Showing papers on "Agency cost published in 2009"

The "Wall Street Walk" and Shareholder Activism: Exit as a Form of Voice

Abstract: We examine whether a large shareholder can alleviate conflicts of interest between managers and shareholders through the credible threat of exit on the basis of private information. In our model, the threat of exit often reduces agency costs, but additional private information need not enhance the effectiveness of the mechanism. Moreover, the threat of exit can produce quite different effects depending on whether the agency problem involves desirable or undesirable actions from shareholders’ perspective. Our results are consistent with empirical findings on the interaction between managers and minority large shareholders and have further empirical implications. (JEL D53, D82, G10, G30, G34) The role of active large shareholders in improving corporate performance has been discussed extensively in the last two decades. Although large shareholders (including pension funds, mutual funds, hedge funds, and other investors) hold a substantial and increasing fraction of shares in public companies in the United States, most large shareholders play a limited role in overt forms of shareholder activism such as takeovers, proxy fights, strategic voting, shareholders’ proposals, etc. One likely reason for this is that active shareholders only realize a relatively small fraction of the benefits from their monitoring while bearing the full cost, which can be substantial. In other words, we have a classic “free rider” problem. In addition, legal barriers, agency problems affecting the incentives of the large shareholder, and the fact that many large shareholders are committed to being passive and not investing resources to monitor their portfolio firms

Entrepreneurial Shareholder Activism: Hedge Funds and Other Private Investors

Abstract: We examine recent confrontational activism campaigns by hedge funds and other private investors. The main parallels between the groups are a significantly positive market reaction for the target firm around the initial Schedule 13D filing date, significantly positive returns over the subsequent year, and the activist’s high success rate in achieving its original objective. Further, both activists frequently gain board representation through real or threatened proxy solicitations. Two major differences are that hedge funds target more profitable firms than other activists, and hedge funds address cash flow agency costs whereas other private investors change the target’s investment strategies. IN THIS PAPER, WE EXAMINE RECENT aggressive campaigns by entrepreneurial shareholder activists. In the spirit of Pound (1992), we define an entrepreneurial activist as an investor who buys a large stake in a publicly held corporation with the intention to bring about change and thereby realize a profit on the investment. We conduct our analyses on two samples of entrepreneurial activists. The common feature to both groups is that the investor is relatively free from the regulatory controls of the Securities Act of 1933, the Securities Exchange Act of 1934, and most notably the Investment Company Act of 1940. The first sample consists of 151 hedge fund activist campaigns conducted primarily between 2003 and 2005. Hedge fund activism has received widespread attention, both in the popular press and by legal and financial scholars. 1 Our paper complements and extends this research by examining the determinants, methods, and consequences of hedge fund managers who undertake confrontational activist

Promarket Reforms and Firm profitability in Developing Countries

Abstract: This study proposes that promarket reforms positively affect firms' profitability in developing countries because the accompanying improvements in external monitoring decrease firms' agency costs. ...

Misselling through Agents

Abstract: This paper analyzes the implications of the inherent conflict between two tasks performed by direct marketing agents: prospecting for customers and advis ing on the product's "suitability" for the specific needs of customers. When structuring salesforce compensation, firms trade off the expected losses from "misselling" unsuitable products with the agency costs of providing market ing incentives. We characterize how the equilibrium amount of misselling (and thus the scope of policy intervention) depends on features of the agency problem including: the internal organization of a firm's sales process, the transparency of its commission structure, and the steepness of its agents' sales incentives. (JEL M31, M37, M52) When purchasing unfamiliar products, consumers often rely on information and advice pro vided by representatives of the seller. This creates the possibility of "misselling," the question able practice of a salesperson selling a product that may not match a customer's specific needs.1 This problem is particularly severe in markets for technically complex products, such as con sumer electronics, auto repairs, medical care, and retail financial services including securities, pensions, insurance policies, and mortgages. An important feature of these markets is that the seller often deals with the customer through an agent, rather than directly. For example, financial brokers typically recommend purchase of a specific product after inquiring about their customers' particular circumstances and needs. The possibility of abuse has led to regulation in some of these markets, most notably for securities transactions. The Financial Industry Regulatory Authority (FINRA), the major self-regulatory organization for securities firms operating in the United States, mandates that broker-dealers make a reasonable effort to obtain information about the individual characteristics of their (noninstitutional) cus tomers and to ensure that their recommendations are "suitable" to customers' financial situations

