Capital Account Liberalization and Aggregate Productivity: The Role of Firm Capital Allocation

We study the effects of capital account liberalization on firm capital allocation and aggregate productivity in 10 Eastern European countries. Using a large firm‐level data set, we show that capital account liberalization decreases the dispersion in the return to capital across firms, particularly in sectors more dependent on external finance. We provide evidence that capital account liberalization improves capital allocation by allowing financially constrained firms to demand more capital and produce at a more efficient level. Finally, using a model of misallocation we document that capital account liberalization increases aggregate productivity through more efficient capital allocation by 10% to 16%.     

Capital and Labor Reallocation within Firms

We document how a positive shock to investment opportunities at one plant (“treated plant”) spills over to other plants within the same firm, but only if the firm is financially constrained. To provide the treated plant with resources, the firm's headquarters withdraws capital and labor from other plants, especially plants that are relatively less productive, not part of the firm's core industries, and located far away from headquarters. As a result of the resource reallocation, aggregate firm‐wide productivity increases. We do not find evidence of capital or labor spillovers among plants of financially unconstrained firms.     

Real Options,Volatility, and Stock Returns

We provide evidence that the positive relation between firm‐level stock returns and firm‐level return volatility is due to firms’ real options. Consistent with real option theory, we find that the positive volatility‐return relation is much stronger for firms with more real options and that the sensitivity of firm value to changes in volatility declines significantly after firms exercise their real options. We reconcile the evidence at the aggregate and firm levels by showing that the negative relation at the aggregate level may be due to aggregate market conditions that simultaneously affect both market returns and return volatility.     

The Bright Side of Internal Capital Markets

We examine capital expenditure decisions of discount firms in response to Wal-Mart's entry into their markets. Before Wal-Mart's entry, focused incumbents and discount divisions of diversified incumbents are similar in size, geographic dispersion, and firm debt levels. However, discount divisions of diversified firms are significantly more productive. After Wal-Mart's entry, diversified firms are quicker to either "exit" the discount business or "stay and fight." Also, their capital expenditures are more sensitive to the productivity of their discount business. Internal capital markets function well, as transfers are away from the worsening discount divisions. It appears diversified firms make better investment decisions.     

Biomarker of Quality? Venture‐backed Biotech IPOs and Insider Participation

Corporate financial managers of biotech firms need long‐term financing to reach key milestones, and that requires a long‐ term capital structure. They must balance a mix of investors with different objectives and different investment horizons that includes traditional venture capitalists and also hedge funds and mutual funds. This study helps practitioners understand the complex role of exit decisions, as venture capitalists seek better exit strategies and performance. IPOs are financing but not “exit” moves. In addition to certifying firm value, insider purchasing of shares in the IPO offering has two major consequences. First, venture capitalists reallocate large sums of capital from early‐stage to late‐stage deals that are expected to have lower risk (but also lower expected return) and shorter time to exit. Second, the speed at which VCs exit after the IPO depends on the firm ownership structure after the IPO and the stock liquidity. Going public with a significant participation by venture capitalists will probably increase the post‐IPO ownership and decrease the free float of the stock, implying a delay of the exit and the realization of the capital gains from the investments. Although this study has focused exclusively on the biotechnology industry, insider participation is not unique to it. Biotech's venture brethren in the software and technology industries also have insider participation in IPOs. During 2003–2015, approximately 41 venture‐backed firms outside of the biotechnology sector had insider participation.     

Industry dynamics with stochastic demand

We study the dynamics of an industry subject to aggregate demand shocks where the productivity of a firm's technology evolves stochastically over time. To characterize the intertemporal evolution of the distribution of firms, we discuss in particular how exit decisions, aggregate output, profits, and distributions of firm productivities vary (a) across different demand realization paths; (b) along a demand history path, detailing the effects of continued good or bad market conditions; and (c) for different anticipated future market conditions. We show how poor demand conditions can lead to increased exit of low‐productivity firms at all future dates and states and raise welfare due to the impact on exit decisions.     

