Monitoring via staging: Evidence from Private investments in public equity

I study the causes and consequences of staging in the setting of private investments in public equities (PIPEs). I find that, in PIPE investments, as in venture capital staging, the staging strategy is used by investors as a monitoring mechanism to mitigate information asymmetry and agency problems. Moreover, strategic investors and investors investing alone are more likely to utilize staging. I show also that staging reduces the cost of financing and has positive implications for PIPE issuers’ long-run stock performance.     

Debt and managerial rents in a real-options model of the firm

We present a theory of capital investment and debt and equity financing in a real-options model of a public corporation. The theory assumes that managers maximize the present value of their future compensation (managerial rents), subject to constraints imposed by outside shareholders’ property rights to the firm's assets. Absent bankruptcy costs, managers follow an optimal debt policy that generates efficient investment and disinvestment. We show how bankruptcy costs can distort both investment and disinvestment. We also show how managers’ personal wealth constraints can lead to delayed investment and increased reliance on debt financing. Changes in cash flow can cause changes in investment by tightening or loosening the wealth constraints. Firms with weaker investor protection adopt higher debt levels.     

Who gets credit after bankruptcy and why? An information channel

Conventional wisdom holds that individuals find it difficult to obtain new credit post-bankruptcy. Using credit bureau data, we test this hypothesis and show that more than 90% of bankrupt individuals receive credit shortly after filing. Individuals with good credit history prior to filing have reduced credit availability after bankruptcy while those with ex-ante low credit quality receive more credit. We show that credit supplied to low quality individuals is severely curtailed during the financial crisis. We also find that the default probability on new debt increases after bankruptcy, especially among individuals with high ex-ante credit score. These findings are consistent with an information channel, in which bankruptcy reveals new information about a borrower’s credit quality.     

Collateral,debt capacity,and corporate investment: Evidence from a natural experiment

This paper examines how a shock to collateral value influences firms’ debt capacities and investments. Using a source of exogenous variation in collateral value provided by the land market collapse in Japan, I find that collateral has a statistically and economically significant impact on corporate investments. I also provide direct evidence on the workings of such a collateral channel. Exploiting a unique dataset of matched bank-firm lending, I show that firms with greater collateral losses are less likely to sustain their banking relationships and tend to obtain a smaller amount of bank credit.     

Information asymmetry and firms’ credit market access: Evidence from Moody's credit rating format refinement

I exploit Moody's 1982 credit rating refinement to examine its effects on firms’ credit market access, financing decisions, and investment policies. While firms’ ex ante yield spread can partially predict the direction of refinement changes, firms with refinement upgrades experience an additional decrease in their ex post borrowing cost compared with firms with downgrades. The former subsequently also issue more debt and rely more on debt financing over equity than the latter. Lastly, upgraded firms have more capital investments, less cash accumulation, and faster asset growth than downgraded firms. These findings show that credit market information asymmetry significantly affects firms’ real outcomes.     

Evidence on the insurance effect of bankruptcy exemptions

Defaulting on one’s debts when experiencing an adverse event can help insure households against unexpected income risks. But the effect of allowing default on debt levels is ambiguous, not least because lenders may restrict access to credit. Hence the optimal punishment for bankruptcy is unclear. The US states allows householders to keep a variety of assets when filing for bankruptcy – the ‘bankruptcy exemptions’ – and these exemptions change substantially between states and over time. By exploiting these differences this study shows that raising the exemptions (i) marginally decreases the level of unsecured debt that household’s hold; (ii) makes consumption smoother. Thus, despite the effect on debt levels, the generous provisions to debtors in arrears may be helping US households to insure themselves against income risk.     

Building legal indexes to explain recovery rates: An analysis of the French and English bankruptcy codes

The paper analyzes the characteristics of bankruptcy procedures that may impact on creditors’ recoveries. We propose 132 legal indexes accounting for the main functions of bankruptcy codes: namely, the accessibility of the procedures, their ability to disclose information, the protection of debtor’s assets, the coordination of the claimants and their decision power, and the sanction of management. The French procedures are more protective of the debtor’s assets and prioritize the coordination of claims. In England, liquidation procedures protect more secured claims, while unsecured creditors have more decision power under reorganization procedures. Our indexes are then used to explain recovery rates on a set of 833 bankrupt SMEs. Several bankruptcy rules are associated with higher recoveries: namely, accessibility of the procedure, protection of the debtor’s assets, protection of claims, and sanction of faulty management. On the contrary, information disclosure has negative impact on recoveries, probably due to the breach in confidentiality.     

