Abstract
We show that corporate governance mechanisms play an important role in controlling managers’ opportunistic behavior. Low executive equity compensation and a high intensity of outside monitoring help to discourage undesirable self-interested disclosure decisions by management before share repurchases. Corporate governance mechanisms also have a significant impact on long-run abnormal stock prices and operating performance. Firms that manipulate pre-repurchase disclosures experience positive long-term abnormal stock returns. However, we do not find that these firms experience positive long-run operating performance. Corporate governance mechanisms significantly attenuate the tendency toward negative pre-repurchase disclosures and their effects on stock prices and operating performance.
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Instead of focusing on the governance effects of managerial equity compensation and outside monitoring, Caton et al. (2016) employ an index of the number of antitakeover laws enacted by the state in which the firm is incorporated to proxy for the strength of a firm’s corporate governance.
Although Brockman et al. (2008) also analyze the effects of CEO compensation on the pre-repurchase disclosure policy, they do not explore the effect of CEO compensation on post-repurchase stock and operating performance.
In the United States, disclosure requirements for share repurchases are relatively lenient. Corporations can buy back shares without making repurchase announcements, and those announcing repurchases are under no obligation to carry out their proposed programs. According to the survey of Kim et al. (2005), among the 10 major stock markets around the world, the United States has relatively loose regulations for share repurchases in terms of disclosure and execution.
Managers with low equity compensation do not have strong incentives to depress repurchase prices because there is less wealth transfer from the shareholders who sell their stock to the remaining shareholders who do not sell, including managers themselves, which in turn results in less incentive for management stock purchases subsequent to pre-repurchase information manipulation. In addition, since strategic disclosures prior to repurchases involve management’s personal incentives, outside monitoring is expected to partially control for this incentive. High intensity of outside monitoring can thus mitigate managerial opportunism. Although transactions to deflate the repurchase price also benefit the remaining stockholders, the accompanying management trading behavior for personal benefit makes corporate governance matter to this strategic disclosure. Hence, low executive equity compensation and high outside monitoring intensity make managers less likely to engage in pre-repurchase strategic disclosures.
Wright et al. (2002) propose that security analysts, independent outside board members, and activist institutional investors may limit selfish managerial behavior and thus protect the interests of shareholders. Beasley (1996), Smith (1996), Core et al. (1999), Klein (2002), Hartzell and Starks (2003), Ajinkya et al. (2005), and Karamanou and Vafeas (2005) find evidence that corporate monitoring by institutional investors and outside directors can constrain managers’ behavior. Chung and Jo (1996), Healy and Palepu (2001), and Yu (2008) suggest that analysts play an important role in corporate governance.
Our research differs from Brockman et al. (2008) in the following ways. We additionally study the effects of CFO equity compensation on repurchase events, which is not tested by Brockman et al. (2008). In addition, we relate the pre-repurchase disclosure policy to the post-repurchase long-run stock and operating performance, which again are not examined by Brockman et al. (2008).
Our findings indicate that the motivation of management to depress buyback prices is mainly to pursue personal benefits, rather than to maximize the wealth of the majority of shareholders. As most of the shareholders are likely uninformed and unaware of such deceptive behavior, they might easily fall prey to subsequent false discourses. Thus, from the corporate governance perspective, it is improper for managers to engage in pre-repurchase strategic disclosures, as such behavior indicates a lack of integrity when managing a firm. Firms operated by managers without integrity could lead to severe conflicts of interest between managers and shareholders or to agency problems, such as the free cash flow problems. If the corporate governance mechanism cannot lead managers to behave honestly in the event of repurchases, in the long run, it is possible that managers with excess cash flow will tend toward over-investment or engage in empire building, instead of investing in positive net present value projects to maximize shareholder value. Such adverse effects of lack of integrity would eventually be detrimental to firms’ long-term performance. Accordingly, good governance should restrain managerial pre-repurchase opportunistic disclosure behavior and encourage the managers to maintain integrity in managing the firm.
Dechow et al. (1996) and Beasley (1996) show a negative relation between independent outside directors and the likelihood of financial fraud. Klein (2002) finds a negative association between independent outside directors and earnings management. Ajinkya et al. (2005) and Karamanou and Vafeas (2005) report that independent outside directors are positively associated with the issuance, frequency, and accuracy of management earnings forecasts.
The types of repurchase programs include open-market repurchases, privately negotiated transactions, Dutch auctions, and self-tender offers.
Lie (2005) finds that actual repurchases typically occur during the quarter of and the quarter after the repurchase announcements.
If actual repurchases occur during the quarter of the repurchase announcements, we use the repurchase announcement date as the date that managers begin to buy shares. If actual repurchases occur during the quarter subsequent to the repurchase announcements, we use the first date of this quarter as the date that managers begin to buy back stocks.
After the implementation of Regulation FD (Fair Disclosure) on October 23, 2000, firms privately disclosing value-relevant information to their preferred securities market professionals have to concurrently disclose the same information to the public.
