Journal of Corporate Finance

Published by Elsevier
Print ISSN: 0929-1199
From 1989 through 1993, the United Shareholders Association (USA) published its Shareholder 1000 report, which ranked 1000 firms on several dimensions of corporate performance, including shareholder rights and management compensation. We examine two measures reported by the USA of the alignment between managers' and shareholders' interests: a shareholder rights score and a management compensation rating. The associations between these measures and measures of operating performance and investment levels are analyzed. We find evidence that the USA shareholder rights and management compensation scores are significantly and positively associated with measures of operating performance and investment spending. Further tests indicate that USA management compensation scores proxy for aspects of corporate behavior that have significant valuation implications not reflected in financial statements.
This paper analyzes whether judges' actions within Chapter 11 bankruptcy affect debtor firms' ability to reorganize (e.g., debt restructurings and mergers) as opposed to being liquidated in Chapter 7 bankruptcy. Our main finding is that debtor firms' control of the process, e.g., the exclusivity period, affects their ability to restructure debt. A reduction in the exclusivity period decreases the likelihood of reorganization, but increases the likelihood of deviation from absolute priority when plans of reorganization are agreed upon. An extension of the exclusivity period, however, does not increase the likelihood of either reorganization or deviation from absolute priority.
We examine the risk-return characteristics of a rolling portfolio investment strategy where more than six thousand Nasdaq initial public offering (IPO) stocks are bought and held for up to five years. The average long-run portfolio return is low, but IPO stocks appear as ‘longshots’, as five-year buy-and-hold returns of 1000% or more are somewhat more frequent than for non-issuing Nasdaq firms matched on size and book-to-market ratio. The typical IPO firm is of average Nasdaq market capitalization but has relatively low book-to-market ratio. We also show that IPO firms exhibit relatively high stock turnover and low leverage, which may lower systematic risk exposures. To examine this possibility, we launch an easily constructed ‘low minus high’ (LMH) stock turnover portfolio as a liquidity risk factor. The LMH factor produces significant betas for broad-based stock portfolios, as well as for our IPO portfolio and a comparison portfolio of seasoned equity offerings. The factor-model estimation also includes standard characteristics-based risk factors, and we explore mimicking portfolios for leverage-related macroeconomic risks. Because they track macroeconomic aggregates, these mimicking portfolios are relatively immune to market sentiment effects. Overall, we cannot reject the hypothesis that the realized return on the IPO portfolio is commensurable with the portfolio’s risk exposures, as defined here.
In cross-border acquisitions, the differences between the bidder and target corporate governance (measured by newly constructed indices capturing shareholder, minority shareholder, and creditor protection) have an important impact on the takeover returns. Our country-level corporate governance indices capture the changes in the quality of the national corporate governance regulations over the past 15 years. When the bidder is from a country with a strong shareholder orientation (relative to the target), part of the total synergy value of the takeover may result from the improvement in the governance of the target assets. In full takeovers, the corporate governance regulation of the bidder is imposed on the target (the positive spillover by law hypothesis). In partial takeovers, the improvement in the target corporate governance may occur on voluntary basis (the spillover by control hypothesis). Our empirical analysis corroborates both spillover effects. In contrast, when the bidder is from a country with poorer shareholder protection, the negative spillover by law hypothesis states that the anticipated takeover gains will be lower as the poorer corporate governance regime of the bidder will be imposed on the target. The alternative bootstrapping hypothesis argues that poor-governance bidders voluntarily bootstrap to the better-governance regime of the target. We do find support for the bootstrapping effect.
We estimate continuous-time event-history models of the acquisition of conglomerate vs. non-conglomerate and predatory vs. friendly acquisitions among the 1962 Fortune 500 between January, 1963, and December, 1968. Our analysis of predatory acquisitions reveals that there were strong disciplinary motivations for these acquisitions in the 1960s. Q ratios were, by a large margin, the most important determinant of predatory acquisition likelihood. Surprisingly, however, corporate boards appear to have provided little alternative to predatory acquisition as a monitoring mechanism during this period. Friendly acquisitions, on the other hand, were concentrated among firms with low price-earnings ratios and high return on equity, suggestive of the earnings manipulation story often associated with conglomerate acquisitions. Our analysis of conglomerate acquisitions reveals that there were strong disciplinary motivations for conglomerate acquisitions during this period. Conglomerate targets had low Q ratios and were as likely as non-conglomerate targets to be acquired in a predatory fashion. We find no evidence that conglomerate acquisitions were motivated by a desire to improve earnings-per-share numbers, as some have maintained.In addition, regardless of type or tenor, we find managerial ownership, firm size, and industrial organization motivations for acquisition are consistently important determinants of acquisition likelihood.
