Showing papers on "Agency cost published in 2016"

Agency Costs of Free Cash Flow

Abstract: Free Cash Flow (FCF) agency conflicts exist when managers divert cash flow for private benefits. We identify the impact of unobservable FCF conflicts on firm policy using a structural approach. Measurement equations are constructed based on observable managerial choices: payout policy changes and personal portfolio decisions around exogenous tax rate changes. We find that FCF agency conflicts cause (i) under-leverage, leading to higher corporate taxes and (ii) under-investment in PP&E, leading to slower firm growth. Capital markets recognize FCF conflicts and discount such firms. Finally, firms with (i) large institutional holdings or (ii) better-aligned executive compensation, suffer less from FCF agency conflicts.

Corporate governance and firm performance in developing countries: evidence from India

Abstract: Purpose This study aims to examine the impact of corporate governance on firm performance for a large representative sample. Design/methodology/approach This empirical analysis focuses on a large number of companies covering 20 important industries of the Indian manufacturing sector for the period 2001-2010. Several alternative specifications and estimation techniques are used for analysis purposes, including system generalized methods of moments, which effectively overcomes the problem of endogeneity and simultaneity bias. Findings On one side, the findings indicate that larger boards are associated with a greater depth of intellectual knowledge, which in turn helps in improving decision-making and enhancing the performance. On the other side, the results indicate that return on equity and profitability is not related to corporate governance indicators. The results also suggest that CEO duality is not related to any firm performance measures for the sample firms. Practical implications The outcomes of the analyses advocated that companies that comply with good corporate governance practices can expect to achieve higher accounting and market performance. It implies that good corporate governance practices lead to reduced agency costs. Hence, it is concluded that firms of the developing world can possibly enhance their performance by implementing good corporate governance practices. Originality/value Departing from the conventional system of the prior studies and instead of focusing on a single measure framework, a range of measures of corporate governance and firm's performance variables are used. Also, several alternative specifications and estimation techniques are used for analysis purposes. Furthermore, the sample also covers a large sample of manufacturing firms.

Auditor Changes: A Joint Test of Theories Relating to Agency Costs and Auditor Differentiation

Abstract: This study tests whether there is a positive association between a firm's agency costs and its demand for a quality-differentiated audit. Audit firm quality is represented in two ways: a continuous size model in which a direct association is posited between auditor size (measured by clients' sales) and audit quality, and a "brand name" model in which the Big Eight group of auditors is defined as higher quality suppliers. The tests are supportive of the brand name model of audit quality: agency cost proxies are significant as a group, after controlling for client size and growth, only in the brand name model. The results are also supportive (albeit weakly in some instances) of the following individual agency-related incentives for higher quality audits: monitoring of incentive performance contracts, diffusion of ownership, owner-debtholder conflict, and the subsequent issue of public securities after the auditor change. However, the explanatory power of the models tested is low, after controlling for client size and growth. T HIS paper tests whether the demand for quality-differentiated audits is, in part, associated with variables that proxy for the firm's agency costs (after controlling for client size and growth). Auditing is widely viewed as a means of reducing agency costs [Jensen and Meckling, 1976; Ng, 1978; Simunic and Stein, 1987; Watts, 1977; and Watts and Zimmerman, 1983]. It follows that when agency costs are greater there is increased demand for higher-level audit quality. To test the hypothesis that higherquality audits are demanded as a function of increasing agency costs, a sample of firms is selected that changed auditors. The framework adopted for testing can be described as follows: given that a change in auditor has occurred, is the choice of the new auditor associated with the firm's agency costs? Audit quality is measured in each of two different ways to correspond to the two general theories of audit quality: (1) a continuous auditor size metric based on combined sales of all public companies audited (a proxy for client-specific quasi-rents) and (2) an ordinal categorical variable representing either the brand name Big Eight or nonBig Eight accounting firms. Two repreJere R. Francis is an Associate Professor at University of Iowa, and Earl R. Wilson is an Assistant Professor at University of Missouri-Columbia. Manuscript received June 1986. Revisions received March 1987, September 1987, and April 1988. Accepted May 1988.

