Internal governance, external governance, and corporate strategic decisions

Abstract

This thesis comprises three self-contained essays analysing topics in the field of internal governance, external governance, and corporate strategic decisions. The first essay explores the impact of managerial ability of the entire top management team, as an internal corporate governance entity, on firms’ risky-taking in investing financial assets. Utilising hand-collected data on detailed financial asset portfolios from S&P 500 index firms spanning the period from 2009 to 2019, we find that, generally, management with higher ability scores allocates a greater proportion of financial assets to risky positions, while management with relatively lower scores holds fewer risky financial assets. This positive effect is more pronounced when firms encounter fewer financial constraints, exhibit lower financial asymmetry, have higher bank debt ratios, and have more industry peers. In addition, the market perceives a higher firm value when high-ability management runs more risky financial assets. Further, the positive effect is stronger when current CEOs are younger and in the early stages of their careers. The second essay delves into the impact of an exogenous shock in corporate governance, specifically focusing on an immutable part of the duty of loyalty and corporate law, on firms’ financial reporting in terms of earnings management. By exploiting the staggered introduction of Corporate Opportunity Waivers (COW) since 2000, our findings indicate that firms incorporated in states that eventually adopted the waivers experienced a reduction in accrual-based earnings management. The effect is more pronounced for firms led by managers with greater ex-ante career concerns and pressures for short-term profits. Further, we are unable to find evidence suggesting that firms resort to real earnings management, nor does it support the argument that earnings management decreases due to an improvement in corporate governance. Overall, we provide insights suggesting that adopting COW might not be detrimental; instead, it could yield plausible benefits such as fostering more precise and transparent financial reporting. The third essay examines the relationship between auditors, as an external corporate governance mechanism, and firms’ strategic decisions. Specifically, we utilise state-level exogenous shocks in third-party auditor liability for ordinary negligence to explore the dynamics between governance and dividend payouts. Our findings indicate that the client firms’ dividend payments decrease when the state shifts to a higher auditor liability regime. In addition, we conduct separate analyses for positive and negative shocks and find that this impact is symmetrical. We subject the main findings to several robustness tests to reinforce the key inferences. Further, we find that main results are more pronounced among firms with weaker governance and more severe free cash flow problems, providing support for the substitute view in the competing agency theory of dividend puzzles.

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Identifiers

ORCID for Jing Feng: orcid.org/0009-0008-6553-6443

ORCID for Jason Zhang: orcid.org/0000-0001-5369-3144

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