Sok-Hyon Kang

Corporate Governance, Takeovers, and Top-Management Compensation: Theory and Evidence

We examine, both theoretically and empirically, top-management compensation in the presence of agency conflicts when shareholders have delegated governance responsibilities to a self-interested Board of Directors (BOD). We develop a theoretical framework that explicitly incorporates the BOD as a strategic player, models the negotiation process between the CEO and the BOD in designing CEO compensation, and considers the impact of potential takeovers by large shareholders monitoring the CEO-BOD negotiations. In equilibrium, internal governance by the BOD and external takeover threats by a large shareholder act as substitutes in imposing managerial control, especially in constraining managements profligacy in awarding equity-based compensation to itself. The model emphasizes factors in the design of compensation contracts that are rarely considered in the literature, such as equity ownership of the largest outside shareholder and the firms bankruptcy risk. It also provides new perspectives on factors that are often considered in the literature, such as firm size, firm performance, equity ownership of the BOD, and BOD structure. Our empirical tests lend considerable support for our theoretical predictions. Equity ownership of the largest external shareholder, that of the BOD, and the default risk, are strongly negatively related to the size of CEO equity compensation. Consistent with the theoretical model, these factors do not significantly influence the growth of fixed (or non-performance-related) compensation. We also find that the equity ownership of the BOD is more important in managerial compensation control than other BOD related variables, such as BOD size or the proportion of outside directors.

Agency and corporate investment: The role of executive compensation and corporate governance

The agency theory of the firm implies that executive incentive compensation and corporate investment policies are endogenously determined. We estimate jointly the relationship between long-term corporate investment and CEO incentive compensation structure, while considering the strength of corporate governance mechanisms. The analysis indicates that long-term business investment is positively related to the weight placed on equity-based incentive compensation, after controlling for internal financing constraints and the quality of the investment opportunity set. We also confirm that CEO compensation structure is influenced by factors that represent the strength of the firms internal governance mechanisms.

Estimates of economic rates of return for the U.S. pharmaceutical industry, 1976–1987☆

Abstract Estimation procedures are designed to consider features of publicly-available financial accounting information which allegedly compromise its use to estimate economic internal rates of return. These procedures, which focus on cashflows rather than conventional accounting income measures, are used to investigate the relative profitability of the U.S. pharamaceutical industry. Results indicate that pharmceutical returns exceed returns for comparable U.S. industrial firms during the period encompassed by the study. Differences for these comparisons are substantially less than what is implied by an uniformed use of accounting information, however. In particular, differences in implied internal rates of return of 2.1% to 3.8%, whereas differences in accounting rates of return are 4.0% to 5.6%. Results are robust for a wide variety of assumptions about industry growth rates and investment payout profiles, characteristics which potentially cause accounting-based return measures to differ from underlying internal rates of return.

External Corporate Governance and Misreporting

This study investigates how external corporate governance provisions, specifically statutory and corporate charter provisions that limit direct shareholder participation in the governance process, affect the likelihood of an accounting restatement. The analysis indicates that strong external governance (fewer restrictions on shareholder participation) is associated with a relatively low incidence of accounting restatements. The effect of external governance is incremental to that of internal governance, which is considered as provisions that foster effective board oversight of management. Such evidence supports the premise that shareholder participation improves financial reporting quality.

Managerial objectives and firm dividend policy: A behavioral theory and empirical evidence

Abstract We construct a dynamical model of firm dividend policy based on some basic ingredients of the behavioral theory of the firm, in particular, uncertainty avoidance and sequential decision-making by self-seeking managers. We characterize the optimal dividend policy and show that comparative statics on this policy generate restrictions on the relation of the likelihood of future dividend changes with respect to current real and financial variables such as investments, dividends, and technological parameters that govern the evolution of economic earnings of the firm, such as the variance and persistence of the systematic shocks on capital productivity. These relations are then empirically tested on NYSE dividend data. The empirical results are supportive of the predictions from the behavioral model. Specifically, current investment, dividend payouts and the return on capital appear to have significant impact on the likelihood of future dividend changes, as do the variance and persistence of capital productivity shocks. In particular, idiosyncratic firm risk is found to have a negative relation to the likelihood of dividend charges. Finally, these variables are shown to impact the likelihood of dividend increases and decreases asymmetrically, a distinction emphasized by the behavioral model.