Markus Christopher Arnold

Stock Options and Dividend Protection

Stock-option programs (SOPs) became the dominant compensation instrument for top management in the nineties. Usually, they are not dividend-protected, i.e., any dividend payout decreases the value of a managers options. Empirical evidence shows that this results in a significant decrease in the level of corporate dividends and, at the same time, in an increase in share repurchases. This paper analyzes different forms of dividend protection and addresses the importance of dividend protection in SOPs. Finally, the paper relates the theoretical analysis to empirical work on the link between share repurchases and SOPs.

Integrating Sustainability Reports into Financial Statements: An Experimental Study

In recent years, sustainability has increasingly attracted the attention of capital market participants. While event studies have established that stock prices react to news about environmental, social, and governance (ESG) performance, further empirical evidence raises the question of whether market participants always rationally process ESG information included in a standalone sustainability report. In an experiment with investment professionals, this study investigates whether a disconnect between financial statements and sustainability reports leads to an anchoring effect in the assessment of ESG information. Results show that users of standalone sustainability reports fully adjust their valuations to the level of integrated (financial and sustainability) report users following information about bad ESG performance. However, none of the standalone reports users adjust their valuations following information about good ESG performance. Thus, financial statement users asymmetrically anchor on their financial value judgments when assessing ESG information provided in a standalone report.

Timing effects of corporate social responsibility disclosure: an experimental study with investment professionals

ABSTRACT Companies disclose increasingly more corporate social responsibility (CSR) related information. However, CSR information is not always treated entirely rationally by capital market participants. In an experiment using experienced investment professionals, we investigate how the timing of CSR disclosure influences firm valuations by professional investors. The results suggest that CSR disclosure in a stand-alone report, temporally disconnected to firm’s financial disclosure, may lead to asymmetric anchoring, whereby simultaneous disclosure of CSR and financial information in an integrated report prevents anchoring in investors’ judgement. Investors’ asymmetric anchoring is induced by differences in cognitive effort invested in CSR information processing, which depends on whether CSR information signals future profits or losses. Our results contribute to the debate on disclosure standards for CSR information and the use of CSR information by professional investors.

Managerial Discretion and Task Interdependence in Teams

This study investigates whether the effect of managerial discretion over team members’ compensation on team performance depends on task interdependence. Task interdependence reflects the degree to which the increase in team performance resulting from a team member’s effort depends on the efforts and skills of the other team members. Consistent with our predictions, we find that, regardless of task interdependence, managers use their discretion over compensation to differentiate team members’ compensations. However, the effect of this differentiation on team performance depends on task interdependence. Specifically, our results show that managerial discretion over compensation has a positive effect on team performance when task interdependence is absent and negative effect on team performance when task interdependence is present. The results also suggest that predicted effects of task interdependence become more pronounced when task interdependence goes up. Supplemental analysis reveals that differentiating compensation among team members through managerial discretion hurts coordination and helping behavior among them. Our results have practical implications for firms, which have flexibility in designing their incentive systems in a team environment, because we identify conditions under which the effectiveness of granting managers discretion over team compensation is likely to vary.

Investment Professionals’ Use of Corporate Social Responsibility Disclosures

We conduct an experiment to examine investment professionals’ use of corporate social responsibility (CSR) disclosures when making personal investment decisions or investment recommendations to clients. We predict and find that investment professionals are more willing to personally invest and recommend investment to a client when a firm discloses positive CSR performance than when it makes no CSR disclosures. Investment professionals’ decisions and recommendations are influenced by CSR disclosures both because, on average, they believe that better CSR performance results in better current and longer-term financial performance and because they value the societal benefits of CSR activities. We also find that investment professionals’ general beliefs regarding whether CSR activities benefit society affect how they assess firms’ CSR performance and their view of the relation between CSR performance and financial performance. Finally, investment professionals’ experience appears to protect them from the potential biasing effect of appealing pictures that accompany many CSR disclosures.

The Unintended Consequences of Headquarters’ Involvement in Decentralized Transfer Price Negotiations : Experimental Evidence

This study investigates how headquarters involvement affects the efficiency of decentralized transfer price negotiations. Prior research assumes that decentralized managers negotiate transfer prices autonomously. However, evidence suggests that headquarters can become involved in transfer price negotiations, particularly after negotiation failure. While the intention of headquarters involvement is to overcome inefficiencies arising from decentralized managers’ inability to agree on a transfer price, we suggest that such involvement is likely to have the unintended consequences of further reducing both agreement frequency and the efficiency of negotiated transfer pricing. Reduced agreement is likely to occur because decentralized managers are likely to feel less responsible for the negotiation outcome and may be overly optimistic about headquarters’ decision. Reduced efficiency is likely to result because overconfidence is likely to make headquarters underestimate its informational disadvantage compared to decentralized managers and, consequently, induces inefficient transfer decisions. For the same reasons, inefficiency is likely to be the larger, the more decision authority headquarters takes over after negotiation failure. In an experiment, we manipulate whether headquarters involvement is absent vs. present. Nested within headquarters involvement present are two conditions: one where, after negotiation failure, headquarters suggests a transfer price that either decentralized manager can reject (weak involvement) and one where it can impose a price at which they must trade (strong involvement). Consistent with our predictions, we find that headquarters involvement reduces the frequency of negotiation agreement and the efficiency of transfer pricing. Additionally, we find that efficiency is reduced more when headquarters involvement is strong rather than weak. We contribute to the literature on negotiated transfer pricing by providing evidence about headquarters’ biased perceptions of negotiation impasse and the unintended consequences of its involvement. Additionally, our study informs organizations about the benefits of committing to non-involvement in decentralized transfer price negotiations.

