Hostname: page-component-848d4c4894-sjtt6 Total loading time: 0 Render date: 2024-06-17T05:13:44.810Z Has data issue: false hasContentIssue false
  • English
  • Français

Trust and Debt Contracting: Evidence From the Backdating Scandal

Published online by Cambridge University Press:  11 April 2022

Veljko Fotak ,
Feng (Jack) Jiang Open the ORCID record for Feng (Jack) Jiang [Opens in a new window] ,
Haekwon Lee  and
Erik Lie
Veljko Fotak
Affiliation:
University at Buffalo School of Management and Università Bocconi Sovereign Investment Lab veljkofo@buffalo.edu
Feng (Jack) Jiang*
Affiliation:
University at Buffalo School of Management
Haekwon Lee
Affiliation:
University of Sydney Business School haekwon.lee@sydney.edu.au
Erik Lie
Affiliation:
University of Iowa Tippie College of Business erik@lie@uiowa.edu
*
fjiang6@buffalo.edu (corresponding author)
Get access Rights & Permissions [Opens in a new window]

Abstract

We study the effect of trust on debt contracting. We find that, after the revelation of option backdating, borrowers that likely backdated their previous option grants pay higher interest rates on loans. This adverse effect is mitigated by CEO replacements. Results are similar for public debt, but only if a third party identified the backdaters. After the backdating revelation, firms that engaged in backdating increase their reliance on public debt, and those without access to the public debt market experience capital constraints.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 58 , Issue 2 , March 2023 , pp. 615 - 646
Copyright
© The Author(s), 2022. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

We thank Gennaro Bernile, Michael Dambra, Xian Gu, Sahn-Wook Huh, Bill Kross, Bill Megginson, Yihui Pan, Kelly Shue, Inho Suk, Xinyuan Tao, Cristian Tiu, Alexander Wagner, Brian Wolfe, and Fei Xie, conference participants at the Financial Management Association (FMA) Annual Meeting, the Australasian Finance and Banking Conference, the Midwest Finance Association (MFA) Annual Meeting, the European Meeting of the FMA, and the UIBE International Conference, and seminar participants at Florida State University, the University of Missouri, Binghamton University (SUNY), and the University at Buffalo for their valuable feedback and comments.

