Specification and negotiation in incomplete contracts

We investigate contractors' bargaining power and holdup on buyers in procurement auctions of incomplete contracts held by California Department of Transportation. Using a model where contractors bid competitively in response to a buyer's choice of initial contract design, we infer the contractors' costs and bargaining power from the bids and transfers negotiated after the auction. We find that the contract winners have substantial bargaining power in post‐auction negotiation. The average holdup on the buyer is about 20% of project costs. Counterfactual cost‐plus contracts would reduce the buyer's surplus in 72% of the projects, with an average reduction over $382,000.     

Estimation of default probabilities using incomplete contracts data

This paper develops a count data model for credit scoring which allows the estimation of default probabilities using incomplete contracts data. The main advantage of the proposed approach is that it permits a more efficient use of the data, including that for the most recent clients. Moreover, because the probability of default is specified as a function of the age of the contract, the model provides some information on the timing of the defaults. The model is based on the beta-binomial distribution, which is found to be particularly adequate for this purpose. A well-known dataset on personal loans is used to illustrate the application of the proposed model.     

Measuring managerial equity ownership: a comparison of sources of ownership data

This paper demonstrates that differences in managerial ownership data cannot explain contradictory empirical evidence on the relation between equity ownership and the entrenchment of managers. Three commonly used sources of managerial equity ownership data are described and contrasted. The Value Line Investment Survey is shown to be a relatively low-cost substitute for the data on beneficial ownership by officers and directors found in corporate proxy statements.     

Family ownership and productivity: the role of owner-management

This article analyses the relationship between family ownership and productivity, with special focus on the role of owner-management. The results show that family-owned firms are less productive than non-family-owned firms. This productivity gap is, however, explained by differences in management regime. Family-owned firms managed by a person hired outside the owner family are equally productive as non-family-owned firms, while family-owned firms managed by a person from the owner family are significantly less productive. This finding is sustained after controlling for endogeneity of management regime.     

The role of cross-listing,foreign ownership and state ownership in dividend policy in an emerging market

In this paper, we investigate if dividend policy is influenced by ownership type. Within the dividend literature, dividends have a signaling role regarding agency costs, such that dividends may diminish insider conflicts (reduce free cash flow) or may be used to extract cash from firms (tunneling effect) – which could be predominant in emerging markets. We expect firms with foreign ownership and those that are listed in overseas markets to have different dividend policies and practices than those that are not, and firms with more state ownership and less individual ownership to be more likely to pay cash dividends and less likely to pay stock dividends. Using firms from an emerging economy (China), we examine whether these effects exist in corporate dividend policy and practice. We find that both foreign ownership and cross-listing have significant negative effects on cash dividends, consistent with the signaling effect and the notion of reduced tunneling activities for firms with the ability to raise capital from outside of China. Consistent with the tunneling effect, we find that firms with higher state ownership tend to pay higher cash dividends and lower stock dividends, while the opposite is true for public (individual) ownership. Further analysis shows that foreign ownership mediates the effect of state ownership on dividend policy. Our results have significant implications for researchers, investors, policy makers and regulators in emerging markets.     

Renegotiation of financial contracts: Evidence from private credit agreements

Using a large sample of private credit agreements between U.S. publicly traded firms and financial institutions, we show that over 90% of long-term debt contracts are renegotiated prior to their stated maturity. Renegotiations result in large changes to the amount, maturity, and pricing of the contract, occur relatively early in the life of the contract, and are rarely a consequence of distress or default. The accrual of new information concerning the credit quality, investment opportunities, and collateral of the borrower, as well as macroeconomic fluctuations in credit and equity market conditions, are the primary determinants of renegotiation and its outcomes. The terms of the initial contract (e.g., contingencies) also play an important role in renegotiations; by altering the structure of the contract in a state contingent manner, renegotiation is partially controlled by the contractual assignment of bargaining power.     

