period. Our conclusions are strengthened by the fact that these differences do not exist in the pre–SFAS 131 period and do not relate to domestic operations. We find differences in the predicted direction only for foreign operations and only after adoption of SFAS 131. Our results are robust to the inclusion of an extensive set of control variables related to alternative corporate governance mechanisms, operating performance, and the firm's information environment. Overall, the results are consistent with the agency cost hypothesis and the important role of financial disclosures in monitoring managers.

Agency Problems at Dual-Class Companies

Abstract: We use a sample of U.S. dual-class companies to examine how the divergence between insider voting rights and cash-flow rights affects managerial extraction of private benefits of control. We find that as the divergence widens at dual-class companies, corporate cash holdings are worth less to outside shareholders, CEOs receive higher levels of compensation, managers are more likely to make shareholder-value destroying acquisitions, and capital expenditures contribute less to shareholder value. These findings support the hypothesis that managers with greater control rights in excess of cash-flow rights are prone to waste corporate resources to pursue private benefits at the expense of shareholders. As such, they contribute to our understanding of why firm value is decreasing in the insider control-cash flow rights divergence.

Board Structure, Ownership, and Voluntary Disclosure in Ireland

Abstract: Manuscript Type: Empirical Research Question/Issue: This is a cross-sectional study of the relation between corporate governance and voluntary disclosure in Ireland. Research Findings/Results: We report clear evidence that voluntary disclosure increases with the number of nonexecutive directors on the board. Firms that have a nonexecutive chairman make greater voluntary disclosures than other firms. This finding is not robust to the inclusion of other explanatory variables. We find no evidence that ownership structure is related to voluntary disclosure. Theoretical Implications: The results regarding nonexecutive directors are interpreted as independent boards facilitating a reduction in information asymmetry between owners and managers. While this supports the predictions of agency theory, the absence of evidence that ownership structure influences voluntary disclosure does not. It is posited that sociological and organizational factors (e.g., informal networking) that pervade the Irish market mitigate against our disclosure measure capturing all aspects of voluntary disclosure. Furthermore, indirect evidence is provided that there are other costs and benefits to disclosure that vary across firms and may outweigh agency costs in many situations. We conclude that while agency theory has some explanatory power for voluntary disclosure, it cannot explain all the cross-sectional differences in voluntary disclosure by Irish public limited companies. Practical Implications: The results support the attention paid by regulators to the proportion of nonexecutive directors on the board. However, the costs and benefits to disclosure vary across firms. Regardless of agency considerations and regulatory guidelines, firms will ultimately formulate their disclosure policy with reference to overall marginal costs and marginal benefits.

Agency costs and corporate governance mechanisms: evidence for UK firms

Abstract: Purpose – This paper aims to extend the empirical literature on the determinants of agency costs by using a large sample of UK listed firms.Design/methodology/approach – The paper investigates the impact of several corporate governance mechanisms on two alternative proxies for agency costs, namely the ratio of total sales to total assets (asset turnover) and the ratio of selling, general and administrative expenses to total sales (SG&A). The analysis depends on a cross‐sectional regression approach.Findings – The results reveal that the capital structure characteristics of firms, namely bank debt and debt maturity, constitute important corporate governance devices for UK companies. Also, managerial ownership, managerial compensation and ownership concentration are strongly associated with agency costs. Finally, the results suggest that the impact exerted by specific internal governance mechanisms on agency costs varies with firms' growth opportunities.Originality/value – The analysis adds to the empirical...

Corporate Governance and Capital Structure Dynamics

Abstract: We develop a dynamic tradeoff model to examine the importance of manager-shareholder conflicts in capital structure choice. Using panel data on leverage choices and the model's predictions for different statistical moments of leverage, we show that while refinancing costs help explain the patterns observed in the data, their quantitative effects on debt choices are too small to explain financing decisions. We also show that by adding agency conflicts in the model and giving the manager control over the leverage decision, one can obtain capital structure dynamics consistent with the data. In particular, we find that the model needs an average agency cost of 1.5% of equity value to resolve the low-leverage puzzle and to explain the time series of observed leverage ratios. Our estimates also reveal that the variation in agency costs across firms is sizeable and that the levels of agency conflicts inferred from the data correlate with commonly used proxies for corporate governance.

