CEOs’ Decision-making Power and Stock Price Crash Risk: Evidence from Iran

Document Type : Accounting

Authors

• Hamid Zarei ¹
• Mohsen Dahmarde Ghaleno ²
• Hossein JafariJam ¹
• Fatemeh Rakhshani ³

¹ Sistan and Baluchistan University

² Higher Educational Complex of Saravan

³ University of sistan and baluchistan

10.22067/ijaaf.v3i1.79002

Abstract

The aim of the current paper is to examine whether the chief executive officer’s (CEOs’) decision-making power effects stock price crash risk. Using an index that encompasses CEO duality, ownership power and CEO tenure as the sources of CEO power and negative conditional return skewness to measure stock price crash risk, empirical findings sufficiently reveal that there is a significant and reverse relation between CEOs’ decision-making power and stock price crash risk. The results prove that among three determinant of CEOs’ decision-making power, CEO tenure provides the most significant impact on decision-making power. The paper reliably provides sufficient evidence of CEOs’ decision-making power implications and progressively expands the academic literature on stock price crash risk. These findings provide further insights on the importance of CEO power in driving stock price crash risk and emphasize that improving CEOs’ decision-making power mitigates stock price crash risk in the context of Iran as a developing country.

Keywords

• CEO duality
• CEOs’ tenure
• Ownership Power
• stock price crash risk

---

References

Adams, R.B., Almeida, H., and Ferreira, D. (2005). Powerful CEOs and their impact on corporate performance. Review of Financial Studies 18, pp. 1403–1432.

Agrawal, A., & Knoeber, C.R. (1996). Firm performance and mechanisms to control agency problems between managers and shareholders. Journal of Financial Quantitative Analysis, 31(3), pp. 377-397.

Al Mamun, M., Balachandran, B., & Duong, H. N. (2016). Powerful CEOs and Stock Price Crash Risk.

An, H., & Zhang, T. (2013). Stock price synchronicity, crash risk, and institutional investors. Journal of Corporate Finance, 21, pp. 1-15.

Andreou, P. C., Louca, C., and Petrou, A. P. (2016). CEO age and stock price crash risk. Review of Finance, 21 (3), pp. 1287-1325.

Andreou, P. C., Louca, C., and Petrou, A. P. (2016). CEO age and stock price crash risk. Review of Finance, 21 (3), pp. 1287-1325.

Ball, R. (2009). Market and political/regulatory perspectives on the recent accounting scandals. Journal of Accounting Research, 47 (2), pp. 277-323.

Baysinger, B.D., and Butler, H.N. (1985). Corporate governance and the board of directors: Performance effects of changes in board composition. Journal of Law, Economics & Organization, 1 (1), pp. 101-124.

Bebchuk, L. A., and Stole, L. A. (1993). Do short‐term objectives lead to under‐or overinvestment in long‐term projects. The Journal of Finance, 48 (2), pp. 719-729.

Bebchuk, L., Cremers, K.J.M., and Peyer, U.C. (2011) The CEO pay slice. Journal of Financial Economics 102, pp. 199–221.

Berger, R., Dutta, S., Raffel, T., and Samuels, G. (2008). Innovating at the top: how global CEOs drive innovation for growth and profit. Springer.

Bhagat, S., and Black, B.S. (2002). The non-correlation between board independence and longterm firm performance. Journal of Corporation Law, 27, pp. 231–273.

Boyd, B. K. (1995). CEO duality and firm performance: A contingency model. Strategic Management Journal, 16, pp. 301-312.

Brickley, J.A., Coles, J.L., and Terry, R.L. (1994). Outside directors and the adoption of poison pills. Journal of Financial Economics 35, pp. 371–390.

Callen, J. L., & Fang, X. (2013). Institutional investor stability and crash risk: Monitoring versus short-termism?. Journal of Banking & Finance, 37(8), pp. 3047-3063.

Callen, J. L., & Fang, X. (2015). Religion and stock price crash risk. Journal of Financial and Quantitative Analysis, 50 (1-2), 169-195.

Chang, X., Chen, Y., and Zolotoy, L., (2016). Stock liquidity and stock price crash risk. Journal of Financial and Quantitative Analysis, forthcoming.

Chen, J., Hong, H., and Stein, J. C. (2001). Forecasting crashes: Trading volume, past returns, and conditional skewness in stock prices. Journal of financial Economics, 61(3), pp. 345-381.

Chen, X., Zhang, F., and Zhang, S. (2015). CEO Duality and Stock Price Crash Risk: Evidence from China.

Chiu, T. T., Guan, Y., and Kim, J. B. (2018). The effect of risk factor disclosures on the pricing of credit default swaps. Contemporary Accounting Research, 35(4), 2191-2224.

Cotter, J.F., Shivdasani, A. and Zenner, M. (1997). Do independent directors enhance target shareholder wealth during tender offers? Journal of Financial Economics, 43, pp. 195–218.

