Stock options and managerial incentives to invest

We examine the effect of stock options on managerial incentives to invest. Our chief innovation is a model wherein firm value and executive decisions are endogenous. Numerical solutions to our model show that managerial incentives to invest are multi-dimensional and highly sensitive to option strike prices, the manager's wealth, degree of diversification, risk aversion, and career concerns. We find that over-investment problems are far more likely and far more severe that many researchers suggest. Finally, firm value is not a strictly increasing function of a manager's incentive compensation or conventional pay-for-performance metrics. Stronger managerial incentives to invest can benefit or harm a firm. Our results should send a cautionary signal to researchers who study managerial behavior. It is not sufficient to rely on one-dimensional risk-neutral valuation metrics, such as pay-for-performance, to describe the degree of incentive alignment between managers and shareholders.

Three Essays on Strategic Risk Taking

The three essays that comprise this dissertation collectively explore strategic risk taking. The dissertation is underpinned by the notion that corporate executives take strategic risks not randomly, but based on the expectation that outcomes are more likely to be positive rather than negative. Each essay examines how and why decision makers come to vary in their cognitive evaluation of the acceptability of strategic risk taking. Essay 1 draws from the approach/inhibition theory of power, to explore how power not only provides the means for CEOs to exert their risk preferences, but actually affects what the risk preferences are. Power is theorized to influence CEO cognitions, such that there is a prevailing focus on the upsides of strategic risk taking and a tendency to underestimate the downsides, increasing the proclivity to engage in such actions. Focusing on upsides as opposed to downsides is also evoked in explaining why stock options induce risk taking, thus the possibility that there are interaction (complementary or substitutive) effects with CEO power is also explored in a sample of firms listed in the S&P 1500 from 2003–2007. Essay 2 uses the behavioral agency model, to examine how the risk bearing attributes of specific CEO compensation elements affect the decision to engage in cross-border acquisitions. This subsequently increases the proclivity to engage in cross-border acquisitions. Moderating effects of managerial discretion are also evaluated. The theoretical model is tested in a sample of US firms operating in four industries from 2007–2011. Essay 3 combines the behavioral theory of the firm idea that firm behavior is goal directed and history dependent with arguments from national social culture literature. A multilevel model is presented and tested with a multinational sample of firms operating in the paper products industry. Findings demonstrate outperforming competitors in the past motivates firm R&D investment and that various cultural dimensions (future orientation, institutional collectivism, power distance and uncertainty avoidance) of a firm\u27s home country either encourage or discourage firm R&D investment

Inside debt compensation and its effect on corporate financial policy choices

This dissertation examines the effects of inside debt compensation on managerial risk-seeking behaviour. Extant literature argues that besides equity and cash, managers are also compensated with debt-like instruments such as deferred compensation and pensions. These compensation components are typically unfunded and unsecured and expose the CEO to default risk similar to that faced by external debtholders (Edmans and Liu, 2011). As a result, managers with large inside debt holdings are expected to display lower financial risk tolerance (Cassel et al., 2012). Motivated by this argument, I first examine the effects of CEO inside debt compensation on corporate financial policy choices. I document a negative association between inside debt holdings and firm book leverage and a positive relationship between CEO inside debt holdings and firm solvency. Subsequently, I examine whether women, who are perceived to possess a risk profile similar to a manager with significant inside debt holdings receive similar inside debt compensation to men. However, I document no evidence of a difference in the inside debt compensation between genders

