Economic consequences of regulated changes in disclosure:

the case of executive compensation

Kin Lo
Faculty of Commerce and Business Administration
The University of British Columbia
2053 Main Mall, Vancouver, BC, Canada, V6T 1Z2
Ph. (604) 822-8430 Fax (604) 822-9470
Email: kin.lo@commerce.ubc.ca

July 2002

Abstract
The 1992 revision of executive compensation disclosure rules in the U.S. could have benefited
shareholders by inducing corporate governance improvements or harmed them by increasing
disclosure costs. Consistent with the governance improvement hypothesis, companies that
lobbied against the regulation had, relative to control firms: (i) return-on-assets and return-onequity that improved by 0.5% and 3%, respectively; and (ii) excess stock returns of 6% over the
8-month period between the announcement and the adoption of the proposed regulation. Also,
firms lobbying more vigorously against the proposal had more positive abnormal stock returns
during events that increased the probability of regulation.
Key Words: Disclosure, Executive Compensation, Securities Regulation
JEL Classification: D61, G38, K22, M40

This manuscript has improved greatly as a result of comments from an anonymous referee and
Jerry Zimmerman (the editor). I am grateful for the comments and guidance provided by my
dissertation committee, Rachel Hayes, Thomas Lys, Edward Zajac, and especially Robert Magee
(chair). Helpful comments were received from Ron Dye, Tom Fields, Ole-Kristian Hope, Ramu
Thiagarajan, Ross Watts, and workshop participants at the University of British Columbia,
Chinese University of Hong Kong, Hong Kong University of Science and Technology, INSEAD,
London Business School, Northwestern University, University of Oregon, University of
Rochester, and Tulane University. Financial support was received from the Kellogg Graduate
School of Management, the Institute of Chartered Accountants of Alberta, and the Social
Sciences and Humanities Research Council.
Data used in this study may be obtained from the author upon request.

1. Introduction
One central theme in accounting research is the economic consequence of changes in reporting
rules.1 The documented effects validate the theory that stakeholders are affected by regulated
changes in financial reports because contracts rely on those reported numbers. Prior research
examines regulations that affect the recognition of values on accounting statements, such as net
income. In contrast, this study considers a change in regulation that alters disclosures only:
executive compensation disclosures provided to shareholders in the annual proxy statement.2
The Securities and Exchange Commission (SEC) in 1992 adopted regulations aimed at
increasing the quality and quantity of compensation disclosures. The SECs goal (as stated by
the Director of the SECs Division of Corporate Finance, for example) was to encourage
improved corporate governance by increasing the transparency of the amounts and ways in
which executives are remunerated (Quinn, 1995). Thus, the SEC expected the new rules to
increase shareholder value. From a contrary perspective, if the extra disclosures were beneficial
to firms, that information would have been provided without regulation; increasing the regulated
minimum level of disclosure would impose additional costs on companies.
This study takes three complementary approaches to examine whether the change in SEC
rules was beneficial to investors. The first approach uses stock returns surrounding the key
events to gauge the change in shareholder wealth. The second method analyzes the operating
performance of firms that lobbied the SEC in the years surrounding 1992 to determine whether
the new rules affected managers motivation to maximize shareholder value. The third approach

Fields, Lys, and Vincent (2001) provide reviews of related studies.

McGahran (1988) found that new perquisite disclosures were associated with a shift in pay from perquisites to
monetary compensation, but the effect is due to the inclusion of the perquisite in the employees taxable income,
that is, the employees financial statements. Wysocki (1999) examines the informativeness of SFAS 131 segment
disclosures, which does not directly affect recognition, but he does not examine their economic consequences.
2

examines firms lobbying activity in the form of comment letters to the SEC, as a reflection of
corporate executives assessment of the regulations effect on them personally. Overall, the
results are more consistent with the SECs view that additional mandated disclosures enhance
shareholder wealth. However, whether costs to other parties exceed these benefits remains an
open question.

2. Hypothesis Development
Since 1938, the Securities and Exchange Act of 1934 has required registrants to publicly disclose
information on their executives compensation. The revision to these rules in 1992 was the
SECs response to demands for better information on executive compensation.3 On February 13,
1992, Richard Breeden, (then) Chairman of the SEC, announced that more stringent disclosure
rules were on the way. The announcement outlined the major components of the new rules,
including a summary table that includes practically all forms of compensation, a comparison of
pay and stock performance, and an explanation of incentive compensation by the compensation
committee (Salwen, 1992). Following the release of the detailed proposal on June 23, 1992, both
investors and corporate representatives lobbied the SEC aggressively. 4 The Commission adopted
the final rules on October 16, 1992, for implementation five days later. While the final rules
were not identical to the proposal, the major elements of the proposal were adopted. In
particular, all 10 items in the proposal, such as the summary compensation table and
compensation committee report, were adopted with only minor revisions.
The president of the United Shareholders Association, Ralph Whitworth, hailed the new
rules as sweeping reforms [that] pave the way for shareholders to take back their companies

Johnson (1995, 20) notes, The difficulty in correctly ascertaining an executives actual compensation from all
sources had been a common complaint
4
In the executive summary of the final rules, the SEC notes it had received over 900 comment letters.

(Johnson, 1996, 196). This statement reflects the popular belief that poor governance of
executive compensation was widespread, with low quality disclosures contributing to that poor
governance. However, the rules were proposed and adopted at a time of unprecedented political
pressure and could have been the SECs response to that pressure.5 This view suggests that the
rules could have negative effects on shareholders by inducing changes to compensation contracts
that were previously optimal. These two arguments are developed more fully below.
2.1 Governance Improvement Hypothesis
The concern expressed by the public and investor groups over executive pay indicates that there
was a widespread belief that contracts with managers are sub-optimal. The fact that individual
investors and investor groups lobbied aggressively for the adoption of more extensive
compensation disclosures (see footnote 4) suggests that, in their estimation, such disclosures
would improve corporate governance.
The improvement in compensation contracts could be obtained by reducing four sources
of friction between shareholders and managers. First, there are agency costs associated with the
indirect contracting between shareholders and management through the board of directors.
While boards have a fiduciary duty to shareholders, agency theory suggests that a priori boards
will not contract as shareholders themselves would because their incentives differ. Jensen (1993)
argues that boards ineffective discipline of management is a prime contributor to the failure of
internal control systems. While the effects of stock ownership, legal liability, and reputation do
help align the interests of boards with those of shareholders, these are only mitigating factors.
They reduce but do not eliminate the shareholder-board incentive differences, just as such forces

Signs of such political pressure include Senate hearings on Runaway Executive Pay in May 1991, the Corporate
Pay Responsibility Act (H.R. 2522 and S. 1198, not adopted) in June 1991, and Section 162(m) of the Internal
Revenue Code limiting the deductibility of compensation enacted in 1993.

do not by themselves solve the prototypical moral hazard problem between owners and
managers. The requirement for the compensation committee to prepare a report describing the
major performance measures used to reward management could further reduce this incentive
difference by encouraging committee members to more diligently participate in the contracting
process.6 In addition, results from organizational behavior research predict that board members
will behave differently if their actions are public instead of private (e.g., Diekmann, 1997).
Second, there could be asymmetry in the information available to the board and the
manager. It is reasonable to assume that executives have incentives to be informed for purposes
of negotiating their own compensation contracts. They are likely to access compensation
consultants, possibly at no personal cost. In contrast, even though the board could also use
consultants, it has less incentive to do so than the manager since the personal benefits to board
members are much lower. The requirement for a compensation committee report encourages the
compensation committee to reduce the information asymmetry in order to justify compensation
policies to shareholders. For example, the committee is more likely to engage compensation
consultants to become more informed. While it remains possible for compensation committees
to provide boilerplate descriptions in their reports, a cursory examination of recent compensation
committee reports show that they are not just standardized, uninformative statements.
Third, there could be collusion between the compensation committee and management.
Specifically, collusion could result from interlocking relationships between members of the
committee and management. The requirement to disclose interlocking relationships should
discourage such collusion.