Do Exogenous Changes in Passive Institutional Ownership Affect Corporate Governance and Firm Value

Abstract: We investigate whether corporations and their executives react to an exogenous change in passive institutional ownership and alter their corporate governance structure. We find that exogenous increases in passive ownership lead to increases in CEO power and fewer new independent director appointments. Consistent with these changes not being beneficial for shareholders, we observe negative announcement returns to the appointments of new independent directors. We also show that firms carry out worse mergers and acquisitions after exogenous increases in passive ownership. These results suggest that the changed ownership structure causes higher agency costs.

Corporate Governance and Executive Compensation for Corporate Social Responsibility

Abstract: We link the corporate governance literature in financial economics to the agency cost perspective of corporate social responsibility (CSR) to derive theoretical predictions about the relationship between corporate governance and the existence of executive compensation incentives for CSR. We test our predictions using novel executive compensation contract data, and find that firms with more shareholder-friendly corporate governance are more likely to provide compensation to executives linked to firm social performance outcomes. Also, providing executives with direct incentives for CSR is an effective tool to increase firm social performance. The findings provide evidence identifying corporate governance as a determinant of managerial incentives for social performance, and suggest that CSR activities are more likely to be beneficial to shareholders, as opposed to an agency cost.

Earnings management behaviors under different monitoring mechanisms: The case of Islamic and conventional banks

Abstract: We investigate the impact of organizational religiosity on the earnings quality of listed banks in the Middle East and North Africa region. We analyze Islamic banking institutions, which operate within strict religious norms and extended accountability constraints, and compare them with their conventional counterparts during 2008–2013. We find that Islamic banks are less likely to manage earnings and that they adopt more conservative accounting policies. Based on these findings, we argue that religious norms and moral accountability constraints in these organizations have a significant impact on financial reporting quality and agency costs, which have implications for both regulators and market participants.

CEO power, corporate social responsibility, and firm value: a test of agency theory

Abstract: Purpose The purpose of this paper is to explore whether firms with powerful chief executive officers (CEOs) tend to invest (more) in corporate social responsibility (CSR) activities as the over-investment hypothesis based on classical agency theory predicts. Design/methodology/approach This paper tests an alternative hypothesis that if CSR investment is indeed an agency cost like the over-investment hypothesis suggests, then those activities may destroy firm value. Findings Using CEO pay slice (Bebchuk et al., 2011), CEO tenure, and CEO duality to measure CEO power, the authors show that CEO power is negatively correlated with firm’s choice to engage in CSR and with the level of CSR activities in the firm. Furthermore, the results suggest that CSR activities are in fact value enhancing in that as firms engage in more CSR activities their value increases. Originality/value The first paper to study CEO power and CSR and their impact on firm value.

Free cash flow, over-investment and corporate governance in China

Abstract: We investigate whether and how free cash flow and corporate governance characteristics affect firm level investments, using a sample of 865 Chinese listed firms. Consistent with the agency cost explanation, we find that firms' over-investment is more sensitive to current free cash flow and that over-investment is more pronounced in firms with positive free cash flows. Also, we find that certain corporate governance characteristics are significantly related to firm level investment. Further, we divide the full sample into two subsamples: over-investment firms and under-investment firms. For over-investment firms, our evidence indicates that higher state-ownership concentration boosts over-investment, while firms with higher proportion of tradable shares, larger board size of supervisors or higher leverage mitigate over-investment. For under-investment firms, our evidence shows that firms with higher state-ownership concentration, larger board size of directors or higher proportion of outside directors are associated with severer under-investment, while firms with higher leverage or higher proportion of tradable shares alleviate under-investment.

National culture and the cost of debt

Abstract: This study investigates how Schwartz’s cultural dimensions of embeddedness and mastery affect the corporate cost of debt through bankruptcy risk and sensitivity to agency activity channels. Using data from 33 countries, we find a strong and robust negative relation between embeddedness and the cost of debt. The estimated relation between mastery and the corporate cost of debt is negative and significant in most of the tests. Further analyses reveal that the development of financial intermediation and the enforcement of insider trading law moderate the relation between culture and the cost of debt. Confirming our hypotheses, we document that embeddedness is negatively related to bankruptcy risk and sensitivity to agency activity. We find that mastery is positively related to bankruptcy risk across countries as well, but this relation is weaker. We also show that mastery is positively related to sensitivity to agency activity among countries with highly leveraged firms.