Corporate Payout Policy

Abstract: We present a synthesis of academic research on corporate payout policy grounded in the pioneering contributions of Lintner (1956) and Miller and Modigliani (1961). We conclude that a simple asymmetric information framework that emphasizes the need to distribute FCF and that embeds agency costs (as in Jensen (1986)) and security valuation problems (as in Myers and Majluf (1984)) does a good job of explaining the main features of observed payout policies - i.e., the massive size of corporate payouts, their timing and, to a lesser degree, their (dividend versus stock repurchase) form. We also conclude that managerial signaling motives, clientele demands, tax deferral benefits, investors' behavioral heuristics, and investor sentiment have at best minor influences on payout policy, but that behavioral biases at the managerial level (e.g., over-confidence) and the idiosyncratic preferences of controlling stockholders plausibly have a first-order impact. 1 Introduction 2 Basic Theory: The Need to Distribute Free Cash Flow is Foundational 3 Security Valuation Problems, Agency Costs, and Optimal Payout Policy 4 Corporate Payouts: Scale, Concentration, and Earnings Linkage 5 Payouts and Earnings: A Closer Look 6 Are Dividends Disappearing' 7 Why Do Dividends Survive' 8 Signaling and the Information Content of Dividends 9 Behavioral Influences on Payout Policy 10 Clientele Effects: Transaction Costs, Institutional Ownership, and Payout Policy 11 Controlling Stockholders and Payout Policy 12 Taxes and Payout Policy 13 The Advantages of Stock Repurchases 14 Conclusion: What We Know About Payout Policy and Promising Avenues for Future Research

The Impact of Managerial Entrenchment on Agency Costs: An Empirical Investigation Using UK Panel Data

Abstract: This paper empirically investigates the relationship between managerial entrenchment and agency costs for a large sample of UK firms over the period 1999-2005. To measure managerial entrenchment, we use detailed information on ownership and board structures and managerial compensation. We develop a managerial entrenchment index, which captures the extent to which managers have the ability and incentives to expropriate wealth from shareholders. Our findings, which are based on a dynamic panel data analysis, show that there is a strong negative relationship between managerial entrenchment and our inverse proxy for agency costs, namely asset turnover ratio. There is also evidence that short-term debt and dividend payments work as effective corporate governance devices for UK firms. Finally, our findings reveal that agency costs are persistent over time. The results are robust to a number of alternative specifications, including varying measures of managerial entrenchment and agency costs. © 2007 Blackwell Publishing Ltd.

Financial Reporting Quality, Private Information, Monitoring and the Lease-Versus-Buy Decision

Abstract: A flourishing research stream examining how accounting quality affects asset purchases ignores off-balance sheet leasing. This research concludes that low accounting quality limits firms’ access to capital for investments. Our finding that low accounting quality firms lease more of their assets has important implications for interpreting this research. Although low accounting quality firms may purchase fewer assets, our results suggest that these firms may substitute leased assets for purchased assets. To verify that leasing does not merely reflect these firms’ desire for off-balance sheet accounting but instead substitutes for accounting quality when addressing agency problems, we investigate how banks' private information and monitoring affect the relation between accounting quality and leasing. We find a lower association between accounting quality and leasing when banks’ have higher monitoring incentives and when loans contain capital expenditure provisions. The mitigation of the negative relation between accounting quality and leasing by other information asymmetry and agency cost reducing mechanisms suggests that this association reflects the role of accounting quality in reducing information problems. These findings also document cross-sectional variation in accounting quality’s affect on leasing. Our paper suggests that ignoring the substitution between leasing and asset purchases affects the inferences from prior research.

Do multiple large shareholders play a corporate governance role? evidence from east asia

Abstract: We examine the governance role of multiple large shareholder structures (MLSS) to determine their valuation effects in a sample of 1,252 publicly traded firms from nine East Asian economies. We find that the presence, number, and size of multiple large shareholders are associated with a significant valuation premium. Our results also show that the identity of MLSS influences corporate value and that the valuation effects of MLSS are more pronounced in firms with greater agency costs. Our results imply that MLSS play a valuable monitoring role in curbing the diversion of corporate resources.