Betting on the future: the virtues of contingent contracts

It happens all the time. Two parties with common interests fail to reach an agreement--about a sale, a merger, a technology transfer--because they have different expectations about the future. They are both so confident in their prediction, or so suspicious of the other side's motives, that they refuse to compromise. Such impasses are hard to break through. Fortunately, they can often be avoided altogether by using a straightforward but frequently overlooked type of agreement called a contingent contract. The terms of a contingent contract are not finalized until the uncertain event in question--the contingency--takes place. In some areas of business, such as compensation, contingent contracts are common: a CEO's pay is tied to the company's stock price, for instance. But in many business negotiations, contingent contracts are either ignored or rejected out of hand. That's mistake, according to the authors. In an increasingly uncertain world, flexible contingent contracts can actually be more rational and less risky than rigid, traditional ones. In particular, contingent contracts offer six benefits: they enable a difference of opinion to become the basis of an agreement, not an obstacle to it; they cancel out the biases of negotiators; they level the playing field by reducing the impact of asymmetric information; they provide a means of uncovering deceitful dealings; they reduce risk by sharing it among parties; and they motivate parties to fulfill their promises. While contingent contracts are not appropriate in all instances, they are much more broadly applicable than managers may think.     

Design of public procurement auctions: evidence from cleaning contracts

We analyze a regime change from beauty contests to first‐price sealed‐bid and scoring auctions, using Swedish data on public procurement of cleaning services. In beauty contests, the lowest bid often lost, leaving substantial money on the table. The procurement costs were similar before and after the regime change: (i) Entry strongly decreases the procurement cost but did not change. Entry would have decreased had the municipalities not adjusted the objects of auctions. (ii) Municipalities favored in‐house suppliers in the old regime, leading to more aggressive bidding by others. With favoritism reduced, these changes balanced each other out.     

Debt contracts in the presence of performance manipulation

Empirical evidence suggests that firms often manipulate reported numbers to avoid debt covenant violations. We study how a firm’s ability to manipulate reports affects the terms of its debt contracts and the resulting investment and manipulation decisions that the firm implements. Our model generates novel empirical predictions regarding the use and the level of debt covenant, the interest rate, the efficiency of investment decisions, and the likelihood of covenant violations. For example, the model predicts that the optimal debt contract for firms with relatively strong (weak) corporate governance (i.e., cost of manipulation) induces overinvestment (underinvestment). Moreover, for firms with strong (weak) corporate governance, an increase in corporate governance quality leads to tighter (looser) covenant, more (less) frequent covenant violations and lower (higher) interest rate. Our model highlights that the interest rate, which is a common proxy for the cost of debt, neither accounts for the distortion of investment efficiency nor the expected manipulation costs arising under debt financing. We propose a measure of cost of debt capital that accounts for these effects.     

The performance effect of managerial ownership: Evidence from China

By examining a sample of non-listed Chinese firms, we provide the first evidence from China for the effect of managerial ownership on firm performance. In matching-sample comparisons, we find that firms of significant managerial ownership outperform firms whose managers do not own equity shares. Our further results indicate the relation between firm performance and managerial ownership is nonlinear, and the inflection point at which the relation turns negative occurs at ownership above 50%. Compared with previous studies, our results are less likely to suffer from an endogeneity problem due to the non-list nature of our sample and the unique institutional environment in China.     

Whole of government accounting in New Zealand: the ownership form of control

There are lessons to be learned from the emergence of comprehensive government financial reporting in New Zealand. Developments suggest ownership assumptions shaped policy and implied a particular role of government. These lessons are instructive on the relationship between reporting, organizational form, and constitutional considerations, and, importantly, about usefulness.     

The economics of loan commitment contracts: Credit pricing and utilization

Our purpose is to examine the circumstances under which enduring customer relationships (such as revolving credit agreements) will become predominant. We compare loan commitment contracts, under which borrowers may take down funds at fixed marginal mark up, to spot lending, under which funds are priced in consideration of customers' leverage. Under the first arrangement, insurance against default risk is priced as a fixed front-end fee. Under the second arrangement, it is priced under a rising leverage-specific markup schedule. We show that when default risk is independent of take down, the loan commitment contract will always dominate spot loans. When default risk increases with credit use, spot loans may become dominant.     

Further analysis on leadership in tax competition: the role of capital ownership

This paper extends the work of Kempf and Rota-Graziosi (J. Pub. Econ. 94:768–776, 2010), which argues that under capital tax competition the sub-game perfect equilibria (SPEs) correspond to two Stackelberg outcomes. The findings show that the Kempf and Rota-Graziosi result depends on the form of capital ownership. By generalizing the form of capital ownership, this paper shows that the simultaneous-move outcome prevails as an SPE if the capital is owned by residents in the countries, whereas the Kempf and Rota-Graziosi argument holds if the capital is owned by nonresidents.     