Multiple Large Shareholders, Control Contests, and Implied Cost of Equity

Abstract: In this paper, we examine whether the presence of multiple large shareholders alleviates firm's agency costs and information asymmetry embedded in ultimate ownership structures. We extend extant corporate governance research by addressing the effects of multiple large shareholders on firm's cost of equity capital - a proxy for firm's information quality. Using data for 1,165 listed corporations from 8 East Asian and 13 Western European countries, we find evidence that the implied cost of equity decreases in the presence of large shareholders beyond the controlling owner. We also find that the voting rights, the relative voting size (vis-a-vis the first largest shareholder) and the number of blockholders reduces firm's cost of equity. Interestingly, we uncover that the presence of multiple controlling shareholders with comparable voting power lowers firm's cost of equity. We also find that the identity of the second largest shareholder is important in determining the risk of corporate expropriation in family-controlled firms. Our regional analysis reveals that, mainly in East Asian firms, multiple large shareholders structures exert an internal governance role in curbing private benefits and reducing information asymmetry evident in cost of equity financing, perhaps to sidestep deficiencies in the external institutional environment.

Principal-Principal Conflict in the Governance of the Chinese Public Corporation

Abstract: By examining the level of ownership concentration across firms, we determine how principal-principal conflict, defined as the incongruence of ownership goals among shareholder groups in a corporation, impacts agency costs of Chinese boards of directors. Based on data from Chinese companies listed on the Shanghai and Shenzhen stock exchanges during 1999-2003, we found that ownership concentration had a U-shaped relationship with board compensation, board size and the presence of independent directors. These results provide corroborating evidence that principal-principal conflict can lead to high agency costs.

Managerial Empire Building and Firm Disclosure

Abstract: This study tests the agency cost hypothesis in the context of geographic earnings disclosures. The agency cost hypothesis predicts that managers, when not monitored by shareholders, will make self-maximizing decisions which may not necessarily be in the best interest of shareholders. These decisions include aggressively growing the firm, which reduces profitability and destroys firm value. Geographic earnings disclosures provide an interesting context to examine this issue. Beginning with Statement of Financial Accounting Standards No. 131 (SFAS 131), most U.S. multinational firms are no longer required to disclose earnings by geographic area (e.g., net income in Mexico or net income in East Asia). Such non-disclosure potentially reduces the ability of shareholders to monitor managers' decisions related to foreign operations. Using a sample of U.S. multinationals with substantial foreign operations, we find that non-disclosing firms, relative to firms that continue to disclose geographic earnings, experience greater expansion of foreign sales, produce lower foreign profit margins, and have lower firm value in the post-SFAS 131 period. Our conclusions are strengthened by the fact that these differences do not exist in the pre-SFAS 131 period and do not relate to domestic operations. We find differences in the predicted direction only for foreign operations and only after adoption of SFAS 131. Our results are robust to the inclusion of an extensive set of control variables related to alternative corporate governance mechanisms, operating performance, and the firm's information environment. Overall, the results are consistent with the agency cost hypothesis and the important role of financial disclosures in monitoring managers.

Women in Top Management and Agency Costs

Abstract: This study investigates gender diversity among the top managers of Fortune 500 firms and its effect on agency costs. The study finds that firms with a greater percentage of female officers present lower agency costs but that the negative relation is not robust when considering the endogeneity of diversity. Moreover, the study finds that external governance influences the relationship. Although increasing diversity does not reduce agency costs for all firms, the evidence shows that diversity is significantly negatively related to agency costs in firms in less competitive markets. The results suggest that increasing diversity in management can have beneficial effects for firms where strong external governance is absent.

Executive pay dispersion, corporate governance, and firm performance

Abstract: Much of the research on management compensation focuses on the level and structure of executives’ pay. In this study, we examine a compensation element that has not received so far considerable research attention—the dispersion of compensation across managers—and its impact on firm performance. We examine the implications of two theoretical models dealing with pay dispersion—tournament versus equity fairness. Tournament theory stipulates that a large pay dispersion provides strong incentives to highly qualified managers, leading to higher efforts and improved enterprise performance, while arguments for equity fairness suggest that greater pay dispersion increases envy and dysfunctional behavior among team members, adversely affecting performance. Consistent with tournament theory, we find that firm performance, measured by either Tobin’s Q or stock performance, is positively associated with the dispersion of management compensation. We also document that the positive association between firm performance and pay dispersion is stronger in firms with high agency costs related to managerial discretion. Furthermore, effective corporate governance, especially high board independence, strengthens the positive association between firm performance and pay dispersion. Our findings thus add to the compensation literature a potentially important dimension: managerial pay dispersion.

Large Shareholder Entrenchment and Performance: Empirical Evidence from Canada

Abstract: Recent empirical evidence indicates that the largest publicly traded companies throughout the world have concentrated ownership. This is the case in Canada where voting rights are often concentrated in the hands of large shareholders, mostly wealthy families. Such concentrated ownership structures can generate specific agency problems, such as large shareholders expropriating wealth from minority shareholders. These costs are aggravated when large shareholders don't bear the full costs of their decisions because of the presence of mechanisms (dual class voting shares, pyramids) which lead to voting rights being greater than the cash flow rights (separation). We assess the impact of separation on various performance metrics while controlling for situations when the large shareholder has (1) the opportunity to expropriate (high free cash flows in the firm) and (2) the incentive to expropriate (low cash flow rights). We also control for when the large shareholder has the power to expropriate (high voting rights, outright control and insider management) and for the presence of family ownership. The results support our hypotheses and indicate that firm performance is lower when large shareholders have both the incentives and the opportunity to expropriate minority shareholders.

