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The current crisis has rocked the financial system worldwide and has cast doubt on the effectiveness of the existing regulatory regime. Thousands of firms have gone bankrupt and many financial institutions were bailed out by governments. The effects of the crisis have shaken emerging and developing markets alike and have not spared neither small nor large businesses.

Many scholars and practitioners attribute the roots of the crisis to failures and weaknesses in the way corporate governance has been practiced since the mid-1990s. Lax board oversight of top management, short-termism and self-interested behavior have been fingered as the culprits behind recent financial turmoil.

This book highlights the recent developments and new trends in corporate governance. The eighteen chapters, written by leading academics and experts, can assist corporate executives, governance bodies, investors, market regulators, and policymakers in having a global picture of major corporate governance issues.

This book highlights the recent developments and new trends in corporate governance. The eighteen chapters, written by leading academics and experts, can assist corporate executives, governance bodies, investors, market regulators, and policymakers in having a global picture of major corporate governance issues.




Where Are the Shareholders’ Mansions? CEOs’ Home Purchases, Stock Sales, and Subsequent Company Performance

We study real estate purchases by major company CEOs, compiling a database of the principal residences of nearly every top executive in the Standard and Poor’s 500 index. When a CEO buys real estate, future company performance is inversely related to the CEO’s liquidation of company shares and options for financing the transaction. We also find that, regardless of the source of finance, future company performance deteriorates when CEOs acquire extremely large or costly mansions and estates. We therefore interpret large home acquisitions as signals of CEO entrenchment. Our research also provides useful insights for calibrating utility based models of executive compensation and for understanding patterns of Veblenian conspicuous consumption.
Crocker Liu, David Yermack

Does One Size Fit All? A Study of the Simultaneous Relations Among Ownership, Corporate Governance Mechanisms, and the Financial Performance of Firms in China

We draw on the many aspects of corporate governance examined in the developed economies and extend them to the Chinese environment. We find evidence of strong linkage and interdependence in the use of different control mechanisms. While there are significant relations between the governance control mechanisms and firm performance, these disappear when using simultaneous equation estimation. Our findings support the argument that governance control mechanisms are substitutes for one another and there is no one set of mechanisms that are optimal in maximizing firms’ performances.
Michael A. Firth, Oliver M. Rui

The Role of Multiple Large Shareholders in Public Listed Firms: An Overview

A key issue in corporate governance is whether large owners contribute to resolving agency problems or exacerbate them. This paper surveys how large shareholders interact among themselves and how the composition of the controlling group, as well as the type of shareholders, can affect both monitoring and the level of private benefit extraction and, consequently, firm value. Recent studies on ownership structure of listed firms reveal that family firms are the most common form of ownership. We therefore also analyse potential agency conflicts that can emerge between families and other large shareholders by examining the governance roles of the structures of multiple large shareholder.
Ana Paula Matias Gama

Shareholder Activism in Canada: The Emergence of a New Tool for Improving Corporate Governance Practices

Shareholder democracy is gaining ground the world over. This chapter analyses the emergence of shareholder activism in Canada as a tool for improving corporate governance practices and explains the reasons underlying the recent apparition of activism in this country. In addition, it describes the nature of proposals according to filer type and targeted firms, which in turn provides a complete overview of shareholder democracy since its early beginnings and from 2000 to 2009. Finally, a review of activism in other countries offers some elements of comparison.
Vanessa Serret, Sylvie Berthelot


Corporate Governance and Firm Cash Holdings in the U.S.

