Shareholder governance, bondholder governance, and managerial risk-taking

We examine the relation between the overall corporate governance structure and managerial risk-taking behavior. We find that the overall governance structure has a significant impact on how managers make decisions on investment policy: strong bondholder governance motivates more low-risk investments such as capital expenditure and lower high-risk investments such as R&D expenditures, whereas weak shareholder governance (entrenched managers) leads to more R&D expenditures. Moreover, we find that the effects of governance on investment policy differ significantly between speculative and investment-grade firms. For speculative firms, strong bondholder or shareholder governance leads to more capital expenditures and low R&D investments. For investment-grade firms, strong bondholder or shareholder governance leads to low capital expenditures and an insignificant impact on R&D investments. Furthermore, financing and investment covenants exhibit strong binding power to deter risky investments. Finally, a more dependent (or a less independent) board is associated with low capital expenditures and high R&D investments.     

CEO Ownership and Discretionary Investments

Abstract:  This study investigates empirically the relationship between CEO ownership and discretionary investments such as R&D and capital expenditures. We assert that the under-investment problem is high for R&D-intensive projects, while the over-investment problem is high for capital expenditures because of differences in risk between the two types of investments. Building on the linkages between investments and investment-related agency problems, we hypothesize that the relationship between CEO ownership and investments depends on whether increasing ownership mitigates or exacerbates the under- or over-investment problem. We find a non-linear association between CEO stock ownership and R&D investments; R&D investments increase and then decline across increasing levels of ownership. Further, we find that R&D investments and CEO stock options are positively associated at high levels of option holdings. In contrast, capital expenditures do not vary with CEO ownership (stock or options). Finally, consistent with our underlying assumption, we find that the influence of R&D investments on future firm risk is significantly larger than that of capital expenditures. Our findings indicate that managerial risk aversion affects discretionary investments.     

R&D investments,capital expenditures,and earnings thresholds

Prior studies find that firms cut research and development (R&D) expense in response to earnings considerations. We extend this stream of research by documenting that firms narrowly achieving an earnings threshold also report unusually high capital expenditures. In addition, these firms’ total investments (R&D expense plus capital expenditures) do not vary in response to earnings thresholds, which suggests that, on average, reductions in R&D expense are offset by concurrent increases in capital expenditures. Lastly, our research design allows us to infer that the increased capital expenditures are largely R&D investments that are capitalized instead of non-R&D capital expenditures, suggesting that overall investments in R&D are relatively unchanged.     

The unintended real effects of short selling in an emerging market

Exploiting the staggered removal of short-sale bans in China, we document unintended real effects of allowing short selling in an emerging market featured by concentrated ownership and weak investor protection. Pilot firms have worse short-term and long-term market performances after the removal of short-sale bans. Additionally, pilot firms undertake less risk and have worse performance following the launch of the program. The effect is stronger when controlling shareholders' private benefit is large and when corporate governance is weak. Faced with increased short selling threats, pilot firms cut capital investments and R&D expenditures, reduce equity financing, and lower debt ratios. Contrary to prior studies showing that short selling encourages value-enhancing risky investments in developed markets, our findings suggest that in emerging markets such as China, short selling can result in value losses by inducing firms to forgo profitable risky projects.     

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.     

R&D sensitivity to asset sale proceeds: New evidence on financing constraints and intangible investment

We examine the intersection between corporate divestitures of tangible assets and investment in intangible capital (R&D) to provide new tests for the impact financing constraints have on real activity. A positive R&D sensitivity to asset sale proceeds indicates binding financing constraints since cash inflows from tangible asset sales are negatively correlated with productivity shocks and not otherwise connected to intangible investment via non-financial channels. Using a variety of estimation approaches, we document a strong, positive link between cash inflows from fixed asset sales and corporate R&D investment, but only among firms most likely facing binding financing constraints. These results offer robust evidence that financing frictions impact the increasingly important yet understudied intangible corporate investments that drive innovative activity, and they highlight a previously unexplored but potentially valuable use of proceeds from fixed asset divestitures.     

Do institutional investors exacerbate managerial myopia?

This study analyzes corporate expenditures for property, plant and equipment (PP&E), and research and development (R&D) for over 2500 US firms from 1988 to 1994. We find no support for the contention that institutional investors cause corporate managers to behave myopically. Indeed, we document a positive relation between industry-adjusted expenditures for PP&E and R&D and the fraction of shares owned by institutional investors. This relation is robust to a variety of empirical tests, including those that account for endogeneity between institutional ownership and firm-level discretionary expenditures.     

