Foreign entry and bank competition

Foreign entry and bank competition are modeled as the interaction between asymmetrically informed principals: The entrant uses collateral as a screening device to contest the incumbent's informational advantage. Both better information ex ante and stronger legal protection ex post are shown to facilitate the entry of low-cost outside competitors into credit markets. The entrant's success in gaining borrowers of higher quality by offering cheaper loans increases with its efficiency (cost) advantage. This paper accounts for evidence suggesting that foreign banks tend to lend more to large firms thereby neglecting small and medium enterprises. The results also explain why this observed bias is stronger in emerging markets.     

Does corporate social responsibility affect the cost of capital?

We examine the effect of corporate social responsibility (CSR) on the cost of equity capital for a large sample of US firms. Using several approaches to estimate firms’ ex ante cost of equity, we find that firms with better CSR scores exhibit cheaper equity financing. In particular, our findings suggest that investment in improving responsible employee relations, environmental policies, and product strategies contributes substantially to reducing firms’ cost of equity. Our results also show that participation in two “sin” industries, namely, tobacco and nuclear power, increases firms’ cost of equity. These findings support arguments in the literature that firms with socially responsible practices have higher valuation and lower risk.     

Safety-net benefits conferred on difficult-to-fail-and-unwind banks in the US and EU before and during the great recession

This paper investigates the links between regulatory arbitrage, financial instability, and taxpayer loss exposures. We model and estimate ex ante safety-net benefits from increased leverage and asset volatility at a sample of large banks in US and Europe during 2003–2008. Hypothesis tests indicate that, in both crisis and precrisis years, difficult-to-fail-and-unwind (DFU) banks enjoyed substantially higher ex ante benefits than other institutions. Compared to the US sample, safety-net benefits prove significantly larger for DFU firms in Europe and bailout decisions are less driven by asset size. Introducing a proxy for differences in government susceptibility to regulatory capture helps to explain bailout decisions in Europe. Our findings suggest that authorities in both venues could better contain safety-net benefits if they refocused their information systems on monitoring volatility as well as capital.     

Does international cross-listing improve the information environment

We investigate whether cross-listing in the U.S. affects the information environment for non-U.S. stocks. Our findings suggest cross-listing has an asymmetric impact on stock price informativeness around the world, as measured by firm-specific stock return variation. Cross-listing improves price informativeness for developed market firms. For firms in emerging markets, however, cross-listing decreases price informativeness. The added analyst coverage associated with cross-listing likely explains the findings in emerging markets, rather than changes in liquidity, ownership, or accounting quality. Our results indicate that the added analyst coverage fosters the production of marketwide information, rather than firm-specific information.     

Voluntary Disclosure of Management Earnings Forecasts in IPO Prospectuses

Asymmetric information and mechanisms for its resolution in the initial public offering (IPO) process are subjects of extensive research and debate. In this paper, we investigate the impact of one such mechanism, namely voluntary disclosure of management earnings forecasts by issuers of IPOs, as a means of reducing asymmetric information as well as ex ante uncertainty. Our focus is on the relative importance of this voluntary disclosure mechanism on both IPO underpricing and post‐issue return performance. Our results indicate that management earnings forecasts provide important and incremental information compared to other means of reducing asymmetric information, and these disclosures appear to improve the environment of IPO issuance. For example, our underpricing results show that firms that choose to provide forecasts leave 'less money on the table' with a lower degree of underpricing. In terms of post‐issue performance, firms whose forecasts turn out to be optimistic are penalized significantly relative to other forecasters and non‐forecasters.     

The Determinants of Execution Costs in Short‐Term Money Markets

Prior research attributes the observed negative relation between execution costs and trade size in opaque markets to two factors—information asymmetry and broker‐client relationships. We provide evidence that a trader's ex ante transaction price information and the relationship traders have with their brokers are both significant determinants of a trader's execution costs in an opaque market; however, traders who establish strong relationships with their brokers will achieve a greater reduction in execution costs than traders with ex ante transaction price information. We also find evidence that trade size has little explanatory power after controlling for a trader's ex ante transaction price information and broker‐client relationships.     

CORPORATE BOARDS AND BANK LOAN CONTRACTING

We investigate the role of corporate boards in bank loan contracting. We find that when corporate boards are more independent, both price and nonprice loan terms (e.g., interest rates, collateral, covenants, and performance‐pricing provisions) are more favorable, and syndicated loans comprise more lenders. In addition, board size, audit committee structure, and other board characteristics influence bank loan prices. However, they do not consistently affect all nonprice loan terms except for audit committee independence. Our study provides strong evidence that banks recognize the benefits of board monitoring in mitigating information risk ex ante and controlling agency risk ex post, and they reward higher quality boards with more favorable loan contract terms.     

