CEO option compensation and systemic risk in the banking industry

Jeong-Bon Kim*, University of Waterloo, Canada
Li Li, University of International Business and Economics, China
Mary L. Z. Ma, York University, Canada
Frank M. Song, University of Hong Kong, Hong Kong

Abstract 
We document that CEO risk-taking incentives induced by stock option compensation increase a bank’s contribution to systemic distress risk and systemic crash risk through reacting to common risk exposure of the banking industry. We also find that this relation operates through channels of engagement in non-interest income-generating activities and maturity mismatch associated with short-term debt financing. Further analysis reveals that CEO option-based risk-taking incentives increase investments in innovative financial products that form naturally interconnected networks, which increase systemic risk. Finally, we show that market illiquidity and financial crisis accentuate the relation between CEO risk-taking incentives and systemic risk.

Keywords: Stock option compensation, CEO risk-taking incentives, systemic risk, banking

JEL Codes: G01, G21, G32

Factors inhibiting Japanese firms from zero leverage: financial constraints and bank relationships

Shigeo Takami*, Rissho University, Japan

Abstract 
The objective of our paper is to clarify the factors that inhibit Japanese firms from being unlevered, focusing on the interactions between financial constraints and bank relationships. Through analysis of variance, logistic regressions, and sensitivity analyses, we conclude that financial constraints and bank shareholdings, which inhibit firms from being unlevered, are more powerful than the presence of foreign investors that encourage unleverage. Based on our panel data on 822 Japanese public firms, we find that among developed countries, Japan has the fewest unlevered firms, with less than 5%. Additionally, we observe reciprocal cross stock holdings between unlevered firms and their banks.

Keywords: zero leverage, financial constraints, bank relationships, cross stock holdings

JEL Codes: G31, G32

Do auditor-provided tax services improve the relation between tax-related internal control and book-tax differences?

Der-Fen Huang, National Dong Hwa University, Taiwan
Ming-Lei Chang*, Yuan Ze University, Taiwan

Abstract 
This study investigates whether companies purchasing tax services from auditors can improve the relation between tax-related internal controls and book-tax differences. We employ permanent book-tax differences as a proxy of tax avoidance and temporary book-tax differences as a proxy of earnings management via pre-tax accruals. Our findings show that companies with a higher probability of reporting a material weakness regarding tax-related internal controls have larger permanent and temporary differences (i.e. a higher degree of tax avoidance and earnings management activities); however, companies purchasing auditor-provided tax services can mitigate the positive relation between tax-related internal control weaknesses and permanent differences in the post-SOX period, but no effect on temporary differences.

Keywords: auditor-provided tax services, book-tax differences, internal controls, tax avoidance, earnings management

Changes in the value implications of compensation costs throughout the economic cycle: an examination of high-tech versus low-tech industries

Ilanit Gavious*, Ben-Gurion University of the Negev, Israel
Yaron Lahav, Ben-Gurion University of the Negev, Israel
Meir Russ, University of Wisconsin - Green Bay, USA

Abstract 
This study explores whether and how the value implications of compensation costs change throughout the economic cycle. Given that we are dealing with the human aspect of the intangibles that drive the value created by a company, it is not obvious what impact the ‘boom’ and ‘bust’ phases of the economic cycle will have on investor valuations of this primary component of a company’s investment in human capital (HC). Our results reveal that economic cycles have a substantial immediate impact on the value implications of compensation costs. Specifically, these value implications increase significantly during upticks in the economy and decline in the downturns, in high-tech as well as low-tech firms. Notwithstanding, the value implications of compensation costs are consistently higher for high-tech firms. Furthermore, the changes in value implications for high-tech firms throughout the economic trends are more volatile than those observed for low-tech firms. When differentiating between investors on and outside the exchange, we find consistently stronger value implications of compensation costs for the latter. It seems that throughout the economic cycle more informed and sophisticated investors have a higher assessment of the role of a firm’s investment in HC in value creation. Another important implication of our results is that, in response to economic changes, investors modify their valuations of HC quickly rather than gradually, which is unexpected given the strategic value and complexity of the human aspect of the firm’s intangibles.

Keywords: human capital, compensation cost, economic cycle, economic trends, valuation,

Related-party transactions and financial statement comparability: evidence from South Korea

Myung-Gun Lee, Yeungnam University, South Korea
Minjung Kang, Daejeon University, South Korea
Ho-Young Lee*, Yonsei University, South Korea
Jong Chool Park, Old Dominion University, USA

Abstract 
This study examines the association between related-party transactions (RPTs, hereafter) and comparability of accounting information. We posit that comparability decreases with RPTs where much management discretion is likely to be involved in determining volume and terms. In addition, firms conducting RPTs are more likely to make accounting choices which make their accounting information less comparable to their industry peers to prevent government detection of illegal RPTs. Using a unique data-set on RPTs among firms listed on the Korean stock market, we provide evidence consistent with our prediction. Specifically, by defining three different measures of annual RPTs; (1) size of RPTs, (2) volatility of RPTs, and (3) size of non-cash RPTs, we find that financial statement comparability decreases as RPTs increase for all three measures of RPTs. Additional analyses show that the negative association is more pronounced in abnormal RPTs than the predicted RPTs and less pronounced in operating RPTs than non-operating RPTs.

Keywords: related-party transactions (RPTs), financial statement comparability