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Last updated: May 2009

Publications

Why Do Firms Appoint CEOs as Outside Directors?, 2009, forthcoming Journal of Financial Economics (joint with Angie Low, and René M. Stulz)

Appointments of outside CEOs to boards are highly sought after by companies. To understand why this is so, we examine the determinants of appointments of CEOs to boards, the stock market’s reaction to such appointments, and how these appointments impact the appointing companies. We find that CEOs are most likely to join boards of large established firms that are geographically close, pursue similar financial and investment policies, and have comparable governance mechanisms to their own firms. Though the first appointment of a CEO to a board has a higher stock-price reaction than the appointment of another outside director, subsequent CEO appointments are not associated with a higher stock-price reaction. Outside CEO director appointments are followed by decreases in the appointing firm’s operating performance in the case of interlocks, but otherwise CEO directors have no impact on the appointing firm’s operating performance, its decision-making, the compensation of its CEO, and the monitoring of management by the board. Consequently, to the extent that the appointment of an outside CEO to a board is beneficial to the appointing firm, it is because it certifies the firm rather than because it improves governance. Except in the case of interlocks, none of our evidence supports the view that CEO director appointments help entrench the appointing firm’s CEO.

Managerial Ownership Dynamics and Firm Value, 2008, forthcoming Journal of Financial Economics (joint with René Stulz)

Abstract: From 1988 to 2003, the average change in managerial ownership is significantly negative every year for American firms. We find that managers are more likely to significantly decrease their ownership when their firms are performing well, but not more likely to increase their ownership when their firms have poor performance. Because investors learn about the total change in managerial ownership with a lag, changes in Tobin's q in a period can be affected by changes in managerial ownership in the previous period. In an efficient market, it is unlikely that changes in managerial ownership in one period are caused by future changes in q. When controlling for past stock returns, we find that large increases in managerial ownership increase q. This result is driven by increases in shares held by officers, while increases in shares held by directors appear unrelated to changes in firm value. There is no evidence that large decreases in ownership have an adverse impact on firm value. We argue that our evidence cannot be wholly explained by existing theories and propose a managerial discretion theory of ownership consistent with our evidence.

Large Shareholders and Corporate Policies, 2008, forthcoming Review of Financial Studies (joint with Henrik Cronqvist)

We develop an empirical framework that allows us to analyze the effects of heterogeneity across large shareholders, and we construct a new blockholder-firm panel data set in which we can track all unique blockholders among large U.S. public firms. We find statistically significant and economically important blockholder fixed effects in investment, financial, and executive compensation policies. This evidence suggests that blockholders vary in their beliefs, skills, or preferences. Different large shareholders have distinct investment and governance styles: they differ in their approaches to corporate investment and growth, their appetites for financial leverage, and their attitudes towards CEO pay. We also find blockholder fixed effects in firm performance measures, and differences in style are systematically related to firm performance differences. Our results are consistent with influence for activist, pension fund, corporate, individual, and private equity blockholders, but consistent with systematic selection for mutual funds. Finally, we analyze sources of the heterogeneity, and find that blockholders with a larger block size, board membership, direct management involvement as officers, or with a single decision maker are associated with larger effects on corporate policies and firm performance.

Founder-CEOs, Investment Decisions, and Stock Market Performance, 2008, forthcoming Journal of Financial and Quantitative Analysis

Eleven percent of the largest public U.S. firms are headed by the CEO who founded the firm. Founder-CEO firms differ systematically from successor-CEO firms. They have a higher accounting performance and a higher firm valuation. Founder-CEO firms invest more in R&D, have higher capital expenditures, and make more focused mergers and acquisitions. Moreover, an equal-weighted investment strategy that had invested in founder-CEO firms from 1993-2002 would have earned a benchmark-adjusted return of 8.3% annually. A value-weighted investment strategy would have earned an abnormal return of 10.7%. The excess return is robust; after controlling for a wide variety of firm characteristics, CEO characteristics, and industry affiliation, the abnormal return is still 4.4% annually.

Shareholder Rights, Boards, and Executive Compensation, 2009, Review of Finance 13, 81-113.

I analyze the role of executive compensation in corporate governance. As proxies for corporate governance, I use board size, board independence, CEO-chair duality, institutional ownership concentration, CEO tenure, and an index of shareholder rights. The results from a broad cross-section of large U.S. public firms are inconsistent with recent claims that entrenched managers design their own compensation contracts. The interactions of the corporate governance mechanisms with total pay-for-performance and excess compensation can be explained by governance substitution. If a firm has generally weaker governance, the compensation contract helps better align the interests of shareholders and the CEO.

