[Show abstract][Hide abstract] ABSTRACT: This paper presents an industry equilibrium model where firms can choose to engage in corporate social responsibility (CSR). We model CSR activities as an investment in customer loyalty and derive predictions for how CSR affects systematic risk and firm value. The paper tests the predictions empirically and finds evidence consistent with the following: CSR firms exhibit lower systematic risk and this effect is stronger in differentiated goods industries, in consumer goods industries and in industries where the market capitalization of CSR firms is lowest; CSR firms have higher firm value; and, the ratio of CSR profits to non-CSR profits is countercyclical. In the empirical tests, we address a potential endogeneity problem by instrumenting CSR using data on the political affiliation of the firm’s home state, and data on environmental and engineering disasters and product recalls.
[Show abstract][Hide abstract] ABSTRACT: Corporate social responsibility (CSR) represents a growing strategic concern for corporations around the world, many of which are adopting CSR as a core management or board-level function. The Global Reporting Initiative founded in the late 1990’s, embraced by the United Nations Environment Program, has provided corporations with a reporting framework on their economic, environmental, and social sustainability. No longer necessarily viewed outside the profit maximizing framework, many questions still remain on how CSR policies affect the risks firms are facing and the stock market implications of those policies. We aim to understand the asset pricing consequences of CSR adoption, but also of non-adoption in the presence of industry CSR trends. We plan to develop an industry equilibrium model where firms make production and CSR investment decisions and embed this model within a standard asset pricing framework. Following the exiting work in finance and marketing, we model an investment in CSR as a mechanism to acquire customer loyalty. Greater customer loyalty takes the form of a less price elastic demand, which the firm uses to smooth out the effect of demand fluctuations. With this assumption, the model captures the folklore view in the literature that a firm with a more loyal demand has profits that are relatively less sensitive to aggregate economic conditions than a firm with a less loyal demand. A risk averse investor will therefore, all else equal, value more highly the firm with the more loyal demand, pricing a lower systematic risk (lower beta) and expecting a lower return. We will test the model predictions using a comprehensive dataset on firm-level CSR from MSCI’s Environmental, Social and Governance (ESG) database. The database provides coverage for companies that constitute several major international stock indices. The full sample includes 34 countries and 3,005 firms from 2004 to 2010, equivalent to an unbalanced panel with 9,795 firm-year observations. To address the endogenity issues, we will create two instruments for CSR. The first instrument is based on the sample of environmental and engineering disasters. The second instrument is based on data on product recalls. We adjust these data for their relevance using hand collected data on newspaper articles before and after the incidents. Our results will have important practical capital budgeting and policy implications. Beta is the major parameter used in estimating the cost of equity. Given our results, we expect CSR companies to have lower cost of equity than non-CSR firms. In addition, projects that increase firms’ reputation for CSR should be discounted with lower cost of equity, compared to otherwise similar projects. Thus, for example, investments in green energy should be discounted with a lower cost of equity than investments in more polluting sources of energy.
[Show abstract][Hide abstract] ABSTRACT: In a real options framework, we provide a model of innovative activity where multiple agents compete against each other by submitting investment proposals to the principal. Competition helps to speed up innovation not only because multiple agents are working on the same problem, but also because competition helps to solve the agency problems involved. In our model the principal asks proposals from n-number of agents and contracts with the agent who comes up with the best proposal. Agents will have to provide costly and unobservable effort. While working on the proposal agents will also privately learn the quality of their proposals. Multiple proposals make it easier to elicit truthful information from the agents, but all the efforts put into those proposals have to be compensated for. A key insight from the model is that the principal has less need to delay investments because competition among agents makes lying about the quality less profitable for the agents. We show that when the number of agents is endogenous, agents' information rents are completely dissipated and the agency problem is reduced to a pure moral hazard problem. As a consequence the first best investment policy is always achieved and innovations are implemented earlier.
