Skip to main content
SpringerLink
Log in

Idiosyncratic volatility, executive compensation and corporate governance: examination of the direct and moderate effects

  • Original Paper
  • Published:
Review of Managerial Science Aims and scope Submit manuscript

Abstract

Entrenchment of private benefits by the CEO or dominant owners can lead corporations to avoid riskier but more private benefits resulting in greater idiosyncratic volatility and information flow trading. Using a unique database of 806 listed firms, we investigate the impact of CEO compensation and corporate governance on idiosyncratic volatility and information flow trading. We find strong and robust evidence that equity-based (fixed income) CEO compensation is negatively (positively) related to volatility and information trading. Incorporating an agent principal–principal perspective into our models of managerial discretion provides us with an accurate prediction of how the proportion of CEO compensation and the degree of entrenchment will influence risk-taking decisions as well as how equity-based compensation interacts with related-party transaction and ownership dispersion to influence stock volatility. Finally, we find that idiosyncratic volatility and information flow trading are also affected by CEO compensation and corporate governance, which act as instrumental variables, while subject to environmental variants and the jointly determined.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1

Similar content being viewed by others

Notes

  1. China’s PwC announced that their compensation and salary growth rates have been higher than the corporation’s profit growth rate since 2008. The directors and CEO of the Ping An Insurance (Group) Company of China received the highest compensation of all Chinese listed companies [over 66 million Renminbi (RMB) per year]. The directors and president of Gree Electric Appliances both received salaries of over 170 million RMB.

  2. There is clear separation between ownership and management, as well as dominance of the board of directors by the CEO in US and UK listed firms. In European firms, CEOs are representatives of the majority shareholders and there is less differentiation between managers and owners in the ownership structure. Su et al. (2008) studied principal–principal conflict in the corporate governance of Chinese public corporations.

  3. The nature of firm ownership is determined from annual reports. Almost all Taiwan listed firms have a controlling shareholder that controls 30 % or more of the votes or shares, who can elect half or more of the directors, and who can effectively control the listed company. Firms for which we cannot identify the type of ultimate controller are excluded from the sample.

References

  • Ahn S, Walker MD (2007) Corporate governance and the spinoff decision. J Corp Financ 13(1):76–93

    Article  Google Scholar 

  • Albuquerque R, Miao J (2009) Advance information and asset prices. Working paper, Boston Unversity

  • Albuquerque R, Miao J (2014) Advance information and asset prices. J Econ Theory 149:236–275

  • Alti A (2003) How sensitive is investment to cash flow when financing is frictionless? J Financ 58(2):707–722

    Article  Google Scholar 

  • Bai C, Wang Y (1998) Bureaucratic control and the soft budget constraint. J Comp Econ 26(1):41–61

    Article  Google Scholar 

  • Baixauli-Soler JS, Sanchez-Marin G (2014) Executive compensation and corporate governance in Spanish listed firms: a principal-principal perspective. Rev Manage Sci. doi:10.1007/s11846-014-0122-z

  • Bebchuk LA, Cohen A, Ferrell A (2009) What matters in corporate governance? Rev Financ Stud 22(2):783–827

    Article  Google Scholar 

  • Bhagat S, Bolton B (2008) Corporate governance and firm performance. J Corp Financ 14:257–273

    Article  Google Scholar 

  • Bizjak J, Brickley J, Coles J (1993) Stock-based incentive compensation and investment behavior. J Account Econ 16:349–372

    Article  Google Scholar 

  • Black BS, Jang H, Kim W (2006) Does corporate governance predict firms’ market values? Evidence from Korea. J Law Econ Organ 22(2):366–413

    Article  Google Scholar 

  • Boubakri N, Cosset J, Saffar W (2013) The role of state and foreign owners in corporate risk-taking: evidence from privatization. J Financ Econ 108(3):641–658

    Article  Google Scholar 

  • Brennan M, Xia Y (2001) Stock return volatility and equity premium. J Monet Econ 47(2):249–283