Institutional incentives and earnings quality: The influence of government ownership in China

We examine the effect of government ownership and its associated institutional incentives on firms’ earnings quality using a sample of Chinese firms during the transitional economy between 1998 and 2005 when state-owned and non-state-owned firms were traded in the stock exchanges. We find that, in China, state-owned firms exhibit a lower earnings quality property than non-state-owned firms. Particularly, state-owned firms have more earnings smoothing, more frequently managed earnings toward target, less frequent timely recognition of losses, and less value relevance, relative to non-state-owned firms. We also find that state-owned firms have significantly higher discretionary current accruals than non-state-owned firms. We conclude that the Chinese government, through its controlling ownership of state-owned firms, creates incentives and regulatory backing for self-serving purposes that negatively influence these listed firms’ financial reporting.     

Financing bank stock ownership: A question of conflict of interest

The bank stock loan conflict of interest question arises when compensating balances are intermingled with a bank's correspondent balances for the benefit of those bank stockholders seeking a bank stock loan. This study attempts to determine if this practice exists usign two-stage least square regression analysis and cross-sectional data obtained from one-bank holding company applications in the Tenth Federal Reserve District. Our results suggest that bankers with established correspondent banking relationships capitalize on their correspondent balances to obtain favorable interest rates on bank stock loans.     

Junior-for-senior announcements: A study of the role of inside ownership

In this paper, we investigate the role of inside ownership in explaining announcement period stock returns for 455 junior-for-senior transactions. We find that returns are more negative for firms with higher inside ownership percentages. Returns become even more negative for firms in which insiders are expected to be decreasing their ownership percentages.     

State ownership and abnormal accruals in highly-valued firms: Evidence from China

We examine how state ownership affects Chinese firms’ abnormal accruals during a period of high valuation. We find the magnitude of abnormal accruals first increases for up to three years of high valuation, and then reduces after the fourth year. We also find that managers turn to using abnormal real transactions after four consecutive years of high valuation. Next, we examine whether the degree of abnormal accruals in highly-valued firms differs between state-owned enterprises (SOEs) and non-NSOEs. Supporting the view that SOE managers have less incentive to sustain high stock prices, we find evidence that highly-valued SOEs have significantly lower levels of abnormal accruals than highly-valued NSOEs during the period of high valuation. Our findings contribute to the literature on the cross-sectional variation in the relation between managers’ pressure to sustain high stock prices and their accounting choices in firms with different ownership structures.     

Equilibrium leadership in tax competition models with capital ownership: a rejoinder

This paper reconciles two opposite results in the tax competition literature. Kempf and Rota-Graziosi (J Public Econ 94(9–10):768–776, 2010) and Hindriks and Nishimura (J Public Econ 121:66–68, 2015) have shown that the two Stackelberg outcomes prevail as the subgame perfect equilibria when capital is entirely owned by nonresidents. However, Ogawa (Int Tax Public Finance 20(3):474–484, 2013) has shown that the simultaneous-move outcome prevails when capital is entirely owned by residents. We develop a model in which capital ownership can vary freely between these two polar cases. We show that there exists a unique degree of residential capital ownership such that the equilibrium switches from the Stackelberg to the simultaneous-move outcomes. The chance for the simultaneous-move outcome to prevail increases with the extent of production asymmetry between regions. Partial ownership also induces a novel effect of tax leadership that we call the preference reversion effect.     

Optimal job design in the presence of implicit contracts

We characterize the optimal job design in a multitasking environment when the firms use implicit contracts (i.e., bonus payments). Two natural forms of job design are compared: (i) individual assignment, where each agent is assigned to a particular job and (ii) team assignment, where a group of agents share responsibility for a job and are jointly accountable for its outcome. Team assignment mitigates the multitasking problem but may weaken the implicit contracts. The optimal job design follows a cutoff rule where only the firms with high reputation concerns opt for team assignment. However, the cutoff rule need not hold if the firm can combine implicit incentives with explicit pay‐per‐performance contracts.