CEO Ownership, External Governance, and Risk-taking

This paper shows the relation between CEO ownership and firm valuation hinges critically on the strength of external governance (EG). The relation is hump-shaped when EG is weak, but is insignificant when EG is strong. The results imply that CEO ownership and EG are substitutes for mitigating agency problems when ownership is low. However, very high levels of share ownership can reduce firm value by entrenching the CEO and discouraging him from taking risk, unless mitigated by strong EG. We identify channels through which CEO ownership affects firm value by examining R&D, which is discretionary and risky. We find CEO ownership similarly exhibits a hump-shaped relation with R&D when EG is weak, but no relation when EG is strong. Our results are robust to endogeneity issues concerning CEO ownership and EG.

[1]  W. Guay,et al.  The sensitivity of CEO wealth to equity risk: an analysis of the magnitude and determinants ☆ , 1999 .

[2]  P. Volpin,et al.  Governance with Poor Investor Protection: Evidence from Top Executive Turnover in Italy , 2002 .

[3]  Daniel Ferreira,et al.  Understanding the Relationship between Founder-CEOs and Firm Performance , 2008 .

[4]  René M. Stulz,et al.  The Determinants of Firms' Hedging Policies , 1985, Journal of Financial and Quantitative Analysis.

[5]  Julie Wulf,et al.  The Flattening Firm and Product Market Competition , 2009 .

[6]  Campbell R. Harvey,et al.  The Theory and Practice of Corporate Finance: Evidence from the Field , 1999 .

[7]  L. Bebchuk,et al.  Pay without Performance, The Unfulfilled Promise of Executive Compensation, Part IV: Going Forward , 2004 .

[8]  A. Shleifer,et al.  Large Shareholders and Corporate Control , 1986, Journal of Political Economy.

[9]  Jeffrey B. Liebman,et al.  Are CEOS Really Paid Like Bureaucrats? , 1997 .

[10]  E. H. Kim,et al.  To Steal or Not to Steal: Firm Attributes, Legal Environment, and Valuation , 2003 .

[11]  H. Demsetz,et al.  The Structure of Corporate Ownership: Causes and Consequences , 1985, Journal of Political Economy.

[12]  J. Carpenter,et al.  Does Option Compensation Increase Managerial Risk Appetite? , 1999 .

[13]  Holger M. Mueller,et al.  Does Corporate Governance Matter in Competitive Industries? , 2007 .

[14]  Gustavo Manso,et al.  The Rodney L . White Center for Financial Research Governance Through Exit and Voice : A Theory of Multiple Blockholders , 2008 .

[15]  Jeffrey L. Coles,et al.  Managerial Incentives and Risk-Taking , 2006 .

[16]  Alex Edmans,et al.  Blockholder Trading, Market Efficiency, and Managerial Myopia , 2009 .

[17]  The Temporal Structure of Equity Compensation , 2010 .

[18]  E. H. Kim,et al.  Miller's Equilibrium, Shareholder Leverage Clienteles, and Optimal Capital Structure , 1982 .

[19]  Christopher J. Skousen,et al.  Advances in Financial Economics , 2009 .

[20]  Bengt Holmstrom,et al.  Moral Hazard and Observability , 1979 .

[21]  Joseph J. Gerakos,et al.  Pay Without Performance – The Unfulfilled Promise of Executive Compensation. By Lucian Bebchuk and Jesse Fried. Harvard University Press, 2004. ISBN 0-674-01665-304 pages, Price $24.95. , 2005, Journal of Pension Economics and Finance.

[22]  L. Starks,et al.  Institutional Investors and Executive Compensation , 2000 .

[23]  Neil Brisley.  Executive Stock Options: Early Exercise Provisions and Risk-Taking Incentives , 2006 .

[24]  John Mcconnell,et al.  Additional evidence on equity ownership and corporate value , 1990 .

[25]  S. R. Kole.  Managerial Ownership and Firm Performance: Incentives or Rewards? , 1996 .

[26]  Darius Palia,et al.  Tenure and CEO pay , 2010 .

[27]  Paul A. Gompers,et al.  CORPORATE GOVERNANCE AND EQUITY PRICES , 2002 .

[28]  David A. Hirshleifer,et al.  Risk, managerial effort, and project choice , 1992 .

[29]  Renée B. Adams,et al.  Identifying the Effect of Managerial Control on Firm Performance , 2004 .

[30]  Ronald C. Anderson,et al.  Founding-Family Ownership and Firm Performance: Evidence from the S&P 500 , 2003 .

