Institutions and Capital Structure: The Case of Chinese Property Firms

Different institutional features have been found to affect capital structure decisions, but their connections to corporate finance theories are not always clear. This study aims to assess the predictive power of the agency and pecking order theories in two distinct information environments. The strategy is to compare two similar groups of property firms listed on the Mainland and Hong Kong stock exchanges respectively. Both groups operate in the Mainland property market and are subject to the same tax code, but the degrees of transparency and integrity of the stock markets are weaker for the Mainland-listed firms. We find that factors related to agency conflicts and information asymmetries exert a stronger influence on the capital structure decisions of Mainland-listed firms than on those of the Hong Kong-listed firms. This is confirmed by a test of the agency theory using such corporate governance factors as managerial shareholding and shareholding concentration and by a test of the pecking order theory using an error correction model. A further test on the increments of R-squared in the regression models shows that variables derived from the two theories better explain the variations of the capital structure of Mainland-listed firms than those of Hong Kong-listed firms.     

Choice of foreign listing location: Experience of Chinese firms

At the end of October 2003, there were 237 Chinese firms' listings on various stock exchanges outside of Mainland China. Beyond geographical proximity and other obvious explanations of why Chinese firms prefer listing in Hong Kong more than in the United States, we identify two additional benefits of a Hong Kong listing. We find that Chinese firms listed in Hong Kong have a better information environment than those listed solely in the United States. We also find that the Hong Kong-listed firms are less financially constrained, which may be due to their ability to access the Hong Kong capital market for external financing. The results of our study show that different stock markets offer different benefits as a listing venue and the benefits of foreign listing may depend on the choice of listing location.     

Incentive Effects, Monitoring Mechanisms and the Market for Corporate Control: An Analysis of the Factors Affecting Public to Private Transactions in the UK

Abstract:   This paper investigates the factors that influence the decision to change the status of a publicly quoted company to that of a private company. We find that firms that go private are more likely to have higher CEO ownership and higher institutional ownership. In relation to their board structures, firms going private tend to have more duality but there is no statistical difference in the proportion of non‐executive directors. They do not show signs of having excess free cash flows but there is some evidence of lower growth opportunities. We do not find that firms going private experience a greater threat of hostile acquisition. The results are therefore consistent with incentive and monitoring explanations of going private. Calculation of the probability of going private shows that incentive effects are stronger than the monitoring effects.     

Disruption and stock markets: Evidence from Hong Kong

We examine the impact of disruption on stock markets using the 2019 Hong Kong protests for identification. We find that greater protest intensity corresponds to higher bid–ask spreads, lower trading volume, and greater return volatility for dual-listed Chinese firms’ Hong Kong (H) shares but not their home (A) shares. We also document negative abnormal returns only for these firms’ H-shares around major protest events, which shortly after exhibit reversal. Next, we validate our main findings by documenting similar results using Hong Kong-listed firms only. Overall, we provide new evidence highlighting the impact of protest-induced disruption on financial markets.     

Free Cash Flow and Stockholder Gains in Going Private Transactions

We investigate the source of stockholder gains in going private transactions. We find support for the hypothesis advanced by Jensen that a major source of these gains is the mitigation of agency problems associated with free cash flow. Using a sample of 263 going private transactions from 1980 through 1987, our results indicate a significant relationship between undistributed cash flow and a firm's decision to go private. In addition, we find that premiums paid to stockholders are significantly related to undistributed cash flow. These results are especially strong for firms that went private between 1984 and 1987 and also for firms whose managers owned relatively little equity before the going private transaction.     

Why do firms go dark? Causes and economic consequences of voluntary SEC deregistrations

We examine a comprehensive sample of going-dark deregistrations where companies cease SEC reporting, but continue to trade publicly. We document a spike in going dark that is largely attributable to the Sarbanes–Oxley Act. Firms experience large negative abnormal returns when going dark. We find that many firms go dark due to poor future prospects, distress and increased compliance costs after SOX. But we also find evidence suggesting that controlling insiders take their firms dark to protect private control benefits and decrease outside scrutiny, particularly when governance and investor protection are weak. Finally, we show that going dark and going private are distinct economic events.     

