Corporate Governance Brain Drain

Corporate Governance Brain Drain

August 6, 2011 Research Insights, Corporate Governance
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(Last Updated On: January 13, 2017)

I’d like to welcome a new contributor to the Empirical Finance Blog™–Jack Vogel.

Jack is currently a PhD student in finance at Drexel University. He also happens to be my teammate when it comes to completing research projects. I’ve worked with Jack on a variety of academic research projects and I can tell you that his work is nothing short of outstanding.

Jack recently endured the “Initial Right of Passage” for all PhD students–the dreaded comprehensive exams.


Part of Jack’s preparation involved understanding the hundreds of papers related to corporate governance–a difficult task indeed, but not for a former Math PhD student who decided finance was a better fit (less work, more money–>easy decision).

Luckily, Jack’s trial and tribulations allow Empirical Finance Blog readers an opportunity to take a crash course in Corporate Governance.


So grab some coffee, start your reading, and grow that brain into a finance-filled compartment of useful information.

And if your not ragged after digesting all the material, head over to the LeBow College of Business Center for Corporate Governance at Drexel University–sure to impress (and no, they did NOT pay me to say that–it would have been against our corporate governance policy, obviously).

Corporate Governance Research  (In a nutshell)

Theory of the Firm and Agency Theory

  1. Jensen and Meckling (1976) talk about the firm being a nexus of contracts.  They also begin the discussion of agency costs, and how once the entrepreneur gives up some of the cash flows right, he may now attempt to extract extra benefits from the firm.  As a result, the shareholders and debt holders will pay a little extra to monitor the manager to minimize these costs.
  2. Fama in 1980 again talks about the theory of the firm being a nexus of contracts, and tries to eliminate the idea of the firm being “owned” by a person or group of persons.  Fama talks about the contracts for managerial positions as a way to minimize the agency costs that occur, and talks about disciplining the manager, also known as “ex post settling up.”  Fama also talks about external governance being implemented by the managerial labor market, and also about outside directors being effective monitors of the CEO.
  3. Fama and Jensen in “Separation of Ownership and Control” in 1983, talk about how when there is a separation of ownership and control, and talks about those who are receive the residual claims.  They claim that once the residual risk/claims are separated from the decision management, that these organizations must also separate decision management from decision control.  They talk about the different types of organizations, such as open corporations, partnerships, financial mutuals, and non-profits.  Separating the residual claims can be justified because of the benefits of specialization of management.
  4. Fama and Jensen in 1983 “Agency Problems and Residual Claims,” talk again about the separation of ownership and control.  They talk about the four different types of organizations and when each one is appropriate.  For open corporations, these work the best when there are benefits of unrestricted risk sharing, benefits of specialized management, greater amount of firm-specific assets and large demand for wealth, and the lower the costs of separating decision management and decision control.  Proprietorships are most likely to survive when costs of separating management and control are high, there is not a high demand for wealth, and there are no economies of scale.  Partnerships work the best when there are no strong demands for tangible assets, more necessary to use human capital.  Financial mutuals and non-profits are two other types of organizations.
  5. Jensen in 1986 talks about the agency costs of FCF and how this affects the organization.  It talks about the benefits of using debt to reduce FCF that CEOs may waste on low NPV diversification programs.  It then goes on to talk about the need for restructuring in the oil business, strip financing used in LBOs, how takeovers are only value increasing in declining industries, and how firms use FCF to diversify and end up taking on low return projects.  Jensen claims that firms with high FCF and a low Q have a FCF problem.
  6. Jensen in 1993 “Modern Industrial Revolution, Exit and the Failure of Internal Control Systems” talks about the modern industrial revolution, which brought about increasing average productivity of labor, reduced growth rates of labor income, excess capacity, and eventually the need for firms to exit the market.  He talks specifically about the failure of internal control systems in many firms and how they invested in many bad projects.  One such example is GM, which lost about 100.7 billion in R&D investments.  Jensen gives suggestions to better the internal control systems such as: CEO not being the COB, the CEO being the only insider on the board, the board having fewer members (7-8), and increasing the number of large outside blockholders.

