Firm boundaries matter: Evidence from conglomerates and R&D activity

This paper examines the impact of the conglomerate form on the scale and novelty of corporate Research and Development (R&D) activity. I exploit a quasi-experiment involving failed mergers to generate exogenous variation in acquisition outcomes of target firms. A difference-in-differences estimation reveals that, relative to failed targets, firms acquired in diversifying mergers produce both a smaller number of innovations and also less-novel innovations, where innovations are measured using patent-based metrics. The treatment effect is amplified if the acquiring conglomerate operates a more active internal capital market and is largely driven by inventors becoming less productive after the merger rather than inventor exits. Concurrently, acquirers move R&D activity outside the boundary of the firm via the use of strategic alliances and joint ventures. There is complementary evidence that conglomerates with more novel R&D tend to operate with decentralized R&D budgets. These findings suggest that conglomerate organizational form affects the allocation and productivity of resources.     

R&D sensitivity to asset sale proceeds: New evidence on financing constraints and intangible investment

We examine the intersection between corporate divestitures of tangible assets and investment in intangible capital (R&D) to provide new tests for the impact financing constraints have on real activity. A positive R&D sensitivity to asset sale proceeds indicates binding financing constraints since cash inflows from tangible asset sales are negatively correlated with productivity shocks and not otherwise connected to intangible investment via non-financial channels. Using a variety of estimation approaches, we document a strong, positive link between cash inflows from fixed asset sales and corporate R&D investment, but only among firms most likely facing binding financing constraints. These results offer robust evidence that financing frictions impact the increasingly important yet understudied intangible corporate investments that drive innovative activity, and they highlight a previously unexplored but potentially valuable use of proceeds from fixed asset divestitures.     

A stochastic frontier approach to modelling financial constraints in firms: An application to India

We propose the use of stochastic frontier approach to modelling financial constraints of firms. The main advantage of the stochastic frontier approach over the stylised approaches that use pooled OLS or fixed effects panel regression models is that we can not only decide whether or not the average firm is financially constrained, but also estimate a measure of the degree of the constraint for each firm and for each time period, and also the marginal impact of firm characteristics on this measure. We then apply the stochastic frontier approach to a panel of Indian manufacturing firms, for the 1997–2006 period. In our application, we highlight and discuss the aforementioned advantages, while also demonstrating that the stochastic frontier approach generates regression estimates that are consistent with the stylised intuition found in the literature on financial constraint and the wider literature on the Indian credit/capital market.     

Beauty is in the eye of the beholder: The effect of corporate tax avoidance on the cost of bank loans

We find that firms with greater tax avoidance incur higher spreads when obtaining bank loans. This finding is robust in a battery of sensitivity analyses and in two quasi-experimental settings including the implementation of Financial Accounting Standards Board Interpretation No. 48 and the revelation of past tax sheltering activity. Firms with greater tax avoidance also incur more stringent nonprice loan terms, incur higher at-issue bond spreads, and prefer bank loans over public bonds when obtaining debt financing. Overall, these findings indicate that banks perceive tax avoidance as engendering significant risks.     

Debt financing: Does it boost or hurt firm performance in product markets?

Previous research seeks to establish whether debt boosts or hurts a firm's product market performance. This paper proposes that both of these outcomes can be observed: debt can boost and hurt performance. I first model a nonmonotonic relation between debt-like finance and competitive conduct. I then empirically examine the within-industry relation between leverage and sales performance using data from 115 industries over 30 years. My tests deal with the endogeneity of debt in a novel fashion: I use creditors’ valuation of assets in liquidation to identify financial leverage. I find that moderate debt taking is associated with relative-to-rival sales gains; high indebtedness, however, leads to product market underperformance.     

Operating and stock market performance of state-owned enterprise privatizations: The Spanish experience

We investigate the operating and stock market performance of Spanish state-owned enterprises (SOEs) privatized through public share issue offerings (SIPs) from 1990 to 2001, when the last SIP was conducted. We compare the performance of SOEs and privately-owned firms. We find significant operating improvements in Spanish SOEs after the privatization. Specifically, they show significant increases in income efficiency, real sales and employment. Spanish governments tried to minimize the foregone proceeds when selling SOE shares and underpriced them lower than private firms. We relate these results with the pressure of the Maastricht Treaty fiscal criteria, as well as lower information asymmetries between firms and investors. Finally, we do not find long-term abnormal stock market performance after SIPs.     

Corporate tax avoidance and stock price crash risk: Firm-level analysis

Using a large sample of U.S. firms for the period 1995–2008, we provide strong and robust evidence that corporate tax avoidance is positively associated with firm-specific stock price crash risk. This finding is consistent with the following view: Tax avoidance facilitates managerial rent extraction and bad news hoarding activities for extended periods by providing tools, masks, and justifications for these opportunistic behaviors. The hoarding and accumulation of bad news for extended periods lead to stock price crashes when the accumulated hidden bad news crosses a tipping point, and thus comes out all at once. Moreover, we show that the positive relation between tax avoidance and crash risk is attenuated when firms have strong external monitoring mechanisms such as high institutional ownership, high analyst coverage, and greater takeover threat from corporate control markets.     

