CEO Turnover and Relative Performance Evaluation 
with Fadi Kanaan
(August 2010) Journal of Finance forthcoming
Award for the Best Corporate Finance Paper at the 2006 Western Finance Association Meeting.
[ Full Text ]
Abstract: This paper shows that CEOs are fired after bad firm performance caused by factors beyond their control. Standard economic theory predicts that corporate boards filter out exogenous industry and market shocks from firm performance before deciding on CEO retention. Using a hand-collected sample of 1,627 CEO turnovers from 1993 to 2001, we document that CEOs are significantly more likely to be dismissed from their jobs after bad industry or bad market performance. A decline in industry performance from the 75th to the 25th percentile increases the probability of a forced CEO turnover by approximately 50 percent. The increase in forced turnovers after bad peer performance is concentrated on CEOs who have underperformed their peers. Our findings suggest that the standard CEO turnover model is too simple to explain the empirical relation between performance and forced turnovers, and we evaluate several extensions to the standard model.


Security Issue Timing: What Do Managers Know, and When Do They Know It? 
with Katharina Lewellen and Jerold B. Warner
Journal of Finance, Vol. 66 No. 2, April 2011.
[ Full Text ] [ Online Appendix ]
Abstract: We study put option sales on company stock by large firms.  An often cited motivation for these transactions is market timing.  Like the decision to repurchase stock, the decision to issue puts should be sensitive to whether the stock is undervalued.  We provide new evidence that large firms successfully time security sales.  In the 100 days following put option issues, there is roughly a 5% abnormal stock price return, with much of the abnormal return following the first earnings release date after the sale.  Direct evidence on put option exercises reinforces these findings: exercise frequencies and payoffs to put holders are abnormally low.


Institutional Cross-holdings and Their Effect on Acquisition Decisions 
with Jarrad Harford and Kai Li
Journal of Financial Economics, Vol. 99 No. 1, January 2011. 
[ Full Text ]
Abstract: Cross-holdings are created when a shareholder of one firm holds shares in other firms as well, and cross-holdings alter shareholder preferences over corporate decisions that affect those other firms. Prior evidence suggests that such cross-holdings explain the puzzle of why shareholders allow acquisitions that reduce the value of the bidder. Conducting a shareholder-level analysis of cross-holdings, we instead find that cross-holdings are too small to matter in most acquisitions and that bidders do not bid more aggressively even in the few cases in which cross-holdings are large. We conclude that cross-holdings do not explain value-reducing acquisitions. Beyond acquisitions, we find that institutional cross-holdings between large firms have, in fact, increased rapidly over the last 20 years, but mostly due to indexing and quasi-indexing. As in acquisitions,cross-holdings by active investors are typically too small to matter.


CEO Compensation
with Carola Frydman
Annual Review of Financial Economics, Vol. 2, December 2010.
[ Full Text ]
Abstract: This paper surveys the recent literature on CEO compensation.  The rapid rise in CEO pay over the last 30 years has sparked an intense debate about the nature of the pay-setting process.  Many view the high level of CEO compensation as the result of powerful managers setting their own pay.  Others interpret high pay as the result of optimal contracting in a competitive market for managerial talent.  We describe and discuss the empirical evidence on the evolution of CEO pay and on the relationship between pay and firm performance since the 1930s.  Our review suggests that both managerial power and competitive market forces are important determinants of CEO pay, but that neither approach is fully consistent with the available evidence.  We briefly discuss promising directions for future research.


Employee Sentiment and Stock Option Compensation 
with Nittai Bergman
Journal of Financial Economics Vol. 84 No. 3, June 2007.
[ Full Text ]
Abstract: The use of equity-based compensation for rank-and-file employees is a puzzle.  We analyze whether the popularity of option compensation may be driven by employee optimism, and show that optimism by itself is insufficient to make option compensation optimal.  The crucial insight is that firms compete with financial markets as suppliers of equity to employees and that employees’ access to the equity market restricts firms’ ability to profit from employee optimism.  Firms must be able to extract some of the implied rents even though employees can purchase company equity in the financial markets.  Such rent extraction becomes feasible if employees prefer the stock options offered by firms to the equity offered by the market, or if the traded equity is overvalued.  We provide empirical evidence that firms use broad-based options compensation when boundedly rational employees are likely to be excessively optimistic about company stock, and when employees are likely to strictly prefer options over stock.


Market Timing and Managerial Portfolio Decisions
Journal of Finance Vol. 60 No. 4, August 2005.
Nominated for the Brattle Prize for the Best Corporate Finance Paper in the Journal of Finance.
[ Full Text ] 
Abstract:This paper provides evidence that top managers have contrarian views on firm value. Managers' perceptions of fundamental value diverge systematically from market valuations, and perceived mispricing seems an important determinant of managers' decision making. An analysis of insider trading patterns shows that low valuation ("value") firms are regarded as undervalued by their own managers relative to high valuation ("growth") firms. This finding is robust to controlling for non-information motivated trading. Managers in value firms actively purchase additional equity on the open market despite substantial prior exposure to firm risk through stock and option holdings, equity-based compensation and firm-specific human capital. Further evidence links managers' private portfolio decisions directly to changes in corporate capital structures, suggesting that managers actively time the market both in their private trades and in firm-wide decisions.

Selling Company Shares to Reluctant Employees: France Télécom’s Experience
Journal of Financial Economics Vol. 71 No. 1, January 2004.
[ Abstract ]  [ Full Text ] with Francois Degeorge, Alberto Moel and Peter Tufano

Executive Compensation, Incentives, and Risk
(April 2002) [ Full Text ]
Award for the Outstanding Doctoral Student Paper at the 2001 SFA Meeting.

Abstract: This paper analyzes the link between equity-based compensation and created incentives by (1) deriving a measure of incentives suitable for both linear and non-linear compensation contracts, (2) analyzing the effect of risk on incentives, and (3) clarifying the role of the agent’s private trading decisions in incentive creation. With option-based compensation contracts, the average pay-for-performance sensitivity is not an adequate measure of ex-ante incentives. Pay-for-performance covaries negatively with marginal utility and hence overstates the created incentives. Second, more noise in the performance measure may imply that also the manager is less certain about the effect of effort on performance, which in turn makes her less willing to exert effort. Finally, the private trading decisions by the manager have first-order effects on incentives. By reducing her holdings of the market asset, the manager achieves an effect similar to indexing the stock or option grant, making explicit indexation of the contract redundant.

Copyright © Dirk Jenter 2011