As discussed in textbooks on managerial accounting, the benefits of budgeting derive partly from the process
(rather than the budget itself) by stimulating communication and analysis of the business (Zimmerman 2003,
Chapter 6). Similarly, the requirement for a compensation committee report may encourage more careful
consideration of executive pay packages, even if the report itself were not particularly informative.

Fourth, low quality information dissemination to shareholders hinders their ability to

monitor both the board and the manager. In particular, if ownership is diffuse, each shareholder
will find insufficient benefit to offset the high costs of understanding a convoluted proxy
statement. The increased information and standardization make it less costly to collect and to
process the information. Consequently, shareholders are more likely to complain if
compensation practices appear sub-optimal.
The argument that disclosure could mitigate contracting frictions and increase firm value
raises the question of why firms did not voluntarily disclose more. That is, if additional
disclosures signal better incentive contracting, firms could disclose more to distinguish
themselves from inferior types to increase their stock prices. However, several facts show that
firms are reluctant to disclose compensation information. First, a detailed review of 25 randomly
chosen proxy statements issued in 1991 shows that companies did not provide information
beyond that mandated by the SEC. Second, all corporate submissions to the SEC were in favor
of the 1983 relaxation of compensation disclosure rules. In addition, firms rarely disclose any
compensation information in jurisdictions where such disclosures are not required. For example,
Canadian companies generally did not disclose compensation information prior to regulation by
the Ontario Securities Commission in 1993.
There are two reasons why firms do not voluntary disclose compensation beyond that
required by regulation. First, disclosing more may entail additional costs to the firm or the
executives who determine the disclosure policy. If all firms disclosed the same amount of
compensation information, and one firm tries to distinguish itself by disclosing more, that
company may attract the attention of compensation critics or outspoken shareholders. Even
though the companys compensation structure may in fact be superior to those in other

companies, the firm may wish to avoid the political costs associated with additional scrutiny.
Along the same lines, compensation disclosure can be viewed as a collective good, because the
ability to compare different companies enhances the value of those disclosures. However, if
individual firms do not find it in their interests to disclose, a prisoners dilemma equilibrium
would result and no firms would provide the disclosure (Leftwich, 1980).
Second, if the increase in firm value associated with more disclosure does not translate
into higher compensation for managers, they would have no incentive to disclose more. While
equity-based compensation does increase with firm value, the additional disclosure may bring
about changes in the contracts that reduce the managers (utility from) total compensation. If
managers are extracting rents from the existing compensation contract at the expense of
shareholders, they will have no reason to change the status quo to reduce those rents.
The differential implications for managers under these two explanations result in opposite
lobbying positions: in the prisoners dilemma explanation, managers would lobby in support of
the regulation, while they would lobby against increased disclosure in the second scenario. The
data show an overwhelming opposition to the regulation by managers (see section 3.3)
suggesting that the latter explanation is more plausible.
If the governance improvement arguments were valid, we would expect several
consequences from the adoption of more stringent compensation disclosure rules. First, there
would be abnormal stock returns surrounding events that increase the probability of adoption,
particularly for firms in which the executives resisted the new regulation, as investors bid up
stock prices in anticipation of the governance improvements. Similarly, better governance would
lead to compensation contracts that better align the interest of managers and shareholders.
Increased managerial effort would translate into improvements in operating performance (e.g.,

return on book assets and equity). Third, executives who expect to see the most improvement in
governance in their companies and the biggest reductions in rents from their compensation
contracts would be the ones who most vigorously object to the rules. Formally, the first
hypothesis and predictions (in alternative form) are as follows:
H1 GOVERNANCE IMPROVEMENT: The expansion of compensation disclosure
rules resulted in, or were anticipated to lead to, value-increasing governance
improvements.
P1A Stock returns between samples: In the period surrounding events that
increased the regulations probability of adoption, firms that lobbied against the
new compensation disclosure regulation tended to have higher stock returns than
those that did not lobby.
P1B Operating performance: Firms that lobbied against the new compensation
disclosure regulation tended to have returns on assets and equity that were
abnormally low before the regulation change and their performance improved
subsequent to the regulation.
P1C Stock returns within sample of lobbyers: In the period surrounding events
that increased the regulations probability of adoption, within the set of lobbying
firms, those who lobbied most vigorously tended to have higher stock returns.
Note that the hypothesized positive stock price reaction and operating performance changes
derive primarily from improved contracting leading to better alignment of manager and
shareholder interests. The effect of any reduction in compensation expense is secondary in
magnitude, because even 100% of executive pay is only a small proportion of firm value.
2.2 Disclosure Cost Hypothesis
There are several potential sources of costs related to compensation disclosure. One source is
suggested by Jensen and Murphy (1990), who conclude that political costs prevent higher payperformance sensitivities. If the new rules allow less compensation to remain unreported,
companies could be induced to adversely alter their contracts to mitigate additional political
costs from reporting higher compensation.

Firm values could also be reduced if managers and compensation committees become
more concerned about the appearance of the compensation contract rather than about its
efficiency in motivating value-maximizing actions and sharing risk. If managers and
compensation committees want to reduce the amount of shareholder and public scrutiny of
executive pay, they might contract so that pay correlates closely with current year stock returns,
for example, even though those contracts may impose inefficient levels of risk on the manager.
As Sloan (1993) argues, accounting performance measures are used in compensation contracts to
shield executives from market-wide fluctuations. In addition, it may be optimal for a manager to
be (partly) compensated based on operating results that are anticipated in the future due to
actions taken in the current year (Hayes and Schaefer, 2000). While such contracts may be
optimal, boards concerned about investor pressure may not adopt them because current pay
appears not to be closely related to performance.
Value reduction could also result from the release of proprietary information. The
voluntary disclosure literature suggests that firms will voluntarily disclose information as long as
the information increases shareholder value. A necessary condition for a full disclosure
equilibrium is the absence of disclosure costs (Grossman 1981; and Milgrom 1981), in which
case, minimum disclosure regulations are redundant. A partial disclosure equilibrium results if
there are proprietary or nonproprietary costs of disclosure (Verrecchia 1983, Wagenhofer 1990).7
In this case, imposing a minimum disclosure level that is above the endogenously determined
amount would reduce shareholder wealth. In particular, the firm may be required to disclose
proprietary information it would not otherwise reveal, or it could alter its compensation contract
in ways that would prevent that proprietary information from being transmitted through

Partial disclosure equilibriums arising from uncertainty of whether managers have private information (Dye 1985)
is not descriptive here, as shareholders do know that managers do possess compensation information.

compensation and its disclosure. In either case, the actions reduce shareholder wealth. As an
example, disclosing information showing high executive compensation may lead to higher labor
costs if there is an increased probability that unions will be able to negotiate higher wages
(Jensen and Murphy 1990).
A broader view of the disclosure literature suggests another reason that the disclosure
regulation might impose costs on firms. It is conceivable that firms with better compensation
policies would choose to disclose more in order to distinguish themselves from other firms, so
that a separating equilibrium results. The fact that this equilibrium was not observed before the
regulatory change suggests that the costs of disclosure outweighed the benefits of doing so.
In summary, the disclosure cost hypothesis argues that compensation contracts are
already optimal without regulation so expanded mandatory disclosures are possibly detrimental
to the contracting parties. This reasoning leads to Hypothesis 2, again with three predictions:
H2 DISCLOSURE COST HYPOTHESIS :
The expansion of compensation
disclosure rules resulted in, or were anticipated to lead to, value-decreasing
changes in contracts.
P2A Stock returns between samples: In the period surrounding events that
increased the regulations probability of adoption, firms that lobbied against the
new compensation disclosure regulation tended to have lower stock returns than
those that did not lobby.
P2B Operating performance: Firms that lobbied against the new compensation
disclosure regulation tended to have returns on assets and equity that were not
systematically high or low before the regulation change, and their performance
deteriorated subsequent to the regulation.
P2C Stock returns within sample of lobbyers: In the period surrounding events
that increased the regulations probability of adoption, within the set of lobbying
firms, those who lobbied most vigorously tended to have lower stock returns.
Tests of this disclosure cost hypothesis and the governance improvement hypothesis are
described below in Section 4. Before proceeding, the sample is described next.