The size,concentration and evolution of corporate R&D spending in U.S. firms from 1976 to 2010: Evidence and implications

The use of research and development (R&D) spending as an empirical proxy for managerial discretion, information asymmetry and growth opportunities, is pervasive in empirical corporate finance research. Underlying this is the implicit assumption that firms choose levels of R&D to maximize value, given firm and industry characteristics. An alternative framework views the level of R&D spending as subject to idiosyncratic behavior as managers myopically manipulate R&D expenditures to meet short-term earnings goals. Using aggregate firm and industry level data, we find evidence consistent with the view that R&D is determined by firm and industry characteristics. Time invariant firm and industry fixed effects explain most of the cross-sectional variation in observed R&D spending, while time-varying factors like size, profitability, or market-to-book explain little of the cross-sectional variation. We find that R&D spending continues to grow faster than advertising and capital expenditures. We also find no evidence of managerial myopia as corporate aggregate R&D expenditures are growing faster than aggregate profitability and the number of firms that undertake R&D has increased over the period from 1976 to 2010.     

Corporate investment and changes in GAAP

This paper investigates whether changes in Generally Accepted Accounting Principles (GAAP) affect corporate investment decisions. Using a sample containing forty nine changes in GAAP, I find that changes in accounting rules affect investment decisions. I then examine two mechanisms through which changes in GAAP affect investment. First, I find that changes in GAAP affect investment, particularly R&D expenditures, when firms have financial covenants that are affected by changes in GAAP. Second, I find evidence suggesting that the process of complying with some changes in GAAP alters managers’ information sets and consequently changes their investment decisions, particularly their capital and R&D expenditures and, to a weaker extent, their acquistion expenditures. This paper contributes to the literature on the real effects of accounting by providing evidence that accounting rules affect investment decisions even when the rule change does not concern the measurement and reporting of investment, and by documenting specific mechanisms through which the relation manifests.     

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.     

The Association of R&D and Capital Expenditures with Subsequent Earnings Variability

Abstract:  We estimate the association of investments in R&D and in physical assets (CAPEX) with subsequent earnings variability. We estimate these relations in different time periods and across industries. We find that R&D contributes to subsequent earnings variability more than CAPEX only in relative R&D-intensive industries – industries in which R&D is relatively more intensive than physical capital. In physical assets-intensive industries, we do not find similar relations. The findings suggest that with respect to subsequent earnings variability, fundamental differences between investment information about R&D and CAPEX exist. However, they are mainly noticeable in firms that operate in relatively R&D-intensive industries. The evidence also suggests there was a shift in the relations between R&D and CAPEX over time. Our findings contribute to the debate on accounting for R&D expenditures.     

GSIB status and corporate lending

Global Systemically Important Banks (GSIBs) face additional capital requirements and closer supervision. We study how closer supervision affects corporate credit supply and investigate consequences for firms. GSIB designations reduce lending on average by 5.9% but to risky firms by 7.2%. The consequences are lower asset, sales, and investment growth, especially among high-risk borrowers, and reduced R&D expenditures among all GSIB-dependent firms. Closer supervision therefore reduces banks' risk-taking but has potentially unintended implications for firms' ability to finance innovation, which seems to crucially depend on bank credit. The supervision-induced effects are larger than those attributed to GSIB-specific capital surcharges.     

Legal shareholder protection and corporate R&D investment

This paper investigates the effects of shareholder protection law on corporate R&D investment. I find that the institutional protection of shareholder benefits reduces both underinvestment and overinvestment in R&D projects. Legal shareholder rights significantly increase R&D investment for firms that may underinvest, but reduce R&D for firms that may overinvest. Shareholder protection further enhances the growth of firms in R&D intensive industries, and promotes the economic growth of innovative countries. The results consistently show that enforcing stronger legal shareholder protection can help firms achieve an overall more efficient capital allocation to productive R&D investment.     

Cash holdings and R&D smoothing

The sharp increase in R&D investment in recent decades has important but unexplored implications for corporate liquidity management. Because R&D has high adjustment costs and is financed with volatile sources, it is very expensive for firms to adjust the flow of R&D in response to transitory finance shocks. The main contribution of this paper is to directly examine whether firms use cash reserves to smooth their R&D expenditures. We estimate dynamic R&D models and find that firms most likely to face financing frictions rely extensively on cash holdings to smooth R&D. In particular, our estimates suggest that young firms used cash holdings to dampen the volatility in R&D by approximately 75% during the 1998–2002 boom and bust in equity issues. Firms less likely to face financing frictions appear to smooth R&D without the use of costly cash holdings. Our findings provide new insights into the value of liquidity and the financing of intangible investment, and suggest that R&D smoothing with cash reserves is now important for understanding cash management for a substantial fraction of publicly traded firms.     

Access to private equity and real firm activity: Evidence from PIPEs

We study how access to private equity financing affects real firm activities using a broad panel of publicly traded U.S. firms that raise external equity through private placements (PIPEs) between 1995 and 2008. The public firms relying on PIPEs are generally small, high-tech firms that cannot finance investment internally and likely face severe external financing constraints; PIPEs are by far the most important source of finance for these firms. We show that firms use PIPE inflows to maintain extremely high R&D investment ratios and to build substantial cash reserves. We also use GMM techniques that control for firm-specific effects and the endogeneity of the decision to raise private equity and find that PIPE funding has a substantial impact on corporate investment in cash reserves and R&D, and a smaller but significant impact on investment in non-cash working capital, but little impact on fixed investment or acquisitions. Our estimates indicate that R&D investment initially increases by $0.20–$0.25 for each dollar of private equity flowing into the firm, and that PIPE funds initially invested in cash ultimately go to R&D. These findings offer direct evidence that access to private equity finance has an important effect on the key input that drives innovation at the firm- and economy-wide levels.     

