Recent theory suggests that firms incorporate synergistic interrelationships among executives into optimal incentive design (Edmans, Goldstein, and Zhu 2013). We focus on Pay Performance ...Sensitivities (PPS) and use dispersion in PPS across top executives as a proxy for the incentive design component shaped by an executive team's synergy profile. We model optimal PPS dispersion and use residuals from this model to measure deviations from optimal. We find that firm performance is increasing (decreasing) in the residual when PPS dispersion is too low (too high). We conjecture that deviations from optimal are sustained by adjustment costs, finding that firms only close around 60 percent of the gap between target and actual PPS dispersion over the subsequent year. Viewing a team's equity grants as a vector, we provide evidence that firms use subsequent equity grants to actively manage PPS dispersion toward optimality. Cross-sectional analysis reveals that the deleterious effect of deviations from optimal is decreasing in the duration of a team's tenure together, and increasing in the importance of effort coordination across team members for firm performance.
Risk and CEO turnover Bushman, Robert; Dai, Zhonglan; Wang, Xue
Journal of financial economics,
06/2010, Letnik:
96, Številka:
3
Journal Article
Recenzirano
This paper investigates how performance risk impacts a board's ability to learn about the unknown talent of a chief executive officer (CEO). We theorize that the information content of performance is ...increasing in idiosyncratic risk and decreasing in systematic risk. We provide robust empirical evidence that the likelihood of CEO turnover is increasing in idiosyncratic risk and decreasing in systematic risk and that turnover-performance-sensitivity is also increasing in idiosyncratic risk and decreasing in systematic risk. We further investigate relations between the threat of termination and CEO compensation, showing that for retained CEOs, both subsequent pay-performance-sensitivity and pay levels decrease in the probability of turnover.
•Corporate boards rarely make cuts to CEO bonus payments.•We conjecture boards to cut bonus only when they have negative private information about CEO's ability.•We find unexpected bonus cuts predict ...of poor subsequent performance and CEO firings.•Transparency improvement following post-Regulation S-K strengthens this predictive power.
An extensive literature finds that CEO compensation, especially bonus pay, exhibits downward rigidity. This is despite corporate boards usually retaining the discretion to deviate from their stated bonus formulae. We conjecture that the infrequent occasions in which there is an unexpected bonus cut, the board likely possesses unfavorable private information about the firm's long-term prospects and the CEO's ability. We hypothesize, therefore, that unexpected bonus cuts will be predictive of the company's future operating performance as well as forced CEO turnovers. We first validate our private information premise by showing that stock market reactions to CEO firings or earnings announcements are muted for firms experiencing unexpected bonus cuts but not for those without cuts. Consistent with these predictions, we find that unexpected bonus cuts are robust predictors of subsequent underperformance (ROE) and lower firm valuation (Tobin's Q) as well as CEO firings. Further, we examine the impact of Regulation S-K (2006) and show that predictive power becomes stronger post Reg. S-K, along with the disappearance of downward rigidity. This suggests that compensation transparency makes it harder for boards to deviate from stated bonus formulae and, if they do, the deviations are more informative.
The public outcry over executive compensation, especially the substantial bonuses paid to top executives at some financial institutions during the most recent financial crisis,1 highlights the ...still-considerable confoundedness about compensation practice, notwithstanding some 30 years of studies on the subject. It seems reasonable to question, indeed, how well we understand compensation practices and how descriptive our compensation theories are with respect to, for example, the relation between pay-performance sensitivity (PPS) and firm risk. In this study, we employ an event study approach to address this particular question. Efficient contracting theory, and the standard principal-agent model particularly, argues that under a set of assumptions we should observe, ceteris paribus, a negative relation between risk and incentives (see, e.g., Holmstrom 1979).2 This is because the board has to trade off the cost of compensating the agent for bearing adequate risk with the benefit of extracting more effort from the agent. Yet, existing empirical studies have documented a positive as well as a negative relation between PPS and firm risk. Instead of regressing PPS directly on firm risk using cross-sectional data, we address the mixed empirical evidence by using an event study approach to conduct a comparative static analysis. An event study approach with a carefully selected (and statistically validated) sample is intended to address specifically the potential omitted variables and endogeneity problems that afflict prior studies.
This paper demonstrates that the equilibrium impact of capital gains taxes reflects both the capitalization effect (i.e., capital gains taxes decrease demand) and the lock-in effect (i.e., capital ...gains taxes decrease supply). Depending on time periods and stock characteristics, either effect may dominate. Using the Taxpayer Relief Act of 1997 as our event, we find evidence supporting a dominant capitalization effect in the week following news that sharply increased the probability of a reduction in the capital gains tax rate and a dominant lock-in effect in the week after the rate reduction became effective.