3. Sample Selection and Descriptive Statistics

Two samples are used in this study: a sample of firms that lobbied the SEC and a control sample
of firms that did not. While free riding is a concern in voting and lobbying settings, the lobbyers
should be, on average, those affected most by the regulation. To the extent that the control
sample includes firms that are substantially affected, but that did not lobby, such
misclassification would tend to reduce the power of the tests to reject the null hypothesis of zero
differences between samples, but should not produce significant results when there are none.
The procedures used to collect these samples are described in Section 3.1, followed by sample
statistics in Section 3.2. Sections 3.3 and 3.4 describe firms lobbying activity.
3.1 Sample Selection
The sample of lobbyers was identified by reviewing the letters commenting on the proposal,
which are in the SEC archives (File S7-16-92). Two hundred and ten firms submitted comments
to the SEC in the period between the proposal date and the close of the comment period, August
31, 1992. In cases where a company submitted more than one letter, the combined information
from all letters for the same firm are considered to be one observation. In addition, bar
associations, accounting firms, the Business Roundtable, the American Society of Corporate
Secretaries, and other similar organizations also submitted letters.8 For firms that made
reference to comments submitted by such organizations, those comments are counted as if the
firm made those comments directly. Of the 210 firms in the comment letter sample, 15 have
missing or insufficient return data in the files of the Center for Research in Security Prices
(CRSP). The remaining sample of 195 firms is used in analyses not requiring a control sample.
For purposes of testing whether the comment letter sample experienced abnormal stock

Incidentally, only half of the Big 6 accounting firms submitted comments on behalf of their clients.

10

returns and operating performance, a matching control sample is required. Recent studies
examine the efficacy of various matching procedures. Barber and Lyon (1996) examine
measures of operating performance such as return on assets and recommend performance-based
matching. However, they also conclude that matching by industry and firm size yield wellspecified and powerful test statistics (360, 396). Kothari and Warner (1997) and Barber and
Lyon (1997) examine the measurement of long-term (>1 year) stock returns. The latter paper
concludes, matching sample firms to control firms of similar size and book-to-market ratios
yield well-specified test statistics (370). Combining these findings, it would be best to construct
a control sample based on industry, size, and book-to-market. However, a reasonable match
along all three dimensions is not feasible. Consequently, this study uses a control sample
matched on industry and size, while book-to-market is included as a control variable in
regressions involving long-term stock returns. Industry is defined using SIC codes and size
using market values of equity (MV). The details of the matching algorithm are as follows:
1. For each comment letter firm i, identify the SIC code.
2. Calculate the size distance (Distance(i,j)) between firm i and every nonlobbyer j with the same four-digit SIC. Distance(i, j) is defined as |ln(MV(i))
ln(MV(j))| = |ln(MV(i) / MV(j))|. Such a definition is insensitive to the
ordering of the comparison.
3. Select the j that minimizes Distance(i,j). Denote this firm as j * .
4. If Distance(i,j * ) ln(4), then firm j * is selected as a match and removed from
the list of potential match firms.
5. If Distance(i,j * ) > ln(4), then no matching firm is identified.
6. Within each SIC group, the algorithm begins with the smallest firm so that the
best overall match obtains in terms of proximity on a dollar basis.
7. Steps 2 to 5 are repeated at the three- then two-digit SIC levels for the
remaining unmatched comment letter firms.9
Of the 195 firms with stock return data, five could not be matched; so 190 firms are used

An alternate matching algorithm could minimize the difference in dollar values. However, this alternative is less
reliable since, for a hypothetical $10 billion firm, a $1 billion firm would be judged to be a closer match than one
worth $20 billion. Common sense suggests that the latter firm is a better match since it is only twice as large as the
test firm, whereas the test firm is 10 times as large as the $1 billion firm.

11

in analyses using the matched-pair design. The 190 control firms are distinct, as sampling is
performed without replacement. Seventy percent of the matches (133 firms) were at the fourdigit SIC level, while 11 and 19 percent (21 and 36 firms) were at the three- and two-digit levels.
Panel A of Table 1 summarizes the results of the sample selection procedures.
3.2 Financial Statistics
Panel B of Table 1 contains the descriptive statistics of the comment letter and control samples.
The statistics show that the matching procedure was successful at matching firm sizes the
median market values of equity do not differ significantly ($2.57 vs. $2.16 billion, Wilcoxon p =
0.21).10 However, other indicators of size show some differences: the comment letter samples
median book values of equity and assets are significantly higher. The $6.95 billion mean equity
market value for the 190 comment letter firms equals a combined market value of $1.32 trillion,
or 38% of the total of all firms in the CRSP database. The control sample comprises another
23%, so the samples in this study cover a majority of the population by market value.
The significant differences in the book value of equity also result in significant
differences in the book-to-market ratio (median 0.61 vs. 0.53). Since Fama and French (1992)
find that book-to-market is an important factor explaining expected returns, returns analysis over
longer horizons need to take this difference into account.
While the firms that submitted comments have insignificantly different after-tax return on
assets on average (median of 3.62% vs. 3.98%, p = 0.10), they have a significantly lower return
on equity (median of 11.15% vs. 13.07%, p = 0.04). Comparisons of the means for these
statistics are consistent with those for the medians.
10

The median is the correct measure of the success of the matching procedure because the distribution of differences
is predictably right skewed, since the matching algorithm minimizes the difference in the log of equity market
values. In other words, the algorithm tries to find two firms that yield a ratio of market values that is closest to

12

3.3 Lobbying Activity

From the comment letters, it is possible to determine the companys position regarding the
SECs proposed rules. The letters generally have a negative tenor, with 160 of 195 firms
explicitly opposing the rules in their entirety. A further 17 firms do not provide an overall
opinion. The remaining 18 firms state support for the proposal. The indicator variable Oppose
takes on a value of one for the 160 firms that clearly stated opposition, and zero for the other 35
firms.11 The low proportion of firms supporting the proposal (9%) suggests that there was an
overwhelming consensus among managers regarding the negative impact of the regulation, and
that the lack of voluntary disclosure is not a result of a prisoners dilemma. Given the small
number of observations in that category, the 18 supporting firms are not analyzed as a separate
sample below, aside from being coded zero in the variable Oppose.12
Objections to the proposal of a more specific nature are classified into eight categories.
Eight (0, 1) indicators identify whether a company voiced a particular objection.

Object1 = 1 if a firm asked the SEC to provide less onerous provisions for smaller firms.

Object2 = 1 if a firm stated that the compliance costs would be too high.

Object3 = 1 if a firm objected to the inclusion of a report from the compensation committee.

Object4 = 1 if a firm said that a dollar value should not be attached to stock option grants.13

Object5 = 1 if a firm disagreed with the disclosure of future stock option values based on
hypothetical rates of appreciation in stock prices.

Object6 = 1 if a firm did not want a graph depicting the performance of the company
compared to a market index and a peer group of companies.

unity, so a ratio of 2/1 is deemed as close a match as a ratio of 1/2.

11
The neutral and supporting firms have been combined in subsequent analyses because of (i) the small number of
observations in each category, and (ii) preliminary comparisons of the stock returns and operating performance
show no significant difference between the two sub-groups.
12
Results in Table 5 through Table 8 are not sensitive to excluding the supporting firms.
13
These comments are intriguing since the proposal explicitly states that there will be no requirement to value stock
options at the grant date. It seems the issue was so important to these firms that they felt compelled to make it
known that option valuation was not acceptable, whether it is for executive stock options or for broader plans.

13

Object7 = 1 if a firm disagreed with the disclosure of options with lowered strike prices.

Object8 = 1 if a firm objected to the disclosure of interlocks in the compensation committee.

