Corporate governance includes legal, contractual, and market mechanisms that structure decision-making within business corporations. Most attention has focused on corporate governance in large U.S. public corporations with dispersed shareholding. The separation of ownership from control in those corporations creates a unique problem, as shareholders typically have weak individual incentive to monitor managers. Mechanisms that have been developed to address this agency problem include independent directors, fiduciary duty, securities law disclosure, executive compensation, various professional gatekeepers, the market for corporate control, and shareholder activism. In most countries outside the United States, there are few companies with dispersed shareholding. Instead, most companies have a controlling shareholder or group. These companies face a different agency problem, the possibility that controlling shareholders may use their power to gain at the expense of minority shareholders. Enterprise governance refers to mechanisms aimed at related agency problems that occur in closely held companies without publicly traded equity interests. Here too the agency problem typically encountered is the potential conflict between controllers and minority investors, with the added twist that share illiquidity removes an important protection for the minority. Closely held companies have adopted a variety of contractual mechanisms to address these concerns. Other than the important but special cases of venture capital and private equity fund investments, there is less empirical evidence on governance in closely held companies because information is generally much harder to find.
Marius Guenzel and Ulrike Malmendier
One of the fastest-growing areas of finance research is the study of managerial biases and their implications for firm outcomes. Since the mid-2000s, this strand of behavioral corporate finance has provided theoretical and empirical evidence on the influence of biases in the corporate realm, such as overconfidence, experience effects, and the sunk-cost fallacy. The field has been a leading force in dismantling the argument that traditional economic mechanisms—selection, learning, and market discipline—would suffice to uphold the rational-manager paradigm. Instead, the evidence reveals that behavioral forces exert a significant influence at every stage of a chief executive officer’s (CEO’s) career. First, at the appointment stage, selection does not impede the promotion of behavioral managers. Instead, competitive environments oftentimes promote their advancement, even under value-maximizing selection mechanisms. Second, while at the helm of the company, learning opportunities are limited, since many managerial decisions occur at low frequency, and their causal effects are clouded by self-attribution bias and difficult to disentangle from those of concurrent events. Third, at the dismissal stage, market discipline does not ensure the firing of biased decision-makers as board members themselves are subject to biases in their evaluation of CEOs. By documenting how biases affect even the most educated and influential decision-makers, such as CEOs, the field has generated important insights into the hard-wiring of biases. Biases do not simply stem from a lack of education, nor are they restricted to low-ability agents. Instead, biases are significant elements of human decision-making at the highest levels of organizations. An important question for future research is how to limit, in each CEO career phase, the adverse effects of managerial biases. Potential approaches include refining selection mechanisms, designing and implementing corporate repairs, and reshaping corporate governance to account not only for incentive misalignments, but also for biased decision-making.
Luc Renneboog and Cara Vansteenkiste
Despite the aggregate value of M&A market transactions amounting to several trillions dollars on an annual basis, acquiring firms often underperform relative to non-acquiring firms, especially in public takeovers. Although hundreds of academic studies have investigated the deal- and firm-level factors associated with M&A announcement returns, many factors that increase M&A performance in the short run fail to relate to sustained long-run returns. In order to understand value creation in M&As, it is key to identify the firm and deal characteristics that can reliably predict long-run performance. Broadly speaking, long-run underperformance in M&A deals results from poor acquirer governance (reflected by CEO overconfidence and a lack of (institutional) shareholder monitoring) as well as from poor merger execution and integration (as captured by the degree of acquirer-target relatedness in the post-merger integration process). Although many more dimensions affect immediate deal transaction success, their effect on long-run performance is non-existent, or mixed at best.
