Essays on corporate governance and firm performance

Guo, Ran and Banerjee, Shantanu and Dasgupta, Sudipto (2020) Essays on corporate governance and firm performance. PhD thesis, Lancaster University.

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Abstract

This thesis contains two studies that examine the interaction between corporate governance and firm performance. In the first study, I examine whether board friendliness reduces crash risk. I measure friendliness by the Political Homophily Index (PHI), which captures the similarity of political orientations of managers and directors. We find that firms’ crash risk decreases in political homophily. The results are robust when we instrument the change in PHI by the change in local political homogeneity. Our results suggest that better alignment in political orientations facilitates information sharing, including information on bad outcomes in a timely manner. The effect is more pronounced when firms have stronger corporate governance mechanisms and directors have a stronger incentive to acquire information. In the second study, I examine how the use of relative performance evaluation (RPE) affects industry competition. Using data from the U.S. airline industry, we estimate a dynamic game of competition with heterogeneous firms in an oligopolistic market with the presence of RPE contracts. As is standard, RPE makes CEO compensation less sensitive to market conditions. Therefore, the CEO’s propensity to operate in a given market is determined by a trade-off that arises between the reduction in compensation based on market conditions and the gain from being compared to competing agents. The estimation results show that the use of RPE decreases a firm’s tendency to be active under bad market conditions by 10.1%. Conversely, the tendency to be active rises in good market conditions by 12.4%. These effects are stronger for firms with lower fixed operating costs.