Using governance metrics based on antitakeover provisions and inside ownership, we find that firms with weaker corporate governance structures actually have smaller cash reserves. When distributing cash to shareholders, firms with weaker governance structures choose to repurchase instead of increasing dividends, avoiding future payout commitments. The combination of excess cash and weak shareholder rights leads to increases in capital expenditures and acquisitions. Firms with low shareholder rights and excess cash have lower profitability and valuations. However, there is only limited evidence that the presence of excess cash alters the overall relation between governance and profitability. In the U.S., weakly controlled managers choose to spend cash quickly on acquisitions and capital expenditures, rather than hoard it.
Jarrad Harford, Sattar A. Mansi, William F. Maxwell

Executive Debt-Like Compensation

While executive compensation in the United States is believed to consist primarily of cash- and equity-based components, a nascent literature argues that compensation accrued by executives under pension and other deferred compensation (DC) plans has debt-like payoffs, and could function as “inside debt”. Inside debt holdings are predicted to counteract the risk-taking incentives created by inside equity holdings, and align top managers closer to outside debtholders vis-à-vis equityholders. Recent empirical studies suggest that pension and DC plan balances serve the role of inside debt to some extent, and are effective at mitigating equityholder-debtholder conflicts in leveraged firms. These findings not only change our understanding of the composition of top executive compensation, but also have implications for the recent debate on reforming executive compensation to mitigate excessive risk-taking by top executives.
Divya Anantharaman, Vivian W. Fang

Pay More Stocks and Options to Directors? Theory and Evidence of Board Compensation

The compensation of board directors has received much attention, along with the growing debates on corporate governance in recent years, partly due to the ongoing financial crisis. While prior studies including Hall and Liebman (1998) have shown evidence of a dramatic increase in the use of equity-based incentives, resulting in an increase in the sensitivity of executive pay to firm performance, we ask whether it benefits shareholders to offer similar incentive contracts to board directors. This paper suggests that equity-based compensation for board directors is necessary and the level of incentives depends on directors’ effectiveness in monitoring and friendliness in advising CEOs. Using the market competition and pay correlation to proxy for monitoring effectiveness and advisory friendliness, we report empirical evidence supporting our hypotheses.
Gang Nathan Dong

Directors in Banks: Compensation and Characteristics

Banks are frequently excluded from studies on executive compensation and corporate governance even though they play a critical role in the economy. In this chapter, we examine whether and how compensation of CEOs and board members in UK banks differs from compensation practices in other firms, using a sample of UK banks, FTSE 100, and matched-sample firms. We also examine differences in individual characteristics of both executive and non-executive board members of banks and those in other firms. We find that, contrary to public perception, CEOs in banks receive lower total compensation than CEOs of other firms. However, their compensation packages are weighted significantly more towards short-term compensation than in other firms. We also find that non-executives in banks are more highly paid than those in other firms.
Lisa Goh, Aditi Gupta

Intended and Unintended Consequences of CEO and Top Management Team Compensation

Executive compensation has become a major issue in contemporary society, particularly with the lavish compensatory packages that today seem to be the standard rather than the rule. The aims of this chapter are to discuss different components of executive compensation and more importantly the impact that these components have on executive behavior and firm performance. The chapter begins by addressing both the theoretical and practical intentions of different aspects of both individual aspects of executive compensation packages and then from a more macro view, the intentions of behind inequality of the overall executive level compensation structure within the firm. Following this discussion, focus is turned to the more ominous unanticipated outcomes that have been demonstrated to be produced through different aspects of compensatory packages and structures. Generally, this chapter addresses both how individual executive compensation packages and firm level compensation structure achieve intended benefits (i.e., goal and risk alignment between shareholder and executive) while also eliciting unintended consequences (i.e., negative effects of risk taking, fraudulent reporting, earnings manipulation, inter-team conflict, decreased employee satisfaction, decreased firm performance).
Jason W. Ridge


Are Busy Boards Effective Monitors?