The 1964 Securities Acts Amendments extended disclosures mandated of NYSE firms to most firms trading in the Over-the-Counter (OTC) market. Although some prior evidence suggests substantial value increases for OTC firms due to the "value enhancing" mandated disclosures, we find no statistical difference in announcement returns for OTC firms moving to the NYSE before and after the legislation. One purported advantage to investors from the 1964 legislation was increased financial reporting. Yet, we document that the bulk of OTC firms analyzed in prior studies was already providing investors financial information before the legislation. Apparently, investors did not value the mandated disclosures. We do find evidence that the NYSE benefited from the legislation by increasing the number of OTC firms switching to their exchange around its passage.
We investigate the extent to which managerial incentives, including golden parachute (GP) payments, have influenced target acquisition gains over the past two decades. We find that the use and scope of GP contracts expanded dramatically for a large sample of firms acquired from 1980 through 1995. To investigate the effect of managerial incentives on target acquisition gains, we estimate a regression of abnormal stock returns for acquisitions on variables including managerial incentives, the value of GP payments, and the interaction between GPs and management incentives. The regression results indicate that management incentives are positively associated with target acquisition returns and that GP payments serve to mitigate this influence. We do not, however, detect any direct association between the level of GP payments and target gains.
This paper examines the relationship between the likelihood a firm is acquired and the governance and financial characteristics of the firm. Given many of the developments in the corporate control market in the late 1980s, I suspect that the process governing takeover likelihood may have changed in the 1990s. I examine a sample of 342 NYSE/AMEX firms that were acquired during the 1990–1997 period and compare them to a matched sample of nonacquired firms. I find that firms that were acquired over this period can be characterized as having lower managerial ownership and higher ownership by outsiders, particularly higher ownership by nonmanagement blockholders with board representation. The fact that managerial ownership is negatively related to takeover likelihood is consistent with studies using data from 1970s and 1980s. This suggests that managerial ownership helps managers maintain control, or alternatively that ownership proxies for how much managers care about control.
Contracting theory predicts that greater equity-related compensation will decrease the agency problems of equity but may exacerbate the agency problems of debt. We present evidence that the agency costs of debt may have declined during the 1990s. Specifically, changes in the financial characteristics of our sample firms suggest that underinvestment, asset substitution, and financial distress became less likely. Furthermore, agency costs of equity increased during the 1990s, primarily because firms became more difficult to monitor. Together, the findings provide an explanation for why more firms used option-based compensation in the latter 1990s, and why the proportion of options in compensation structure increased throughout the decade of the 1990s.
One dimension of competition among stock exchanges is the quality of products they have to offer. In order to attract listings and trading volume, exchanges can affect the quality of their listed firms by altering their standards for firm disclosure and governance. We identify a competition with respect to delisting standards between Korea's two stock exchanges and show that it complies with the three components of a regulatory race to the top: external trigger, mobility among diverse regimes and meaningful changes that converge to similar rules. The race between the two Korean exchanges ended with stricter rules and better protected minority shareholders. The race also ended, however, with neither exchange gaining market share with respect to trading volume or new listings. Korea's experience, therefore, suggests a reason why these races are rare. In the absence of an external trigger, exchanges will be reluctant to enter a race if they think it will result in rule convergence and no winner.
This study examines the sensitivity of equity values of oil producers to changes in the uncertainty of future oil prices. We document that this sensitivity is negatively correlated with a firm's debt ratio and its production costs. These results indicate that companies that are more likely to experience financial distress or underinvestment from low cash flows are adversely affected by increases in the uncertainty of future cash flows. We conclude that corporate risk management can increase shareholder value by reducing the expected costs of financial distress and underinvestment.
Proponents of state antitakeover legislation argue that previous empirical tests by financial economists of the wealth effects of Pennsylvania's 1990 antitakeover law are biased. We show that the proponents are correct. In particular, firm size, event-time clustering, and non-synchronous trading effects account for the wealth decreases reported in earlier studies. We also show, however, that both proponents and critics of the Pennsylvania legislation have ignored the earliest press release about it. The wealth effect associated with this announcement is negative, large, and statistically significant. These results therefore are consistent with the hypothesis that the Pennsylvania law decreased company values and with the hypothesis that the initial market reaction is an unbiased estimate of the law's effect on firm values.
