Execution Risk

Kevin Lewis

May 12, 2021

No-Fly Zone in the Loan Office: How Chief Executive Officers' Risky Hobbies Affect Credit Stakeholders' Evaluation of Firms
Bo Ouyang et al.
Organization Science, forthcoming


The extant research has often examined the work-related experiences of corporate executives, but their off-the-job activities could be just as insightful. This study employs a novel proxy for the risky hobbies of chief executive officers (CEOs) -- CEOs' hobby of piloting a private aircraft -- and investigates its effect on credit stakeholders' evaluation of the firms led by the CEOs as reflected in bank loan contracting. Using a longitudinal data set on CEOs of large United States-listed firms across multiple industries between 1993 and 2010, we obtain strong evidence that bank loans to firms steered by CEOs who fly private jets as a hobby tend to incur a higher cost of debt, to be secured, to have more covenants, and to be syndicated. These effects are mainly driven by banks, which perceive such firms as having a higher default risk. These relationships become stronger when the CEO is more important to the firm and/or can exercise stronger control over decision making. Supplemented by field interviews, our results are also robust to various endogeneity checks using different experimental designs, the Heckman two-stage model, a propensity score-matching approach, a difference-in-differences test, and the impact threshold of confounding variables.

CEO early-life disaster experience and stock price crash risk
Yangyang Chen et al.
Journal of Corporate Finance, forthcoming


We study the impact of CEO early-life disaster experience on stock price crash risk. Using a longitudinal sample of U.S. firms, we document that firms led by CEOs with early-life disaster experience have higher stock price crash risk. Our findings are consistent with CEOs who experienced early-life disasters being more risk tolerant, and thus more willing to accept the risks associated with bad news hoarding, engendering formation of stock price crashes. In cross-sectional analyses, we find that the effect of CEO disaster experience is amplified when a CEO has greater equity compensation-based incentives and power over corporate board to hoard bad news. Reinforcing bad news hoarding narrative, we also find that stocks of the firms led by CEOs with early-life disaster experience exhibit stronger asymmetric response to bad versus good news disclosures and are more likely to experience crashes accompanied by breaks in the strings of uninterrupted earnings increases. Further, consistent with early-life disaster experience making CEOs more risk tolerant, we find that firms led by CEOs with early-life disaster experience tend to have higher cash-flow volatility and stock return volatility. Evidence from supplemental analysis suggests that the impact of CEO early-life disaster experience on crash risk varies in a curvilinear manner with the severity of disaster.

Pumping the Brakes: Examining the Impact of CEO Political Ideology Divergence on Firm Responses
Matthew Semadeni, M.K. Chin & Ryan Krause
Academy of Management Journal, forthcoming


Research on CEO political ideology has demonstrated the construct's impact on many firm outcomes. Yet, political ideology does not exist in a vacuum; beyond representing a CEO's values, political ideology also affects the CEO's perception of the political environment. It remains unclear how a difference between the national political climate and the CEO's own political ideology might affect strategic decision-making. Applying upper echelons and threat response perspectives, we propose that divergence between the national political climate and the CEO's own ideology provokes a threat response, leading CEOs to cut R&D spending and increase retained earnings. We then examine two boundary conditions for this relationship. First, we propose that CEO wealth tied to the firm in the form of vested stock options will increase the perceived threat of ideology divergence, strengthening the threat response. Second, we propose that industry regulation will dampen the threat perceived from divergence, as well as hinder the CEO's ability to respond to the threat at all because of greater stability and lower discretion, respectively. We test these predictions on a sample of S&P 500 CEOs from 2004 to 2017 and find support for our hypothesized relationships.

Where Do Shareholder Gains in Hedge Fund Activism Come From? Evidence from Employee Pension Plans
Anup Agrawal & Yuree Lim
Journal of Financial and Quantitative Analysis, forthcoming


We find that defined benefit employee pension plans of firms that are targets of hedge fund activism experience underfunding and their defined contribution plans experience reductions in employer contributions. Pension underfunding occurs due to reduced employer contributions to the plans, which target firms justify by increasing the assumed rates of returns on plan investments and the discount rate used to compute the present value of plan obligations. Despite tilting plan investments toward riskier assets, pension fund performance does not improve after activists target a firm. Our evidence suggests that shareholder wealth gains from activism are partly wealth transfers from employees.

Insider Giving
Burcu Avci et al.
Duke Law Journal, forthcoming


Corporate insiders can avoid losses if they dispose of their stock while in possession of material, non-public information. One means of disposal, selling the stock, is illegal and subject to prompt mandatory reporting. A second strategy is almost as effective and it faces lax reporting requirements and legal restrictions. That second method is to donate the stock to a charity and take a charitable tax deduction at the inflated stock price. "Insider giving" is a potent substitute for insider trading. We show that insider giving is far more widespread than previously believed. In particular, we show that it is not limited to officers and directors. Large investors appear to regularly receive material non-public information and use it to avoid losses. Using a vast dataset of essentially all transactions in public company stock since 1986, we find consistent and economically significant evidence that these shareholders' impeccable timing likely reflects information leakage. We also document substantial evidence of backdating - investors falsifying the date of their gift to capture a larger tax break. We show why lax reporting and enforcement encourage insider giving, explain why insider giving represents a policy failure, and highlight the theoretical implications of these findings to broader corporate, securities, and tax debates.

