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RESEARCH PAPERS | CORPORATE FINANCE

Unicorns

MUTUAL FUNDS AS VENTURE CAPITALISTS? EVIDENCE FROM UNICORNS

Sergey Chernenko, Josh Lerner, and  Yao Zeng
2017
Using novel contract-level data, we study the recent trend in open-end mutual funds investing in unicorns — highly valued, privately held start-ups — and the consequences of mutual fund investment for corporate governance provisions. Larger funds and those with more stable funding are more likely to invest in unicorns. Compared to venture capital groups (VCs), mutual funds appear to have weaker cash flow rights and to be less involved in terms of corporate governance, being particularly underrepresented on boards of directors. Having to carefully manage their own liquidity pushes mutual funds to require stronger redemption rights and eschew “pay-to-play” provisions, suggesting contractual choices consistent with mutual funds’ short-term capital sources. >more


IPOs

INITIAL PUBLIC OFFERING: A SYNTHESIS OF THE LITERATURE AND DIRECTIONS FOR FUTURE RESEARCH

Michelle Lowry, Roni Michaely, and Ekaterina Volkova
2017
The purpose of this chapter is to provide an overview of the IPO literature since 2000. The fewer numbers of companies going public in recent years has raised many questions regarding the IPO process, in both academic and regulatory circles. As we all strive to understand these changes in the market, it is especially important to understand the dynamics underlying the IPO process. If the process of going public is too costly or the IPO mechanism is plagued by too many conflicts of interest among the various intermediaries, then private companies may rationally choose other methods of raising capital. In a related vein, it is imperative that new regulations not be based on research focusing solely on large, more mature firms. Newly public firms have unique characteristics, and an increased understanding of such issues will contribute positively to well-functioning public markets and further growth of the entrepreneurial sector. >more


Bond Returns

CORPORATE BOND GUARANTEES AND THE VALUE OF FINANCIAL FLEXIBILITY

Michela Altieri, Alberto Manconi, and Massimo Massa
2016
We examine the effects of the decision of parent companies to guarantee bonds issued by their subsidiaries. The market value of the parent firm’s outstanding bonds drops two times more when it issues a guarantee for subsidiary debt than when it issues a new bond in its own name. This effect is exacerbated when the parent is financially constrained, or when its bonds are less liquid. Subsidiary guaranteed debt has less stringent covenant protection, and a longer maturity, consistent with subsidiary guaranteed debt providing greater flexibility to the parent. Our estimates imply a value of financial flexibility, measured as the difference in the impact on bond yield spreads between parent and subsidiary guaranteed bonds, of about 30 bps. >more


Impact of Career Paths

SHAPED BY BOOMS AND BUSTS: HOW THE ECONOMY IMPACTS CEO CAREERS AND MANAGEMENT STYLES

Antoinette Schoar, and Luo Zuo
2017
We show that economic conditions when managers enter the labor market have long-run effects on their career paths and managerial styles. Managers who began their careers during recessions become CEOs more quickly, but at smaller firms. They also have more conservative styles, such as lower investment in capital expenditures and research and development, more cost cutting, and lower leverage and working capital needs. These recession effects appear to be largely driven by the characteristics of the CEO’s first job (recession CEOs tend to start in smaller or private firms), which suggests that the early work environment is important to the formation and selection of managers. >more


Covenants

WHY DO LOANS CONTAIN COVENANTS? EVIDENCE FROM LENDING RELATIONSHIPS

Robert Prilmeier
2016
Despite the importance of banks' role as delegated monitors, little is known about how non-price terms of loan contracts are structured to optimize information production in a lending relationship. Using a large sample of corporate loans, this paper examines the effect of relationship lending on covenant choice. Consistent with information asymmetry theories, covenant tightness is relaxed over the duration of a relationship, especially for opaque borrowers. In contrast, the effect of lending relationship intensity on the number of covenants included in a loan follows an inverted U shape. I discuss potential explanations for this finding. >more


Dividend Policy

DO INVESTORS VALUE DIVIDEND SMOOTHING STOCKS DIFFERENTLY?

Yelena Larkin, Mark T. Leary, and Roni Michaely
2016
It is widely documented that managers strive to maintain smooth dividends. Yet, it is not clear if this behavior reflects investors’ preferences. In this paper, we study whether investors indeed value dividend smoothing stocks differently by exploring the implications of dividend smoothing for firms’ investor clientele, stock prices and cost of capital. We find that retail investors are less likely to hold dividend smoothing stocks, while institutional investors, and especially mutual funds, are more likely. However, this preference does not result in any detectable relation between the smoothness of a firm’s dividends and the expected return, or market value, of its stock. Together, the evidence suggests that firms adjust the supply of smoothed dividends to match investors’ demand. Dividend smoothing affects the composition of a firm’s shareholders but has little impact on its stock price. >more


Credit Ratings

THE REAL EFFECTS OF CREDIT RATINGS: EVIDENCE FROM CORPORATE ASSET SALES

Dion Bongaerts, and Frederik P. Schlingemann
2016
What is the relative contribution of credit rating downgrades on financial distress and managerial discipline? We find that firms are more likely to conduct asset sales following a credit rating downgrade, particularly so if firms indicate the purpose is to use the proceeds to pay down outstanding debt or to raise cash. We find a smaller or no effect if the sale is motivated by concentrating on core assets or involves the sale of a loss making or bankrupt operation. Shareholder wealth effects of the asset sale following a credit rating downgrade are consistent with the event being perceived by the market as a successful mechanism by the seller to mitigate financial distress caused by the downgrade and where buyers benefit from discounted fire-sale prices and when the assets have greater asset redeployability. Asset sales following a downgrade are more likely to involve segments that are the most liquid, generate the least current cash flows, and have the highest growth opportunities. Peer-based performance, intrafirm performance, or relatedness to core activities, do not explain the choice for which segments are divested. Our results suggest that firms respond to credit rating downgrades with asset sales in an attempt to reduce financial distress and that downgrades, at the margin, exacerbate financial distress rather than induce managerial discipline. >more


Freezeouts

ARE TARGET SHAREHOLDERS SYSTEMATICALLY EXPLOITED IN MANAGEMENT BUYOUTS AND FREEZEOUTS?