Ownership Structure and the Distribution of Power

  1. Demsetz and Lehn in 1985 argue that the ownership structure of the firm varies from company to company, and that there is no significant relationship between ownership structure and accounting rates of profit.
  2. Stulz in 1987 develops a model that shows a link between managerial control and accounting profits.  The model predicts that for low levels of managerial ownership, this increases the accounting profits, but for much higher levels the accounting profits begin to fall.  The higher the insider ownership, the higher the bid premium, up until 50% ownership.  Also debt can make the management more powerful in the model.
  3. McConnell and Servaes in 1990 finds that there exists a relation between ownership distribution and firm value.  The paper finds a strong curvilinear relation between Q and insider ownership.  Also, there is a positive reaction to institutional ownership which is consistent with Pound’s efficient monitoring hypothesis.  Last, there is no independent reaction to blockholders, which does not support the theory of blockholders (Shleifer and Vishny) being effective monitors.  One caveat is that blockholder’s are not classified as either passive or active, and this should be examined in the future.
  4. Villalonga and Amit in 2006 look at how family ownership, control and management affect firm value.  They claim that there are two types of agency problems, the first being the normal principal-agent conflict, and the other being the problem where larger shareholders extract private benefits from smaller shareholders.  The paper finds that the most firm value, measured by Q, is created when the founder is either still the CEO or is the COB while the CEO is an outsider.  If the CEO is a descendant of the founder, there is a loss in firm value.
  5. Field and Karpoff in 2002 talk about the takeover defenses of IPO firms.  They find significant differences between seasoned firms and IPO firms, with seasoned firms having more defenses.  There results indicate that the defenses do not affect the take-over premium paid, and that these are positively related to CEO pay and negatively related to CEO ownership.  Also they find that the decision to have defenses does not affect a firm’s adjusted operating ROA from years 0-5.  Last, they find that the presence of defenses is negatively related to acquisition likelihood.
  6. Jensen and Warner in 1988 write a summary paper that discusses the distribution of power amongst managers, shareholders and directors.  The major findings are that (1) patterns of ownership structure can affect management, performance, and shareholder voting in elections (2) corporate leverage, insider ownership, and the control market are interrelated, (3) departures from one share one vote affect firm value and efficiency, (4) takeover resistance through defensive restructurings or poison pills are associated with declines in share price, and (5) management performance is inversely related to firm performance.