References

Aboody, D., and Kasznik, R.. “CEO Stock Option Awards and the Timing of Corporate Voluntary Disclosures.” Journal of Accounting and Economics, 29 (2000), 73–100.CrossRefGoogle Scholar
Allayannis, G., and Mozumdar, A.. “The Impact of Negative Cash Flow and Influential Observations on Investment-Cash Flow Sensitivity Estimates.” Journal of Banking and Finance, 28 (2004), 901–930.CrossRefGoogle Scholar
Almeida, H.; Campello, M.; and Weisbach, M.. “The Cash Flow Sensitivity of Cash.” Journal of Finance, 59 (2004), 1777–1804.CrossRefGoogle Scholar
Amel-Zadeh, A., and Zhang, Y.. “The Economic Consequences of Financial Restatements: Evidence from the Market for Corporate Control.” Accounting Review, 90 (2015), 1–29.CrossRefGoogle Scholar
Armstrong, C. S., and Larcker, D. F.. “Discussion of ‘The Impact of the Options Backdating Scandal on Shareholders’ and ‘Taxes and the Backdating of Stock Option Exercise Dates’.” Journal of Accounting and Economics, 47 (2009), 50–58.CrossRefGoogle Scholar
Arrow, K. J. “Gifts and Exchanges.” Philosophy and Public Affairs, 1 (1972), 343–362.Google Scholar
Bamber, L. S.; Jiang, X.; and Wang, I. Y.. “What’s My Style? The Influence of Top Managers on Voluntary Corporate Financial Disclosure.” Accounting Review, 85 (2010), 1131–1162.CrossRefGoogle Scholar
Bebchuk, L.; Grinstein, Y.; and Peyer, U.. “Lucky CEOs and Lucky Directors.” Journal of Finance, 65 (2010), 2263–2401.Google Scholar
Ben-David, I.; Franzoni, F.; and Moussawi, R.. “Hedge Fund Stock Trading in the Financial Crisis of 2007–2009.” Review of Financial Studies, 25 (2012), 1–54.CrossRefGoogle Scholar
Benmelech, E., and Frydman, C.. “Military CEOs.” Journal of Financial Economics, 117 (2015), 43–59.CrossRefGoogle Scholar
Berlin, M., and Loeys, J.. “Bond Covenants and Delegated Monitoring.” Journal of Finance, 43 (1988), 397–412.Google Scholar
Bernile, G., and Jarrell, G.. “The Impact of the Options Backdating Scandal on Shareholders.” Journal of Accounting and Economics, 47 (2009), 2–26.CrossRefGoogle Scholar
Bessembinder, H.; Kahle, K. M.; Maxwell, W. F.; and Xu, D.. “Measuring Abnormal Bond Performance.” Review of Financial Studies, 22 (2008), 4219–4258.CrossRefGoogle Scholar
Bharath, S.; Dahiya, S.; Saunders, A.; and Srinivasan, A.. “Lending Relationships and Loan Contract Terms.” Review of Financial Studies, 24 (2011), 1141–1203.CrossRefGoogle Scholar
Bharath, S.; Sunder, J.; and Sunder, S.. “Accounting Quality and Debt Contracting.” Accounting Review, 83 (2008), 1–28.CrossRefGoogle Scholar
Biggerstaff, L.; Cicero, C. D.; and Puckett, A.. “Unethical Culture, Suspect CEOs and Corporate Misbehavior.” Journal of Financial Economics, 117 (2015), 98–121.CrossRefGoogle Scholar
Bizjak, J.; Lemmon, M.; and Whitby, R.. “Option Backdating and Board Interlocks.” Review of Financial Studies, 22 (2009), 4821–4847.CrossRefGoogle Scholar
Bodnaruk, A., and Rossi, M.. “Dual Ownership, Returns, and Voting in Mergers.” Journal of Financial Economics, 120 (2016), 58–80.CrossRefGoogle Scholar
Bolton, P.; Freixas, X.; and Shapiro, J.. “The Credit Ratings Game.” Journal of Finance, 67 (2012), 85–111.CrossRefGoogle Scholar
Boot, A. W. A.; Milbourn, T. T.; and Schmeits, A.. “Credit Ratings as Coordination Mechanisms.” Review of Financial Studies, 19 (2006), 81–118.Google Scholar
Bottazzi, L.; Da Rin, M.; and Hellman, T.. “The Importance of Trust for Investment: Evidence from Venture Capital.” Review of Financial Studies, 29 (2016), 2283–2318.Google Scholar
Boyd, J. H., and Prescott, E. C.. “Financial Intermediary-Coalitions.” Journal of Economic Theory, 38 (1986), 211–232.CrossRefGoogle Scholar
Campbell, T. S., and Kracaw, W. A.. “Information Production, Market Signaling, and the Theory of Financial Intermediation.” Journal of Finance, 35 (1980), 863–882.CrossRefGoogle Scholar
