The Default Risk of Swaps

We characterize the exchange of financial claims from risky swaps. These transfers are among three groups: shareholders, debtholders, and the swap counterparty. From this analysis we derive equilibrium swap rates and relate them to debt market spreads. We then show that equilibrium swaps in perfect markets transfer wealth from shareholders to debtholders. In a simplified case, we obtain closed-form solutions for the value of the default risk in the swap. For interest-rate swaps, we obtain numerical solutions for the equilibrium swap rate, including default risk. We compare these with equilibrium debt market default risk spreads.     

The effects of financial distress and capital structure on the work effort of outside directors

This paper investigates the conflict of interests between shareholders and debtholders by examining the work effort of outside directors when a company experiences financial distress or has a high financial leverage. We find that at both company level and individual director level: (i) outside directors of a firm with higher financial distress exert less work effort in controlling for financial leverage; (ii) outside directors of a firm with a higher financial leverage work harder controlling for financial distress.     

Outside monitoring and CEO compensation in the banking industry

We hypothesize that CEO compensation is optimally designed to trade off two types of agency problems: the standard shareholder-management agency problem as well as the risk-shifting problem between shareholders and debtholders. Analyses in this setup produces two predictions: (1) the pay-for-performance sensitivity of CEO compensation decreases with the leverage ratio; and (2) the pay-for-performance sensitivity of CEO compensation increases with the intensity of outside monitoring on the firm's risk choice. We test these two hypotheses for the banking industry where regulators and nondepository (subordinated) debtholders provide outside monitoring on the risk choice. We construct an index of the intensity of outside monitoring based on three variables: subordinated debt rating, non performing loan ratio and examination rating assigned by regulators. We find supporting evidence for both hypotheses.     

Do shareholder protection and creditor rights have distinct effects on the association between debt maturity and ownership structure?

This study examines the effects of the firm's ownership concentration and its institutional environment on corporate debt maturity choices. As ownership concentration and debt maturity are alternative governance mechanisms, we theorize and investigate whether their association is influenced by country-level governance factors that enhance outside monitoring by minority shareholders and debtholders. Our investigation is based on a dataset of 50,599 firm-year observations from 38 countries. We use a propensity-score matching approach and find that the effect of ownership concentration on debt maturity is conditional to country-level governance attributes. Ownership concentration has a negative effect on debt maturity in countries where both shareholder protection and creditor rights are weak. Ownership concentration, however, tends to lengthen debt maturity as protection increases, and this positive effect on the length of debt maturity is stronger in countries enhancing protection towards debtholders (instead of shareholders). We also explore other characteristics of ownership structure, such as the identity and presence of controlling shareholders. These results corroborate the view that entrenched shareholders may use debt maturity opportunistically. Our study provides new insights into the interplay between firm- and country-level governance mechanisms and a deeper understanding of cross-country differences in the association between ownership structure and debt financing.     

Board and Monitoring Committee Independence

This study focuses on the composition of boards of directors and their monitoring committees (audit and compensation) for large Australian companies. For firms whose boards use a committee structure, much of the monitoring responsibility of the board is expected to rest with the independent committee members. We document a positive association between the proportion of independent directors on the full board and its monitoring committees, and a greater proportion of independent directors on both audit and compensation committees than the full board. Our hypotheses tests involve an examination of the impact of other mechanisms used to control agency conflicts on full board and committee independence, and the association between this independence and firm value. We find that full board independence is associated with low management ownership and an absence of substantial shareholders. Audit committee independence is associated with reduced monitoring by debtholders when leverage is low. While we predict a positive relationship between board and monitoring committee independence and firm value, our results do not support this conjecture.     

