Board Characteristics,Firm Profitability and Earnings Management: Evidence from India

The present paper explores the association between earnings management and specific board characteristics and the firm's profitability in the Indian context. In India, the corporate ownership model is the promoter dominated shareholders model. This is the first study based on a panel data framework that employs a fixed effect model to control for time‐invariant endogeneity. It also contributes to the literature by exploring the role of the firm's profitability in transmitting the impact of audit committee independence on earnings management. The study finds that profitability is an important variable, as it moderates the association between audit committee independence and earnings management. Managers of a profit‐making company would have little need to modify their earnings. This signifies that independent audit committees are more effective monitors of earnings management in profitable firms than in non‐profitable firms. Independent directors with multiple directorships are also found to be ineffective monitors. The findings are of material significance to policymakers in analysing board effectiveness and earnings management and improving policymaking for corporate governance by using profitability and related variables.     

Corporate Life Cycle and Earnings Benchmarks

We examine whether and how corporate life cycle significantly influences meeting or beating earnings benchmarks (MBE). We find that corporate life cycle plays a significant role in a firm's meeting or beating earnings benchmarks behaviour. Developing strategies that fit into the stage of corporate life cycle is crucial for corporate success. MBE is an important financial goal that requires strategies. In this study, we examine whether and how corporate life cycle significantly influences MBE. Specifically, we focus on the incentives of MBE in growth and mature firms. We find that corporate life cycle significantly influences a firm's tendency to meet or beat zero earnings, prior earnings and analysts’ earnings forecasts. Based on logit regressions for the period from 1988 to 2008, the results indicate that growth firms are more likely to meet or beat all three earnings benchmarks. Overall, the results of this study indicate that a firm's MBE behaviour should be examined in the context of its life cycle stage.     

Do shareholder views affect corporate political activities?

In this paper, we study shareholder views on corporate political contributions. We find that, with shareholders' explicit approval, firms are more likely to have higher corporate political contribution, measured by the amount of donations to the US political parties in the next election cycle. Firm's political contributions also have a positive long-run impact on firm valuations. When analysing firm's political ideology, we find weak evidence that Democratic party may benefit more from this shareholder's support than Republican party, particularly in case of firms which have recently switched their political ideology to Democratic party. Our results show that shareholders' explicit approval has an impact on firm's engagement of political activities and imply that if the shareholders stand at the same side of the firms, firms engage more in politically-related corporate activities. Our key results are supported in a regression discontinuity design and are robust to two-way clustered standard errors.     

Credit ratings and social capital

We posit that credit ratings are higher for firms headquartered in high social capital regions, where managers are more likely to be trustworthy. To test this hypothesis, 9460 corporate debt ratings of US firms from 2001– 2015 was examined. We find that firms headquartered in a county with high social capital in the US have a higher credit rating. This effect is incremental and economically comparable to that of corporate social responsibility. Additional tests suggest that the impact of social capital on ratings is likely because analysts find them more credible. We conclude that credit analysts may consider the social norm around the firm's headquarters when rating firms.     

The innovation consequences of mandatory patent disclosures

We investigate the effect of patent disclosures on corporate innovation. Using the American Inventor's Protection Act (AIPA) as a shock that increased patent disclosures, we find an increase in innovation for firms whose rivals reveal more information after the AIPA and a decrease in innovation for firms whose own disclosures are divulged to competitors as a result of the law. These findings suggest patent disclosures generate both spillover benefits and proprietary costs. Our findings provide justification for patent disclosure requirements by demonstrating positive externalities: rivals' disclosures facilitate a firm's innovation. However, we also highlight that mandatory patent disclosures can impose proprietary costs on firms. These results broadly contribute to our understanding of the real effects of disclosure, such that forcing firms to share proprietary information can be privately costly but beneficial to other firms.     

Capital Structure,Corporate Taxation and Firm Age*

This paper analyses the relationship between corporate taxation, firm age and debt. We adapt a standard model of capital structure choice under corporate taxation, focusing on the financing and investment decisions typically faced by a firm. Our model suggests that the debt ratio is associated positively with the corporate tax rate and negatively with firm age. Further, we predict that the tax-induced advantage of debt is more important for older firms than for younger ones. To test these hypotheses empirically, we use a cross-section of around 405,000 firms from 35 European countries and 127 NACE three-digit industries. In line with previous research, we find that a firm's debt ratio increases with the corporate tax rate. Further, we observe that older firms exhibit smaller debt ratios than their younger counterparts. Finally, consistent with our theoretical model, we find a positive interaction between corporate taxation and firm age, indicating that the impact of corporate taxation on debt increases over a firm's lifetime.     