The association between dividend payout and outside directorships

Abstract: Purpose – The purpose of this paper is to examine whether the number of outside directors on the board of directors and dividend payout are substitutes or complements mechanisms applied by UK firms to control agency conflicts of interest within the firm. Design/methodology/approach – The authors use tobit and logit regression models to examine the extent to which firms with a majority of outside directors on their boards experience significantly lower or higher dividend payout after controlling for insider ownership, profitability, liquidity, asset structure, business risk, firm size, firms' growth rate and borrowing ratio. Findings – Based on a sample of 400 non‐financial firms listed at London Stock Exchange for the period from 1991 to 2002, it was found that dividend payout is negatively associated with the number of outside directors on the board of directors. Originality/value – The results suggest that firms pay lower dividends when higher number of outside directors is employed on the board. This evidence is consistent with the substitution hypothesis, which indicated that firms with weak corporate governance need to establish a reputation by paying dividends. In other words, dividends substitute for independent directors on the board. This finding offers novel insights to policy makers interested in agency conflicts of interest within the firm. It also provides evidence on the use of different substitute mechanisms for reducing agency costs.

The economic nature of the firm : a reader

Abstract: Preface The economic nature of the firm: a new introduction Louis Putterman and Randall S. Kroszner Part I. Within and Among Firms. The Division of Labor: 1. From The Wealth of Nations Adam Smith 2. From Capital Karl Marx 3. From Risk, Uncertainty, and Profit Frank Knight 4. The use of knowledge in society Friedrich Hayek 5. Relational exchange: economics and complex contracts Victor Goldberg 6. From The Visible Hand Alfred Chandler Part II. The Scope of the Firm: 7. The nature of the firm Ronald Coase 8. Vertical integration, appropriable rents, and the competitive contracting process Benjamin Klein, Robert Crawford and Armen Alchian 9. The governance of contractual relations Oliver Williamson 10. The organization of industry G. B. Richardson 11. The limits of firms: incentive and bureaucratic features Oliver Williamson 12. Bargaining costs, influence costs, and the organization of economic activity Paul Milgrom and John Roberts 13. Towards an economic theory of the multiproduct firm David Teece Part III. The Employment Relation, The Human Factor, and Internal Organization: 14. Production, information costs, and economic organization Armen Alchian and Harold Demsetz 15. Contested exchange: new microfoundations for the political economy of capitalism Samuel Bowles and Herbert Gintis 16. Understanding the employment relation: the analysis of idiosyncratic exchange Oliver Williamson, Michael Wachter and Jeffrey Harris 17. Multitask principal-agent analyses: incentive contracts, asset ownership, and job design Bengt Holmstrom and Paul Milgrom 18. The prisoners' dilemma in the invisible hand: an analysis of intrafirm productivity Harvey Leibenstein 19. Labor contracts as partial gift exchange George Akerlof 20. Profit sharing and productivity Martin Weitzman and Douglas Kruse Part IV. Finance and the Control of the Firm: 21. Mergers and the market for corporate control Henry Manne 22. Agency problems and the theory of the firm Eugene Fama 23. Theory of the firm: managerial behavior, agency costs, and ownership structure Michael Jensen and William Meckling 24. Organizational forms and decision control Eugene Fama and Michael Jensen 25. The structure of ownership and the theory of the firm Harold Demsetz 26. An economist's perspective on the theory of the firm Oliver Hart 27. Ownership and the nature of the firm Louis Putterman References.

