Investor protection and cash holdings: Evidence from US cross-listing

This paper examines (i) whether the level of firms’ cash holdings differ depending on the strength of investor protection, (ii) whether excess cash holdings are valued more with better investor protection, and (iii) whether cross-listed firms that improve investor protection through “bonding” hold relatively more cash than non-cross-listed firms. We analyze 1405 ADR firms and their corresponding matched firms from 39 different countries and document that ADR firms have significantly higher cash holdings relative to their non-cross-listed peers, especially in recent years. The increase in cash holdings is much higher for emerging market firms because of their transition from particularly poor home country investor protection and accounting standards before cross-listing to much higher standards after cross-listing. In addition, firms with level III ADR listing, which represents the strongest investor protection, have higher cash holdings relative to other types of ADR firms.     

Governance,product market competition and cash management in IPO firms

This study evaluates the link between CEO governance heterogeneity, power structure of the firm, and product market competition on various facets of post-IPO cash policy. Our results suggest that post-IPO cash holdings as well as marginal value of cash reserves are higher under a founder CEO governance regime relative to non-founder CEOs. Concentrating board power in the hands of founder CEOs however, reduces their ability to maintain higher post-IPO cash reserves. Our results also suggest that product market competition influences both the level and marginal value of cash reserves in the hands of founder CEOs. Further, we find that stronger internal governance reduces the tendency of IPO firms to deploy excess cash reserves to fund internal investments in excess of industry rivals. Finally, our results suggest that excess cash reserves in competitive industry environments lead to superior post-IPO operating performance.     

Corporate governance and firm cash holdings in the US

Using governance metrics based on antitakeover provisions and inside ownership, we find that firms with weaker corporate governance structures actually have smaller cash reserves. When distributing cash to shareholders, firms with weaker governance structures choose to repurchase instead of increasing dividends, avoiding future payout commitments. The combination of excess cash and weak shareholder rights leads to increases in capital expenditures and acquisitions. Firms with low shareholder rights and excess cash have lower profitability and valuations. However, there is only limited evidence that the presence of excess cash alters the overall relation between governance and profitability. In the US, weakly controlled managers choose to spend cash quickly on acquisitions and capital expenditures, rather than hoard it.     

Cross-country analysis of secular cash trends

This study documents a pronounced secular upward trend in cash holdings which is almost systemic across seven industrialized countries over 1991-2008, with France exhibiting a modest rise and Japan a substantial decline. However, the driving forces underlying the cash pattern are not uniform across countries. While the evolution in firm characteristics necessitated elevated cash balances, the time-varying firm attributes explain the cash trend only in Canada, France, UK and the US. The agency motive plays a role in the rise in cash balances in Germany. Our analysis highlights that the functioning of the financial system is crucial to corporate cash policy as Australia’s cash pattern is driven by shallow private credit markets that curbed cash reserves earlier on and the decelerating cash trend in Japan is ascribed to financial reforms. While there is a degree of commonality in the determinants of cash policies, we find some divergence in cash practices.     

Competition among stock exchanges for equity

We consider cross-border competition by stock exchanges for listings from firms that have controlling shareholders who have private benefits. We examine exchanges’ choices of their listing standards and firms’ choices of the exchanges where they cross-list their shares. We show that the share price compensates controlling shareholders for giving up some private benefits and enables firms with growth opportunities to obtain listings on exchanges with different listing standards. In particular, firms with high-growth opportunities tend to obtain listings on stock exchanges with high listing standards. We empirically examine these predictions and find that they are consistent with evidence.     

Competition and cooperation among exchanges: A theory of cross-listing and endogenous listing standards

We analyze firms’ choice of exchange to list equity and exchanges’ choice of listing standards when insiders have private information about firm value, but outsiders can produce (noisy) information at a cost. Exchanges are populated by two kinds of investors, whose numbers vary across exchanges: sophisticated (low information production cost) investors and ordinary (high–cost) investors. While firms are short-lived, exchanges are long-lived, value-maximizing agents whose listing and disclosure standards evolve over time. The listing standards chosen by exchanges affect their “reputation,” since outsiders can partially infer the rigor of these standards from the post-listing performance of firms. We show that, while exchanges use their listing standards as a tool in competing for listings with other exchanges, this will not necessarily lead to a “race to the bottom” in listing standards. Further, a merger between two exchanges may result in a higher listing standard for the combined exchange relative to that of either of the merging exchanges. We develop several other implications for firms’ listing choices and resulting valuation effects, the impact of competition and co-operation among exchanges on listing standards, and the optimal regulation of exchanges.     