Earnings Management, Capital Structure, and the Role of Institutional Environments

Abstract: This paper examines the effect of earnings management on financial leverage and how this relation is influenced by institutional environments by employing a large panel of 25,777 firms across 37 countries spanning the years 1989–2009. We find that firms with high earnings management activities are associated with high financial leverage. More importantly, this positive relation is attenuated by strong institutional environments. Our results lend strong support to the notions that (1) both corporate debt and institutional environments can be served as external control mechanisms to alleviate the agency cost of free cash flow; and (2) it is less costly to rely on institutional environments than debt. After meticulously addressing the possible endogeneity issues and conducting various robustness tests, our main conclusions remain confirmed.

Managerial Ownership and Agency Cost: Evidence from Bangladesh

Abstract: This study examines the influence of managerial ownership on firm agency costs among listed firms in Bangladesh. This is an institutional setting that features a mixture of agency costs. This institutional setting has a concentration of ownership by managers, but the firms are not solely owned by managers. The extant literature suggests that the sacrifice of wealth by the principal and potential costs associated with monitoring the agents is known as the agency cost. This study uses three measures of agency cost: the ‘expense ratio’, the ‘Q-free cash flow interaction’, and the ‘asset utilisation ratio’. The finding of the study is that managerial ownership reduces the firm agency cost only under the ‘asset utilisation ratio’ measure of agency cost; this is robust with regard to a number of robustness tests. Furthermore, the non-linearity tests suggest that the convergence of interest is evident with very high and low levels of managerial ownership. The entrenchment effect by the owners is evident at moderate levels of managerial ownership. Although there has been great scepticism among management researchers on the validity of agency theory, overall, the findings of this study do not reject the validity of agency theory. Given that the entrenchment by managers is evident at certain levels of ownership and that the agency problem may still exist between insiders and outsiders, legislative guidelines for controlling share ownership may be required.

Corporate political connections, agency costs and audit quality

Abstract: Purpose The effect of political connections of agency costs has attracted considerable research attention due to the increasing recognition of the fact that political connection influences corporate decisions and outcomes. This paper aims to explore the association between corporate political connections and agency cost and examine whether audit quality moderates this association. Design/methodology/approach A data set of Bangladeshi listed non-financial companies is used. A usable sample of 968 firm-year observations was drawn for the period from 2005 to 2013. Asset utilisation ratio, the interaction of Tobin’s Q and free cash flow and expense ratio are used as alternative proxies for agency costs; membership to Big 4 audit firms or local associates of Big 4 firms is used as a proxy for audit quality. Findings Results show that politically connected firms exhibit higher agency costs than their unconnected counterparts, and audit quality moderates the relationship between political connection and agency costs. The results of this paper suggest the importance of audit quality to mitigate agency problem in an emerging economic setting. Research limitations/implications The findings of this paper could be of interest to regulators wishing to focus regulatory effort on significant issues influencing stock market efficiency. The findings could also inform auditors in directing audit effort through a more complete assessment of risk and determining reasonable levels of audit fees. Finally, results could inform financial statement users to direct investments to firms with lower agency costs. Originality/value To the knowledge of the authors, this study is one of the first to explore the relationship between political connection and agency costs, and the moderating effect of audit quality of this relationship.

Cross-country evidence on the importance of auditor choice to corporate debt maturity

Abstract: We examine the importance of Big Four audits in reducing agency costs evident in corporate debt maturity worldwide. Analyzing a large sample of public firms from 42 countries reveals that the fraction of long-term debt in firms' capital structures rises with the presence of a Big Four auditor, suggesting that higher-quality audits substitute for short-term debt for monitoring purposes. In additional analyses, we find that the role that auditor choice plays in debt maturity is concentrated in firms from countries with strong legal institutions governing property rights and creditor rights. Collectively, our research implies that Big Four audits matter to corporate debt maturity, although the impact is isolated in firms operating in countries with more protective legal regimes.

