Tunneling or propping: Evidence from connected transactions in China

Friedman et al. (2003) develop a model in which, in equilibrium, controlling shareholders may choose either tunneling or propping of their listed companies depending on the magnitude of an adverse shock and the magnitude of the private benefits of control. In this paper, we employ connected transaction data from China to test the implications of their model. We hypothesize that, when listed companies are financially healthy (in financial distress), their controlling shareholders are more likely to conduct connected transactions to tunnel (prop up) their listed companies and the market reacts unfavorably (favorably) to the announcement of these transactions. Our empirical findings strongly support our hypotheses. We also find that all of the transaction types in our sample can be used for tunneling or propping depending on different financial situations of the firms. Finally, political connection is negatively associated with the announcement effect. Overall, our analysis supports Friedman et al.'s (2003) model by furnishing clear evidence for propping and tunneling to occur in the same company but at different times.     

Does governance travel around the world? Evidence from institutional investors

We examine whether institutional investors affect corporate governance by analyzing portfolio holdings of institutions in companies from 23 countries during the period 2003–2008. We find that firm-level governance is positively associated with international institutional investment. Changes in institutional ownership over time positively affect subsequent changes in firm-level governance, but the opposite is not true. Foreign institutions and institutions from countries with strong shareholder protection play a role in promoting governance improvements outside of the U.S. Institutional investors affect not only which corporate governance mechanisms are in place, but also outcomes. Firms with higher institutional ownership are more likely to terminate poorly performing Chief Executive Officers (CEOs) and exhibit improvements in valuation over time. Our results suggest that international portfolio investment by institutional investors promotes good corporate governance practices around the world.     

Ineffective corporate governance: Director busyness and board committee memberships

Our paper examines whether holding multiple outside board seats compromises a director’s ability to effectively perform monitoring duties. Analyzing over 1400 firms, we report that individuals who hold more outside directorships serve on fewer board committees. The relation, however, appears non-linear, U-shaped, and in support for both the busyness and the reputation hypotheses. In addition, we find that holding more outside board seats decreases the likelihood of membership on compensation and audit committees. The findings substantiate evidence [Akhigbe, A., Martin, A.D., 2006. Valuation impact of Sarbanes–Oxley: Evidence from disclosure and governance within the financial services industry. Journal of Banking and Finance 30 (3), 989–1006] of value relevance of board committee structures. Additional analysis of committee memberships suggests that women and ethnic minorities are placed on more board committees. Also, directors on smaller and independent boards serve on more committees. Finally, it appears that the Sarbanes–Oxley act had a material impact on the association between the number of multiple board seats and committee memberships.     

Corporate governance and firm value: International evidence

In this paper, we investigate the relation between firm-level corporate governance and firm value based on a large and previously unused dataset from Governance Metrics International (GMI) comprising 6663 firm-year observations from 22 developed countries over the period from 2003 to 2007. Based on a set of 64 individual governance attributes we construct two alternative additive corporate governance indices with equal weights attributed to the governance attributes and one index derived from a principal component analysis. For all three indices we find a strong and positive relation between firm-level corporate governance and firm valuation. In addition, we investigate the value relevance of governance attributes that document the companies' social behavior. Regardless of whether these attributes are considered individually or aggregated into indices, and even when “standard” corporate governance attributes are controlled for, they exhibit a positive and significant effect on firm value. Our findings are robust to alternative calculation procedures for the corporate governance indices and to alternative estimation techniques.     

The effect of board structure on firm value: A multiple identification strategies approach using Korean data

Outside directors and audit committees are widely considered to be central elements of good corporate governance. We use a 1999 Korean law as an exogenous shock to assess whether and how board structure affects firm market value. The law mandates 50% outside directors and an audit committee for large public firms, but not smaller firms. We study this shock using event study, difference-in-differences, and instrumental variable methods, within an overall regression discontinuity approach. The legal shock produces economically large share price increases for large firms, relative to mid-sized firms; their share prices jump in 1999 when the reforms are announced.     

Disclosures of material weaknesses by Japanese firms after the passage of the 2006 Financial Instruments and Exchange Law

We investigate the disclosures of material weaknesses in internal control mandated for Japanese firms under the 2006 Financial Instruments and Exchange Law. We find that the presence of a material weakness is more likely for firms that are younger, have better growth prospects, have a volatile operating environment, are financially constrained, and have weak governance structures. We examine the role of Japan’s main banks in this process and find that the likelihood of a material weakness is higher for firms with stronger links with their main banks. We also show that the financial health of the main banks themselves—proxied for by the banks’ BIS ratios and bad loan ratios—increases the likelihood of a material weakness in affiliated firms. This paper provides novel insights into the determinants of material weaknesses of Japanese firms since the passage of the law. Results from this study contribute to the literature on material weaknesses and relationship banking.     

Great expectations: Banks as equity underwriters

We examine the in-roads commercial banks have made into equity underwriting over 1990–2002. While banks end the period handling upwards of 25% of equity underwriting, this increase results almost exclusively from acquisitions of investment banks with an already established market share of equity underwriting. We find a significant decline in the market share of equity underwriting that banks acquired in the post-merger period, a decline that is larger than that experienced by independent investment banks of comparable reputation. Banks lose market share because they originate fewer IPOs and their IPOs have a lower incidence of follow-on SEOs compared to independent investment banks. Following the merger, banks experience a large fall off in their ability to retain follow-on SEOs and are less successful in winning SEO mandates when an issuer switches from its IPO underwriter. Overall, the findings suggest it has been difficult for banks to achieve scope economies in equity underwriting.     

