Asset liquidity,corporate investment,and endogenous financing costs

We analyze how the liquidity of real and financial assets affects corporate investment. The trade-off between liquidation costs and underinvestment costs implies that low-liquidity firms exhibit negative investment sensitivities to liquid funds, whereas high-liquidity firms have positive sensitivities. If real assets are not divisible in liquidation, firms with high financial liquidity optimally avoid external financing and instead cut new investment. If real assets are divisible, firms use external financing, which implies a lower sensitivity. In addition, asset redeployability decreases the investment sensitivity. Our findings demonstrate that asset liquidity is an important determinant of corporate investment.     

Tournament incentives, firm risk, and corporate policies

This paper tests the proposition that higher tournament incentives will result in greater risk-taking by senior managers in order to increase their chance of promotion to the rank of CEO. Measuring tournament incentives as the pay gap between the CEO and the next layer of senior managers, we find a significantly positive relation between firm risk and tournament incentives. Further, we find that greater tournament incentives lead to higher R&D intensity, firm focus, and leverage, but lower capital expenditures intensity. Our results support the hypothesis that option-like features of intra-organizational CEO promotion tournaments provide incentives to senior executives to increase firm risk by following riskier policies. Finally, the compensation levels and structures of executives of financial institutions have received a great deal of scrutiny after the financial crisis. In a separate examination of financial firms, we again find a significantly positive relation between firm risk and tournament incentives.     

Creditor rights and corporate risk-taking

We propose that stronger creditor rights in bankruptcy affect corporate investment choice by reducing corporate risk-taking. In cross-country analysis, we find that stronger creditor rights induce greater propensity of firms to engage in diversifying acquisitions that are value-reducing, to acquire targets whose assets have high recovery value in default, and to lower cash-flow risk. Also, corporate leverage declines when creditor rights are stronger. These relations are usually strongest in countries where management is dismissed in reorganization and are also observed over time following changes in creditor rights. Our results thus identify a potentially adverse consequence of strong creditor rights.     

The role of state and foreign owners in corporate risk-taking: Evidence from privatization

Using a unique database of 381 newly privatized firms from 57 countries, we investigate the impact of shareholders' identity on corporate risk-taking behavior. We find strong and robust evidence that state (foreign) ownership is negatively (positively) related to corporate risk-taking. Moreover, we find that high risk-taking by foreign owners depends on the strength of country-level governance institutions. Our results suggest that relinquishment of government control, openness to foreign investment, and improvement of country-level governance institutions are key determining factors of corporate risk-taking in newly privatized firms.     

Financial distress,corporate control,and management turnover

We empirically investigate the effect of financial distress on corporate ownership and control. Our analysis is based on a panel of 267 German firms that suffered from repeated interest coverage shortfalls between 1996 and 2004. We track each firm’s development over the distress cycle with particular attention to corporate ownership, restructuring, and management turnover. We find a significant decrease in ownership concentration. Private investors gradually give up their dominating role and thereby cease to be an effective source of managerial control. By contrast, ownership representation by banks and outside investors almost doubles. Shareholdings by executive and non-executive directors also substantially increase but have no effect on managerial tenure. Forced management turnover is mostly initiated by outside investors and banks and often occurs subsequent to debt restructurings, block investments, and takeovers.     

Large shareholder diversification,corporate risk taking,and the benefits of changing to differential voting rights

We show how the change to differential voting rights allows dominant shareholders to retain control even after selling substantial economic ownership in the firm and diversifying their wealth. This unbundling of cash flow and control rights leads to more dispersed economic ownership and a closer alignment of dominant and dispersed shareholder interests. When insiders sell sizeable amounts of their economic interests, firms increase capital expenditures, strengthen corporate focus, divest non-core operations, and generate superior industry-adjusted performance. The change to differential voting rights both fosters corporate control activity and creates higher takeover premiums that are paid equally to all shareholders.     

Labor unemployment risk and corporate financing decisions

This paper presents evidence that firms choose conservative financial policies partly to mitigate workers' exposure to unemployment risk. We exploit changes in state unemployment insurance laws as a source of variation in the costs borne by workers during layoff spells. We find that higher unemployment benefits lead to increased corporate leverage, particularly for labor-intensive and financially constrained firms. We estimate the ex ante, indirect costs of financial distress due to unemployment risk to be about 60 basis points of firm value for a typical BBB-rated firm. The findings suggest that labor market frictions have a significant impact on corporate financing decisions.     