Carow, K.; Heron, R.; Lie, E.; and Neal, R.. “Option Grant Backdating Investigations and Capital Market Discipline.” Journal of Corporate Finance, 15 (2009), 562–672.CrossRefGoogle Scholar
Carver, B. T.; Cline, B. N.; and Hoag, M. L.. “Underperformance of Founder-Led Firms: An Examination of Compensation Contracting Theories during the Executive Stock Options Backdating Scandal.” Journal of Corporate Finance, 23 (2013), 294–310.CrossRefGoogle Scholar
Chakravarthy, J.; deHaan, E.; and Rajgopal, S.. “Reputation Repair After a Serious Restatement.” Accounting Review, 89 (2014), 1329–1363.CrossRefGoogle Scholar
Chauvin, K. W., and Shenoy, C.. “Stock Price Decreases Prior to Executive Stock Option Grants.” Journal of Corporate Finance, 7 (2001), 53–76.CrossRefGoogle Scholar
Chava, S., and Roberts, M.. “How Does Financing Impact Investment? The Role of Debt Covenants.” Journal of Finance, 63 (2008), 2085–2121.CrossRefGoogle Scholar
Chen, P. C. “Banks’ Acquisition of Private Information about Financial Misreporting.” Accounting Review, 91 (2016), 835–857.CrossRefGoogle Scholar
Chung, K. H.; Elder, J.; and Kim, J.. “Corporate Governance and Liquidity.” Journal of Financial and Quantitative Analysis, 45 (2010), 265–291.CrossRefGoogle Scholar
Chung, K. H., and Zhang, H.. “Corporate Governance and Institutional Ownership.” Journal of Financial and Quantitative Analysis, 46 (2011), 247–273.CrossRefGoogle Scholar
Cline, B. N.; Walking, R. A.; and Yore, A. S.. “The Consequences of Managerial Indiscretions: Sex, Lies, and Firm Value.” Journal of Financial Economics, 127 (2018), 389–415.CrossRefGoogle Scholar
Coles, J. L.; Daniel, N. D.; and Naveen, L.. “Managerial Incentives and Risk-Taking.” Journal of Financial Economics, 79 (2006), 431–468.Google Scholar
Collins, D. W.; Gong, G.; and Li, H.. “Corporate Governance and Backdating of Executive Stock Options.” Contemporary Accounting Research, 26 (2009), 403–445.CrossRefGoogle Scholar
Core, J., and Guay, W.. “Estimating the Value of Employee Stock Option Portfolios and Their Sensitivities to Price and Volatility.” Journal of Accounting Research, 40 (2002), 613–630.Google Scholar
Cornaggia, K. R.; Hund, J.; and Nguyen, G.. “Investor Attention and Municipal Bond Returns.” Working Paper, Pennsylvania State University and University of Georgia (2018).Google Scholar
Denis, D. J., and Mihov, V. T.. “The Choice among Bank Debt, Non-bank Private Debt, and Public Debt: Evidence from New Corporate Borrowings.” Journal of Financial Economics, 70 (2003), 3–28.CrossRefGoogle Scholar
Diamond, D. W. “Financial Intermediation and Delegated Monitoring.” Review of Economic Studies, 51 (1984), 393–414.CrossRefGoogle Scholar
Diamond, D. W. “Monitoring and Reputation: The Choice between Bank Loans and Directly Placed Debt.” Journal of Political Economy, 99 (1991), 689–721.CrossRefGoogle Scholar
Duarte, J.; Siegel, S.; and Young, L.. “Trust and Credit: The Role of Appearance in Peer-to-Peer Lending.” Review of Financial Studies, 25 (2012), 2455–2484.CrossRefGoogle Scholar
Engelberg, J.; Gao, P.; and Parsons, C. A.. “Friends with Money.” Journal of Financial Economics, 103 (2012), 169–188.CrossRefGoogle Scholar
Erel, I.; Jang, Y.; and Weisbach, M. S.. “Do Acquisitions Relieve Target Firms’ Financial Constraints?” Journal of Finance, 70 (2015), 289–328.CrossRefGoogle Scholar
Fama, E. F. “What’s Different about Banks?” Journal of Monetary Economics, 15 (1985), 29–39.CrossRefGoogle Scholar
Fazzari, S.; Hubbard, G.; and Petersen, B.. “Financing Constraints and Corporate Investment.” Brookings Papers on Economic Activity, 1 (1988), 141–206.Google Scholar