Firms with busy boards, those in which a majority of outside directors hold three or more directorships, are associated with weak corporate governance. These firms exhibit lower market-to-book ratios, weaker profitability, and lower sensitivity of CEO turnover to firm performance. Independent but busy boards display CEO turnover-performance sensitivities indistinguishable from those of inside-dominated boards. Departures of busy outside directors generate positive abnormal returns. When directors become busy as a result of acquiring an additional directorship, other companies in which they hold board seats experience negative abnormal returns. Busy outside directors are more likely to depart boards following poor performance.
Eliezer M. Fich, Anil Shivdasani

Board Diversity as a Shield During the Financial Crisis

This chapter examines the link between board diversity and firm financial performance for a sample of Dutch listed companies during the recent financial crisis. We examine seven dimensions of diversity: nationality diversity, gender diversity, diversity with respect to the level of education, diversity with respect to the field of education, expertise diversity, socioeconomic background diversity and age diversity. Our empirical results show a hyperbolic relation between the focal variables age diversity, expertise diversity and background diversity and firm financial performance. We also find that gender diversity, nationality diversity and diversity with respect to education have no impact on firm performance during crisis times. Our empirical results show that focusing on only one dimension of the full diversity vector or on linear effects only can lead to detrimental economic effects.
Peter-Jan Engelen, Annette van den Berg, Gerwin van der Laan

What Are Friends for? CEO Networks, Pay and Corporate Governance

We investigate the impact of CEO networking on compensation arrangements. Unlike existing studies that are largely based on board interlocks, we use a unique measure that calculates the direct ties the CEO has created during her life. We show that a CEO’s compensation is significantly affected by her power in the managerial labour market. We find that the size of the CEO network is positively related to the level of CEO compensation and inversely related to its pay-performance sensitivity. We interpret our results as direct evidence that managerial power influences compensation. However, in firms where shareholders rights are well protected, the impact of the CEO network over pay arrangements diminishes. This implies that outrage cost and governance reduces managerial power in pay negotiation. Overall, our results are consistent with the predictions of the managerial power approach.
Rayna Brown, Ning Gao, Edward Lee, Konstantinos Stathopoulos

Board Independence, Corporate Governance and Earnings Management in France

The financial markets increasingly look to corporate governance mechanisms to help guarantee reliable and accurate financial information. The evaluation of the effectiveness of this role is therefore an interesting empirical question. This question has been brought to the fore by recent financial scandals and made crucial by the recent changes in the French institutional context. It is from this standpoint that this chapter aims to examine the influence of the board independence and two other corporate governance mechanisms, namely the audit quality and the ownership structure, on earnings management as measured by discretionary accruals. The empirical findings show that the presence of independent directors can moderate the management of discretionary accruals. The Big 4 auditors can also limit this discretionary adjustment. However, no statistically significant relationship was observed between dispersion vs. concentration of ownership structure and these accruals. This study makes an interesting contribution by making it possible to evaluate empirically the effectiveness of the role of three important corporate governance mechanisms. It adds to the limited research into the relationship between corporate governance and earnings management in France. Thus, it should be of interest to academics as well as regulators in preparing and amending corporate governance laws.
Ramzi Benkraiem


The State of Corporate Governance Research

This paper, which serves as an introduction to the special issue on corporate governance of the Review of Financial Studies, reviews and comments on the state of corporate governance research. The special issue features seven papers on corporate governance that were presented in a meeting of the National Bureau of Economic Research’s (NBER’s) corporate governance project. Each of the papers represents state-of-the-art research in an important area of corporate governance research. For each of these areas, we discuss the importance of the area and the questions it focuses on, how the paper in the special issue makes a significant contribution to this area, and what we do and do not know about the area. We discuss in turn work on shareholders and shareholder activism, directors, executives and their compensation, controlling shareholders, comparative corporate governance, cross-border investments in global capital markets, and the political economy of corporate governance.
Lucian A. Bebchuk, Michael S. Weisbach