Board of Directors


  1. Weisbach in 1988 talks about “outside directors and CEO turnover.”  He finds that there is a higher correlation between past performance and the probability of resignation (using a logit model) for companies with outsider dominated boards.  Also find that there is more of a positive stock price reaction to the resignation of a CEO for firms with outside dominated boards (>60%), but this is not significantly different from other mixed or insider dominated boards.
  2. Hermalin and Wesibach In 1998 create a theory model to explain “endogenously chosen BOD and their monitoring of the CEO.”  Their model has a few predictions: CEOs whose firms are performing poorly are more likely to be replaced; CEO turnover is more sensitive to performance the more independent the board; the probability of adding more independent directors rises after a period of poor performance; board independence declines over the tenure of the CEO; accounting measures are better predictors of CEO turnover than stock price performance.   Other predictions that need to be tested are that stock price reactions to CEO turnover should be negative for turnover because of private information, and to see if CEO salary is sensitive to prior performance measures.
  3. Shivdasani and Yermack in 1999 talk about “CEO involvement in the selection of new board members.”  They find that when the CEO sits on the nominating committee or no nominating committee exists, that there are fewer appointments of independent outside directors and more appointments of grey directors.  Stock price reactions to independent outsiders are much lower when the CEO is involved in the nominating process.  Also find a significantly positive relationship between the CEO being involved and the number of busy directors being appointed.  However they do find a pattern of moving away from the CEO being involved in the nominating process.
  4. Brickley, Coles and Jarrell in 1997 talk about “leadership structure: separating the CEO and the COB.”  They argue that while separating the CEO and the COB can reduce some of the agency costs, there are also benefits of having the CEO as the COB, and these benefits have been overlooked.  They find that overall that there is no evidence that separating the positions is good for the firm.  They talk about passing the baton from the CEO/COB who then just becomes the COB, and how some firms use the COB title as incentives for the CEO.  They find no evidence that unitary leadership structure is associated with lower accounting and market returns.
  5. Yermack in 2004 talks about the “remuneration, retention and reputation incentives for outside directors.”  He finds that the wealth effect are 6.1 cents per $1000 for the stocks and options that the director holds in the firm; finds that the options tend to reduce the risk aversion by having a positive relationship to Q; finds that the wealth effects of the firm doing well are .4 cents per $1000; finds that the wealth effects of losing a seat due to poor performance is .2 cents per $1000; finds that the wealth effects of gaining more boards seats as a result of being an effective monitor are 4.3 cents per $1000.  Overall the wealth effects are 11 cents per $1000, which mean the wealth effects are about 285,000 for one SD of firm performance.
  6. Fich and Shivdasani in 2006 asks whether or not “busy boards are effective monitors.”  They classify a member as busy if he sits on three or more board seats.  They find that firms with a majority of outside directors being busy are associated with weak corporate governance, and these firms have lower MTB, weaker profitability, and lower sensitivity to CEO turnover and prior firm performance.  Independent but busy boards show the same sensitivity for CEO turnover and prior performance of insider dominated boards.  The loss of a busy director have a positive abnormal return, when a director becomes busy the firm has another negative abnormal return, and busy directors are more likely to leave after poor firm performance.
  7. Bebchuk and Cohen in 2005 look at the “costs of entrenched boards.”  They find that staggered boards are related to lower firm value as measured by Q, and this association is stronger for firms with staggered boards in the charter (which shareholders cannot amend) as compared to the company’s bylaws (which the shareholders can amend).  Controlling for staggered boards in 1990, firms still have lower value from 1995-2002.  They control for the other 23 provisions in the G index, but find that staggered boards have 7 times the effect of all the other provisions combined.
  8. Fich in 2005 ask the question as to whether or not “some outside directors are better than others.”  He finds that there is a significantly positive reaction to the nomination of an outside director that is also the CEO of another firm, and an even higher reaction if the outside CEO is also a former commercial banker.  If the outside CEO is not of retirement age, he finds a negative stock price reaction for the CEO’s firm, and also finds that the outside CEOs tend to join firms with more growth opportunities (have a high Q), that CEOs are rewarded with seats when their firm does well, and there is an even higher reaction when the difference in firm sizes gets bigger (implicating an certification).

Corporate Governance and Returns

  1. Gompers, Ishii, and Metrick in 2003 look at “corporate governance and equity prices.”  They construct the G index by looking at firms that have different shareholder rights.  They find that if you had bought firms in the highest decile of rights (G <= 5, also known as the democracy portfolio) and sold the lowest decile of rights (G >=14, also known as the dictatorship portfolio), you would have earned an 8.5% abnormal return.  Also find that the democracy portfolio had higher firm value, higher profits, higher sales growth, lower CAPEX, and made fewer corporate acquisitions.  By the end of the decade, a one point increase in the G-index would lower the Q by 11.4%.  However, they cannot conclude the causality from governance and returns.
  2. Bebchuk, Cohen and Farrell in 2004 look at “what matters in corporate governance.”  They ask what factors of the G index are associated with firm value.  They come up with the “entrenchment index,” which is composed of 6 variables that are: poison pills, golden parachutes, staggered boards, limits to shareholder by-law amendments, and supermajority for both mergers and charter amendments.  They find that the higher the E-index, the lower the firms Q and stock returns.  They find that going long the firms with a low E-index and shorting firms with a high E-index would produce high abnormal returns such as 7.2% for the equal weight.  However, they cannot conclude the causality from governance and returns.
  3. Lehn, Patro, and Zhao in 2005 look at “governance indices and valuation multiples.”  They want to know which causes which.  They do so by regressing MTB as the dependent variable instead of Q since they argue that the 2 are highly correlated.  They regress the MTB from the early 1980s, before the governance mechanisms started, on the current governance indices (G index and the E index).  They find that firms with lower MTB in the 1980s were more likely to adopt poor governance provisions, and as a result, they claim that valuation multiples explain the governance indices. They also find that after controlling for the MTB in the 1980s, there is no significant relation between current MTB and governance indices.  This implies that low MTB firms are poorly run and as a result, put defenses in place to block bids, as well as those firms have low growth opportunities and put defenses in place as well.
  4. Cremer and Nair in 2005 again look at “governance mechanisms and equity prices.”  They want to see how both internal and external governance mechanisms interact and how they affect equity prices.  The paper finds that firms with good internal governance (institutional, blockholders, and pension fund holdings) and good external governance (takeover vulnerability measured as 24 – G) have a complementary interaction that is associated with high abnormal returns.  The alpha is 10-15% for a portfolio that buys firms with the highest level of takeover vulnerability  and shorts firms with the lowest level of vulnerability only when the level of pension fund holdings are high (internal governance).  A similar portfolio to capture the importance of internal governance has an alpha a 8% but only when external governance is high.  The paper also finds that this complementary relation works the best for firms that have low leverage and smaller firms.  They also run a robustness check by creating another external governance mechanism and get similar results.

