Internal governance mechanisms and their impact on corporate policies and performance : evidence from the London Stock Exchange

The present thesis examines whether important corporate governance characteristics of British boards are related to corporate cash holdings/liquidity, firm performance and stock price crashes. By conducting this research, we examine the informational content for investors and policymakers of two important corporate governance characteristics: i) the number of directorships held by executive directors or directors’ “busyness”; ii) the level of gap in compensation companies pay to their CEO and other executive directors, or CEO “pay slice”. Chapter 2 examines the effect of board busyness on corporate cash holdings. We offer new insights by evaluating two conflicting views regarding the quality of service that busy directors provide to corporate boards and their impact on decision making. One view is that directors who simultaneously serve on multiple boards improve board decision making ability as they have better experience and business connections (reputational effect). The opposite view is that directors with multiple seats are “too busy to mind the business”, which creates serious agency problems and leads into suboptimal corporate decisions (busyness effect). We analyse a large sample of UK listed companies over the 1997 to 2009 period and document evidence supporting a non-linear relationship between our proxy for board busyness and corporate cash holdings. In line with the reputational effect, we find that companies with board members that hold seats in other companies maintain a higher level of cash, net cash and financial slack. This effect is present, however, only at low levels of board busyness. In line with the busyness effect, our findings suggest that as board busyness increases beyond a certain threshold, it negatively affects cash holdings, net cash and financial slack. Chapter 3 examines a relationship between the CEO Pay Slice (CPS) – the fraction of the top five executive directors’ total compensation that is captured by CEO - and firm value in the UK. CPS reflects the relative importance of CEO as well as the extent to which the CEO is able to extract rents . CPS may also alter effectiveness of board performance by influencing cooperation and cohesiveness among its members. Using a large sample of UK-listed companies over the 1997 to 2010 period, we document evidence supporting a negative relationship between CPS and firm value as measured by Tobin’s Q. Our results are consistent with the hypothesis that high CPS is associated with agency problems, and is likely to impact negatively on the executive team’s spirit and motivation. Our results have major implications for the on-going debate on how to reform executive remuneration, and highlight the importance of considering remuneration issues at the board level, supporting the principles of UK Corporate Governance Code (2010). Chapter 4 examines the relationship between corporate governance characteristics and risk of stock price crash in UK firms. We use CEO Pay Slice (CPS) – the fraction of the maximum top-five executives’ total compensation that goes to the CEO, and board ‘busyness’ – the proportion of board level directors who have three or more directorships , to evaluate the effect of these two important aspects of corporate governance on stock price crash risk. The CPS reflects relative importance of the CEO as well as the extent to which the CEO is able to extract rents and expropriate shareholders wealth (expropriation effect). Board busyness may create a serious agency problem because directors are “too busy to mind the business”, allowing for executives’ short-termism and bad news hoarding (busyness effect). Stock price crash risk captures asymmetry in risk, especially downside risk, and is important for investment decisions and risk management (Kim et al., 2014). Using a large sample of UK listed companies over the 1997 to 2010 period, we document evidence supporting a positive relationship between CPS, board busyness and stock price crash risk. In line with the expropriation and busyness effects, we find that companies with high CPS and high levels of board busyness are exposed to higher level of stock price crash risk. The fact that CPS positively impacts on stock price crash risk has a strong implication for the on-going debate on how to reform executive remuneration so that it provides the right incentives to directors. There is also a direct implication for the public debate on limitation of the number of directorships held by executives from our findings, as we argue that board effectiveness depends on the overall level of board business. Chapter 5 concludes this thesis, providing an overview of its contribution and empirical results and outlining their implications.