Capital structure under collusion

We analyze the financial leverage of firms that collude to soften product market competition by forming a cartel. We find that cartel firms have lower leverage during collusion periods. This is consistent with the idea that cartel firms strategically reduce leverage to make their cartels more stable, because high leverage makes deviations from a cartel agreement more attractive. Given that cartels have a large economic footprint, their study is also relevant for the capital structure literature, which has largely ignored the role of anti-competitive behavior.     

Tacit collusion and capacity withholding in repeated uniform price auctions

This article analyzes tacit collusion in infinitely repeated multiunit uniform price auctions in a symmetric oligopoly with capacity‐constrained firms. Under two popular definitions of the uniform price, when each firm sets a price‐quantity pair, perfect collusion with equal sharing of profit is easier to sustain in the uniform price auction than in the corresponding discriminatory auction. Moreover, capacity withholding may be necessary to sustain this outcome. Even when firms may set bids that are arbitrary finite step functions of price‐quantity pairs, in repeated uniform price auctions maximal collusion is attained with simple price‐quantity strategies exhibiting capacity withholding.     

Information exchange in cartels

Antitrust authorities view the exchange of information among firms regarding costs, prices, or sales as anticompetitive. Such exchanges allow competitors to closely monitor each other, thereby facilitating collusion. But the exchange of aggregate information, perhaps via a third party, is legal. The logic is that collusion is difficult if the identity of a price-cutting firm cannot be ascertained. Here, we examine this logic using Stigler's model of secret price cuts. We first identify circumstances such that when no information exchange is possible, collusion is difficult. We then show that if firms' aggregate sales are made public, nearly perfect collusion is possible.     

MARKET POWER IN THE PROPERTY/CASUALTY INSURANCE INDUSTRY

Abstract: Pro-consumer groups have charged that insurance firms are able to exercise market power to reduce coverage and/or increase rates. The ability of firms to earn economic rents (abnormal profits) is a factor in banks' interest in entering insurance markets. In classical economics such collusion is usually only possible with cartels. Recent work, examining the relationship between industry structure indicates that the power that can be exercised by cartels may be more limited than under the classical paradigms. We examine the ability of insurers to exercise market power in light of these modern theories.     

Colluding through suppliers

This article investigates downstream firms’ ability to collude in a repeated game of competition between supply chains. We show that downstream firms with buyer power can collude more easily in the output market if they also collude on their input supply contracts. More specifically, an implicit agreement on input supply contracts with above‐cost wholesale prices and negative fixed fees (that is, slotting fees) facilitates collusion on downstream prices. Banning information exchange about wholesale prices decreases the scope for collusion. Moreover, high downstream prices are more difficult to sustain if upstream rather than downstream firms make contract offers.     

Bidding rings and the winner's curse

This article extends the theory of legal cartels to affiliated private value and common value environments. We show that efficient collusion is always possible in private value environments, but may not be in common value environments with a binding reserve price. In the latter case, collusion does more than simply transfer rents from the seller to the buyers, it also gives buyers a chance to pool their information prior to trade and make an efficient investment decision. However, full efficiency may not be compatible with information revelation. Buyers with high signals may be better off if no one colludes, leading to inefficient trade. This result provides a possible explanation for the low incidence of joint bidding, especially on marginal tracts, in U.S. federal government offshore oil and gas lease auctions.     

The effects of global leniency programs on margins and mergers

In a cross‐country study, we investigate how staggered passage of national leniency programs from 1990–2012 has affected firms’ margins and merger activity. We find that these programs, which give amnesty to cartel conspirators that cooperate with antitrust authorities, reduced the gross margins of the affected firms. However, firms reacted to new regulations by engaging in more mergers that had negative effects on downstream firms. Our results imply that although these programs were generally effective, their full potential was mitigated by mergers that substitute for cartels, and that a strong merger review process might be a prerequisite for strengthening anti‐collusion enforcement.     

Collusion with intertemporal price dispersion

We develop a theory of optimal collusive intertemporal price dispersion. Dispersion clouds consumer price awareness, encouraging firms to coordinate on dispersed prices. Our theory generates a collusive rationale for price cycles and sales. Patient firms can support optimal collusion at the monopoly price. For less patient firms, monopoly prices must be punctuated with fleeting sales. The most robust structure involves price cycles that resemble Edgeworth cycles. Low consumer attentiveness enhances the effectiveness of price dispersion by reducing the payoff to deviations involving price reductions. However, for sufficiently low attentiveness, price rises are also a concern.     

