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Abstract:
Many theories have been proposed to explain how corporate boards are structured. This paper groups these theories into three hypotheses and tests them empirically. We utilize a unique panel dataset that tracks corporate board development from the time of a firm's IPO through 10 years later. The data indicate that: (i) board size and independence increase as firms grow in size and diversify over time; (ii) board size - but not board independence - reflects a trade-off between the firm-specific benefits of monitoring and the costs of such monitoring; and (iii) board independence is negatively related to the manager's influence and positively related to constraints on such influence. These results are consistent with the view that economic considerations - in particular, the specific nature of the firm's competitive environment and managerial team - help explain cross-sectional variation in corporate board size and composition. Nonetheless, much of the variation in board structures remains unexplained even when all three hypotheses are combined, suggesting that idiosyncratic factors affect many individual boards' characteristics.

Boards of Directors, IPOs, Ownership Evolution

Abstract:
Researchers and investors disagree over the extent to which shareholder activism facilitates improvements in target firms' values, earnings, operations, and governance structures. The disagreement persists despite numerous empirical studies on the topic. In this paper I survey the recent empirical research on shareholder activism, and conclude that the disagreement among researchers is more apparent than real. Most evidence indicates that shareholder activism can prompt small changes in target firms' governance structures, but has negligible impacts on share values and earnings. To be sure, some empirical results are mixed. But much of the disagreement among researchers reflects differences in the metrics emphasized. Researchers emphasizing changes in target firms' governance structures tend to characterize shareholder activism as a successful tool to improve firm performance. Most of those emphasizing changes in share values, earnings, or operations, in contrast, characterize shareholder activism as having negligible effects on target companies.

Shareholder activism

Abstract:
We examine the penalties imposed on all 585 firms that were targeted by SEC enforcement actions for financial misrepresentation from 1978 - 2002, which we track through November 15, 2005. The penalties imposed on firms through the legal system average only $23.5 million per firm. The penalties imposed by the market, in contrast, are huge. Our point estimate of the reputational penalty - which we define as the expected loss in the present value of future cash flows due to lower sales and higher contracting and financing costs - is over 7.5 times the sum of all penalties imposed through the legal and regulatory system. For each dollar that a firm misleadingly inflates its market value, on average, it loses this dollar when its misconduct is revealed, plus an additional $3.08. Of this additional loss, $0.36 is due to expected legal penalties and $2.71 is due to lost reputation. In firms that survive the enforcement process, lost reputation is even greater at $3.83. In the cross-section, the reputational penalty is positively related to measures of the firm's reliance on implicit contracts. This evidence belies a widespread belief that financial misrepresentation is disciplined lightly. To the contrary, reputation losses impose substantial penalties for cooking the books.

Financial reporting violations, fraud, financial disclosure, penalties, reputation

Abstract:
Many firms deploy takeover defenses at the time of their IPOs, although at significantly lower rates than for seasoned corporations. We find that IPO managers deploy takeover defenses particularly when their compensation is high, shareholdings are small, and the oversight from non-managerial shareholders is weak. We also find that the presence of a takeover defense in IPO firms is negatively related to acquisition likelihood, yet has no impact on takeover premiums for those firms that are acquired. Together, these results suggest that shareholders' marginal costs of takeover defenses exceed the benefits.

initial public offerings, antitakeover provisions, dual class shares, acquisitions

Abstract:
We examine several theoretical and empirical issues concerning punitive damage awards and their importance to businesses. First, we argue that previous justifications of punitive awards ignore the role of private contracting and reputation in assuring contractual performance. In the absence of externalities, punitive awards are not necessary to assure contractual performance even when firms face less than a 100% probability of being sued for contractual breach. Next, we examine empirically the sizes, determinants, and valuation impacts of punitive awards assessed against publicly held companies. We find that settlement amounts are low compared to jury awards, and punitive awards are highly variable and difficult to explain using characteristics of the lawsuit or defendant company. Supreme Court and legislative actions affecting punitive awards generally have not had systematic impacts on firm values. Specific punitive lawsuits, however, decrease the values of defendant companies by amounts that exceed settlement or jury verdict amounts, indicating that punitive lawsuits impose reputational costs on defendants.