Uncertainty and Information Asymmetry in Budget Negotiations

Participative budgeting processes are an important element of management control systems in many firms. The literature on participative budgeting has studied the role of information asymmetry. However, prior contributions do not differentiate between superior uncertainty about future profitability arising from information asymmetry between the superior and the subordinate (one-sided uncertainty) and superior uncertainty arising from a volatile environment in which even the subordinate does not know the future profitability (common uncertainty). While both kinds of superior uncertainty are equivalent from an economic perspective as the superior cannot expect the subordinate to convey private information under a slack-inducing bonus scheme, they may strongly differ with regard the psychological factors affecting behavior in these settings. We conduct a laboratory experiment to disentangle these effects. We find that the psychological effect, but not the economic effect, increases conflict in budget negotiations and hurts performance. Specifically, initial negotiation positions are more distant under one-sided than under common uncertainty, because superiors are more contending when information is asymmetric. As a consequence, negotiation failures are more frequent. Furthermore, when setting budgets following negotiation disagreement, we find that superiors account for the risk of losing the subordinate’s motivation under common uncertainty but not under one-sided uncertainty. Finally, after controlling for financial incentives, subordinates’ negative performance reactions to negotiation disagreement is particularly large under one-sided uncertainty.

Strategic Reputation Building and Norm Enforcement: An Experimental Study in a Capital Budgeting Setting

This experimental study investigates the effects of the superiors’ and the subordinates’ abilities to build reputations on ex post controls in capital budgeting. Investigating reputational aspects is particularly important in the context of capital budgeting as there is strong evidence that norms and norm enforcement affect superior and subordinate behavior in this setting. This means that both the willingness to conduct ex post controls and the control intensity might crucially depend on the reputation building abilities of superiors and subordinates. In particular, both the subordinate reputation as a “norm violating subordinate” as well as the intention to strategically build a reputation as a “norm enforcing superior” to prevent future slack creation might be strong triggers of ex post controls. However, there is no or little evidence so far that superiors or subordinates (successfully) build reputations in capital budgeting and that counterparts react to these reputations. This is surprising given the high relevance of norm enforcement and its potential interaction with reputations as well as the high importance of reputation as an (auxiliary) control mechanism in many other settings. The findings of our experimental study indicate that both the superiors’ control willingness and their control intensity depend on the superiors’ and the subordinates’ abilities to build reputations. The results show that both the non-monetary motive of norm enforcement as well as the monetary motivation of self-interested superiors to build reputations as norm enforcing superiors strongly influence decisions to conduct ex post control. Moreover, we find that ex post controls like internal audits are particularly useful in disciplining slack creation when reputational mechanisms are relevant. This contributes to the literature in several important ways: First, we add to the evidence on the role of reputations in capital budgeting and contribute to solve conflicting evidence as to the importance of reputations in capital budgeting. Second, our results contribute to explain how different superior motivations to conduct controls affect their control willingness and the control intensity which contributes to explain the way controls are conducted. Finally, our findings add to the growing literature on the effects of socially-mediated controls and norm enforcing motives in management control processes. Our results imply that reputational considerations may represent an important (auxiliary) control mechanism for capital budgeting.

Costly Budget Negotiations and Financial Distress: An Experimental Investigation

This experiment examines how two exogenous constraints, financial distress and high opportunity costs of the negotiation, affect superiors’ and subordinates’ behavior during and after budget negotiations. Both constraints manipulated in the experiment impair the superior’s situation only and leave the subordinate’s monetary position unchanged. Thus, the experiment studies behavioral effects on subordinate behavior that extend beyond monetary incentives. However, the constraints differ with respect to the degree of the superior’s dependency on the subordinate. The question of how exogenous constraints affect behavior in budget negotiations represents an important research topic, as the answer might contribute to resolving the tension inherent in prior experimental and empirical evidence. In particular, the empirical evidence of less participative decision making under adverse financial conditions challenges findings in the budgeting literature of performance decreases following budget impositions. If the performance decreases persisted under financial distress, the decision to abandon participative decision making might be suboptimal, as the impact of performance decreases in a financially constrained situation is likely to be worse than under “normal” conditions. Findings show that exogenous constraints strongly affect the behavior during and after negotiations as well as the process by which fairness perceptions affect performance. First, financial distress but not increased opportunity costs decrease the initial negotiation conflict between superior and subordinate. Second, under exogenous constraints, subordinates seem to attribute superiors’ budget impositions to the constraints and not to the superior, their performance following a budget imposition strongly increases relative to the baseline treatment. Finally, exogenous constraints moderate the effect of procedural fairness considerations on subordinate performance. The paper contributes to the accounting literature in several important ways: First, the results raise doubt that findings derived under “normal” conditions can always be generalized to constrained settings. Second, the study provides a behavioral rationale for the observed tendency toward less participative decision making in financially constrained situations. In these situations the trade-off between efficiency of the decision making process and motivational benefits of participative decision making might be shifted. Finally, the study informs theory about the relevance of procedural fairness in budgeting processes. While prior contributions have stressed their relevance, this study provides evidence that procedural considerations lose importance if individuals have other, direct information to judge fairness.