investigating the human element in corporate policies

Investigating the Human Element in Corporate Policies DISSERTATION Presented in Partial Fulfillment of the Requirements for the Degree Doctor of Philosophy in the Graduate School of The Ohio State University By Scott E. Yonker, B.S., M.A. Graduate Program in Business Administration The Ohio State University 2010 Dissertation Committee: Ren´e Stulz, Adviser G. Andrew Karolyi, Co-adviser Bernadette Minton c  Copyright by Scott E. Yonker 2010 ABSTRACT I explore how the “human element” of corporate managers impacts corporate policies and decisions. Specifically, I investigate how identifiable differences in managers affects: 1) executive labor market outcomes, 2) capital structure decisions, and 3) employment decisions. In the first essay, I examine the role of geography in the labor market for CEOs. I find that the frequency with which firms hire CEOs from their own state is five times more than is expected if CEO geographic origin were random. Smaller, less R&D-intensive firms located in less desirable locations, with weaker board incentive alignment, and whose previous CEO was locally hired are more likely to hire local CEOs. Compensation and turnover are lower for local CEOs than for non-locals and adjusted operating performance significantly decreases when firms replace non-locally hired CEOs with locals. These findings are consistent with the existence of search costs, agency conflicts and CEO geographic preference. In the second essay, co-authored with Anil Makhija and Henrik Cronqvist, I show empirically that firms behave remarkably similarly to how their CEOs behave personally in the context of leverage choices. Using a database of CEOs’ leverage in their most recent home purchases, I find a positive, economically significant, robust relation between personal home leverage and corporate leverage in the cross-section and when I examine CEO changes. The results are consistent with an endogenous ii matching of CEOs with firms based on leverage preferences on both sides, as well as with CEOs imprinting their personal preferences on the firms they manage, especially when governance is weaker. In the third essay, I find that local managers are more labor-friendly than their non-local industry peers during times of poor industry performance. During industry downturns layoffs are 13 percent less frequent among firms run by local managers than among similar firms run by non-locals. This number increases to 22 percent when investigating layoffs of 10 percent of the workforce or more, but for large-scale layoffs (20% of the workforce or more) there is no differential effect of local managers, implying that there are limits to the influence of these managers on corporate decisions. iii To Leah iv ACKNOWLEDGMENTS A note of acknowledgement must begin with two people who have shaped my understanding of finance and whose guidance has been instrumental in my research. The first of whom is Andrew Karolyi. He is the reason I began the finance program at The Ohio State University. It was his enthusiasm and obvious love for finance that brought me to Columbus. Once here, Andrew guided me throughout the process. I credit Andrew and his empirical asset pricing course, for teaching me how to conduct empirical work. Without Andrew I would not be writing this document. The second person who has been instrumental in my education is Ren´e Stulz. Ren´e is truly one of the hardest working people I have ever met. I have learned so much from Ren´e during the one year that I have been under his advisement. I have benefitted greatly from his vast knowledge, attention to detail, and sometimes painful honesty. Probably the most important lesson I have learned from Ren´e is that you are never too successful to seek out criticism and help. I am very grateful for all the time both of these distinguished academics have invested in me. I realize that they are both very busy individuals, but I always felt as though they made time to work with me. For this I am extremely grateful. There are several others at Ohio State who have been instrumental in producing this document. Most notable are Anil Makhija and Henrik Cronqvist. It was Anil’s corporate finance course during my second year at Ohio State that started my love v for the topic. It was from a conversation in that course that began our research with Hernik Cronqvist that turned into the second essay in this dissertation. The level and lack of variability in kindness and grace with which Anil conducts his daily life is absolutely amazing to me. While working with he and Henrik on the second essay in this dissertation, I learned the process of academic writing. Finally, I would like to acknowledge the help of Bernadette Minton. Bernadette has supported me from early on. She was instrumental in preparing me for the job market, insisting on mock interviews and providing constructive criticism. In addition, I would also like to acknowledge the many helpful discussions with Jack Bao, Jia Chen, Kewei Hou, Roger Loh, Berk Sensoy, and Mike Weisbach. While those mentioned previously are responsible for my education in the field of finance, I would like to acknowledge that my parents, Bob and Pam Yonker, and older brother, Bob Yonker are responsible for the remainder of what I know. Without their love and support I would not be writing this