Determinants of the Dividend Policy in Emerging Stock Exchanges: The Case of GCC Countries

Abstract: This paper investigates the determinants of dividend policies for firms listed on Gulf Co-operation Council (GCC) country stock exchanges . This is a case study of emerging stock exchanges, where the determinants of dividend policy have received little attention. This study used a panel dataset of non-financial firms listed on the GCC country stock exchanges between the years of 1999 and 2003. Seven hypotheses pertaining to agency cost theory were investigated using a series of random effect Tobit models. The models considered the impact of government ownership, free cash flow, firm size, growth rate, growth opportunity, business risk, and firm profitability on dividend payout ratios. The results suggest that the main characteristics of firm dividend payout policy were that dividend payments related strongly and directly to government ownership, firm size and firm profitability, but negatively to the leverage ratio. These results, taken as a whole, indicate that firms pay dividends with the intention of reducing the agency problem and maintaining firm reputation, since the legal protection for outside shareholders was limited. In addition, and as a result of the significant agency conflicts interacting with the need to built firm reputation, a firm’s dividend policy was found to depend heavily on firm profitability. This may indicate that listed firms in GCC countries alter their dividend policy frequently and do not adopt a long-run target dividend policy.

The Case Against Shareholder Empowerment

Abstract: Many look toward enactment of the law reform agenda held out by proponents of shareholder empowerment as a part of the regulatory response to the financial crisis. This Article argues that the financial crisis exposes major weaknesses in the shareholder case. Our claim is that shareholder empowerment delivers management a simple and emphatic marching order: manage to maximize the market price of the stock. And that is exactly what the managers of a critical set of financial firms did in recent years. They managed to a market that focused on increasing observable earnings and, as it turned out, failed to factor in concomitant increases in risk that went largely unobserved. The fact that management bears primary responsibility for the disastrous results does not suffice to effect a policy connection between increased shareholder power and sound regulatory reform. A policy connection instead turns on a counterfactual question: Whether increased shareholder power would have imported more effective risk management in advance of the crisis. We conclude that no plausible grounds exist for making such a case. In the years preceding the financial crisis, shareholders validated the strategies of the very financial firms that pursued high leverage, high return, and high risk strategies and penalized those that did not. It is hard to see how shareholders, having played a role in fomenting the crisis, have a positive role to play in its resolution.The prevailing legal model of the corporation strikes a better balance between the powers of directors and shareholders than does the shareholder-centered alternative. Shareholder proponents see management agency costs as a constant in history and shareholder empowerment as the only tool available to reduce them. This Article counters this picture, making reference to agency theory and recent history to describe a dynamic process of agency cost reduction. It goes on to show that shareholder empowerment would occasion significant agency costs on its own by forcing management to a market price set in most cases under asymmetric information and set in some cases in speculative markets in which heterogeneous expectations obscure the price’s informational content.

Private Equity Syndication: Agency Costs, Reputation and Collaboration

Abstract: Syndicates are a form of inter-firm alliance in which two or more private equity firms invest together in an investee firm and share a joint pay-off, and are an enduring feature of the leveraged buyout (LBO) and private equity industry. This study examines the relationship between syndication and agency costs at the investor-investee level, and the extent to which the reputation and the network position of the lead investor mediate this relationship. We examine this relationship using a sample of 1,122 buyout investments by 80 private equity companies in the UK between 1993 and 2006. Our findings show that where agency costs are highest, and hence ex-post monitoring by the lead investor is more important, syndication is less likely to occur. The negative relationship between agency costs and syndication, however, is alleviated by the reputation and network position of the lead investor firm.

Private Family Ownership and the Agency Costs of Debt

Abstract: This article presents empirical evidence on the agency costs of debt in private family firms by examining the explicit (interest rate) as well as implicit (business and personal collateral) bank loan price simultaneously. Using a cross sectional sample of lines-of-credit of the NSSBF database, family firms appear to be more likely to pledge personal collateral which suggests that agency costs of debt are higher in family firms. Hence, personal collateral seems to be a better instrument than interest rates or business collateral for financial institutions to cope with the specific agency problems (e.g. self-control problems and negative effects of parental altruism) in family firms.