Was audit quality of Laventhol and Horwath poor?

Laventhol and Horwath (L&H), the then seventh largest accounting firm in the US, declared bankruptcy in November 1990. The firm claimed that its bankruptcy was due to the perception of it being a deep pocket rather than inherent deficiencies in its performance. In this study, we examine whether the audit quality of L&H was lower than other auditors. Results do not show that L&H is associated with lower quality audits either in terms of lower likelihood of issuing modified audit opinion, higher levels of discretionary accruals for its clients, or lower predictability of discretionary accruals for future non-discretionary net income for its clients than for clients of other auditors. Results of additional tests also do not suggest that auditors that take up clients of L&H report differently from L&H. This evidence does not support the proposition that L&H’s audit quality was less than audit quality of other audit firms during the period leading up to the bankruptcy.     

Cooperative investments induced by contract law

I revisit the economic analysis of contract law for a setting of cooperative investments. While Che and Chung (1999) have shown that expectation damages perform rather poorly, I argue that this negative result follows from their implicit assumption of unilateral expectation damages. Yet the very nature of cooperative investments gives rise to the possibility that both parties may claim expectation damages. I show that such a regime of bilateral expectation damages provides the incentives for the first‐best solution even in a framework of binary choice where, for selfish investments, the traditional overreliance result would hold.     

Tunneling and propping: A justification for pyramidal ownership

This paper links existence of the pyramidal ownership structure to tunneling and propping. Tunneling refers to a transfer of resources from a lower-level firm to a higher-level firm in the pyramidal chain, whereas propping concerns a transfer in the opposite direction intended to bail out the receiving firm from bankruptcy. We show that tunneling alone cannot justify the pyramidal structure unless outside investors are myopic, since rational outside investors anticipate tunneling and adjust their willingness-to-pay for the firm’s shares accordingly. With propping, however, they may be willing to be expropriated in exchange for implicit insurance against bankruptcy.     

Do financial markets care about SRI? Evidence from mergers and acquisitions

Mergers and acquisitions offer a framework for shedding new light on the stock market performance of socially responsible investments (SRI). We use Innovest’s Intangible Value Assessment (IVA) ratings as a measure of firms’ ability to cope with social and environmental risks. The IVA ratings allow us to uncover a positive relation between acquirer gains and the level of the target’s social and environmental risk management practices. Our findings suggest that the stock market rewards the acquirer for making socially and environmentally responsible investments. We also document that the environmental and social performance of the acquirer increases following the acquisition of a SRI aware target. These results are consistent with acquirer learning from the target’s SRI practices and experiences.     

What is behind the magic of O-Score? An alternative interpretation of Dichev’s (1998) bankruptcy risk anomaly

Using Ohlson’s (J Account Res 18(1):109–131, 1980) measure of bankruptcy risk (O-Score), Dichev (J Fin 53(3):1131–1147, 1998) documents a bankruptcy risk anomaly in which firms with high bankruptcy risk earn lower than average returns. This study first demonstrates that the negative association between bankruptcy risk and returns does not generalize to an alternative measure of bankruptcy risk. Then, by examining the nine individual components of O-Score, I find that funds from operations (FFO) is the only component that is associated with returns. Furthermore, I show that the return-predictive power of FFO is due to cash flows from operations. Taken as a whole, this study provides evidence that Dichev’s bankruptcy risk anomaly is a manifestation of investors’ under (over)-pricing of cash flows (accrual) component of earnings, i.e., the accrual anomaly documented by Sloan (Account Rev 71(3):289–316, 1996).     

Assessing the Probability of Bankruptcy

We assess whether two popular accounting-based measures, Altmans (1968) Z-Score and Ohlsons (1980) O-Score, effectively summarize publicly-available information about the probability of bankruptcy. We compare the relative information content of these Scores to a market-based measure of the probability of bankruptcy that we develop based on the Black–Scholes–Merton option-pricing model, BSM-Prob. Our tests show that BSM-Prob provides significantly more information than either of the two accounting-based measures. This finding is robust to various modifications of Z-Score and O-Score, including updating the coefficients, making industry adjustments, and decomposing them into their lagged levels and changes. We recommend that researchers use BSM-Prob instead of Z-Score and O-Score in their studies and provide the SAS code to calculate BSM-Prob.     