The anatomy of bank diversification

We use panel data from nine countries over the period 1996–2008 to test how revenue diversification affects bank value. Relying on a comprehensive framework for bank performance measurement, we find robust evidence against a conglomerate discount, unlike studies concerned with industrial firms. Rather, diversification increases bank profitability and, as a consequence also market valuations. This indirect performance effect does not depend on whether diversification was achieved through organic growth or through M&A activity. We further demonstrate that previous results in the literature on the impact of diversification on bank value presumably differ due to the way diversification is measured, and the negligence of the indirect value effect via bank profitability. Our evidence against a conglomerate discount in banking remains robust also during the sub-prime crisis.     

Entrepreneurial finance: Banks versus venture capital

We analyze how entrepreneurial firms choose between two funding institution: banks, which monitor less intensively and face liquidity demands from their own investors, and venture capitalists, who can monitor more intensively but face a higher cost of capital because of the liquidity constraints that they impose on their own investors. Because the firm's manager prefers continuing the firm over liquidating it and aggressive (risky) continuation strategies over conservative (safe) continuation strategies, the institution must monitor the firm and exercise some control over its decisions. Bank finance takes the form of debt, whereas venture capital finance often resembles convertible debt. Venture capital finance is optimal only when the aggressive continuation strategy is not too profitable, ex ante; the uncertainty associated with the risky continuation strategy (strategic uncertainty) is high; and the firm's cash flow distribution is highly risky and positively skewed, with low probability of success, low liquidation value, and high returns if successful. A decrease in venture capitalists’ cost of capital encourages firms to switch from safe strategies and bank finance to riskier strategies and venture capital finance, increasing the average risk of firms in the economy.     

TAKEOVER EXPOSURE, AGENCY, AND THE CHOICE BETWEEN PRIVATE AND PUBLIC DEBT

We examine how governance characteristics are related to the corporate choice between public and private debt. We find that firms with fewer takeover defenses and larger outside blockholder ownership are more likely to borrow from banks and to issue 144A debt. We also document that public debt cost is more sensitive to takeover exposure than bank debt cost. These results are consistent with the hypothesis that banks mitigate the expected negative effect of takeovers on debt value through covenants and debt renegotiations. Moreover, we show that firms with weaker internal monitoring are less likely to borrow from banks.     

Corporate ownership structure and bank loan syndicate structure

Using a novel data set on corporate ownership and control, we show that the divergence between the control rights and cash-flow rights of a borrowing firm's largest ultimate owner has a significant impact on the concentration and composition of the firm's loan syndicate. When the control-ownership divergence is large, lead arrangers form syndicates with structures that facilitate enhanced due diligence and monitoring efforts. These syndicates tend to be relatively concentrated and composed of domestic banks that are geographically close to the borrowing firms and that have lending expertise related to the industries of the borrowers. We also examine factors that influence the relation between ownership structure and syndicate structure, including lead arranger reputation, prior lending relationship, borrowing firm informational opacity, presence of multiple large owners, laws and institutions, and financial crises.     

Ownership structure,risk and performance in the European banking industry

We compare the performance and risk of a sample of 181 large banks from 15 European countries over the 1999–2004 period and evaluate the impact of alternative ownership models, together with the degree of ownership concentration, on their profitability, cost efficiency and risk. Three main results emerge. First, after controlling for bank characteristics, country and time effects, mutual banks and government-owned banks exhibit a lower profitability than privately owned banks, in spite of their lower costs. Second, public sector banks have poorer loan quality and higher insolvency risk than other types of banks while mutual banks have better loan quality and lower asset risk than both private and public sector banks. Finally, while ownership concentration does not significantly affect a bank’s profitability, a higher ownership concentration is associated with better loan quality, lower asset risk and lower insolvency risk. These differences, along with differences in asset composition and funding mix, indicate a different financial intermediation model for the different ownership forms.     

The determinants of shareholder value in European banking

This paper examines the determinants of shareholder value creation for a large sample of European banks between 1998 and 2005. As the recent turmoil in global banking systems has illustrated, bank performance can have a substantial influence on efficient capital allocation, company growth and economic development. We use a dynamic panel data model where the bank’s shareholder value is a linear function of various bank-specific, industry-specific and macroeconomic variables. We show that shareholder value has a positive relationship with cost efficiency changes, while economic profits are linked to revenue efficiency changes. Credit losses, market and liquidity risk and leverage are also found to substantially influence bank performance. These results are robust to a variety of different model specifications.     

Incentive and entrenchment effects in European ownership

In a large sample of European firms we analyze the value discount associated with disproportional ownership structures first documented by Claessens et al. (2002). Consistent with a theoretical model of incentive and entrenchment effects, we find higher value discount in family firms, in firms with low cash flow concentration, and in industries with higher amenity value. Furthermore, the discount is higher in countries with good investor protection and higher for dual class shares than for pyramids. We find no impact on operating performance, likelihood of bankruptcy, dividend policy, or growth. Finally, we discuss policy implications of these findings.     

The colors of investors’ money: The role of institutional investors around the world

We study the role of institutional investors around the world using a comprehensive data set of equity holdings from 27 countries. We find that all institutional investors have a strong preference for the stock of large firms and firms with good governance, while foreign institutions tend to overweight firms that are cross-listed in the U.S. and members of the Morgan Stanley Capital International World Index. Firms with higher ownership by foreign and independent institutions have higher firm valuations, better operating performance, and lower capital expenditures. Our results indicate that foreign and independent institutions, with potentially fewer business ties to firms, are involved in monitoring corporations worldwide.