No preview · Article · Mar 2012 · SSRN Electronic Journal
[Show abstract][Hide abstract] ABSTRACT: This paper presents an industry equilibrium model where firms can choose to engage in corporate social responsibility (CSR). We model CSR activities as an investment in customer loyalty and derive predictions for how CSR affeects systematic risk and firm value. The paper tests the predictions empirically and finds evidence consistent with the following: CSR firms exhibit lower systematic risk and this effect is stronger in differentiated goods industries, in consumer goods industries and in industries where the market capitalization of CSR firms is lowest; CSR firms have higher firm value; and, the ratio of CSR profits to non-CSR profits is countercyclical. In the empirical tests, we address a potential endogeneity problem by instrumenting CSR using data on the political affiliation of the firm’s home state, and data on environmental and engineering disasters and product recalls.
No preview · Article · Nov 2011 · SSRN Electronic Journal
[Show abstract][Hide abstract] ABSTRACT: We model the natural evolution of private information over the life of a venture capitalist financed project. In the early stages, the entrepreneur is better informed regarding the project, and when the project matures, the venture capitalist has an informational advantage over the entrepreneur. Within this framework, we examine how the venture capitalist's relative bargaining power affects cash flow rights and investment. When the bargaining advantage lies with the entrepreneur, the project may not be screened and the venture capitalist may acquiesce to excessive initial investment, but subsequently terminate the project. Increased venture capitalist bargaining power encourages project screening, attenuates the incentive to overinvest, and reduces the incidence of project termination subsequent to the initial investment. The payoff sensitivity of venture capitalist's financing contract also increases as his bargaining power improves.
Preview · Article · Jan 2011 · SSRN Electronic Journal
[Show abstract][Hide abstract] ABSTRACT: In this paper we study how the introduction of the euro has affected corporate financing in Europe. We use firm level data from eleven euro-countries as well as from a control group of five other European countries spanning the years 1991-2006. We show that firms from euro-countries that previously had weak currencies have increased both their equity and debt financing compared to the control group. We also show that results are stronger for firms that hail from less financially developed euro-countries, and that large firms from industries that are dependent on external financing have increased their debt financing more. These results support the hypothesis that improved access to capital markets in the euro-area has enabled increased external financing, especially debt financing.
Full-text · Article · Jan 2011 · SSRN Electronic Journal
[Show abstract][Hide abstract] ABSTRACT: The introduction of the euro has led to an expansion of the corporate bond and syndicated loan markets in the euro area. In this paper we study how this increase in the supply of capital has affected external financing in Europe. We use corporate level data from eleven euro-countries as well as from a control group of five other European countries and show that firms from euro-countries that previously had weak currencies have increased both their equity and debt financing. This result could be due to increased demand for financing. We also show that results are stronger for firms that hail from less financially developed countries, and that large firms from industries that are dependent on external financing have increased their debt financing more. These results support the hypothesis that improved supply of capital in the euro area has led to increased use of external financing.
No preview · Article · Mar 2010 · SSRN Electronic Journal
[Show abstract][Hide abstract] ABSTRACT: We analyze the effects that real-time domestic and foreign news about fundamentals have on the co-movement between stock returns of a small, open economy, Portugal, and a large economy, the United States. Consistent with our theoretical model, we find that US macroeconomic news and Portuguese earnings news do not affect cross-country stock market co-movement, whereas Portuguese macroeconomic news lowers cross-country stock market co-movement. We also find that US public information affects Portuguese stock market returns. However, this effect is much reduced when US stock market returns are included in the regression. We provide evidence, contrary to common wisdom, that this last result does not derive from contagion. JEL Classification: F3, G12, G14, G15.
[Show abstract][Hide abstract] ABSTRACT: We examine how the relative bargaining power of privately informed venture capitalists and entrepreneurs - determined either by market conditions or by prior experience - affects both the willingness of venture capitalists to invest and the terms of their financing contracts. Our results demonstrate that shifts in the venture capitalists' bargaining power have a profound influence both on the terms of contracts and on investments in venture-backed projects. As witnessed in the recent past, when the bargaining advantage lies with entrepreneurs, venture capitalists may acquiesce to both investing in negative NPV projects and excessive investments in early stages of projects. Further, they will subsequently terminate poor projects. An improvement in the bargaining position of venture capitalists increases the payoff sensitivity of their financing contracts. It also completely attenuates their incentive to overinvest, limiting the need for excessive project terminations arter the initial round of financing.