Co-movements of Index Options and Futures Quotes, 2009, Journal of Empirical Finance 16, 151-163 (joint with Patrik Sandas)

We report evidence that the co-movements of index options and index futures quotes differ sharply from perfect correlation in periods with option trades. In half-hour intervals with (without) option trades 25% (12%) of call option quote changes have either the opposite sign or are larger in magnitude than the corresponding index futures quote changes. We calibrate a stochastic volatility model that allows for trade and no-trade periods using real data and simulate the joint co-movements of index quotes and option quotes in this model. We show that for trade intervals the observed co-movements differ from the benchmark case established by our simulations approximately three times too often. We provide empirical evidence that market microstructure effects - specifically, stale quotes and aggressive quotes - explain the majority of the deviations from the benchmark. Our findings are relevant for techniques that use estimates of local co-movements as inputs to price or hedge options.

Large Blocks of Stock: Prevalence, Size, and Measurement, 2006, Journal of Corporate Finance 12, 594-618 (joint with Jennifer Dlugosz, Paul Gompers, and Andrew Metrick)

Large blocks of stock play an important role in many studies of corporate governance and finance. Despite this important role, there is no standardized data set for these blocks, and the best available data source, Compact Disclosure, has many mistakes and biases. In this paper, we document these mistakes and show how to fix them. The mistakes and biases tend to increase with the level of reported blockholdings: in firms where Compact Disclosure reports that aggregate blockholdings are greater than 50 percent, these aggregate holdings are incorrect more than half the time and average holdings for these incorrect firms are overstated by almost 30 percentage points. For researchers using uncorrected blockholder data as a dependent variable, these errors will increase the standard error of coefficient estimates but do not appear to cause bias. However, we find that if blockholders are used as an independent variable, economically significant errors-in-variables biases can occur. We demonstrate these biases using a representative analysis of the relationship between firm value and outside blockholders. An online appendix to our paper provides a “clean” data set for our sample firms and time period. For researchers who need to work outside of this sample, we also test the efficacy of alternative (cheaper) fixes to this data problem, and find that truncating or winsorizing the sample can reduce about half of the bias in our representative application.

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Working papers

Estimating the Effects of Large Shareholders Using a Geographic Instrument, 2008, Ohio State University working paper (joint with Bo Becker and Henrik Cronqvist).

Abstract: Large shareholders may play an important role for firm policies and performance, but identifying an effect empirically presents a challenge due to the endogeneity of ownership structures. However, unlike other blockholders, individuals tend to hold blocks in corporations that are located close to where they live. Using this fact, we create an instrument - the density of wealthy individuals near a firm's headquarters - for the presence of a large, non-managerial individual shareholder in a public firm. We show that these shareholders have a large impact on firms. Consistent with theories of large shareholders as monitors, we find that they increase firm profitability, increase dividends, reduce corporate cash holdings, and reduce executive compensation. Consistent with the view that there exist conflicts between large and small owners in public firms, we uncover evidence of substitution toward less tax-efficient forms of distribution (dividends over repurchases). In addition, our analysis shows that large shareholders reduce the liquidity of the firm's stock.

Former CEO Directors: Lingering CEOs or Valuable Resources?, Ohio State University Working Paper (joint with Bernadette Minton and Carrie Pan).

A firm is more likely to reappoint a former CEO to its board of directors after retirement the better is the firm's market-adjusted stock performance, the longer is the CEO's tenure, if the CEO is a founder of the firm, and the more inexperienced is the successor CEO. Firms with former CEO directors make different corporate decisions. The relative performance-turnover sensitivity of the successor CEO is higher and there is better firm performance when the former CEO is a director. After extremely poor firm performance under their successors, former CEOs often return to the CEO position. When they do so, their firms do as well as industry and past performance matched firms.

Do Funds Need Governance? Evidence from Variable Annuity-Mutual Fund Twins, 2008, Ohio State University working paper (joint with Richard Evans)

We study the roles of traditional governance (boards, sponsors, etc.) and market governance(investors voting with their feet) in mutual funds and variable annuities. We find that market governance is less pronounced for variable annuity investors. Using a matched sample of variable annuity-mutual fund twins, we find that variable annuity investors are less sensitive to poor performance and high fees than mutual fund investors. Given the weaker role played by market governance, we then examine the role played by traditional governance in variable annuities. Variable annuity boards and sponsors add alternative investment options and replace advisors on behalf of their investors after poor performance and high fees. These traditional governance mechanisms are, however, less effective when conflicts of interest exist between variable annuity sponsors and fund advisors.