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Cash-rich firms are more likely than other firms to attempt acquisitions. Stock return evidence shows that acquisitions by cash-rich firms are value decreasing. Cash-rich bidders destroy seven cents in value for every excess dollar of cash reserves held. Cash-rich firms are more likely to make diversifying acquisitions and their targets are less likely to attract other bidders. Consistent with the stock return evidence, mergers in which the bidder is cash-rich are followed by abnormal declines in operating performance. Overall, the evidence supports the agency costs of free cash f low explanation for acquisitions by cash-rich firms.

We explore how compensation policies following mergers affect a CEO's incentives to pursue a merger. We find that even in mergers where bidding shareholders are worse off, bidding CEOs are better off three quarters of the time. Following a merger, a CEO's pay and overall wealth become insensitive to negative stock performance, but a CEO's wealth rises in step with positive stock performance. Corporate governance matters; bidding firms with stronger boards retain the sensitivity of their CEOs' compensation to poor performance following the merger. In comparison, we find that CEOs are not rewarded for undertaking major capital expenditures. Copyright 2007 by The American Finance Association.

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Building on two sources of exogenous shocks to analyst coverage-broker closures and mergers, we explore the causal effects of analyst coverage on mitigating managerial expropriation of outside shareholders. We find that as a firm experiences an exogenous decrease in analyst coverage, shareholders value internal cash holdings less, its CEO receives higher excess compensation, its management is more likely to make value-destroying acquisitions, and its managers are more likely to engage in earnings management activities. Importantly, we find that most of these effects are mainly driven by the firms with smaller initial analyst coverage and less product market competition. We further find that after exogenous brokerage exits, a CEO's total and excess compensation become less sensitive to firm performance in firms with low initial analyst coverage. These findings are consistent with the monitoring hypothesis, specifically that financial analysts play an important governance role in scrutinizing management behavior, and the market is pricing an increase in expected agency problems after the loss in analyst coverage.