Large Shareholders,the Board of Directors and the Allocation of Cash Proceeds from Corporate Asset Sell‐offs

Recent finance literature suggests that managers of divesting firms may retain cash proceeds from corporate asset sell‐offs in order to pursue their own objectives, and, therefore, shareholders' gains due to these deals are linked to a distribution of proceeds to shareholders or to debtholders. We add to this literature by examining the role of various corporate governance mechanisms in the context of the allocation of sell‐off proceeds. Specifically, we examine the impact of directors' share‐ownership and stock options, board composition and external large shareholdings on (1) shareholders' abnormal returns around asset sell‐off announcements, and (2) managers' decision to either retain or distribute (to shareholders or to debtholders) sell‐off proceeds. We find that non‐executive directors' and CEO's share‐ownership and stock options are related to shareholders' gains from sell‐offs for firms that retain proceeds. However, corporate governance mechanisms are not significantly related to shareholders' gains for firms that distribute sell‐off proceeds. Furthermore, we find that the likelihood of a distribution of proceeds, relative to the retention decision, is increasing in large institutional shareholdings, executive and non‐executive directors' share‐ownership and non‐executive representation in the board.     

Should corporate debt include a rating trigger?

Recent corporate debt offerings have included a covenant specifying a pre-determined payment to debtholders when the debt is downgraded. We examine the incentive for equityholders to increase firm risk (and the associated costs) when debt includes a “rating trigger.” Equityholders of firms with a low-risk profile and operating flexibility choose debt with a trigger, while equityholders of firms with a high-risk profile and less flexibility choose regular debt. A trigger that requires an equity infusion better mitigates conflicts between equityholders and debtholders than a trigger paid by liquidating assets. A trigger that increases the coupon rate is not optimal.     

Large Shareholder Entrenchment and Performance: Empirical Evidence from Canada

Abstract:  Recent empirical evidence indicates that the largest publicly traded companies throughout the world have concentrated ownership. This is the case in Canada where voting rights are often concentrated in the hands of large shareholders, mostly wealthy families. Such concentrated ownership structures can generate specific agency problems, such as large shareholders expropriating wealth from minority shareholders. These costs are aggravated when large shareholders don't bear the full costs of their decisions because of the presence of mechanisms (dual class voting shares, pyramids) which lead to voting rights being greater than the cash flow rights (separation). We assess the impact of separation on various performance metrics while controlling for situations when the large shareholder has (1) the opportunity to expropriate (high free cash flows in the firm) and (2) the incentive to expropriate (low cash flow rights). We also control for when the large shareholder has the power to expropriate (high voting rights, outright control and insider management) and for the presence of family ownership. The results support our hypotheses and indicate that firm performance is lower when large shareholders have both the incentives and the opportunity to expropriate minority shareholders.     

The role of financial reporting in debt contracting and in stewardship

In this paper, I review the role that financial accounting plays in contracts aimed at mitigating agency problems between shareholders and managers and between shareholders and debtholders. The paper discusses the reasons why and how financial accounting numbers are used in debt and stewardship contracting. It further considers the effects of conservatism and fair-value accounting on the relevance of financial reports for contracting. The paper provides some key takeaways from academic literature for accounting practice and regulation.     

Investment Policy and Exit-Exchange Offers Within Financially Distressed Firms

This article examines the conflict of interest between shareholders and bondholders in a setting in which firms can renegotiate the terms of existing debt with public debtholders. In particular, we consider one of the most common types of debt restructuring: the exit-exchange offer. Our analysis explores the relation between exit-exchange offers and investment choice by the manager, and it concludes that managers, acting strategically on behalf of shareholders, may select inefficient investment projects in order to enhance their bargaining position vis-a-vis creditors. Holding the upside potential of an investment project fixed, managers/shareholders prefer projects with lower payoffs in states of bankruptcy because it induces individual bondholders to accept poorer terms in a debt-for-debt exit-exchange offer, thus generating a greater residual for shareholders in states of solvency. Additionally, we show how the investment inefficiencies in our analysis depend on (i) the inability of bondholders to coordinate their actions; (ii) the ability of managers to commit to suboptimal investment projects; and (iii) the coupling of an individual bondholder's decision to tender and her decision to consent to allow the firm to strip fiduciary covenants. We suggest conditions under which a ban on coupled exit-exchange offers—or alternatively, constraints on “debt-for-debt” exchanges—would be efficiency-enhancing.     

