Does CEO reputation matter for capital investments?

This paper examines the association between CEO reputation and corporate capital investments. The efficient contracting hypothesis predicts a positive association between CEO reputation and wealth effects of corporate capital investments. In contrast, the rent extraction hypothesis predicts that the wealth effects of capital investments are negatively associated with CEO reputation. We find that the stock market's responses to announcements of capital investments are more favorable for firms with more reputable CEOs. Moreover, CEO reputation mitigates the negative stock price reaction associated with announcements of capital investments by firms with high free cash flow and low growth opportunities. Additional analysis indicates that firms with more reputable CEOs exhibit significantly better post-investment operating performance improvements than those with less reputable CEOs, especially in firms with high free cash flow and low growth opportunities. Collectively, our results suggest that the efficient contracting hypothesis dominates the rent extraction hypothesis in terms of net economic impact of capital investments on the investing firm.     

Do corporate tax cuts increase investments?

This paper studies the effect of corporate taxes on investment. Since firms with a foreign parent have more cross-country profit shifting opportunities than domestically owned firms do, their effective tax rate and, consequently, their tax-induced costs to investment are lower. We therefore expect capital investment responses to a corporate tax cut to be heterogeneous across firms. Using firm-level data on German corporations, we exploit the 2008 tax reform, which substantially cut corporate taxes as an exogenous policy shock and expect domestically owned firms' investments to be more responsive to the reform. We show exactly this in a difference-in-differences setting. We find that the reduction in corporate tax payments led to a one-to-one increase in the real investments of domestic firms. The effect is stronger for domestic firms relying more on internal funds. Correspondingly, labor investment increased more for domestic firms, ensuring a constant mix of input factors. In addition, we show that domestic firms' sales grew faster after the tax cut than the sales of foreign-owned firms. Our results imply that corporate tax changes can increase corporate investment but that domestic firms benefit more than foreign-owned firms from a tax cut through higher investment responses resulting in greater sales growth.     

Target Firm Returns: Does the Form of Payment Affect Abnormal Returns?

Research indicates that at the time of a takeover announcement, target firm shareholders receiving cash earn larger abnormal returns than those receiving stock. Our work confirms that cash targets receive larger direct payments from bidders and that the size of target firm abnormal returns is related to the relative size of this direct payment. Once we control for the size of the payment, however, we find the target firm abnormal returns to be unrelated to the payment method. Thus the relationship between payment method and target firm abnormal returns is indirect. This finding is important because it casts doubt on the signaling (asymmetric information) hypothesis. That is, cash offers do not seem to be valued by the market as a means of reducing this uncertainty. Something else, such as the tax implication differences between cash and stock offers, drives cash target firms to demand larger payments from bidding firms.     

The Choice of Payment Method in European Mergers and Acquisitions

We study merger and acquisition (M&A) payment choices of European bidders for publicly and privately held targets in the 1997–2000 period. Europe is an ideal venue for studying the importance of corporate governance in making M&A payment choices, given the large number of closely held firms and the wide range of capital markets, institutional settings, laws, and regulations. The tradeoff between corporate governance concerns and debt financing constraints is found to have a large bearing on the bidder's payment choice. Consistent with earlier evidence, we find that several deal and target characteristics significantly affect the method of payment choice.     

Corporate Takeovers: Mode of Payment, Returns and Trading Activity

This paper examines the impact of takeover bids and, in particular, the method of payment to the shareholders of the target firms on the returns, trading activity and bid-ask spreads of target and bidding firms traded on the London Stock Exchange. It suggests that the shareholders of target firms benefit substantially from takeover activity while the shareholders of bidding firms do not suffer. The combined value of the firms engaged in takeover activity increases by a small percentage during the event period. However, the benefit from a takeover announcement to the shareholders of the target firm varies from year to year and has declined in the recent past. The magnitude of excess returns available to the shareholders is also dependent on the mode of payment. Prices of target (bidding) firms increase (decrease) most if the shareholders of the target firms are given an option to receive payment in shares or in cash. The findings also reveal that during the event period trading activity in target and bidding companies increases depending on the form in which payments to shareholders are made. In response to this increased liquidity, the bid-ask spreads of target and bidding firms decline during the event period.     

The Responsiveness of Corporate Investments to Changes in Corporate Income Taxation During the Financial Crisis: Empirical Evidence from Slovenian Firms

I examine the responsiveness of corporate investments to changes in corporate income taxation during the financial crisis. When investigating tax effects in financially constrained firms, the model of investment demand needs to be extended to include an additional channel through which taxes could affect investments. I model the tax effects via two transmission channels, the traditional user cost of capital channel and the cash flow channel, which is crucial for financially constrained firms. The empirical results show that corporate investments in financially constrained firms do not respond to changes in corporate income taxation through the user cost of capital channel, but there is strong evidence of the effect that materializes through the cash flow channel.     

