Essays on institutional trader monitoring and its impact on firm value, CEO compensation, and board composition
The ?Wall Street Rule? (WSR), a form of institutional investor monitoring, has long been viewed as a ?cut-and-run? strategy adopted by disillusioned institutional investors to express their dissatisfaction with the management of a company. This dissertation shows that WSR, far from being a passive way of protesting, is in fact a potent weapon to improve corporate governance, and ultimately, create value for shareholders. By following the ?Wall Street Rule? or equivalently, engaging in informed trading, institutional investors impound massive information in stock prices, making them more revealing about the fundamental firm value and managerial action. Knowing that her value-decreasing activities will lead to the sell-off of informed traders and hence a drop in the stock price (along with her equity-linked compensation), the CEO would exert more effort in increasing firm value ex ante. In other words, institutional informed trading, albeit driven purely by self-interest, becomes a credible disciplining mechanism in corporate governance. This dissertation builds upon this argument and takes further steps to investigate how WSR affects managerial compensation, firm performance and board monitoring. A theoretical model endogenizing managerial contracting problem is proposed, which predicts that WSR and manager?s equity-based incentives are likely to be substitutes. The empirical results confirm this hypothesis: aggressive institutional informed trading is indeed associated with the lower use of managerial equity-based incentives. Given the powerful role of incentives, one might thus think that institutional informed trading results in lower firm performance. This dissertation rejects this conjecture. In fact, firm performance improves as the positive impact of WSR on managerial action outweighs its negative impact on incentives, as predicted by the model. The overall information environment for board monitoring should also improve as stock prices become more revealing about managerial behaviour. The results of this dissertation support this argument?WSR is positively associated with the effectiveness of board monitoring (measured by board independence). However, the initial condition of board monitoring matters. Specifically, when the firm is endowed with an outsider-dominated board, WSR and board monitoring are complements; stock price informativeness will not help much if the firm is endowed with an insider-dominated board. This dissertation not only helps enrich current research on institutional investor activism, but also paves the way for future research on the role of WSR-type monitoring in other corporate governance issues.
Year of publication: |
2011
|
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Institutions: | Chen, Chi-Wei Brandon, Banking & Finance, Australian School of Business, UNSW ; Swan, Peter, Banking & Finance, Australian School of Business, UNSW (contributor) ; Reeves, Jonathan, Banking & Finance, Australian School of Business, UNSW (contributor) |
Publisher: |
Awarded By:University of New South Wales. Banking & Finance |
Subject: | CEO Incentives | Corporate Governance | Wall Street Rule | Price Informativeness | Firm Performance | Board Independence |
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