dissertation. My idolization of my father was the reason I entered into academia over ten years ago at Duke University and he was the one who encouraged me to go back again. He was the first to teach me about academic research, taking the time to help me hand collect mutual fund prices from microfiche for a high school paper. My parents have given me every opportunity in life and have supported my decisions throughout my life. For this I will be forever grateful. Finally, I would like to acknowledge that without the patience, kindness, love, and support of my wife, Leah, I would never have started nor finished this dissertation. She has changed my life (for the better) and always inspires me to do better. She is and will always be everything to me. vi VITA June 22, 1975 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Born - Bowling Green, Ohio 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B.S., Mathematics, Summa Cum Laude, Bowling Green State University. 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Actuarial Assistant-life, Nationwide Fi- nancial Services, Columbus, OH. 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . M.A., Economics, Duke University 2001-2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Analyst, Pension Research Institute, Inc., Chapel Hill, NC. 2002-2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Portfolio Manager, Pension Research Institute, Inc., Chapel Hill, NC. 2005-2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . President, Frontier Asset Management, Inc., Columbus, OH. 2006-2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . University Fellow, The Ohio State Uni- versity 2007-2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Graduate Research Assistant to G. An- drew Karolyi, Department of Finance, The Ohio State University. 2009-2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Graduate Research Assistant to Ren´e M. Stulz, Department of Finance, The Ohio State University. FIELDS OF STUDY Major Field: Business Administration, Finance vii TABLE OF CONTENTS Page Abstract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ii Dedication . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iv Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v Vita . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii List of Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi List of Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii Chapters: 1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2. Geography and the Market for CEOs . . . . . . . . . . . . . . . . . . . . 6 2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 2.2 Economics of the Market for CEOs . . . . . . . . . . . . . . . . . . 13 2.2.1 Demand for CEOs . . . . . . . . . . . . . . . . . . . . . . . 14 2.2.2 Supply of CEOs . . . . . . . . . . . . . . . . . . . . . . . . 19 2.3 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 2.3.1 CEO State of Origin . . . . . . . . . . . . . . . . . . . . . . 22 2.3.2 Firm Headquarters Location . . . . . . . . . . . . . . . . . . 26 2.4 Is the Market for CEOs Geographically Segmented? . . . . . . . . . 27 2.4.1 The Hiring Home Bias . . . . . . . . . . . . . . . . . . . . . 28 2.4.2 Estimation of the Hiring Home Bias . . . . . . . . . . . . . 32 2.4.3 Robustness Checks . . . . . . . . . . . . . . . . . . . . . . . 34 2.5 Why Does Geographic Segmentation Exist? . . . . . . . . . . . . . 41 viii 2.5.1 Univariate Analysis . . . . . . . . . . . . . . . . . . . . . . 42 2.5.2 Predicting Local Hiring Decisions . . . . . . . . . . . . . . . 45 2.6 CEO Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . 53 2.7 CEO Turnover . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 2.8 Firm Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 2.9 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 3. Behavioral Consistency in Corporate Finance: CEO Personal and Corpo- rate Leverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 3.2 Empirical Predictions . . . . . . . . . . . . . . . . . . . . . . . . . 103 3.2.1 Behavioral Consistency . . . . . . . . . . . . . . . . . . . . 103 3.2.2 Hedging . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105 3.3 The Personal Leverage of CEOs in the U.S. . . . . . . . . . . . . . 106 3.3.1 Database Construction . . . . . . . . . . . . . . . . . . . . . 106 3.3.2 Summary Statistics . . . . . . . . . . . . . . . . . . . . . . . 107 3.3.3 Determinants of CEOs’ Personal Leverage . . . . . . . . . . 108 3.4 Are Personal and Corporate Leverage Related? . . . . . . . . . . . 110 3.4.1 Regression Results . . . . . . . . . . . . . . . . . . . . . . . 110 3.4.2 Timing of Home Purchases . . . . . . . . . . . . . . . . . . 113 3.4.3 Economic Magnitude of the Estimated Effect . . . . . . . . 114 3.4.4 Alternative Measures of Personal Leverage . . . . . . . . . . 115 3.4.5 Effects of Other Personal Characteristics . . . . . . . . . . . 116 3.4.6 Robustness Checks . . . . . . . . . . . . . . . . . . . . . . . 121 3.5 Further Evidence and Extensions . . . . . . . . . . . . . . . . . . . 122 3.5.1 CEO Turnover and Changes in Corporate Leverage . . . . . 122 3.5.2 Endogenous Matching of CEOs and Firms . . . . . . . . . . 125 3.5.3 Effects of Corporate Governance . . . . . . . . . . . . . . . 126 3.5.4 Corporate Valuation Effects . . . . . . . . . . . . . . . . . . 