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# 经济代写|计量经济学代写Introduction to Econometrics代考|ECON471 The impact of CEO compensation or board structure on firm value

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## 经济代写|计量经济学代写Introduction to Econometrics代考|The impact of CEO compensation or board structure on firm value

An interesting question in corporate finance is to what extent firm value is affected by characteristics of the firm’s governance (e. g., Gompers et al., 2003), the compensation contract of the Chief Executive Officer (CEO) (e. g., Palia, 2001), or other choices made by the firm. A typical model for this would relate a measure of firm value (often Tobin’s $Q$ or the market-to-book ratio) to the characteristic of interest and a set of control variables. We can write this as
$$\text { firmvalue }{i t}=\beta_1+\beta_2 \text { comp }{i t}+\text { controls }+\alpha_i+u_{i t} \text {, }$$
where $\alpha_i$ captures unobserved time-invariant heterogeneity across firms, and where we have included comp ${ }_{i t}$, a variable describing the compensation contract of the CEO, as our key variable of interest. A particularly interesting characteristic is the pay-toperformance sensitivity, often defined as the change in the dollar value of the executive’s wealth for a one-percentage-point change in stock price (delta, see Coles et al., 2006). Delta can be interpreted as a measure of alignment of incentives of managers with the interests of shareholders. A higher delta means that managers will deliver more effort because they share gains and losses with shareholders. However, the compensation contract of the CEO is not exogenous. Unobservable characteristics of the firm, such a firm culture, are likely to correlate with both firm value and the incentive scheme of the CEO. The inclusion of $\alpha_i$ as a fixed firm effect can control for these unobservable differences, as long as they are time-invariant.

## 经济代写|计量经济学代写Introduction to Econometrics代考|Explaining capital structure choice

Explaining the capital structure of firms is one of the key questions in corporate finance. In their seminal paper, Modigliani and Miller (1958) show that in a frictionless world with efficient capital markets a firm’s capital structure is irrelevant for its value. In reality, however, market imperfections, like taxes and bankruptcy costs, may make firm value depend on capital structure, and it can be argued that firms select optimal target debt ratios on the basis of a trade-off between the costs and benefits of debt. For example, firms would make a trade-off between the tax benefits of debt financing and the costs of financial distress when they have borrowed too much. Alternatively, the pecking order theory (Myers, 1984) argues that, due to asymmetric information, firms adopt a hierarchical order of financing preferences so that internal financing is preferred over external financing. If external financing is needed, firms first seek debt funding. Equity is only issued as a last resort.

Lemmon et al. (2008) specify alternative equations to explain a firm’s leverage ratio, defined as the amount of debt relative to the market or book value of the firm. One of their specifications is given by
$$\text { leverage }{i t}=x{i, t-1}^{\prime} \beta+\mu_t+\alpha_i+u_{i t} \text {, }$$
where leverage ${ }{i t}$ denotes leverage of firm $i$ in year $t$, and $x{i, t-1}$ is a vector of explanatory variables, including $\log$ (sales) and measures profitability and tangibility, observed in the previous year. Further, $\mu_t$ is an overall time effect, and $\alpha_i$ is a firm-specific timeinvariant effect. Because leverage is highly persistent, the firm-specific effects in $\alpha_i$ have the purpose of capturing firm-level heterogeneity. Lemmon et al. (2008) argue that this time-invariant unobserved component of a firm’s leverage ratio is likely to be correlated with the traditional right-hand side variables. Thus, treating $\alpha_i+u_{i t}$ as a random error term, uncorrelated with the regressors, is inappropriate, and tends to lead to biased and inconsistent estimators. Instead, fixed effects or other approaches are required to control for this endogeneity problem. In addition to the presence of $\alpha_i$, there is a year-specific intercept term to capture correlation between different firms’ leverage ratios within the same year. Fama and French (2002) argue that this correlation is important. In addition, serial correlation in $u_{i t}$ may be present. All of these problems have an impact on the question what is the appropriate estimator for (1.4) and what is the appropriate way to calculate correct standard errors. Different authors make different choices here.

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