How Executive Compensation Affects Firms’ Choice of Financing

The separation of corporate ownership from control leads to an agency problem caused by the divergent interests of shareholders (the principals) and management (the agent).  One area of contention is the level of risk-taking by the firm.  Managers’ investment in human capital makes them more risk-averse than shareholders are, and this difference creates losses that account in part for the agency cost of equity.  To mitigate this cost, prior research suggests that managers be paid in stock and stock options, in addition to cash compensation, so that their interests are aligned with those of shareholders.

Unfortunately, the convergence of managers’ … Read more

Tournament-Based Incentives, Corporate Cash Holdings and the Value of Cash

In a new paper, we examine how tournament-based incentives affect corporate cash holdings and the value of those holdings for shareholders.

Before a firm selects a new CEO, it may run a tournament within the firm to rank its vice-presidents (VPs) as candidates. Because the actual ability of a VP is unobservable, the VP with the best performance relative to his peers will likely win the tournament. The payoff structure of tournament-based incentives is similar to that of stock options, in which the payoff is an increase in pay, perquisites, and prestige associated with being the CEO. This option-like feature … Read more

How Policy Uncertainty Affects M&A

Uncertainty about government economic policy reduces corporate investment and increases financing costs, as prior research has shown. In our new paper, we examine the relationship between policy uncertainty and M&A and the implications for shareholder value. We use the BBD policy uncertainty index developed by Baker, Bloom, and Davis (2016) as a proxy to examine how policy-related economic uncertainty affects firm acquisitiveness, the time it takes to complete a deal, the method of payment, and acquirer and target shareholder value. The BBD index is based on the weighted average of three components: the frequency of newspaper articles containing key terms … Read more