Disappearing internal capital markets: Evidence from diversified business groups in Korea

This paper examines how the onset of a financial crisis affects the operation of internal capital markets among firms within a diversified business group. We find that active internal capital markets within Korean business groups (chaebols) attenuate the financial constraints of the group-affiliated firms, allowing them to make efficient capital allocations during the early 1990s. However, these markets barely function after the financial crisis of 1997. Instead, we observe public debt markets serving as a substitute for internal capital markets. Our results suggest that chaebol firms’ coordinated attempts to achieve healthier financial structures in the wake of the crisis have taken place at the expense of investment efficiency.     

Accountability of independent directors: Evidence from firms subject to securities litigation

We examine which independent directors are held accountable when investors sue firms for financial and disclosure-related fraud. Investors can name independent directors as defendants in lawsuits, and they can vote against their reelection to express displeasure over the directors’ ineffectiveness at monitoring managers. In a sample of securities class action lawsuits from 1996 to 2010, about 11% of independent directors are named as defendants. The likelihood of being named is greater for audit committee members and directors who sell stock during the class period. Named directors receive more negative recommendations from Institutional Shareholder Services, a proxy advisory firm, and significantly more negative votes from shareholders than directors in a benchmark sample. They are also more likely than other independent directors to leave sued firms. Overall, shareholders use litigation along with director elections and director retention to hold some independent directors more accountable than others when firms experience financial fraud.     

Small business groups enhance performance and promote stability, not expropriation. Evidence from French SMEs

This paper investigates the influence that a firm’s distance from control has on its performance, using balance sheet information and a unique data set on small business ownership. This study fills a gap in the empirical governance literature by investigating whether there is expropriation of minority shareholders in small business groups. Contrary to observations for large business groups, results show a positive relationship between the separation of control from ownership and firm performance. Results also underline that tunneling promotes controlling shareholders’ profit stability rather than profit maximization in small business groups.     

Cross-listing and legal bonding: Evidence from mergers and acquisitions

Using a sample of foreign acquisitions of US targets, this study examines the extent to which cross-listing in the US leads to legal and regulatory bonding, and/or whether reputational bonding proxied by financial intermediaries monitoring, an often ignored component of the bonding mechanism, is an important factor in US investors decision to hold shares in cross-listed firms. We find that compared to US firms, cross-listed firms are less likely to use equity in takeovers of US targets. Further, cross-listed firms from countries with poorer legal protections are less likely to finance with equity and pay higher premiums than cross-listed firms from countries with better legal protections. Using analysts’ coverage and institutional following as proxies for financial intermediary monitoring, we find some support for the importance of reputational bonding. The evidence suggests that while cross-listing reduces barriers to investment, there are limits to its ability to completely subsume both the legal environment and the importance of the monitoring of financial intermediaries. This further suggests that the extent of actual legal and regulatory bonding by cross-listed firms may be more limited than often assumed.     

Ownership structure and financial constraints: Evidence from a structural estimation

This article examines the impact of the divergence between corporate insiders' control rights and cash-flow rights on firms' external finance constraints via generalized method of moments estimation of an investment Euler equation. Using a large sample of U.S. firms during the 1994-2002 period, we find that the shadow value of external funds is significantly higher for companies with a wider insider control-ownership divergence, suggesting that companies whose corporate insiders have larger excess control rights are more financially constrained. The effect of insider excess control rights on external finance constraints is more pronounced for firms with higher degrees of informational opacity and for firms with financial misreporting, and is moderated by institutional ownership. The results show that the agency problems associated with the control-ownership divergence can have a real impact on corporate financial and investment outcomes.     

Stock exchange governance initiatives: Evidence from the Italian STARs

Can a stock exchange improve corporate governance and transparency by designating companies that exhibit superior corporate governance? In 2000, the Borsa Italiana created a mid-cap segment with strong listing standards, which is composed of firms (called STARS) that follow stricter standards of transparency, disclosure, monitoring and liquidity. We find that STAR firms exhibit governance characteristics not observed in non-STAR firms, such as a higher incidence of audit and executive committees and higher debt ratios. They experienced a modestly favorable share price response upon the implementation of the STAR initiative. Moreover, they experienced significantly higher buy and hold returns and transparency after the initiative. Several governance characteristics are cross-sectionally associated with performance following the STAR initiative. Overall, the results suggest that firms may be willing to improve governance when they are endorsed by a credible agency for doing so, and such improvements may lead to better performance. The STAR initiative may serve as a model that can be adapted by other stock exchanges to promote transparency and governance.     