Abstract:
This paper provides the first integrated analysis of the complex mix of private and regulatory penalties for financial misrepresentation. We examine the sizes, types, and determinants of legal penalties imposed for all 697 enforcement actions initiated by the Securities and Exchange Commission for financial misrepresentation from 1978 through 2004. These penalties include private class action awards, monetary penalties imposed by the SEC and Department of Justice, and such non-monetary sanctions as censures, trading suspensions, and jail time. Contrary to many criticisms of private lawsuits and regulatory actions, we find that legal penalties are highly systematic, and in particular, are positively related to the size and severity of the harm from the misconduct. The data also indicate deep pockets effects, as both private and regulatory monetary penalties are related to defendants' abilities to pay. A recent increase in regulatory penalties has coincided with a decrease in private monetary penalties, consistent with regulatory penalties crowding out the use of private penalties.

Fraud, penalties, Securities and Exchange Commission, financial misrepresentation

Abstract:
Contrary to arguments that poison pills degrade firm performance, we find that operating performance generally improves during the five-year period after pill adoption. Performance improvements are present in a wide range of firms, and are independent of board structure, year of adoption, and whether the firm is R&D intensive. Furthermore, the stock price reaction to announcements of pill adoptions is positively related to subsequent improvements in earnings before interest and taxes, suggesting that investors anticipate the improvements. Combined with the evidence from Comment and Schwert (1995), that the presence of a poison pill does not reduce takeover probabilities or premiums, the evidence in this paper undermines the widely held view that poison pills have systematically negative effects on firm value and performance.

poison pills, operating performance

Abstract:
We track the fortunes of all 2,206 individuals identified as responsible parties for all 788 SEC and Department of Justice enforcement actions for financial misrepresentation from 1978 through September 30, 2006. Fully 93% lose their jobs by the end of the regulatory enforcement period. A majority explicitly are fired. The likelihood of ouster increases with the cost of the misconduct to shareholders and the quality of the firm's governance. Culpable managers also bear substantial financial losses through restrictions on their future employment, their shareholdings in the firm, and SEC fines. A sizeable minority (28%) face criminal charges and penalties, including jail sentences that average 4.3 years. These results indicate that the individual perpetrators of financial misconduct face significant disciplinary action.

Management turnover, CEO turnover, financial misrepresentation, fraud, penalties, Securities and Exchange Commission

Abstract:
We examine whether short sellers identify firms that misrepresent their financial statements, and whether their trading conveys external costs or benefits to other investors. Abnormal short interest increases steadily in the 19 months before the initial public revelation of financial misrepresentation that subsequently triggers SEC sanctions. Short interest is positively related to the severity of the misrepresentation, and it is higher in misrepresenting firms than in other firms. There is no evidence that short selling exacerbates a downward price spiral when the misconduct is publicly revealed. Short selling is, however, associated with a faster time-to-discovery of the misconduct, and it dampens the share price inflation that occurs when firms overstate their earnings. Our point estimates of the net external benefits to uninformed investors who trade during the average firm’s violation period range from 0.19% to 1.53% of the firm’s equity value. Overall, this evidence indicates that short sellers anticipate the eventual discovery and severity of financial misconduct. Short selling also conveys external benefits to uninformed investors, by helping to uncover financial misconduct and by keeping prices closer to fundamental values when firms provide incorrect financial information.

Short sales, financial misrepresentation, market efficiency, information

Abstract:
This paper examines the sizes of the fines, damage awards, remediation costs, and market value losses imposed on companies that violate environmental regulations. Firms violating environmental laws suffer statistically significant losses in the market value of firm equity. The losses, however, are of similar magnitudes to the legal penalties imposed; and in the cross section, the market value loss is related to the size of the legal penalty. Thus, environmental violations are disciplined largely through legal and regulatory penalties, not through reputational penalties.

Environmental violations, corporate misconduct, legal penalties, reputation costs

Abstract:
Press reports of military procurement fraud investigations, indictments, and suspensions are associated with significantly negative average abnormal returns in the stocks of affected firms. Abnormal stock returns are significantly less negative, however, for firms ranking among the Top 100 defense contractors than for unranked contractors, even after controlling for firm size, the fraud's characteristics, and the firm's recidivism. Unranked contractors are penalized heavily for procurement frauds, experiencing both a decline in market value and a subsequent loss in government-derived revenues. Furthermore, these losses are related to the percentage of the firm's revenues that derive from government contracts. Influential contractors, in contrast, are penalized lightly, experiencing negligible changes in share value and government contract revenue.