[Show abstract][Hide abstract] ABSTRACT: In this Paper we study the changes in corporate valuation induced by the formation of Economic and Monetary Union (EMU) in Europe. We use corporate-level data from ten countries that adopted the euro, the three EU countries that did not join EMU, as well as Norway and Switzerland. We show that the introduction of the euro has increased Tobin's Q-ratios in EMU countries by 7.4%. The effects prevail even if we account for the decrease in long-term interest rates. The increases in Tobin's Q are larger for firms that are ex-ante expected to benefit more, i.e. firms from countries that had weak currencies and firms that were exposed to intra-European currency risks. Finally, the increases are also more significant for firms that are financially unconstrained. The evidence provided here supports the view that the introduction of the euro has lowered firms' cost of capital in EMU-countries.
[Show abstract][Hide abstract] ABSTRACT: One measure of the health of the Social Security system is the difference between the market value of the trust fund and the present value of benefits accrued to date. How should present values be computed for this calculation in light of future uncertainties? We think it is important to use market value. Since claims on accrued benefits are not currently traded in financial markets, we cannot directly observe a market value. In this paper, we use a model to estimate what the market price for these claims would be if they were traded. In valuing such claims, the key issue is properly adjusting for risk. The traditional actuarial approach â€“ the approach currently used by the Social Security Administration in generating its most widely cited numbers - ignores risk and instead simply discounts â€œexpectedâ€ future flows back to the present using a risk-free rate. If benefits are risky and this risk is priced by the market, then actuarial estimates will differ from market value. Effectively, market valuation uses a discount rate that incorporates a risk premium. Developing the proper adjustment for risk requires a careful examination of the stream of future benefits. The U.S. Social Security system is â€œwage-indexedâ€: future benefits depend directly on future realizations of the economy-wide average wage index. We assume that there is a positive long-run correlation between average labor earnings and the stock market. We then use derivative pricing methods standard in the finance literature to compute the market price of individual claims on future benefits, which depend on age and macro state variables. Finally, we aggregate the market value of benefits across all cohorts to arrive at an overall value of accrued benefits. We find that the difference between market valuation and â€œactuarialâ€ valuation is large, especially when valuing the benefits of younger cohorts. Overall, the market value of accrued benefits
No preview · Article · Jan 2002 · Journal of Financial Economics
[Show abstract][Hide abstract] ABSTRACT: Using data from 20 countries that have suffered a currency crisis, this paper studies firm-level leverage and performance before and after a crisis has occurred. First we provide some evidence of increasing leverage both before and after a crisis. We show that, in the years preceding a currency crisis, companies that benefit from currency depreciations increase their leverage more than companies that are harmed by currency depreciations. These findings do not hold for countries with either floating exchange rates or currency boards. We argue that increasing leverage is a sign that some firms behave strategically towards governments that lack commintment mechanisms not to devalue their currencies. We also provide evidence that the Asian crisis is different from the previous European and Latin American ones: in Asia firms become more fragile after the crisis and their profitability declines further, whereas in Europe and Latin America there are clear signs of recovery after a crisis has occurred.
Preview · Article · Dec 2001 · The Journal of Business
[Show abstract][Hide abstract] ABSTRACT: Using company level data from 17 countries that have suffered a currency crisis during the past decade, this paper documents that firms have increasing leverage and declining profitability prior to a crisis, while still making positive net investments. After sorting companies into two groups based on their exchange rate beta, we show that companies that benefit from currency depreciations have higher leverage, lower earnings to revenue ratios and lower interest coverage ratios compared to firms that are harmed by currency deprecations. These results are consistent with the recent literature that puts the financial policies and performance of corporations as the central issue in currency crises.
Preview · Article · Aug 2001 · SSRN Electronic Journal