Does CEO overconfidence help to explain merger decisions? Overconfident CEOs overestimate their ability to generate returns. As a result, they overpay for target companies and undertake value-destroying mergers. The effects are strongest if they have access to internal financing. We test these predictions using two proxies for overconfidence: CEOs' personal overinvestment in their company and their press portrayal. We find that the odds of making an acquisition are 65 % higher if the CEO is classified as overconfident. The effect is largest if the merger is diversifying and does not require external financing. The market reaction at merger announcement (–90 basis points) is significantly more negative than for non-overconfident CEOs (–12 basis points). We consider alternative interpretations including inside information, signaling, and risk tolerance.

Several non-mutually exclusive theories have been proposed to explain how corporate boards are structured. In this paper we group these theories into three hypotheses and test them empirically. The first hypothesis is that boards are shaped by the scope and complexity of the organization they are designed to oversee. Consistent with this hypothesis, we find that board size and the fraction of independent outsiders are positively related to firm size, age, and diversification. The second hypothesis is that board composition is determined through negotiations between the CEO and outside board members. Consistent with this view, we find that the fraction of independent outsiders is negatively related to contemporaneous and lagged measures of the CEO's power. We also find support for the third hypothesis, which is that boards are shaped by the opportunities for private benefits and monitoring costs afforded by the firm's unique business environment. These results indicate that corporate boards adjust to the firm's specific advising and monitoring requirements, and undermine notions that one-size-fitsall remedies can improve board and firm performance. *This paper is preliminary and incomplete. Please do not quote without the authors'

We consider a “managerial optimal” framework for top executive compensation, where top management sets their own compensation subject to limited entrenchment, instead of the conventional setting where such compensation is set by a board that maximizes firm value. Top management would like to pay themselves as much as possible, but are constrained by the need to ensure sufficient efficiency to avoid a replacement. Shareholders can remove a manager, but only at a cost, and will therefore only do so if the anticipated future value of the manager (given by anticipated future performance net future compensation) falls short of that of a replacement by this replacement cost. In this setting, observable compensation (salary) and hidden compensation (perks, pet projects, pensions, etc.) serve different roles for management and have different costs, and both are used in equilibrium. We examine the relationship between observable and hidden compensation and other variable in a dynamic model, and derive a number of unique predictions regarding these two types of pay. We then test these implications and find results that generally support the predictions of our model.

Proxy advisory and corporate governance rating firms (such as RiskMetrics/ISS, GovernanceMetrics International, and The Corporate Library) play an increasingly important role in U.S. public markets. They rank the quality of firm corporate governance, advise shareholders how to vote and sometimes press for governance changes. We examine whether commercially available corporate governance rankings provide useful information for shareholders. Our results suggest that they do not. Commercial ratings do not predict governancerelated outcomes with the precision or strength necessary to support the bold claims made by most of these firms. Moreover, we find little or no relation between the governance ratings provided by RiskMetrics with either their voting recommendations or the actual votes by shareholders on proxy proposals.

This paper investigates the economic consequences of the Sarbanes-Oxley Act through a study of market reactions to legislative events related to the Act. I find that the cumulative abnormal return around all legislative events leading to the passage of the Act is significantly negative. The loss in total market value around the most significant rulemaking events amounts to $1.4 trillion. I then examine the private benefits and costs of major provisions of the Act by investigating the cross-sectional variation in market reactions to the rulemaking events. Regression results are consistent with the hypothesis that shareholders consider both the restriction of nonaudit services and the provisions to enhance corporate governance costly to business. The results also show that Section 404 of SOX, which mandates an internal control test, imposes significant costs on firms

Corporate Governance and Equilar Inc. for providing a portion of the data used in this paper,

Abstract not found

This paper examines the effects of director labor markets at firm headquarter locations on board governance. We argue that firms can implement better board governance by drawing on local director talent when a larger pool of prospective directors (officers and directors of same-industry firms, financial institutions, and universities) is located near the firm. We find that firms located near large pools of prospective directors have a higher percentage of outside directors and directors with executive expertise on the board. Firms located closer to financial institutions and universities attract a higher percentage of directors with financial and academic expertise, respectively. The dependence of board governance on local director labor markets is greatest for less established firms (small size, short history, low product market share, no institutional blockholder). With the adoption of Sarbanes Oxley and exchange governance requirements, firms appear to have expanded the search for outside directors beyond local director labor markets. Based on our empirical evidence, we formulate an instrument for board composition and use it in a two-stage setting to reexamine the relation between governance and firm value with correction for endogeneity.

Our research provides the first empirical analysis of uncontested director elections. Using a large sample of data recently available, we find that shareholder votes are significantly related to firm performance, director performance, voting mechanisms, and the level of shareholder rights associated with a firm. Directors attending less than 75 % of board meetings and those receiving negative ISS recommendations receive 14 % and 19 % fewer votes, respectively. Meanwhile, other variables have little economic impact on shareholder votes, and even directors and firms that are poorly performing typically receive more than 90 % of the vote. However, fewer director votes lead to reductions in ‘abnormal ’ compensation levels and higher levels of CEO turnover. We also find that director votes affect a firm’s likelihood of removing poison pills and classified boards. At the same time, director votes have little impact on the election outcome, firm performance, or director reputation. These results provide important benchmarks for the current debate about reform of the election process.

We document investment distortions induced by the use of a single discount rate within firms. According to textbook capital budgeting, firms should value any project using a discount rate determined by the risk characteristics of the project. If they use a unique company-wide discount rate, they overinvest (resp. underinvest) in divisions with a market beta higher (resp. lower) than the firm’s core industry beta. We directly test this consequence of the “WACC fallacy”and establish a robust and significant positive relationship between division-level investment and the spread between the division’s market beta and the firm’s core industry beta. Consistently with bounded rationality theories, this bias is stronger when the measured cost of taking the wrong discount rate is low, for instance, when the division is small. Finally, we measure the value loss due to the WACC fallacy in the context of acquisitions. Bidder abnormal returns are higher in diversifying mergers and acquisitions in which the bidder’s beta exceeds that of the target. On average, the present value loss is about 0.7 % of the bidder’s market equity.