[31]  Michael L. Lemmon,et al.  Structural Models and Endogeneity in Corporate Finance: The Link Between Managerial Ownership and Corporate Performance , 2003 .

[32]  D. Larcker,et al.  Executive Equity Compensation and Incentives: A Survey , 2002 .

[33]  D. Sheehan,et al.  Were the Good Old Days That Good? The Evolution of Managerial Stock Ownership Since the Great Depression , 1996 .

[34]  Stephen A. Ross,et al.  Compensation, Incentives, and the Duality of Risk Aversion and Riskiness , 2004 .

[35]  Martijn Cremers,et al.  The CEO Pay Slice , 2010 .

[36]  Ruediger Fahlenbrach,et al.  Founder-CEOs, Investment Decisions, and Stock Market Performance , 2007, Journal of Financial and Quantitative Analysis.

[37]  A. Low,et al.  Managerial Risk-Taking Behavior and Equity-Based Compensation , 2008 .

[38]  Matthew Rhodes-Kropf,et al.  Concentrating on Governance , 2010 .

[39]  Xianming Zhou.  Understanding the determinants of managerial ownership and the link between ownership and performance: comment , 2001 .

[40]  Karl V. Lins,et al.  Changes in Equity Ownership and Changes in the Market Value of the Firm , 2004 .

[41]  Martijn Cremers,et al.  Governance Mechanisms and Equity Prices , 2003 .

[42]  Maria Guadalupe,et al.  The Flattening Firm and Product Market Competition: The Effect of Trade Costs and Liberalization , 2007 .

[43]  Kevin J. Murphy,et al.  Performance Pay and Top Management Incentives , 1990 .

[44]  Raphael Amit,et al.  How Do Family Ownership, Control, and Management Affect Firm Value? , 2006 .

[45]  Sendhil Mullainathan,et al.  Agents with and Without Principals , 2000 .

[46]  Julie Wulf,et al.  The Flattening Firm and Product Market Competition: The Effect of Trade Liberalization , 2008 .

[47]  Xavier Gabaix,et al.  The Rodney L . White Center for Financial Research A Multiplicative Model of Optimal CEO Incentives in Market Equilibrium , 2008 .

[48]  Todd T. Milbourn,et al.  CEO Compensation and Corporate Risk: Evidence from a Natural Experiment , 2013 .

[49]  Myeong-Hyeon Cho,et al.  Ownership structure, investment, and the corporate value: an empirical analysis , 1998 .

[50]  Y. Amihud,et al.  Risk Reduction as a Managerial Motive for Conglomerate Mergers , 1981 .

[51]  H. Demsetz,et al.  Ownership Structure and Corporate Performance , 2001 .

[52]  René M. Stulz,et al.  Managerial Ownership Dynamics and Firm Value , 2007 .

[53]  M. Marchica,et al.  Large Shareholder Diversification and Corporate Risk-Taking , 2010 .

[54]  Kevin J. Murphy,et al.  Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence , 1991, Journal of Political Economy.

[55]  Xavier Gabaix,et al.  The Effect of Risk on the CEO Market , 2010 .

[56]  Julian Atanassov,et al.  Labor and Corporate Governance: International Evidence from Restructuring Decisions , 2009 .

[57]  X. Gabaix,et al.  Dynamic Incentive Accounts , 2009 .

[58]  Corporate Investments: Learning from Restatements , 2009 .

[59]  Darius Palia,et al.  The Endogeneity of Managerial Compensation in Firm Valuation: A Solution , 2001 .

[60]  Jan Mahrt-Smith,et al.  Corporate Governance and the Value of Cash Holdings , 2007 .

[61]  E. Fama,et al.  Industry costs of equity , 1997 .

[62]  A. Shleifer,et al.  Management Ownership and Market Valuation: An Empirical Analysis , 1988 .

[63]  Anup Agrawal,et al.  Firm Performance and Mechanisms to Control Agency Problems between Managers and Shareholders , 1995 .

[64]  Julian Atanassov.  Do Hostile Takeovers Stifle Innovation? Evidence from Antitakeover Legislation and Corporate Patenting , 2012 .

[65]  Merton H. Miller,et al.  DEBT AND TAXES , 1977 .

[66]  John E. Core,et al.  Estimating the Value of Employee Stock Option Portfolios and Their Sensitivities to Price and Volatility , 2002 .

[67]  Kenneth J. Martin,et al.  Executive stock ownership and performance tracking faint traces , 1997 .

[68]  Gustavo Manso,et al.  Governance Through Trading and Intervention: A Theory of Multiple Blockholders , 2011 .