Forelle, C., and Bandler, J.. “The Perfect Payday.” The Wall Street Journal, available at https://www.wsj.com/articles/SB114265075068802118 (2006).Google Scholar
Gambetta, D. “Can We Trust Trust?” In Trust: Making and Breaking Cooperative Relations, Gambetta, D., ed. New York, NY: Basil Blackwell (1988), 213–237.Google Scholar
Gertner, R., and Scharfstein, D.. “A Theory of Workouts and the Effects of Reorganization Law.” Journal of Finance, 46 (1991), 1189–1222.Google Scholar
Giannetti, M., and Wang, T. Y.. “Corporate Scandals and Household Stock Market Participation.” Journal of Finance, 71 (2016), 2591–2636.CrossRefGoogle Scholar
Gompers, P. A.; Ishii, J. L.; and Metrick, A.. “Corporate Governance and Equity Prices.” Quarterly Journal of Economics, 118 (2003), 107–156.CrossRefGoogle Scholar
Graham, J. R.; Li, S.; and Qiu, J.. “Corporate Misreporting and Bank Loan Contracting.” Journal of Financial Economics, 89 (2008), 44–61.CrossRefGoogle Scholar
Grullon, G.; Kanatas, G.; and Weston, J.. “Religion and Corporate (Mis)behavior.” Working Paper, Rice University (2010).CrossRefGoogle Scholar
Guay, W. “The Sensitivity of CEO Wealth to Equity Risk: An Analysis of the Magnitude and Determinants.” Journal of Financial Economics, 53 (1999), 43–71.CrossRefGoogle Scholar
Guiso, L.; Sapienza, P.; and Zingales, L.. “The Role of Social Capital in Financial Development.” American Economic Review, 94 (2004), 526–556.CrossRefGoogle Scholar
Guiso, L.; Sapienza, P.; and Zingales, L.. “Trusting the Stock Market.” Journal of Finance, 63 (2008), 2557–2600.Google Scholar
Guiso, L.; Sapienza, P.; and Zingales, L.. “Cultural Biases in Economic Exchange.” Quarterly Journal of Economics, 124 (2009), 1095–1131.CrossRefGoogle Scholar
Guiso, L.; Sapienza, P.; and Zingales, L.. “The Value of Corporate Culture.” Journal of Financial Economics, 117 (2015), 60–76.CrossRefGoogle Scholar
Guner, A. B.; Malmendier, U.; and Tate, G.. “Financial Expertise of Directors.” Journal of Financial Economics, 88 (2008), 323–354.Google Scholar
Gurun, U.; Stoffman, N.; and Yonker, S. E.. “Trust Busting: The Effect of Fraud on Investor Behavior.” Review of Financial Studies, 31 (2018), 1341–1376.CrossRefGoogle Scholar
Hambrick, D. “Upper Echelons Theory: An Update.” Academy of Management Review, 32 (2007), 334–343.CrossRefGoogle Scholar
Hambrick, D., and Mason, P.. “Upper Echelons: The Organization as a Reflection of Its Top Managers.” Academy of Management Review, 9 (1984), 193–206.CrossRefGoogle Scholar
Hasan, I.; Hoi, C. K.; Wu, Q.; and Zhang, H.. “Social Capital and Debt Contracting: Evidence from Bank Loans and Public Bonds.” Journal of Financial and Quantitative Analysis, 52 (2017), 1017–1047.CrossRefGoogle Scholar
Heron, R. A., and Lie, E.. “Does Backdating Explain the Stock Price Pattern around Executive Stock Option Grants?” Journal of Financial Economics, 83 (2007), 271–295.CrossRefGoogle Scholar
Heron, R. A., and Lie, E.. “What Fraction of Stock Option Grants to Top Executives Have Been Backdated or Manipulated?” Management Science, 55 (2009), 513–525.CrossRefGoogle Scholar
Hirshleifer, D., and Teoh, S. H.. “Limited Attention, Information Disclosure, and Financial Reporting.” Journal of Accounting and Economics, 36 (2003), 337–386.CrossRefGoogle Scholar
Houston, J., and James, C.. “Bank Information Monopolies and the Mix of Private and Public Debt Claims.” Journal of Finance, 51 (1996), 1863–1889.CrossRefGoogle Scholar
James, C., and Smith, D. C.. “Are Banks Still Special? New Evidence on Their Role in the Corporate Capital-Raising Process.” Journal of Applied Corporate Finance, 13 (2000), 52–63.CrossRefGoogle Scholar
