Jeffrey L. Coles

Boards: Does One Size Fit All?

This paper reexamines the relation between firm value and board structure. We find that complex firms, which have greater advising requirements than simple firms, have larger boards with more outside directors. The relation between Tobin’s Q and board size is U-shaped, which, at face value, suggests that either very small or very large boards are optimal. This relation, however, arises from differences between complex and simple firms. Tobin’s Q increases (decreases) in board size for complex (simple) firms, and this relation is driven by the number of outside directors. We find some evidence that R&D-intensive firms, for which the firm-specific knowledge of insiders is relatively important, have a higher fraction of insiders on the board and that, for these firms, Q increases with the fraction of insiders on the board. Our findings challenge the notion that restrictions on board size and management representation on the board necessarily enhance firm value. r 2007 Published by Elsevier B.V. JEL classification: G32; G34; K22

Leadership Structure: Separating the CEO and Chairman of the Board

Shareholder activists and regulators are pressuring U.S. firms to separate the titles of CEO and Chairman of the Board. They argue that separating the titles will reduce agency costs in corporations and improve performance. The existing empirical evidence appears to support this view. We argue that this separation has potential costs, as well as potential benefits. In contrast to most of the previous empirical work, our evidence suggests that the costs of separation are larger than the benefits for most large firms.

Outside directors and the adoption of poison pills

We find that the average stock-market reaction to announcements of poison pills is positive when the board has a majority of outside directors and negative when it does not. The probability that a subsequent control contest is associated with an auction is also positively related to the fraction of outsiders on the board. These results are largely driven by directors who are retired executives from other companies. The evidence suggests that outside directors serve the interests of shareholders.

Stock-based incentive compensation and investment behavior*

Abstract This paper examines how excessive concern over current stock price can motivate managers to use observable investment decisions to manipulate the markets inferences about the firm. The result can be overinvestment or underinvestment. Shareholders can induce optimal investment choices by structuring managerial compensation to balance both future and present stock-price performance. Our analysis suggests that firms with high/persistent informational asymmetries between managers and shareholders will tend to favor contracts that focus on long-run stock returns (both current and future) over contracts that focus on near-term stock returns alone. Our empirical results, as well as other results in the literature, are generally consistent with this hypothesis.

What Happens to CEOs After They Retire? New Evidence on Career Concerns, Horizon Problems, and CEO Incentives

This paper provides evidence on a previously unidentified source of managerial incentives: concerns about post-retirement board service. Both the likelihood that a retired CEO serves on his own board two years after departure, as well as the likelihood of serving as an outside director on other boards, are positively and strongly related to his performance while CEO. Retention on the CEOs own board depends primarily on stock returns, while service on outside boards is better explained by accounting returns. The evidence also suggests that firms consider ability in choosing board members.

Corporate Policies Restricting Trading By Insiders

This paper provides the first systematic examination of policies and procedures put in place by corporations to regulate trading in the stock by the firms own insiders. Over 90 percent of our sample companies have their own policy restricting trading by insiders, and nearly 80 percent have explicit blackout periods during which the company prohibits trading by its insiders. We provide detailed information on: the form of such policies; the incidence of the various types of rules and restrictions; and the monitoring and assistance activities associated with implementation of the policy. In addition, we examine the characteristics of firms that choose to self-regulate, and find that both stock return volatility and insider trading frequency are positively-related to the use of blackout periods. Our data indicate that blackout periods successfully suppress trading by insiders (both purchases and sales) and that the blackout period is associated with a slightly narrower bid-ask spread. Consistent with this small effect on the spread, we find that the profitability of trades made during allowed trading windows is only slightly higher than profitability based on trades made in prohibited blackout periods. Finally, our findings on trading around earnings announcements suggest that experiments designed to address the issues of the effectiveness of insider trading regulations and the efficiency of capital markets are likely to be more powerful if they account for the presence and effects of corporate restrictions on trading.

On Equilibrium Pricing under Parameter Uncertainty

Prior theoretical work on estimation risk generally has been restricted to single-period, returns-based models in which the investor must estimate the vector of expected returns but the covariance matrix is known. This paper extends the literature on parameter uncertainty in several ways. First, we analyze asymmetric parameter uncertainty in a model based on payoffs. Second, we explore the effects of both symmetric and asymmetric estimation risk on equilibrium asset prices when the covariance matrix for payoffs must also be estimated. Finally, we investigate the effects on equilibrium of asymmetric parameter uncertainty in a simple multiperiod model.

Co-opted Boards

We develop two measures of board composition to investigate whether directors appointed by the CEO have allegiance to the CEO and decrease their monitoring. Co-option is the fraction of the board comprised of directors appointed after the CEO assumed office. As Co-option increases, board monitoring decreases: turnover-performance sensitivity diminishes, pay increases (without commensurate increase in pay-performance sensitivity), and investment increases. Non-Co-opted Independence—the fraction of directors who are independent and were appointed before the CEO—has more explanatory power for monitoring effectiveness than the conventional measure of board independence. Our results suggest that not all independent directors are effective monitors.

The Shareholder Wealth Implications of Corporate Lawsuits

Large revisions in dividends are accompanied by stock price reactions for industry rivals of the announcing firm. Though these effects are near-zero on average, their magnitude differs systematically across the firms in the industry. Rivals that are unlikely to be affected by competitive realignments within the industry tend to experience stock price effects like those of the announcing firm. Those that are likely to be affected tend to experience statistically insignificant reactions of the opposite sign. Thus, for some rivals, competitive effects apparently offset contagion effects. We find supporting results for changes in rivals dividends over a longer period. We examine the intra-industry information effects of announcements of dividend initiations. Our results indicate that the stock prices of industry competitors do not react to dividend initiations. Further, analysts do not revise their earnings forecasts for nonannouncing, rival firms. These findings are not sensitive to the manner in which we estimate abnormal returns or calculate forecast revisions. Thus, the information conveyed to the market by the decision to initiate dividends contains no industry-wide component. Dividend initiation appears to be a firm-specific event.

New Evidence on the Market for Directors: Board Membership and Pennsylvania Senate Bill 1310

We examine the relation between a boards decision to reject antitakeover provisions of Pennsylvania Senate Bill 1310 and subsequent labor market opportunities of those same board members. Compared to directors retaining all provisions, directors rejecting all protective provisions of SB1310 are three times as likely to gain additional external directorships and are 30 percent more likely to retain their internal slot on the board of that same Pennsylvania company. For external board seats, the results are driven by nonexecutive directors who are not members of the management team; for internal board seats, the results are driven by executive directors. Copyright 2003 by the American Finance Association.