Corporate governance mechanisms and agency costs: cross-country analysis

Abstract: Purpose The purpose of this paper is to investigate whether specific corporate governance mechanisms, such as board size, board composition, leverage and firm size, tend to mitigate agency cost occurrence in the USA, Russia and Norway. Design/methodology/approach The authors analyze the sample of 243 US, 196 Russian and 175 Norwegian joint stock companies for the period 2004-2012. The regression analysis is applied to test the models. Findings It is revealed that larger boards increase agency costs (measured by asset utilization ratio and asset liquidity ratio) in all sample companies. The proportion of female members has a very slight positive effect in US companies, a negative influence on agency costs in the Norwegian sample and is not significant in the Russian market. The authors find that the big Russian and US companies in the samples of this paper have lower agency costs. Practical implications The results of this paper show which agency-mitigation mechanisms work more effectively in companies operating in the analyzed countries characterized by specific corporate governance models. Originality/value The main contribution of this paper to the empirical literature is that it extends the stream of agency research by introducing new, emerging markets: represented by Scandinavian (depicted by the Norwegian sample) and Russian companies. Considering that each market – US, Norwegian and Russian – represents significant distinguishing features in their institutional framework, the paper provides an important research setting in which corporate governance mechanisms can be analyzed from the perspective of a country’s peculiar characteristics. Unlike other agency cost studies, this paper accounts for the gender diversity component in the companies and contributes to gender diversity issues.

How to design infrastructure contracts in a warming world: a critical appraisal of public–private partnerships*

Abstract: We analyze how long-term uncertainty, for example, regarding future climate conditions, affects the design of concession contracts and organizational forms in a principal–agent context, with dynamic moral hazard, limited liability, and irreversibility constraints. The prospect of future, uncertain productivity shocks on the returns on the firm's effort creates an option value of delaying efforts, a course that exacerbates agency costs. Contracts and organizational forms are drafted to control this cost of delegated flexibility. The possibility for the agent to delay investment in response to uncertainty and irreversibility also elicits preference for unbundling different stages of the project through short-term contracts. Our analysis is relevant to infrastructure sectors that are sensitive to changing weather conditions and sheds a pessimistic light on the relevance of public–private partnerships in this context.

Do business groups affect corporate cash holdings? Evidence from a transition economy

Abstract: We examine whether business groups’ influence on cash holdings depends on ownership. Group affiliation can increase firms’ agency costs or benefit firms by providing an internal capital market, especially in transition economies characterized by weak investor protection and difficult external capital acquisition. A hand-collected dataset of Chinese firms reveals that group affiliation decreases cash holdings, alleviating the free-cash-flow problem of agency costs. State ownership and control of listed firms moderate this benefit, which is more pronounced when the financial market is less liquid. Group affiliation facilitates related-party transactions, increases debt capacity and decreases investment-cash-flow sensitivity and overinvestment. In transitional economies, privately controlled firms are more likely to benefit from group affiliation than state-controlled firms propped up by the government.

Socially Responsible Firms

Abstract: In the corporate finance tradition, starting with Berle and Means (1932), corporations should generally be run to maximize shareholder value. The agency view of corporate social responsibility (CSR) considers CSR an agency problem and a waste of corporate resources. Given our identification strategy by means of an instrumental variable approach, we find that well-governed firms that suffer less from agency concerns (less cash abundance, positive pay-for-performance, small control wedge, strong minority protection) engage more in CSR. We also find that a positive relation exists between CSR and value and that CSR attenuates the negative relation between managerial entrenchment and value.

Managerial power, agency cost and executive compensation – an empirical study from China

Abstract: Purpose Based on the theory of “optimal contracting approach” and “the managerial power approach”, this paper aims to investigate whether senior executives of listed companies in China make use of their power to gain their own private benefits. The paper also compares compensation contracts between state- and private-owned enterprises to test whether there is a significant difference between senior executives from different ownership types of enterprises in terms of compensation contracts. Design/methodology/approach The paper raises four hypotheses based on the theories of “company agency”, “optimal contracting approach” and “managerial power approach”. After that, 5,680 A-share-listed companies of stock market in Shanghai and in Shenzhen Stock Market from 2008 to 2012 were taken as research samples to conduct a series of research analysis, including t-test, reliability analysis and regression analysis, with the help of SPSS 18.0. Findings The senior executives of listed companies in China could make use of their power to increase their own salary to gain power pay and, at the same time, company performance, company size and other factors that are important to influence the executive compensation. This paper further argues that senior executives of private-owned listed companies are more likely to use their power to obtain power pay and increase their own compensation. Additionally, the agency costs of Chinese listed companies are negatively related to the performance pay of senior executives, whereas there is no obvious negative correlation with the power pay of senior executives. Practical implications This paper takes multiple, in-depth approaches to study the relationship among managerial power, agency cost and executive compensation and to find out the differences in compensation contracts of senior executives between private-owned listed companies and state-owned companies. It also provides necessary suggestions to ensure the interests of stockholders, such as: optimizing the management structure of listed companies; improving the transparence of information disclosure of listed companies; establishing effective mechanism of incentive and constraint; and improving and standardizing the market of professional managers. Social implications The compensation contract of senior executives in China is critical to enhance enterprises’ performance, and it will become an important factor that will facilitate the interests of stockholders and management. However, this paper argues that some phenomena of over-payment of senior executives in listed companies cannot be explained by the theory of “optimal contracting approach”, but it is necessary and important to compare the differences of compensation contract of senior executives between private-owned listed companies and state-owned companies. A series of findings are proposed in this paper. Originality/value This paper made use of a principal analysis to extract the main factors that could represent the managerial power from different angles. In addition, this paper also compared the differences between compensation contracts of senior executives between private-owned listed companies and state-owned companies. Additionally, in this paper, the compensation of senior executives was divided into “power compensation” and “performance compensation”, which were used to test the relationship with the management cost of companies.