Shareholder Activism Proxy Access

  1. Pound in 1988 talks about “proxy contests and efficiency of shareholder oversight.” He claims that these are the least efficient for changing corporate control.  First, there is inefficiency in the proxy vote solicitation process which gives management the upper hand.  Also the management has advantages because of diffuse ownership.  Second, due to conflict on interests, institutional investors and blockholders tend to vote more often with the management.  Third, dissidents have to incur a large expense to signal that the bid is serious.  The most successful votes are proxy contests for partial control.
  2. Karpoff, Malatesta and Walkling in 1996 talk about “corporate governance and shareholder initiatives.”  They look at the empirical results and find that firms that attract shareholder initiated proposals on corporate governance are more likely to occur for firms that are poor performers when measured by MTB, returns on sales, and sales growth.  They look at the short term reactions to these proposals and find that there is little effect.  They also find that there is little evidence that operating returns improve after the proposals.
  3. Gillian and Starks in 2000 look at “corporate governance proposals and shareholder activism, the role of institutional investors.”  They find that the sponsor type, issue type, prior performance and time period affect the voting outcome.  Proposals by institutions and coordinated groups gain more votes, and the nature of the stock market reaction varies according to the sponsor.  Gadfly investors gain little votes but have a slightly positive return, whereas institutional investors receive more votes but are met with a measurable negative impact on stock prices.  Gadflies usually have issues with executive compensation, director ownership, and limitation of director terms which are not viewed as serious as institutional issues such as repealing takeover devices.
  4. Karpoff in 1998 write a summary paper looking at the “impact of shareholder activism on target companies.”  He finds that while there are disagreements about the effects on governance, most find that there is little effect on market returns, earnings and operations.