Did financing constraints cause investment stagnation in Japan after the 1990s?

Has investment by Japanese firms been affected by financing constraints since the collapse of the asset price bubble? This study answers the question while improving on the weaknesses of the models used in previous studies. It employs panel data for Japanese listed firms in four R&D-intensive industries. We divide our sample by firm size and examine three periods with different economic environments: the first half of the “two lost decades” from 1991 to 2000, the second half of the ‘two lost decades’ from 2001 to 2009, and the period following the ‘two lost decades’ from 2010 to 2016. We construct new investment functions based on the Euler equation by considering both physical and R&D investment factors to remove estimator bias, thus enabling us to determine whether firms face financing constraints accurately. The estimation results indicate that there were financing constraints on both R&D and physical investments by large listed firms from 1991 to 2000 and from 2010 to 2016. Conversely, the weak growth of both R&D and physical investments by small listed firms from 2010 to 2016 was not attributed to financing constraints but the lack of productive investment opportunities. Different policy measures are needed depending on whether the investment is stagnant due to financing constraints or the lack of investment opportunities.     

Corporate responsibility towards employees and innovation: Evidence from an emerging market

Against a background of rising labor costs and the need to build a harmonious labor–capital relationship in China, this paper focuses on non-pecuniary incentives for employees and discusses the impact of corporate social responsibility (CSR) towards employees on innovation performance. The empirical results show that CSR towards employees significantly promotes corporate innovation, and that this effect remains robust after accounting for alternative proxies and endogeneity issues. In addition, the positive effect of CSR towards employees on innovation is more significant for firms in high-tech industries, with high levels of R&D inputs and high valuation of employee collaboration. Further analysis indicates that CSR towards employees does not promote R&D investment, but does significantly improve innovation efficiency and the marginal output of R&D investment and reduces the turnover rate of management-level staff with production and R&D backgrounds, which is conducive to stability of the innovation team. In addition, this paper also finds that for companies with high R&D expenditures, CSR towards employees significantly eases the sensitivity between executive turnover and performance, which helps executives resist pressure arising from a decline in short-term performance. The findings of this paper have implications for improving labor–capital relations and enhancing firm innovation capabilities.     

Corporate governance and cash holdings: Evidence from worldwide board reforms

Using staggered board reforms as a quasi-natural experiment and a difference-in-differences approach, this study examines the impact of corporate governance on cash holdings in 41 countries. We find that board reforms are followed by significant reductions in cash holdings. This effect is more pronounced for firms with weaker pre-reform corporate governance and for firms from countries with weaker institutional environments. Analysis of cash spending suggests that, following board reforms, firms are more likely to use cash to increase R&D expenditures, dividend payouts, and share repurchases, but not to increase capital or acquisition expenditures. Finally, the results indicate that enhanced corporate governance following board reforms leads to higher (lower) cash (dividend payouts) values, consistent with the view that board reforms strengthen corporate governance.     

The Effects of Ownership Structure and Intragroup Loans on Leverage: Evidence from Family Firms in Chile

This article examines the effects of family control and pyramidal ownership on firms’ capital structure decisions. After studying a sample of listed family and nonfamily firms in Chile, we find that families take a conservative approach to debt and financial risk exposure. We test the hypothesis that family firms restrict the use of debt in order to avoid the monitoring role of creditors, which could limit their enjoyment of the private benefits of control. In keeping with this hypothesis, we find a U-shaped relationship between leverage and the degree of pyramidal ownership that is more pronounced among family firms than nonfamily firms. We do not find any evidence that is consistent with the hypothesis that family-controlled firms have low leverage ratios due to their access to internal capital markets. In fact, conversely, we find that listed family firms provide more loans to related companies than comparable nonfamily firms.     

The Effects of Private Investments in Public Equity on R&D Investment in Small and Medium-Size Enterprises

This paper provides evidence that small and medium-size enterprises (SMEs) use a portion of private investments in public equity (PIPEs) for current research and development (R&D) investment, hold the rest in liquidity reserves such as cash assets and working capital, and ultimately use these reserves to smooth R&D investment. That is, PIPEs may have a direct effect on R&D investment and an indirect or smoothing effect using liquidity reserves. This paper also shows that innovative SMEs such as venture businesses, inno-biz firms, and management innovative firms are more likely to use PIPEs for R&D investment than are noninnovative SMEs. The implications of this paper are that PIPEs can be used as an important source of external financing to fund R&D investment and can be particularly valuable for R&D investment in innovative SMEs.