This paper examines a recent financial innovation in corporate bond contracts, referred to as the clawback provision. A clawback provision in debt contracts gives the issuer an option to redeem a specified fraction of the bond issue within a specified period at a predetermined price and with funds that must come from a subsequent equity offering. We argue that issuers use clawback provisions to mitigate the wealth losses that would otherwise occur when new equity is offered. Consistent with the hypotheses, the evidence shows that bond offerings are more likely to include a clawback provision if their issuers are private, have more intangible assets, have fewer liquid assets, and are unregulated. We also estimate the price of clawback provisions and find that yield spreads on bonds with clawback provisions are a median of 86 basis points higher relative to what they otherwise would be.
We evaluate methods used to measure abnormal changes in capital expenditures. We examine both statistical tests and models of expected capital expenditures. We find that commonly used research designs yield test statistics that are misspecified, even in random samples. In cases where sample firms share a common characteristic such as extremely low or high investment, size, leverage, return on assets or market-to-book ratio, it is very important to match sample firms to a control group that shares this pre-event characteristic. We also find that using control groups, rather than a single control firm, yields more powerful test statistics.
This paper provides a theory for the choice of an organizational structure by the headquarters of a unitary structure concerned about overload. The headquarters can avoid overload by delegating operational decisions to divisions, i.e., moving the firm to a multidivisional structure. We show that, under moral hazard, these divisions receive rents for incentive purposes, and that the multidivisional structure is able to invest more. Thus, there is a trade-off between increasing investment and paying rents. We also show that this trade-off applies to situations where firms consider engaging in acquisitions and joint ventures, or where entrepreneurs consider resorting to venture capitalists.
This paper examines the role of certain fair value accounting (FVA) outcomes in compensation of US bank CEOs. The use of FVA in compensation invites an agency cost--the clawback problem--if cash compensation is based on unrealized profits that may reverse in the future. At the same time FVA may be a good measure of current managerial effort and so be cash compensated. We find evidence consistent with a positive link between CEO cash bonus and fair value (FV) valuation of trading assets, managed for short-term profit, as well as (amongst banks with limited trading exposure) a positive link between CEO pay and FV valuations of available for sale (AFS) assets. We find no evidence that trading income is incrementally compensation relevant, indicating that compensation committees avoided the clawback problem for unrealized trading gains. The paper also provides evidence on the link between FVA outcomes and equity-based pay.
Previous research indicates that operating performance improves following corporate acquisitions relative to industry-median firms. Such performance results are likely to be biased because acquiring firms undertake acquisitions following a period of superior performance and they are generally larger than industry-median firms. Using firms matched on performance and size as a benchmark, I find no evidence that operating performance improves following acquisitions. I also analyze if performance is higher in cash acquisitions as suggested by various studies. The results indicate that cash flows increase significantly following acquisitions that are made with cash, but decline for stock acquisitions.
Most of the theoretical literature on tender offers has been devoted to illustrating the positive effects of the toehold on the bidder's profits. Empirical research, however, shows that a high proportion of bidders do not trade on the target's shares prior to the tender offer announcement. This paper presents a model in which the bidder trades in the open market before announcing a tender offer and the incumbent shareholders form beliefs about the rival's quality given the order size. Market liquidity allows the potential bidder to partially hide her trade, and thus insiders are not able to ascertain whether an increase in volume indicates toehold acquisition. Stock price prior to the announcement date and market perception about the probability of a takeover are therefore contingent on players actions. We show that in some situations no trade will be optimal, and a negative relationship between takeover premium and toehold size arises. Interestingly, stock liquidity and initial stake are positively related. Our results also provide a theoretical basis for the observed pre-bid stock price dynamics. In particular, we show that the ratio between price runup and bid premium is increasing in the toehold size.
This study provides large sample evidence on the effects of antitakeover provisions (ATPs) on takeover probability and premia in modern takeover contests. Despite the fact that hostile bids are uncommon during the 1990s–2000s, some ATPs have strong but opposing effects on takeover outcomes. Consistent with recent theory, the staggered board-poison pill combination is the strongest antitakeover mechanism. Takeover compensation arrangements reduce managerial resistance to takeovers, and many commonly used ATPs are irrelevant in modern takeover battles. Furthermore, compensation plans are associated with higher takeover premia. Although individual ATPs have significant effects on takeover outcomes, the G-Index, which does not account for the diverse effects of ATPs, is not significant in predicting the firm's takeover probability or the size of takeover premia.