Agency costs,governance, and organizational forms: Evidence from the mutual fund industry

Using a comprehensive sample of mutual funds and fund families for the period 1992–2004, this study examines the impact of fund management companies’ organizational forms on the level of agency costs within mutual funds. We find that, all else being equal: (1) funds managed by public fund families charge higher fees than those managed by private fund families; (2) public fund families acquire more funds than private fund families; and (3) funds of public fund families significantly underperform funds of private fund families. Collectively, these findings suggest that agency costs are higher in mutual funds managed by public fund families. Our results are consistent with the idea that the agency conflict between the fund management company and fund shareholders is more acute for public management companies because of their shorter-term focus.     

Board classification and managerial entrenchment: Evidence from the market for corporate control

This paper considers the relation between board classification, takeover activity, and transaction outcomes for a panel of firms between 1990 and 2002. Target board classification does not change the likelihood that a firm, once targeted, is ultimately acquired. Moreover, shareholders of targets with a classified board realize bid returns that are equivalent to those of targets with a single class of directors, but receive a higher proportion of total bid surplus. Board classification does reduce the likelihood of receiving a takeover bid, however, the economic effect of bid deterrence on the value of the firm is quite small. Overall, the evidence is inconsistent with the conventional wisdom that board classification is an anti-takeover device that facilitates managerial entrenchment.     

Executive option exercises and financial misreporting

Several recent papers document that the magnitude of potential gains from stock-based compensation is positively related to the likelihood of misreporting. In a sample of firms that announce restatements of their financial statements from 1997 to 2002, we examine whether managers realize these potential gains occurring from their accounting choices. After controlling for diversification needs and stock price impact, we find no significant evidence of higher option exercises by executives in the misreported years. However, for firms that are more likely to have made deliberate aggressive accounting choices, we find significant evidence of higher option exercises. For these firms, option exercises are higher by 20–60% in comparison to industry and size matched nonrestating firms. Options exercises by executives are also increasing in the magnitude of the restatement as captured by the effect of the restatement on net income. These higher option exercises tend to be more pervasive and are not just confined to the CEO and CFO of the firm.     

Market discipline, financial crisis and regulatory changes: Evidence from Indonesian banks

Following the 1997/1998 financial crisis, Indonesian banks experienced major regulatory changes, including the adoption of the blanket guarantee scheme (BGS) in 1998, a limited guarantee (LG) in 2005, and changes in capital regulation in 1998 and 2001. We examine the impact of these regulatory changes on market discipline during the period 1995-2009. The price of deposits is used to measure market discipline in a dynamic panel data methodology on a sample of 104 commercial banks. We find a weakening of market discipline following the introduction of the BGS. The result is consistent with the deposit insurance scheme being credible in the lower capital requirement environment. The adoption of LG in a recovering economy also mitigates the role of market discipline. However, market discipline is more pronounced in listed banks than unlisted banks and in foreign banks than domestic banks. These results have important implications for banking regulation and supervision, particularly during a crisis period.     

Corporate governance and the cost of debt: Evidence from director limited liability and indemnification provisions

We find that firms that provide limited liability and indemnification for their directors enjoy higher credit ratings and lower yield spreads. We argue that such provisions insulate corporate directors from the discipline from potential litigation, and allow them to pursue their own interests by adopting low-risk, self-serving operating strategies, which coincidentally redound to the benefit of corporate bondholders. Our evidence further suggests that the reduction in the cost of debt may offset the costs of directorial shirking and suboptimal corporate policies occasioned by this insulation, which may explain why stockholders have little incentive to rescind these legal protections.     

Does industry-wide distress affect defaulted firms? Evidence from creditor recoveries

Using data on defaulted firms in the United States over the period 1982–1999, we show that creditors of defaulted firms recover significantly lower amounts in present-value terms when the industry of defaulted firms is in distress. We investigate whether this is purely an economic-downturn effect or also a fire-sales effect along the lines of Shleifer and Vishny [1992. Liquidation values and debt capacity: a market equilibrium approach. Journal of Finance 47, 1343–1366]. We find the fire-sales effect to be also at work: Creditors recover less if the industry is in distress and non-defaulted firms in the industry are illiquid, particularly if the industry is characterized by assets that are specific, that is, not easily redeployable by other industries, and if the debt is collateralized by such specific assets. The interaction effect of industry-level distress and asset-specificity is strongest for senior unsecured creditors, is economically significant, and robust to contract-specific, firm-specific, macroeconomic, and bond-market supply effects. We also document that defaulted firms in distressed industries are more likely to emerge as restructured firms than to be acquired or liquidated, and spend longer time in bankruptcy.     