Costly external finance,corporate investment,and the subprime mortgage credit crisis

We study the effect of the recent financial crisis on corporate investment. The crisis represents an unexplored negative shock to the supply of external finance for non-financial firms. Corporate investment declines significantly following the onset of the crisis, controlling for firm fixed effects and time-varying measures of investment opportunities. Consistent with a causal effect of a supply shock, the decline is greatest for firms that have low cash reserves or high net short-term debt, are financially constrained, or operate in industries dependent on external finance. To address endogeneity concerns, we measure firms’ financial positions as much as four years prior to the crisis, and confirm that similar results do not follow placebo crises in the summers of 2003–2006. Nor do similar results follow the negative demand shock caused by September 11, 2001. The effects weaken considerably beginning in the third quarter of 2008, when the demand-side effects of the crisis became apparent. Additional analysis suggests an important precautionary savings motive for seemingly excess cash that is generally overlooked in the literature.     

The Federal Reserve’s balance sheet and overnight interest rates: Empirical modeling of exit strategies

This paper provides a comprehensive study of the interplay between the Federal Reserve’s balance sheet and overnight interest rates. We model both the supply of and the demand for excess reserves. Treating outright securities holdings of the Federal Reserve as a policy tool, we estimate the effects of unconventional monetary policy on overnight funding rates. Further, we offer the first empirical assessment of the FOMC’s principles of the exit strategy. Assuming a path for removing monetary policy accommodation that is consistent with the FOMC’s exit principles, we project that the federal funds rate increases to 70 basis points by 2016, settling in a corridor bracketed by the discount rate and the interest rate on excess reserves, as excess reserves of depository institutions decline to near zero.     

Institutional investment horizon and investment–cash flow sensitivity

This paper examines the relevance of institutional investors’ investment horizon, as reflected in the response of firm investment to internal cash flows. We argue that institutional investors with longer investment horizons have greater incentives and efficiencies to engage in effective monitoring. This improved monitoring mitigates asymmetric information and agency problems, and in turn reduces the wedge between the costs of internal and external funds. As a result, the sensitivity of firms’ investment outlays to internal cash flows decreases in the presence of institutional investors with long-term investment horizons. Using a sample of 8402 US firms over the period 1981–2008, we provide empirical evidence consistent with these arguments.     

Does cross-listing facilitate changes in corporate ownership and control?

This paper examines whether controlling shareholders of foreign firms use a US cross-listing to facilitate changes in ownership and control. Prior to listing, about three quarters of the firms in our sample have a controlling shareholder. After listing, about half of the controlling shareholders’ voting rights decrease, with an average decrease of 24% points that differs significantly from that of the controlling shareholders of benchmark firms that do not cross-list. Large decreases in voting rights are associated with controlling shareholder characteristics, domestic market constraints, and better stock market performance and liquidity. In addition, there is control change in 22% of the firms. Controlling shareholders are more likely to sell control, and are more likely to do so to a foreign buyer, than controlling shareholders of benchmark firms. The results suggest that controlling shareholders who want to sell shares or their control stake can use a US cross-listing to decrease the cost of transferring ownership.     

Share reacquisitions,surplus cash,and agency problems

Share repurchases help alleviate agency costs of surplus cash by restricting management’s scope to waste corporate resources. But why do self-interested managers agree to disgorge surplus cash in the first place? This study examines the intervening effect of managerial monitoring and incentive alignment mechanisms on the decision to distribute excess cash through a share repurchase. Findings indicate that repurchases substitute for cash retention decisions that would otherwise prove costly for shareholders, and that better managerial incentive alignment and closer monitoring by external shareholders are important factors stimulating such payouts.     

Hedging,speculation, and shareholder value

We document that gold mining firms have consistently realized economically significant cash flow gains from their derivatives transactions. We conclude that these cash flows have increased shareholder value since there is no evidence of an offsetting adjustment in firms’ systematic risk. This finding contradicts a central assumption in the risk management literature that derivatives transactions have zero net present value, and highlights an important motive for firms to use derivatives that the literature has hitherto ignored. Although we find considerable evidence of selective hedging in our sample, the cash flow gains from selective hedging appear to be small at best.     

Ownership, control, and pyramids in Spanish commercial banks

Using the law and finance approach we analyze how the ultimate ownership and control structure influences the performance of Spanish commercial banks during the period 1996-2004. Our evidence shows that 96% of Spanish commercial banks have an ultimate controlling owner. Also, we observe that whenever there is a gap between the ultimate controlling owner’s cash flow and control rights, than the bigger the gap, the poorer the bank’s performance. We find that whenever there is no difference between the ultimate controlling owner’s cash flow and control rights, there is a non-monotonic relation between ownership concentration and the bank’s performance.     