Cross-listing and corporate malfeasance: Evidence from P-chip firms

The rapid growth of the private sector in China in recent decades has resulted in a large number of capital-hungry private sector firms. An increasing number of these firms choose to raise equity capital on international exchanges, which typically have stronger disclosure, corporate governance, and investor protection regulations. In light of international investors' and regulators' concerns about the corporate finance practice of China's private sector firms, particularly regarding the integrity of their reported earnings, we investigate whether these firms aggressively manipulate their accounts by examining those listed in Hong Kong, commonly known as P-chips. We find systematic evidence that P-chips engage in more earnings management and other corporate misbehaviors than their counterparts in Hong Kong. We posit and provide evidence consistent with cross-jurisdictional enforcement difficulty as a possible explanation for P-chips' questionable practices, and discuss its implications.     

Acquisition Activity and IPO Underpricing

We propose an “M&A activity” hypothesis as a partial explanation for initial public offering (IPO) underpricing. When going public during active corporate control markets, managers may take actions to safeguard their control. In support of this conjecture, we find that pre-IPO M&A activity directly explains IPO underpricing. We also find that underpricing and ownership dispersion are positively correlated, as are ownership dispersion and the probability of remaining independent. Considering the possibility that some managers take their firms public to be acquired, we find that the positive link between M&A activity and underpricing is not robust for firms that are viewed as likely targets.     

What drives the valuation premium in IPOs versus acquisitions? An empirical analysis

Using a hand-collected data set of private firm acquisitions and IPOs, this paper develops the first empirical analysis in the literature of the “IPO valuation premium puzzle,” which refers to a situation where many private firms choose to be acquired rather than to go public at higher valuations. We also test several new hypotheses regarding a private firm's choice between IPOs and acquisitions. Our analysis of private firm valuations in IPOs and acquisitions indicates that IPO valuation premia disappear for larger VC backed firms after controlling for various observable factors affecting a firm's propensity to choose IPOs over acquisitions. Further, after controlling for the long-run component of the expected payoff to firm insiders from an IPO exit, we find that the IPO valuation premium vanishes even for larger non-VC backed firms and shrinks substantially for smaller firms as well. Our Heckman-style treatment effects regression analysis demonstrates that the above results are robust to controlling for the selection of exit mechanism by firm insiders based on unobservables. Our findings on private firms' choice between IPOs and acquisitions can be summarized as follows. First, firms operating in industries characterized by the absence of a dominant market player (and therefore more viable against product market competition) are more likely to go public rather than to be acquired. Second, more capital intensive firms, those operating in industries characterized by greater private benefits of control, and those which are harder to value by IPO market investors are more likely to go public rather than to be acquired. Third, the likelihood of an IPO over an acquisition is greater for venture backed firms and those characterized by higher pre-exit sales growth.     

Shaking hands with common foes: Clique premium and information diffusion in private equity networks

The fastest growing segment of private equity deals is secondary buyouts (SBOs) sales from one private equity (PE) firm to another. We operationalize a novel FactSet database to map the network structures of secondary buyouts between PE firms. We offer three contributions. First, after controlling for economic covariates, we find that PE firms are almost three times more likely to transact if they share a partner, that is both firms belong to the same clique. Second, we find that the profitability of such transactions is unambiguously higher relative to the baseline only if these are the result of repeated interaction between firms belonging to the same cliques. In other words, a clique premium exists under repeated interaction. Third, we provide evidence that the economic incentive at the core of clique premium may be related to access to information. In fact, we show that information related to transactions diffuses through the network, with 23% and 16% of the information going one and two steps beyond transacting parties, respectively.     

