Tunneling through intercorporate loans: The China experience

This study investigates a particularly brazen form of corporate abuse, in which controlling shareholders use intercorporate loans to siphon billions of RMB from hundreds of Chinese listed companies during the 1996–2006 period. We document the nature and extent of these transactions, evaluate their economic consequences, examine factors that affect their cross-sectional severity, and report on the mitigating roles of auditors, institutional investors, and regulators. Collectively, our findings shed light on the severity of the minority shareholder expropriation problem in China, as well as the relative efficacy of various legal and extra-legal governance mechanisms in that country.     

The economics of conflicts of interest in financial institutions

A conflict of interest exists when a party to a transaction can gain by taking actions that are detrimental to its counterparty. This paper examines the growing empirical literature on the economics of conflicts of interest in financial institutions. Economic analysis shows that, although conflicts of interest are omnipresent when contracting is costly and parties are imperfectly informed, there are important factors that mitigate their impact and, strikingly, it is possible for customers of financial institutions to benefit from the existence of such conflicts. The empirical literature reaches conclusions that differ across types of conflicts of interest but are overall more ambivalent and certainly more benign than the conclusions drawn by journalists and politicians from mostly anecdotal evidence.     

Insider trading law enforcement and gross spreads of ADR IPOs

Using American Depositary Receipt (ADR) IPOs from 34 countries during 1980-2004, we find that, on average, the enforcement of insider trading laws reduces the underwriter gross spread by 49-61 basis points, which is about 10-12% of the average gross spread for ADR IPOs. This relation is present regardless of whether issuers have a prior listing or whether issuers are from developed or emerging markets. The association becomes stronger for ADRs underwritten by less prestigious underwriters and for issuers that are involved in privatization. The political institutions in the issuers’ home markets also affect gross spreads.     

Escape from New York: The market impact of loosening disclosure requirements

We examine the first significant deregulation of U.S. disclosure requirements since the passage of the 1933/1934 Exchange and Securities Acts: the 2007 Securities and Exchange Commission (SEC) Rule 12h-6. Rule 12h-6 has made it easier for foreign firms to deregister with the SEC and thereby terminate their U.S. disclosure obligations. We show that the market reacted negatively to the announcement by the SEC that firms from countries with weak disclosure and governance regimes could more easily opt out of the stringent U.S. reporting and legal environment. We also find that since the rule's passage, an unprecedented number of firms have deregistered, and these firms often had been previous targets of U.S. class action securities lawsuits or SEC enforcement actions. Our findings suggest that shareholders of non-U.S firms place significant value on U.S. securities regulations, especially when the home country investor protections are weak.     

Evidence on the international evolution and convergence of corporate governance regulations

The issue of appropriate corporate governance framework has been a focal point of recent reforms in many countries. This study provides a comprehensive comparative analysis of corporate governance regulatory systems and their evolution since 1990 in 30 European countries and the US. It proposes a methodology to create detailed corporate governance indices which capture the major features of capital market laws in the analyzed countries. The indices indicate how the law in each country addresses various potential agency conflicts between corporate constituencies: namely, between shareholder and managers, between majority and minority shareholders, and between shareholders and bondholders. The analysis of regulatory provisions within the suggested framework enables us to understand better how corporate law works in a particular country and which strategies regulators adopt to achieve their goals. The 15-year time series of constructed indices and large country-coverage also allows us to draw conclusions about the convergence of corporate governance regimes across the countries.     

The market reaction to corporate governance regulation

This paper investigates the market reaction to recent legislative and regulatory actions pertaining to corporate governance. The managerial power view of governance suggests that executive pay, the existing process of proxy access, and various governance provisions [e.g., staggered boards and Chief Executive Officer (CEO)-chairman duality] are associated with managerial rent extraction. This perspective predicts that broad government actions that reduce executive pay, increase proxy access, and ban such governance provisions are value-enhancing. In contrast, another view of governance suggests that observed governance choices are the result of value-maximizing contracts between shareholders and management. This perspective predicts that broad government actions that regulate such governance choices are value destroying. Consistent with the latter view, we find that the abnormal returns to recent events relating to corporate governance regulations are, on average, decreasing in CEO pay, decreasing in the number of large blockholders, decreasing in the ease by which small institutional investors can access the proxy process, and decreasing in the presence of a staggered board.     

When are outside directors effective?