Hedge Fund Activism and Corporate M&A Decisions
Szu-Yin (Jennifer) Wu & Kee Chung
Management Science, forthcoming


This paper shows that hedge fund activism is associated with a decrease in mergers and acquisitions (M&A) and offer premiums and an increase in stock and operating performance. Activist hedge funds improve target firms' M&A performance by reducing poor M&A, diversifying M&A, and the M&A of firms with multiple business segments. Activist hedge funds improve target firms' M&A decisions by influencing their governance practices. We show that our results are unlikely driven by selection bias. Overall, activist hedge funds play an important role in the market for corporate control by increasing the efficiency of target firms' M&A activities through interventions.

Does it pay to be socially connected with Wall Street brokerages? Evidence from cost of equity
Thanh Son Luong, Buhui Qiu & Ava Wu
Journal of Corporate Finance, forthcoming


We show that social connections between a firm's executives and directors and brokerages that follow the firm decrease the firm's cost of equity. We use quasi-natural experiments to address endogeneity concerns and find that the uncovered effect of firm-brokerage social connections on cost of equity is likely causal. The effect is found to be more pronounced for firms with more soft information, opaque information environments, tight financial constraints, weak corporate monitoring, or high executive equity ownership. Further, consistent with the evidence on cost of equity, we find that firm-brokerage social connections reduce SEO underpricing, decrease information asymmetry in stock markets, and improve the firm's equity valuation.

Investment differences between public and private firms: Evidence from U.S. tax returns
Naomi Feldman et al.
Journal of Public Economics, April 2021


Using tax data, we compare the investment behavior of public and private firms for a representative sample of all U.S. corporations. We find that while both types of firms invest similarly in physical capital, public firms out-invest private firms in R&D. Compared to observationally-similar private firms, public firms invest roughly 50% more in R&D relative to their asset bases. Further, public firms dedicate 7.4 percentage points more of their investments to R&D than private firms. This stronger public firm R&D investment is muted when shareholder earnings pressures are heightened, but not so much as to overcome the baseline investment advantage.

The Index-Fund Dilemma: An Empirical Study of the Lending-Voting Tradeoff
Edwin Hu, Joshua Mitts & Haley Sylvester
NYU Working Paper, December 2020


Institutional investors' role in shareholder voting is among the most hotly debated subjects in corporate governance. Some argue that institutions lack adequate incentives to effectively monitor managers; others contend that the largest institutions have developed analytical resources that produce informed votes. But little attention has been paid to the tradeoff these institutions face between voting their shares and earning profits - both for themselves and for the ultimate beneficiary of institutional funds - by lending those shares. Using a unique dataset and a recent change in SEC rules as an empirical setting, we document a substantial increase in the degree to which large institutions lend shares rather than cast votes in corporate elections. We show that, after the SEC clarified funds' power to lend shares rather than vote them at shareholder meetings, institutions supplied 58% more shares for lending immediately prior to those meetings. The change is concentrated in stocks with high index fund ownership; a difference-in-differences approach shows that supply increases from 15.6% to 22.3% in those stocks. Even when it comes to proxy fights, we show, stocks with high index ownership see a marked increase in shares available for lending immediately prior to the meeting. Overall, we show that loosening the legal constraints on institutional share lending has had significant implications for how index funds balance the lending-voting tradeoff.

Litigation Risk and Debt Contracting: Evidence from a Natural Experiment
Zhihong Chen, Ningzhong Li & Jianghua Shen
Journal of Law and Economics, November 2020, Pages 595-630


In June 2001, Nevada changed its state corporate law by substantially reducing the legal liability of directors and officers for breaching fiduciary duties owed to the corporation. We examine the impact of the reduced litigation risk caused by this legislative change on Nevada-incorporated firms' loan contract terms and related borrower-lender agency conflicts. Using a difference-in-differences analysis, we find that the legislative change led to less favorable loan contract terms for Nevada-incorporated firms: higher spread and more restrictive covenants. In addition, after the legislative change, Nevada-incorporated firms with severe borrower-lender agency conflicts took more risk, increased payout through stock repurchase, and reduced capital investment and equity issuance. Collectively, these results suggest that the reduced litigation risk exacerbates the borrower-lender agency conflicts.

A Rationale for Imperfect Reporting Standards
Henry Friedman, John Hughes & Beatrice Michaeli
Management Science, forthcoming


The aim of general purpose financial reporting is to provide information that is useful to investors, lenders, and other creditors. With this goal, regulators have tended to mandate increased disclosure. We show that increased mandatory disclosure can weaken a firm's incentive to acquire and voluntarily disclose private information that is not amenable to inclusion in mandated reports. Specifically, we provide conditions under which a regulator, seeking to maximize the total amount of information provided to investors via both mandatory and voluntary disclosures, would mandate less informative and more conservative financial reports even in the absence of any direct costs of increasing informativeness. This result is robust to allowing the firm to make reports more informative and to imposing a nondisclosure cost or penalty on the firm. The results and comparative statics analysis contribute to our understanding of interactions between mandatory reporting and voluntary disclosure and demonstrate a novel benefit to setting accounting standards that mandate imperfectly informative reports.

The effect of managers on M&As
Feng Dong & John Doukas
Journal of Corporate Finance, forthcoming


In this paper, we document diverse levels of managerial ability and firm performance in the cross section of acquiring firms. Acquirers with strong managerial ability realize higher announcement-period abnormal returns and experience better post-merger firm performance than their low-ability counterparts. Our results are robust to endogeneity concerns and show that the observed variation in acquirer abnormal returns is attributed to the heterogeneity of managerial ability fixed effects across acquirers. Managerial ability adds value to acquirers, especially in stock-financed acquisitions, implying that the method of payment is not driving the negative stock-financed valuation effect documented in previous literature. Moreover, we find that target firms with strongly ingrained growth potential and low levels of financial constraint and bankruptcy risk are highly favored by skilled acquiring managers.


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