Jarrad Harford

The cash-flow permanence and information content of dividend increases versus repurchases

We hypothesize that firms choose dividend increases to distribute relatively permanent cash-flow shocks and repurchases to distribute more transient shocks. As predicted, we find that post-shock cash flows of dividend increasing firms exhibit less reversion to pre-shock levels compared with repurchasing firms. We also examine whether the stock market uses the announcement of the payout method to update its beliefs about the permanence of cash-flow shocks. Controlling for payout size and the markets expectation about the permanence of the cash-flow shock, the stock price reaction to dividend increases is more positive than the reaction to repurchases.

Takeover bids and target directors' incentives: the impact of a bid on directors' wealth and board seats

Abstract I investigate the nature of the incentives that lead outside directors to serve stockholders’ interests. Specifically, I document the effect of a takeover bid on target directors, both in terms of its immediate financial impact and its effect on the number of future board seats held by those target directors. Directors are rarely retained following a completed offer. All target directors hold fewer directorships in the future than a control group, suggesting that the target board seat is difficult to replace. For outside directors, the direct financial impact of a completed merger is predominately negative. This documents a cost to outside directors should they fail as monitors, forcing the external control market to act for them. Future seats are related to pre-bid performance. Among outside directors of poorly performing firms, those who rebuff an offer face partial settling-up in the directorial labor market, while those who complete the merger do not.

Determinants of Corporate Cash Policy: Insights from Private Firms

We provide one of the first large sample comparisons of cash policies in public and private U.S. firms. We first show that despite higher financing frictions, private firms hold, on average, about half as much cash as public firms do. By examining the drivers of cash policies for each group, we are able to attribute the difference to the much higher agency costs in public firms. By combining evidence from across public and private firms as well as within public firms across different qualities of governance, we are able to reconcile existing mixed evidence on the effects of agency problems on cash policies. Specifically, agency problems affect not only the target level of cash, but also how managers react to cash in excess of the target.

Refinancing Risk and Cash Holdings

Although a firm’s use of shorter-term debt can potentially help it to reduce agency costs of debt and align managers’ interests with those of shareholders, the use of this type of debt increases the firm’s refinancing risk. We hypothesize that firms with debt that has a shorter maturity hold larger cash reserves to reduce important costs they could incur if they have difficulty refinancing their debt. Using a simultaneous equations framework that accounts for the joint determination of cash holdings and debt maturity, we find that firms that shorten (lengthen) the maturity of their debt increase (decrease) their cash holdings. Additionally, we document that U.S. firms have markedly shortened the maturity of their debt over the 1980-2008 period and that this can explain a large fraction of the increase in the cash holdings of these firms over this period. We also show that the market value of a dollar of cash holdings is higher for firms whose debt has a shorter maturity. Further, the inverse associations between the maturity of a firm’s debt with the level and market value of its cash holdings are more pronounced during periods when credit market conditions are tighter and refinancing risk is consequently higher. Finally, we show that larger cash holdings help to mitigate underinvestment problems resulting from refinancing risk. Overall, our findings suggest that refinancing risk is a key determinant of corporate cash holdings. * We thank Malcolm Baker, Travis Box, Murillo Campello, Amar Gande, Kathy Kahle, Swaminathan Kalpathy, and seminar participants at McGill University, Texas Tech University, Virginia Tech University, the University of Arizona, and the 2011 University of Innsbruck – Financial Markets and Risk conference for helpful comments. We also thank Douglas Fairhurst for excellent research assistance.

Does the Director Labor Market Offer Ex Post Settling-Up for CEOs? The Case of Acquisitions

A common view in the literature is that the director labor market provides an ex post settling-up for past decisions by rewarding CEO ability and actions that are consistent with shareholder interests. In this paper we focus on large CEO acquisition decisions to investigate whether the director labor market offers ex post settling-up for value-destroying decisions. Prior studies have found that the director labor market values CEO ability as reflected in overall firm performance suggesting that only value creating acquisitions should lead to additional subsequent directorships. However, given that CEOs that make acquisitions, even value-destroying ones, gain important experience that may be valuable to other firms, it is possible that by rewarding experience, the director labor market’s settling-up breaks down for these important decisions. In this paper we show that large acquisitions are associated with significantly increased numbers of subsequent board seats for the acquiring CEO, target CEO, and the directors. We also find that in the case of acquisitions, experience is more important than ability — value-destroying and value-increasing acquisitions have equally significant and positive effects on a CEO’s future prospects in the director labor market. In addition to increasing our understanding of the director labor market, these results suggest that the ex post settling-up incentives thought to exist in the director labor market do not exist for acquisitions, and if anything exacerbate the agency conflict over acquisitions by encouraging them.

Bonus-Driven Repurchases

Using a large hand-collected database of chief executive officer (CEO) bonus structures, we find that when a CEO’s bonus is directly tied to earnings per share (EPS), his company is more likely to conduct a buyback. This effect is especially pronounced when a company’s EPS is right below the threshold for a bonus award. Share repurchasing increases the probability the CEO receives a bonus and the magnitude of that bonus, but only when bonus pay is EPS based. Bonus-driven repurchasing firms do not exhibit positive long-run abnormal returns.

Financial Flexibility, Risk Management, and Payout Choice

Both risk management and payout decisions affect a firms financial flexibility—the ability to avoid costly financial distress as well as underinvestment. We provide evidence of substitution between hedging and payout decisions using samples of both financial and nonfinancial firms. We find that a more flexible distribution, favoring repurchases over dividends, is negatively related to financial hedging within a firm, consistent with financial flexibility in payout decisions and hedging being substitutes. Our findings, which are robust to controlling for the endogeneity of hedging and payout choices, suggest that payout flexibility offers operational hedging benefits.

Precautionary Savings with Risky Assets: When Cash Is Not Cash

We show that U.S. industrial firms invest heavily in non-cash, risky financial assets such as corporate debt, equity, and mortgage-backed securities. Risky assets represent 40% of firms’ financial portfolios, or 6% of total book assets. We present a formal model to assess the optimality of risky financial investments. Consistent with the model’s predictions, risky assets are concentrated in financially unconstrained firms that hold large financial portfolios. Further, they are undertaken by poorly governed firms and discounted by 13-22% compared to safe assets. We conclude that this activity represents an unregulated asset management industry of more than

CEO Turnover-Performance Sensitivities in Private Firms

1.5 trillion, questioning the traditional boundaries of nonfinancial firms.

Financial Flexibility and Corporate Cash Policy

We compare CEO turnover in public and private firms to gain insight into whether and how investor horizon influences CEO firing decisions. Controlling for governance structures, public firms have higher CEO turnover rates and exhibit greater turnover-performance sensitivity than private firms. Performance improvement and corporate policy changes around CEO turnover are more evident for private firms than for public firms. We conclude that investor myopia is the main cause of the differences and provide evidence of segmentation in the CEO labor market as an explanation for how differing turnover risks can persist in public versus private firms.We compare CEO turnover in public and large private firms. Public firms have higher turnover rates and exhibit greater turnover-performance sensitivities than private firms. Controlling for pre-turnover performance, performance improvements are greater for private firms than for public firms. We investigate whether these differences are due to differences in quality of accounting information, the CEO candidate pool, CEO power, board structure, ownership structure, investor horizon, or some unobservable differences between public and private firms. One factor contributing to public firms’ higher turnover rates and greater turnover-performance sensitivities appears to be investor myopia.