Jarrad Harford, Jared R. Stanfield, and Feng Zhang
2016
We provide evidence that managers and controlling shareholders time MBOs and freezeout transactions to take advantage of industry-wide undervaluation. Portfolios of industry peers of MBO and freezeout targets show significant alphas of around 1% per month over the first twelve months following the transaction. These returns are not explained by a battery of risk-factors, including a takeover-risk factor. In contrast, abnormal returns are not observed following arms-length third-party acquisitions. Investors appear to be unaware of the industry-wide undervaluation when the MBO or freezeout bid is announced. Target shareholders receive bid premiums comparable to those of arms-length third-party acquisitions, and industry peers of MBO and freezeout targets have insignificant returns around the announcement. >more


Behavioral Finance and Credit Origination

CLOUDED JUDGMENT: THE ROLE OF SENTIMENT IN CREDIT ORIGINATION

Kristle Romero Cortés,  Ran Duchin, and Denis Sosyura
2016
Using daily fluctuations in local sunshine as an instrument for sentiment, we study its effect on day-to-day decisions of lower-level financial officers. Positive sentiment is associated with higher credit approvals, and negative sentiment has the opposite effect of a larger magnitude. These effects are stronger when financial decisions require more discretion, when reviews are less automated, and when capital constraints are less binding. The variation in approval rates affects ex post financial performance and produces significant real effects. Our analysis of the economic channels suggests that sentiment influences managers' risk tolerance and subjective judgment. >more


Corporate Venture Capital

THE LIFE CYCLE OF CORPORATE VENTURE CAPITAL

Song Ma
2016
This paper studies the economics of financing innovation through establishing the life cycle of Corporate Venture Capital (CVC). Using an identification strategy that isolates firm-specific innovation shocks, I find that the CVC life cycle typically follows a period of deteriorated internal innovation and when external information is valuable, lending support to the hypothesis that firms use CVC to acquire innovation knowledge from startups. This information acquisition rationale is further supported at the operation and termination stage of the CVC life cycle -- CVCs select portfolio companies with similar technological focus but that have a different knowledge base, actively use newly acquired information, and change their human capital to facilitate information acquisition; CVC programs are terminated when the informational benefit diminishes. >more


Sovereign Debt Crisis

THE INVISIBLE HAND OF THE GOVERNMENT: 'MORAL SUASION' DURING THE EUROPEAN SOVEREIGN DEBT CRISIS

Steven Ongena, Alexander A. Popov, and Neeltje van Horen
2016
Sovereign debt crisis, domestic banks in fiscally stressed countries were considerably more likely than foreign banks to increase their holdings of domestic sovereign bonds in months with relatively high domestic sovereign bond issuance. This effect is stronger for state?owned banks and for banks with low initial holdings of domestic sovereign bonds, and it is not fueled by Central Bank liquidity provision. Our results point to a “moral suasion” mechanism, and cannot be explained by concurrent risk?shifting, carry?trading, regulatory compliance, or shocks to investment opportunities. >more


Credit Ratings

THE REAL EFFECTS OF CREDIT RATINGS: EVIDENCE FROM CORPORATE ASSET SALES

Dion Bongaerts, and Frederik P. Schlingemann
2016
What is the relative contribution of credit rating downgrades on financial distress and managerial discipline? We find that firms are more likely to conduct asset sales following a credit rating downgrade, particularly so if firms indicate the purpose is to use the proceeds to pay down outstanding debt or to raise cash. We find a smaller or no effect if the sale is motivated by concentrating on core assets or involves the sale of a loss making or bankrupt operation. Shareholder wealth effects of the asset sale following a credit rating downgrade are consistent with the event being perceived by the market as a successful mechanism by the seller to mitigate financial distress caused by the downgrade and where buyers benefit from discounted fire-sale prices and when the assets have greater asset redeployability. Asset sales following a downgrade are more likely to involve segments that are the most liquid, generate the least current cash flows, and have the highest growth opportunities. Peer-based performance, intrafirm performance, or relatedness to core activities, do not explain the choice for which segments are divested. Our results suggest that firms respond to credit rating downgrades with asset sales in an attempt to reduce financial distress and that downgrades, at the margin, exacerbate financial distress rather than induce managerial discipline. >more


Agency Conflicts

PLAYING IT SAFE? MANAGERIAL PREFERENCES, RISK, AND AGENCY CONFLICTS

Todd A. Gormley, and David A. Matsa
2016
This article examines managers’ incentive to play it safe. We find that, after managers are insulated by the adoption of an antitakeover law, they take value-destroying actions that reduce their firms’ stock volatility and risk of distress. To illustrate one such action, we show that managers undertake diversifying acquisitions that target firms likely to reduce risk, have negative announcement returns, and are concentrated among firms with managers who gain the most from reducing risk. Our findings suggest that instruments typically used to motivate managers, such as greater financial leverage and larger ownership stakes, exacerbate risk-related agency challenges. >more


Corporate Debt

MIND THE GAP: THE DIFFERENCE BETWEEN U.S. AND EUROPEAN LOAN RATES

Tobias Berg, Anthony Saunders, Sascha Steffen, and Daniel Streitz
2016
We analyze pricing differences between U.S. and European syndicated loans over the 1992-2014 period. We explicitly distinguish credit lines from term loans. For credit lines, U.S. borrowers pay significantly higher spreads, but lower fees, resulting in similar total costs of borrowing in both markets. Credit line usage is more cyclical in the U.S., which provides a rationale for the pricing structure difference. For term loans, we analyze the channels of the cross-country loan price differential and document the importance of: the composition of term loan borrowers and the loan supply by institutional investors and foreign banks. >more