Bank relationships and underwriter competition: Evidence from Japan

I examine the effects of bank relationships on underwriter choice in the Japanese corporate bond market following the 1993 deregulation. Bank relationships have significant positive effects on a firm's underwriter choice. Relationship firms receive a small but significant fee discount and, consistent with the mitigating effect of competition on hold-up costs, multiple-relationship firms receive a significantly deeper discount than single-relationship firms. Bank shareholding alone negatively affects underwriter choice, whereas shareholding together with loans has significantly more positive effects than loans alone. Finally, existing relationships reduce a Japanese firm's switching probability by 32%, in contrast to only 6% for U.S. firms.     

An Ohlson valuation framework for valuing corporate governance: The case of Taiwan

We examine the relation between a firm's market value, financial performance, and corporate governance as a cointegrated system in the Ohlson (1995) valuation framework. Using a comprehensive set of 29 governance measures in 4 categories for Taiwanese firms, we find that governance related to ownership structure and divergence between cash flow rights and control rights are important for a firm's market valuation. In particular, information about shareholdings of board directors and supervisors, shareholdings of controlling family, and voting rights are influential for firm value. Controlling for book value and residual incomes in the model, these governance measures track much of the remaining firm valuation that is unrelated to a firm's financial performance. Our findings provide some insight into the intrinsic value of corporate governance and the types of corporate governance mechanisms that are especially important for firms with similar ownership structure and controls.     

Corporate Lobbying,Visibility and Accounting Conservatism

In this study, we examine the relationship between a firm's lobbying activities and financial reporting quality using a US setting where public scrutiny of corporate political activities is high. More importantly, we examine whether and how a firm's visibility shapes the relationship between its corporate lobbying activities and accounting conservatism. Adopting annual lobbying expenditure data to measure firms’ lobbying activities, and using a propensity‐score‐matching methodology to control for differences in firm characteristics between lobbying and non‐lobbying firms, we find a positive relationship between a firm's lobbying intensity and the degree of accounting conservatism in its financial reporting. We further find this positive relationship to be more pronounced in lobbying firms with a higher level of visibility. These results are robust after controlling for a firm's political connections, across various conditional conservatism measures, and across a number of visibility measures including firm size, the number of analysts following the firm, the age of the firm, the number of foreign stock exchanges that the firm is cross‐listed in, and the level of the firm's media coverage. Together, our findings add to the literature on how firms’ political activities shape their accounting practices in general, and accounting conservatism in particular. More importantly, our findings suggest that the heightened public attention paid to political activities in the US yields incentives for firms to be more conservative in their accounting practices.     

Corporate culture and IPOs

This study documents corporate culture at the time of initial public offering (IPO) and the relationship between corporate culture at the time of IPO and firm financial performance. Based on a sample of 1157 US firms that went public between 1996 and 2011 and performance information through 2016, the data provide strong evidence that regional culture, industry characteristics, and pre-IPO financing play key roles in explaining a firm's cultural orientation. Moreover, the data indicate that IPO firms with a highly competition- and creation-oriented culture experience higher profitability and less risk of financial distress than other IPO firms.     

Corporate ownership structure and the choice between bank debt and public debt

This article examines the relation between a borrowing firm's ownership structure and its choice of debt source using a novel data set on corporate ownership, control, and debt structures for 9,831 firms in 20 countries from 2001 to 2010. We find that the divergence between the control rights and cash-flow rights of a borrowing firm's largest ultimate owner has a significant negative impact on the firm's reliance on bank debt financing. In addition, we show that the control-ownership divergence affects other aspects of debt structure including debt maturity and security. Our results indicate that firms controlled by large shareholders with excess control rights may choose public debt financing over bank debt as a way of avoiding scrutiny and insulating themselves from bank monitoring.     

Are real options a missing piece in the diversification-value puzzle?

This paper examines the impact of corporate diversification on a firm's market value in terms of changes in its mix of value sources between growth options and assets-in-place. We argue that the traditionally assumed replicability of corporate diversification benefits by individual investors might not be as feasible when diversification implies acquiring new growth options as when it only involves assets-in-place investments. We further explain why a different effect of diversification on a firm's mix of value sources can occur, therefore leading to a mediating role of growth options between diversification and market value. Using a panel sample of U.S. firms from 1998 to 2010, we find that a firm's growth options portfolio helps explain the effect of diversification strategy on its market value.     