These objections were submitted not just by firms explicitly opposed to the proposal, but also by
the 35 firms who were apparently supportive or neutral.
3.4 Statistics on Lobbying Activity
Table 2 contains information pertaining to the content of the comment letters. The main
diagonal in Panel A tabulates the eight specific objections, and the overall stance of the
company. The most common objection was Object3 on the inclusion of compensation
committee reports, with 146 comments whereas the least frequent was Object1 on relief for small
firms, with nine comments. In addition, Panel A shows the number of instances in which each of
two types of objections is observed together. For instance, of the 160 letters opposed to the new
disclosure rules overall, 130 also objected to the inclusion of compensation committee reports.
Hence, conditional on a firm having Oppose = 1, the probability of Object3 is 130/160 = 0.81.
Panel B shows these conditional probabilities. These probabilities show that the comment
variables overlap to a high degree, particularly objections 2, 3, 5, and 6.
Given the high degree of dependence of the various objections, the specificity of the
objections may be artificial. It is possible that firms were not really disagreeing with anything in
particular, but wanted to raise any issue possible to support the position that the proposal should
be rejected in its entirety. Also, from a purely econometric viewpoint, the collinearity of these
variables makes inferences difficult if they are used as explanatory variables at the same time.
To address these issues, factor analysis is relied upon to reduce the number of independent
variables. The input for the analysis are seven variables, Object2 through Object8; Object1 is
not included because the nine firms submitting comments relating to small firm size a priori

14

have very different motivations than the remainder. (Unreported factor analysis shows that
excluding Object1 is indeed warranted.) The estimation is carried out by maximum likelihood.
As Panel A of Table 3 shows, there is one and only one common factor for the seven variables.
This common factor substitutes for the seven objection variables in some of the analyses below.
Another parsimonious way to aggregate the various objections is to compute the sum of
the objections voiced by each company. The variable Nobject is defined as the sum of the seven
indicator variables, Object2 to Object8. As shown in Panel B of Table 3, the variable Nobject is
97% correlated with the common factor. This high correlation suggests that there should be little
difference in substituting Nobject for the common factor.

4. Results
Three sets of results are presented below, which correspond to the three predictions of the
hypotheses. Section 4.1 analyzes the two samples average stock returns and Section 4.2
compares their average operating performance. The cross-sectional relation between stock
returns and lobbying behavior within the lobbying sample are examined in Sections 4.3 and 4.4.
4.1 Stock Returns
Prior research has focused on key events leading up to the adoption of regulations because such
events are hypothesized to have the largest impact on the likelihood of adoption (Leftwich, 1981
and Dechow et al., 1996). This study looks at the following three events in 1992, which were
previously described in Section 2:
Event 1 the announcement by Chairman Breeden on February 13;
Event 2 the release of the proposed rules on June 23; and
Event 3 the adoption of the final rules on October16.
These events are crucial points in the regulatory process and are thus likely to significantly affect
15

investors assessment of whether the SEC will adopt the new regulations. To the extent that
investors had anticipated these events, or news was disseminated outside these three event dates,
the power of the returns tests will be reduced.
Two other events were considered but excluded from analysis because they were judged
to have little potential to affect investors expectations. This determination was made without
looking at returns so as to avoid data-snooping biases. One of these events is a speech by the
SECs Director of Corporate Finance on November 8, 1991. The speech transcript provides no
specifics on the future regulation. Given the overall political environment at the time, such
vague comments are unlikely to have swayed investors. The other event is a speech by an SEC
Commissioner on February 20, 1992, which essentially reiterated the points made by the SEC
Chairman one week earlier in Event 1.
The short windows used to capture the abnormal returns are the three days (1, 0, +1)
centered on each of the three dates identified above, consistent with most event studies.14 A
period of 200 days before Event 1 is used to estimate the market model parameters, using the
CRSP value-weighted index as the market portfolio.15 Abnormal returns are calculated as the
prediction errors from this market model. However, as noted in Section 3.2, the test sample
comprises 38% of the market portfolio, so returns in the test sample will non-trivially affect the
market portfolio. As a result, the market model will tend to understate the magnitude of the
prediction errors, reducing the power of the tests. To mitigate this problem, I also examine raw
returns, which do not adjust for systematic movements in the market.16

14

Sensitivity analyses show that inferences are unchanged with two-day event windows.
No substantive differences result if the estimation period for each event is the 200 days before that event. The
chosen approach avoids the contamination of the estimation period with prior event days.
16
To see how the market model understates the magnitude of abnormal returns in this study, assume a beta of 1 and
that the regulation has a hypothetical impact on test firms of 1%, and no other information is released in the market.
The market return would be increased by 0.38%, so that the average market model adjusted return is 1 0. 38 =
15

16

To address the possibility that a substantial portion or even most of the news relating to
the regulation was released outside these three event dates, I also examine longer term abnormal
returns spanning the period between day 1 of Event 1 and day +1 of Event 3. While this
analysis should capture a much higher portion of any impact of the regulation, it is expected to
have low power since the variance of long-term returns will be high. In addition, the statistical
significance of findings becomes more susceptible to misspecification as the horizon increases
(Barber and Lyon, 1997), so caution is warranted when interpreting the results of this analysis.
While Barber and Lyon suggest using buy-and-hold returns, reported results use cumulative
abnormal returns to be consistent with short-window tests; the effect of using buy-and-hold
returns does not alter inferences.17
With longer accumulation periods, factors affecting expected returns become more
important. To account for the size and book-to-market factors (Fama and French, 1992), I
estimate the following equation for the 380 firms in the two samples:
CARi = a + bDComment, i + cSize i + dBM i + ei ,

(1)

where CAR is abnormal return accumulated from Event 1 1 day to Event 2 +1 day (or Event 3
+1 day), DComment is an indicator equaling 1 if the firm is in the comment sample, Size is the log
of market value, and BM is the book-to-market ratio. In this equation, the coefficient on DComment
is the difference in returns between the samples, after controlling for size and book-to-market.
It is important to note that while this return analysis uses information from the comment
letters, which are not available until after Event 2, the maintained hypothesis is that investors are
able to correctly conjecture, on average, who will or will not lobby based on existing information

0.62%. Also note that other common measures of abnormal returns have the same or even more severe problems.
For example, if size-adjusted returns are used, the predominance of comment letter firms in the largest decile results
in the decile return being largely determined by the test firms.
17
Buy-and-hold returns are the product of firms returns, whereas cumulative abnormal returns use the sum.

17

regarding the companies, their compensation policies, governance, and disclosure policies.
Thus, lobbying activity and investor expectations should be correlated with each other.
Results
Table 4 shows the short-window market-model-excess and raw returns for the two samples. The
statistics generally show that there are no significant unusual price movements in the event
period. While the comment letter sample has significantly positive raw returns of 1.66%, mainly
due to the three days of the final rules adoption (t = 5.95), the control sample showed similar
positive returns, so that the difference between samples is insignificant (t = 0.02). Thus, shortwindow stock return results provide support for neither H1 nor H2. Unreported results show that
inferences are unaffected when bootstrapped p-values or median returns are used.
It appears, however, that the stock market reaction to the regulation is substantially
dispersed over time. Figure 1 and Table 5 show that there are significant between-sample
differences in market-model-excess returns over the eight-month period of the regulations
deliberation. The return difference primarily occurs in the period between Event 1 and Event 2,
with a mean cumulative abnormal return of 5.82% with a significant t-statistic of 2.68.
(Unreported results using the median show similar results.) These cumulative returns increased
modestly to 7.23% by Event 3. Adding controls for firm size and book-to-market in Model 2
reduces these returns by roughly 1% but the differences remain significant.18
Note that the above analysis of returns uses the between-sample differences in marketmodel excess returns. As a result, it controls for the market component of returns, as well as
returns that are related to industry and size. To gain further assurance that the excess returns are
not due to omitted risk factors, Figure 1 also plots the difference in cumulative excess returns

18

The 1% decline in abnormal returns when book-to-market is added to the regression is close to the magnitudes
reported in Table IV of Fama and French (1992).