A Sustainable Future for Corporate Governance Theory and Practice

This chapter shows how the natural “science of control and communications in the animal and the machine” identified by Wiener in 1948 can be applied to social organizations to establish a science of governance. The science of governance provides a sustainable future for corporate governance theory and practice. Good governance is defined as the ability of organizations in the private, public and non-profit sectors to achieve their purpose in the most efficacious manner while minimizing the need for laws, regulations, regulators, courts or codes of so called “best practices” to protect and further the interests of their stakeholders and society. Evidence is provided that current best practices: (a) did not prevent firms failing to create the 2008 financial crisis; (b) are not based on theory or conclusive empirical evidence; and (c) are inconsistent with common sense. Systemic problems arising from organizations governed by a single board are identified. These include the absolute power of directors to manage their own conflicts of interest to allow the corruption of themselves and the organization. Examples of organizations with over a hundred boards show how network governance provides: (a) division of powers; (b) checks and balances; (c) distributed intelligence; (d) decomposition in decision making labor; (e) cross checking communication and control channels from stakeholder engagement; (f) integration of management and governance to further self-regulation and self-governance with: (g) operating advantage and sustainability. The examples illustrate how an ecological form of network governance could reduce the size, scope, cost and intrusiveness of government and their regulators while improving economic efficiency, resiliency and enriching democracy with widespread citizen stakeholder engagement.
Shann Turnbull

National Culture and Corporate Governance

In a series of cross-country comparisons, we show that national culture is statistically significant in differentiating countries with different corporate governance systems. Using the Schwartz cultural value model and data on corporate governance systems, we analyze the impact of national culture on six dimensions of corporate governance. Countries that have stronger emphasis on the dimensions of Embeddedness, Egalitarianism, and Harmony are more likely to have bank-based systems, while countries with a stronger emphasis on Autonomy, Hierarchy, and Mastery tend to have market-based systems. The findings suggest several implications for the ongoing debate on convergence and divergence of corporate governance systems and policy reforms regarding financial crises.
Wolfgang Breuer, Astrid Juliane Salzmann

Effective Governance in the Family Owned Business

Family business is the most prevalent form of organization in the world. It has been estimated that as many as 90 % of businesses are either family owned or family controlled. A third of the firms listed on the S&P 500 and those of the Fortune 500 are family owned or controlled by families. Much of the governance literature focuses on the larger publicly owned non-family corporations rather than on the unique issues of the more prevalent family businesses. This chapter presents information to give the reader an understanding of the unique and complex nature of family owned businesses, their problems and challenges, and the unique governance structures and practices used to effectively manage a family business to greater performance. Due to the predominance of family members in upper management roles, which leads to a reduction of agency costs, family firms have less bureaucracy, allowing for fast decision-making and the creation of competitive advantages. Depending on the organizational structure, family firms have shown superior financial performance compared to their non-family counterparts. Goal congruency among the top management team and a long-term outlook are differentiating factors that lead to improved performance. Family firms, however, can also benefit from an increase in more formal governance mechanisms.
Keanon J. Alderson

Enlightened Shareholder Value: Is It the New Modus Operandi for Modern Companies?

The present financial crisis has led to more and more calls for changes in the way modern companies operate. The need for increased scrutiny of corporate governance, greater corporate accountability and monitoring has been repeatedly highlighted. As a result, a new trend has been developed the last few years, according to which business success and shareholder value cannot be achieved solely through maximizing short-term profits, but instead through market-oriented yet responsible behavior. Failure to effectively manage both the financial and non-financial aspects of corporate responsibility places shareholder value at risk. However, it is extremely difficult to achieve total transformation of the objectives of the company or the market system, thus the right approach is not to shift the focus away from shareholder value, but to reaffirm shareholder value as the central focus of corporate responsibility. The rules of the corporate game have changed and corporate boards are required to change the existing corporate mentality, in order to create companies, which are sustainable and economically, ethically and socially responsible. The enlightened shareholder value theory represents an attempt to strike a balance between shareholders’ primacy and corporate stakeholders’ interests. Effective corporate social responsibility management is not incompatible with shareholder value and having wider interests can be the key to long-term financial performance. Companies should not be seen only as vehicles for profit maximization, but as having a wider social role. The companies, which are willing to change their mentality and adopt a long-term perspective, will be rewarded with sustainability and efficiency.
Stelios Andreadakis
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