Investments

CORPORATE RISK CULTURE

Yihui Pan, Stephan Siegel, and Tracy Yue Wang
2016
We examine the formation and evolution of corporate risk culture, i.e., the preferences towards risk and uncertainty shared by a firm's leaders, as well as its effect on corporate policies. We document persistent commonality in risk attitudes inside firms, which arises through the selection of leaders with similar preferences and is rooted in the founders' risk attitudes. Changes in corporate risk culture over time affect corporate investment policies, while cross-sectional differences in founders' risk attitudes, i.e., firms' initial risk culture, contribute to differences across firms in persistent firm policies, such as R&D intensity. >more


Liquidity

DO FINANCIAL ANALYSTS RESTRAIN INSIDERS' INFORMATIONAL ADVANTAGE?

Andrew Ellul, and Marios A. Panayides
2016
By collecting and disseminating price sensitive information, financial analysts should reduce firm insiders’ informational advantage with a consequent impact on trading dynamics and market quality. We empirically examine the impact of complete analysts’ coverage termination on stocks’ liquidity, price discovery and profitability of insider trading. Termination leads to deteriorating liquidity and price efficiency, more informed trading, and higher profitability of insider trades. The magnitude of these effects depends on the strength of insiders’ ownership and on management’s decision whether to improve the firm’s information environment after coverage termination. Institutional investors alleviate, but do not eliminate, the negative effects of termination. >more


Investments

CEO INVESTMENT CYCLES

Yihui Pan, Tracy Yue Wang, and Michael S. Weisbach
2015
This paper documents the existence of a CEO Investment Cycle, in which disinvestment decreases over CEO tenure while investment increases, leading to “cyclical” firm growth in assets as well as in employment. The estimated variation in investment rate over the CEO cycle is of the same order of magnitude as the differences caused by business cycles or financial constraints. This investment cycle appears to reflect CEOs’ preference for investment growth, which leads to increasing investment quantity and decreasing investment quality over time as the CEO gains more control over his board. >more


Impact of Culture

THE GRAVITY OF CULTURE FOR FINANCE

George Andrew Karolyi
2015
Scholarship in finance has paid relatively little attention to the role of culture in financial decision-making relative to other business disciplines and economics. This paper will review what research has been done to date including a critical assessment of the key databases used to measure differences in cultural values. Notwithstanding the concerns with the measures of cultural values, I conduct an empirical analysis of the role of cultural distance for explaining the foreign bias in international portfolio holdings using traditional gravity models in economics. I affirm the statistical explanatory power of culture for these investment biases and outline several new potential directions for research. >more


Short Selling

RETAIL SHORT SELLING AND STOCK PRICES

Eric K. Kelley, and  Paul C. Tetlock
2016
Using proprietary data on millions of trades by retail investors, we provide the first large-scale evidence that retail short selling predicts negative stock returns. A portfolio that mimics weekly retail shorting earns an annualized risk-adjusted return of 9%. The predictive ability of retail short selling lasts for one year and is not subsumed by institutional short selling. In contrast to institutional shorting, retail shorting best predicts returns in small stocks and those that are heavily bought by other retail investors. Our findings are consistent with retail short sellers having unique insights into the retail investor community and small firms' fundamentals. >more


Capital Structure

Leverage Dynamics over the Business Cycle

Michael Halling, Jin Yu, and Josef Zechner
2015
Surprisingly little is known about the business cycle dynamics of leverage. The existing evidence documents that target leverage evolves pro-cyclically either for all firms or financially constrained ones. In contrast, we show that, on average, target leverage ratios evolve counter-cyclically once cyclicality is measured comprehensively, accounting for variation in explanatory variables and model parameters. These counter-cyclical dynamics are robust to different subsamples of firms, data samples, empirical models of leverage, and definitions of leverage. There is a fraction of 10 to 25% of firms with pro-cyclical dynamics whose characteristics are consistent with counter-cyclical dynamics for loss-given-default and probability of default. >more


Asset Volatility

The Volatility of a Firm's Assets and the Leverage Effect

Jaewon Choi, and  Matthew P. Richardson
2015
We investigate the volatility of firms’ assets in contrast to existing studies that focus on equity volatility. We estimate asset volatility using a comprehensive dataset on the market values of corporate security returns. We find significant differences between the properties of equity and asset volatilities with implications for several important areas of finance. First, financial leverage has a large influence on equity volatility. Second, leverage and asset volatility have permanent and transitory effects respectively on equity volatility, helping explain the short- and long-run dynamics of equity volatility. Third, we analyze and compare the cross section of asset versus equity returns. >more


Diversification

DIVERSIFICATION AND CASH DYNAMICS

Tor-Erik Bakke, and Tiantian Gu
2016
Why do diversified firms hold significantly less cash than focused firms? We study this using a dynamic model of corporate investment, saving, and diversification decisions. We find that investment dynamics are more important in explaining the cash differences than financing frictions. More efficient internal capital markets increase cash differences and are especially valuable when a firm diversifies or refocuses. Contrary to static models, more diverse conglomerates have lower cash differences. Endogenous selection – diversifying firms are larger and have better growth opportunities – accounts for 68% of the cash difference while the diversification event itself reduces cash holdings by 32%. >more


CDS

THE ANATOMY OF THE CDS MARKET

Martin Oehmke, and Adam Zawadowski
2015
Using novel position and trading data for single-name corporate credit default swaps (CDSs), we provide evidence that CDS markets emerge as “alternative trading venues” that serve a standardization and liquidity role. CDS positions and trading volume are larger for firms with bonds that are fragmented into many separate issues and have heterogeneous contractual terms. Whereas hedging motives are associated with trading volume in the bond and CDS markets, speculative trading concentrates in the CDS. Cross-market arbitrage links the CDS and bond market via the basis trade, compressing the negative CDS-bond basis and reducing price impact in the bond market. >more