We follow Brockman et al. (2008) to define the repurchase event window as 30 days prior to the date a share repurchase begins. Only management forecasts that fall in the repurchase event window are identified as the event sample. All other management forecasts that are issued by the same repurchasing firms and fall outside the event window are classified as the non-event sample. Based on the sample design, only a small portion of management forecasts will be the event sample. Brockman et al. (2008) find approximately 6.6% of management forecasts are issued in the pre-repurchase event window, which is close to our ratio of 5.24%.
The mean abnormal return around all management forecasts in Brockman et al. (2008) is − 0.9%, in which bad news is − 7.7% and good news is 5.8%.
Brockman et al. (2008) find that the probability that firms will disclose bad news significantly increases by 9% before upcoming share repurchases, and the average magnitude of bad news is larger by roughly 4%.
We also use regression analyses by three subsamples for the five governance measures to examine the effects of executive compensation and outside monitoring. We find that firms release significantly more bad news, both in terms of frequency and magnitude, within 30 days before the start of a share repurchase in the subsample of high executive compensation and low outside monitoring intensity but not in the subsample of low executive compensation and high outside monitoring intensity. The evidence of subsample regression analyses again supports our hypothesis.
We also run regressions for the three subsamples classified by the equity compensation and outside monitoring measures to examine the effects of executive compensation and outside monitoring on the information content of voluntary disclosures. Again, we find that managers of firms in the subsamples of high executive compensation and low outside monitoring intensity tend to issue downward-biased earnings forecast.
Except for the test variables of executive equity compensation and outside monitoring, we also include several additional governance variables as our control variables, including institutional ownership, board size, duality of the CEO and the chairman of the board, busy board, the dispersion of analysts’ forecasts, and the analysts’ working experience. These additional governance variables are found in the literature to have monitoring effects on management forecasts (Ajinkya et al. 2005; Karamanou and Vafeas 2005; Cheng and Lo 2006; Fich and Shivdasani 2006; Brockman et al. 2008; Cornett et al. 2008; Yu 2008). The role of governance is thus the combined effect of all these variables. In our regression analyses in Tables 4 and 5, all the models show the consistent results that lower executive equity compensation and higher outside monitoring intensity combined with other governance variables discourage pre-repurchase managerial manipulation behavior.
In order to assure that firm-specific variables (e.g., CFOprt and NumRep) are predetermined and are not affected by the firm-specific disclosure policy during the share repurchase year, they are measured at the preceding year of the repurchase event. On the other hand, since marketwide variables (e.g. Rf and MktVol) that affect firm-specific disclosure policy are not likely to be affected by the disclosure policy, they are measured at the repurchase event year.
The number of instruments (four) is greater than the number of endogenous regressors (two), which means that the model in Table 6 is set to be overidentified. We use the Sargan-Hansen statistic to test the validity of the overidentifying restrictions. The last line of Table 6 reports the Sargan-Hansen tests for each stage of the two-stage estimate. The null that these instruments are uncorrelated with the residuals cannot be rejected at conventional significance levels. Therefore, our four instrumental variables are found to be valid.
We identify a carry-through repurchase announcement as an announcement followed by actual share repurchases during the fiscal quarter of the announcement and/or the subsequent quarter (Lie 2005; Gong et al. 2008). If actual repurchases only occur during the quarter of the repurchase announcements, we use the last date of this quarter as the completion date of repurchases. Otherwise, we use the last date of the quarter subsequent to the repurchase announcements as the completion date of repurchases.
In the general case, Kothari et al. (2009) find that a range of incentives, including career concerns, motivates managers to withhold bad news up to a certain threshold but to quickly reveal good news to investors. However, we report evidence that in some specific cases, such as repurchases, managers accelerate bad news and accumulate or withhold good news.
We report the univariate analysis of the pre-repurchase managerial disclosure behavior by the low, middle, and high corporate governance subsamples in Tables 3 and 7. Tables 9 and 11 show the post-repurchase stock and operating performance of the low, middle, and high corporate governance subsamples. In these tables, because test variables of executive compensation and outside monitoring have different implications with respect to the governance effect on restraining management’s opportunistic behavior before repurchases and associated post-repurchase stock and operating performances, not all variables show a linear relationship for the low, middle, and high subsamples. Although there may exist confounding results in the middle subsample, subsamples with low executive equity compensation and high outside monitoring intensity consistently show the strongest governance effect, while the subsamples of high executive equity compensation and low outside monitoring intensity show the weakest governance effect.
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Chen, SS., Chou, R.K. & Lee, YC. The effects of executive compensation and outside monitoring on firms’ pre-repurchase disclosure behavior and post-repurchase performance. Rev Quant Finan Acc 54, 111–158 (2020). https://doi.org/10.1007/s11156-018-00785-1
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DOI: https://doi.org/10.1007/s11156-018-00785-1