Janney, J. J., and Gove, S.. “Do Executive Departures to Signal the End of a Scandal Create or Reduce Uncertainty? An Examination of Market Reaction in Stock Option Backdating Scandal Events.” Business & Society, 58 (2019), 1209–1233.CrossRefGoogle Scholar
Jenter, D., and Lewellen, K.. “CEO Preferences and Acquisitions.” Journal of Finance, 70 (2015), 2813–2852.CrossRefGoogle Scholar
Karpoff, J. M.; Lee, D. S.; and Martin, G. S.. “The Cost to Firms of Cooking the Books.” Journal of Financial and Quantitative Analysis, 43 (2008), 581–611.CrossRefGoogle Scholar
Khandani, A. E., and Lo, A. W.. “What Happened to the Quants in August 2007? Evidence from Factors and Transactions Data.” Journal of Financial Markets, 14 (2011), 1–46.CrossRefGoogle Scholar
Knack, S., and Keefer, P.. “Does Social Capital have an Economic Payoff? A Cross-Country Investigation.” Quarterly Journal of Economics, 112 (1997), 1251–1288.CrossRefGoogle Scholar
La Porta, R.; Lopez-de-Silanes, F.; Shleifer, A.; and Vishny, R.. “Trust in Large Organizations.” American Economic Review, 87 (1997), 333–338.Google Scholar
Leland, H. E., and Pyle, D. H.. “Informational Asymmetries, Financial Structure, and Financial Intermediation.” Journal of Finance, 32 (1977), 371–387.CrossRefGoogle Scholar
Lewicki, R. J.; McCallister, D. J.; and Bies, R. J.. “Trust and Distrust: New Relationships and Realities.” Academy of Management Review, 23 (1998), 438–458.CrossRefGoogle Scholar
Li, J. “Endogenous Investor Inattention and Price Underreaction to Information.” Working Paper, University of Utah (2018).Google Scholar
Lie, E. “On the Timing of CEO Stock Option Awards.” Management Science, 51 (2005), 802–812.CrossRefGoogle Scholar
Lins, K. V.; Servaes, H.; and Tamayo, A.. “Social Capital, Trust, and Firm Performance: The Value of Corporate Social Responsibility during the Financial Crisis.” Journal of Finance, 72 (2017), 1785–1824.CrossRefGoogle Scholar
Liu, X. “Corruption Culture and Corporate Misconduct.” Journal of Financial Economics, 122 (2016), 307–327.CrossRefGoogle Scholar
Moro, A., and Fink, M.. “Loan Managers’ Trust and Credit Access for SMEs.” Journal of Banking and Finance, 37 (2013), 927–936.CrossRefGoogle Scholar
Pan, Y.; Siegel, S.; and Wang, T. Y.. “The Cultural Origin of Preferences: CEO Cultural Heritage and Corporate Investment.” Working Paper, University of Utah, University of Washington, and University of Minnesota (2016).Google Scholar
Pan, Y.; Wang, T. Y.; and Weisbach, M. S.. “How Management Risk Affects Corporate Debt.” Review of Financial Studies, 31 (2018), 3491–3531.Google Scholar
Park, C. “Monitoring and Structure of Debt Contracts.” Journal of Finance, 5 (2000), 2157–2195.Google Scholar
Pevzner, M.; Xie, F.; and Xin, X.. “When Firms Talk, Do Investors Listen? The Role of Trust in Stock Market Reactions to Corporate Earnings Announcements.” Journal of Financial Economics, 117 (2015), 190–223.Google Scholar
Rajan, R. G. “Insiders and Outsiders: The Choice Between Informed and Arm’s Length Debt.” Journal of Finance, 47 (1992), 1367–1400.CrossRefGoogle Scholar
Sacconi, L., and Antoni, G. D.. Social Capital, Corporate Responsibility, Economic Behaviour and Performance, Sacconi, L. and Antoni, G. D., eds. New York, NY: Palgrave MacMillan (2011).CrossRefGoogle Scholar
Stiglitz, J., and Weiss, A.. “Credit Rationing in Markets with Imperfect Information.” American Economic Review, 71 (1981), 393–410.Google Scholar
Yermack, D. “Good Timing: CEO Stock Option Awards and Company News Announcements.” Journal of Finance, 52 (1997), 449–476.CrossRefGoogle Scholar
Zak, P., and Knack, S.. “Trust and Growth.” Economic Journal, 111 (2001), 295–321.Google Scholar
Supplementary material: PDF

Fotak et al. supplementary material

Online Appendix

Download Fotak et al. supplementary material(PDF)
PDF 198.2 KB