Ronald Masulis

Reputation concerns create strong incentives for independent directors to be viewed externally as capable monitors as well as to retain their most valuable directorships.

In our paper, Reputation Incentives of Independent Directors: Impacts on Board Monitoring and Adverse Corporate Actions, co-author Shawn Mobbs and I extend this literature significantly by examining the effects of differential reputation incentives across firms that arise when a director holds multiple directorships.

Firms having boards composed of a greater portion of independent directors for whom this directorship represents one of their most prestigious are associated with firm actions known to reward directors and are negatively associated with firm actions known to be costly to director reputations.

Specifically, they are associated with a lower likelihood of covenant violations, earnings management, earnings restatements, shareholder class-action suits and dividend reductions. In addition, we also find they are positively associated with stock repurchases and dividend increases.

We also find evidence that these directors are motivated to retain these valuable directorships and thus, they have incentives to not upset a CEO who can exert substantial influence over their renominations to the board.

Firms with boards composed of a greater portion of directors for whom this is one of their most prestigious directorships are associated with CEOs having a greater fraction of equity-based pay as well as higher total pay, which is in part compensation for their higher risk-bearing.

We also report in an earlier study, forthcoming in the Journal of Financial Economics, that the sensitivity of CEO forced turnover to performance is higher for these same firms, which is another source of higher CEO risk-bearing that also necessitates higher CEO pay.

One concern with the greater use of option-based pay and an incentive to build a cordial relationship with the CEO is a greater willingness of the board to allow backdating of option grants to increase CEO compensation in a non-transparent manner.

However, we find that boards with a greater proportion of independent director with greater reputation incentives are less likely to experience “lucky” CEO option grants. This suggests the incentives to please the CEO do not dominate the incentives to be viewed as a careful monitor by the labour market.

Finally, there is evidence that these boards also are more negatively disposed to takeovers and more positively disposed toward CEO empire-building, which both protects and increases the relative prestige of their directorship, raising the reputation benefits of being a director.

Using alternative approaches to extract out firm size effects potentially embedded in our director reputation measures, including a matched sample based on firm size and controlling for the expected size factor in our director reputation measure by using randomising director-board assignments, reduces concerns that firm size is the primary driver of our findings. The results are consistent with directors being more concerned with their reputation at their largest directorships.

In summary, these findings underscore the importance of considering individual reputation concerns. Although directors have an incentive to retain their more prestigious directorships and expand these firms’ empires, the main findings in this study indicate that director reputational concerns dominate directorship retention concerns.

In conclusion, the findings of this study document that reputation-based incentives are important for researchers, firms, and policy-makers to understand.

The full paper is available for download here.

Ronald Masulis is a Scientia Professor of Finance and Macquarie Group Chair of Financial Services at The Australian School of Business. H. Shawn Mobbs is an Assistant Professor of Finance Economics, Finance and Legal Studies at the Culverhouse College of Commerce. A version of this post appeared on the Harvard Law School Forum on Corporate Governance and Financial Regulation.

Dale Boccabella

The newly installed Government has declared that the former Government’s $2,000 deduction cap announcement for self education expenses will be abandoned.

This decision has been widely welcomed, no doubt .

Part of the explanation given was that “there was no credible evidence of substantial abuse of this deduction.” 

The former Government observed that some taxpayers are deriving a significant private benefit from their self-education expenditure, and that the general body of taxpayers should not have to carry this. Travel on first class air fares and taxpayers staying in five star accommodation were expressly mentioned.

Further, the former Government did have some basis for arguing that capping can be justified on the “private benefit” aspect. There has been a steady stream of tax cases involving claims for overseas and interstate travel where the taxpayer attaches leisure to his or her attendance at a relevant conference, study tour, etc.The tax tribunals have been generous when it comes to apportioning expenditure on air travel between the deductible conference attendance and the non-deductible leisure pursuit.

The Government has not stated the basis for the advice it has received that there is no “substantial abuse” of the current rules. In any event, “substantial” seems too high a threshold of tolerance when it comes to assertions of deductions being claimed for private benefits.

Dale Boccabella is an Associate Professor of Taxation Law at the Australian School of Business.

Geoffrey Garrett

The early days of Tony Abbott’s prime ministership are looking a lot like Ronald Reagan’s first year as US president in 1981. First cut taxes. Then hope this not only increases growth and creates jobs but also balances the budget.

Reagan called this supply side economics, replete with Laffer curves on how cutting tax rates can increase tax revenues. Reagan’s critics labeled this voodoo economics that would only blow up the US budget.

Both sides were half right. The American economy climbed out of a very deep recession by the mid 1980s, and Reagan’s tax cuts—along with serious deregulation—can take at least some of the credit.

But public debt and budget deficits ballooned, partly because the projected Laffer windfall never materialised but more importantly because Reagan spent his way to winning the cold war through massive increases in military expenditures.

Australia’s economic and fiscal position today is much stronger than America’s was when Reagan came to power and even if the Coalition increases defence spending, with US support if not insistence, the rise of China isn’t a second cold war.

So Abbott is starting in a much stronger place than Reagan did. The Coalition campaigned on repealing the carbon and mining taxes and cutting company tax. Now Joe Hockey has announced the government will not implement higher taxes proposed by Labor on foreign income, depreciation, self-education expenses and big superannuation payouts. 

The government can reasonably expect its tax cuts and more business-friendly approach overall will stimulate growth and jobs they way Reaganomics did.