Investor Attention

DISTRACTED SHAREHOLDERS AND CORPORATE ACTIONS

Elisabeth Kempf, Alberto Manconi, and  Oliver G. Spalt
2016
Investor attention matters for corporate actions. Our new identification approach constructs firm-level shareholder "distraction" measures, by exploiting exogenous shocks to unrelated parts of institutional shareholders' portfolios. Firms with "distracted" shareholders are more likely to announce diversifying, value-destroying, acquisitions. They are also more likely to grant opportunistically-timed CEO stock options, more likely to cut dividends, and less likely to fire their CEO for bad performance. Firms with distracted shareholders have abnormally low stock returns. Combined, these patterns are consistent with a model in which the unrelated shock shifts investor attention, leading to a temporary loosening of monitoring constraints. >more


Credit Risk

EXODUS FROM SOVEREIGN RISK: GLOBAL ASSET AND INFORMATION NETWORKS IN THE PRICING OF CORPORATE CREDIT RISK

Jongsub Lee, Andy Naranjo, and Stace Sirmans
2015
Using 5-year credit default swap (CDS) spreads on 2,364 companies in 54 countries during 2004-2011, we show firms exposed to better property rights institutions through their foreign asset positions (Institutional channel) and firms whose stocks are cross-listed on exchanges with stricter disclosure requirements (Informational channel) reduce their CDS spreads by 40 bps for a one standard deviation increase in their exposure on the two channels. These channels capture distinct effects beyond those associated with firm- and country-level fundamentals. Overall, we find that firm-level global asset and information connections are important mechanisms to delink firms from their sovereign and country risks. >more


Capital Structure

FIRING COSTS AND CAPITAL STRUCTURE DECISIONS

Matthew Serfling
2016
I exploit the adoption of state-level labor protection laws as an exogenous increase in employee firing costs to examine how the costs associated with discharging workers affect capital structure decisions. I find that firms reduce debt ratios following the adoption of these laws, with this result stronger for firms that experience larger increases in firing costs. I also document that, following the adoption of these laws, a firm’s degree of operating leverage rises, earnings variability increases, and employment becomes more rigid. Overall, these results are consistent with higher firing costs crowding out financial leverage via increasing financial distress costs. >more


Fraud

CORPORATE SCANDALS AND HOUSEHOLD STOCK MARKET PARTICIPATION

Mariassunta Giannetti, and  Tracy Yue Wang
2015
We show that after the revelation of corporate fraud in a state, household stock market participation in that state decreases. Households decrease their holdings in fraudulent as well as non-fraudulent firms, even if they did not hold stocks in fraudulent firms. Within a state, households with more lifetime experience of corporate fraud hold less equity. Furthermore, following the arguably exogenous increase in fraud revelation due to the Arthur Andersen’s demise, a one-standard-deviation increase in fraud revelation due to the presence of Arthur Andersen’s clients increases the probability that a household exits the stock market by 7 percentage points. We provide evidence that the negative effect of fraud revelation on stock market participation is likely to be due to a loss of trust in the stock market. >more


Fire Sales

FIRE SALE DISCOUNT: EVIDENCE FROM THE SALE OF MINORITY EQUITY STAKES

Serdar Dinc, Isil Erel, and Rose C. Liao
2016
Most of the existing empirical studies estimate the impact of fire sales either without the benefit of market prices from frequent trades, as with aircraft sales, or without observing the prices received by distressed sellers, as with the sales of equity securities by mutual funds facing outflows. We study transactions where the selling firm sells minority equity stakes it holds in publicly-listed third parties. In these transactions, market prices from frequent trades in the shares of those third parties are available and the transaction prices received by the sellers are reported. We estimate the industry-adjusted distressed sale discount based on the four-week window to be about 8% while controlling for the firm size and stock liquidity. This discount magnitude is higher than the 4% estimated for forced sales of stocks by mutual funds without the benefit of transaction prices. The discount we estimate becomes 13-14% if the stake sold is more than 5% of the firm or if the stake is sold as a block. Prices recover after the distressed sale. >more


Credit Ratings

THE REAL EFFECTS OF CREDIT RATINGS: THE SOVEREIGN CEILING CHANNEL

Heitor Almeida, Igor Cunha, Miguel A. Ferreira, and  Felipe Restrepo
2016
We show that sovereign debt impairments can have a significant impact on financial markets and real economies through a credit ratings channel. Specifically, we find that firms reduce their investment and reliance on credit markets due to a rising cost of debt capital following a sovereign rating downgrade. We identify these effects by exploiting exogenous variation on corporate ratings due to rating agencies' sovereign ceiling policies that require firms' ratings to remain at or below the sovereign rating of their country of domicile. >more


Capital Structure

THE LEVERAGE RATCHET EFFECT

Anat R. Admati,  Peter M. DeMarzo, Martin F. Hellwig, and Paul C. Pfleiderer
2015
This paper explores the dynamics of corporate leverage when funding decisions are made in the interests of shareholders. In the absence of prior commitments or regulations, shareholder-creditor conflicts give rise to a leverage ratchet effect, which induces shareholders to resist reductions while favoring increases in leverage even when total-value maximization calls for the opposite. Unlike inefficiencies based on asymmetric information, the leverage ratchet effect applies to all forms of leverage reduction, including earnings retentions and rights offerings.The leverage ratchet effect is present even in the absence of frictions other than the inability to write complete contracts. The effect creates an agency cost of debt that lowers the value of the leveraged firm. Standard frictions magnify the impact of the effect. In a dynamic context, since leverage becomes effectively irreversible, firms may limit leverage initially but then ratchet it up in response to shocks. The resulting leverage dynamics lead to history-dependent capital structure that cannot be explained by simple tradeoff considerations. Leverage can be adjusted in many ways. For example, leverage reductions can be achieved by issuing equity to either buy back debt or purchase new assets, or by selling assets to buy back debt. We study shareholders’ preferences over different ways to adjust leverage. A benchmark result gives conditions for shareholder indifference, but generally, shareholders have clear rankings over the alternatives. For example, shareholders prefer reducing leverage by selling assets, even at distressed prices, if by doing so they can benefit at the expense of senior creditors. >more