The economic determinants of depreciation accounting in late nineteenth-century Britain

This paper examines the economic incentives for unregulated companies, in late nineteenth-century Britain, to disclose in their published accounts the fact that they had charged depreciation. We argue that the disclosure will be positively associated with whether a company has outside shareholders and long-term debtholders, profitability, extent of depreciable assets, appointment of a professional auditor, and size. These hypotheses are tested using 150 British companies from the years 1880/81, 1889/90 and 1899/01. Our results indicate that whether depreciation was charged is related to profitability and, to a lesser extent, to the presence of outside shareholders, long-term debt holders and the appointment of a professional auditor. However, the amount of depreciation charged is related only to profitability and appears to be opportunistically determined.     

Pricing Options with Extendible Maturities: Analysis and Applications

Many common types of financial contracts incorporate options with extendible maturities. This paper derives closed-form expressions for options that can be extended by the optionholder and presents a number of applications including the valuation of American options with stochastic dividends, junk bonds, and shared-equity mortgages. We also derive closed-form expressions for writer-extendible options and discuss the writer's economic incentives for extending an out-of-the-money option. We apply these results to show that corporate debtholders have a strong incentive to extend the maturity of defaulting debt if there are liquidation costs. We model and solve the debtholders' optimal extension problem and show that the possibility of an extension can induce shareholders in highly levered firms to accept negative NPV projects.     

Bailouts,the incentive to manage risk,and financial crises

A firm's termination leads to bankruptcy costs. This may create an incentive for outside stakeholders or the firm's debtholders to bail out the firm as bankruptcy looms. Because of this implicit guarantee, firm shareholders have an incentive to increase volatility in order to exploit the implicit protection. However, if they increase volatility too much they may induce the guarantee-extending parties to “walk away.” I derive the optimal risk management rule in such a framework and show that it allows high volatility choices, while net worth is high. However, risk limits tighten abruptly when the firm's net worth declines below an endogenously determined threshold. Hence, the model reproduces the qualitative features of existing risk management rules, and can account for phenomena such as “flight to quality.”     

Does good governance matter to debtholders? Evidence from the credit ratings of Japanese firms

Consistent with existing evidence based on US firms, we show that good governance is associated with higher credit ratings. The most significant variables are institutional ownership and disclosure quality. This finding suggests that active monitoring (by large shareholders) and lower information asymmetry (through better disclosures) mitigate agency conflicts and reduce the risk to debtholders. Credit ratings are also found to increase with board size, consistent with a moderation effect in large decision-making groups. As a rule, firms are expected to benefit from better governance by being able to access funding at a lower cost and in larger amounts.     

Do bankers on the board reduce crash risk?

Commercial banker‐directors (CBDs) bring both financial expertise in risk management and conflicts of interest between shareholders and debtholders. The burgeoning literature on stock price crash risk generates important questions of whether CBDs reduce crash risk. Using BoardEx data from 1999 to 2009, we find supporting evidence that the firms with CBDs experience lower stock price crash risk. Moreover, the reduction of crash risk is more pronounced for high‐risk firms under the monitoring of affiliated banker‐directors. The results of this study are robust to the Heckman selection model, propensity score matching, and alternative measures of crash risk.     

A Reexamination of the Tradeoff between the Future Benefit and Riskiness of R&D Increases

Many previous studies document a positive relation between research and development (R&D) and equity value. Though R&D can increase equity value by increasing firm value, it can also increase equity value at the expense of bondholder wealth through an increase in firm risk because equity is analogous to a call option on the underlying firm value. Shi [2003] tests this hypothesis by examining the relation between a firm's R&D intensity and its bond ratings and risk premiums at issuance. His results show that the net effect of R&D is negative for bondholders. We reexamine Shi's [2003] findings and in so doing make three contributions to the literature. First, we find that Shi's [2003] results are sensitive to the method of measuring R&D intensity. When we use what we argue is a better measure of R&D intensity, we find that the net effect of R&D is positive for bondholders. Second, when we use tests that Shi [2003] recognizes are even better than the ones that he uses, we find even stronger evidence of the positive effect of R&D on bondholders. Third, we examine cross‐sectional differences in the effect of R&D on debtholders. Consistent with our main finding, we document a negative relation between R&D increases and default risk. The default risk reduction is also more pronounced for firms with higher initial default scores (where the debtholders have more to gain from an R&D increase) and for firms with more bank debt (where the debtholders have greater covenant protection from the possible detriments associated with R&D increases).     