    Article  Google Scholar 

  • Bromiley P (1991) Testing a causal model of corporate risk taking and performance. Acad Manag J 34(1):37–59

    Article  Google Scholar 

  • Brown LD, Caylor ML (2006) Corporate governance and firm valuation. J Account Public Policy 25(4):409–434

    Article  Google Scholar 

  • Chen S, Chen I (2012) Corporate governance and capital allocations of diversified firms. J Bank Finance 36(2):395–409

    Article  Google Scholar 

  • Chen Q, Goldstein I, Jiang W (2005) Price informativeness and investment sensitivity to stock price. Working paper, Duke University

  • Chen G, Firth M, Rui O (2006) Have China’s enterprise reforms led to improved efficiency and profitability? Emerg Mark Rev 7:82–109

    Article  Google Scholar 

  • Chen G, Firth M, Xu L (2009) Does the type of ownership control matter? Evidence from China’s listed companies. J Bank Financ 33(1):171–181

    Article  Google Scholar 

  • Chen Q, Chen X, Schipper K, Xu Y, Xue J (2012) The sensitivity of corporate cash holdings to corporate governance. Rev Financ Stud 25(12):3610–3644

    Article  Google Scholar 

  • Cheung Y, Jing L, Lu T, Rau R, Stouraitis A (2009) Tunneling and propping up: an analysis of related party transactions by Chinese listed company. Pac Basin Financ J 17(3):372–393

    Article  Google Scholar 

  • Conyon M, He L (2011) Executive compensation and corporate governance in China. J Corp Financ 17(4):1158–1175

    Article  Google Scholar 

  • Core JE, Holthausen RW, Larcker DF (1999) Corporate governance, chief executive officer compensation, and firm performance. J Financ Econ 51(3):371–406

    Article  Google Scholar 

  • Datta S, Iskandar-Datta M, Raman K (2001) Executive compensation and corporate diversification decisions. J Financ 56:2299–2336

    Article  Google Scholar 

  • Devers CE, Namara G, Wiseman RM, Arrfelt M (2008) Moving closer to the action: examining compensation design effects on firm risk. Organ Sci 19(4):548–566

    Article  Google Scholar 

  • Dittmar A, Mahrt-Smith J (2007) Corporate governance and the value of cash holdings. J Financ Econ 83:599–634

    Article  Google Scholar 

  • Durnev A, Kim EH (2005) To steal or not to steal: firm attributes, legal environment, and valuation. J Financ 60(3):1461–1493

    Article  Google Scholar 

  • Durnev A, Morck R, Yeung B, Zarowin P (2003) Does greater firm-specific return variation mean more or less informed stock pricing? J Account Res 25:797–836

    Article  Google Scholar 

  • Durnev A, Morck R, Yeung B (2004) Value-enhancing capital budgeting and firm-specific stock return variation. J Financ 25:65–105

    Article  Google Scholar 

  • Easley D, Hvidkjacr S, O'Hara M (2002) Is information risk a determinant of asset returns? J Financ 25:2185–2221

  • Fama EF (1980) Agency problems and the theory of the firm. J Polit Econ 88:288–307

    Article  Google Scholar 

  • Fama EF (1991) Efficient capital markets: II. J Financ 46(5):1575–1617

    Article  Google Scholar 

  • Fan JPH, Wong TJ, Zhang T (2007) Politically-connected CEOs, corporate governance and post-IPO performance of China’s partially privatized firms. J Financ Econ 84(2):330–357

    Article  Google Scholar 

  • Ferreira MA, Laux PA (2007) Corporate governance, idiosyncratic risk, and information flow. J Financ 62(2):951–989

    Article  Google Scholar 

  • Finkelstein S, Boyed BK (1998) How much does the CEO matter? The role of managerial discretion in the setting of CEO compensation. Acad Manage J 41(2):179–199

    Article  Google Scholar 

  • Finkelstein S, Hambrick DC (1990) Top management-team tenure and organizational outcomes: the moderating role of managerial discretion. Adm Sci Q 35(3):484–503