Bidding into the Red: A Model of Post-Auction Bankruptcy

This paper investigates auctions where bidders have limited liability. First, we analyze bidding behavior under different auction formats, showing that the second‐price auction induces higher prices, higher bankruptcy rates, and lower utilities than the first‐price auction. Second, we show that the cost of bankruptcy critically affects the seller's preference over the choice of auction. If bankruptcy is very costly, the seller prefers the first‐price auction over the second‐price auction. Alternatively, if the bankrupt assets are resold among the losers of the initial auction, the seller prefers the second‐price auction.     

Extending the Basel II approach to estimate capital requirements for equity investments

Under the Basel II banking regulatory capital regime the capital requirements for credit exposures are calculated using the Asymptotic Single Risk Factor (ASRF) approach. The capital requirement is taken to be the contribution of an exposure to the unexpected loss on the bank’s diversified portfolio. Here we extend this approach to calculate capital requirements for equity investments. We show that in the case when asset values have a normal distribution an analytical formula for the unexpected loss contribution may be developed. We show that the capital requirements for equity investments are quite different to those of credit exposures, since equity investments can suffer substantial loss of value even when the underlying company has not defaulted.     

Intangibles: The soft side of innovation

The ‘soft side’ of the innovation process is easily ignored. Nonetheless it is crucial in understanding the complexity of innovation processes and competitiveness in a knowledge-based, de-materialized economy. This article focuses on intangible investments as a component of this soft side of innovation practice. First, we will introduce and discuss the concept and meaning of intangible investments. Next, we will illustrate the growing significance of intangibles by considering examples from five industries (producing clothes and fashion, flowers, beer, publishing and financial services). Synthesizing the results from these five cases, we will link the role of intangible investments with service functions in innovation practice. Finally, we will discuss some emerging implications for both future business strategy and policy-making.     

Institutional arrangements and debt financing

I find that institutional arrangements have an impact on the real economy by affecting firms’ choice between private and public debt and the subsequent financing costs. Using new debt issued by firms in 26 non-US countries, I find, after controlling for firm characteristics predicted by debt agency and information asymmetry theories, that the level of financial market development, the efficiency of bankruptcy procedure, the integrity and enforceability of laws, and the transparency of financial information have significant impacts not only on firms’ debt choice and yield to maturity in domestic debt market, but also their issuance choice in the international debt market.     

The choice of ADRs

We study the determinants of a firm’s decision to issue one of the four available ADR programs (Level I, Level II, Level III, and Rule 144A). We find that the firm’s attributes (size, income, asset growth, leverage, privatization, ownership structure, and country-of-origin) and the firm’s home-country institutional variables (accounting rating and legal protection of minority shareholders) condition this choice. We also examine the issuing activity and the determinants of the ADR choice before and after the enactment of the Sarbanes–Oxley (SOX) Act. Following this structural change, we provide evidence of a reallocation between ADR programs. Compared to the pre-SOX period, firms from emerging markets, and those from countries with weak legal protection of minority shareholders, are more likely after SOX to choose Rule 144A and Level III, respectively.     

The Enron Bankruptcy: When did the options market in Enron lose it’s smirk?

The Enron Corporation went from a $65 billion dollar market capitalization to bankruptcy in just 16 months. Using statistical techniques for extracting the implied probability distributions built into option prices, I examine the market’s expectation of Enron’s risk of collapse. I find that the options market remained far too optimistic about the stock until just weeks before their bankruptcy filing. I thank Oded Palmon and an anonymous referee for helpful comments. JEL Classification G13 · G14     

Does debtor protection really protect debtors? Evidence from the small business credit market

This paper analyzes how different levels of debtor protection across US states affect small firms’ access to credit, as well as the price and non-price terms of their loans. We use an individual-specific measure of debtor protection that has its maximum value when the borrower’s home equity is lower than the state homestead exemption (the debtor’s home equity is fully protected), and is decreasing in the difference between the home equity and the homestead exemption (the amount that the creditor can seize). We find that unlimited liability small businesses have lower access to credit in states with more debtor-friendly bankruptcy laws. In addition, these businesses face tighter loan terms - they are more likely to pledge business collateral, have shorter maturities, and borrow smaller amounts. For limited liability small businesses, we also find a reduction in credit availability, but of smaller magnitude, together with an increase in the loan rate.