This paper uses recent regulations that have required some companies to increase the number of outside directors on their boards to generate estimates of the effect of board independence on performance that are largely free from endogeneity problems. Our main finding is that the effectiveness of outside directors depends on the cost of acquiring information about the firm: when the cost of acquiring information is low, performance increases when outsiders are added to the board, and when the cost of information is high, performance worsens when outsiders are added to the board. The estimates provide some of the cleanest estimates to date that board independence matters, and the finding that board effectiveness depends on information cost supports a nascent theoretical literature emphasizing information asymmetry. We also find that firms compose their boards as if they understand that outsider effectiveness varies with information costs.     

Do independent directors cause improvements in firm transparency?

Although recent research documents a positive relation between corporate transparency and the proportion of independent directors, the direction of causality is unclear. We examine a regulatory shock that substantially increased board independence for some firms, and find that information asymmetry, and to some extent management disclosure and financial intermediation, changed at firms affected by this shock. We also examine whether these effects vary as a function of management entrenchment, information processing costs, and required changes to audit committee independence. Our results suggest that firms can alter their corporate transparency to suit the informational demands of a particular board structure.     

The consequences to managers for financial misrepresentation

We track the fortunes of all 2,206 individuals identified as responsible parties for all 788 Securities and Exchange Commission (SEC) and Department of Justice (DOJ) enforcement actions for financial misrepresentation from January 1, 1978 through September 30, 2006. Fully 93% lose their jobs by the end of the regulatory enforcement period. Most are explicitly fired. The likelihood of ouster increases with the cost of the misconduct to shareholders and the quality of the firm's governance. Culpable managers also bear substantial financial losses through restrictions on their future employment, their shareholdings in the firm, and SEC fines. A sizeable minority (28%) face criminal charges and penalties, including jail sentences that average 4.3 years. These results indicate that the individual perpetrators of financial misconduct face significant disciplinary action.     

Equity home bias and corporate disclosure

I show that more comprehensive corporate disclosure reduces investors’ uncertainty about domestic companies’ payoffs at no cost, thereby decreasing investors’ equity home bias toward a country. Since investors should base their investment decisions on valid and easily interpretable company information only, more comprehensive disclosure will reduce the home bias only if domestic securities law is sufficiently stratified and domestic companies use international accounting standards. Using panel data for 38 countries from 2003 to 2008 I find that more comprehensive disclosure reduces investors’ home bias, though significantly only for countries that sufficiently enforce their securities law and implement international accounting standards.     

Underpricing of IPOs: Firm-, issue- and country-specific characteristics

Using a large firm-level dataset of 2920 IPOs from 21 countries we examine the impact of country-level institutional characteristics on the underpricing of IPOs. Through hierarchical linear modeling we are able to control for firm-specific and issue-specific characteristics and test whether country-specific institutional characteristics add explanatory power to explain the level of underpricing. Our results show that about 10% of the variation in the level of underpricing is between countries. The quality of a country’s legal framework, as measured by its level of investor protection, the overall quality of its legal system and its level of legal enforcement, reduces the level of underpricing significantly.     

Political relationships,global financing,and corporate transparency: Evidence from Indonesia

This study examines the role of political connections in firms’ financing strategies and their long-run performance. We view political connections as an example for domestic arrangements which can reduce the benefits of global financing. Using data from Indonesia, we find that firms with strong political connections are less likely to have publicly traded foreign securities. As a result, estimates of the performance consequences of foreign financing are severely biased if value-creating domestic arrangements such as political relationships are ignored. Connections not only alter firms’ financing strategies, they also influence long-run performance. Tracking returns across several regimes, we show that firms have difficulty re-establishing connections with a new government when their patron falls from power, leading closely connected firms to underperform under the new regime and subsequently to increase their foreign financing.     

Bankruptcy law and corporate investment decisions

Major European countries have recently adopted bankruptcy codes that strengthen entrepreneurs’ power to renegotiate outstanding liabilities. Renegotiation in bankruptcy allows lenders to increase recovery rates, however it also weakens the contract’s ability to solve the moral hazard problem embedded in the production project. Hinging on this trade-off, I show in which circumstances a soft bankruptcy law that resembles Chapter 11 in the balance of lenders’ and entrepreneur’s rights encourages the choice of investments that privilege the achievement of long-term results. However, I also show that, in contrast to the common wisdom, soft bankruptcy can lead to the choice of investments that are biased towards the achievement of short-term outcomes.     