DETERMINANTS OF CAPITAL STRUCTURE IN BUSINESS START‐UPS: THE ROLE OF NONFINANCIAL STAKEHOLDER RELATIONSHIP COSTS

According to the finance literature, nonfinancial stakeholders (NFS), such as customers, suppliers, and employees, take into account their expected liquidation costs when dealing with a firm. In this framework, firms can influence their probability of liquidation by choosing an appropriate capital structure. Also, the literature suggests NFS bargaining power may affect firm financing decisions. In the current article we investigate these ideas for initial financing decisions by business start‐ups, where ex ante failure risk is high and NFS must decide whether to make relationship‐specific investments. We find that start‐ups imposing larger costs on their NFS following liquidation significantly reduce leverage. This effect is strengthened when suppliers have greater bargaining power. We also document a marginally negative effect of NFS liquidation costs on the proportion of bank loans. Finally, business start‐ups rely less on bank loans when customers and suppliers are in a powerful bargaining position.     

The American keiretsu and universal banks: Investing,voting and sitting on nonfinancials’ corporate boards

This paper investigates the equity investments and voting rights that American banks control through their trust business. The paper also studies whether the voting rights American banks control through their trust business help explain their presence on firms’ corporate boards. We find that on average the largest 100 American banks control 10% of the voting rights of S&P 500 firms. We also find that there are several firms in the S&P 500 index in which the top banks control more than 20% of their voting rights, and several firms in the country in which these banks control more than 60% of their voting rights. Our investigation into the presence of American bankers on corporate boards shows that bankers are more likely to join the boards of firms in which they control a large voting stake. We also find that banks’ lending relationships help explain bankers’ board memberships. Our results further show that bankers who have both a voting stake in a firm and a lending relationship with it have a higher likelihood of joining the firm's board of directors.     

Wall Street’s bailout bet: Market reactions to house price releases in the presence of bailout expectations

The rise and subsequent collapse of US house prices was one of the factors underlying the recent financial crisis. One could expect that the crisis brought increased attention to the housing market and thus led to stronger market reactions to house price news. We find that reactions indeed change, but with a peculiar twist: from September 2008 on, good news from the housing market are associated with falling US stock prices, and vice versa. The likely explanation, for which we provide cross-sectional evidence, is that falling house prices increased the market’s trust in a government bailout, thereby increasing market valuations of firms that were expected to benefit from government rescue measures.     

Vertical integration to avoid contracting with potential competitors: Evidence from bankers' banks

We examine a vertical integration decision within the commercial banking industry. During the last quarter of the 20th century, some community banks reduced their traditional reliance on correspondent banks for upstream products and services by joining bankers' banks, a form of business cooperative. Research on vertical integration focuses primarily on firm-specific investment, market power, and government regulation. However, this case is difficult to explain in terms of these standard vertical integration motives. Our evidence suggests that bankers' banks are a response to technological change and deregulation that results in increased costs faced by community banks in dealing with correspondent banks as both suppliers and potential competitors. For instance, loan participations require sharing proprietary information about major loan customers, something a community bank would not want to provide to a potential competitor.     

Population Ageing,Fiscal Pressure and Tax Smoothing: A CGE Application to Australia*

This paper analyses the fiscal pressure from population ageing using an intertemporal CGE model, applied to Australia, and compares the results with those of a recent government‐commissioned study. The latter study uses an alternative modelling approach based on extrapolation rather than optimising behaviour of consumers and firms. The deadweight losses from the fiscal pressure caused by population ageing are equivalent to an annual loss of consumption of $260 per person per year in 2003 dollars in the balanced‐budget scenario. A feasible degree of tax smoothing would reduce this welfare loss by an equivalent of $70 per person per year. Unlike the extrapolation‐based model, the CGE approach takes account of feedback effects of ageing‐induced tax increases on consumption and labour supply, which in turn impact on the ultimate magnitude of fiscal pressure and therefore tax increases. However, a counterfactual simulation suggests that the difference in terms of deadweight losses between the two modelling approaches is modest, at about $30 per person per year.     

Response of Tax Credit Claims to Tax Enforcement: Evidence from a Quasi‐Experiment in Chile

Diesel in Chile receives different tax treatments depending on its use. If diesel is used in industrial activities, the diesel taxes paid can be fully used as a credit against VAT, but if it is used in freight or public transportation – basically trucks and buses – only a fraction of diesel taxes paid can be claimed as a tax credit for VAT payments. As a result of this different tax treatment, firms have incentives to use ‘tax‐exempted’ diesel in activities requiring ‘non‐tax‐exempted’ diesel. This tax wedge therefore generates an opportunity for tax evasion, especially for firms with multiple economic activities, one of them being transport. In this paper, we analyse the impact of a tax enforcement programme implemented by the Chilean Internal Revenue Service (IRS), where letters requiring information about diesel purchases and use and vehicle ownership were sent to around 200 firms in 2003. Using different empirical strategies to consider the non‐randomness of the selection of firms, the empirical results show consistently that firms receiving a letter decreased their diesel tax credits by around 10 per cent.     