Effect of cash flow risk on corporate failures,and the moderating role of earnings management and abnormal compensation

In this study, we find that United States firms' average cash flow risk (CFR) shows a significantly increasing trend over the past four decades or so. This does not portend well considering the significance of cash flows in maintaining a firm's financial health and going concern status. The CFR also increases dramatically for firms approaching financial distress or bankruptcy, suggesting its important role in predicting a firm's failure. Empirically, we find that CFR has a strong positive effect on a firm's financial distress likelihood. We also find that the association between CFR and financial distress is negatively moderated in firms with high earnings management and abnormal compensation. The results suggest that managers in firms with high CFR are more likely to use heuristics in form of earnings management. Thus, supporting the upper echelons theory related to managers under performance pressure. Meanwhile, consistent with the notion in the agency theory that financial incentives serve as effective monitoring mechanisms, compensation packages can incentivize better risk management practices and decrease the likelihood of a firm's failure. Our findings are also robust to alternative definitions of a firm's failure: financial constraints, presumed debt covenant violation and legal bankruptcy filings.     

Underinvestment,capital structure and strategic debt restructuring

This paper shows that shareholders' option to renegotiate debt in a period of financial distress exacerbates Myers' (1977) underinvestment problem at the time of the firm's expansion. This result is a consequence of a higher wealth transfer from shareholders to creditors occurring upon investment in the presence of the option to renegotiate. This additional underinvestment is eliminated by granting creditors the entire bargaining power. In such a case, renegotiation commences at shareholders' bankruptcy trigger so no additional wealth transfer occurs. In addition to deriving the firm's policies, we provide results on the values of corporate claims, the agency cost of debt, and the optimal capital structure. Empirically, we predict, among others, a lower sensitivity of capital investment to shocks to Tobin's q and cash flow for firms financed with renegotiable debt, and a negative effect of debt renegotiability on the relationship between growth opportunities and systematic risk as well as leverage.     

The Economics of Director Heterogeneity

We investigate the potential costs and benefits of firms constituting a heterogeneous pool of directors relative to more homogeneous boards. We measure director heterogeneity along six separate dimensions and divide board heterogeneity into occupational and social components. Our empirical analysis indicates that corporate complexity and managerial control exhibit significant influence on board heterogeneity. Using the heterogeneity of the county population of the firm's headquarters as an instrument, we also find that investors place valuation premiums on heterogeneous boards in complex firms but discount heterogeneity in less complex firms. Overall, our analysis indicates greater heterogeneity may not necessarily improve board efficacy.     

Managerial incentives and corporate leverage: evidence from the United Kingdom

This paper investigates the effect of managerial incentives and corporate governance on capital structure using a large sample of UK firms during the period 1999–2004. The analysis revolves around the view that managerial incentives are important in determining a firm's leverage. However, we argue that the exact impact of these incentives on leverage is likely to be determined by firm‐specific governance characteristics. To conduct our investigation, we construct a simple corporate governance measure using detailed ownership and governance information. We present evidence of a significant non‐monotonic relationship between executive ownership and leverage. There is also strong evidence suggesting that corporate governance practices have a significant impact on leverage. More importantly, the results reveal that the nature of the relation between executive ownership and leverage depends on the firm's corporate governance structure.     

Ownership structure,cash flow,and capital investment: Evidence from East Asian economies before the financial crisis

Using financial and ownership data from eight East Asian emerging markets before the Asian financial crisis, we document that while the sensitivity of a firm's capital investment to its cash flow decreases as the cash-flow rights of its largest shareholders increase, this sensitivity increases as the degree of the divergence between the control rights and cash-flow rights of the firm's largest shareholders increases. We interpret the results to be consistent with the free cash-flow hypothesis, which postulates that too much free cash flow in the hands of entrenched managers is likely to lead to overinvestment. This is particularly true for firms with the greatest divergence between the largest shareholders' control rights and their cash-flow rights and for firms with lower profitability.     

The impact of corporate fraud on director‐interlocked firms: Evidence from bank loans

We examine the impact of corporate fraud committed by one firm (the “fraudulent firm”) on other firms with interlocking directors (the “interlocked firms”), focusing on the debtholder side. We argue that the revelation of a fraudulent firm's fraud can damage the reputation of the interlocked firms because corporate governance can propagate via director interlocks. Empirically, we find that the interlocked firms' cost of debt is higher and the loan covenants become stricter after the fraud cases of the fraudulent firms are revealed. Consistent with the corporate governance propagation explanation, our results are weaker (stronger) for interlocked firms that have better (worse) pre‐event corporate governance standards. Our findings suggest that corporate fraud of fraudulent firms can affect other firms through director‐interlocks beyond shareholder value.     

The Cash Flow Sensitivity of Cash

We model a firm's demand for liquidity to develop a new test of the effect of financial constraints on corporate policies. The effect of financial constraints is captured by the firm's propensity to save cash out of cash flows (the cash flow sensitivity of cash). We hypothesize that constrained firms should have a positive cash flow sensitivity of cash, while unconstrained firms' cash savings should not be systematically related to cash flows. We empirically estimate the cash flow sensitivity of cash using a large sample of manufacturing firms over the 1971 to 2000 period and find robust support for our theory.