Competition for Flow and Short-Termism in Activism

We develop a dual-layered agency model to study blockholder monitoring by activist funds competing for investor flow. Competition for flow affects the manner in which activist funds govern as blockholders. In particular, funds inflate their short-term performance by increasing payouts that are financed by higher (net) leverage. Doing so subsequently discourages value-creating interventions during economic downturns because of debt overhang. Our theory suggests a new channel via which asset manager incentives may foster economic fragility and links together the observed procyclicality of activist investments with the documented effect of such funds on the leverage of their target companies.

Do firms use early guidance to disclose the effect of conservatism on future earnings?

Purpose By deferring profits and anticipating losses, conservatism makes earnings increases more persistent and earnings declines more likely to revert. Therefore, the level of conservatism in current earnings has implications for future earnings expectations. Past research shows that outsiders can fail to understand these implications. This paper aims to investigate whether firms help outsiders by voluntarily disclosing their expectations about how conservatism will affect future earnings trends. Design/methodology/approach The authors examine the likelihood and content of “early” earnings guidance – i.e. guidance about future earnings that is released around or before the announcement of current earnings. The sample is made of 8,820 annual earnings announcements, 62 per cent of which are combined with early guidance. Findings The authors find that the more conservative current earnings, the higher: the likelihood that the firm releases early guidance; the likelihood that the firm predicts a positive change in earnings; and the difference between the forecasted earnings and current earnings. The authors also find such guidance to be relevant to analysts, who use it to update their forecasts. Practical implications By showing that firms use early guidance to disclose the effect of conservatism on future earnings, the study is interesting to users and preparers because it shows that analysts need and use such disclosure; and regulators because it alleviates concerns about the information consequences of conservatism. Originality/value The findings show that firms do not refrain from committing to positive early guidance to disclose the earnings effects of conservatism. This is interesting in light of the difficulty of predicting such effects, the manager incentives to keep expectations low and the cost of committing to positive guidance instead of less risky qualitative disclosure alternatives. In this way, the authors contribute to the literature on the interrelation between voluntary disclosure and conservatism in financial reports.

Why Do Cities Hoard Cash? Determinants and Implications of Municipal Cash Holdings

ABSTRACT: This study examines the determinants of municipal cash holdings and the implications of holding high levels of cash. The first part of the analysis investigates municipal manager incentives to accumulate cash as part of normal operations. Results indicate that municipalities with a higher variation in revenues, fewer sources of revenues, and higher growth accumulate more cash. Larger governments and those receiving relatively more state revenue accumulate less cash. Further analysis considers whether high levels of cash indicate agency problems, and finds municipalities with high cash holdings spend more on administrative expenses, city manager salaries, and bonuses. I find no evidence that municipalities with excess cash reduce taxes. The presence of staggered councils and councils that are not independent tend to exacerbate excessive cash holdings. These results are consistent with the proposition that municipalities with high cash levels have agency problems relative to those with lower cash holdings.

Capital Budgeting and Managerial Compensation: Incentive and Retention Effects

This paper considers an agency model in which a firm's manager receives private information about an investment project. The manager has unique skills that are essential for implementing the project, and he can pursue the project inside the firm or as an outside venture on his own. The firm's owner thus faces a potential managerial retention problem, where the severity of the retention problem depends on the project's outside viability. My analysis shows that if the managerial retention problem is not too severe, the owner can delegate the investment decision to the manager and use a residua-lincome-based bonus contract to give the manager incentives to work hard and make appropriate investment decisions. If the retention problem is severe, however, then the owner must use an option-based compensation contract to retain the manager and provide him with appropriate incentives. I also establish that as the managerial retention problem becomes more severe, the owner reduces the rate of return, or hurdle rate, required to approve the investment project. These results predict that new-economy firms, in which managerial expertise is critical and yet mobile, are more likely to (1) include stock options in their managers' compensation contracts, and (2) apply lower hurdle rates for approving capital investments.