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Erschienen in:

2013 | OriginalPaper | Buchkapitel

12. Voluntary and Mandatory Skin in the Game: Understanding Outside Directors’ Stock Holdings

verfasst von : Sanjai Bhagat, Heather Tookes

Erschienen in: Entrepreneurship, Finance, Governance and Ethics

Verlag: Springer Netherlands

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Abstract

We examine the determinants of equity ownership by outside directors as well as the relationship between ownership and operating performance. Unlike previous studies of equity ownership by directors, we use hand-collected data on firm-level policies requiring director ownership for S&P 500 firms during the years 2003 and 2005. Ownership requirements allow us to shed further light on the determinants of director holdings and to separate voluntary from mandatory holdings of directors. If ownership requirements reflect optimal ownership levels (from the firm’s perspective), they provide a useful identification tool in the examination of ownership-performance relationships. Our primary findings are that mandatory holdings are unrelated to future performance; this is consistent with the theory that ownership requirements reflect optimal ownership levels. By contrast, voluntary holdings are positively and significantly related to future performance, suggesting that they perform an incentivizing role for management.

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These requirements can be a useful supplement to equity-based compensation schemes. Ofek and Yermack (2000) find that after an initial level of holdings is met, managers sell whenever they get stock. If directors’ desired level of holdings differs from levels that are optimal from the viewpoint of shareholders of that company, they may have incentives to sell their shares. Ownership policies can help curb director stock sales and keep incentives aligned.

Duchin et al. (2010). These authors also document that companies did not immediately respond to the requirements of Sarbanes-Oxley regarding board composition. Over a period of years companies became more compliant.

Several recent papers document a positive relation between director stock ownership and future firm operating performance; for example, see Bhagat and Bolton (2008), Guest (2009), and Dey and Liu (2011). However, these papers do not distinguish between mandatory and voluntary director stock ownership.

We collect information on both director and executive policies. In unreported analysis of performance, we use executive policies as a control for unobserved firm heterogeneity and the results remain qualitatively similar. We select 2003 since it was the first full-year after the enactment of Sarbanes-Oxley. At the time we initiated this research project – Fall of 2006 – the most recent year for which complete ownership and accounting data were available was 2005.

The Proxy Statement year depends on the firm’s fiscal year end. As most firms in the sample have December fiscal year ends, for year t, we consider the proxy statement dated year t + 1 (typically dated before the end of April). For firms with, January through June fiscal year ends, we consider the proxy statement dated year t.

Share requirements are converted into dollars using the closing stock price at the end of year t.

See Adams and Ferreira (2008).

Gompers et al. (2003) [hereinafter GIM]. CEO Pay Slice, and G-Index are corporate governance measures; however; see discussion below.

Note that there are two potential forces at work: It may be more difficult to monitor a large firm because of its size and the amount of information that must be processed, therefore increasing the value of providing directors with equity incentives. On the other hand, empirically, large firms have been associated with variables related to low information asymmetry (analyst coverage, equity market spreads, etc.), which suggests that more information about these firms is produced. The precise role of size is an empirical question.

For robustness, we also consider log of total assets as a proxy for firm size. Results are consistent with those reported here.

Ownership guidelines are set by boards of directors. An important assumption underlying the discussion is that directors act in shareholder best interest. They set policies to give themselves the correct incentives to effectively monitor. Findings in Yermack (2004) that directors of Fortune 500 firms have significant equity and reputation incentives are consistent with this assumption.

Khurshed et al. (2011) provide evidence consistent with the argument that board ownership is a substitute governance mechanism.

The results in Appendix Table 12.B allow us to reject the hypothesis that the slope coefficients for the explanatory variables are statistically different for 2003 and 2005.