We argue that reductions in shareholder taxes should lower the cost of equity capital more for financially constrained firms than for other companies. Consistent with this prediction, we find that, ...following the 1997 (TRA) and the 2003 (JGTRRA) cuts in U.S. individual shareholder taxes, financially constrained firms enjoyed larger reductions in their cost of equity capital than did other firms. The results are consistent with the incidence of the tax reductions falling mostly on firms with both pressing needs for capital and disproportionate ownership by individuals, the only shareholders who benefited from the legislations. The paper provides a partial explanation for the seemingly puzzling finding that, following the unprecedented 2003 reduction in dividend tax rates, non-dividend-paying firms outperformed dividend-paying firms. The results suggest that it was not dividend status that mattered, but financial constraint, a common attribute of non-dividend-paying companies.
Capital Gains Taxes and Stock Return Volatility Dai, Zhonglan; Shackelford, Douglas A.; Zhang, Harold H.
The Journal of the American Taxation Association,
10/2013, Letnik:
35, Številka:
2
Journal Article
Recenzirano
ABSTRACT
This paper presents an empirical investigation of the impact of capital gains taxes on stock return volatility. We predict that the more stock returns are subject to capital gains taxation, ...the greater the increase in return volatility following a capital gains tax rate cut due to reduced risk-sharing in firms' cash flows between shareholders and the government. Consistent with this prediction, we find larger increases in the return volatility for more appreciated stocks than for less appreciated stocks and for non-dividend-paying stocks than for dividend-paying stocks after both 1978 and 1997 capital gains tax rate reductions. The findings imply that capital gains taxes convey a heretofore overlooked benefit of lower stock return volatility.
This study investigates a firm's optimal CEO firing decision and its subsequent effect on CEO compensation in a dynamic model with moral hazard and learning. Based on perceived CEO talent, I ...explicitly solve for the cutoff point below which a firm will fire its CEO and show that the cutoff depends on variance of assessed talent. As a result, CEO turnover depends on both CEO performance and variance of his performance. Using risk as a proxy for variance of CEO talent, I find empirically that risk, not firm's past accounting or stock price performance, has the most significant impact on CEO turnover. Further, it is the firm-specific risk, not the market risk which affects the CEO turnover decision. I also find that after controlling for the risk, there exists a trade-off between the first two moments of stock price performance in CEO turnover decision. In addition, I solve for the optimal linear compensation contract and compare pay-for-performance sensitivity (PPS) over CEO's tenure (as well as across different firms) to examine how the pressure from firing affects the pay-for-performance sensitivity. Empirical results from accounting earnings show that the pay-for-performance sensitivity is smaller for CEOs who face larger firing pressures. This is consistent with the model predictions. However, the empirical results from stock returns are not statistically significant.
Chinese government has implemented the one-child policy since 1979. It has not only directly alleviated the population pressure, but exerted profound influence on the Chinese families, such as family ...structure, family consumption, children's behavior. While demographers and sociologists are concentrating their research on the population itself$\sp1$, this research is to examine the effects the policy has on parents' consumption behavior, especially, the spending on children to see if there exists the child quantity and child quality trade-off. The parents are assumed to maximize their utility derived from the family consumption, the number of children they have, and the quality of their children. However, in addition to the regular family budget constraint, each couple is facing the one child policy constraint. Thinking of the policy constraint as a quantity rationing government imposes on the couple, I apply rationing theory to the problem in that I adopt dual approach and use the idea of "virtual" price to derive the relationship between the rationed demand and unrationed demand. Then comparative statics analysis are conducted to compare two regimes. And empirical implications with testable hypothesis are derived thereafter. With the cross-sectional data I collected in the summer of 1993 in Hubei province of China, first, TOBIT procedure is used to predict the would-have-paid penalty for one-child families and would-have-obtained subsidy for more-than-one-child families which will later serve as "virtual" price. Second, because of sample selection problem involved, the Heckman two-step procedure is used to analyze the two types of families' behavior. The results indicate that there exists the spillover between the child quantity and child quality. When there is ten percent increase in income, an average one-child family would increase child quality spending by 10.33 percent while an average more-than- one-child family would increase child quality spending by only 7.39 percent. So child quality can substitute child quantity. However, family consumption is not a substitute for child quantity, rather, they are complements. For every ten percent increase in family income, family consumption will increase 1.2 percent for a one-child family while 3.2 percent increase for a more-than-one- child family. Finally, the results from PROBIT procedure confirm the findings by demographers and sociologists with respect to the discussion of the factors affecting the Chinese family fertility decisions. ftn$\sp1$They answer questions such as if the one child policy is effective in controlling the population; what are the consequences of the policy with respect to the sex ratio, age structure, population projection, area difference in the fertility rate; how the social economic characteristics affect the implementation of the policy; etc.
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