18

over two other 8-month periods, one ending just before Event 1, and one beginning just after
Event 3. The absence of any discernible patterns in the returns in these surrounding periods
provides additional confidence that the excess returns in the test period is not spurious.
Unreported results also show that these return differences are not a result of differences in
earnings surprises in the period. Nevertheless, one can only have limited confidence in
attributing long-term returns to any particular event. Taken in isolation, the abnormally positive
8-month returns provide only weak evidence in support of H1. However, other findings below
corroborate this result.
4.2 Operating Performance
The analysis of operating performance uses two measures common in the literature: return on
assets and return on equity. Both metrics are used since there is no consensus as to whether preor post-leverage performance is more appropriate. However, the two metrics should yield
consistent inferences given the similarity in the leverage ratios of the two samples (see Table 1).
After-tax return on assets (ROA) is defined as income before extraordinary items
(Compustat item 18) plus after-tax interest (item 15 (1 tax rate)) divided by the average of
assets (item 6) at the beginning and end of the fiscal year. Interest expense is added back
because ROA measures performance independently of leverage. The tax rate is calculated as
income taxes (item 16) divided by pretax income (item 170). Return on equity (ROE) is income
before extraordinary items (item 18) divided by average equity (item 60). Firms with negative
equity are excluded (five per year on average) since ROE is undefined for such observations.
ROA and ROE are known to have unusual distributional characteristics because small
denominators (possibly due to conservative accounting) can yield very large return numbers that
unduly influence the statistics, especially the mean. To mitigate this problem, values of |ROA| or

19

|ROE| exceeding one are winsorized to 1. In addition, to ensure that the results are not driven
by observations with small denominators, the aggregate ROA and ROE is computed for each
sample. Aggregate ROA (ROE) is obtained by dividing the sum of the sample firms before(after-) interest profits by the sum of their assets (equity), as previously defined. While these
aggregate measures avoid the small denominator problem, no test of statistical significance is
possible given that there is only one observation per sample. Nevertheless, the magnitudes of
the differences in operating performance provide indications of economic significance.
Results
Table 6 shows the results of these analyses, which covers the six-year period starting two years
before the event year (1992). The three panels in the table show the ROA and ROE means,
medians, and aggregate statistics, respectively. Using any or all of 1990, 1991, 1992 as
benchmarks, lobbying firms operating performance improved in later years, while there are no
noticeable changes for control firms. For example, Panel B shows that between 1990 and 1995,
the median ROA (ROE) increases by 0.39% (1.75%) for firms in the comment letter sample,
while control firms have a comparatively small decrease of 0.13% (0.66%), for a difference
between samples of 0.52% (2.41%). The change in operating performance is significantly
different between samples (ROA: Wilcoxon Z = 2.63 and ROE: Z = 2.87). The means show
similar changes in performance; however, the standard errors are higher due to the
aforementioned small denominator problem, so statistical significance is lower. On an aggregate
basis, the difference is similar, at about 0.56% for ROA and 3.38% for ROE.
To show that the comparisons of the first and last years are representative of the general
pattern over the six-year period, Figure 2 plots the annual between-sample differences in
operating performance contained in Table 6. Figure 2a plots the mean and median ROA and

20

ROE differences while Figure 2b plots the difference in the aggregate ROA and ROE. Both
charts show that the improvement between the first and last year is not isolated to those two
years. In summary, the evidence on operating performance is consistent with the Governance
Improvement Hypothesis and inconsistent with the Disclosure Cost Hypothesis 19
To better gauge the economic significance of these results, note from Table 1 that at the
end of 1991, lobbying firms combined book assets total $3,088 billion and book equity total
$626 billion. The difference in aggregate performance thus amounts to $17 to 21 billion of
income per year. These estimates of the economic impact of the regulation is in line with the
long-window returns discussed in Section 4.1. Specifically, capitalizing the $17 to 21 billion in
perpetuity at discount rates in the range of 12 20% (the range of historical equity returns)
results in $85 to 175 billion in value added. In comparison, the mean abnormal return of 5 to 7%
from Table 5 applied to the comment samples $1.32 trillion of equity market value (see Table 1)
equals $66 to 92 billion. Thus, notwithstanding the substantial estimation errors in accounting
and stock returns, both measures produce estimates that are of similar magnitudes.
These amounts are clearly economically significant in either percentage or monetary
terms. They may seem even implausibly large considering that the change in regulation affected
only disclosure. However, the governance improvement hypothesis argues that compensation
disclosure is a critical factor for motivating management. Results from prior research show that
(i) effective managers comprise a substantial portion of firm value (Hayes and Schafer, 1999)
and (ii) compensation plays an important role in motivating them (Jensen and Murphy, 1990;
Lys and Vincent, 1995). First, the large sums paid to CEOs and other top-level managers is
prima facie evidence of the crucial role they play in creating value for shareholders. More
19

In long-horizon analyses of stock or book rates of return, survivorship bias is potentially a confounding factor. To
check whether survivorship could drive the results in this section, the analysis was repeated using samples that had

21

specific evidence in Hayes and Schafer suggests that differences in CEO talent are substantive:
when that talent is hired away, the average negative abnormal return is 1.5%. Note that this
amount represents just the difference in the value of the incumbent and the next best alternative
manager, so the total value of managerial talent as a percent of firm value is much higher.
Second, in addition to theoretical predictions that compensation is a primary determinant of
managerial decisions, evidence in Lys and Vincent shows that in the case of AT&Ts acquisition
of NCR, private monetary incentives for managers with a magnitude of around only $100,000,
nevertheless contributed to the pursuit of pooling-of-interest accounting that cost AT&T
shareholders upwards of $500 million. Thus, it is plausible that improved governance over
compensation could have such large economic consequences.
4.3 Cross-sectional Analysis - Association of Stock Returns and Lobbying Activity
This section analyzes the relation between returns and more specific lobbying behavior. The
rationale for these analyses is that one reasonably conjectures that executives who anticipate the
most harm would tend to lobby more vigorously. According to the Governance Improvement
Hypothesis, more lobbying indicates that the rules are anticipated to be more costly to the
manager, but more beneficial for governance and shareholders. On the other hand, if the
Disclosure Cost Hypothesis were true, then more vigorous lobbying would indicate that the
regulations are anticipated to be more harmful to both the executive and the firm.
This cross-sectional analysis is more powerful than the analysis of average returns in
Section 4.1, to the extent that a reliable measure of the degree of objection to the regulation can
be constructed. It is possible that certain managers (especially those in large firms where
research staff is available) may submit comments to the SEC as a matter of course, without fully

complete data through the six-year period. The results are very similar to those reported above.

22

considering the ramifications of the regulation. The 40 objections to option valuation is

consistent with this possibility, since the issue was explicitly excluded from the proposal. Thus,
the submission of a comment letter could be a noisy indicator of executives preferences. A
more detailed analysis of the content of the comment letters could possibly better identify those
who are genuinely affected by the rules.
The first regression model implemented relates abnormal stock returns with the eight
categories of objections, Object1 to Object8, and the overall position of the company, Oppose:
8

Model 1:

ARi = a 0 + a j Object ( j ) i + a9 Oppose i + e i

(2)

j =1

where ARi is the cumulative abnormal return for firm i on the nine days of the three events. As
noted earlier, the variable Common factor from factor analysis sufficiently captures the common
variance in Object2 to Object8, so Model 2 replaces the seven variables with the common factor.
Model 3 uses Nobject in place of Common factor as it is so highly correlated with the common
factor. Formally, these models in equation form are as follows:
Model 2:

ARi = b0 + b1 Object1i + b2 Common factori + b3 Oppose i + ei .

(3)

Model 3:

ARi = c 0 + c1 Object1i +

(4)

c2 Nobject i

+ c3 Oppose i + ei .