Abstract:
Models of trade by Pfleiderer (1984), Holthausen and Verrecchia (1990), and Kim and Verrecchia (1991) imply that the trading volume prompted by a public announcement is positively related to the announcement's precision. Relying upon this notion, empirical researchers interpret high trading volume as an indication that an announcement is highly informative. We show that such interpretations can be incorrect. In a world with transaction costs, the relation between information precision and trading volume is ambiguous, and can be negative. This explains why, in empirical tests, the relation between announcement precision and trading volume is not monotonically positive, even though in laboratory experiments it is. Cross-sectionally, our results imply that trading volume reactions to highly informative announcements will be positive primarily for low-transaction cost securities.

Abstract:
We examine whether short sellers identify firms that misrepresent their financial statements, and whether their trading conveys external costs or benefits to other investors. Abnormal short interest increases steadily in the 19 months before the initial public revelation of financial misrepresentation that subsequently triggers SEC sanctions. Short interest is positively related to the severity of the misrepresentation, and it is higher in misrepresenting firms than in other firms. There is no evidence that short selling exacerbates a downward price spiral when the misconduct is publicly revealed. Short selling is, however, associated with a faster time-to-discovery of the misconduct, and it dampens the share price inflation that occurs when firms overstate their earnings. Our point estimates of the net external benefits to uninformed investors who trade during the average firm’s violation period range from 0.19% to 1.53% of the firm’s equity value. Overall, this evidence indicates that short sellers anticipate the eventual discovery and severity of financial misconduct. Short selling also conveys external benefits to uninformed investors, by helping to uncover financial misconduct and by keeping prices closer to fundamental values when firms provide incorrect financial information.

Short selling, fraud, financial misconduct

Abstract:
From 1818 to 1909, 35 government and 57 privately-funded expeditions sought to locate and navigate a Northwest Passage, discover the North Pole, and make other significant discoveries in arctic regions. Most major arctic discoveries were made by private expeditions. Most tragedies were publicly funded. By other measures as well, publicly-funded expeditions performed poorly. On average, 5.9 (8.9%) of their crew members died per outing, compared to 0.9 (6.0%) for private expeditions. Among expeditions based on ships, those that were publicly funded used an average of 1.63 ships and lost 0.53 of them. Private ship-based expeditions, in contrast, used 1.15 ships and lost 0.24 of them. Of public expeditions that lasted longer than one year, 47% were debilitated by scurvy, compared to 13% for private expeditions. Although public expeditions made some significant discoveries, they did so at substantially higher cost (as measured by crew size or vessel tonnage) than private discoveries.

Multivariate tests indicate that these differences are not due to differences in the exploratory objectives sought, country of origin, the number of previous expeditions on which the leader served, or the decade in which the expedition occurred. Rather, they are due to systematic differences in the ways public and private expeditions were organized. Historical accounts indicate that, compared to private expeditions, public expeditions: (1) employed leaders that were relatively unmotivated and unprepared for arctic exploration; (2) separated the initiation and implementation functions of executive leadership; and (3) adapted slowly to new information about clothing, diet, shelter, modes of arctic travel, organizational structure, and optimal party size. These shortcomings resulted from, and contributed to, poorly aligned incentives among key contributors.

Abstract:
CEOs who manage earnings can impose costs on shareholders. But do boards act proactively to discipline such managers, or reactively and only when the earnings manipulations lead to external consequences? Using a sample of 297 forced turnovers and 1,185 voluntary turnovers from 1992-2004, we find that the likelihood and speed of forced CEO turnover are positively related to earnings management. A CEO’s job tenure also is negatively related to how actively earnings are managed. These results persist in tests that control for the possible endogeneity of CEO turnover and earnings management, and for such external consequences as earnings restatements and SEC enforcement actions. The relation between earnings management and forced turnover occurs both in firms with good and bad performance, and when the accruals work to inflate or deflate reported earnings. We infer that at least some boards act proactively to discipline managers who manage earnings aggressively, before the manipulations lead to costly external consequences. This is consistent with the view that internal governance does in fact work to mitigate managerial agency problems.