Corporate Fraud


  1. Karpoff and Lott in 1993 talk about the “reputational penalty that firms bear from committing corporate fraud.”  They specifically talk about 4 types of fraud: fraud by cheating the stakeholders, the government, financial reporting fraud, and regulatory fraud.  They look at the abnormal returns around the announcement date, and find significantly negative (-1.58%) returns from day -1 to day 0 for all fraud except regulatory fraud.  They also find a negative reaction for allegations or lawsuits, but not for settlements.  They also find weak evidence that earnings fall after the announcement date.  Overall, they find that the reputational costs from the market are very high compared to the fines that are levied against the company as well as the legal fees (fines and legal fees are only 6.5%), and that there should not be an increase in the fines.
  2. Alexander in 1999 talks about the “nature of the reputational penalty for corporate crimes.”  Similar to Karpoff and Lott, Alexander finds that there are major reputational penalties from corporate fraud.  Overall, the paper finds that the reputational penalties are the highest for crimes to related party (-3.06%) compared to unrelated (+.44%) and gray (-.04%).  The average court penalty is 6.5 million, whereas the market loss is 27 million.  For related party crimes, there are reputational losses such as the loss of business.  The paper does find that for related party crimes, the firm does attempt to signal that changes have been made.  Last, the paper finds that most crimes to related parties were against the government, which confounds that ability of related parties to impose reputational sanctions.
  3. Beasley in 1996 looks at the relation between the “board of director composition and financial statement fraud.” He looks at 75 cases of financial reporting fraud and then matches these to 75 other similar firms.  The results from the logit shows that the no fraud firms have a higher percentage of outside directors (including both independent outsiders and grey outsiders), and the presence of an audit committee does not affect the probability of fraud.   The paper also finds that more ownership of outside directors, more tenure, less director positions (less busy) and smaller boards all decrease the probability of financial reporting fraud.
  4. Uzun, Szewczyk, and Varma in 2004 look at “board composition and corporate fraud.”  They find a similar relationship between board composition and corporate fraud as Beasley using 133 pairs of firms. The results are that the boards of no fraud companies have higher percentage of outsiders and independents; size, COB, financial performance, institutional investors and CEO tenure do not have an effect on the probability of fraud; the presence of an audit committee as well as more independents on the committee lowers the probability of fraud; having a compensation committee increases the probability of fraud.
  5. Farber in 2005 looks at “restoring trust after fraud; does corporate governance matter?”  For 87 pairs of only financial reporting fraud, he looks to see how governance mechanisms have changed over a period of 3 years.  Found that governance increases did not change the number of institutional ownership, the number of short sellers, and the number of analysts following the firm.  However, the firms that did make governance changes such as increasing the number of outsider on the board had a significantly positive BHAR over the 3 years (increasing outsiders by 1% increased BHAR by 2.2%).  Also finds that the fraud firms had worse governance before (fewer numbers and percentages of outsiders on the board, fewer audit committee meetings, smaller percentage of big 4, higher percentage of CEOs as COB) the fraud compared to the non-fraud firms, but make many improvements over 3 years, and by the end were similar to the non-fraud firms and even had more audit meetings than the non-fraud firms.
  6. Uzun, Szewzyck, Varma and Dalia M. in 2006 look at “governance and performance changes after accusations of corporate fraud.”  They look at before and after tests to look for changes in corporate governance for 276 pairs.  They find no differences between the fraud and no-fraud firms BHAR after the event, and that the fraud firms increased the number of outsiders on the board as well as in the committees.  They find that by year 3 the firms have very similar governance characteristics.  They find negative alphas during the announcement periods, no difference between the long-term BHAR of the fraud and non-fraud firm, and do not find evidence of long-term impact on operating performance.  Find that reputational costs are enough to make firms make changes.
  7. Dechow, Sloan and Sweeney in 1996 talk about the “causes and consequences of earnings manipulation.”  They look at 92 pairs of observations and find that following: fraud firms have higher MTB, higher leverage, more insiders  on the board, more insider percentage of shares held, CEO more likely the COB, less likely to have an audit committee, less likely to have an outside blockholder, more likely to have insiders with greater than 50% of the shares, more likely (beginning 2 months before) to have shares shorted, a higher dispersion of analyst recommendations, higher bid-ask spreads after the announcement, and more likely the CEO is the founder compared to the non-fraud firms.  Overall they claim that the main reason for the manipulation is to gain lower costs of capital.
  8. Bhagat, BIzjak and Coles in 1998 look at the “shareholder implications of corporate lawsuits.”  This paper looks at corporate lawsuits involving firms from a different perspective than previous papers by looking at a large heterogeneous sample of lawsuits.  In the past, most studies were either small homogeneous samples or case studies.  This paper specifically looks at corporate lawsuits that involve a firm from 1981-1983, and attempts to see how the different opponents (government, other firms, or private parties) in the suit as well as different legal issues affect the shareholder’s wealth around the announcement date and settlement date of the suit.  Overall, the paper finds that the average defendant suffers a loss of 0.97% of the firm’s market capitalization, or about $15.96 million.  The median loss is 0.62% or about $1.11 million.  The paper looks at the wealth implications for firms by varying either the opponent or the legal issue.  In the univariate tests, the paper finds that defendants involved in government suits experience larger declines in shareholder wealth (-1.73%) compared to suits with other firms (-0.75%) and private parties (-0.81%).  Also in the univariate tests, the paper finds that defendants in environmental suits (-3.08%), product-liability suits (-1.46%) and violations of security laws suits (-2.71%) experience greater losses than suits for antitrust (-0.81%) and breach of contract issues (-0.16%).  The paper does not find any significant effect for the plaintiff firm, which indicates that there are “leakages” since the combined wealth effect of the plaintiff and defendant is negative.  Last, the paper finds that the CARs are positively related to size and negatively related to proximity to bankruptcy.  Thus bigger defendant firms experience a smaller loss and defendant firms closer to bankruptcy experience a bigger loss.    Overall, this paper adds to the literature by looking at a large number of suits and examining how differences in the type of opponent as well as legal issues affect shareholder value in lawsuits.  The paper shows that legal issues, the type of opponent, and firm characteristics (proximity to bankruptcy, firm size) have power to explain cross-sectional variation in defendant wealth effects.