But the Coalition no doubt fears that Australian public debt and budget deficits will also follow the dire Reagan path. The problem is that Australia doesn’t have the US’s privileged position in the global financial system that continues to shield it from the kind of pain the markets have inflicted on Europe in recent years.

That is why the government, unlike Reagan, has no choice but to take on the political challenge of cutting spending, with Tony Shepherd’s audit and the likely upcoming mini budget poised to set the stage.

There are three economic reasons focusing on tax cuts first makes sense for the Abbott government.

First, as the investment phase of the mining boom winds down and global commodity prices soften, restoring business confidence to encourage investment is a must do. There is no way to make business feel more confident than to cut their taxes.

Second, unlike 2009 when both China and the US went on unprecedented sprees of massive government spending and monetary loosening, the two biggest drivers of the world economy are now committed to turning off their stimulus boosters. If Australian growth and employment are to pick up, the recovery will have to be domestically led.

Third, with interest rates at all time lows, there is little scope for the Reserve Bank to do more to rev up the Australian economy. Glenn Stephens worries aloud about the high Australian dollar, but he knows cutting interest rates much more would unduly risk inflationary asset bubbles.

So business tax cut-led economic policy fits Australia’s current situation well.

But whereas Reagan went out of his way to explain to the American people what he was doing and why he was doing it, the Abbott government is not erecting billboards saying “we are cutting business taxation and here’s why”.  Indeed, the Abbott government seems hell bent on starving the 24-7 media cycle of oxygen.

The government’s silence when it comes to what is emerging as the major theme of its first term, tax cuts.

Everyone remembers the public debt scaremongering the Coalition used so effectively in opposition to discredit Labor’s post GFC stimulus cum profligacy. Saying a return to surplus can wait was a hard enough sell.

Convincing the electorate that an increase in the deficit through tax cuts that privilege business and the wealthy is much harder. All the more so because average Australians don’t feel like the country is facing an economic crisis, and both sides of politics have gone out of their way to reassure them. This is a world apart from early 80s America with double digit inflation, interest rates and unemployment.

So cutting taxes as quietly as possible and hoping this increases jobs and growth is good politics. But unlike 1980s America, the Coalition’s day of reckoning when it comes to cutting spending must come, and quite soon.

Channeling Reagan is smart for Abbott. But he knows his government won’t be able to get away with the fiscal profligacy that tends to be overlooked in the history of the Reagan revolution.

Geoffrey Garrett is Dean of the Australian School of Business at UNSW. A version of this post appeared in the Australian Financial Review.

Tim Harcourt | The Airport Economist

Now that you’ve got over punting on this year’s Melbourne Cup, have a bit of sympathy for Australian export businesses that have to make their big bets on international markets in the Asian region.

Like a good punter, Australian exporters have to look at the horse, the jockey, the state of the track, and of course, the odds. And it is not just a flutter for them but a major business decision that will affect their livelihood as well as the wellbeing of those whom are dependent on their business as well.

To help the average racegoer understand the nuances of exporting, the following export ‘form guide’ has been produced. 

Horse number one is Great Samurai, representing the Japanese market. It’s a longstanding champion, has been written off by some, but still very capable and strong and has helped others develop in the East Asian stable yards through outward investment. Maybe Abe-nomics will make a difference?

Secondly, there’s New Dynasty, representing China. This dynamic new colt has surprised seasoned punters with his ability to maintain a fast pace, year after year. But can it keep that pace up as it matures?

Thirdly, Passionate Tradition, representing Korea. This little known but powerful galloper with an industrious approach has revealed new appeal to punters in recent years.

Fourthly, there’s Fragrant Harbour, representing Hong Kong. Known for slipstreaming the colt from China but also an attractive performer in her own right.

Fifthly, there’s Little Dragon, representing Taiwan. She is occasionally overshadowed by her new high profile cousin, New Dynasty, but she’s a tidy performer who has rewarded loyal supporters well over many seasons.

Next is The ASEAN Emissary, representing Vietnam. This is the dark horse of the East Asian field that has put together a string of good seasons in recent years and seems set for even better days ahead.

Next is Taj Mahal, representing India, who is an up-and-comer twinned sometimes unfairly with New Dynasty, but is coming into his own thanks to ongoing reform of stable practices. But recent fiscal position may cause a scratching.

Finally there’s Archipelago, representing Indonesia. Had question marks a while ago, but can now start challenging the field and become an up-and-coming favourite amongst Aussie punters with high rates of return.

Racegoers should also consider a few newcomers amongst the emerging markets including Arabian Nights from Abu Dhabi in the United Arab Emirates, Samba Fever from Brazil and even a roughy like Genghis Khan from Mongolia, Burmese Days from Myanmar or Boratnomics from Kazakhstan might be good for a place.

So there you have it, your own export form guide for Asia.

Fortunately, back in the real world, exporting is clearly not all about luck as much as skill and strategy. It requires good research, innovation, flexibility and good knowledge of your prospective market. And most importantly, the evidence shows that it does pay off.

According to economic research, exporters are, on average, faster growing, more profitable and more productive than non-exporters. Exporters also pay better wages; provide better employment conditions and higher quality jobs than non-exporters. In short, exporting is a good bet for both large and small players in the international trade game but you’ve got to be a stayer in the Asian Century.

A shorter version of this blog post was previously published in Smart Company.

Tim Harcourt is the JW Nevile Fellow in Economics and an adjunct professor in International Business Strategy, at the Australian School of Business, the University of New South Wales (UNSW) & author of The Airport Economist:  www.theairporteconomist.com.