Table 7 shows the predicted signs for the coefficients under each of the two hypotheses.
For studies of regulatory change such as this one, event returns are aligned in calendar
time. As a result, cross-sectional correlation of returns creates potentially serious inference
problems (Bernard, 1987). Not accounting for positive correlations will tend to overstate the
significance of the results. Two approaches are used to address this issue. First, the regressions
are also estimated using the method suggested by Sefcik and Thompson (1986), which accounts
for cross-sectional correlation in the errors. These results do not alter the inference qualitatively,
so the simpler OLS results are presented. Second, bootstrapped p-values have been calculated

23

and are presented along with the asymptotic OLS values. Specifically, bootstrapped p-values are
calculated as follows: one-tailed p-values are the proportions of 10,000 repetitions that generated
coefficients greater than the OLS coefficients in the table (less than the OLS coefficient if it is
negative); these fractions are then doubled to obtain two-tailed p-values. Each repetition uses
sample firms ARs from nine random non-event days selected from 1992. This procedure
maintains the cross-sectional correlation structure of firms returns in the non-event period so
that one can assess whether the event returns, which are also cross-correlated, are truly unusual.
Results
The results in Table 7 show that the specific objections are generally positively related to
abnormal returns but are not significant, with one exception. Object1 (comments on an
exemption for small firms) is significantly negative (bootstrapped p = 0.01), indicating that the
rules are anticipated to be harmful to those small firms. The insignificance of Object2 to Object
8 is largely due to multicollinearity of these variables, since Models 2 and 3 show that Common
factor and Nobject are significantly positively related to abnormal returns (bootstrapped p = 0.02
for both variables). This evidence of a positive relationship between abnormal returns and the
degree of objection is consistent with the Governance Improvement Hypothesis. The negative
coefficient on Object1 is consistent with the Disclosure Cost Hypothesis, but it must be
recognized that only nine small firms raised concerns in this area so the conclusion is limited to
such firms.
4.4 Using Stock Returns to Predict Lobbying Behavior in the Cross-section
The analysis in the previous section examines the contemporaneous association of returns with
lobbying activity. It should be noted that all comment letters were submitted after Event 1, and
with few exceptions, after the proposals release in Event 2. A natural question that arises is, can

24

one use stock price movements in response to Event 1 to predict managers lobbying activity that
followed? Hypothesis 1 predicts that firms experiencing the most positive stock price reactions
to the proposed regulation have executives who will then resist the rule change the most, because
anticipated governance improvements will diminish rents being earned by the manager. In
contrast, Hypothesis 2 predicts that more lobbying will follow more negative stock returns.
The regression model used to investigate this issue is as follows:
Nobject i = d 0 + d 1 ARi + d 2 ARMatch,i + d 3 Size i + i

(5)

where ARi is the three-day cumulative abnormal return for firm i during Event 1, ARMatch,i is the
corresponding return for the firm in the control sample that matches firm i, and Sizei is the
natural log of market value at the end of 1991. The latter two variables are used as controls.
ARMatch,i is included to verify that any significant association between lobbying activity and ARi
is not also present for control firms that did not lobby (i.e. to ensure that the result is not spurious
because, for example, lobbying is related to firm characteristics that are correlated with risk
factors or industry specific news). Sizei controls for the fact that large firms tend to lobby more,
because they have the staff and resources to prepare submissions to the SEC.
In addition, since the dependent variable is discrete, a linear regression is possibly
misspecified. To check the robustness of the results, an ordered logit equation is also estimated:
J

Pr( Nobject i J ) = F ( f j + f 8 ARi + f 9 ARMatch,i + f 10 Size i ),

j = 1, ..., 7

j =1

where f 1 , , f 7 are the intercept and cutoff values between the seven categories
F(x) = ex / (1+ex) is the logistic distribution function.
While the analysis in this section is by no means independent of that of the previous section (the
three-day returns here are subsets of the nine-day returns), the interpretation is distinctly different
because the timing of Event 1 precedes any lobbying.

25

(6)

Results
Table 8 contains the results of estimating equations (5) and (6) in Panels A and B, respectively.
Model 1 shows that the abnormal returns during Event 1 does predict the subsequent lobbying
activity in the direction predicted by the Governance Improvement Hypothesis. Firms
experiencing more positive abnormal returns are likely to submit more objections to the SEC
(OLS coefficient on AR = 0.15, t = 4.16, p < 0.001). Model 2 shows that it is unlikely for this
result to be spurious; there are no significant associations between the lobbying intensity with
returns of matching control firms. The inferences using the ordered logit estimation are similar
(coefficient = 0.19, 2 = 17.33, p < 0.001).

5. Discussion and Conclusion

This paper used several complementary approaches to assess the impact of the SECs regulation
of executive compensation disclosure. First, lobbying companies experienced abnormally high
stock returns over the 8-month event period. By itself, this would be only weak evidence for the
Governance Improvement Hypothesis. Corroborating this result is the finding that operating
performance of lobbying firms was on average lower before the regulation, and subsequently
improved to match or exceed that of the control firms. Also, cross-sectional variations in
abnormal returns in events days are positively associated with the extent of lobbying activity.
Finally, one could have used abnormal returns in reaction to the SEC Chairmans announcement
of impending regulation to help predict the extent of companies lobbying efforts; more lobbying
tended to follow higher returns. Taken as a whole, these results are consistent with the
Governance Improvement Hypothesis: investors and managers anticipated that the regulation
would improve corporate governance if implemented. In contrast, there is no evidence for the
Disclosure Cost Hypothesis, with the exception of negative abnormal returns for the nine

26

smallest firms.
In light of these results, it may seem puzzling why the short-window tests did not detect
any differences in the average stock returns between samples. One plausible explanation is that
there were unrelated confounding events that affected the mean. This is a general concern with
event studies with aligned calendar times, as confounding events could either cause spurious
results (which is the more common concern) or make the effect of interest undetectable. In the
same vein, the evidence over longer periods should be interpreted with some caution. In
particular, it is difficult to make strong inferences of cause-and-effect using the long-horizon
returns and changes in operating performance over six years, as other events occurring in the
intervening period could have been responsible for the changes. Nevertheless, these results are
consistent with the results of short-window cross-sectional analyses of returns, with which
stronger inferences can be made because it is less likely for confounding events to generate
cross-sectional variations in returns that coincide with the variation in lobbying.
This study examined a change in regulation that affects disclosures not directly
recognized on the financial statements. This focus departs from existing studies, which have
thus far examined changes in regulations that impact the accounting statements. The evidence
showed that disclosure regulation did have substantive economic consequences for producers
and consumers of that information. Other disclosure regulations such as those concerning
segmented reporting and the use of derivatives could provide fruitful research opportunities.

27

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29

Table 1: Sample selection and financial statistics

Panel A: Construction of comment letter sample and control sample
Total number of firms submitting comments to SEC
Firms not found on CRSP database or have missing returns
Number of comment letter firms in stock return analyses
Observations without matching firms
Number of firms in comment letter sample / control sample

210
15
195
5
190

Number of firms with 4-digit SIC match

Number of firms with 3-digit SIC match
Number of firms with 2-digit SIC match
Total

133
21
36
190

Panel B: Financial statistics (for 1991 fiscal year-end)

n

Mean

Comment letter sample

Total assets ($ millions)
Book value of equity ($ millions)
Market value of equity ($ millions)

190 16,255 **
190 3,294 ***
190 6,953 **

Book-to-market equity
Leverage
Return on assets (%)
Return on equity (%)

190
190
187
187

Control sample
Total assets ($ millions)
Book value of equity ($ millions)
Market value of equity ($ millions)

190
190
190

Book-to-market equity
Leverage
Return on assets (%)
Return on equity (%)

190
190
189
185

S.D.

Lower
Quartile Median

Upper
Quartile

32,689
4,983
11,904

1,608
431
710

5,221 ** 13,326
1,515 ** 4,163
2,572
6,536

0.46
0.18
7.65
20.90

0.44
0.54
0.87
3.57

0.61 *** 0.79

0.65
0.75
3.62
5.75
11.15 *
15.16

8,496
1,638
4,209

16,883
1,860
6,464

792
321
669

3,359
959
2,159

8,656
2,396
5,181

0.57
0.61
4.70
10.61

0.50
0.21
8.91
17.52

0.32
0.49
1.10
5.02

0.53
0.62
3.98
13.07

0.71
0.76
7.53
17.30

0.68 **
0.65
4.35
8.99

Notes for Table 1:

Total assets is Compustat item 6. Book value of equity is item 60. Market value of equity is year-end price (item
199) multiplied by shares outstanding (item 25). Leverage is total liabilities (data181) divided by total assets (item
6). Three control firms with leverage > 1 winsorized to 1. Return on assets (ROA) is income before extraordinary
items (item 18) plus after-tax interest (item 15 x (1 - tax rate)) divided by average assets (item 6). Tax rate is
calculated as income taxes (item 16) divided by pretax income (item 170). Return on equity (ROE) is income before
extraordinary items (item 18) divided by average equity (item 60). Three (one) firms in comment letter (control)
sample with missing lag assets are excluded. A further four observations in the control sample with negative equity
are excluded from ROE calculations. One (two) observations in comment letter (control) sample with ROE < -1
winsorized to -1. *, **, *** denote two-tail significance levels for between sample differences, at the 5%, 1%, and
0.1% level, respectively, using two-sample t-tests (for mean) and two-sample Wilcoxon rank sums test (for median).