Capital Structure

THE MISALLOCATION OF FINANCE

Toni M. Whited, and Jake Zhao
2016
We ask whether financial assets are well-allocated in the cross-section of firms. Extending the framework of Hsieh and Klenow (2009) to the liabilities side of the balance sheet, we estimate the real losses that accrue from the cross-sectional misallocation of financial liabilities across firms. Using U.S. and Chinese data on manufacturing firms, we find significant misallocation of debt and equity. Although financial liabilities appear well-allocated in the United States, they are not in China. If China's debt and equity markets were as developed as those in the United States, China would realize gains of 40-55% in real firm value. We also back out the cost of debt and equity for each firm with our model, taking into account allocation distortions. We find that larger firms and firms located in more developed cities face markedly lower costs. >more


Cash Holdings

THE EVOLUTION OF CORPORATE CASH

John R. Graham, and Mark T. Leary
2016
We study the evolution of corporate cash holdings from 1920 to 2014. We show that the recent increase in average cash is not unique but is one of three large magnitude changes in average cash over the past century. However, there are several key differences in modern cash holdings relative to the earlier periods: Earlier changes in cash were broad-based and within-firm; in contrast, the modern run-up in average cash is dominated by cash-rich Nasdaq firms entering the sample, with negative or flat within-firm changes. Moreover, the modern increase in aggregate cash did not start until about 2000. Perhaps surprisingly, we find that estimated relations thought to support precautionary and transaction motives for holding cash are weaker or disappear earlier in the century, when financial frictions were arguably more severe. In general, firm characteristics have little ability to explain time-series changes in average or aggregate cash through the century, but macroeconomic forces, corporate profitability and investment, and repatriation tax incentives help fill this gap. >more


Equity Lending Market

THE RISE OF THE EQUITY LENDING MARKET: IMPLICATIONS FOR CORPORATE FINANCIAL POLICIES

Murillo Campello, and Pedro A. C. Saffi
2015
Ever increasing competition and search for yield have prompted institutional investors to routinely lend their equity holdings, making them the largest suppliers of stocks used for short selling. Shorting depresses stock prices, making it harder for firms to plan their payout policies, investments, merger deals, and employee compensation. We exploit the framework of institutional investing to show how shifts in the supply of lendable (shortable) stocks affect corporate policies. Firms react promptly to increases in lendable stocks by repurchasing shares and building cash reserves. The relations we document appear to be causal and consistent with the argument that firms shore up defenses against shorting activity. To fund their responses, firms pay fewer dividends, issue debt, and reduce investment spending. Firm responses are more pronounced when stocks are ex-ante more liquid, relatively overvalued, have higher pent-up shorting demand, and whose managers' personal compensation is more sensitive to stock prices. >more


Financing Constraints

AGGREGATE EFFECTS OF COLLATERAL CONSTRAINTS

Thomas Chaney, Zongbo Huang, David Alexandre Sraer, and  David Thesmar
2016
This paper provides a quantitative exploration of the aggregate effects of an important source of financing friction, collateral constraints. We develop a general equilibrium model of firm dynamics with collateral constraints and adjustment costs, which we structurally estimate using administrative data on French firms. The model is estimated using the joint firm-level dynamics of capital and labor observed following exogenous shocks to the value of collateral. We find that welfare increases by 5.4% when collateral constraints are removed. 25% of these welfare gains come from an improved allocation of inputs across heterogenous firms; 75% are derived from an aggregate increase in capital. Interestingly, removing collateral constraints has little effect on aggregate employment, as financially constrained firms tend to substitute labor for capital. >more


Liquidity

A NEW PERSPECTIVE ON BANK-DEPENDENCY: THE LIQUIDITY INSURANCE CHANNEL

Viral V. Acharya, Heitor Almeida, Filippo Ippolito, and Ander Perez-Orive
2016
We provide a new perspective on bank-dependency - the (bank) "liquidity insurance channel" - based on the predominance of large, high credit quality firms among credit line users. Our model can match the pattern of bank dependency in the cross-section of firms, and predicts when shocks to bank health will affect primarily low or high credit quality firms. Our framework can also explain why credit line origination is more cyclical than loan origination. Overall, we uncover an important link between bank health and economic activity through the provision and effectiveness of bank credit lines to large, high credit quality firms. >more


Rights Issue

CHOICES IN EQUITY FINANCE: A GLOBAL PERSPECTIVE

Massimo Massa, Virginie Mataigne, Theo Vermaelen, and Moqi Groen-Xu
2016
When companies raise equity finance they have to make two choices: the issuing method (cash versus rights) and, when they choose the rights issue method, whether rights should be traded or not. We study these choices using a sample of 15,751 rights issues and 22,016 cash offers announced during 1995-2011 in 127 countries. To explain these choices we consider three hypotheses: the adverse selection hypothesis, the control hypothesis and the financial distress hypothesis. The general conclusion is that none of these theories by themselves can fully explain what we observe. However, we clearly reject the most popular explanation in the literature, i.e. the adverse selection hypothesis, as both rights issues and cash offers are followed by long-term negative excess returns. When we examine the second choice, i.e. the choice to have tradable rights, we find that in the short run the market appreciates the fact that rights are not trading, but in the long run firms with non-tradable rights underperform. In fact, firms seem to restrict rights trading in order to raise financing when the prospect of restructuring is more doubtful and the need to force the hand of the existing shareholders is higher. This provides additional support for the hypothesis that many rights issues are made by firms in financial distress. >more