Contingent Capital, Real Options, and Agency Costs

Abstract: This paper aims to clarify how contingent convertible bond (CoCo) as a debt financing instrument affects a firm's investment policy, agency cost of debt, and capital structure. We consider endogenous and exogenous conversion thresholds, respectively. Under the exogenous case, there is an explicit optimal fraction of equity allocated to CoCo holders upon conversion, such that the agency cost reaches zero. Numerical analysis demonstrates that under an endogenous conversion threshold, CoCo induces overinvestment, a higher leverage, a possible bigger agency cost, and a stronger incentive to increase risk. But if the conversion threshold is exogenously determined, almost the opposite holds true.

Bank Dividends, Agency Costs and Shareholder and Creditor Rights

Abstract: Using data on listed bankes in 51 countries, we analyze whether banks’ dividend payouts are influenced by the relative strengths of the agency conflicts faced by their shareholders and creditors. We show that dividend policy depends on the relative strengths of these agency conflicts, but with a more decisive role played by the agency cost of equity than the one of debt, in contrast to results found in the literature on non-financial firms. We then further investigate whether those relationships are shaped by differences in funding structure, levels of capitalization and capital stringency, and potential differences in external corporate governance mechanisms.

Director network resources and firm performance: Evidence from Indian corporate governance reforms

Abstract: Drawing on resource-dependence theory, we hypothesized that in an emerging economy characterized by weak underdeveloped institutions, director interlocks would be a conduit of resources external to the firm. Using data from 651 large Indian firms for the years 2006–2012, we found that directors’, especially independent directors’, social capital and industry-level expertise enhanced firm performance. Our findings contribute by providing evidence of the beneficial role of directors in providing resources through their interlocks, contrary to the basic tenet of corporate governance that independent directors are chosen for their monitoring role to reduce agency costs.

Essays on Financing and Performance: The role of firms, banks and boards

Abstract: markdownThe way firms and their boards interact with their shareholders or financiers is a difficult balancing act. How firms, banks and board fulfil their role has a significant impact on corporate financing decisions and performance. In three studies, this dissertation combines studies in economic history with contemporary research in corporate finance. The first study investigate the determinants of this bank distress in the Netherlands during the 1920s. During this period the Dutch economy suffered an unequalled financial crisis. This study finds that during this time, banks that acquired too much leverage and attracted large quantities of deposits were more likely to fail. More so the investigation showed that international activities increased bankruptcy risk and that board characteristics, such as interlocking directorates, were important determinants of failure probabilities. The second study takes a more long-run perspective and examines the relation between individual Dutch board members and the outcome of corporate policies such as dividends, investments and capital structures over the entire twentieth century. The study shows that individual Dutch directors have significant impact on corporate policies and performance, their contribution explains between four and eleven percent of the cross-sectional variation in various key metrics over the century. Moreover the study identifies individuals with substantial contributions to corporate performance and provides a historical understanding of the effects these individuals have on corporate policies. Results suggest that the impact of big linkers is primarily due to their social capital and their extensive management experience. The third study investigates the impact of corporate financial flexibility on dividend smoothing practices. First, the study documents that firms smooth their dividends more when they are more financially flexible. Second, the examination shows that firms smooth their dividends more when agency costs are high and that corporate capital structure choices absorb shocks to net income and enables dividend smoothing. The empirical results of these studies highlight each in their own manner the role of firms, banks and boards.