An Examination of the Impact of the Sarbanes-Oxley Act on the Attractiveness of US Capital Markets for Foreign Firms

Abstract: We examine whether voluntary deregistrations after the passage of Sarbanes-Oxley Act of 2002 (SOX) were intended to benefit common shareholders by avoiding firms’ costs of complying with SOX and/or to protect the control rents of managers or controlling shareholders (MCOs) from the corporate governance mandates of SOX. We find that, compared to foreign firms that maintained their SEC registrations, foreign firms which voluntarily deregistered on average had weaker corporate governance, had a significantly less negative stock market reaction when SOX was passed, and suffered a significant price decline when they announced their decision to deregister. We also find evidence indicating that the deregistrations were (to a lesser extent) motivated by firms’ compliance costs related to SOX. Taken together, our results suggest that both agency costs (i.e., private benefit of control of the MCOs) and the compliance cost of SOX play a role in motivating foreign firms to withdraw from the U.S. market. Comparative analysis of voluntary delistings from the LSE Main Market supports the notion that SOX and its related agency costs constitute important factors in firms’ decision to leave the U.S.

Discretionary Disclosure in Financial Reporting: An Examination Comparing Internal Firm Data to Externally Reported Segment Data

Abstract: We use confidential, US Census Bureau, plant-level data to investigate aggregation in external reporting We compare firms’ plant-level data to their published segment reports, conducting our tests by grouping a firm’s plants that share the same four-digit SIC code into a “pseudo-segment” We then determine whether that pseudo-segment is disclosed as an external segment, or whether it is subsumed into a different business unit for external reporting purposes We find pseudo-segments are more likely to be aggregated within a line-of-business segment when the agency and proprietary costs of separately reporting the pseudo-segment are higher and when firm and pseudo-segment characteristics allow for more discretion in the application of segment reporting rules For firms reporting multiple external segments, aggregation of pseudosegments is driven by both agency and proprietary costs However, for firms reporting a single external segment, we find no evidence of an agency cost motive for aggregation

Agency Problems and Audit Fees: Further Tests of the Free Cash Flow Hypothesis

Abstract: This study finds that the agency problems of companies with high free cash flow (FCF) and low growth opportunities induce auditors of companies in the US to raise audit fees to compensate for the additional effort. We also find that high FCF companies with high growth prospects have higher audit fees. In both cases, higher debt levels moderate the increased fees, consistent with the role of debt as a monitoring mechanism. Other mechanisms to mitigate the agency costs of FCF such as dividend payout and share repurchase (not studied earlier) do not moderate the higher audit fees.

The Conditional Nature of the Value of Corporate Governance

Abstract: Agency theory suggests that governance matters more among firms with greater potential agency costs. Rational investors are unlikely to value safeguards against unlikely events. Yet, few studies of the relation between governance and firm value control for investor perceptions of the likelihood of agency conflicts. Shleifer and Vishny (1997) identify investment-related agency conflicts as the more severe type of agency conflicts in the U.S. We measure the perceived likelihood of this type of agency conflict using free cash flow (Jensen, 1986). We find that firm value is an increasing function of improved governance quality among firms with high free cash flow. In contrast, governance benefits are lower or insignificant among firms with low free cash flow. We show that not controlling for this conditional relation between governance and firm value could lead to erroneous conclusions that governance and firm value are unrelated.

Worker Directors: A German Product that Didn't Export?

Abstract: Despite its lack of attractiveness to other countries, the German system of quasi-parity codetermination at company level has held up remarkably well. We recount the theoretical arguments for and against codetermination and survey the empirical evidence on the effects of the institution, tracing the three phases of a still sparse literature. Recent findings hold out the prospect that good corporate governance might include employee representation by virtue of the monitoring function and the reduction in agency costs, while yet cautioning that the optimal level of representation is likely below parity. And although the German system may be better than its reputation among foreigners, it might have to adapt to globalization and the availability of alternative forms of corporate governance in the EU.

Agency Problems and Audit Fees: Further Tests of the Free Cash Flow Hypothesis

Abstract: This study finds that the agency problems of companies with high free cash flow (FCF) and low growth opportunities induce auditors of companies in the United States to raise audit fees to compensate for the additional effort. We also find that high FCF companies with high growth prospects have higher audit fees. In both cases, higher debt levels moderate the increased fees, consistent with the role of debt as a monitoring mechanism. Other mechanisms to mitigate the agency costs of FCF such as dividend payout and share repurchase (not studied earlier) do not moderate the higher audit fees.