Essays on corporate governance and banking

This dissertation consists of three empirical essays related to corporate governance and banking. The first essay, entitled Independent or co-opted? Corporate directors with ties to the nonprofit sector, studies the relation of independence and firm outcome, and focuses on independent directors that also belong to a nonprofit organization. Independent directors who also sit at boards of non-profit organizations (NPOs) may contribute valuable knowledge to their firms or possess personality traits that enhance their value as monitors. However, they may also be prone to be co-opted by the CEO with promises of donations to the NPO of their interest. This paper studies whether independent director’s links with NPOs affect their performance by analyzing how the presence of NPO-linked directors affects firm value, CEO pay and earnings management. To identify the causal effect of NPO-linked directors I use the retirement of independent directors as a source of exogenous variation in the composition of the board and its committees. I find that the participation of NPO-linked directors at the compensation committee is significant in terms of firm value, level of pay and compensation structure. The sign of the effect will depend on managerial power, measured as CEO entrenchment. The results suggest that less entrenched CEOs use the appointment of NPO-linked directors to increase their influence over the board. The second essay, co-authored with Pablo Ruiz-Verdú and is entitled CEO Risk Taking Incentives and Bank Failure during the 2007-2010 Financial Crisis. In this paper we show that stronger CEO risk taking incentives prior to the 2007–2010 financial crisis are associated with a higher probability of bank failure during the crisis. We define failure to include acquisitions facilitated by supervisors and employ measures of incentives that account for the risk taking incentives generated by CEOs’ stock and stock option holdings. Risk taking incentives and bank risk were not the result of the use of particular compensation vehicles (such as stock options) or the governance failures usually considered in the corporate governance literature. On the contrary, CEOs’ incentives were tightly aligned with those of shareholders. Related to the risk-taking incentives of large financial institutions, the third essay (Too big too discipline?, also co-authored with Pablo Ruiz-Verdú) documents a possible bias in bank supervisors behavior that benefits systematically large firms in the industry. Through formal enforcement actions, bank supervisors can coerce banks into adopting policies or practices to limit their risk. Moreover, formal enforcement actions are public, so they can communicate important information to investors and depositors and, thus, constitute a source of market discipline. In this paper, we document that supervisors appear to have a bias when issuing formal enforcement actions: very large financial institutions are less likely to receive formal enforcement actions than one would expect on the basis of their fundamentals. At the same time, they do not seem to be less risky than smaller, yet large, financial firms. Very large financial institutions seem to be too big to publicly discipline.This research has been funded with "Ayudas a la Investigación Santander Financial Institute (2013 Edition)" granted by Fundación de la Universidad de Cantabria para el Estudio y la Investigación del Sector Financiero (UCEIF) and the research grants ECO2009-08278 from the Ministerio de Ciencia e Innovación and ECO2012-33308 from Ministerio de Economía y Competitividad.Independent or co-opted? : corporate directors with ties to the nonprofit sector. CEO risk : taking incentives and bank failure duing the 2007-2010 financial crisis. Too big to discipline?Presidente: Manuel Fernández; Vocal: Gaizka Ormazabal Sánchez; Secretaria: María Gutiérrez Urtiag

Venture Capital on the Downside: Preferred Stock and Corporate Control

This Article takes the occasion of the simultaneous collapse of the high technology stock market and the failure of the dot-coin startups, along with the subsequent retrenchment of the venture capital business, to examine the law and economics of downside arrangements in venture capital contracts. The subject matter implicates core concerns of legal and economic theory of the firm. Debates about the separation of ownership and control, relational investing, takeover policy, the law and economics of debt capitalization, and bankruptcy reform, all grapple with the downside problem of controlling and terminating unsuccessful managers for the benefit of outside debt and equity investors (and the related upside problem of incentivizing effective but fallible managers). The factors motivating these debates also bear on venture capital contracting. But venture capital presents a special puzzle for solution. Convertible preferred stock is the dominant financial contract in the venture capital market, at least in the United States. This contrasts with other contexts in corporate finance, where preferred stock is thought to be a financing vehicle long in decline. The only mature firms that finance with preferred, which once was ubiquitous in American capital structures, tend to be firms in regulated industries having little choice in the matter. Tax rules favoring debt finance provide the primary explanation for preferred\u27s decline. But many corporate law observers would suggest dysfunctional downside contracting as a concomitant cause. Simply, preferred performs badly on the downside, where senior security contracts supposedly are at their most effective. Preferred stockholders routinely have been victimized in distress situations by opportunistic issuers who strip them of their contract rights, transferring value to the junior equity holders who control the firm\u27s management. The cumulation of bad experiences adds impetus to a wider trend in favor of debt as the mode of senior participation

Financial sector pro-cyclicality: lessons from the crisis

We analyze the main forces affecting financial system pro-cyclicality (the fact that developments in the financial sector can amplify business cycle fluctuations). We first review some major structural developments in financial markets that may influence pro-cyclicality and that have been overlooked in earlier analyses. We then examine three issues that are center stage in the current debate: capital regulation, accounting standards and managers’ incentives. After reviewing the institutional set-up and the key mechanisms at work, we critically examine a series of proposals designed to mitigate pro-cyclicality.pro-cyclicality, financial accelerator, capital requirements, leverage, accounting standards, incentives

