The Latest Research in Corporate Governance

1. The Latest Research inCorporate Governance

2. Who we are • The Corporate Governance Institute (CGI) is a research and education center dedicated to the study and application of responsible corporate governance principles worldwide • Founded as a joint venture of San Diego State University and the Corporate Directors Forum in 1998

3. CGI Board of Advisors • Nell Minow Editor and Co-founder The Corporate Library • Cynthia Richson • Garry Ridge CEO WD-40 Company • Hugh Friedman Professor of Law University of San Diego • Gail Naughton Dean SDSU College of Business

4. The Latest Research inCorporate Governance

5. Lori Verstegen Ryan, Ph.D.Director • Professor of Management, San Diego State University • Research focuses on the intersection of corporate governance and ethics • Previously spent 11 years with Honeywell

6. Paul Graf, J.D.Associate Director for Law and Finance • Professor of Law, San Diego State University • Research focuses on board assess- ment and accountability • Previously Senior VP and Corporate Counsel, GE Capital Business Asset Funding

7. Nikhil Varaiya, Ph.D. • Professor of Finance, San Diego State University • Research focuses on mergers and acquisitions, valuation, and strategic management • Previously chairman of the board, University & State Employees Credit Union

8. David DeBoskey, Ph.D., CPA • Assistant Professor of Accountancy, San Diego State University • Research focuses on executive compensation, corporate transparency and accountability, and audit quality • Previously CFO and Senior Vice President of CareAdvantage, Inc.

9. Event Timetable 1:00-1:15 Welcome   1:15-2:30 Session 1 - Management or Finance 2:30-2:45 Break  2:45-4:00 Session 2 - Law or Accounting 4:45     First shuttle departs from the Hilton  5:00  Directors Forum reception at USD

10. The Latest Research inCorporate Governance:Management Lori Verstegen Ryan Professor of Management

11. Top-Tier Management Journals • Administrative Science Quarterly** • Academy of Management Review* • Academy of Management Journal* • Strategic Management Journal* • Organization Science • Journal of Management

12. Business Ethics Journals • Business Ethics Quarterly • Business & Society • Journal of Business Ethics

13. Corporate Governance Journals • Corporate Governance: An International Review • Journal of Management and Governance • Corporate Governance

14. Topics • Boards of directors • Top management • Shareholders • Ethics and social responsibility

15. Boards of Directors

16. Boards of Directors – Identification • The strength of a director’s identification with the organization will have a positive relationship with resource provision and monitoring • The strength of a director’s identification with being a director will have a positive relationship with resource provision and monitoring • The strength of a director’s identification with being a CEO will have a positive relationship with resource provision, but a negative relationship with monitoring • The strength of a director’s identification with shareholders will have a positive relationship with resource provision and monitoring • The strength of a director’s identification with customers and/or suppliers will have • An inverted-U-shaped relationship with resource provision • A positive relationship with monitoring (Hillman, Nicholson & Shropshire)

17. Boards of Directors – Political Officials • 1988-2003: 66 former cabinet secretaries, 74 former senators, and 96 former representatives • 36% of sample joined firms as outside directors • 11 individuals accounted for 32% of board seats • Longer government tenure increases the likelihood of joining a board (depth) • Cabinet secretaries are 2.1 times more likely than senators to join a board; representatives are 58% less likely than senators (breadth) • After a large spike in likelihood of taking a board seat in year 1, it drops significantly (deterioration) • If the official’s opposition party is in power, the likelihood of joining a board drops 29% (Lester, Hillman, Zardkoohi & Cannella*)

18. Boards of Directors – Interlock Dangers • 244 firms with director interlocks to 30 firms accused of fraud between 1998 and 2002 • Linked firms lost an average 1% of market value within 2 days of fraud allegation announcement, $49B overall • 18% (45) of linked firms suffered significant reputational penalties ($39B for 45 firms) • Penalties were more likely when the interlocking director held audit or governance chair positions in the linked firm • The likelihood of escalated penalties diminished when the linked firm exhibited certain “effective” corporate governance structures (heavily independent board, inside director ownership, mutual fund/public pension fund ownership) (Kang*)

19. Boards of Directors – Acquisitions • 1997-2001: 500 acquisitions (100/year) • Significantly higher returns from acquisitions were found to be associated with • Board vigilance variables • A higher number of independent outside board members • A higher percentage of blockholder director ownership • Greater outside board member ownership • Board experience variables • Directors experienced in the target industry • Directors with prior CEO experience with acquisitions • Directors with prior board experience with acquisitions • The interaction of the two heightens returns further • Previous CEO experience with acquisitions is not significant except as it enhances board effects (Kroll, Walters & Wright*)

20. Boards of Directors – Demographics • Over 43 countries: • More women sit on boards in countries with more women in senior management and greater earnings equality • Fewer women sit on boards in countries with long traditions of female elected political officials (Terjesen & Singh) • Over 68 Spanish companies 1995-2000: • Mere presence of women on boards does not increase firm value • Greater gender diversity on boards does increase firm value (Campbell & Mínguez-Vera)

21. Top Management

22. Top Management – Investor Ingratiation • 803 dyads of top managers and institutional investors (II) • 88% of complimented fund managers received praise for their funds’ performance or their professional reputations • Over the past twelve months (1) complimenting IIs three times more than average, (2) expressing agreement with IIs three more times, and (3) doing two more personal favors for IIs: • Reduces the likelihood of CEO/chair separation by 62% • Raises the rate at which CEO compensation increases by 37% • Reduces the rate at which compensation risk increases by 59% (Westphal & Bednar**)