Board reforms and innovation

We study the effect of board reforms on firms' research and development (R&D) investments utilizing a sample of 41 countries. Using a difference-in-differences analysis, we find that firms invest more in R&D following corporate governance reforms. Of these, two legal reforms — having an independent audit committee and board independence — have a greater impact on R&D investment. Additionally, we show that board reforms have a more pronounced effect on R&D investment in hi-tech industries and the health sector.     

Internal controls,risk management,and cash holdings

Exploiting a unique setting in China where internal controls are intended to manage risks, we investigate how internal controls shape the cash holding policies. Results show that firms with higher internal control quality (ICQ) are less likely to have abnormal cash holdings, either excess or deficit cash, and this effect is not driven by corporate governance quality. We also find that firms with higher ICQ are more likely to increase dividend payments and are less likely to increase M&A investments, especially when the firms have had a negative experience with prior M&A investments. Furthermore, our tests on the market valuation of cash holdings show that investors place a higher value on cash holdings of firms with higher ICQ. Collectively, our findings suggest that internal controls help companies shape reasonable cash policies that lead to value creation.     

Dividend Payouts and Information Shocks

We examine changes in firms’ dividend payouts following an exogenous shock to the information asymmetry problem between managers and investors. Agency theories predict a decrease in dividend payments to the extent that improved public information lowers managers’ need to convey their commitment to avoid overinvestment via costly dividend payouts. Conversely, dividends could increase if minority investors are in a better position to extract cash dividends. We test these predictions by analyzing the dividend payment behavior of a global sample of firms around the mandatory adoption of IFRS and the initial enforcement of new insider trading laws. Both events serve as proxies for a general improvement of the information environment and, hence, the corporate governance structure in the economy. We find that, following the two events, firms are less likely to pay (increase) dividends, but more likely to cut (stop) such payments. The changes occur around the time of the informational shock, and only in countries and for firms subject to the regulatory change. They are more pronounced when the inherent agency issues or the informational shocks are stronger. We further find that the information content of dividends decreases after the events. The results highlight the importance of the agency costs of free cash flows (and changes therein) for shaping firms’ payout policies.     

Mergers, Method of Payment and Returns to Manager- and Owner-Controlled Firms

Previous work provides evidence of disparate consequences for acquiring firms initiating stock and cash merger exchanges. These studies show that the choice of payment method and the subsequent consequences may be a result of dissimilar motivations. This paper addresses the role of corporate control by examining the consequences of stock, cash and mixed exchanges to manager- and owner-controlled firms. Particular attention is paid to mixed exchanges as a test of the total consequences of acquisition activity. The results indicate that the market valuation of the acquiring firm's stock is related to both the method of payment and the acquiring firm control structure.     

Substitution of Noncash Payment Instruments for Cash in Europe

The substitution of noncash (check, giro, credit and debit card) payments for cash transactions is of interest for monetary policy and for determining central banks' future seigniorage revenue. We develop a novel method for approximating the share of cash transactions using public information on currency stocks, noncash payments, and card payment technology for 10 European countries. We also provide a forecast of future cash use by country. The trend in cash substitution across countries is quite similar, but the countries themselves are at significantly different stages in this process. The spread of debit and credit card payments has been the key factor behind the substitution away from cash as the use of electronic cash is still in its infancy.     

Pension return assumptions and shareholder-employee risk-shifting

Firm managers of defined-benefit (DB) pension plan sponsors reveal their primary motives — risk-shifting or risk-management — through their assumed expected rates of return (ERRs) on the plan assets. Managers with risk-shifting motives choose high ERRs to exploit flexible internal financing from employees via pension underfunding. Those with risk-management motives choose low ERRs to reduce future cash-flow uncertainty by improving the pension funding status. We examine if ERRs predict the firms’ future cash-flow allocation between pension funding and corporate investments, in a Japanese sample that mitigates the selection bias concern for US DB plan sponsors. Using dynamic panel regressions that control for lagged dependent variables, firms’ business prospects, and unobserved fixed effects, we show that higher ERRs precede higher capital investments, R&D expenses, and net pension obligations while revealing managerial aggression, especially among firms with high external financing costs. Higher ERRs predict higher market-to-book ratios for the firms with larger R&Ds and/or underfunding, suggesting that the risk-shifting channel of internal financing with high ERRs can help alleviate underinvestment problems.     

Private Equity and Local Public Finances

We study the economic impact of private equity (PE) investments on local governments, which are important corporate stakeholders. Examining over 11,000 deals and private firm data in Europe, we document that target firms' effective tax rates and total tax expenses decrease by 15% and 13% after PE deals. At the same time, target firms expand their capital expenditures and firm boundaries, but do not increase employment. Using administrative data on the public finances of German municipalities and exploiting the geographical and time-series variation in PE deals, we document that PE activity is negatively associated with local governments' tax revenues and spending. This result is likely driven by reduced tax payments of PE portfolio firms, accompanied by only modest positive spillovers of PE investments on regional economic growth. Collectively, our findings suggest that corporate tax efficiency serves as a cost-cutting channel in the PE sector and constrains the finances of local governments.     