A Study of Risk-Taking Behavior in Investment Banking

This dissertation examines corporate risk-taking behavior by investment banks in the United States. This study was sparked by the collapse of Lehman Brothers, one of the largest bankruptcy filings in U.S. history. This dissertation examines the specific factors that drove investment banks such as Lehman Brothers to take excessive risks, and how the deregulation of the US financial services industry towards the end of the 1990s contributed to risk-taking behavior. I use four theoretical perspectives to examine corporate risk-taking behavior among investment banks. These perspectives include: institutional theory, behavioral theory of the firm, knowledge based view (KBV) of the firm, and agency theory. Risk research in strategic management has mostly tended to adopt three theoretical perspectives: behavioral theory of the firm (Cyert & March, 1963), prospect theory (Kahneman & Tversky, 1979), and agency theory (Jensen & Meckling, 1976). I included institutional theory and KBV perspectives because numerous studies suggest that the regulatory environment (Scott, 2003) and knowledge base of a firm (Grant, 1996b) matters in corporate risk-taking. A review of the practitioner literature also suggests that regulatory frameworks and lack of firm competence have played a role in firm risk-taking behavior (Pirson & Turnbull, 2011; Summers, 2011; Wallison, 2011). My analysis suggests that both external and internal factors were associated with excessive corporate risk-taking among investment banks. External factors associated with firm risk-taking include the institutional environment, such as regulation (or absence thereof). Internal factors associated with firm risk-taking include aspirations of executives, level of corporate diversification, knowledge base of company, number of interlocking directorships in the board, size of the board, ratio of insiders to outsiders on the board, and ownership of the stock by board members of investment banks. The findings of this study contribute to the literature on corporate risk-taking behavior, and suggest that the study of such a complex phenomenon as corporate-risk taking needs to be done using multiple theoretical perspectives

Managerial wealth, behavioural biases and corporate monitoring : impact on managerial risk taking and value creation in UK high-tech and low-tech acquisitions

While the traditional agency model assumes managerial risk aversion and underinvestment in high-risk opportunities, the behavioural agency model allows for risk seeking by managers leading possibly to over-risky investments. Corporate governance mechanisms through their disciplining roles can steer managers towards optimal risk and avoid value destruction from either risk-deficit or risk-excess on the part of their managers. None of the existing studies offer a complete picture of managerial risk taking by allowing for both managerial risk aversion and risk seeking. The painting of just such a picture is the primary focus of this thesis. This thesis aims to answer the following two research questions in the context of corporate acquisitions: 1. What are the factors that drive managers to undertake risky projects? 2. To what extent is firm performance related to the optimal or suboptimal risk level of an investment project? This thesis investigates 289 UK domestic high-tech acquisitions and 289 matching low-tech acquisitions over the period 1993-2000. High-tech acquisitions are argued to be riskier than low-tech acquisitions. This thesis documents that fixed compensation, annual bonus, and LTIP cash provide few incentives for managers to conduct risky acquisitions. It finds significant evidence that equity-based wealth (such as LTIP shares, stock options and managerial shareholdings) which links managers' wealth to firm stock performance, has a nonlinear incentive effect on managers' selection of acquisition risk. At a low level, it encourages managers to pursue risky acquisitions. However, at high levels it discourages managerial risk taking. This nonlinear effect is mainly contributed to by managerial shareholdings. No evidence is found that stock options make managers select riskier acquisitions. Strong evidence is found that a high level of managerial wealth, which induces managerial risk aversion, can weaken the incentive alignment effect of equitybased wealth. This thesis finds significant evidence that managerial behavioural biases (such as overconfidence, over-optimism, and hubris) boosted by good past performance, firm glamour ratings by the stock market and a flattering media profile induce managers to engage in risky high-tech acquisitions. Corporate monitors are generally ineffective in disciplining managers' selection of acquisition risk. Overall, this thesis concludes that what makes managers take risky acquisitions appears to be the internal factors, i. e., factors that work within managers' inner selves and give them more confidence that they can control risks. External factors such as corporate monitoring devices that try to control managerial behaviour, do not necessarily boost managers' confidence in their risk managing capabilities. Regarding post-acquisition performance, this thesis documents that UK hightech acquisitions in the 1990s do not bring any value to acquirer shareholders up to three years after acquisition completion. However, high-risk high-tech acquisitions do not necessarily destroy more shareholder value than low-risk low-tech acquisitions. Acquisitions that are identified as at 'optimal' risk level perform better than under-risk acquisitions. Indeed, more shareholder value is created in acquisitions that are over-risk than acquisitions that are either optimal-risk or under-risk. Therefore, this thesis suggests that many UK acquirer managers during the period over 1993-2000 have foregone valuable but high risk growth opportunities and destroyed shareholder value more by being excessively risk-averse rather than being adventurous in their risk choices.EThOS - Electronic Theses Online ServiceGBUnited Kingdo