Staggered Boards, Managerial Entrenchment, and Dividend Policy

Abstract: Motivated by agency theory, we explore the potential impact of managerial entrenchment through staggered boards on dividend policy. The evidence suggests that firms with staggered boards are more likely to pay dividends. Among firms that pay dividends, those with staggered boards pay larger dividends. We also show that the impact of staggered boards on dividend payouts is substantially stronger (as much as two to three times larger) than the effect of all other corporate governance provisions combined. Overall, the evidence is consistent with the notion that dividends help alleviate agency conflicts. Thus, firms more vulnerable to managerial entrenchment, i.e., firms with staggered boards, rely more on dividends to mitigate agency costs. Aware of potential endogeneity, we demonstrate that staggered boards likely bring about, and are not merely associated with, larger dividend payouts. Our results are important, as they show that certain governance provisions have considerably more influence than others on critical corporate activities such as dividend payout decisions.

Securities Laws, Disclosure, and National Capital Markets in the Age of Financial Globalization

Abstract: As barriers to international investment fall and technology improves, the cost advantages for a firm's securities to trade publicly in the country in which that firm is located and for that country to have a market for publicly traded securities distinct from the capital markets of other countries will progressively disappear. Securities laws remain an important determinant of whether and where securities are issued, how they are valued, who owns them, and where they trade. I show that there is a demand from entrepreneurs for mechanisms that allow them to commit to credible disclosure because disclosure helps reduce agency costs. Under some circumstances, mandatory disclosure through securities laws can help satisfy that demand, but only provided investors or the state can act on the information disclosed and the laws cannot be weakened ex post too much through lobbying by corporate insiders. With financial globalization, national disclosure laws can have wide-ranging effects on a country's welfare, on firms and on investor portfolios, including the extent to which share holdings reveal a home bias. In equilibrium, if firms can choose the securities laws they are subject to when they go public, some firms will choose stronger securities laws than those of the country in which they are located and some firms will do the opposite.

Does a Family-Controlled Firm Perform Better in Corporate Venturing?

Abstract: Family control involves issues of agency costs and nepotism. This study investigated the impacts of family control on stock market reactions to corporate venturing announcements by public firms. Moreover, in this paper we examined whether the monitoring effect of institutional investors influenced the relationship between family control and stock market reactions. In terms of research findings/results, with different measures of family control, the evidence indicated that family control is significantly and negatively associated with the abnormal returns of corporate venturing announcements. Furthermore, we found that the divergence of cash flow and voting rights had a strong negative impact on abnormal returns. Finally, the empirical results suggested that institutional ownership had a significant positive moderating effect on the relationship of family control and stock market reactions. Prior research focused on the influence of private family firms on venturing activities. This study contributes to the literature by highlighting the unique characteristics of family control in public firms. This research suggests that nepotism embedded in public family firms is likely to create agency costs resulting from deviations in cash flow and voting rights. This study further shows that institutional ownership plays an important role in reducing agency costs associated with public family firms. Our findings suggest that family control is an important consideration for investors in evaluating the wealth impacts of corporate venturing. Therefore, a well-established governance system could be a crucial signal of the quality of corporate venturing for family businesses, particularly the outside governance mechanism.

Executive Compensation and the Maturity Structure of Corporate Debt

Abstract: Executive compensation influences managerial risk preferences through the executive’s portfolio sensitivities to changes in stock prices (delta) and stock return volatility (vega). Large deltas discourage managerial risk-taking, while large vegas encourage risk-taking. Theory suggests that short-maturity debt mitigates agency costs of debt by constraining managerial risk preferences. We posit and confirm a negative (positive) relation between CEO portfolio deltas (vegas) and short-term debt. We also find that the influence of vega- and delta-related incentives on bond yields is mitigated by short-maturity debt. Overall, our empirical evidence shows that short-term debt mitigates agency costs of debt arising from compensation risk.

Entrepreneurial Financing and Costly Due Diligence

Abstract: In the traditional solution to the adverse selection problem, entrepreneurs indirectly signal quality via security choice, typically debt. This paper models an alternative solution. The costly due diligence of venture capitalists directly reveals the quality of projects, thereby reducing information asymmetry. It is shown that this mechanism necessitates profit-sharing, a contractual feature usually associated in the literature with managerial agency costs rather than adverse selection.