Vertical collusion

We characterize collusion involving secret vertical contracts between retailers and their supplier—who are all equally patient (“vertical collusion”). We show such collusion is easier to sustain than collusion among retailers. Furthermore, vertical collusion can solve the supplier's inability to commit to charging the monopoly wholesale price when retailers are differentiated. The supplier pays retailers slotting allowances as a prize for adhering to the collusive scheme and rejects contract deviations. In the presence of competing suppliers, vertical collusion can be sustained using short-term exclusive dealing.     

Corporate governance and the profitability of insider trading

This paper examines the influence of corporate governance systems on insiders' ability to profit from their information advantage and the ways through which corporate governance systems influence such ability. We find that corporate governance significantly reduces the profitability of insider sales but not that of insider purchases. Given that sales involve greater legal risk than purchases, the results suggest that well-governed firms restrict informed insider trading mainly to reduce legal risk. We also find that better-governed firms reduce the profitability of insider sales by increasing the likelihood of adopting ex-ante preventive measures (e.g., voluntary insider trading restriction policies), implementing such measures more effectively, and taking ex-post disciplinary actions more actively. These results highlight how better-governed firms are able to restrict insiders from exploiting private information.     

Government assisted earnings management in China

As the socialist system in China embraces the market economy, it has created many conflicts of interests and collusion between firms and different layers of governments. The central government in China sets regulations to ensure the quality of firms listed in the capital market, while local governments engage in inter-jurisdictional competition for more capital, and their interests are aligned with listed firms through the stringent IPO quota system. This paper examines how local governments in China help listed firms in earnings management to circumvent the central government’s regulation. We find that local governments provide subsidies to help firms boost their earnings above the regulatory threshold of rights offering and delisting. Moreover, this collusion between government and listed firms in earnings management exists mainly in firms controlled by local governments.     

The sharpest tool in the shed: IPO financial statement management of STEM vs. non-STEM firms

The valuation of STEM (science, technology, engineering, and math) firms has recently gained attention in the literature. Research has shown that, for valuation of STEM firms, accounting items such as sales growth and R&D expenditures matter more than bottom-line earnings. We examine whether, around the time of the IPO, STEM managers apply discretion over the accounting items most weighted by investors for their valuation. We find that investors tend to weigh sales growth and R&D more heavily than earnings in valuing STEM firms and that managers respond by managing those items rather than bottom-line earnings as in prior research. We find that future stock returns of STEM firms are negatively associated with sales management and not with abnormal accruals as for non-STEM firms. Our results illuminate the differential behavior of STEM managers and highlight the importance of a departure from the traditional IPO earnings management paradigm, which assumes that firms mainly manage their earnings.     

Asymmetric information consolidation and price discovery: Inferring bad news from insider sales

Due to the paucity of sources of negative firm‐specific information, US capital markets have more difficulty identifying and incorporating bad news into stock prices than they do good news. Even though insider selling is a potentially important proxy for undisclosed bad news, researchers have difficulty ex ante identifying information‐based sales due to an inability to separate liquidity‐motivated from information‐based insider trades. We hypothesize that when insiders in multiple firms sell shares of one firm in which they are insiders and at the same time buy shares of other insider portfolio firms, the sale is more likely to be information‐based, since the proceeds are reinvested. Conversely, when an insider sells one firm without purchasing others or sells multiple insider firms the sale is likely liquidity‐motivated. We find that insider sales identified as information‐based using this algorithm are followed by significant negative abnormal returns. Information‐based sales are also more likely to be associated with delistings, earnings declines and earnings restatements. Analysts are also more likely to revise their earnings forecasts downwards for these firms. It is thus possible to ex ante identify insider sales with information content. Our results will be of interest to investors and also to regulators designing insider trading rules.     

The incidence of earnings management on information asymmetry in an uncertain environment: Some Canadian evidence

In this study, we investigate the association between earnings management and information asymmetry considering environmental uncertainty. Results show that a complex and dynamic environment weakens the relationship between discretionary accruals and information asymmetry measured as share price volatility and bid-ask spread. More specifically, the positive relationship between earnings management and information asymmetry is weakened for diversified firms, those intensively investing in R&D, and those facing high sales volatility. This highlights the difficulty for investors to assess earnings management in an uncertain environment. Finally, in such a context, discretionary accruals are more likely to be detected by investors for firms cross-listed on a U.S. stock exchange, a more liquid and transparent stock market compared with the Canadian stock market.     