Liquidity risk of corporate bond returns: conditional approach

We study the exposure of the US corporate bond returns to liquidity shocks of stocks and Treasury bonds over the period 1973–2007 in a regime-switching model. In one regime, liquidity shocks have mostly insignificant effects on bond prices, whereas in another regime, a rise in illiquidity produces significant but conflicting effects: Prices of investment-grade bonds rise while prices of speculative-grade (junk) bonds fall substantially (relative to the market). Relating the probability of these regimes to macroeconomic conditions we find that the second regime can be predicted by economic conditions that are characterized as “stress.” These effects, which are robust to controlling for other systematic risks (term and default), suggest the existence of time-varying liquidity risk of corporate bond returns conditional on episodes of flight to liquidity. Our model can predict the out-of-sample bond returns for the stress years 2008–2009. We find a similar pattern for stocks classified by high or low book-to-market ratio, where again, liquidity shocks play a special role in periods characterized by adverse economic conditions.     

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.     

Corporate use of derivatives and excess value of diversification

We provide a link between diversification discount and corporate use of financial derivatives. We show that diversified firms benefit from financial risk management. Our findings are consistent with the notion that derivative usage lowers information asymmetry and thereby reduces the negative valuation effects of diversification. Our evidence complements the earlier findings of both the risk management literature and diversification discount literature and is robust to controls for endogeneity and information asymmetry levels.     

Board diversity,firm risk,and corporate policies

We examine the effects of diversity in the board of directors on corporate policies and risk. Using a multidimensional measure, we find that greater board diversity leads to lower volatility and better performance. The lower risk levels are largely due to diverse boards adopting more persistent and less risky financial policies. However, consistent with diversity fostering more efficient (real) risk-taking, firms with greater board diversity also invest persistently more in research and development (R&D) and have more efficient innovation processes. Instrumental variable tests that exploit exogenous variation in firm access to the supply of diverse nonlocal directors indicate that these relations are causal.     

Managerial attitudes and corporate actions

We administer psychometric tests to senior executives to obtain evidence on their underlying psychological traits and attitudes. We find US CEOs differ significantly from non-US CEOs in terms of their underlying attitudes. In addition, we find that CEOs are significantly more optimistic and risk-tolerant than the lay population. We provide evidence that CEOs' behavioral traits such as optimism and managerial risk-aversion are related to corporate financial policies. Further, we provide new empirical evidence that CEO traits such as risk-aversion and time preference are related to their compensation.     

Bankruptcy spillover effects on strategic alliance partners

This paper examines whether a party to a strategic alliance or joint venture suffers from spillover effects when the other partner files for bankruptcy. We find that the non-bankrupt strategic alliance partners, on average, experience a negative stock price reaction around their partner firm's bankruptcy filing announcement. This negative effect is strongest for longer partnerships and those with higher returns at the announcement of the initial alliance formation. Furthermore, horizontal alliance firms in declining industries have lower returns, indicating that industry conditions can exacerbate expected problems for the non-bankrupt firm. Non-bankrupt partners also experience drops in profit margins and investment levels in the subsequent two years with the worst performance concentrated among the longer-term agreements. There is very little impact on the returns or performance for joint venture partners, which suggests that these agreements are more insulating for the partner firm.     

Government ownership and corporate governance: Evidence from the EU

The ongoing global financial crisis has led to the largest increase in state intervention since the Great Depression. Direct government ownership in publicly-traded corporations has increased dramatically since 2008. How will this increase in public ownership affect the governance of these erstwhile private companies? We examine the impact of government ownership on corporate governance using a sample of firms from the European Union, a region that is relatively familiar with active government participation. Our main finding is that government ownership is associated with lower governance quality. We further show that while government intervention is negatively related to governance quality in civil law countries, it is positively related to governance quality in common law countries. Finally, we find that the preferential voting rights of golden shares are especially damaging to governance quality.     