Dechow, P. M., Sloan, R. G., and Sweeney, A. P. (1995). Detecting earnings management. Accounting review, 193-225.

Dichev, I. D., Graham, J. R., Harvey, C. R., and Rajgopal, S. (2013). Earnings quality: Evidence from the field. Journal of Accounting and Economics, 56(2), pp. 1-33.

Duffee, G. R. (1995). Stock returns and volatility a firm-level analysis. Journal of Financial Economics, 37 (3), pp. 399-420.

Fahlenbrach, R. (2009). Founder-CEOs, investment decisions, and stock market performance. Journal of Financial and Quantitative Analysis, 44, pp. 439–466.

Feizi, K. and Moghaddasi, A. (2005). Application of Decision Support Systems in Managers Decision Making, Improvement Management Studies, 45, pp. 139-162 (In Persian).

Feng, M., Ge, W., Luo, S., & Shevlin, T. (2011). Why do CFOs become involved in material accounting manipulations?. Journal of Accounting and Economics, 51(1), 21-36.

Finkelstein, S. (1992). Power in top management teams: Dimensions, measurement, and

validation. Academy of Management Journal, 35, 505-538.

Finkelstein, S., and D’Aveni, R. A. (1994). CEO duality as a double-edged sword: How boards of directors balance entrenchment avoidance and unity of command. Academy of Management Journal, 37, pp. 1079-1108.

Francis, B., Hasan, I., and Li, L. (2016). Abnormal real operations, real earnings management, and subsequent crashes in stock prices. Review of Quantitative Finance and Accounting, 46(2), pp. 217-260.

French, K. R., and Roll, R. (1986). Stock return variances: The arrival of information and the reaction of traders. Journal of financial economics, 17 (1), pp. 5-26.

Friedman, H. L. (2014). Implications of power: When CEO can pressure the CFO to bias reports. Journal of Accounting and Economics, 58 (1), pp. 117-141.

Gao, W., Li, Q., and Drougas, A. (2017). Ownership Structure and Stock Price Crash Risk: Evidence from China. Journal of Applied Business and Economics, 19 (4), pp. 65-78.

Goyal, P., and Park, C.W. (2002). Board leadership structure and CEO turnover. Journal of Corporate Finance, 8 (1), pp. 49-66.

Graham, J. R., Harvey, C. R., & Rajgopal, S. (2005). The economic implications of corporate financial reporting. Journal of accounting and economics, 40 (1), pp. 3-73.

Graham, J. R., Kim, H., and Leary, M. (2017). CEO power and board dynamics. Working paper, Duke University.

Grinstein, Y., and Hribar, P. (2004). CEO compensation and incentives: Evidence from M&A bonuses. Journal of financial economics, 73 (1), pp. 119-143.

Haider, J., & Fang, H. X. (2018). CEO power, corporate risk taking and role of large shareholders. Journal of Financial Economic Policy, 10(1), 55-72.

Hayward, M., and Hambrick, D. (1997). Explaining the premiums paidfor large acquisitions: Evidence of CEO hubris. Administrative Science Quarterly, 42: pp. 103–127.

Hermalin, B. E., and Weisbach, M. S. (1988). The determinants of board composition. The RAND Journal of Economics, pp. 589-606.

Hermalin, B. E., and Weisbach, M. S. (1998). Endogenously chosen boards of directors and their monitoring of the CEO. American Economic Review, pp. 96-118.

Hermalin, B.E., and Weisbach, M.S. (1991). The effects of board composition and direct incentives on firm performance. Financial Management 20, pp. 101–112.

Hong, H. A., KIM, J. B., and Welker, M. (2017). Divergence of cash flow and voting rights, opacity, and stock price crash risk: International evidence. Journal of Accounting Research, 55 (5), pp. 1167-1212.

Hong, H., & Stein, J. C. (2003). Differences of opinion, short-sales constraints, and market crashes. The Review of Financial Studies, 16 (2), pp. 487-525.

Hu, G., & Wang, Y. (2018). Political connections and stock price crash risk: The role of intermediary information disclosure. China Finance Review International, 8 (2), pp. 140-157.

Hutton, A. P., Marcus, A. J., and Tehranian, H. (2009). Opaque financial reports, R 2, and crash risk. Journal of financial Economics, 94 (1), pp. 67-86.

Jensen, M. C. (1994). Self‐interest, altruism, incentives, and agency theory. Journal of applied corporate finance, 7 (2), pp. 40-45.

Jensen, M.C., and Meckling W.H. (1976). Theory of the firm: managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 2, pp. 305-60.

Jin, L., and Myers, S. C. (2006). R 2 around the world: New theory and new tests. Journal of financial Economics, 79 (2), pp. 257-292.

Kim, J. B., and Zhang, L. (2016). Accounting conservatism and stock price crash risk: Firm‐level evidence. Contemporary Accounting Research, 33 (1), pp. 412-441.