Say-on-Pay

DO SMALL INSTITUTIONAL SHAREHOLDERS USE LOW-COST MONITORING OPPORTUNITIES? EVIDENCE FROM THE SAY ON PAY VOTE

Miriam Schwartz-Ziv, and  Russ Wermers
2016
Theories of free-riding predict that only large shareholders will monitor management. We document that, when shareholders are given a low-cost opportunity to monitor and discipline management, small institutional shareholders are particularly likely to do so. We focus on the “Say-On-Pay” (SOP) vote, because it represents the best low-cost opportunity shareholders have. By examining three levels of votes — aggregate, institutional, and fund level — we document that institutions with a smaller ownership stake in a company are particularly likely to vote against management. Further, firms are particularly likely to demonstrate responsiveness to SOP when non-insider blockholders are present. >more


Credit Ratings

BUYING ON CERTIFICATION: GOVERNMENT PROCUREMENT AND CREDIT RATINGS

Xuan Tian, and  Han Xia
2016
This paper examines how the spending of the public sector is influenced by a certification from the private sector – that is, how the federal government responds to a change in supplier firms’ credit ratings in the process of government procurement. The government significantly increases the spending on firms that receive positive rating certification, and lowers the spending on firms that receive negative certification. This effect is more pronounced in industries that are heavily dependent on government spending, and is concentrated on firms close to the investment-speculative grade threshold. In contrast, firms’ non-government customers do not exhibit a similar response. Positive rating certification appears to enable firms to adopt more aggressive pricing strategies and collect a premium from government customers. These findings highlight a significant impact of credit rating certification on government spending, and potentially, on taxpayers’ wealth. >more


Shareholder Activism

THIRTY YEARS OF SHAREHOLDER ACTIVISM: A SURVEY OF EMPIRICAL RESEARCH

Matthew Denes, Jonathan M. Karpoff, and Victoria McWilliams
2016
We summarize and synthesize the results from 73 studies that examine the consequences of shareholder activism for targeted firms, and draw two primary conclusions. First, activism that adopts some characteristics of corporate takeovers, especially significant stockholdings, is associated with improvements in share values and firm operations. Activism that is not associated with the formation of ownership blocks is associated with insignificant or very small changes in target firm value. Second, shareholder activism has become more value increasing over time. Research based on shareholder activism from the 1980s and 1990s generally finds few consequential effects, while activism in more recent years is more frequently associated with increased share values and operating performance. These results are consistent with Alchian and Demsetz’ (1972) argument that managerial agency problems are controlled in part by dynamic changes in ownership, and with Alchian’s (1950) observation that business practices adapt over time to mimic successful strategies. >more


Credit Ratings

CREDIT RATINGS AND ACQUISITIONS

Nihat Aktas, Nikolaos Karampatsas, Dimitris Petmezas, and Henri Servaes
2015
We document a curvilinear relation between credit ratings and acquisitions. Acquisitions first increase and then decrease as ratings improve, with a high around the A? threshold. The increase at low rating levels is accompanied by lower announcement returns. Acquisitions have a negative impact on future ratings for highly-rated firms, and a positive impact for firms with low ratings, even after controlling for all the characteristics potentially influenced by the transaction. These results indicate that credit ratings exert substantial influence on the acquisition process, and that rating agencies pay particular attention to acquisitions when deciding on the creditworthiness of firms. >more


Investor Expectations

DER TANZ AUF DEM DRAHTSEIL – UNTERNEHMEN IN DER ZWICKMÜHLE VON GESUNKENEN RENDITEERWARTUNGEN UND HOHEN ANFORDERUNGEN DES KAPITALMARKTS

Dr. Frank Plaschke and Dr. Hady Farag
Corporate Finance, 11(2015), p. 433-439
Despite the capital market slowdown in 2015, companies continue to face substantial investor expectations with regard to growth and capital gains as well as cash returns. In addition, not all companies benefit from the same macroeconomic and industry tailwinds, making value creation more challenging to some. Still, our research shows that companies can outperform not just their peers but the broader market, regardless of their industry. Identifying the most suitable value creation profile and an aligned resource allocation are key value creation unlocks, ranging from doubling-down on well positioned businesses to shaking up the portfolio. In return, they require clear focus and commitment to value creation both in terms of corporate strategy and management processes. >more


Credit Supply

THE SYSTEM-WIDE EFFECTS OF BANK CAPITAL REGULATION ON CREDIT SUPPLY AND RISK-TAKING

Milton Harris, Christian C. Opp, and Marcus M. Opp
2015
We propose a tractable framework to examine the system-wide effects of bank capital requirements. In our model, banks can serve a socially beneficial role by financing firms that are credit rationed by public markets, but banks' access to deposit insurance (and implicit debt guarantees) creates socially undesirable risk-shifting incentives. Equity ratio requirements reduce banks' risk-taking incentives, but may also constrain banks' balance sheets. When existing bank capital is sufficiently high, increases in equity-ratio requirements unambiguously improve welfare and the stability of the banking system. However, when bank capital is scarce, increased equity-ratio requirements induce credit rationing of both bank-dependent firms with positive NPV projects and risky firms with negative NPV. In this case, the net effects on welfare and the risk-taking of banks are ambiguous, as they depend on which type of credit rationing dominates. Our model provides conceptual guidance on the cyclicality of optimum capital requirements as well as their dependence on the development of public markets and the cross-sectional distribution of firms. >more


Credit Rating Agencies

NON-RATING REVENUE AND CONFLICTS OF INTEREST

Ramin Baghai, and Bo Becker
2016
Rating agencies produce ratings used by investors, but obtain most of their revenue from issuers, both as ratings fees and as payment for other services. This leads to a potential conflict of interest. We employ a detailed panel data set on the use of non-rating services as well as payment flows between issuers and rating agencies in India to test if this conflict affects credit ratings. Rating agencies rate securities issued by companies that also hire them for non-rating services 0.3 notches higher (than agencies that are not paid for such services by the issuer). This effect is increasing in the revenue generated. We also find that, within rating categories, default rates are higher for firms that have paid for non-rating services. This suggests that the better rating that such firms receive does not reflect lower credit risk. >more