23. Top Management – Analyst Ingratiation • 986 analyst surveys, each covering up to three analyst/ firm dyads • The greater the earnings shortfall, the more favors top management grants to analysts • The greater the favors granted, the less likely the analyst will downgrade the stock • Analysts who downgrade a stock receive significantly fewer favors thereafter • Analysts who see a fellow analyst receive reduced favors from a firm are less likely to downgrade that firm (Westphal & Clement*)

24. Top Management – Advice Networks • 224 firms—surveys from CEO and at least one outside director • The likelihood rises that CEOs seek advice from executives at other firms who are a) non-friends or b) from disparate functional areas with • Increases in CEOs’ stock ownership • Increases in performance-contingent compensation • Increases in board monitoring (McDonald, Khanna, & Westphal*)

25. Top Management – Earnings Manipulation • 1995-2001—225 firms with restatements • No relationship was found between the number of a CEO’s in-the-money options and earnings manipulation • The larger the number of a CEO’s out-of-the-money options, the greater the likelihood of earnings manipulation • Lower levels of CEO stock ownership and low firm perfor-mance were positively related to earnings manipulation • Both relationships were stronger with longer tenured CEOs (Zhang, Bartol, Smith, Pfarrer,& Khanin*)

26. Top Management – Firm Performance • 1992-2002: 92 “mobile” CEOs across 52 firms • Adds to the “performance variance decomposition” literature • The CEOs in these firms account for 29% of the variance in firm performance, corporate effect for 8%, and industry effect for 6% • The CEOs account for 13% of the variance in business-segment performance, industry effect for 8%, and corporate effect for 7% (Mackey*)

27. Top Management – Equity Reduction • 1997-1999: 208 U.S. CEOs • Firm-specific downside risk is strongly correlated with CEOs’ stock divestitures and their magnitude • Firm performance is negatively correlated with CEOs’ stock divestitures and their magnitude • Neither the firm’s returns variability nor a high level of CEO shareholdings has a demonstrable effect on CEOs’ stock divestitures (Matta & McGuire)

28. Top Management – CEO Dismissal • 1993-1998: 204 CEO successions in 184 firms (Zhang*)

29. Shareholders

30. Shareholders – Information Advantages • 1983-1991: 6,515 firm-quarter observations • On average, IIs hold 28% of firm shares, largest holds 7%, firms have 28 institutional investors • Only a firm’s largest institutional holder is perceived as having an information advantage, based on an increased buy/ask spread • The greater the percentage of shares held by the largest institutional investor, the greater the perceived informa-tion advantage (Schnatterly, Shaw & Jennings*)

31. Shareholders – Portfolio Effects • 1993-2002: 533 firms • Average blockholder stake $86M • Blockholders’ monitoring effectiveness decreased with larger average holdings, more blockholdings, firm significance in the portfolio, and greater turnover • CEO compensation is high when the firm is a high proportion of the investor’s portfolio, but drops Presence of a blockholder is associated with lower CEO total compensation (Dharwadkar, Goranova, Brandes & Khan)

32. (Dharwadkar, Goranova, Brandes & Khan)

33. Shareholders – Activism and Justice • 1999-2005: 1,719 shareholder resolutions (IRRC) • Justice issues constituted 34-50% of resolutions (peaking in 2001-2002)—e.g., EEO, economic development, environment) • Employee-to-community ratio 9 to 1 • Many justice-related issues considered ordinary business and excluded; some phrased instrumentally (Logsdon & Van Buren)

34. Ethics and Social Responsibility

35. Ethics – Ignoring Shareholder Directives • 2000-2004: 281 anti-takeover-recission proposals approved by shareholder majority vote (207 enacted) • Firms with outsider-dominated (80%+) boards are more likely to enact • Smaller outsider-dominated boards are more likely to enact than larger • Larger non-outsider-dominated boards are more likely to enact than small • High levels of CEO ownership reduce the likelihood of enactment • Outsider tenure, blockholder presence, and director stock ownership are not significant factors (Howton, Howton & McWilliams)

36. Ethics –Hedge Funds • Philosophical analysis of the “hedge-fund regulation problem” • “Intentional opaqueness” protects strategies from theft, but could also harm “duped” investors and the overall market • Regulation could stifle fund managers’ incentives and violate intellectual property rights • A few behaviors lend themselves to regulation, e.g., pred-atory short-selling based on circulating false information • Recommends an industry “best practices” code of conduct (Donaldson)

37. Ethics – Governance in Russia • Traditional agency theory norms should not be used to evaluate the ethics of business behavior in Russia • Both market-based norms and Russian cultural norms must be taken into account • Integrative Social Contracts Theory is better applied, recognizing the Russian “micro social contract” • Global corporate governance “hypernorms” should be recognized, otherwise allowing for local variations (McCarthy & Puffer*)

38. Social Responsibility – Pension Funds • 2001-2001: 540 UK firms (80% of largest firms) • Corporate social performance (CSP) is measured by an index of employment, environment, and community factors • CSP is correlated to the degree to which shares are held by pension funds (marginal significance, p<.06) • CSP is strongly correlated to holdings by internally managed pension funds • CSP is strongly correlated to holdings by private pension funds; significance is accounted for by internally managed private pension funds • CSP is correlated to holdings by internally managed public pension funds (not to externally managed or public funds overall) (Cox, Brammer & Millington)

39. Ethics – Use of Ratings Services • Commercial ratings are not linked to firm performance • Commercial ratings are not linked to shareholder voting (or ISS voting recommendations) • Investors validate ratings by buying services • Firms modify their corporate governance structures and processes to conform to ratings • Firm performance may suffer (Ryan, forthcoming)

40. The Latest Research inCorporate Governance