Kim, J. B., Li, Y., and Zhang, L. (2011a). Corporate tax avoidance and stock price crash risk: Firm-level analysis. Journal of Financial Economics, 100(3), 639-662.

Kim, J. B., Li, Y., and Zhang, L. (2011b). CFOs versus CEOs: Equity incentives and crashes. Journal of Financial Economics, 101(3), pp. 713-730.

Kim, J. B., Wang, Z., and Zhang, L. (2016). CEO overconfidence and stock price crash risk. Contemporary Accounting Research, 33 (4), pp. 1720-1749.

Kim, K. H., Al-Shammari, H. A., Kim, B., and Lee, S. H. (2009). CEO duality leadership and corporate diversification behavior. Journal of Business Research, 62 (11), pp. 1173-1180.

Kothari, S. P., Shu, S., and Wysocki, P. D. (2009). Do managers withhold bad news?. Journal of Accounting Research, 47(1), pp. 241-276.

LaFond, R., & Watts, R. L. (2008). The information role of conservatism. The Accounting Review, 83(2), pp. 447-478.

Landier, A., Sauvagnat, J. Sraer, D. and Thesmar, D (2013). Bottom-up corporate governance. Review of Finance 17, pp. 161–201.

Li, B. (2012). CEO turnover and internal control material weaknesses (Doctoral dissertation, The Hong Kong Polytechnic University).

Li, M., Lu, Y., and Phillips, G. (2017). CEOs and the product market: when are powerful CEOs beneficial?.

Liu, Y., and Jiraporn, P. (2010). The effect of CEO power on bond ratings and yields. Journal of Empirical Finance, 17 (4), pp. 744-762.

Mehran, H. (1995). Executive compensation structure, ownership, and firm performance. Journal of Financial Economics 38, pp. 163–184.

Morse, A., Nanda, V., & Seru, A. (2011). Are incentive contracts rigged by powerful CEOs?” Journal of Finance 66, 1779–1821.

Papadakis, V. M. (2006). Do CEOs shape the process of making strategic decisions? Evidence from Greece. Management Decision, 44 (3), pp. 367-394.

Pourghaz, A. and Mohammadi, A. (2011). Investigating the relation between CEO’ Power resources and entrepreneurship characteristics of Employee, Public Management Researches, 4 (12), pp. 111-130 (In Persian).

Qiao, P. H., and Fung, A. (2016). How Does CEO Power Affect Innovation Efficiency?. The Chinese Economy, 49 (4), pp. 231-238.

Quinn, J. B. (1985). Managing innovation: Controlled chaos. Harvard Business Review, 63(3), 73–84.

Robin, A. J., and Zhang, H. (2014). Do industry-specialist auditors influence stock price crash risk?. AUDITING: A Journal of Practice & Theory, 34 (3), pp. 47-79.

Rosenstein, S., and Wyatt, J.G. (1997). Inside directors, board effectiveness, and shareholder wealth. Journal of Financial Economics 44, pp. 229–250.

Ryan, H.E., and Wiggins, R.A. (2004). Who is in whose pocket? Director compensation, board independence, and barriers to effective monitoring. Journal of Financial Economics, 73, pp. 497–524.

Sah, R. K., and J. E. Stiglitz. (1986). The architecture of economic systems: Hierarchies and polyarchies. American Economic Review, 76, pp. 716–27.

Sariol, A. M., & Abebe, M. A. (2017). The influence of CEO power on explorative and exploitative organizational innovation. Journal of Business Research, 73, 38-45.

Sheikh, S. (2018). CEO power, product market competition and firm value. Research in International Business and Finance.

Sheikh, S. (2018). The impact of market competition on the relation between CEO power and firm innovation. Journal of Multinational Financial Management, 44, pp. 36-50.

Simsek, Z. (2007). CEO tenure and organizational performance. Strategic Management Journal, 28, pp. 653-662.

Stein, J. C. (1989). Efficient capital markets, inefficient firms: A model of myopic corporate behavior. The Quarterly Journal of Economics, 104 (4), pp. 655-669.

Tang, J., Crossan, M., and Rowe, W.G. (2011). Dominant CEO, deviant strategy, and extreme performance: The moderating role of a powerful board. Journal of Management Studies, 48, pp. 1479–1503.

Villalonga, B., and Amit, R. (2006). How do family ownership, control and management affect firm value? Journal of Financial Economics, 80 (2), pp. 385-417.

Walls, J. L., & Berrone, P. (2017). The power of one to make a difference: How informal and formal CEO power affect environmental sustainability. Journal of Business Ethics, 145 (2), pp. 293-308.

Weisbach, M.S. (1988). Outside directors and CEO turnover. Journal of Financial Economics, 20, pp. 431–460.

Yermack, D. (1996). Higher market valuation of companies with a small board of directors. Journal of Financial Economics 40, pp. 185–211.

Yeung, W. H., and Lento, C. (2018). Stock price crash risk and unexpected earnings thresholds. Managerial Finance, 44 (8), pp. 1012-1030.