This summary contains the following papers:
Misangyi, Ndofor, Hill, Hou, Shin, Zhang, Hooghiemstra, Krause, Nguyen, Harrison, He, Hillman, Ashbaugh-skaife, Connelly, Hillman, Sauerwald, Christensen, De Villiers, Flammer, Kang
Lecture 1: PowerPoint
(principal) Agency theory is about aligning the interest of the principal and agent. Separation of
ownership and control leads to agency problems. There are a few agency problems. The first agency
problem is information asymmetry. Information asymmetry is about the agent knowing something
that the principal does not know. This could have happened ex ante (beforehand) during the hiring
process of the CEO and ex post (after) with moral hazard in which the agent chooses to take
decisions which are not in the best interest of the principal. Examples of moral hazard are:
investment in bad projects, company jet, financial statement fraud.
To solve the agency problems either monitoring (by board of directors) and incentive alignment
(rewarding the agent for good performance) can be used. The market for corporate control (possible
takeovers). The lower the stock price, relative to what it could be with more efficient management,
the more attractive the take-over becomes to those who believe that they can manage the company
more efficient.
Two papers this week:
Misangyi & Acharya: Corporate mechanisms as bundles.
Ndofor: Information asymmetry on financial reporting fraud.
Lecture 1: Misangyi & Acharya 2014
An research on how corporate governance mechanisms work together effectively. Agency theory:
incentives & monitoring. A host of governance mechanisms have been used to mitigate the agency
problems: Alignment of executives interest with those of the shareholders by compensation or stock
ownership, internal monitoring and external monitoring.
Current existing corporate governance research focuses on separate mechanisms, but this research
will focus on the bundle of governance mechanisms. Some mechanisms have interdependencies.
Some substitute each other, others complement each other.
In this research the mechanisms are put into categories. The first category is internal or external
mechanisms. Internal mechanisms are: alignment and monitoring by board (align CEO and
shareholder interest through CEO compensation). External mechanisms are: monitoring of CEO
behaviour. Another category is if the mechanisms are to align or to monitor.
CEO duality: Both CEO and chairman of the board.
Can firms be profitable when there only are either “alignment” or “monitoring” mechanisms?
The results of the research are that: Both incentive alignment and monitoring mechanisms need to
be present for the effectiveness of the governance bundle. Alignment and monitoring complement
each other. It is crucial that at least one internal and at least one external monitoring mechanism is
present. (internal: self-auditing. External: independent third party audits).
Lecture 1: Ndofor 2015
Opportunities for financial reporting fraud arise because of information asymmetries, often labelled
“lack of transparency”. Financial reporting fraud requires three simultaneous circumstances:
- The opportunity to deceive;
- A motive for doing so;
, - And willingness.
The agency theory is about when the interests of agents and principals conflict, an agent may take
actions that are not in the best interest of the principals. Goal alignment of owners and management
increases with the distribution of equity to executives. Firms have adopted stock-based
compensation as a means to align the goals of principals and agents. Stock-based compensation has
an increased effect on aggressive accounting practices or to misreport the firms financial results.
Two kinds of moral hazard arise due to asymmetry problems. Agents can engage in activities that
benefit only themselves and the second kind is that agents have hidden knowledge that the principal
does not have. Differences in proximity and experience can also cause information asymmetry.
Another source of increased information asymmetry is the complexity of the firm and its industry.
Complexity reduces transparency and increases uncertainty which creates information asymmetry.
H1: The level of complexity and the likelihood of financial statement fraud are positively associated.
TRUE
H2: CEO stock options strengthen the effect of complexity-based information asymmetry on the
likelihood of fraudulent financial reporting by a firm’s top manager. TRUE
H3: Aggressive audit committee monitoring weakens the effect of complexity-based information
asymmetry on the likelihood of fraudulent financial reporting by a firm’s top managers. TRUE
, Lecture 2: PowerPoint
The goal of today’s papers is incentive alignment to solve agency problems.
How are pay levels set?
Hill paper: A CEO gender pay gap?
Hou paper: Role of CEO tenure
Shin paper: Role of benchmarking and CEO power
Zhang: The risk of options (vs stocks)
There a different kinds of ways CEO’s can be paid: Fixed salary, Variable salary (short term bonus,
stock options, stock plans (long term) and other (pensions, corporate jet).
There are two views regarding pay setting process: contracting view (agency theory) and managerial
power view. The contracting view is an incentive alignment to solve agency problems. Executives are
trying to get the best deal for themselves and boards are trying to get the best deal for their
shareholders (arm’s length contracting). The outcome is a fair salary pay.
Executive pay is not at arm’s length, Directors on the board may not always want to seek to maximize
shareholder value. Managerial power view: High earners are not necessarily high performers. CEO
has certain powers over the board like: Directors want to be re-elected, friendships and loyalty and
authority.
Lecture 2: Hill 2015
Do woman benefit or suffer from their minority status? White males are the stereotypical CEO.
Suffer from minority status:
H1: Female and ethnic minority CEO’s will be associated with lower compensation. UNTRUE
Because female and ethnic minority CEO are more likely to be less compensated, female and ethnic
minority seek to voluntary exit from their position. Besides, female an ethnic minorities might not
feel welcome because of the large ratio of white male executives.
H2: Female and ethnic minority CEO’s will be associated with a higher likelihood of job exit. ?
Benefit of minority status:
H3: Female and ethnic minority CEO’s will be associated with higher compensation. TRUE
H4: Female and ethnic minority CEO’s will be associated with lower likelihood of job exit. ?
This concludes that female and ethnic minority CEO’s are paid more than white male CEO’s.
With the gender pay gap comes two contradicting perspectives: Stereotyping logic (white male
CEO’s) and Resource-based logic (woman bring new perspectives to the job)
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