    Article  Google Scholar 

  • Firth M, Malatesta PH, Qingquan X, Xu L (2012) Corporate investment, government control, and financing channels: evidence from China’s listed companies. J Corp Financ 18(3):433–450

    Article  Google Scholar 

  • French K, Roll R (1986) Stock return variances: the arrival of information and the reaction of traders. J Financ Econ 25:295–327

    Google Scholar 

  • Friedman E, Johnson S, Mitton T (2003) Propping and tunneling. J Comp Econ 31(4):732–750

    Article  Google Scholar 

  • Glostein L, Milgrom P (1985) Bid, ask and transaction prices in a specialist market with heterogeneously informed traders. J Financ Econ 25:71–101

    Article  Google Scholar 

  • Gompers P, Ishill J, Metrick A (2003) Corporate governance and equity prices. Quart J Econ 25:107–155

    Article  Google Scholar 

  • Guedhami O, Pittman JA, Saffar W (2009) Auditor choice in privatized firms: empirical evidence on the role of State and foreign owners. J Account Econ 48(2–3):151–171

    Article  Google Scholar 

  • Hartzell J, Ofek E, Yermack D (2004) What’s in if for me? Personal benefits obtained by CEOs whose firms are acquired. Rev Financ Stud 17(1):37–61

    Article  Google Scholar 

  • Hayward M, Hambrick D (1997) Explaining the premiums paid for large acquisitions: evidence of CEO hubris. Adm Sci Q 42:103–127

    Article  Google Scholar 

  • Hiller N, Hambrick D (2005) Conceptualizing executive hubris: the role of (hyper-) core self-evaluations in strategic: decision-making. Strateg Manag J 26(4):297–319

    Article  Google Scholar 

  • Jensen MC (1986) Agency costs of free cash flow, corporate finance and takeover. Am Econ Rev 76:323–329

    Google Scholar 

  • John K, Litov L, Yeung B (2008) Corporate governance and risk-taking. J Financ 63:1679–1728

    Article  Google Scholar 

  • Johnson JL, Daily CM, Ellstrand AE (1996) Boards of directors: a review and research agenda. J Manag 22:409–438

    Google Scholar 

  • Kau JB, Linck JS, Rubin PH (2008) Do managers listen to the market? J Corp Financ 14(4):347–362

    Article  Google Scholar 

  • Khanna T, Palepu K (1997) Why focused strategy may be wrong in emerging markets. Harvard Business Rev 75:41–51

    Google Scholar 

  • Klapper L, Love I (2004) Corporate governance, investor protection, and performance in emerging markets. J Corp Financ 10(5):703–728

    Article  Google Scholar 

  • Kohlbeck M, Mayhew BW (2010) Valuation of firms that disclose related party transactions. J Account Public Policy 29(2):115–137

    Article  Google Scholar 

  • Llorente G, Michaely R, Saar G, Wang J (2002) Dynamic volume-return relation of individual stocks. Rev Financ Stud 15(4):1005–1047

  • La Porta R, Lopez-Desilanes F, Shleifer A (2002) Government ownership of banks. J Financ 57(1):265–301

    Article  Google Scholar 

  • Li J, Tang Y (2010) CEO hubris and firm risk taking in China: the moderating role of managerial discretion. Acad Manag J 53(1):45–68

    Article  Google Scholar 

  • Lo AWY, Wong RMK, Firth M (2010) Can corporate governance deter management from manipulating earnings? Evidence from related-party sales transactions in China. J Corp Financ 16:225–235

    Article  Google Scholar 

  • Mehran H (1995) Executive compensation structure, ownership, and the firm performance. J Financ Econ 38(2):163–184

    Article  Google Scholar 

  • Morck RK, Wolfenzon D, Yeung B (2005) Corporate governance, economic entrenchment, and growth. J Econ Lit 43(3):657–722

    Article  Google Scholar 

  • Opler T, Pinkowitz L, Stulz R, Willamson R (1999) The determinants and implications of corporate cash holdings. J Financ Econ 52(1):3–46