128 3.6 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129 4. Do Local Managers Give Labor an Edge? . . . . . . . . . . . . . . . . . . 147 4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147 4.2 Hypothesis & Empirical Methodology . . . . . . . . . . . . . . . . 153 4.3 Sample Construction & Data . . . . . . . . . . . . . . . . . . . . . 156 4.3.1 Sample construction . . . . . . . . . . . . . . . . . . . . . . 156 4.3.2 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159 4.4 Empirical Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . 166 4.4.1 Evidence on Local Managers and Employment . . . . . . . . 166 4.4.2 How Do Local Managers Finance Higher Employment Levels? 179 ix [...]... disentangle to what degree each theory is present in the market for CEOs In order to make the 13 differences in the various theories of the CEO labor market perfectly clear, I outline a general version of the baseline model When explaining alternative theories, I show how each of the theories deviates from this baseline model Table 2.1 lists the theories as well as the general form of the objective functions... geography by focusing on the state in which the CEO “grew up”, or CEO state of origin I obtain these data by combining two facts First, social security numbers are issued by state; the first three numbers are linked to the state of issuance Second, prior to the 1980’s, U.S residents obtained social security numbers during adolescence when applying for their first job Combining these facts, the first three... socially linked to the newly appointed CEO, then the new CEO may be more likely to allow the board members to retain their board seats or to continue a consulting contract with the firm, for example If inside board members tend to be local, then the cronyism theory of CEO demand predicts that firms with lower board independence are more likely to hire locally.7 Like the shirking theory, the cronyism theory... professional situations can, at least in part, predict the corporate financial behavior of the firms they manage 3 In the third essay I revisit the finding in the first essay that over 30% of firms in the S&P 1,500 are run by local managers by asking how this prevalence of local CEOs in large U.S corporations impacts corporate decisions I appeal to an emerging literature in finance on the interaction between managers,... Although all of these theories predict that on average firms should have a local bias when hiring, they make different predictions in regard to the types of firms in which the local hiring bias should be the strongest The theories also differ in their predictions for CEO compensation, turnover, and changes in firm operating performance Later, I use these competing predictions when conducting the empirical... firms within the same industry run by non-locals This number increases to 22 percent when investigating layoffs of 10 percent of the workforce or more, but for large-scale layoffs (20% of the workforce or more) there is no differential effect of local managers, implying that there are limits to the in uence of these managers on corporate decisions The regression estimates imply that following industry downturns... role in the market for CEOs, then the hiring home bias should be indistinguishable from zero For the full sample of hiring decisions this bias is 19.0% Effectively, firms in the sample are over five times more likely to hire a local CEO than would be expected if geography does not play a role in the matching process I find that a significant hiring home bias exists in 30 of the 43 sample states, and in each... requires more effort V is decreasing in the search committee’s effort level, but is increasing with firm value and since the ability of the manager chosen depends on the effort exerted by the search committee and firm value is increasing 17 with managerial ability, there is a tradeoff between maximizing firm value and exerting effort Cronyism Like the shirking theory, the cronyism theory of CEO demand stems from... determine the allocation of top managers to firms, that firms behave remarkably similarly to how their CEOs behave personally in the 1 context of leverage choices, and that CEOs who are more likely to care about their workers implement more labor-friendly corporate policies In the first essay I examine the role of geography in the labor market for CEOs The presumption in the finance literature is that the. .. change in CEO origin from predecessor to successor CEO This change in adjusted operating performance is sizable given that the median firm has unadjusted ROA of 0.137 in the fiscal year prior to the hiring decision Inconsistent with the agency theories, however, I find that this relationship between changes in firm performance and changes in CEO origin is not mitigated by better board incentives Further . Investigating the Human Element in Corporate Policies DISSERTATION Presented in Partial Fulfillment of the Requirements for the Degree Doctor of Philosophy in the Graduate School of The Ohio. to care about their workers implement more labor-friendly corporate policies. In the first essay I examine the role of geography in the labor market for CEOs. The presumption in the finance literature. at least in part, predict the corporate financial behavior of the firms they manage. 3 In the third essay I revisit the finding in the first essay that over 30% of firms in the S&P 1,500 are run