30

Table 2: Descriptive statistics on content of comment letters (n = 195)

Object2

Object3

Object4

Object5

Object6

Object7

Object8

Oppose

Object1
Object2
Object3
Object4
Object5
Object6
Object7
Object8
Oppose

Object1

Panel A: Cross-tabulation of objections to proposal

9
3
5
1
2
5
0
0
8

117
94
27
77
71
12
18
112

146
35
96
93
16
20
130

40
30
29
7
9
35

121
73
13
17
102

103
14
19
95

16
6
16

20
20

160

Panel B: Conditional probability of objections given another objection

Object3

Object4

Object5

Object6

Object7

Object8

Oppose

Object1
Object2
Object3
Object4
Object5
Object6
Object7
Object8
Oppose

Object2

Conditioning
Variable

Object1

Conditional Probability of Second Objection

1.00
0.03
0.03
0.03
0.02
0.05
0.00
0.00
0.05

0.33
1.00
0.64
0.68
0.64
0.69
0.75
0.90
0.70

0.56
0.80
1.00
0.88
0.79
0.90
1.00
1.00
0.81

0.11
0.23
0.24
1.00
0.25
0.28
0.44
0.45
0.22

0.22
0.66
0.66
0.75
1.00
0.71
0.81
0.85
0.64

0.56
0.61
0.64
0.73
0.60
1.00
0.88
0.95
0.59

0.00
0.10
0.11
0.18
0.11
0.14
1.00
0.30
0.10

0.00
0.15
0.14
0.23
0.14
0.18
0.38
1.00
0.13

0.89
0.96
0.89
0.88
0.84
0.92
1.00
1.00
1.00

Notes for Table 2:

Diagonal entries in Panel A indicate the total number of each type of objection. Off-diagonal elements indicate the
number of instances in which both types of objections were observed. Panel B should be read across, row by row,
so that each entry in the first row, for example, shows the probability of observing an objection given Object1=1.
Object1 = 1 if a firm asked the SEC to provide less onerous provisions for smaller firms (and 0 otherwise).
Object2 = 1 if a firm stated that the compliance costs would be too high.
Object3 = 1 if a firm objected to the inclusion of a report from the compensation committee.
Object4 = 1 if a firm said that a dollar value should not be attached to stock option grants.
Object5 = 1 if a firm disagreed with the disclosure of future stock option values using hypothetical returns.
Object6 = 1 if a firm did not want a graph depicting the performance of the company.
Object7 = 1 if a firm disagreed with the disclosure of options with lowered strike prices.
Object8 = 1 if a firm objected to the disclosure of interlocks in the compensation committee.
Oppose = 1 if a firm express an overall negative opinion of the proposed regulation

31

Table 3: Results of Maximum Likelihood Factor Analysis

Panel A: Analysis of available factors
Factor
Eigenvalue

1
1.84

2
0.21

3
0.06

4
0.01

Test of H0 : no common factors

Test of H0 : one factor is sufficient

5
0.05

6
0.09

2
107.67
7.38

d.f
21
14

7
0.14
p-value
< 0.01
0.92

Panel B: Factor identification

Simple correlation of factor 1 with Nobject =

8
j =2

Object ( j )

0.97

Notes to Table 3:
This table shows the results of an analysis of common factors for seven variables, Object2 through Object8. The
number of observations is 195.

32

Table 4: Analysis of market reaction to events for comment letter and control samples
Comment Letter
Sample
(n = 190)
# Days

Control Sample
(n = 190)

Difference

Mean

t-stat

Mean

t-stat

Mean

t-stat

Panel A: Market-model-excess returns

Event 1
3
0.36
Event 2
3
0.19
Event 3
3
0.24
All 3 events
9
0.43

1.57
0.78
0.91
0.94

0.33
0.16
0.20
0.40

1.31
0.72
0.70
0.81

0.02
0.03
0.04
0.03

0.07
0.07
0.09
0.04

Panel B: Raw Returns

Event 1
Event 2
Event 3
All 3 events

1.65
0.50
5.95
4.23

0.29
0.13
1.67
1.86

1.16
0.57
5.66
3.75

0.07
0.02
0.01
0.08

0.22
0.05
0.02
0.11

3
3
3
9

0.36
0.12
1.66
1.93

Notes for Table 4:

All returns are shown in percent. The estimation period for the market model is the 200 trading days preceding
Event 1, using value-weighted returns as the market index. Differences are computed as mean of comment letter
sample mean of control sample or population. Inferences are similar with bootstrapped p-values or using median
returns. Event 1 is the announcement by SEC Chairman Breeden on February 13, 1992. Event 2 is the release of
the proposed rules on June 23, 1992. Event 3 is the adoption of the final rules on October 16, 1992.

33

Table 5: Results from regression of long-window cumulative abnormal returns on the decision to
comment
CARi = a + bDComment, i + cSize i + dBM + ei
n = 379

Predicted Signs
H1
H2

Model 1
Coeff
t-stat

Returns accumulated from Event 1 to Event 2 (93 days)

Intercept
none
none
1.95
DComment
+

5.82**
Size
none
none
BM
none
none
R2 and p-value

1.87%

Returns accumulated from Event 1 to Event 3 (174 days)

Intercept
none
none
4.82
DComment
+

7.23*
Size
none
none
BM
none
none
R2 and p-value

1.26%

(1)
Model 2
Coeff
t-stat

1.27
2.68

34.59
4.90*
3.12***
16.26***

5.82
2.36
4.57
6.24

0.01

12.67%

<0.01

2.07
2.19

44.16
6.02
4.02***
16.22***

4.75
1.86
3.77
3.98

0.03

6.94

<0.01

Notes for Table 5:

CARi is the percentage cumulative abnormal return, calculated as the sum of daily excess returns, where the excess
returns are the prediction errors from the market model, which was estimated using data from the 200 trading days
before February 12, 2001, and the value-weighted index from CRSP as the market return. Accumulation periods
begin one day before Event 1 and end one day after Event 2 (Event 3 in Panel B). DComment = 1 if the firm is in the
comment letter sample and zero otherwise, Size is the log of equity market value, and BM is the book-to-market
ratio. One observation is missing from the control sample due to missing returns, resulting in 190 (189)
observations in the comment letter (control) sample, for a total n = 379. * , ** , *** denote two-tail significance at the
5%, 1%, and 0.1% levels.

34

Table 6: Analysis of Operating Performance (returns in %)

ROA

Year

ROE

Comment Control Differ- t- or ZSample Sample ence statistic n1

n2

Comment Control Differ- t- or ZSample Sample ence statistic n1

n2

Panel A: Means of performance ratios and t-statistic

1990
1991
1992
1993
1994
1995

4.79
4.35
4.44
4.67
5.99
6.81

5.93
4.70
5.44
5.51
5.68
5.53

90-95 0.68 0.30

1.14
0.35
1.00
0.84
0.31
1.28

1.50
0.41
1.37
1.19
0.40
1.24

0.98

1.39

184
187
189
184
180
172

188
189
188
188
186
181

168 179

13.01
8.99
11.10
11.51
14.44
15.90

14.27
10.61
13.01
12.98
13.38
14.21

2.73 0.73

1.26
1.62
1.91
1.47
1.06
1.69
3.46*

0.75
0.81
1.21
0.98
0.60
0.92

180
187
189
184
180
171

184
185
184
183
181
177

1.94 164 173

Panel B: Medians of performance ratios and Z-statistic for Wilcoxon rank sum test
1990
1991
1992
1993
1994
1995