Executive Compensation and Turnover

  1. Jensen and Murphy in 1990 talk about “performance pay and top management incentives.”  They create a measure to see how CEO pay changes with a firm value change of $1000.  They find that $2.50 per $1000 comes from stock and options, $0.45 comes from the CEOs compensation, and $0.30 comes from the CEOs dismissal-related wealth.   Thus the overall change is $3.25 for the median firm,$1.85 for large firms and $8.05 for small firms.   They also note that the average pay for performance has declined since the 1930s even though firm values have doubled, and they comment this is most likely from political pressure to keep CEO pay down.
  2. Grinstein and Hribar in 2004 talk about “CEO compensation and incentives, evidence from M&A bonuses.”  They look at 327 mergers from 1993-1998 for firms with $1 billion in assets.  They look to see whether the traditional view of compensation holds, or the managerial power view holds.  They find that the CEO power (measured by CEO as COB, CEO on nominating committee, insider ratio, number on the board) is a significant factor in the CEO’s compensation, and that firms with higher power have a higher bonus to deal size, as well as more negative 2 day abnormal returns.  They also find that the compensation committee appears to hide why they gave M&A bonuses.  Even though they find that smaller boards give bigger bonuses, they claim this is due to more new era firms that have smaller firms and give bigger bonuses.  Also since the Heckman variable is positively related, this claims that the bonus is positively related to acquisition, which again feeds the CEO power story.   Last besides deal size, effort and performance do not affect the bonus.
  3. Huson, Malatesta and Parrino in 2004 talk about “managerial succession and firm performance.”  Overall, the paper finds the following results.  Financial performance tends to deteriorate prior to turnover, and finds a positive abnormal stock returns with turnover announcements, with higher alphas for forced turnover when a new outsider comes in.  Announcement period alphas are significantly positively related to improvements in OROA.  The paper finds only weak evidence that unadjusted and industry-adjusted OROA increases after turnover, which is contrary to Denis and Denis.  However, the paper finds control group-adjusted OROA are positive and significant after turnover, which favors the improved management hypothesis.  The paper shows that post-turnover performance improvements were greater from 1983-1994 as compared to 1971-1982. Simple pair wise comparisons indicate that board composition, institutional ownership, takeover pressure, and outside CEO positively affect performance changes.  However, only institutional ownership is positive and significantly related to performance changes in the multivariate model.  Last, the paper finds a strong positive relation between outside dominated board and OROA from 1988-1994.
  4. Hartzell, Ofek and Yermack in 2004 look at “what’s in it for me?  CEOs whose firms are acquired.”  They look at 239 mergers in their regressions and study the benefits of acquired CEOs.  They find that certain CEOs negotiate extra cash payments in forms of special bonuses or an increased golden parachute.  These are positively related to the CEOs prior excess compensation, and negatively related to whether or not the CEO joins the new firm.  Regressions suggest that targets receive lower acquisition premium in transactions involving extraordinary benefits, but still inconclusive if the special arrangements come at the shareholders expense.  Target CEOs have very high turnover if they join the new company.   12% of the mergers have a special payment of about 4.2 million, and 26% have increased parachute payments of 3.4 million, and the total payout is about 7-9 times the CEO’s annual compensation.
  5. Bebchuk and Fried in 2003 write about “executive compensation as an agency problem.”  They take on the optimal contracting view in existence and talk about the managerial power view.  They say that directors have incentives to favor the CEO in order to get reappointed, get appointed to other boards, and that CEOs can affect their pay.  Overall as a result, the CEO can affect his own pay by obtaining more power.  Managers with weak boards, no large outside shareholders, fewer institutional shareholders, and more protections against takeovers lead to the CEO having more pay.  Some current practices are having compensation consultants that just justify CEO pay rather than suggest it; there are stealth compensations such as deferred compensation, pensions, loans, and consulting contracts; there are also gratuitous goodbye payments.  Some suggestions are to make the options non-windfall, and should have restrictions on allowing the CEO to reduce his equity holdings in the company.
  6. Jensen, Murphy, and Wruck in 2004 talk about “remuneration, where we’ve been, how we got here, and how to fix it.”  This is a overview paper that has 38 suggestions for ways to change problems in executive compensation.  There is a common perception that CEOs get paid too much, since we have seen throughout history that there have been wasteful diversification programs, the junk bond market collapse, and the tech bubble which reduced dividends.  Some of the suggestions are to not be focused on beating the street, reducing windfall options, having a bonus pool which has clawback provisions, and having more sensitive pay for performance.