Debt Finance

TRANCHING IN THE SYNDICATED LOAN MARKET AROUND THE WORLD

Douglas J. Cumming, Florencio Lopez de Silanes, Joseph A. McCahery, and Armin Schwienbacher
2015
Loan tranching is central to debt markets allowing banks to manage risks and facilitating firm financing. To analyze the determinants of the extent and structure of loan tranching, we assemble a cross-country sample of nearly 100,000 syndicated loans pooling together all tranches of each loan. We find that, in addition to deal and borrower characteristics, legal and institutional differences impact the probability of tranching as well as the structure across tranches of the same loan. Strong creditor protection and efficient debt collection lead to a larger syndicated loan market and facilitate tranching, ultimately promoting firm access to debt finance. >more


Financial Crisis

AN ECONOMETRIC CHRONOLOGY OF THE FINANCIAL CRISIS OF 2007-2008

Gary B. Gorton,  Andrew Metrick, and  Lei Xie
2015
What happened during the financial crisis of 2007-2008? Understanding the dynamics of the financial crisis requires determining the timing of important events. We document the crisis chronology econometrically based on market prices. The empirical chronology is based on locating the dates of structural breaks in panel data sets, based on the methodology of Bai (2010). Narrative chronologies are ex post. In contrast, the econometric chronology is based on contemporaneous market prices, and reveals the crisis building up prior to the Lehman collapse. >more


IPOs

THE U.S. LISTING GAP

Craig Doidge, George Andrew Karolyi, and  René M. Stulz
2015
The U.S. had 14% fewer exchange-listed firms in 2012 than in 1975. Relative to other countries, the U.S. now has abnormally few listed firms given its level of development and the quality of its institutions. We call this the "U.S. listing gap" and investigate possible explanations for it. We rule out industry changes, changes in listing requirements, and the reforms of the early 2000s as explanations for the gap. We show that the probability that a firm is listed has fallen since the listing peak in 1996 for all firm size categories though more so for smaller firms. From 1997 to the end of our sample period in 2012, the new list rate is low and the delist rate is high compared to U.S. history and to other countries. High delists account for roughly 46% of the listing gap and low new lists for 54%. The high delist rate is explained by an unusually high rate of acquisitions of publicly-listed firms compared to previous U.S. history and to other countries. >more


Public-Private Partnerships

RENEGOTIATING PUBLIC-PRIVATE PARTNERSHIPS

Joaquim Miranda Sarmento, and  Luc Renneboog
2016
There is a growing concern about the frequency of renegotiations in Public Private Partnerships (PPPs). We focus our research on the Portuguese experience and study 254 renegotiation events of 35 PPP contracts since 1995, and examine the triggers of renegotiations and who initiates them. We also investigate whether both the public and private sector learn from successive renegotiations in terms of the timing of renegotiations, contract design, regulatory change, and bargaining power extraction. We show that previous experience in renegotiations reduces the likelihood of renegotiations, and that electoral cycles and political connections lead to strategic behavior of both the public and the private sectors. The bargaining power seems to be mostly held by private firms who are often able to extract the rents what they set out to get at the beginning of negotiations by starting negotiations in the year prior to elections, and especially when they built out political connections. The learning from renegotiations on the public sector’s side, in terms of contract design and execution of regulatory change seems modest. >more



Cost of Capital

THE EQUITY RISK PREMIUM IN 2015

John R. Graham, and  Campbell R. Harvey
2015
We analyze the history of the equity risk premium from surveys of U.S. Chief Financial Officers (CFOs) conducted every quarter from June 2000 to March 2015. The risk premium is the expected 10-year S&P 500 return relative to a 10-year U.S. Treasury bond yield. We show that the equity risk premium has increased more than 50 basis points from the levels observed in 2014. The current 10-year risk premium is 4.51%. Similarly, measures of risk such as investor disagreement and perceptions of volatility have increased. Interestingly, the increased premium and risk are not reflected in market-based measures of risk, such as the VIX and credit spreads. We also link our survey results to measures of the weighted average cost of capital and investment hurdle rates. The hurdle rates are significantly higher than the cost of capital implied by the market risk premium. >more


Liquidity Management

DEMAND SHOCK, LIQUIDITY MANAGEMENT, AND FIRM GROWTH DURING THE FINANCIAL CRISIS

Vojislav Maksimovic, T. Mandy Tham, and Youngsuk Yook
2015
We examine the transmission of liquidity across the supply chain during the 2007-09 financial crisis, a period of financial market illiquidity, for a sample of unrated public firms with differential demand shocks. We measure differential demand by comparing firms that primarily supply to government customers with those that primarily supply to corporate customers. A difference-in-difference analysis shows little evidence that relatively high demand firms provide more or less liquidity to their own suppliers. The main determinant of the usage of short-term financing is a product market shock. Firms with relatively high demand have higher raw-material inventory and use more trade credit. There is little evidence that the amount of credit usage per unit of raw-material inventory changes with firms' demand shocks. These outcomes are consistent with theories of trade credit that stress the use of trade credit in financing inputs rather than providing efficient monitoring of creditors by suppliers. The lack of liquidity provision to suppliers by high demand firms is likely due to the high opportunity costs they face: We show that such firms become more investment-constrained over the crisis and engage in more acquisition activities once the liquidity crunch dissipates. >more


Loan Spreads

DOES THE LACK OF FINANCIAL STABILITY IMPAIR THE TRANSMISSION OF MONETARY POLICY?

