Venky Nagar

Real Investment Implications of Employee Stock Option Exercises

This paper examines a real cost of awarding employee stock options. Based on the observation that managers are extremely concerned about earnings-per-share dilution in equity related compensation, we predict and find that firms experiencing significant employee stock option (ESO) exercises shift resources away from real investments towards the repurchase of their own stocks. We further find weak evidence of a decline in subsequent firm performance (as measured by return on assets) for several years following the cut in discretionary investments as a result of stock option exercises, though this result is sensitive to the metric used to measure performance. Collectively, our findings indicate that ESO exercises potentially impose a real cost on the firm in terms of foregone investment opportunities.

Exit as Governance: An Empirical Analysis

Recent theory posits a new governance channel available to blockholders: threat of exit. Threat of exit, as opposed to actual exit, is difficult to measure directly. However, a crucial property is that it is weaker when stock liquidity is lower and vice versa. We use natural experiments of financial crises and decimalization as exogenous shocks to stock liquidity. Firms with larger blockholdings experience greater declines (increases) in firm value during the crises (decimalization), particularly if the managers wealth is sensitive to the stock price and thus to exit threats. Additional tests suggest exit threats are distinct from blockholder intervention.

Measuring Customer Relationships: The Case of the Retail Banking Industry

Arguing that GAAP is ill suited for estimating the future profitability of intangibles, the accounting literature (e.g., Kaplan and Norton 1996, Lev 2001) has recently proposed alternative measurement models. These models view intangibles as composed of a set of fundamental business activities and use multiple financial and nonfinancial metrics causally interlinked to profits to represent this view. Using a unique and proprietary cross-sectional data set of the retail banking industry, we provide some of the first tests on the empirical validity of such measurement models. We characterize the core deposit intangible, an important retail banking intangible representing a banks relationships with its customers, using financial and nonfinancial metrics on price, service, customer usage, and customer satisfaction. We find that the metrics do not individually predict future earnings, but gain individual significance in a collective setting, increasing the predictive power substantially. We argue that this result occurs because the activities underlying the measures are causally interlinked to profits and explicitly illustrate these linkages with a structural path model. Our measurement model also predicts significant interactive effects in the way our measures are informative about future profits, and we document such effects, not just among the individual measures, but also across the measures and environmental factors such as the banks strategy. In sum, our measurement model illustrates the key drivers, measures, and interactions in retail banking customer relationships.

An Empirical Examination of Dynamic Quality-Based Learning Models

Using detailed data on defect rates and quality costs from twelve plants of a Fortune 500 company, we provide the first direct tests of predictions arising from two sets of dynamic quality-based learning models. We find greater support for quality-based learning models that assume learning is a function of both proactive investments in quality improvementand autonomous learning-by-doing, than for models that assume learning is a function of reactive investments in quality improvement alone. We then extend these two sets of models to examine the impact of individual prevention activities and past nonconformance expenditures on defect rates. We find that benefits from different types of prevention expenditures vary, and that past nonconformance expenditures provide learning opportunities that allow the organization to more efficiently cope with future failures, thereby reducing subsequent nonconformance costs. These important implications are absent in current quality-based learning models, providing an opportunity for future theoretical development.

The Role of the Manager?S Human Capital in Discretionary Disclosure

Prior studies have characterized Verrecchias (1983) discretionary disclosure costs mainly in terms of competitive concerns. This study shows that separating the managers and the shareholders into two separate, self-interested beings also leads to disclosure costs, precluding discretionary disclosure in certain cases.

Governance Problems in Closely-Held Corporations

A major governance problem in closely held corporations is the majority shareholders’ expropriation of minority shareholders. As a solution, legal and finance research recommends that the main shareholder surrender some control to minority shareholders via ownership rights. We test this proposition on a large data set of closely held corporations. We find that shared-ownership firms report a substantially larger return on assets and lower expense-to-sales ratios. These findings are robust to institutionally motivated corrections for endogeneity of ownership structure. We provide evidence on the presence of governance problems and the effectiveness of shared ownership as a solution in settings characterized by illiquidity of ownership.

Knowledge, Compensation, and Firm Value: An Empirical Analysis of Firm Communication

Knowledge is central to managing an organization, but its presence in employees is difficult to measure directly. We hypothesize that external communication patterns reveal the location of knowledge within the management team. Using a large database of firm conference call transcripts, we find that CEOs speak less in settings where they are likely to be relatively less knowledgeable. CEOs who speak more are also paid more, and firms whose CEO pay is not commensurate with CEO speaking have a lower industry-adjusted Tobin׳s Q. Communication thus appears to reveal knowledge.

Diversity and Performance

This study measures the performance of U.S. firms initiating same-sex domestic partnership benefit SSDPB policies. The results show that holding these firms upon their SSDPB initiation in a calendar portfolio earns a four-factor annualized excess return alpha of approximately 10% over the 1995--2008 sample period, beating 95% of all professional mutual funds in the United States. This finding is robust to several tests of reverse causality. SSDPB adopters also show significant improvement in operating performance relative to nonadopters. This paper was accepted by Brad Barber, finance.

The Incentive Value of Inventory and Cross-training in Modern Manufacturing

ABSTRACT This paper shows that major components of modern manufacturing processes, such as inventory management and cross-training, play a significant control role. In our model, workers possess information that is critical to efficient ongoing operations. An organizational design that motivates workers to optimally apply this information leverages both the production schedule and worker-management communication. Managements use of these controls results in work-in-process (WIP) inventory that appears excessive from a pure job-scheduling perspective, but is optimal when control issues are considered. Empirical work testing pure job-scheduling theories of modern manufacturing practices has yielded mixed results. We provide control-related interpretations for these empirical findings, and also provide novel predictions regarding the link between inventory levels and the nature of operational information asymmetries. Overall, our model highlights the importance of recognizing both control and scheduling issues when analyzing production processes. Copyright (c), University of Chicago on behalf of the Accounting Research Center, 2009.

An Empirical Analysis of Capacity Costs

This study uses a confidential Census sample of 151,900 U.S. manufacturing plant-years from 1974-2011 to investigate the impact of excluding the costs of unused capacity from key financial indicators, namely product costs and gross margins. We estimate the magnitude of unused capacity cost as a percent of sales to be about 4.8 percent, which for Compustat manufacturing firms in 2011 amounts to