Investor relations,reputational bonding,and corporate governance: The case of Royal Ahold

Royal Ahold (Koninklijke Ahold NV) was one of the major success stories in the 1990s and is one of the major failures, suffering a complete meltdown, in 2003. We investigate the strategy, investor relations, accounting transparency and corporate governance of Ahold; these elements jointly drive the firm’s performance over the past decade. Investor relations and its implications are an important but under researched aspect of the market’s belief formation process. For Ahold, investor relations is an important component of reputational bonding [Siegel, J., 2005. Can foreign firms bond themselves effectively by renting US securities laws? Journal of Financial Economics 75, 319–359]. Our clinical study documents investor relations’ influence on investor expectations. We then provide an in-depth analysis of the strategy, accounting transparency and corporate governance that lead to Ahold’s downfall. We provide insights and implications into these relationships that present theory and empirical studies have not fully addressed.     

Internal corporate governance,CEO turnover,and earnings management

The likelihood and speed of forced CEO turnover – but not voluntary turnover – are positively related to a firm's earnings management. These patterns persist in tests that consider the effects of earnings restatements, regulatory enforcement actions, and the possible endogeneity of CEO turnover and earnings management. The relation between earnings management and forced turnover occurs both in firms with good and bad performance, and when the accruals work to inflate or deflate reported earnings. These results indicate that boards tend to act proactively to discipline managers who manage earnings aggressively, before the manipulations lead to costly external consequences.     

The impact of investor protection law on corporate policy and performance: Evidence from the blue sky laws

Recent studies have debated the impact of investor protection law on corporate behavior and value. I exploit the staggered passage of state securities fraud statutes (“blue sky laws”) in the United States to estimate the causal effects of investor protection law on firm financing decisions and investment activity. The statutes induce firms to increase dividends, issue equity, and grow in size. The laws also facilitate improvements in operating performance and market valuations. Overall, the evidence is strongly supportive of theoretical models that predict investor protection law has a significant impact on corporate policy and performance.     

The impact of governance reform on performance and transparency

This study examines the influence of Mexico’s efforts to improve corporate governance on firm performance and transparency. We utilize compliance data from the Code of ‘Best’ Corporate Practices, disclosed annually by public firms in Mexico, as a measure of corporate governance strength. We document a significant increase in compliance over 2000–2004 indicating Mexican companies view non-compliance as costly. However, we find no association between the governance index and firm performance, nor is there a relation with transparency. Instead, we find firms with greater compliance resort to the more costly mechanism of making dividend payments (higher propensity to pay and greater yield) to reduce agency conflicts. We conclude these associations are the direct result of the institutional features of the Mexican business environment, which is characterized by concentrated ownership of insiders, interlocked boards of directors, a lack of insider trading enforcement, and generally poor protection of minority investors. Our results show that monitoring mechanisms alone are not enough to fundamentally change economic behavior.     

Earnings quality effect of state antitakeover statutes

Existing theories suggest two opposite effects that antitakeover protection may have on earnings management: the exacerbating effect and the mitigating effect. We use the introduction of state antitakeover laws during the mid- to late-1980s as a natural experiment to test the relationship between antitakeover protection and earnings quality. The results show that firms incorporated in states that passed the laws have lower magnitudes of abnormal accruals and higher levels of earnings informativeness in the post-passage periods, suggesting that antitakeover protection mitigates earnings management and enhances earnings quality. Further evidence shows that reductions in earnings management are concentrated in firms with low firm-level antitakeover protection and in firms with serious agency problems, and that the earnings management effect of state antitakeover laws is likely to be of short-term duration.     

CAN STOCK MARKET LIBERALIZATION IN EMERGING ECONOMIES MITIGATE LEGAL SYSTEMS DEFICIENCIES?

We document positive valuation effects around the time of stock market liberalization. We find that the valuation effects are larger for countries with civil law traditions compared with countries with common law origins. Similarly, we find that countries with weaker shareholder protections exhibit greater market valuation increases compared with countries with stronger shareholder protections. The results reinforce the importance of country legal systems and of shareholder protections in determining the quality of corporate governance systems and financial market outcomes. The findings suggest that stock market liberalization may mitigate deficiencies in the existing institutional environments not supportive of effective corporate governance systems.     

The effects of cross-border cooperation on disclosure enforcement,earnings attributes,and transparency

This study tests for changes in U.S.-listed foreign firms’ financial reporting properties and transparency when their home market regulators enter an arrangement that facilitates enforcement cooperation with the Securities and Exchange Commission. This arrangement—the International Organization of Securities Commissions’ Multilateral Memorandum of Understanding Concerning Consultation and Cooperation and the Exchange of Information (MMoU)—has explicit disclosure-related provisions. I show that the MMoU is associated with improvements across various measures of accounting properties and transparency. Collectively, the findings help resolve enduring questions about why the earnings quality of U.S.-listed foreign firms diverged from that of U.S. firms during pre-MMoU periods.