Private Control Benefits and Earnings Management: Evidence from Insider Controlled Firms

We examine earnings management practices of insider controlled firms across 22 countries to shed light on the link between consumption of private benefits and earnings management. Insider controlled firms are associated with more earnings management than noninsider controlled firms in weak investor protection countries. Consistent with the private benefits motive, insider controlled firms with greater divergence between cash‐flow rights and control rights are associated with more earnings management in these countries. Growth opportunities attenuate the association between insider control and earnings management even in weak investor protection countries. We also find some weak evidence that insider controlled firms are associated with less earnings management in strong investor protection countries. Overall, our results highlight a strong link between private benefits consumption and earnings management.     

Private Equity and Investment in Innovation: Evidence from Patents

The authors' analysis of the patenting activity of 472 companies that received private equity investments between 1986 and 2005 provides suggestive evidence of an increase in the effectiveness (though not necessarily the quantity) of their innovative activities. After such companies received private equity backing, the patents they applied for received more frequent citations than patents awarded before the involvement of PE firms. Companies acquired by private equity also show no sign of deterioration in patent “originality” and “generality,” which have been shown to be fairly reliable indicators of the fundamental nature of the research. And while there is no clear pattern of change in the level of patenting activity, corporate patent portfolios become more focused in the years after the private equity investments. The increases in our measure of patent “impact” are greatest in the areas that constitute the companies' historical core strengths. These findings are likely to prove increasingly important as private equity continues its incursions into growth areas of the economy.     

Management Going‐concern Disclosures: Impact of Corporate Governance and Auditor Reputation

The UK regulatory requirements relating to going‐concern disclosures require directors to report on the going‐concern status of their firms. Such directors have incentives not to report fairly in the case of financially‐distressed firms. We expect effective corporate governance mechanisms will encourage directors to report more truthfully in such situations. This paper tests this proposition explicitly using a large sample of going‐concern cases over the period 1994–2000. We find that whereas auditors' going‐concern opinions predict the subsequent resolution of going‐concern uncertainties directors' going‐concern statements convey arbitrary and unhelpful messages to users. However, robust corporate governance structures and high auditor reputation constrain directors to be more truthful in their going‐concern disclosures, bringing these more into line with the more credible auditor opinions.     

Investment and financing decisions of private and public firms

We examine differences in the allocation of cash flow between Western European private and public firms. Public firms have a higher investment‐cash flow sensitivity than comparable private firms. This difference is not attributable to more severe financing constraints of public firms. Instead, because differences in investment‐cash flow sensitivities are only observed for the unexpected portion of firms’ cash flow, the empirical evidence supports an agency‐based explanation. Similar patterns are observable for the expected and unexpected portion of firms’ shareholder distributions. Our results are driven by firms from countries with low ownership concentration and more liquid stock markets, where shareholders have lower incentives to monitor. The results are also more pronounced for public firms with low industry Tobin's q and high free cash flow, which are more prone to suffer from agency problems.     

The Value of Strategic Alliances in Acquisitions and IPOs

This paper investigates how firms’ strategic alliance experience affects their valuations as acquisition targets or in initial public offerings (IPOs). We propose that alliance experience serves as a valuable signaling device for opaque firms. The results show that takeover targets with alliance experience receive higher premiums than those without such experience. More recent alliance experience as well as alliances in the same industry also contributes to a larger target gain. Similarly, IPO firms that have alliance experience obtain higher valuations than those without the experience. Finally, alliance experience increases the likelihood that private firms exit by going public rather than being acquired.     

Private equity alliances in mergers

This paper examines reasons for alliance formation between private equity bidders when compared to sole-sponsored private equity deals. Testing a comprehensive set of hypotheses, we find strong evidence for the relative-risk hypothesis of Robinson (2008), as private bidders are more likely to form an alliance in a diversifying acquisition. We also find that private equity alliances involved more profitable target firms when compared to sole-sponsored private equity deals. Finally, we find that the significantly lower abnormal returns for target firms in private equity alliance deals are eliminated once we control for differences in the types of target firms acquired by private equity alliances and single private equity bidders. The last result suggests that private equity alliances do not generate significantly lower target returns because of collusion.     

