Firm Risk and Ambiguity: The Role of Management and the Board
by Sebastian Trabert
Date of Examination:2021-07-15
Date of issue:2021-07-27
Advisor:Prof. Dr. Olaf Korn
Referee:Prof. Dr. Olaf Korn
Referee:Prof. Dr. Michael Wolff
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Abstract
English
This dissertation is fundamentally concerned with the question of how management and the board of directors influence the uncertainty—that is, both risk and ambiguity—of a corporation. Interest in this question stems from conflicts of interest between management and shareholders that may be resolved by an efficiently functioning board. These conflicts play a major role with respect to both dimensions of uncertainty. With regard to firm risk, conflicts arise because of different attitudes toward risk between managers and shareholders. It is thus a major concern for the board to ensure an adequate risk management by the firm that enhances risky but value-enhancing decisions, yet prevents excessive risk-taking. With regard to ambiguity, I build on the literature that suggests that likely sources of ambiguity are managerial decisions that exhibit frequent changes. For shareholders, this dimension of uncertainty has a decidedly negative effect: it adversely affects the perceived attractiveness of their investment opportunities. Consequently, a functioning board should reduce ambiguity. The three studies constituting this dissertation address particular topics within this context. Specifically, they focus on the influence of management (Chapter 2) and the board (Chapter 3) on firm risk, as well as the board’s effect on ambiguity (Chapter 4). I will briefly summarize each of the three studies in the following. The first study (Chapter 2) examines the influence of a particular CEO characteristic, namely CEO age, on firm risk using data on sudden CEO deaths. Compared to the empirical approach applied in two recent studies on this relation, conducting difference-in-differences analyses around sudden CEO deaths better addresses endogeneity concerns. Hence, my results allow for a causal interpretation. The two main findings are, first, that CEO age indeed negatively influences firm risk, yet, second, for other reasons than suggested by prior literature. In fact, higher firm risk associated with younger CEOs seems to be driven by the market’s lack of knowledge about their abilities, rather than by the CEOs’ risk-taking behavior. The second study (Chapter 3) focuses on the relation between board size and firm risk. It considers and tests two competing explanations that might explain the negative association between board size and firm risk that has been illustrated by prior studies. Across all firms as well as for complex ones, the evidence favors a monitoring capacity explanation. That is, having more directors and, thus, more expertise on the board appears to improve monitoring so that lower firm risk associated with larger boards indicates a beneficial development for shareholders. For high-growth firms, on the other hand, the evidence points towards the inefficiency explanation. In those firms, communication and coordination problems seem to become severe at lower board sizes already suggesting a detrimental development for the shareholders. The third study (Chapter 4) is the first to analyze the board’s influence on firm-level ambiguity. Using the 2003 NYSE and NASDAQ listing rule changes for our identification strategy, we find that improved board oversight induced by greater board independence can significantly reduce ambiguity for shareholders. Independent directors appear to achieve this through inducing more predictable, less fluctuating policies that are easier for shareholders to understand and to evaluate. Additionally, these reductions appear to be beneficial only for shareholders of firms operating in stable industries. In dynamic ones, independent directors seem to limit the firms’ ability to carry out necessary changes. Overall, this dissertation makes several contributions to the academic literature and offers several opportunities for future research. Moreover, the insights from this dissertation are also of interest for practitioners.
Keywords: Firm Risk; Ambiguity; Board of Directors; Management; Chief Executive Officer; Corporate Policies