Are publicly held firms less efficient? Evidence from the US property-liability insurance industry

This paper studies the performance of publicly held firms in the US property-liability insurance industry by analyzing companies that issued initial public offerings (IPOs) from 1994 to 2005, using private firms as the benchmark. I investigate ex ante determinants and ex post effects of IPOs on firm efficiency, operating performance, and other financials. I also analyze stock returns and follow-on SEO and acquisition activities to provide further information on IPO motivation. The paper finds that the likelihood of an IPO significantly increases with firm size and premium growth. IPO firms experience no post-issue underperformance in efficiency, operations, or stock returns; register improvement in allocative and cost efficiency; and reduce financial leverage and reinsurance usage. Moreover, IPO firms are active in follow-on SEO issues and acquisition activities. The findings are mostly consistent with the theory that firms go public for easier access to capital and to ease capital constraints.     

Impact of managerial ownership on investment and liquidity constraints: Evidence from Chinese listed companies

We examine the impact of managerial ownership on investment and financial constraints in the context of China. Using the system generalized method of moments estimation of an investment Euler equation, we find that investment decisions are related to managerial ownership in two ways. First, managerial ownership exerts a positive direct effect on corporate investment decisions by aligning management’s incentives with the interests of shareholders. Second, managerial ownership helps to reduce the degree of financial constraints faced by firms, suggesting that managerial ownership acts as a form of credible guarantee to lenders, signaling the quality of investment projects to the capital markets. Our findings suggest that recent policies enacted by the Chinese government, aimed at reforming ownership structure and encouraging managerial ownership in listed firms, help reduce agency costs and asymmetric information; thereby facilitating firms’ investment efficiency. Our findings will be of interest to scholars, practitioners, and policy makers interested in the financial impacts of management-compensation contracts.     

Banks and bubbles: How good are bankers at spotting winners?

This paper examines the bank lending relations of a large sample of technology and nontechnology firms that went public during the 1996–2000 period. We use a unique hand-collected data set to examine the characteristics of firms that establish pre- Initial Public Offering (IPO) bank lending relations and whether post-IPO performance is related to the existence and size of pre-IPO banking relations. We find that the majority of IPO firms have banking relations before they go public. Firms with banking relations are older, more profitable or, in the case of tech firms, have lower losses, and are more likely to have funding from venture capitalists than firms without banking relations. We also find that banks lent aggressively to technology firms in the sense that current earnings and cash flows were significantly less important in determining banking relations for technology firms than for nontechnology firms. Consistent with the importance of so-called soft information in lending decisions, we find that, controlling for ex ante observable risk measures, there is a positive and significant relation between improvements in post-IPO operating performance and the existence and size of pre-IPO banking relations. Overall, our results indicate that firms with the best current and future prospects establish banking relations. Our findings provide an explanation as to why investors could interpret lending relations as a positive signal of firm quality.     

XBRL adoption and expected crash risk

The U.S. Securities and Exchange Commission (SEC) mandated the adoption of eXtensible Business Reporting Language (XBRL) in 2009, with the aim of facilitating data exchange and reducing information processing costs. To shed light on the economic consequences of this important disclosure regulation, this study investigates whether and how XBRL mandate impacts investor expectations of future crash risk. Using the steepness of the option implied volatility smirk as a proxy for ex ante expectation of crash risk, we find that expected crash risk decreases after adoption of XBRL. Moreover, we document that the effect is more pronounced for firms with higher financial opacity, more volatile earnings, and greater analyst forecast dispersion. Further, our analysis generates evidence that the use of customized extension XBRL elements attenuates the effect of XBRL reporting on reducing expected crash risk. Our empirical results are robust to a variety of sensitivity checks. Overall, the findings indicate that XBRL reduces information processing costs and strengthens information transparency of capital markets, which in turn, reduces investor expectations of future crash risk.     

Understanding Investor Sentiment: The Case of Soccer

We examine the extent to which the stock market's inefficient responses to resolutions of uncertainty depend on investors’ biased ex ante beliefs regarding the probability distribution of future event outcomes or their ex post irrational reactions to these outcomes. We use a sample of publicly traded European soccer clubs and analyze their returns around important matches. Using a novel proxy for investors’ expectations based on contracts traded on betting exchanges (prediction markets), we find that within our sample, investor sentiment is attributable, in part, to a systematic bias in investors’ ex ante expectations. Investors are overly optimistic about their teams’ prospects ex ante and, on average, end up disappointed ex post, leading to negative postgame abnormal returns. Our evidence may have important implications for firms’ investment decisions and corporate control transactions.     