We exploit parent- and subsidiary-level data for publicly listed firms in Thailand before, during, and after the 1997 Asian Financial Crisis to investigate the extent to which firms with different types of ownership restructure their business portfolios, in terms of divestitures and acquisitions. We compare restructuring choices made by firms mostly owned by (a) domestic individuals with block shares (family firms), (b) domestic firms and/or institutions (DI firms), and (c) foreign investors (foreign firms). We show that following the crisis (1) foreign firms' restructuring behavior is the least affected; (2) domestic firms owned by families and domestic institutions (DI) behave similarly to one another; (3) domestic firms do not increase divestiture in their peripheral segments to improve operational focus or to obtain cash in a credit crunch; they actually reduce divestiture in core segments; and (4) domestic firms also significantly reduce the acquisition of new subsidiaries. Our results challenge traditional explanations for divestiture such as corporate governance, operational refocus, and financial constraints. They indicate that in the great uncertainty of a crisis, domestic firms are able to hold onto their core assets to avoid fire-sale. In essence, they act more conservatively in churning their business portfolios.
Protective governance structure is often viewed as costly to minority shareholders who bear the costs of opportunism by entrenched managers. A less common view is that protective governance encourages value-enhancing initiative, allowing risk-averse managers to pursue projects they would otherwise forgo. To assess these views we examine the acquisition decisions of S&P 500 firms between 1994 and 2005 and document two entrenching dimensions of governance: founding family presence and larger boards with more inside directors. We find that family firms destroy value when they acquire, consistent with an agency cost explanation for acquisitions. In contrast, firms with large boards and more insiders are more likely to acquire and to create value when they do acquire. These results are consistent with benefits to managerial initiative when managers are insulated from discipline. Finally, we find no systematic evidence that shareholder right limiting provisions either facilitate managerial entrenchment or lead to wealth losses through acquisition activity.
Corporate cash reserve has an adverse selection effect. Specifically, if investors know a company does not have to issue to invest, an attempt to do so sends a strong signal of overvaluation. This notion has not been explicitly studied in the extant empirical literature, despite its intuitiveness. Using a sample of acquisitions solely financed by stock to exclude the potential complications of free cash flow, I find that announcement returns are lower for a bidder with a higher excess cash reserve. This effect is stronger in hot equity market years or when a bidder's standalone value is more difficult to evaluate. I also find evidence supporting the idea that targets request cash payment to remove "lemon" bidders in normal (non-hot equity market) years, but accept too many stock offers in hot equity market years. After acquisitions, high-excess-cash-reserve bidders operationally outperform low-excess-cash-reserve bidders. Further, they spend more funds on reducing debt but not more on investments, compared with low-excess-cash-reserve bidders. Combined, these results show that cash reserve has information costs. Further, they highlight the importance of the two-sided information asymmetry framework of Rhodes-Kropf and Viswanathan (2004) in describing merger outcomes without resorting to behavioral or agency explanations.
In this paper, we examine the motivations of acquirers undertaking partial acquisitions in emerging markets by testing two competing hypotheses: the market for corporate control hypothesis and the market entry hypothesis. We find that targets of cross-border acquisitions outperform targets of domestic acquisitions in the pre-acquisition period. While cross-border acquisitions have no significant impact on target firms' operating performance, targets of domestic acquisitions experience significant improvements in operating performance and substantial changes in ownership structure after the acquisition. The evidence suggests that domestic partial acquisitions in emerging markets serve as a market for corporate control, while cross-border partial acquisitions are motivated by the strategic market entry rationale.
We analyze how the structure of executive compensation affects the risk choices made by bank CEOs. For a sample of acquiring U.S. banks, we employ the Merton distance to default model to show that CEOs with higher pay-risk sensitivity engage in risk-inducing mergers. Our findings are driven by two types of acquisitions: acquisitions completed during the last decade (after bank deregulation had expanded banks' risk-taking opportunities) and acquisitions completed by the largest banks in our sample (where shareholders benefit from [`]too big to fail' support by regulators and gain most from shifting risk to other stakeholders). Our results control for CEO pay-performance sensitivity and offer evidence consistent with a causal link between financial stability and the risk-taking incentives embedded in the executive compensation contracts at banks.