Management turnover, earnings management, corporate governance

Abstract:
Many firms deploy takeover defenses when they go public. We find that IPO managers are more likely to deploy defenses when their compensation is high, shareholdings are small, and oversight from non-managerial shareholders is weak. The presence of a takeover defense at the time of the IPO is negatively related to subsequent acquisition likelihood, yet has no impact on takeover premiums for firms that are acquired. These results do not support arguments that takeover defenses facilitate the eventual sale of the IPO firm at high takeover premiums. Rather, they suggest that managers shift the cost of takeover protection onto non-managerial shareholders. Thus, agency problems are important even for firms at the IPO stage.

Initial Public Offerings, Takeover Defenses, Acquisitions

Abstract:
Proponents of state antitakeover legislation argue that previous empirical tests by financial economists of the wealth effects of Pennsylvania's 1990 antitakeover law are biased. We show that the proponents are correct. In particular, firm size, event-time clustering, and non- synchronous trading effects account for the wealth decreases in earlier studies. We also show, however, that both proponents and critics of the Pennsylvania legislation have ignored the earliest press release about it. The wealth effect associated with this announcement is negative, large, and statistically significant. These results therefore are consistent with the hypothesis that the Pennsylvania law decreased company values and with the hypothesis that the initial market reaction is an unbiased estimate of the law's effect on firm values.

Abstract:
Anecdotal evidence suggests that top managers of firms that are investigated for fraud lose their jobs. Fraud scandals plausibly create incentives to change managers, in an attempt to improve the firm's performance, recover lost reputational capital, or limit the firm's exposure to liabilities that arise from the fraud. It also is possible that fraud creates incentives to change the composition of the firm's board, to improve the external monitoring of managers or to rent new directors' valuable reputational or political capital.

Despite such claims, we find little systematic evidence that firms suspected or charged with fraud have unusually high turnover among senior managers or directors. In univariate comparisons, there is some evidence that firms committing fraud have higher managerial and director turnover. But in multivariate tests that control for other firm attributes, such evidence disappears. These findings indicate that the revelation of fraud does not, in general, increase the net benefits to changing managers or the firm's leadership structure.

Abstract:
Judging from prior writings, many researchers and practitioners think shareholder-initiated corporate governance proposals promote value-maximizing policies. These proposals are regarded as serving an important role in the governance of public corporations. Our findings, however, do not support this view. Shareholder-initiated corporate governance resolutions tend to target poorly performing firms, as measured by market-to-book ratio, operating return, and recent sales growth. This suggests that their sponsors seek improvements. We find little evidence, however, that proposals increase share values or spur performance improvements. The average wealth effects associated with shareholder-initiated corporate governance proposals are not significantly different from zero. Sales growth subsequently declines for firms receiving proposals relative to sales growth for control firms. And changes in operating return on sales are not significantly larger for proposal firms than their controls. We also find little evidence that shareholder proposals are associated with significant changes in firm policy. Turnover among chief executive officers is not significantly higher among firms that previously attracted proposals than for other firms matched by industry and size. We find that some of the firms attracting successful proposals changed managers or restructured operations, but such changes typically were motivated by external control threats, not the shareholder proposals. Even proposals receiving a majority of share votes are not associated systematically with significant changes in target firms' policies or stock values.

Abstract:
Using data from all 868 SEC and Department of Justice enforcement actions for financial misrepresentation from 1978 through June 30, 2007, we examine firm characteristics during the periods that the firms' financial statements are misrepresented. These characteristics can inform us about managers' apparent motives to misrepresent financial reports. Preliminary test results indicate that the incidence of financial misrepresentation increases with the market-to-book ratio, recent acquisitions and the use of operating leases, the sensitivity of managers' pay to changes in the stock price, and a CEO who also is board chair. This incidence decreases with the prior year's stock performance, board independence, the fraction of shares owned by independent board members, and the fraction of shares owned by institutions. Together, these results suggest that managers are more likely to cook the company books when their pay is sensitive to the company stock price, when oversight from the firm's internal governance or institutional monitors is poor, and when the firm has complicated accounting issues involving recent acquisitions and operating leases.

Financial misrepresentation, fraud, compensation, incentives, governance, analyst forecasts, Securities and Exchange Commission