    Article  Google Scholar 

  • Peng WQ, Wei KCJ, Yang Z (2011) Tunneling or propping: evidence from connected transaction in China. J Corp Financ 17(2):306–325

    Article  Google Scholar 

  • Roll R (1988) R2. J Financ 25:1119–1151

    Google Scholar 

  • Roll R (1989) Price volatility, international market links and their implications for regulatory policies. J Financ Serv Res 3:211–246

    Article  Google Scholar 

  • Sanders WG, Hambrick DC (2007) Swinging for the fences: the effects of CEO stock options on company risk taking and performance. Acad Manag 50(5):1055–1078

    Article  Google Scholar 

  • Shivdasni A (1993) Board composition, ownership structure and hostile takeover. J Account Econ 16(1–3):167–198

    Article  Google Scholar 

  • Shleifer A, Vishny R (1997) The limits of arbitrage. J Financ 52(1):35–55

    Article  Google Scholar 

  • Stulz RM (1990) Managerial discretion and optimal financing policies. J Financ Econ 26:3–27

    Article  Google Scholar 

  • Stulz RM (2005) The limits of financial globalization. J Financ 65(4):1595–1638

    Article  Google Scholar 

  • Su Y, Xu D, Phan PH (2008) Principal-principal conflict in the government of the Chinese public corporation. Manag Organ Rev 4(1):17–38

    Article  Google Scholar 

  • Theil H (1971) Principles of econometrics. Wiley, New York

    Google Scholar 

  • Wright P, Kroll M, Elenkov D (2002) Acquisition returns, increase in firm size, and Chief Executive Officer compensation: the moderating role of monitoring. Acad Manag J 45(3):599–608

    Article  Google Scholar 

  • Wright P, Kroll M, Krug J, Pettus M (2007) Influences of top management team incentives on firm risk taking. Strateg Manag J 28(1):81–89

    Article  Google Scholar 

  • Wulf J (2004) Do CEOs in mergers trade power for premium? Evidence from mergers of equals. J Law Econ Organ 20(1):60–101

    Article  Google Scholar 

  • Yeh Y, Shu P, Lee T, Su Y (2009) Non-tradable share reform and corporate governance in the Chinese stock market. Corp Gov Int Rev 17(4):457–475

    Article  Google Scholar 

  • Yoshikawa T, Phan PH (2005) The effects of ownership and capital structure on board composition and strategic diversification in Japanese Corporations. Corp Gov Int Rev 13(2):303–312

    Article  Google Scholar 

  • Young MN, Peng MW, Ahlstrom D, Bruton GD, Jiang Y (2008) Corporate governance in emerging economies: a review of the principal-principal perspective. J Manage Stud 45(1):196–220

    Article  Google Scholar 

  • Zajac EJ, Westphal TD (1994) The costs and benefits of managerial incentives and monitoring in large US corporations: When is more not better? Strateg Manag J 15(Winter Special Issue):121–144

    Article  Google Scholar 

  • Zwiebel J (1996) Dynamic capital structure under management entrenchment. Am Econ Rev 86:1197–1215

    Google Scholar 

Download references

Acknowledgments

The author would like to thank the anonymous referees and Professor Wolfgang Kürsten for their helpful comments which have helped to improve the quality of this manuscript. We also thank Professor L. Hong from National Central University (Taiwan) and Professor Can An from Wollongong University (Australia) for their helpful comments. The remaining errors and omissions are the responsibility of the author alone.

Author information

Authors and Affiliations

  1. Department of Banking and Finance, Kainan University, Taipei City, Taiwan

    Mu-Shun Wang

  2. No. 1 Kainan Road, Luzhu Shiang, Taoyuan, 33857, Taiwan

    Mu-Shun Wang

Authors
  1. Mu-Shun Wang
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Mu-Shun Wang.

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Wang, MS. Idiosyncratic volatility, executive compensation and corporate governance: examination of the direct and moderate effects. Rev Manag Sci 10, 213–244 (2016). https://doi.org/10.1007/s11846-014-0143-7

Download citation

  • Received:

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11846-014-0143-7

Keywords

JEL Classification

Search

Navigation