We investigate termination fee size in mergers. Although the deal premium does not significantly affect fee size, smaller targets and targets with lower institutional ownership offer larger fees. Low or moderate fees do not eliminate post-announcement competing bids, while large fees do. Fee size is generally positively correlated with deal completion. However, large fees are negatively correlated with the consummation of high-premium deals. Fee size is generally unrelated to announcement-date cumulative abnormal returns. However, returns are significantly lower for deals including fees larger than 5%. Overall, the study provides evidence that low- or moderate-size fees serve as efficient contractual devices, while large fees are less beneficial to shareholders and therefore tend to suggest agency conflicts.
This paper considers whether the first-best level of firm-specific human capital investment is attained by the use of stock option plans for workers and stock offers in acquisitions even though workers are threatened with the possibility of a divestiture and acquisition. We show that the first-best level of investment is achieved by a stock option plan with a positive exercise price for workers conditional on the event of a divestiture. We also suggest that, under certain conditions, a stock offer in acquisition can resolve a collusion problem between the target firm (TF) and its workers.
We examine the motives for and consequences of 4,759 cross-border acquisitions constituting $593 billion of total activity that were led by government-controlled acquirers over the period from 1990 to 2008. Government acquirers are more likely than corporate acquirers to come from autocratic countries with higher levels of foreign currency reserves and more active domestic acquisitions programs, and they are more likely to pursue targets in countries with larger natural resource sectors and more potential to diversify their own industrial structures. When we account for the potential endogeneity of bidder-target matching that arises from a government deal being correlated with such observable or other unobserved characteristics, we find government deals are associated with higher announcement returns for the target firms, a higher probability of engaging in a complete control (100%) transaction, and no higher likelihood of deal failure or withdrawal compared to corporate deals. Policy implications are discussed, especially in light of recent regulatory changes in the U.S. and other countries that seek to restrict foreign acquisitions by government-controlled entities.
This paper explores the market for voting rights and shareholder voting around 350 mergers and acquisitions between 1999 and 2005 by examining institutional-investor trading and voting outcomes. Our results show institutions in aggregate buy shares and hence voting rights before merger record dates. This trading is not related to proxies for merger arbitrage or trading around merger announcements, and thus is not simply a continuation of the latter. Trading and buying before record dates are positively related to voting turnout and negatively related to shareholder support of merger proposals. We explore several possible interpretations of these results.
We examine the announcement-period acquirer returns and target values for a large sample of cross-border acquisitions by U.S. firms, differentiating between private and public targets and paying particular attention to the legal protection of minority shareholders in the target country. For high-protection target countries, acquirer announcement-period returns are significantly negative for public targets and significantly positive for private targets. For low-protection target countries, the acquirer returns are significantly positive for public targets and insignificantly different from zero for private targets. For public targets, acquirer returns are decreasing and target-firm values and acquisition premia are increasing with the level of investor protection. For private targets, investor protection does not affect acquirer returns or target-firm values. We find that bidder returns decrease with the level of creditor protection in the target country and increase with the quality of accounting standards. Our results also show that in low- protection countries, firm-level corporate governance mechanisms, such as higher insider ownership, may substitute for the lower level of investor protection.
In 2005, the US Congress challenged the acquisition by CNOOC (a Chinese state-owned enterprise) of Unocal (a US firm). This challenge creates a political barrier for foreign companies to acquire US oil companies. This paper examines the stock price reaction of US oil companies to this political opposition. Using an event study methodology, we find that this political barrier resulted in a substantial decline in the market value of US oil companies. For a period of 44 days, during which six anti-CNOOC-takeover political events occurred, the cumulative decline in the market value of a portfolio of 13 US oil refining firms was $47.5 billion and that of a portfolio of 66 US oil and gas exploration firms was $11.4 billion. This study is the first to analyze and quantify the stock price reaction of US non-merging firms to political barriers to cross-border acquisitions. It also has a policy implication regarding the recent enactment of the Foreign Investment and National Security Act of 2007.