Controlling shareholder share pledging and the cost of equity capital: Evidence from China

We propose and test the incentive view—that the margin call pressure and ownership-control discrepancy associated with insider share pledging increase investors’ perceived risk, and thus also the cost of equity capital, in an emerging market. Using a controlling shareholder share pledging sample for Chinese listed firms, we find that firms with share pledging have a cost of equity capital that is 23.7 basis points higher than firms without share pledging. Further, share pledging increases the cost of equity capital through the information risks and agency conflicts channels. Cross-sectional analyses show that share pledging has a stronger effect on the cost of equity capital in non-state-owned enterprises, firms without monitoring of multiple large shareholders, firms with controlling shareholders assuming the position of chairperson, and firms with a weak institutional environment. In addition, using the global financial crisis and the outbreak of the coronavirus (COVID-19) as quasi-natural experiments, we disentangle the potential confounding effect of firm fundamentals and show that share pledging is positively associated with the cost of equity capital. Overall, the results are consistent with our incentive view that share pledging increases the cost of equity capital in an emerging market.     

Organization Capital and the Cross‐Section of Expected Returns

Organization capital is a production factor that is embodied in the firm's key talent and has an efficiency that is firm specific. Hence, both shareholders and key talent have a claim to its cash flows. We develop a model in which the outside option of the key talent determines the share of firm cash flows that accrue to shareholders. This outside option varies systematically and renders firms with high organization capital riskier from shareholders' perspective. We find that firms with more organization capital have average returns that are 4.6% higher than firms with less organization capital.     

Productivity and liquidity management under costly financing

We explore theoretically and empirically the relationship between firm productivity and liquidity management in the presence of financial frictions. We build a dynamic investment model and show that, counter to basic economic intuition, more productive firms could demand less capital assets and hold more liquid assets compared to less productive firms when financing costs are sufficiently high. We empirically test this prediction using a comprehensive dataset of Chinese manufacturers and find that more productive firms indeed hold less capital and more cash. We do not, however, observe this for US manufacturers. Our study suggests a larger capital misallocation problem in markets with significant financing frictions than previously documented.     

Capital structure,equity mispricing,and stock repurchases

We evaluate motives for share repurchases using a unified framework where a firm has a target capital structure and has equity that can be mispriced. We document that capital structure adjustments are a value-increasing motive for repurchases and that the extent to which adjusting capital structure through a repurchase creates value depends on the undervaluation of the firm. Underlevered and undervalued firms enjoy the greatest economic gains from a repurchase, as evidenced by the stock price reaction to the repurchase announcement, and these firms are more likely to announce a share repurchase program.     

Controlling Shareholders’ Incentive and Corporate Tax Avoidance: A Natural Experiment in China

The split share structure reform removes a significant market friction in China's capital market by allowing previously non‐tradable shares to be freely tradable at market prices. Such a reform reduces the agency conflict between controlling shareholders and minority shareholders as the former now care more about stock prices. We find that state‐owned firms, but not non‐state‐owned firms, significantly increased their tax avoidance activities after the reform. We attribute this differential effect to the dual role of the government as state‐owned firms’ controlling shareholder as well as the tax claimant. Further, this effect is more pronounced for state‐owned firms that are more likely to be influenced by the government prior to the reform. Finally, the reform reinforces a positive association between tax avoidance and firm value. Overall, our study suggests that when controlling shareholders are more concerned about stock prices, state‐owned firms engage more in tax avoidance activities to enhance firm value.     

Adopting a Label: Heterogeneity in the Economic Consequences Around IAS/IFRS Adoptions

This study examines liquidity and cost of capital effects around voluntary and mandatory IAS/IFRS adoptions. In contrast to prior work, we focus on the firm‐level heterogeneity in the economic consequences, recognizing that firms have considerable discretion in how they implement the new standards. Some firms may make very few changes and adopt IAS/IFRS more in name, while for others the change in standards could be part of a strategy to increase their commitment to transparency. To test these predictions, we classify firms into “label” and “serious” adopters using firm‐level changes in reporting incentives, actual reporting behavior, and the external reporting environment around the switch to IAS/IFRS. We analyze whether capital‐market effects are different across “serious” and “label” firms. While on average liquidity and cost of capital often do not change around voluntary IAS/IFRS adoptions, we find considerable heterogeneity: “Serious” adoptions are associated with an increase in liquidity and a decline in cost of capital, whereas “label” adoptions are not. We obtain similar results when classifying firms around mandatory IFRS adoption. Our findings imply that we have to exercise caution when interpreting capital‐market effects around IAS/IFRS adoption as they also reflect changes in reporting incentives or in firms’ broader reporting strategies, and not just the standards.     

The Determinants of Corporate Trade Credit Policies in a Bank‐dominated Financial Environment: the Case of Finnish Small Firms

This paper examines trade credit policies of small firms operating in a bank‐dominated environment (Finland). We find that creditworthiness and access to capital markets are important determinants of trade credit extended by sellers. The level of purchases is positively correlated with the level of accounts payable. Larger and older firms and firms with strong internal financing are less likely to use trade credit, whereas firms with a high ratio of current assets to total assets, and firms subject to loan restructurings use it more. Negative loan decisions by financial intermediaries increase and a close bank‐borrower relationship decreases the probability that a firm does not take advantage of trade credit discounts.     

