Does Managerial Entrenchment Motivate the Insurance Decision?

Transcription

1 Does Managerial Entrenchment Motivate the Insurance Decision? Wei Jiang (Warwick Business School, UK) Joy Jia (University of Bath, UK) Mike Adams (University of Bath, UK) LMU, Munich 3 November,

2 Research Questions Does Managerial Entrenchment motivate Chinese firms to buy (property) insurance? Does Managerial Entrenchment affect the amount of insurance purchased? Do agency costs impact on corporate insurance decisions in China? 2

3 Context (1) - What is Managerial Entrenchment? Arises from the separation of ownership and control between shareholders and managers and is the extent to which managers have the ability and incentives to pursue their self-interests and expropriate wealth from shareholders (Florackis and Ozkan, 2009, p. 498). 3

4 Context (2) - Why Is Managerial Entrenchment Related to Insurance? Insurance is an important strategic device that helps mitigate sub-optimal managerial behaviour, improve corporate governance, and increase firm value (Mayers and Smith 1982; Aunon-Nerin and Ehling 2008; Jia et al. 2011a, 2011b) Four key agency problems mitigated by insurance are: - under-investment - asset substitution - over-investment - crowding out Alternatively Insurance spending could exacerbate rather than mitigate shareholdermanager conflicts in firms - e.g., by facilitating investment in negative NPV ( pet ) projects and/or incurring excessive transaction costs through over-insurance (e.g., see Tufano 1998) 4

5 Context (3) - Why China? The corporate governance role of insurance is particularly important in emerging markets, such as China, that are highly susceptible to acute information asymmetries and environmental hazards such as earthquakes (Zou and Adams 2006, 2008) viz 2008 Sichuan earthquake Insurance is the predominant risk management technique used in China (Zou 2010) Given the current prominence of China as a recipient of FDI the country provides a novel and interesting context to examine whether insurance is effective in mitigating agency problems (costs) in firms a key issue for global investors (Zou et al 2003; Zou et al 2009; Jia et al 2011a) In China, CEOs tend to have considerable discretion over internal control and insurance decisions (Zou et al 2009; Adams et al 2011) good environment to test CEO power effects on governance Additionally, special institutional characteristics (e.g. traditionally lax accounting rules and practices, political connections etc) which might lead to widespread managerial entrenchment problems(liu 2005) 5

6 How is This Study Different from Previous Research? This study focuses on the overall degree of managerial entrenchment, rather than only one aspect of it such as CEO incentives (e.g. Adams et al 2011) or board structure (Borokhovich et al 2004) The research design of using Principal-Components Analysis (PCA) to combine a wide set of corporate governance variables Links agency costs with corporate risk management via insurance 6

7 Previous Literature (1) - Agency Problems, Corporate Governance and Insurance in China The following issues/questions are not clear from previous literature: The influence of independent non-executive directors on managerial entrenchment, agency costs and insurance decisions The impact of board size on the risk management (insurance)-managerial entrenchment relation The effect of CEO/Chairman duality on the insurance-managerial entrenchment relation The effect of managerial ownership on corporate governance The relation between the amount of insurance purchased and the state of corporate governance (i.e., the insurance volume decision is inherently more complicated than the insurance participation decision) Thus, we don t have unambiguous predictions regarding the above 7

8 Previous Literature (2) - Agency Problems, Corporate Governance and Insurance in China Comparatively little attention to analysing the risk management (insurance) incentives resulting from executive bonus plan e.g., - Managers have incentives to take out insurance (e.g., to manage earnings) if capped bonus plans are in place (Han and MacMinn 2006) We predict, all else equal, a positive effect of having a bonus plan on the corporate purchase of property insurance Doherty (2000) argues that senior managers tend to insure their assets when they are rewarded with a flat-rate salary (e.g., to protect job security) We predict, all else equal, a positive relation between the size of the CEO s salary relative to that of other employees and the insurance decision 8

9 Research Design 1 Data/Models: Varied cross-section of 2375 Chinese firms (World Bank Survey, 2004) After adjusting for missing values, firms in the first stage: Probit model (insurance participation) firms in the second stage: Tobit model (insurance volume) 9

10 Research Design 2 Three definitions for Managerial Entrenchment Index from the narrowest to the broadest: 1. Corporate monitoring - six organizational structure variables: the existence (DMANOWN) and the degree (MANOWN) of insider ownership, state-held enterprise dummy (STATE), the existence (DFOROWN) and the extent (FOROWN) of foreign ownership; publicly listed dummy (STOCK) 2. Adds four board-related variables: audit dummy (AUDIT), board size (BSIZE), independent directors (NED), CEO- Chairman separation (SEP) 3. Four additional variables representing the CEO s personal wealth and human capital invested in the firm bonus plan dummy (BONUS), CEO cash compensation (CASH), CEO tenure (TENURE), CEO as a prominent party member (PARTY) Agency Costs are measured by asset turnover (inverse measure of AC- Florakis & Ozkan, 2009) 10

11 Main Results 1 Summary descriptive statistics reveal significant differences between insurance users and non-users with regard to many variables (e.g., users tend to be bigger) The variable for agency costs is skewed The PCA analysis further reveals significant differences between insurance users and non-users with regard to managerial entrenchment e.g. users tend to have greater entrenchment problems ex-ante 11

12 Main Results 2 Agency costs do not impact on the insurance participation and volume decisions. However, higher entrenchment costs raises the incidence of insurance use but not extent of insurance spending. Therefore insurance appears to be ineffective in controlling agency problems/entrenchment in Chinese firms e.g., because of poor contract design or other reasons for insurance use (e.g., prudential signalling) Participation decisions positively influenced by firm size, liquidity & asset intensity, as expected Participation decisions negatively affected by leverage and capital spending could reflect less acute underinvestment problem in China (e.g., due to government control over liquidations) Volume decisions tend to be influenced by size effects, as expected 12

13 Main Conclusions Firms with a higher managerial entrenchment index score are more likely to insure their assets than other entities, independent of the definition for the managerial entrenchment used The index score does not affect the amount of insurance purchased No association between agency costs and insurance decisions Insurance spending appears to influence agency costs (endogeneity effect) - per Tufano (1998) Firm size affects both insurance participation and the amount purchased Other firm-specific factors are important in affecting insurance participation 13