I study the announcement effects of all acquisitions in the recent telecom wave on both the acquirers and their industry competitors. I find evidence of negative rival returns (- 0.55%, t-stat = 2.47) by focusing on non-horizontal acquisitions where rivals are less susceptible to experience positive returns due to increased market power or expectation that some will become future targets themselves. I find that this effect is worse for closer rivals defined as having similar size and being in the same primary service area as the acquirer. Competitor returns are positively correlated with those of the acquirers suggesting that the negative impact experienced by competitors is driven by acquisitions in which the acquirer itself is earning negative abnormal returns. Results are broadly consistent with the Competitive Advantage Hypothesis that posits acquisitions are a means of corporate restructuring in a changing environment, awarding the acquirer a competitive edge and thereby making these acquisitions costly for their non-merging competitors.
This paper examines speculation spreads following initial acquisition announcements in 362 cash tender offers spanning the 1981-1995 period. Speculation spreads in acquisitions, defined as the percentage difference between the bid price and market price one-day after the initial announcement, exhibit a positive mean, with considerable cross-sectional variation. In fact, over 23% of these speculation spreads are negative, indicating a post announcement price greater than the initial bid price. We model speculation spreads as the visible component of total speculative returns of the target. Rational traders set speculation spreads anticipating the expected price resolution and length of the acquisition bid. Empirically, we find strong support for key implications of the model. Speculation spreads are significantly negatively related to the magnitude of price revision and significantly positively related to offer duration. These results are robust to the inclusion of bid and offer characteristics known ex ante as well as those only revealed ex post. The results are consistent with market pricing of both offer duration and price resolution at the time of the initial announcement.
I assess the role of wealth and systemic risk in explaining future asset returns. I show that the residuals of the trend relationship among asset wealth and human wealth predict both stock returns and government bond yields. Using data for a set of industrialized countries, I find that when the wealth-to-income ratio falls, investors demand a higher risk premium for stocks. As for government bond returns: (i) when they are seen as a component of asset wealth, investors react in the same manner; (ii) if, however, investors perceive the increase in government bond returns as signalling a future rise in taxes or a deterioration of public finances, then investors interpret the fall in the wealth-to-income ratio as a fall in future bond premia. Finally, I show that the occurrence of crises episodes (in particular, systemic crises) amplifies the transmission of housing market shocks to financial markets and the banking sector.
This paper finds new evidence that the threat of legal sanctions significantly affects the trading behavior of insiders. Specifically, I examine the effects of the Insider Trading and Securities Fraud Enforcement Act (ITSFEA) on insider trading around earnings announcements. Given ITSFEA's stated concern with trading on private information prior to its release, I argue that insiders may respond to the Act by altering the timing of their trades. I find that, following ITSFEA, insiders are more likely to postpone liquidity sales until after negative earnings surprises. I also find that insiders increase their relative emphasis on post-event as opposed to pre-event information based trading. Finally, earnings announcements appear to be more informative in the post-ITSFEA period, consistent with less information based trading in front of earnings announcements, after the Act.
This paper uses a natural experiment to measure market response to the adoption of the Sarbanes–Oxley Act (ʽʽSOX"). Because SOX applies to all US public companies, US-based studies have difficulty separating the effects of contemporaneous events. However, controlled analysis is available: SOX applies to some cross-listed firms (those listed on level 2 or 3), but not to others (listed on level 1 or 4). By comparing reactions of SOX-exposed foreign firms to reactions of otherwise similar SOX-unexposed foreign firms, we can test investor beliefs about the costs and benefits of SOX in a way that is not cleanly available for US-based studies. We find that stock prices of foreign firms subject to SOX declined (increased) significantly, compared to cross-listed firms not subject to SOX and to non-cross-listed firms, during key announcements indicating that SOX would (would not) fully apply to cross-listed issuers. In cross-sectional tests, high-disclosing firms and firms from high-disclosing countries experienced the strongest declines, while faster-growing companies experienced weaker declines. This evidence is consistent with the view that investors expected the Sarbanes–Oxley Act to have a net negative effect on cross-listed foreign companies, with high-disclosing and low-growth companies suffering larger net costs, and faster-growing companies suffering smaller costs, particularly when they are located in poorly governed countries.
We examine the relationship between ownership structure and corporate crime. Our approach draws upon two lines of research: (1) the theory of the firm which poses ownership as a critical incentive mechanism and (2) the economic theory of corporate crime, which emphasizes the role played by top management in affecting crime in the corporation. We find that crime occurs less frequently among firms in which management has a larger ownership stake. Our results imply that penalizing `corporations' (shareholders) deters crime, and that corporate crime tends not to benefit shareholders, ex ante. Rather than being something shareholders have encouraged, corporate crime appears to reflect an agency cost limited but not optimally eliminated through the costly efforts of top management. The evidence is consistent with the notion that ownership structure plays an important role in aligning the hidden actions of top management with the shareholder interest.