Capital structure,credit risk,and macroeconomic conditions

This paper develops a framework for analyzing the impact of macroeconomic conditions on credit risk and dynamic capital structure choice. We begin by observing that when cash flows depend on current economic conditions, there will be a benefit for firms to adapt their default and financing policies to the position of the economy in the business cycle phase. We then demonstrate that this simple observation has a wide range of empirical implications for corporations. Notably, we show that our model can replicate observed debt levels and the countercyclicality of leverage ratios. We also demonstrate that it can reproduce the observed term structure of credit spreads and generate strictly positive credit spreads for debt contracts with very short maturities. Finally, we characterize the impact of macroeconomic conditions on the pace and size of capital structure changes, and debt capacity.     

Geographic diversification and firm value in the financial services industry

This paper investigates whether geographic diversification is value-enhancing or value-destroying in the financial services sector, broadly defined. Our dataset comprises approximately 3579 observations over the period from 1985 to 2004 and covers the entire range of U.S. financial intermediaries — commercial banks, investment banks, insurance companies, asset managers, and financial infrastructure services firms. We use two alternative measures of geographic diversification: (1) a dummy variable whether the firm reports more than one geographic segment and (2) the percentage of sales from non-domestic operations. Our results indicate that geographic diversification is not associated with a significant valuation discount in financial intermediaries. However, when accounting for the firms' main activity-areas, we find evidence of a significant discount associated with geographic diversification in securities firms and a premium in credit intermediaries and insurance companies. All these results are robust after taking into account functional diversification of the firms, a potential endogeneity of both functional and geographic diversification, and a potential value transfer from equity to debt holders by using estimates of the market value of debt.     

Annual report readability and corporate agency costs

Annual reports are the main sources of information for outside investors’ investment decisions and enable shareholders to supervise the management. Difficulties with the readability of these reports may therefore have serious consequences. Using 19,221 firm-year observations of Chinese A-share listed firms from 2001 to 2015, we investigate the association between annual report readability and corporate agency costs, where readability is proxied by report file length and/or file size. We find that firms with better annual report readability experience lower agency costs, and the negative association between readability and agency costs is more pronounced in firms with higher external audit quality, internal control quality or analyst coverage. These results hold after several robustness checks. The positive effect of annual report readability is stronger in private firms than in state-owned enterprises, and becomes stronger after the implementation of new accounting standards in 2007. Readable annual reports can help in monitoring corporate insiders’ opportunistic behavior and thus reduce agency costs.     

Ownership structure and the cost of corporate borrowing

This article identifies an important channel through which excess control rights affect firm value. Using a new, hand-collected data set on corporate ownership and control of 3,468 firms in 22 countries during the 1996–2008 period, we find that the cost of debt financing is significantly higher for companies with a wider divergence between the largest ultimate owner’s control rights and cash-flow rights and investigate factors that affect this relation. Our results suggest that potential tunneling and other moral hazard activities by large shareholders are facilitated by their excess control rights. These activities increase the monitoring costs and the credit risk faced by banks and, in turn, raise the cost of debt for the borrower.     

Risk management,corporate governance,and bank performance in the financial crisis

The recent financial crisis has raised several questions with respect to the corporate governance of financial institutions. This paper investigates whether risk management-related corporate governance mechanisms, such as for example the presence of a chief risk officer (CRO) in a bank’s executive board and whether the CRO reports to the CEO or directly to the board of directors, are associated with a better bank performance during the financial crisis of 2007/2008. We measure bank performance by buy-and-hold returns and ROE and we control for standard corporate governance variables such as CEO ownership, board size, and board independence. Most importantly, our results indicate that banks, in which the CRO directly reports to the board of directors and not to the CEO (or other corporate entities), exhibit significantly higher (i.e., less negative) stock returns and ROE during the crisis. In contrast, standard corporate governance variables are mostly insignificantly or even negatively related to the banks’ performance during the crisis.     

Should corporate debt include a rating trigger?

Recent corporate debt offerings have included a covenant specifying a pre-determined payment to debtholders when the debt is downgraded. We examine the incentive for equityholders to increase firm risk (and the associated costs) when debt includes a “rating trigger.” Equityholders of firms with a low-risk profile and operating flexibility choose debt with a trigger, while equityholders of firms with a high-risk profile and less flexibility choose regular debt. A trigger that requires an equity infusion better mitigates conflicts between equityholders and debtholders than a trigger paid by liquidating assets. A trigger that increases the coupon rate is not optimal.