Venture Capital Backing and Overvaluation: Evidence from the High‐Tech Bubble

We investigate the association between venture capital (VC) backing and the likelihood of firm overvaluation in the high‐tech bubble period. We find strong evidence that a VC‐backed firm is more likely than a non‐VC‐backed firm to be overvalued during the bubble period. A further investigation suggests that such an association exists only for VC‐backed firms that have gone public recently and VC‐backed firms over which venture capitalists (VCs) have high ownership or control. But outside the bubble period, all the differences in overvaluation between VC‐backed and non‐VC‐backed firms disappear. Our findings provide additional evidence supporting VC opportunism in boom periods.     

Foreign bank entry and firms’ access to bank credit: Evidence from China

This paper studies the impact of foreign bank entry on domestic firms’ access to bank credit using a within-country staggered geographic variation in the policy of foreign bank lending in China. The paper finds that after foreign bank entry profitable firms use more long-term bank loans; whereas firms with higher value of potential collateral do not. It also finds that non-state-owned firms become able to substitute some trade credit with long-term bank loans. The findings suggest that less opaque firms and non-state-owned firms benefit more from foreign bank entry and that collateral may only play a limited role in mitigating the problem of information asymmetry when creditors’ rights are not well protected in a host country.     

Family control and investment–cash flow sensitivity: Empirical evidence from the Euro zone

This paper considers the ownership structure of family firms to determine whether family control alleviates or exacerbates investment–cash flow sensitivity in the Euro zone. We find that family-controlled corporations have lower investment–cash flow sensitivities. Further, our results show that this reduced sensitivity is mainly attributable to family firms with no deviations between cash flow and voting rights and to family firms in which family members hold managerial positions. We also find that second largest shareholders affect family firms' sensitivity and are associated with either monitoring (non-family second blockholders) or collusion (family second blockholders). Overall, family control seems to mitigate investment inefficiencies that derive from capital market imperfections.     

Testing limits to policy reversal: Evidence from Indian privatizations

We examine the effect of regime change on privatization. In the 2004 Indian election, the pro-reform BJP was unexpectedly defeated by a less reformist coalition. Stock prices of government-controlled companies that had been slated for privatization by the BJP dropped 3.5% relative to private firms. Government-controlled companies that were under study for possible privatization fell 7.5% relative to private firms. This is consistent with investor belief of a “point of no return,” where advanced reforms are more difficult to reverse. Further analysis suggests that layoffs, combined with the privatization announcement, served as a credible commitment to privatize.     

CEO incentive plans and corporate liquidation policy

To investigate CEOs' incentives to liquidate their firms, we examine the effects of insider ownership and compensation in stock options on 30 voluntary liquidation decisions by industrial firms in the period 1975–1986. We find that liquidation decisions are influenced by CEO incentive plans and increase shareholder value. Firms with more outside board members, smaller market-to-book ratios, and attempts by outsiders to gain control are more likely to be liquidated. Although few top executives of liquidating firms subsequently take comparable jobs, at least 41% of CEOs who downsize are made better off by liquidation.     

A revisit to the dependence structure between the stock and foreign exchange markets: A dependence-switching copula approach

This paper develops a dependence-switching copula model to examine dependence and tail dependence for four different market statuses, namely, rising-stocks/appreciating-currency, falling-stocks/depreciating-currency, rising-stocks/depreciating-currency, and falling-stocks/appreciating-currency. The model is then applied to daily stock returns and exchange rate changes for six major industrial countries over the 1990–2010 period. The dependence and tail dependence among the above four market statuses are asymmetric for most countries in the negative correlation regime, but symmetric in the positive correlation regime. These results enrich the findings in the existing literature and suggest that analyzing cross-market linkages within a time-invariant copula framework may not be appropriate.     

Managerial Behavior and the Link between Stock Mispricing and Corporate Investments: Evidence from Market‐to‐Book Ratio Decomposition

We examine the impact of mispricing on corporate investments and its components: capital expenditures, research and development, acquisitions, and asset sales. By decomposing the market‐to‐book ratio into mispricing and growth components, we show that corporate investments are linked to mispricing through market‐timing and catering, after controlling for growth and financial slack. This investment‐mispricing link is more pronounced in financially constrained firms and in firms with short‐horizon shareholders. Overall, our study indicates that the sensitivity of investments to mispricing is a function of the nature of mispricing, the type of investment, and the firm's characteristics.