“Concentrating on Governance” (with Matthew Rhodes-Kropf)
Does corporate governance matter for shareholder value? We examine this notoriously difficult question by modeling and testing a product market channel through which antitakeover provisions affect value. The central insight of our model is that the valuation effect of antitakeover provisions varies with the degree of industry concentration. This insight delivers several unique cross-sectional predictions: (1) firms in concentrated industries should be more likely to adopt antitakeover provisions; (2) antitakeover provisions should lead to higher takeover premiums, but only in concentrated industries; (3) antitakeover provisions should be associated with higher shareholder value, but only in concentrated industries. We test these predictions using a large sample of manufacturing firms over the 1990 to 2005 period and find robust support for our theory. Our results suggest that governance reforms directed toward weakening takeover defenses may come with benefits, but also with costs.
“The Leader-Bias Hypothesis: Corporate Control Dynamics in Industry Equilibrium”
This paper argues that corporate control imperfections have significant consequences for industry structure. In a dynamic oligopoly model with empire-building (Jensen, 1986) managers and endogenously chosen corporate control, one important benefit of managerial discretion is that aggressive product market strategies deter the expansion of rivals. While tight control by shareholders brings about efficiency gains, it also hampers managers’ ability to capture larger market shares. This trade-off implies that the choice of lax control is favored by shareholders of leading firms whose profits are more vulnerable to the expansion of undeterred rivals. The resulting dynamic industry equilibrium suggests a theory of predation based on imperfections in corporate control. Persistent monopolization, the theory predicts and simulations verify, leads to lower turnover, higher concentration, and significantly (up to 30%) lower consumer welfare than in otherwise identical industries with perfect corporate control. Improving corporate governance through public policy measures, such as the Sarbanes-Oxley Act, is potentially pro-competitive. Consistent with the leader-bias hypothesis, industry leaders empirically tend to have weaker shareholder rights than laggards, based on a panel of publicly traded U.S. firms.
“Optimal CEO Incentives and Industry Dynamics” (with Antonio Falato)
This paper develops a competitive equilibrium model of CEO compensation and industry dynamics. CEOs make product pricing and product improvement decisions subject to shareholders’ compensation choices and idiosyncratic shocks to product quality. The choice of high-powered incentives optimally trades-off the benefits from expected product improvements and the associated agency costs. In market equilibrium, the interaction between CEO pay and product market decisions affects the stationary distribution of firms. We characterize a dynamic feedback effect of industry structure on CEO incentives. As a result of this effect, we predict an inverse relation between the magnitude of the performance-based component of CEO pay and, (i) across industries, the degree of heterogeneity of industry structure; (ii) within industries, firm position with respect to its peers. We empirically estimate pay-performance sensitivity for a large sample of U.S. CEOs and other top executives over the 1993 to 2004 period and find strong support for our theory. Our results offer a novel product market rationale for the increased reliance of CEO pay on bonuses and stock options over the 1990s.
“Relative Governance” (with Kose John)
Using data on antitakeover provisions and headquarters location for a large sample of U.S. public corporations, this paper documents robust evidence of complementarity between firm-level and local corporate governance. In particular, we find that: 1) good governance begets good governance - i.e., firms are less likely to adopt antitakeover provisions in areas with good governance; 2) good firm-level governance increases firm value only if local governance is good. This result holds across a variety of measures of firm value, which include the returns to a buy-and-hold portfolio that longs good and shorts bad governance firms; the short term own and peer announcement returns of the passage of state business combination laws, poison pill adoption, and board declassification; Tobin's Q, operating performance, the value of cash holdings, and acquirer returns. A contribution of the paper is to develop a novel triple-difference estimator that addresses causality by exploiting exogenous variation in local governance generated by the passage of state business combination laws. Our results suggest that in order to understand the governance-performance relationship the literature needs to go beyond the standard single-firm assumption.
Work in Progress
“Agency Costs of Idiosyncratic Volatility, Corporate Governance, and Investment” (with Kose John)
“Optimal Managerial Ownership Dynamics: Theory and Evidence” (with Antonio Falato)
“Dissecting Governance and Performance”
“Preemptive Entrenchment: Theory and Evidence”