Charles R. Korsmo
Law and economics has proved a particularly fruitful scholarly approach in the field of mergers and acquisitions. A huge law and economics literature has developed, providing critical insights into merger activity in general and the proper role of corporate and securities law in regulating this activity. Early economic research examined the motivations for merger activity and the antitrust implications of mergers. Later scholarship elucidated the important disciplining effects on management from merger activity and the market for corporate control. If management performs poorly, causing a firm to become undervalued relative to a well-managed firm, the firm becomes vulnerable to a takeover where management will be replaced. This prospect provides a powerful incentive for management to perform well. More recent work has revealed the limitations of market discipline on management actions in the merger context, and the corresponding role of corporate law in protecting stockholders. Because a merger is generally the final interaction between management and the other stakeholders in a firm, the typical constraints and mechanisms of accountability that otherwise constrain managerial opportunism may be rendered ineffective. This work has played a central role in informing modern jurisprudence. It has shaped the application of enhanced judicial scrutiny of management actions in the merger context, as embodied in the landmark Delaware cases Unocal and Revlon. The law and economics literature has also made important contribution to more recent developments in stockholder appraisal. The law and economics tradition has also provided a useful framework for evaluating the dynamics of merger litigation, including stockholder appraisal, and the extent to which such litigation can be made to serve a useful role in corporate governance.
Henrik Cronqvist and Désirée-Jessica Pély
Corporate finance is about understanding the determinants and consequences of the investment and financing policies of corporations. In a standard neoclassical profit maximization framework, rational agents, that is, managers, make corporate finance decisions on behalf of rational principals, that is, shareholders. Over the past two decades, there has been a rapidly growing interest in augmenting standard finance frameworks with novel insights from cognitive psychology, and more recently, social psychology and sociology. This emerging subfield in finance research has been dubbed behavioral corporate finance, which differentiates between rational and behavioral agents and principals. The presence of behavioral shareholders, that is, principals, may lead to market timing and catering behavior by rational managers. Such managers will opportunistically time the market and exploit mispricing by investing capital, issuing securities, or borrowing debt when costs of capital are low and shunning equity, divesting assets, repurchasing securities, and paying back debt when costs of capital are high. Rational managers will also incite mispricing, for example, cater to non-standard preferences of shareholders through earnings management or by transitioning their firms into an in-fashion category to boost the stock’s price. The interaction of behavioral managers, that is, agents, with rational shareholders can also lead to distortions in corporate decision making. For example, managers may perceive fundamental values differently and systematically diverge from optimal decisions. Several personal traits, for example, overconfidence or narcissism, and environmental factors, for example, fatal natural disasters, shape behavioral managers’ preferences and beliefs, short or long term. These factors may bias the value perception by managers and thus lead to inferior decision making. An extension of behavioral corporate finance is social corporate finance, where agents and principals do not make decisions in a vacuum but rather are embedded in a dynamic social environment. Since managers and shareholders take a social position within and across markets, social psychology and sociology can be useful to understand how social traits, states, and activities shape corporate decision making if an individual’s psychology is not directly observable.
Hao Liang and Luc Renneboog
Corporate social responsibility (CSR) refers to the incorporation of environmental, social, and governance (ESG) considerations into corporate management, financial decision-making, and investors’ portfolio decisions. Socially responsible firms are expected to internalize the externalities they create (e.g., pollution) and be accountable to shareholders and other stakeholders (employees, customers, suppliers, local communities, etc.). Rating agencies have developed firm-level measures of ESG performance that are widely used in the literature. However, these ratings show inconsistencies that result from the rating agencies’ preferences, weights of the constituting factors, and rating methodology. CSR also deals with sustainable, responsible, and impact investing. The return implications of investing in the stocks of socially responsible firms include the search for an EGS factor and the performance of SRI funds. SRI funds apply negative screening (exclusion of “sin” industries), positive screening, and activism through engagement or proxy voting. In this context, one wonders whether responsible investors are willing to trade off financial returns with a “moral” dividend (the return given up in exchange for an increase in utility driven by the knowledge that an investment is ethical). Related to the analysis of externalities and the ethical dimension of corporate decisions is the literature on green financing (the financing of environmentally friendly investment projects by means of green bonds) and on how to foster economic decarbonization as climate change affects financial markets and investor behavior.