Viral V. Acharya, Björn Imbierowicz, Sascha Steffen, and Daniel Teichmann
2015
We investigate the transmission of central bank liquidity to bank deposit and loan spreads in Europe over the January 2006 to June 2010 period. We find evidence consistent with an impaired transmission channel due to bank risk. Central bank liquidity does not translate into lower loan spreads for high-risk banks, even as it lowers deposit rates for both high-risk and low-risk banks. This adversely affects the balance sheets of borrowers of high-risk banks, leading to lower payouts, lower capital expenditures, and lower asset growth. These firms replace term loans drawing down existing credit lines. Our results suggest that during a banking crisis, the transmission of central bank liquidity to the real sector may be more effective if accompanied by a strengthening of banking sector health. >more


IPO Underwriting

UNDERWRITER NETWORKS IN INITIAL PUBLIC OFFERINGS

Emanuele Bajo, Thomas J. Chemmanur, Karen Simonyan, and Hassan Tehranian
2015
Using various measures from Social Network Analysis (SNA), we analyze, for the first time in the literature, how various IPO characteristics are affected by the location of the lead IPO underwriter in the network of investment banks generated by repeated participation in IPO underwriting syndicates. We hypothesize that investment banking networks perform two possible information-related roles during the IPO process: an information extraction role, where its investment banking network helps the lead underwriter extract credible information useful in pricing the IPO from various institutional investors; or an information dissemination role, where the lead underwriter is able to use its investment banking network to credibly convey its favorable private information about the IPO firm to various institutional investors. Based on these two roles, we develop testable hypotheses relating the location of the IPO underwriter in investment banking networks to the following IPO characteristics: IPO price revision during book-building; IPO and secondary market valuations; IPO initial returns; participation by financial market players such as financial analysts and institutional investors; and long-run post-IPO stock returns. Consistent with our hypotheses, our empirical findings show that more central lead IPO underwriters are associated with larger price revisions; greater IPO and aftermarket valuations; larger IPO initial returns; greater institutional investor equity holdings and analyst coverage immediately post-IPO; and greater long-run stock returns. These findings are robust to controlling for the endogenous matching between underwriter centrality and IPO firm quality, and are also robust to controlling for various measures of lead underwriter reputation. Overall, our findings are consistent with a strong information dissemination role for investment banking networks in IPOs. >more


Credit Market

BAD TIMES, GOOD CREDIT

Bo Becker, Marieke Bos, and Kasper Roszbach
2015
Asymmetric information between lenders and borrowers is understood to be a key friction in credit markets. Can amplified information problems explain why the supply of corporate credit contracts in recessions and crises? Alternatively, asymmetric information may be reduced by economic slowdowns. We test these opposing views of information frictions in the credit market using data on lending from a large bank, through two business cycles. We find that this banks’ ability to sort borrowers by credit quality is best in bad times. This suggests that information frictions are counter-cyclical in corporate credit markets. >more


Banks and Economic Shocks

LARGE BANKS AND THE TRANSMISSION OF FINANCIAL SHOCKS

Vitaly Bord,  Victoria Ivashina, and Ryan Taliaferro
2015
We explore the role of large banks in propagating economic shocks across the U.S. economy. We show that in 2007 and 2008, large banks operating in U.S. counties most affected by the decline in real estate prices contracted their credit to small businesses in counties that were not affected by falling real estate prices. These exposed banks were also more likely to completely cease operations in unaffected counties. By contrast, healthy banks — those not exposed to real estate price shocks — were more likely to expand operations and even to enter new banking markets, capturing market share in both loans and deposits. On average, the market share gain of healthy banks relative to exposed banks was a standard deviation above the long-run historic average market share growth. This offsetting effect was stronger for counties with a larger presence of exposed banks, and it resulted in changes in market share composition that had lasting effects. However, the net effect was negative and counties with a larger presence of exposed banks experienced slower overall growth in deposits, loans, employment, and number of small business establishments. These effects persist for several years after the initial shock. >more


LIBOR

REFORMING LIBOR AND OTHER FINANCIAL-MARKET BENCHMARKS

Darrell Duffie, and Jeremy C. Stein
2014
We outline key steps necessary to reform the London Interbank Offered Rate (LIBOR) so as to improve its robustness to manipulation. We first discuss the role of financial benchmarks such as LIBOR in promoting over-the-counter market efficiency by improving transparency. We then describe how to mitigate LIBOR manipulation incentives by: (I) widening the types of transactions used to fix LIBOR; (ii) encouraging a transition of "rates trading" applications of LIBOR derivatives to alternative reference rates that are in principle more suitable for this purpose because they do not include the bank-credit-spread component inherent in LIBOR. The current exceptional depth and liquidity of LIBOR-based markets are self-fulfilling sources of dominance for LIBOR as the reference rate of choice among rates traders. This liquidity agglomeration around LIBOR is probably accidental and inefficient, and creates an incentive to manipulate LIBOR. A transition of rates trading to alternative reference rates, however, may be difficult to arrange without official-sector involvement. >more


Fire Sales

LOCAL FINANCIAL CAPACITY AND ASSET VALUES: EVIDENCE FROM BANK FAILURES

Raghuram G. Rajan, and Rodney Ramcharan
2014
Theory suggests the reduction in financing capacity after the failure of a financial intermediary can reduce the value of financial assets. Forced sales of the intermediary's assets could consume liquidity, depressing the liquidation value of the assets of healthy intermediaries and causing contagious runs. These financial fire sales can both cause, and exacerbate, real fire sales, the focus of previous studies. This paper investigates the relevance of financial fire sales using new datasets covering bank failures during the farm depression in the United States just before the Great Depression, as well as bank failures during the Great Depression. Using differences in regulation as a means of identification, we find that the reduction in local financing capacity as a result of bank failures reduces the recovery rates on failed assets of nearby banks, depresses local land prices, renders land markets illiquid, and is associated with subsequent distress in nearby banks. All this indicates a rationale for why bank failures are contagious. >more