Information transfers and learning in financial markets: Evidence from short selling around insider sales

We document significant increases in short positions on days when company insiders sell their firms’ shares. Short selling increases before insider sales are publicly reported and often before insiders finish selling. Furthermore, the magnitude of short selling activity is consistent with short sellers’ knowledge of the insider’s rank (e.g., CEO, CFO, or a lower-ranked manager) and with knowledge of the unobservable size of the insider’s trading position. We show that short sellers’ superior timing is consistent with (i) monitoring of order flow and (ii) obtaining price-relevant information from brokerages that execute insider sales. Some of our results extend to insider purchases.     

Competition and innovation: Evidence from financial services

This paper presents new evidence on the relationship between competition and innovation by extending previous literature from manufacturing to financial services. We introduce a new measure of overall innovation by estimating and enveloping annual minimum cost frontiers to create a global frontier. The distance to the global frontier constitutes each bank’s technology gap, which decreases if the bank manages to innovate. Our innovation measure enables us to derive and estimate the model of Aghion et al. (2005b) at the firm level for the US banking industry. Based on individual bank Call Report data for the period 1984–2004, consistent with theoretical and empirical work by Aghion et al., we find evidence of an inverted-U relationship between competition and innovation that is robust over several different specifications. Further evidence on major structural changes in the US banking industry indicates that banks moved beyond their optimal innovation level and that interstate banking deregulation resulted in lower bank innovation. Policy implications to financial reform and prudential regulation are discussed also.     

The flight home effect: Evidence from the syndicated loan market during financial crises

This paper shows that the collapse of the global market for syndicated loans during financial crises can in part be explained by a flight home effect whereby lenders rebalance their loan portfolios in favor of domestic borrowers. The home bias of lenders' loan origination increases by approximately 20% if the bank's home country experiences a banking crisis. This flight home effect is distinct from flight to quality because borrowers of different quality are equally affected. The results indicate that the home bias in capital allocation tends to increase when adverse economic shocks reduce the wealth of international investors.     

Governance quality and privately negotiated stock repurchases: Evidence of agency conflict

This study examines the impact of shareholder rights on the wealth effects of privately negotiated stock repurchases. Our results show that wealth gains are lower when shareholder rights are more suppressed. We also find that the premium paid for shares is inversely related to the strength of shareholder rights, and this suggests that managers pay higher premiums when shareholder rights are more restricted. These findings imply that managers use shareholders’ funds to eliminate blockholders who are more likely to monitor them when shareholder rights are relatively weak, thereby entrench themselves. Consistent with this view, we further show that significant positive abnormal long-run returns after private stock repurchases are limited to firms with stronger shareholder protection. Overall, the evidence is consistent with the predictions of agency theory.     

Acquisitions and CEO power: Evidence from French networks

During mergers and acquisitions, the CEOs of the acquiring firms are likely to cancel the deal if the market does not react favorably to its announcement. Using a sample of French acquisition announcements during the period from 2000 to 2005, this paper studies the conditions in which CEOs are more willing to listen to investors. Furthermore, according to the strong networks developed through French elite schools' alumni and board ties, the well-connected CEOs are more likely to complete any deal in spite of a negative market reaction to acquisition announcements.     

The internal capital markets of business groups: Evidence from intra-group loans

We study business groups? internal capital markets using a unique data set on intra-group lending in Chile (1990–2009). In line with groups? financing advantage, firms that borrow internally have higher investment, leverage, and return on equity (ROE) than other firms. At the margin, controlling shareholders have higher cash-flow rights in borrowing firms than in lending firms. However, there is no robust evidence of minority shareholders losing out from intra-group loans as tunneling predicts. Our evidence is consistent with the idea that strict regulation and disclosure requirements for intra-group loans, which are features of the Chilean market, reduce the risk of expropriation in pyramids.     

The impact of investor protection law on corporate policy and performance: Evidence from the blue sky laws

Recent studies have debated the impact of investor protection law on corporate behavior and value. I exploit the staggered passage of state securities fraud statutes (“blue sky laws”) in the United States to estimate the causal effects of investor protection law on firm financing decisions and investment activity. The statutes induce firms to increase dividends, issue equity, and grow in size. The laws also facilitate improvements in operating performance and market valuations. Overall, the evidence is strongly supportive of theoretical models that predict investor protection law has a significant impact on corporate policy and performance.