Institutional Logics or Agency Costs: The Influence of Corporate Governance Models on Business Group Restructuring in Emerging Economies

Abstract: Business groups, the leading economic players in emerging economies, have responded to the market-oriented transition primarily through corporate restructuring. Agency theory predicts that acquisition and divestiture would serve the interests of dominant families and foreign investors in different ways. Further, dominant families, foreign investors from shareholder-based countries, and foreign investors from stakeholder-based countries each operate under distinct institutional logics of appropriate restructuring strategies. We test hypotheses about agency and institutional mechanisms using large business groups in Taiwan between 1986 and 1998 as our empirical example. We find that, consistent with both mechanisms, family-controlled business groups are less likely to divest of unrelated businesses. However, the institutional logics mechanism can better explain the relative lack of unrelated acquisition in family-controlled groups and the difference in divestiture between groups with more shareholder-based ...

Do Managers Listen to the Market

Abstract: There are competing theories as to whether managers learn from stock prices. Dye and Sridhar (2002), for example, argue that capital markets can be better informed than the firm itself, while Roll (1986) argues managers may ignore market signals due to hubris. In this paper, we examine whether managers listen to the market in making major corporate investments, and whether agency costs and corporate governance mechanisms help explain managers' propensity to listen. We find that, on average, managers listen to the market: they are more likely to cancel investments when the market reacts unfavorably to the related announcement. Further, we find mixed evidence consistent with the notion that managers' propensity to listen is related to agency costs. We find that firms tend to listen to the market more when more of their shares are held by large blockholders, and when their CEOs have higher pay-performance sensitivities.

Ownership Concentration, Corporate Governance and Firm Performance: Evidence from Pakistan

Abstract: The nature of relation between the ownership structure and corporate governance structure has been the core issue in the corporate governance literature. From a firms’ perspective, ownership structure determines the firms’ profitability, enjoyed by different stake-holders. In particular, ownership structure is an incentive device for reducing the agency costs associated with the separation of ownership and management, which can be used to protect property rights of the firm [Barbosa and Louri (2002)]. With the development of corporate governance, many corporations owned by disperse shareholders and are controlled by hire manager. As a results incorporated firms whose owners are dispersed and each of them owns a small fraction of total outstanding shares, tend to under-perform as indicated by Berle and Means (1932). Latter this theoretical relationship between a firm’s ownership structure and its performance is empirically examined by Jensen and Meckling (1976) and Shlefier and Vishny (1986). In most of developing markets including Pakistan, the closely held firms (family or state-controlled firms or firms held by corporations and by financial institutions) dominate the economic landscape. The main agency problem is not the managershareholder conflict but rather the risk of expropriation by the dominant or controlling shareholder at the expense of minority shareholders. The agency problem in these markets is that control is often obtained through complex pyramid structures,1 interlock directorship,2 cross shareholdings,3 voting pacts and/or dual class voting shares that allow the ultimate owner to maintain (voting) control while owning a small fraction of ownership (cash flow rights).

Disclosure on Corporate Governance in the European Union

Abstract: Manuscript Type: Empirical Research Question/Issue: In this paper, we examine the determinants of the level of disclosure on corporate governance practices among European listed companies in the time period preceding the adoption of the European Union recommendations and Action Plan. Research Findings/Results: Using ratings on corporate governance disclosure issued by an independent rating agency we find that –ceteris paribus– the level of disclosure: (1) is lower for companies with higher ownership concentration; (2) is higher for companies from common-law countries; and (3) increases with the level of working capital accruals. Theoretical Implications: The results of the study support theoretical arguments that companies disclose corporate governance information in order to reduce information asymmetry and agency costs stemming from the separation between ownership and control, and to improve investor confidence in the reported accounting information. The study suggests various avenues for future research on corporate governance. Practical Implications: To policy makers and practitioners, the results suggest that a mandatory corporate governance disclosure requirement is abundant, and perhaps could even be inefficient. The results also indicate which types of companies can be expected to be least willing to comply with recent corporate governance disclosure requirements, and thus will need extra monitoring.