Redacted Disclosure

In this paper we investigate a firm's decision to redact proprietary information from its material contract filings. Information redaction results when the Security and Exchange Commission (SEC) grants a firm's request to withhold information from investors in its material contract filings, presumably because the information is proprietary. We hypothesize that when firms redact information, measures of adverse selection deteriorate. That is, the redaction of proprietary information from material contracts should be associated with: a larger adverse selection component of the bid‐ask spread, reductions in market depth, and lower market turnover. In addition, we conjecture that the decision to redact depends on whether the firm plans on raising capital, the competitiveness of the firm's industry, and the performance of the firm. Overall the results of our analysis generally support our predictions. We find that when firms redact information, contemporaneous measures of the adverse selection component of the bid‐ask spread rise, and market depth and share turnover deteriorate; this suggests an increase in adverse selection. We also find firms are less likely to redact when they issue long‐term debt and are more likely to redact when they are in a competitive industry or experience losses.     

Private and Public Merger Waves

We document that public firms participate more than private firms as buyers and sellers of assets in merger waves and their participation is affected more by credit spreads and aggregate market valuation. Public firm acquisitions realize higher gains in productivity, particularly for on‐the‐wave acquisitions and when the acquirer's stock is liquid and highly valued. Our results are not driven solely by public firms' better access to capital. Using productivity data from early in the firm's life, we find that better private firms subsequently select to become public. Initial size and productivity predict asset purchases and sales 10 and more years later.     

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 Governance and Expected Stock Returns: Evidence from Germany

Recent empirical work shows evidence for higher valuation of firms in countries with a better legal environment. We investigate whether differences in the quality of firm‐level corporate governance also help to explain firm performance in a cross‐section of companies within a single jurisdiction. Constructing a broad corporate governance rating (CGR) for German public firms, we document a positive relationship between governance practices and firm valuation. There is also evidence that expected stock returns are negatively correlated with firm‐level corporate governance, if dividend yields are used as proxies for the cost of capital. An investment strategy that bought high‐CGR firms and shorted low‐CGR firms earned abnormal returns of around 12% on an annual basis during the sample period.     

Sources of Financing,Profitability and Productivity: First Evidence from Matched Firms

This paper contributes to the literature on capital structure and firm performance. Using firm‐level data covering over 11,000 firms from 47 countries over a recent period of 1997‐2007, we address the effect of different sources of financing on corporate performance, employing a matching process, which allows an adequate `like‐for‐like’ comparison between high and low level of financing by firms. Robust to different matching estimators, the main findings are consistent with the theories of capital structure, in that firms with high debt‐to‐equity ratio tend to have lower returns to shareholders (profitability) and lower internal efficiency (productivity). The results become more robust when we separate the firms into advanced and emerging country‐groups or countries with high/low levels of financial development. Given the lower level of leverage below 50% on average in emerging markets (or in countries with lower level of financial reforms), firms in these economies face lower risk of financial distress and thereby less adverse effect on firm profitability and productivity, relative to their counterparts in advanced economies. We also find that retained earnings and equity financing improve performance, while debt financing by firms particularly in the form of bank loans leads to lower performance, although not so in the case of debt raised through issuing bonds.     

Aggregate external financing and savings waves

US data display aggregate external financing and savings waves. Firms can allocate costly external finance to productive capital, or to liquid assets with low physical returns. If firms raise costly external finance and accumulate liquidity, either the cost of external finance is relatively low or the total return to liquidity accumulation, including its shadow value as future internal funds, is particularly high. We formalize this intuition by estimating a dynamic model of firms׳ financing and savings decisions, and use our model along with firm level data to construct an empirical estimate of the average cost of external finance from 1980 to 2014.     

Is a VC Partnership Greater Than the Sum of Its Partners?

This paper investigates whether individual venture capitalists have repeatable investment skill and the extent to which their skill is impacted by the venture capital (VC) firm where they work. We examine a unique data set that tracks the performance of individual venture capitalists' investments over time and as they move between firms. We find evidence of skill and exit style differences even among venture partners investing at the same VC firm at the same time. Furthermore, our estimates suggest the partners' human capital is two to five times more important than the VC firm's organizational capital in explaining performance.