Knowledge that Transforms

This paper examines the relative share pricing of 98 firms with two classes of common stock trading in the United States from 1984 to 1999. The firms feature common stock classes with differential voting rights and, in some cases, differential rights to dividends. The observed voting premiums are higher than those reported in previous studies of U.S. firms and are dependent on the form of dividend promise to the low-vote shareholder. The voting premium is higher in the presence of a control threat, when insiders do not hold controlling voting power, and during periods of poor firm performance.

This paper provides an explanation of callable convertible issue from the viewpoint of managerial entrenchment. Zweibel [American Economic Review 86 (1996)] has shown that an entrenched manager voluntarily issues straight debt in order to avoid hostile takeover. Straight debt, however, may lead the firm into bankruptcy in which a manager loses her position. We show that an entrenched manager can avoid a hostile takeover and bankruptcy at the same time by issuing well-designed callable convertible debt. Although callable convertible debt may decrease the value of the firm, an entrenched manager will prefer it over straight debt.

This study examines the sensitivity of equity values of oil producers to changes in the uncertainty of future oil prices. We document that this sensitivity is negatively correlated with a firm's debt ratio and its production costs. These results indicate that companies that are more likely to experience financial distress or underinvestment from low cash flows are adversely affected by increases in the uncertainty of future cash flows. We conclude that corporate risk management can increase shareholder value by reducing the expected costs of financial distress and underinvestment.

We present a theory of capital structure based on the power of shareholders, bondholders and managers to control the incentive conflicts in large corporations. The manager–owner conflict produces a trade-off between inefficiency in the low state and rents in the high state, and the shareholder–bondholder conflict produces under-investment as in Myers [Journal of Financial Economics 19 (1997) 147]. Since managers and bondholders both prefer more efficient actions in the low state, the two conflicts are interdependent. With risk-less levels of debt, there are no shareholder–bondholder agency costs, but managerial control over the incentive-setting process produces excessive rents. With risky debt, shareholders focus more on returns in the high state so that shareholder–bondholder agency costs increase but managerial rents decrease. Efficient levels of debt holder protection facilitate a reduction in manager–owner agency costs that outweighs shareholder–bondholder agency costs, and are decreasing in firm performance. The results are consistent with the separate empirical results relating control to both compensation and leverage, and suggest how future studies can be integrated.

Using the quarterly Compustat files, we present empirical findings that business capital investment is significantly higher in the fourth quarter than in other quarters. Even after controlling for business capital investment determinants, we find that the fourth quarter capital investment is significantly larger but less sensitive to investment opportunities than other quarters' capital investment. This phenomenon is more evident for firms with larger cash holdings than for firms with smaller cash holdings, for larger firms than for smaller firms, and for diversified firms than for stand-alone firms. Our findings suggest a high level of agency costs in corporate investment decisions.

The traditional financial economics view of the determinants of board composition is based on outside shareholders' demand for external monitoring of management. In comparison, Hermalin and Weisbach (American Economic Review, 88 (1998) 96) model board composition as the outcome of a bargaining process between the CEO and the rest of the board. The model predicts, inter alia, that the bargaining power of the CEO relative to the rest of the board of directors will determine the level of independence of the board and the extent of board monitoring. This study tests Hermalin and Weisbach's model using a random sample of companies that are subject to limited regulatory constraints in relation to board composition and a common set of corporations regulations that may indirectly affect board composition. There is strong evidence that representation by outside directors varies inversely with CEO bargaining power, which is proxied by CEO tenure and inside shareholdings. An extension of the argument of Hermalin and Weisbach to board leadership is also tested. The results indicate that the appointment of the chairman of the board is also the outcome of a bargaining process between the CEO and the rest of the board with more powerful CEOs likely to hold the position of Chairman of the board. Together, these results suggest that more “powerful” CEOs are relatively entrenched and face fewer constraints and less monitoring than other CEOs. This evidence has potential relevance to current debates in relation to the need to control the number or proportion of outside directors.

We analyze a sample of 119 master limited partnership agreements to examine the linkages between the contractual design and performance of organizations. Consistent with either efficient self-selection or focus arguments, partnerships that contractually limit their scope of operations tend to have superior industry-adjusted operating performance. We also find that contracting can substitute for equity ownership as a control mechanism. Partnerships with agreements unfavorable to investors tend to have higher proportions of insider equity ownership, compared to those with agreements more protective of investors.

We analyze the influence of firm and managerial characteristics on executive compensation. Consistent with theory, we find monitoring difficulties result in greater use of options while CEO and blockholder ownership result in less. Risky investment is positively related to options and negatively related to cash bonus and restricted stock, suggesting that firms use options to encourage managers to take risks. We find a negative (positive) relation between options and leverage (convertible debt) consistent with minimizing the agency costs of debt. Finally, we provide new evidence on managerial horizon and incentives, documenting a concave relation between cash bonus and CEO age.

Previous research indicates that operating performance improves following corporate acquisitions relative to industry-median firms. Such performance results are likely to be biased because acquiring firms undertake acquisitions following a period of superior performance and they are generally larger than industry-median firms. Using firms matched on performance and size as a benchmark, I find no evidence that operating performance improves following acquisitions. I also analyze if performance is higher in cash acquisitions as suggested by various studies. The results indicate that cash flows increase significantly following acquisitions that are made with cash, but decline for stock acquisitions.

This study focuses on changes in incentives at the William E. Simon Graduate School of Business Administration in the early 1990s to redirect effort from academic research to classroom teaching. We find a substantial and almost immediate jump in teaching ratings following the changes in incentives. Longer-run learning and turnover effects are present. Evidence also suggests that research output fell. This case illustrates the power of organizational incentives to redirect effort in a multitask environment, even in the presence of apparent human–capital constraints.