This paper presents evidence of the shareholder wealth effect of institutional activism using its spillovers on non-target companies. The spillovers are instructive because they are a response to an exogenous shock and thus create an environment to conduct a clean event study. In particular, we examine the spillover effects of the first target announcement of the Korea Corporate Governance Fund. As the very first sign of institutional activism in the country, this announcement creates an expectation of similar governance efforts even in non-target companies, especially in those companies whose governance is currently poorer and thus the scope for future activism is greater. Consistent with institutional activism contributing to shareholder wealth, we find that, among non-targets, those firms granting fewer rights to outside shareholders experience a more positive stock price reaction. Further analysis lends additional support to the positive wealth effect of institutional activism.
This paper measures the value of shareholder activism focusing on outside blockholders who switch their investment purpose from passive to active but are not likely to engage in control-related activities. Unlike the usual 5% ownership disclosure, a switch does not necessarily involve additional share purchase, and thus provides a cleaner test in effectively ruling out alternative theories such as those related to stock picking skills, private information, or herding. We apply the test to outside blockholders in the Korean market, which experienced a concentrated number of switchers in the first half of 2005 when the government adopted a new disclosure rule. We find that target price reaction is significantly positive around the time of the switch disclosure and this effect is more pronounced when the switcher declares to use a wider scope of activist measures. Following the switch, we also find evidence of increases in dividend payouts for firms targeted by switchers with a wider scope of activism, and those with high free cash flows.
Using a sample of 175 publicly traded bank holding companies (BHCs), we find that managerial incentives and external monitoring affect the decision to use derivatives in the banking industry. Managers with incentives that are more closely aligned with the interests of shareholders, as reflected in a high percentage of CEO shareholdings, are less likely to use derivatives when insider holdings exceed 10%. Similarly, when outside directors own substantial equity, the firm is less likely to use derivatives. These results suggest that managers with large equity stakes take advantage of the risk-shifting opportunities of deposit insurance by not hedging. For BHCs with insider holdings below 10%, however, monitoring by outside directors is associated with a greater likelihood of derivative usage. This suggests that monitoring by outside directors may lead to more risk-averse behavior on the part of managers with small equity stakes.
We compare the investment activities and sources of finance of venture capital (VC) funds in Germany, Israel, Japan and the United Kingdom. VC investments differ across countries in terms of their stage, sector and geographical focus. Sources of VC funds also differ across countries; for example, banks are particularly important in Germany and Japan, corporations in Israel, and pension funds in the United Kingdom. Although the differences in investments are related to funding sources—for example, bank and pension fund-backed VCs invest in later stage activities than individual and corporate backed funds—a large proportion of variation within as well as between countries is unrelated to sources of finance. Moreover, differences in the relation between funding source and VC activity are unrelated to the country's financial systems. We conclude that neither financial systems nor sources of finance are the main explanations for the pronounced differences in VC activities.
I examine the relative effects of replacement investments (RX) and adaptation investments (AX) on equity value. My analysis draws from the real-options theory that stresses the link between firm value and the option a firm holds to continue current practice or to adapt resources to new opportunities. The key prediction is that replacement and adaptation investments reflect the exercise of different investment options that have different implications for firm value; the effect of each investment type on firm value depends on the relative attractiveness of the underlying investment option. The results show that, in the presence of earnings, the effect of replacement investments on equity value is negative and increasing in earnings performance; by contrast, the effect of adaptation investments on equity value is positive and decreasing in earnings performance. Further analyses show that asset sales mediate the importance of adaptation investments in determining equity value.
During the decade of the 1990s the number of women serving on corporate boards increased substantially. Over this decade, we show that the likelihood of a firm adding a woman to its board in a given year is negatively affected by the number of woman already on the board. The probability of adding a woman is materially increased when a female director departs the board. Adding a director, therefore, is clearly not gender neutral. Although we find that women tend to serve on better performing firms, we also document insignificant abnormal returns on the announcement of a woman added to the board. Rather than the demand for women directors being performance based, our results suggest corporations responding to either internal or external calls for diversity.