Debt and managerial rents in a real-options model of the firm

We present a theory of capital investment and debt and equity financing in a real-options model of a public corporation. The theory assumes that managers maximize the present value of their future compensation (managerial rents), subject to constraints imposed by outside shareholders’ property rights to the firm's assets. Absent bankruptcy costs, managers follow an optimal debt policy that generates efficient investment and disinvestment. We show how bankruptcy costs can distort both investment and disinvestment. We also show how managers’ personal wealth constraints can lead to delayed investment and increased reliance on debt financing. Changes in cash flow can cause changes in investment by tightening or loosening the wealth constraints. Firms with weaker investor protection adopt higher debt levels.     

Partial adjustment toward optimal cash holding levels

Recognizing that industry and capital market conditions may impede a firm's desire to achieve its targeted cash holding levels, we estimate a dynamic model that allows firms to adjust their cash holding levels over time and find evidence consistent with a trade-off type behavior in cash holding levels. We estimate a partial adjustment model and find that firms rapidly correct any deviation from their targeted cash levels. A typical firm in our sample closes this gap within two years. Inconsistent with the agency view of excess cash holdings, we find that cash holding levels for firms with excess cash persists over time compared to those that have a deficit. We also find that smaller firms typically hold excess cash and are quicker to correct deviations than large firms consistent with the view that it is more costly for financially constrained firms to operate at sub-optimal levels of liquid assets.     

Earnings quality and corporate cash holdings

Poor earnings quality exacerbates information asymmetry between internal and external stakeholders of a firm. Agency considerations then persuade investors to discount the value of corporate cash holdings out of concern about the inappropriate use of funds. In this study, we show that poor earnings quality has a negative impact on the value of corporate cash holdings and a positive impact on the level of cash reserves. We find that the negative effect of poor earnings quality either neutralizes or more than offsets the positive effect of excess cash on firm value. Our results are robust to several measures of earnings quality and model specifications.     

Can broker-dealer client surveys provide signals for debt investing?

We use a novel data set to study return predictability in debt markets. The data are collected from J.P. Morgan’s periodic surveys on its clients’ outlook for changes in US Treasury yields and corporate credit spreads. We document that simple signals constructed from such surveys predict excess returns on debt portfolios formed on the basis of duration (2-years minus zero) or credit quality (BBB minus AAA). A linear trading strategy placing equal weight on Treasury and Credit signals has an annualized Information Ratio equal to 1.18, before transaction costs. We also show that predictability is likely to stem from private information possessed by survey respondents rather than from risk premia.     

What do investment banks charge to underwrite American Depositary Receipts?

We investigate how investment banks determine the gross spreads paid by American Depositary Receipts (ADRs) from 1980 to 2004. We begin by comparing the gross spreads of ADR IPOs and ADR SEOs to those of matching US IPOs and US SEOs. We document clustering at the 7% level for our ADR IPO sample (44% for the ADR IPO firms without a previous equity listing), whereas our ADR SEO sample exhibits no discernable clustering at any level. We then find that ADR IPO gross spreads can be explained by firm and offer characteristics (similar to our matched sample of US IPOs), and by whether the ADR IPO firm has a previous equity listing. ADR SEO gross spreads can be explained more by offer characteristics (more similar to our matched sample of US SEOs).     

Housing,consumption and asset pricing

This paper considers a consumption-based asset pricing model where housing is explicitly modeled both as an asset and as a consumption good. Nonseparable preferences describe households’ concern with composition risk, that is, fluctuations in the relative share of housing in their consumption basket. Since the housing share moves slowly, a concern with composition risk induces low frequency movements in stock prices that are not driven by news about cash flow. Moreover, the model predicts that the housing share can be used to forecast excess returns on stocks. We document that this indeed true in the data. The presence of composition risk also implies that the riskless rate is low which further helps the model improve on the standard CCAPM.     

Determinants of corporate cash policy: Insights from private firms

We provide one of the first large sample comparisons of cash policies in public and private U.S. firms. We first show that despite higher financing frictions, private firms hold, on average, about half as much cash as public firms do. By examining the drivers of cash policies for each group, we are able to attribute the difference to the much higher agency costs in public firms. By combining evidence from across public and private firms as well as within public firms across different qualities of governance, we are able to reconcile existing mixed evidence on the effects of agency problems on cash policies. Specifically, agency problems affect not only the target level of cash, but also how managers react to cash in excess of the target.