The Impact of the Options Backdating Scandal on Shareholders

Abstract: The revelation that scores of firms engaged in the illegal manipulation of stock options' grant dates (i.e. "backdating") captured much public attention. The evidence indicates that the consequences stemming from management misconduct and misrepresentation are of first-order importance in this context as shareholders of firms accused of backdating experience large negative, statistically significant abnormal returns. Furthermore, shareholders' losses are directly related to firms' likely culpability and the magnitude of the resulting restatements, despite the limited cash flow implications. And, tellingly, the losses are attenuated when tainted management of less successful firms is more likely to be replaced, whereas relatively many firms become takeover targets. We believe this evidence is relevant to the ongoing debate about the economic relevance of seemingly inconsequential corporate misdeeds, in general, and option grants manipulation, in particular.

Insider ownership and corporate performance: evidence from Germany

Abstract: In this paper we address the question whether insider ownership affects corporate performance. Evidence from studies dealing with Anglo-Saxon countries is rather inconclusive, especially because results seem to be significantly affected by endogeneity. Economically, this is due to the fact that in these countries insider ownership seems to be mainly driven by management’s compensation contracts. We argue that Germany is different in this regard, as insider ownership is often related to family control, stock-based compensation is less widespread, and the market for corporate control used to be less developed. Starting from this presumption, our data allows an unbiased observation as to whether insider ownership affects firm performance. Using a pooled data set of 648 firm observations for the years 2003 and 1998, we find evidence for a positive and significant relationship between corporate performance—as measured by stock price performance, market-to-book ratio and return on assets—and insider ownership. This relationship seems to be rather robust, even if we account for potential endogeneity by applying a 2SLS regression approach. Furthermore, the results hold for a sub-sample of firms that did not have a stock-based compensation program in place. Moreover, we find outside block ownership as well as more concentrated insider ownership to have a positive impact on corporate performance. Overall, the results indicate that ownership structure might be an important variable explaining the long term value creation in the corporate sector.

Information Asymmetries, Agency Costs and Venture Capital Exit Outcomes

Abstract: This paper provides theory and evidence relating information asymmetries and agency costs to exit outcomes in venture capital backed entrepreneurial firms. Where venture capitalists are able to better mitigate information asymmetries and agency costs faced by the new owners of the firm, they will be more likely to have a successful exit outcome. Information asymmetries and agency costs will vary depending on the characteristics of the venture capitalist and entrepreneurial firm, as well as the structure of the financing arrangement. This paper introduces a new dataset comprising all venture capital exits in Canada for the years 1991 to 2004. The data provide strong support for the conjecture that the ability to mitigate information asymmetries and agency costs is a central factor in influencing exit outcomes.

Share reacquisitions, surplus cash, and agency problems

Abstract: Share repurchases help alleviate agency costs of surplus cash by restricting management’s scope to waste corporate resources. But why do self-interested managers agree to disgorge surplus cash in the first place? This study examines the intervening effect of managerial monitoring and incentive alignment mechanisms on the decision to distribute excess cash through a share repurchase. Findings indicate that repurchases substitute for cash retention decisions that would otherwise prove costly for shareholders, and that better managerial incentive alignment and closer monitoring by external shareholders are important factors stimulating such payouts.

Factors Influencing Corporate Dividend Decision: Evidence from Jordanian Panel Data

Abstract: This paper examines the determinants of corporate dividend decisions of publicly quoted companies in Jordan as a case study of an emerging market. The analysis is based on 15-year unbalanced panel data with 1137 firm-year observations covering the period between 1989 and 2003. The study develops five research hypotheses and used the general-to-specific modelling approach to choose between the competing hypotheses. We estimate the determinants for a given firm to pay dividends to its shareholders through Probit specifications. The factors that affect dividend policy in developed stock markets seem to apply for this emerging market. For example, factors such as size, profitability, and age increase the likelihood to pay dividends. Financial leverage decreases the probability to pay dividends. Taken together, the findings provide support for the agency costs hypothesis and are broadly consistent with the pecking order hypothesis.

Capital Structure, Staggered Boards, and Firm Value

Abstract: Grounded in agency theory, this study investigates whether staggered boards (in which only a portion of directors are elected at one time) influence capital structure choices. Leverage has been argued and shown to alleviate agency costs. Because staggered boards can entrench inefficient managers, they may motivate managers to adopt a lower level of debt, thereby avoiding the disciplinary mechanisms associated with leverage. The empirical evidence supports this hypothesis, showing that firms with a staggered board are significantly less leveraged than those with unitary boards (in which all board members are elected at one time). The impact of staggered boards on capital structure choices exists both in industrial and regulated firms although it seems to vanish after enactment of the Sarbanes–Oxley Act of 2002. The results show that staggered boards are likely to bring about, and do not merely reflect, lower leverage. Finally, the results demonstrate no significant adverse impact on firm value as a result ...