Equity Agency Costs in Payouts, Pension Plan Manipulation and Firm Performance

Abstract

Purpose – The purpose of this paper is to present novel empirical findings regarding the shareholder-management agency problem. Design/Methodology/Approach – The paper presents new evidence regarding the shareholder-management agency problem. It expands the set of factors that may cause agency problems to include both dollar value of management holdings and its fractional holdings.

Findings – First, the paper finds that this problem is better explained when management fractional holdings and management absolute equity wealth are considered simultaneously than separately. Second, it provides evidence that separation of control and ownership leads management to drive profits artificially upwards by overstating the anticipated long-term rate of return on pension plans (LTROR). The paper's findings point to the LTROR as a promising novel indicator for shareholder-management agency problem.

Research Limitations/Implications – Samples of 628 US firms during the period 1996-2005. Only 238 firms for pension plans as many firms do not have an internal pension fund. Practical Implications – The paper suggests practical ways to alleviate agency problems. Social Implications – The paper shows the strategic use of a change in the anticipated LTROR on pension plan assets that stems from an agency problem and affects the firm's reported net profits. The paper observes the strategic determination of LTROR in firms in which the pension funds are controlled by management. A possible social implication can be a risk for employees in firms in which the pension funds are controlled by management.

Originality/Value – The paper aims to enrich the current literature using a novel indicator of the agency problem: the long-term change in the anticipated LTROR on pension plan assets.

Keywords: Corporate finance, Corporate governance, Financial management, Management power, Pension funds

JEL Classification: G23, G32, G34, G35