The Market for Corporate Control


  1. Walkling and Long in 1984 look “agency theory, managerial welfare, and takeover bid resistance.”  They find that there is a relationship between managerial welfare and takeover bid resistance, with managers who have small wealth gains opposing bids whereas managers who have large wealth gains do not.  They find that the premiums, size, leverage and liquidity are similar for the opposed and unopposed bids as well.  They also find that there appears to be ex post settling up with CEOs.
  2. Malatesta and Walkling in 1988 look at “poison pill securities.”  They find that the results indicate the entrenchment hypothesis as opposed to the shareholder interest hypothesis.  They look at 118 poison pill cases through march 1986 and find that firms that use poison pills are more likely to be taken over, and managers adopt poison pills when they have low ownership.  They find a negative reaction to poison pill announcements, which is even larger for firms that had recently had takeover rumors.  They also find significantly positive reactions when firms abandon their plan to adopt a poison pill.
  3. Lang, Stultz and Walkling in 1989 talk about “managerial performance, tobin’s Q and the gains from successful tender offers.”  They divide the sample or 87 firms into high and low Q firms, with high being above 1 and low being below 1.  They claim that high Q means the firm has more growth opportunities and is managed better.  They find that unopposed offers have higher bidder returns, the best return for the bidders is high Q taking over low Q firms, the worst for bidders is low Q taking over high Q, well managed targets benefit less than poorly managed targets (low Q), and the total takeover gain is the highest for high Q taking over low Q firms.
  4. Lang, Stultz and Walkling in 1991 talk about “a test of the FCF hypothesis.”  They claim that high Q firms are more likely to have positive NPV projects, whereas low Q firms are more likely to not have as many of these projects.  They claim that if a firm has higher FCF and a low Q, this indicates they many have a FCF problem.  They find that bidder returns are significantly negatively related to FCF for low Q firms but not for high Q firms.
  5. Comment and Schwert in 1995 talk about “poison of placebo?  Evidence on the deterrence and wealth effects of modern antitakeover measures.”  Find that for the three days around the pill announcement date, if there are already rumors about takeovers, there is a -2.09% abnormal return.  Since most firms adopt a pill when the likelihood of takeover is higher, they use a 2SLS where the first stage measure the probability of a pill, then the second stage measures the surprise component, which is the difference between the dummy variable and the predictable component.  Show that the likelihood of takeover is 2.83% higher when complete surprise and 5% lower when completely predictable.  Overall, they find that there is no evidence of deterrence from business share laws and control share laws, and even though there is weak evidence of deterrence from poison pills, evidence on how stock prices change on adoption (only before 1985 do see significant negative response) does not imply an economically meaningful degree of deterrence.  Overall the anti-takeover laws did not cause the market for corporate control to shut down.
  6. Karpoff and Malatesta in 1999 talk about the “wealth effects of second generation state takeover legislation.”  They look at the stock-price effects of all second generation state takeover laws introduced from 1982 until 1987.  They find a small but significant decrease in the stock prices of all firms either headquartered or incorporated in the state passing the law.  However, this negative market reaction was only found in the firms that did not already have the defenses in place before the law was passed.  They also find a more pronounced effect in the later period from 1986-1987.
  7. Szewczyk and Tsetsekos in 1992 write about the “state intervention in the market for corporate control, the case of PA senate bill 1310.”  This bill had 3 major provisions that interceded in the market for corporate control: first was a control share provision which made those with >20% lose their voting rights unless given back by the other shareholders; second was disgorgement laws which meant that profit from sales needed to be returned to the firm; third was fiduciary duty, where the BOD did not have to report specifically to the shareholders.  Other provisions were employee severance agreements and labor contracts needed to be upheld.   They looked at 56 firms from PA between the announcement date and the signing date, and found that the combined shareholder loss was about $4 billion.  However, those firms that opted out of all 3 provisions had higher institutional ownership and higher abnormal returns compared to the other firms that did not opt out.
  8. Schwert in 2000 talks about “hostility in takeover, and being in the eye of the beholder.”  This paper looks at a total of 2,346 takeover contests, both successful and unsuccessful, from 1975-1996 to determine if there are any identifiable differences between those deals that are labeled “hostile” and those that are not.  Overall the author finds that differences in the data are consistent with the view that the distinction between hostile and friendly is largely a reflection of negotiation strategy.  In conclusion, the paper has found that “hostile takeover” means different things to different people, as can be seen by low correlations between different measures of hostility.  While, there is support for both the target management entrenchment and the bargaining strategy explanations, overall it appears hostility is strongly related to strategic bargaining.  Variables that measure poor target management (ROE, MTB, etc) contribute little explanatory power, whereas size and secular time dummies contribute the most.  Unnegotiated offers have a lower success rate, which explains lower premiums for these offers, whereas WSJ and SDC have slightly higher premiums.  This is consistent with view that hostility is result of aggressive bargaining by target management.  The paper finds strong evidence that auctions are related to hostility.  Last is that only pre-bid activity lowers bidder’s stock price, which the paper concludes that bidders use hostile offers rationally.  Most characteristics seem to reflect strategic choices by the bidder or the target to maximize their respective gains from a potential transaction.  Overall, the paper claims strategic bargaining is the motivation for hostility.

