Hypotheses - Effects of financial performance on incentive mechanisms in corporate governancee

Table: Hypotheses - Effects of financial performance on incentive mechanisms in corporate governance

Click here to see an exhibition on these issues and their relation to other hypotheses in corporate governance.

35) From financial performance to decision system

35A: Poor financial performance should cause changes in board composition because the board is responsible for performance and if the control apparatus works at all this should be expected (Hermalin and Weisbach [1988]).

31) From financial performance to remuneration system

31A: Performance may determine remuneration, if managers are in control of the remuneration system and increase its sensitivity with performance when they expect high performance and decrease it when they expect low performance (Board et al. [1990]).

19) From financial performance to ownership structure

19A: Reward argument: States that firms reward their managers for good past financial performance by giving them equity ownership; therefore, better financial performance causes more management ownership (Kole [1996, page 16]).

19B: Insider-reward argument: Cho [1998, page 115], “Other things being equal, managers may prefer equity compensation when they expect their firm to perform well and, consequently, the value of the firm to increase. As a result, higher levels of insider ownership are expected at firms with high corporate values.”

19C: Insider-investment argument: Owner-managers are insiders who may capitalize on their insights by increasing their ownership when they expect the financial performance to improve and decrease their ownership when they expect the financial performance to deteriorate (Loderer and Martin [1997, page 237]).

19D: Natural selection argument: Any kind of ownership structure is determined by financial performance in the sense that corporations with inefficient ownership structures will fail to survive in the long run. Demsetz [1983], Demsetz and Lehn [1985] and Kole and Lehn [1997] have argued for this kind of ownership structure endogeneity. Note that an implication of this argument is that in the long-run all ownership structures should be expected to perform equally well.

33) From financial performance to capital structure

33A: When a firm under-performs it looses equity and its leverage should go up. The ‘pecking order’ theory by Myers [1984] also suggests a negative relation between financial performance and leverage.

32) From financial performance to competition in the product markets

32A: If a firm experiences above normal performance in a longer period it may end up being a market leader. Conversely, a firm that experiences below normal performance in a longer period will ultimately lose market share (Phillips [1976]).