Evidence from impending bankrupt firms that long horizon institutional investors are informed about future firm value

A key assumption in many accounting and finance studies is that long horizon institutional investors are informed shareholders. Yet past empirical research finds no evidence that these institutions anticipate major corporate events, including earnings-based events. I find that long horizon institutions are better informed in that they sell more shares of impending bankrupt firms than of matched distress firms at least one quarter ahead of bankruptcy. Share sales are greater in impending bankrupt firms whose shareholders ultimately lose all of their equity. In additional analyses, I document greater share sales by long horizon institutions with supposedly superior information processing abilities and/or access to corporate management. Share sales are significantly less in the post Regulation FD era. Overall, my findings support the validity of the common assumption that long horizon institutions are informed. Regulation FD appears to mitigate (but not eliminate) their information advantage.     

Corporate Disclosure as a Tacit Coordination Mechanism: Evidence from Cartel Enforcement Regulations

We empirically study how collusion in product markets affects firms' financial disclosure strategies. We find that after a rise in cartel enforcement, U.S. firms start sharing more detailed information in their financial disclosure about their customers, contracts, and products. This new information potentially benefits peers by helping to tacitly coordinate actions in product markets. Indeed, changes in disclosure are associated with higher future profitability. Our results highlight the potential conflict between securities and antitrust regulations.     

The information content of director trading: Evidence from acquisition announcements in Australia

In response to the long-standing debate about the information content of director trading, this study investigates the implications of director stock trading before an acquisition announcement by the company. Using a sample of 1249 acquisition announcements made by Australian acquiring firms between 2003 and 2012, we find that the stocks of acquiring firms with net director sales tend to underperform those of acquiring firms with net director purchases or with no director trades. This evidence supports the notion that director trading conveys useful information about the quality of subsequent acquisitions. Further, the informational effect of net director sales is most pronounced for acquisitions where the method of payment is stock, implying that the acquiring firm's stock may be overvalued.     

The effect of asymmetric information on product market outcomes

We explore how asymmetric information in financial markets affects outcomes in product markets. Difference-in-difference tests around brokerage house merger/closure events (which increase asymmetric information through reductions in analyst coverage) indicate worse industry-adjusted sales growth for shocked firms than for their peers. Our results are consistent with Bolton and Scharfstein's (1990) tradeoff between investor agency concerns and predation risk. Further support is found in stronger treatment effects among firms with ex ante greater agency concerns, financing constraints, asymmetric information, and those operating in ex ante more competitive (fluid) product market spaces. Our results are concentrated in industries where we can clearly identify either net firm entry or exit.     

Asymmetric Cost Behavior and Dividend Policy

Costs are sticky on average, that is, they fall less for sales decreases than they rise for equivalent sales increases. We examine the effect of this asymmetric cost behavior on a firm's dividend policy. Given investors’ aversion to dividend cuts, we predict that firms with higher resource adjustment costs and stickier costs pay lower dividends than their peers because they are less able to sustain any higher level of dividend payouts in the future. We find evidence consistent with this prediction. Further, using a regression discontinuity design that exploits variation in labor adjustment costs generated by close-call union elections, we provide evidence suggesting that the negative relation between cost stickiness and dividend payouts is driven by resource adjustment costs. Our paper sheds new light on the determinants of dividend policy and demonstrates the role of cost behavior in corporate decisions.     

Firm strategy and market reaction to earnings

We examine whether a firm's strategy affects the information content of the firm's earnings announcement. A cost leadership strategy is characterized by low sales margins coupled with large sales volumes, economies of scale and major investments in plant and physical assets, whereas a differentiation strategy involves high sales margins achieved through product quality and branding realized by investments in intangibles such as R&D and advertising. These characteristics of the strategies result in differential impact on investor reactions to new information that is revealed about firms. Our results show that firms pursuing a cost leadership strategy have earnings announcements that are more commonly interpreted and result in a greater change in the average belief about stock price. On the other hand, earnings announcements of firms pursuing a differentiation strategy result in more heterogeneous interpretation accompanied by a smaller change in the average belief about stock price. This paper advances our understanding of the cross-sectional variation in the market's reaction to earnings announcements. In addition, the paper demonstrates a predictable instance of divergence in the price reaction and trading volume reaction to an earnings announcement.