4.15
3.62
3.74
3.89
4.38
4.93

4.87
3.98
4.23
4.24
3.97
4.16

90-95 0.39 0.13

0.72**
0.36
0.49
0.35
0.41
0.77

2.82
1.64
1.56
1.39
0.54
1.15

0.52** 2.63

184
187
189
184
180
172

188
189
188
188
186
181

168 179

12.79
11.15
12.33
13.71
14.71
15.18

14.37
13.07
13.12
13.10
14.00
14.33

1.75 0.66

1.58**
1.92*
0.79
0.61
0.71
0.85

2.43
2.03
1.42
0.09
1.13
1.83

2.41** 2.87

180
187
189
184
180
171

184
185
184
183
181
177

164 173

Panel C: Aggregate measures of performance

1990
1991
1992
1993
1994
1995

2.68
1.70
1.93
2.18
3.23
3.45

2.72
2.11
2.40
2.66
2.83
2.93

0.04
0.41
0.47
0.48
0.40
0.52

see 184 188

notes 187 189
below 189 188
184 188
180 186
172 181

12.65
8.18
9.95
12.27
18.38
18.82

13.65
10.70
12.25
14.09
15.52
16.44

1.00
2.52
2.30
1.82
2.86
2.38

see 184 188

notes 187 189
below 189 188
184 188
180 186
172 181

90-95 0.77

0.21

0.56

168 179

6.17

2.79

3.38

168 179

Notes to Table 6:
Return on assets (ROA) is income before extraordinary items (Compustat item 18) plus after-tax interest (item 15
(1-tax rate)) divided by average assets (item 6). Tax rate is calculated as income taxes (item 16) divided by pretax
income (item 170). Return on equity (ROE) is income before extraordinary items (item 18) divided by average
equity (item 60). |ROA| or |ROE| > 1 are winsorized to 1. Firm-years with negative equity have been excluded
from the calculation of firm level ROE, but included for aggregate ROE. Aggregate ROA is the sum of the sample
firms income before extraordinary items plus after-tax interest divided by the sum of average assets. Aggregate
ROE is the sum of income before extraordinary items divided by the sum of average equity. No significance tests
are available for the aggregate measures since these are samples of one. * , ** denote two-tail significance at the 5%
and 1% levels. Note that the means/medians for 90-95 in Panels A and B are calculated on samples where both
the 1990 and 1995 ROA (or ROE) are available, so they do not equal the changes in the means/medians of the
yearly results reported in the table.

35

Table 7: Association of Abnormal Returns with Lobbying Activity (with asymptotic and
bootstrapped p-values below coefficients)
Model 1:

ARi = a 0 + j =1 a j Object ( j ) i + a 9 Oppose i + ei

(2)

Model 2:

ARi = b0 + b1 Object1i + b2 Common factori + b3 Oppose i + ei .

(3)

Model 3:

ARi = c 0 + c1 Object1i + c2 Nobject i + c3 Oppose i + ei .

(4)

Variable
Intercept

Predicted
Signs
H1
H2
none none

Common factor
(for Object2, Object8)
Nobject
(= Object2 + + Object8)
Object1 (Size)

Object2 (Compliance cost)

Object3 (Committee report)

Object4 (Option valuation)

Object5 (Appreciation Rates)

Object6 (Performance Graph)

Object7 (Option Repricing)

Object8 (Committee Interlocks)

Oppose

n = 193

R2 (%)
P-value

Model 1
(Specific
Objections)
0.81
0.46, 0.43

4.13*
0.05, 0.01
0.39
0.66, 0.33
0.95
0.34, 0.14
1.37
0.17, 0.04
0.95
0.25, 0.11
0.82
0.35, 0.08
0.14
0.92, 0.99
1.13
0.41, 0.19
0.16
0.88, 0.91
7.030
0.138, 0.271

Model 2
(Common
Factor)
0.40
0.68, 0.91
1.04*
0.05, 0.02

Model 3
(Sum of
Objections)
1.18
0.23, 0.25

4.39*
0.03, 0.01

0.59*
0.03, 0.02
4.14*
0.04, 0.01

0.14
0.90, 0.80
4.880*
0.024, 0.062

0.304
0.78, 0.62
5.320*
0.016, 0.049

Notes for Table 7:

OLS dependent variable is the percentage market-model excess return, computed daily and accumulated over nine
days. Asymptotic and bootstrapped p -values are respectively presented below coefficients. The White test fails to
reject the assumption of homoscedasticity. From a preliminary regression of Model 3 with 195 observations, two
outliers have been deleted based on |DFFITS| > 3(k/n)1/2 , where k = 4 = the number of parameters (Krasker, Kuh,
and Welsch, 1983). *, ** denote two-tail significance at the 5% and 1% level, respectively. Boots trapped p-values
are calculated as follows: one-tailed p-values are the proportions of 10,000 repetitions that generated coefficients
greater (less) than the positive (negative) coefficient in the table; doubling these fractions results in two-tailed pvalues. Each repetition selects nine random non-event days in 1992 without replacement.

36

Table 8: Prediction of the number of objections using abnormal returns surrounding Event 1
Panel A: OLS estimation
Nobject i = d 0 + d 1 ARi + d 2 ARMatch,i + d 3 Size i + i
Predicted
Signs
Variable
Intercept
AR
ARMatch
Size

H1

H2

Model 1
Estimated
Coefficient
t-statistic

none none
+

none none
none none

1.87***
0.15***

3.64
4.16

0.12

1.90

(n = 187) R2

(5)

Model 2
Estimated
Coefficient
t-statistic
1.93***
0.15***
0.04
0.12

10.86%

3.75
4.24
1.16
1.78
11.51%

Panel B: Ordered Logit estimation

J

Pr( Nobject i J ) = F ( f j + f 8 ARi + f 9 ARMatch,i + f 10 Size i ),

j = 1, ..., 7

(6)

j =1

Predicted
Signs
Variable

H2

H2

Intercepts

none none

AR
ARMatch
Size

none none
none none

Concordant Pairs
(n = 187) Discordant Pairs

Model 1
Estimated
Coefficient
2 statistic

Model 2
Estimated
Coefficient
2 statistic

6.05
to 1.84
0.19***

5.98
to 1.92
0.19***
0.04
0.15*

0.16
to 40.97
17.33

0.16

4.41
55.4%
31.9%

0.29
to 39.94
17.86
0.93
3.89
56.5%
32.2%

Notes for Table 8:

Nobject is the number of objections received from each firm in the comment letter sample, excluding the objection
lobbying for a size exemption (Object1). ARi is the 3-day market-model excess return around Event 1 for firm i in
the comment letter sample. ARMatch,i is the 3-day market-model excess return around Event 1 for the control matched
to firm i. In a preliminary regression of model 2 with 190 observations, 3 outliers have been deleted based on
|DFFITS| > 3(k/n)1/2 , where k = 4 = the number of parameters (Krasker, Kuh, and Welsch., 1983). * , ** , and ***
denote respectively two-tail significance levels of 5%, 1%, and 0.1%.

37

Figure 1: Long-Window Cumulative Market Model Excess Returns

in Pre-Event, Event, and Post-Event Period
- Comment Letter Sample Less Control Sample Returns Average Cumulative Abnormal Return (Percent)

10
Difference in Mean CAR
Difference in Median CAR

Event 3
Oct. 16
Event 2
Jun 23

0
Event 1
Feb. 13
-5

Pre-event Period
-10
7-Jun91

7-Aug91

7-Oct91

7-Dec91

Event Period
7-Feb92

7-Apr92

7-Jun92
Date

38

7-Aug92

Post-event Period
7-Oct92

7-Dec92

7-Feb93

7-Apr93

7-Jun93

Figure 2a: Difference in Average Operating Performance Over Time

- Comment Letter Sample Less Control Sample (Source: Table 6, Panels A and B)
1.5%

3.0%

1.0%

2.0%
Mean ROA

Median ROA

Mean ROE

Median ROE
1.0%

0.0%

0.0%
1990

1991

1992

1993

1994

ROE

ROA

0.5%

1995

-0.5%

-1.0%

-1.0%

-2.0%

-1.5%

-3.0%

Figure 2b: Difference in Aggregate Measures of Performance Over Time

- Comment Letter Sample Less Control Sample (Source: Table 6 Panel C)
0.75%

3.0%

0.50%

2.0%
ROA
ROE
1.0%

0.00%

0.0%
1990

1991

1992

1993

1994

1995

-0.25%

-1.0%

-0.50%

-2.0%

-0.75%

-3.0%

39

ROE

ROA

0.25%