International Corporate Governance


  1. Laporta, Lopez-de-Silanes, and Shleifer in 1999 look into “corporate ownership around the world.”  They see that the world of dispersed ownership as proposed by Berle and Means in 1932 does not actually hold around the world.  This paper gives the methodology to find the ultimate owners of the firms, even through pyramids, dual class shares and cross-holdings.  For the rest of the world, most of the ownership structure is closely held with majority holders participating in management as opposed to the US and UK.  This creates a new agency problem as now the majority shareholders can expropriate goods from the minority shareholders. They also split countries by common and civil law.
  2. Laporta, Lopez-de-Silanes, Shleifer and Vishny in 1999 look at “investor protection and corporate governance.”  They argue that the legal approach is a better way of looking at governance as opposed to bank-centered versus market-centered.  English common law has the best protections for shareholder and creditor rights, Scandinavian law has the best for efficiency, corruption, and accounting standards of civil law, while French civil law has the worst in all categories.  They claim that the legal environment shapes corporate governance structures, the development of markets, and the allocations of real resources.  Real reform of the legal systems is necessary, but this will be opposed politically as well as by those with majority control.
  3. Denis and McConnell in 2003 look at “international corporate governance.”  The first generation looks at internal control, as is studied in the US, while the second generation of research focuses on the legal systems.  There are a few findings in the paper: BOD are similar to the US and UK; there is differences in ownership concentration around the world; firm performance increases for companies that used to be owned by the state with the highest returns being when the company is completely released by the state; they find there are pyramid structures which can expropriate funds from minority shareholders in other countries; find the need for strong investor protection and well developed financial markets for strong economic growth.

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Definitions of common statistics used in our analysis are available here (towards the bottom)

About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes,, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.

  • Wow, that was a long one. It had a lot of great information, but it was really really long.

  • wes

    Yeah, sorry about that. We figured users could bookmark it and read it over time. Maybe next time we do a ‘learning session’ we’ll break it up into chunks

  • Jie Yang

    This is an excellent summary! Thanks!
    P.S.: I found it convenient that it’s all here in one entry.