Is Investment‐Cash Flow Sensitivity Caused by Agency Costs or Asymmetric Information? Evidence from the UK

We investigate the investment‐cash flow sensitivity of a large sample of the UK listed firms and confirm that investment is strongly cash flow‐sensitive. Is this sensitivity a result of agency problems when managers with high discretion overinvest, or of asymmetric information when managers owning equity are underinvesting if the market (erroneously) demands too high a risk premium? We find that investment‐cash flow sensitivity results mainly from the agency costs of free cash flow. The magnitude of the relationship depends on insider ownership in a non‐monotonic way. Furthermore, we obtain that outside blockholders, such as financial institutions, the government, and industrial firms (only at high control levels), reduce the cash flow sensitivity of investment via effective monitoring. Finally, financial institutions appear to play a role in mitigating informational asymmetries between firms and capital markets. We corroborate our findings by performing additional tests based on the stochastic efficient frontier approach and power indices.     

Futures trading volume as a determinant of prices in different momentum phases

Recent studies contend that trading volume has predictive power for ex ante stock prices, particularly small stocks that do not react quickly to macroeconomic information. This study postulates that a significant amount of macro-information that flows on to stock markets is derived from derivative markets. We examine the impact of short-term futures trading volume and prices on cash stock prices using a case study of 15-min data from the Australian stock index futures market which reports actual trading volume. After applying vector error correction modelling (VECM), variance decomposition and impulse functions, we conclude that futures prices provide a short-term information lead to stock prices that dominates trading volume effects. We also observe asymmetric changes in the impact of trading volume between bull and bear price momentum phases and after large trading volume shocks. These results suggest that, in future, studies on trading volume should control for the cross-correlation impact from derivative prices and the differential impact of trading phases.     

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.     

Product market advertising and new equity issues

We analyze the interaction between a firm's product market advertising and its corporate financing decisions. We consider a firm that faces asymmetric information in both the product and financial markets and that needs to raise external financing to fund its growth opportunity (new project). Any product market advertising undertaken by the firm is visible to the financial market as well. In equilibrium, the firm uses a combination of product market advertising, equity underpricing, and underfinancing (raising a smaller amount of external capital than the full information optimum) to convey its true product quality and the intrinsic value of its projects to consumers and investors. The following two predictions arise from our theoretical analysis for the relation between product market advertising and equity underpricing around new equity issues. First, firms choose a higher level of product market advertising when they are planning to issue new equity, compared with situations in which they have no immediate plans to do so. Second, product market advertising and equity underpricing are substitutes for a firm issuing new equity. We empirically test the above two predictions and find supporting evidence in the context of firms making initial public offerings and seasoned equity offerings.     

Alliances and corporate governance

We study the link between a firm's quality of governance and its alliance activity. We consider alliances as a commitment technology that helps a company’ Chief Executive Officer overcome agency problems that relate to the inability to ex ante motivate division managers. We show that well-governed firms are more likely to avail themselves of this technology to anticipate ex post commitment problems and resolve them. The role of governance is particularly important when the commitment problems are more acute, such as for significantly risky/long-horizon projects (“longshots”) or firms more prone to inefficient internal redistribution of resources (conglomerates), as well as in the absence of alternative disciplining devices (e.g., low product market competition). Governance also mitigates agency issues between alliance partners; dominant alliance partners agree to a more equal split of power with junior partners that are better governed. An “experiment” that induces cross-sectional variation in the cost of the alliance commitment technology provides evidence of a causal link between governance and alliances.     

Corporate board reforms around the world and stock price crash risk

We examine the impact of corporate board reforms around the world on stock price crash risk. Using a sample of firms in 41 economies that passed major board reforms between 1990 and 2012, we find that board reforms are associated with a significant reduction in crash risk of about 13%. The effect of reforms on crash risk is stronger among firms with more severe ex ante agency problems. Our analysis further suggests that board reforms reduce crash risk by improving financial transparency and enhancing investment efficiency. In sum, our findings are consistent with the notion that board reforms improve board oversight and mitigate agency problems.     

Freedom of choice between unitary and two-tier boards: An empirical analysis

We examine board structure in France, which since 1966 has allowed firms the freedom to choose between unitary and two-tier boards. We analyze how this choice relates to characteristics of the firm and its environment. Firms with severe asymmetric information tend to opt for unitary boards; firms with a potential for private benefits extraction tend to adopt two-tier boards. Chief executive officer turnover is more sensitive to performance at firms with two-tier boards, indicating greater monitoring. Our results are broadly consistent with the Adams and Ferreira (2007) model and suggest that gains result from allowing freedom of contract about board structure.     

Tests of ex ante versus ex post theories of collateral using private and public information

Collateral is a widely used, but not well understood, debt contracting feature. Two broad strands of theoretical literature explain collateral as arising from the existence of either ex ante private information or ex post incentive problems between borrowers and lenders. However, the extant empirical literature has been unable to isolate each of these effects. This paper attempts to do so using a credit registry that is unique in that it allows the researcher to have access to some private information about borrower risk that is unobserved by the lender. The data also include public information about borrower risk, loan contract terms, and ex post performance for both secured and unsecured loans. The results suggest that the ex post theories of collateral are empirically dominant, although the ex ante theories are also valid for customers with short borrower–lender relations that are relatively unknown to the lender.