IFRS adoption,reporting incentives and financial reporting quality in private firms

This study examines financial reporting quality (FRQ) effects around voluntary International Financial Reporting Standards (IFRS) adoptions by German private firms across two important dimensions, earnings quality and disclosure practices. To capture differences in the motivations for IFRS adoptions, we identify four different types of IFRS adopting firms based on a comprehensive set of firm characteristics. We observe earnings quality improvements around IFRS adoptions primarily for one type of firm, which is young, fast growing and seeking access to public equity markets. Using a matched sample of private German GAAP and IFRS reporting firms, we find some evidence suggesting that IFRS also contribute to higher earnings quality. Recognizing that our earnings quality metrics are only incomplete measures of FRQ, we also compare the disclosure practices of IFRS and German GAAP firms. We find that all IFRS firm types disclose significantly more information in their financial reports and show a higher propensity to publish their financial reports voluntarily on the corporate website. Our findings indicate that failure to identify earnings quality changes around IFRS adoption cannot be automatically interpreted as IFRS adoption having no effect on the FRQ of (private) firms. Collectively, our results suggest that both incentives and accounting standards shape private firms’ FRQ.     

Operational Improvement: The Key to Value Creation in Private Equity

With credit tightening having reduced the availability of leverage and intensified the competition for new deals, the economic recession has caused many companies in private equity firm portfolios to under-perform. These changes are forcing the private equity firms to depend even more on their ability to improve operating performance to achieve their investment goals and generate attractive returns. But few PE firms have proved capable of achieving such improvements in portfolio companies consistently over time.
In this paper, the authors discuss several ways that private equity firms use their operating expertise to drive value in their portfolio companies. They also examine the analytical framework used by some PE firms when assessing and prioritizing the many operational initiatives that could be undertaken within a newly acquired company. Part of that examination involves a detailed look at how private equity firms assemble an attractive mix of operational improvement projects in their initial 100-day plans. Finally, the authors explore one of the challenges faced by private equity firms when attempting to implement operational enhancements in newly acquired companies: bringing about change without alienating company management.
The real-world application of this approach is demonstrated with a case study that shows how one private equity buyer put its operational skills into practice to help create value within a mid-sized portfolio company.     

Excess control,agency costs and the probability of going private in France

The current study investigates the determinants of going private (GP) in France. It contrasts a sample of 161 firms that went private between 1997 and 2009 with a propensity-score-matched sample of firms that remained public during the same period. The results indicate that, unlike for firms that remain public, the largest controlling shareholders (LCSs) of GP firms control their firms using an incommensurately small fraction of ultimate cash flow rights. This is consistent with the view that agency problems between large and minority shareholders make public firms less attractive to investors, which reduces the benefits of staying public and encourages the LCSs to take their firms private or accept takeover offers. Additional results show that GP firms have more undervalued stock prices and higher free cash flows than non-GP firms. Expected interest tax shields, low growth opportunities, and pre-GP takeover interest do not seem to affect the probability of GP.     

The influence of managerial incentives on the resolution of financial distress

This study investigates the influence of managerial incentives on the resolution of financial distress. Our model predicts that when creditors and equityholders prefer different resolution methods, the likelihood of choosing Chapter 11 over private renegotiation is related to the ownership structure of the distressed firm. Empirical test results using a sample of 81 voluntary Chapter 11 firms and 65 private workout firms support the model’s prediction. We show that managerial ownership is positively related to the incidence of Chapter 11 filing when there is conflict between equityholders and creditors over the choice between Chapter 11 and a private renegotiation. Consistent with prior literature, we also find that the choice of resolution methods depends on the extent of creditor holdout problems and the level of economic distress. We also performed the analysis of a subsequent 5 years of post-distress performance for all sample firms. The majorities of firms that file for Chapter 11 lose their independence and are either acquired or liquidated. However, more than half of firms in private workouts survived as independent firms.