Liquid asset sheltering,or cost of capital? The effect of political corruption on corporate cash holdings

I posit that political corruption affects firms through an entrenchment between entrepreneurs and politicians instead of coercive extortion. Based on this postulate, I refute the claim that firms in a more corrupt environment hold less cash due to liquid assets sheltering from political extraction. Instead, I propose that firms in a more corrupt environment hold less cash because of the high cost of capital. In fact, I find that firms in more corrupt countries hold cash beyond their optimum for the given cost of carry due to severe financial constraints. This excess cash results in value destruction. I call this phenomenon the financial effect of corruption. Thus, I challenge the conventional wisdom and argue that the effects of political corruption on corporate cash holdings are primarily indirect through financial mechanisms.     

Local Taxes and Capital Structure Choice

This paper investigates the question of taxation and capital structure choice in Germany. Germany represents an excellent case study for investigating the question of whether and to what extent taxes influence the debt-equity decision of firms, because the relative tax burdens on debt and equity vary greatly across communities. German communities levy local taxes on profits and long-term debt payments in addition to personal and corporate taxes on the federal level. A stylized model is presented incorporating these taxes. The model shows that local taxes create substantial incentives for firms to use debt financing. Furthermore, the paper empirically investigates the effect of local business taxes on the share of debt used to finance incremental investments by German firms. I find that local taxes significantly influence the capital structure choice of firms, controlling for a large number of other factors. In an extensive sensitivity analysis the tax effect are found to be robust across several different specifications.     

An International Analysis of Dividend Payment Behavior

Abstract:  This study investigates patterns in dividend payment across nine common law and sixteen civil law countries over 1994-2007. We begin by examining whether the recent decline in the number of dividend payers is solely a US phenomenon or part of a more global trend. We find that at the beginning of our sample period, 72% of our sample firms pay dividends, but by 2007, this percentage decreases to 55%, with the decline more acute in common law countries. Our analysis further shows that the growing incidence of non-dividend paying firms can be explained by an increase in the percentage of firms that have never paid dividends. We find that common law firms are less likely to initiate new dividend programs than those in civil law nations, although they tend to have more abundant growth opportunities. We further establish that this global decline in the propensity to pay dividends is more pronounced in firms incorporated in common law jurisdictions. Finally, we find that both the percentage increase in aggregate dividends and the dividend payout ratio is higher in civil law countries.     

Managerial Ownership, the Method of Payment for Acquisitions, and Executive Job Retention

This study investigates how acquiring and target firm managers' preferences for control rights motivate the payment for corporate acquisitions. We expect that managers of target firms who value influence in combined firms will prefer to receive stock. One reason top managers desire influence is to enhance their chances of retaining jobs in the combined firm. Our analysis shows a strong, positive association between managerial ownership of target firms and the likelihood of acquisitions for stock. We also find that managers of target firms are more likely to retain jobs in combined firms when they receive stock rather than cash.     

Corporate Governance and Its Impact on R&D Investment in Emerging Markets

Corporate R&D activities are inherently risky but also difficult to monitor. Against this background, we examine the impact of ownership concentration and legal shareholder rights protection on corporate R&D investments in emerging markets. Based on a comprehensive sample of publicly listed firms from 24 countries, we find that R&D intensity is lower in firms with (strategic) block ownership, and this effect is more pronounced in countries with stronger shareholder rights protection. This suggests that, similar to the situation in developed economies, dispersed ownership, which allows shareholders to diversify their investment risks, is beneficial for corporate R&D and that this effect is intensified by more developed institutions.     

Adverse Selection, Moral Hazard, and Outlier Payment Policy

In this article, we analyze the rationale for introducing outlier payments into a prospective payment system for hospitals under adverse selection and moral hazard. The payer has only two instruments: a fixed price for patients whose treatment cost is below a threshold     and a cost-sharing rule for outlier patients. We show that a fixed-price policy is optimal when the hospital is sufficiently benevolent. When the hospital is weakly benevolent, a mixed policy solving a trade-off between rent extraction, efficiency, and dumping deterrence must be preferred. We show how the optimal combination of fixed price and partially cost-based payment depends on the degree of benevolence of the hospital, the social cost of public funds, and the distribution of patients severity.     

A cross-country comparison of corporate governance and firm performance: Do financial structure and the legal system matter?

We blend the corporate governance and the financial structure/legal system literature streams to study whether firm performance is enhanced when its governance structure embodies the demands of the host country’s financial structure and legal system. Using a sample of 1736 unique firms representing 22 countries, we find that the joint effect of a country’s financial structure and legal system does matter when explaining the relationship between performance and the overall level of corporate governance in a given country. The results also suggest that firms operating in the market/common combination countries tend to command higher market valuations than firms with a comparable level of corporate governance that operate in the bank/civil combination countries.