This paper examines outside director compensation for a sample of 237 Fortune 500 firms over the 1998-2004 period. We document a trend towards fixed-value equity compensation and away from cash only and fixed-number equity compensation. Adjustments to director compensation are consistent with firms targeting a market level of compensation, and firms that deviate from their market wage symmetrically adjust compensation back toward the market level. We also document the relation between changes in compensation and changes in equity values, and find that upward adjustments begin sooner than downward adjustments. When equity values rise, we find virtually no immediate offset to director compensation. However, when equity values fall, fixed-number equity compensation is adjusted in the same period (by awarding more shares or options) to offset the loss of income by almost one-third. Thus, the magnitude of adjustments towards the market wage level is symmetric, but the timing is not.
This paper examines the relation between insider ownership and corporate performance in the presence of adjustment costs and investigates how the adjustment costs are determined. In a model specification without adjustment costs, we find that insider ownership is significantly positively associated with corporate performance. But once we allow for adjustment costs, the relationship no longer exists. We find that insider ownership and corporate performance can be explained by their respective lagged values and that many firm characteristics that were previously useful in explaining these two variables turn out to be statistically insignificant. In addition, there is no evidence that insider ownership and corporate performance affect each other. This is consistent with the adjustment cost argument. It is also consistent with the “endogeneity” argument suggested by Demsetz [Demsetz, H. 1983. The structure of ownership and the theory of the firm. Journal of Law and Economics 26, 375–390.], Demsetz and Lehn [Demsetz, H., Lehn, K., 1985. The structure of corporate ownership: causes and consequences. Journal of Political Economy 93, 1155–1177.], and Demsetz and Villalonga [Demsetz, H., Villalonga, B., 2001. The ownership structure and corporate performance. Journal of Corporate Finance 7, 209–233.]. Finally, we document that the speed of adjustment of insider ownership is positively related to insiders' market timing but negatively to the number of insiders and that the speed of adjustment of Tobin's Q is positively associated with financial leverage and stock price volatility.
Using two dynamic partial adjustment capital structure models to estimate the impact of several macroeconomic factors on the speed of capital structure adjustment toward target leverage, we find evidence that firms adjust their leverage toward target faster in good macroeconomic states relative to bad states. This evidence holds whether or not firms are subject to financial constraints. Our results are robust to an alternative method of calculating states and to omitting zero-debt boundary firms and are not driven by firm size, deviation from target, or leverage definitions.
Historical market-to-book has been shown to explain current leverage. Prior studies attribute the evidence to market timing. This study shows that with the presence of time-varying targets and adjustment costs, historical market-to-book has a significant impact on leverage even when firms do not time the market. The historical values of alternative market timing proxies, such as insider sales and the market sentiment index, are shown to have no effects on leverage while the historical values of alternative growth-option proxies do have effects. Overall, the evidence is largely consistent with a partial adjustment model of leverage.
The topic of make-whole call provisions on bond issues remains a relatively unexplored area in modern finance literature, with the exception of Mann and Powers [Mann, S.V. and Powers, E.A., 2003, Indexing a Bond's Call Price: An Analysis of Make-whole Call Provisions, Journal of Corporate Finance 9(5), 535–554.]. This paper examines the corporate finance implications of including such a call feature in bond issuances, and how such issuances are different from bond issuances which are not callable, or which employ regular call features. We find that bond issuances employing make-whole call provisions (1) are accompanied by a significantly positive stock price reaction, (2) exhibit superior post-issuance stock returns, and (3) are associated with positive analyst revisions in the long-term growth rate of earnings. These results suggest that bond issuances which include make-whole call provisions are indeed very different from the other issuances, and are clearly not a case of “much ado about nothing”.
This paper examines the takeover charter amendments made by 128 firms listed on the New Zealand Stock Exchange. By December 31, 1995, firms were to have adopted one of three charter amendments that varied the timing and content of information required to be provided in takeover bids. The results show that after controlling for the probability of takeover and firm size, unaffiliated directors, representing blockholders, are associated with a less restrictive takeover amendment. We also find evidence that equity owned and controlled by executive and affiliated directors is related to the choice of takeover amendment. We find no relation between the choice of takeover amendment and the level of institutional shareholding, the proportion of public directors or the joint role of CEO and board chairman.
Top-cited authors
Michael Firth
  • Lingnan University
Peter J. Dadalt
  • Susquehanna University
Belen Villalonga
  • New York University
Harold Demsetz
  • University of California, Los Angeles
Oliver M. Rui
  • China Europe International Business School