Executive Compensation in UK Property Companies

We study the drivers of executive compensation in the listed UK property sector. The UK provides an excellent opportunity to analyze executive compensation due to high transparency in the different components of executive compensation. We show that company size is the most important variable in explaining the level of executive compensation. We find that absolute and relative share performance significantly explains long-term compensation, that management style has a distinct influence on the level of executive compensation, and that using alternative monitoring mechanisms (institutional shareholders, debtholders, and outside directors) leads to higher levels of long-term incentives. We find only weak evidence of pay-performance sensitivity for both cash and long-term compensation. Executive shareholdings provide a much stronger link between pay and performance than does executive compensation.

政府干预、大股东资产注入:支持抑或掏空

政府干预企业经营活动是普遍存在的现象。本文研究了国有控股上市公司资产注入中的"支持"、"掏空"现象。研究发现,政府控股股东比民营控股股东资产注入的动机更强烈。当上市公司盈利时,政府控股股东通过向上市公司注入资产"掏空"上市公司的动机比民营控股股东更加强烈,从而导致盈利的国有控股上市公司在资产注入之后业绩下降更多;而当政府控股上市公司被ST时,政府控股股东通过向国有控股上市公司注入资产"支持"上市公司的动机和力度比民营控股股东更加强烈,从而导致ST国有控股上市公司在资产注入之后业绩增长更快。     

Entrenched controlling shareholders and the performance consequences of corporate diversification in Taiwan

The main purpose of this paper is to examine the value/performance effects of corporate diversification in an emerging market. Prior evidence on this issue is still mixed. The present study adds the role of entrenched controlling shareholders into this issue. We argue that when controlling shareholders have larger excess board seats control rights, they have higher ability and incentive to expropriate minority shareholders through corporate diversification. Using a sample of firms listed on the Taiwan Stock Exchange in 2003, we find that controlling shareholders’ excess board seats control is negatively associated with the market valuation of corporate diversification. Consistently, we also document that highly diversified firms run by more entrenched controlling shareholders have lower future financial performance than otherwise similar firms. Overall, our findings imply that corporate diversification is not necessarily harmful or beneficial for firms. We conclude that the agency problem arising from the excess board seats control rights owned by controlling shareholders is an influential factor leading to negative performance consequences with regard to firm diversification.     

UNIVERSAL BANKS ARE NOT THE ANSWER TO AMERICA'S CORPORATE GOVERNANCE "PROBLEM": A LOOK AT GERMANY, JAPAN, AND THE U.S.

This article objects to a recent tendency of legal and economic scholars to "romanticize" the corporate governance role of German universal banks and Japanese main banks. There are potential conflicts between banks' interests as lenders and as shareholders that are likely to make banks less-than-ideal monitors for outside shareholders. Citing evidence that Japanese corporate borrowers pay above-market interest rates for their bank financing, Macey and Miller interpret the high interest rates as "rents" earned by Japanese banks on their loan portfolios in exchange for (1) insulating incumbent management of borrower firms from hostile takeover and (2) accepting suboptimal returns on their equity holdings.
The main problems with the German and Japanese systems stem from their failure to produce well-developed capital markets. Concentrated and stable shareholdings reduce the order flow in the market, thereby depriving the market of liquidity. And the lack of capital market liquidity– combined with the intense loyalty of the banks towards incumbent management–removes the ability of outside shareholders to make a credible threat of takeover if managerial performance is substandard.
The problem with American corporate governance–if indeed there is one–is not that hostile takeovers are bad, but that there are not enough of them due to regulatory restrictions and misguided legal policies. While U.S. law should be amended to give banks and other debtholders more power over borrowers in the case of financial distress, encouraging U.S. banks to become large stockholders is not likely to improve corporate efficiency. Strengthening the "voice" of American equity holders by eliminating restrictions on the market for corporate control would be the most effective step in improving firm performance.