Stakeholders
Karl Lins, Henri Servaes & Ane Tamayo
Journal of Finance, forthcoming
Abstract:
During the 2008 to 2009 financial crisis, firms with high social capital, as measured by corporate social responsibility (CSR) intensity, had stock returns that were four to seven percentage points higher than firms with low social capital. High-CSR firms also experienced higher profitability, growth, and sales per employee relative to low-CSR firms, and they raised more debt. This evidence suggests that the trust between a firm and both its stakeholders and investors, built through investments in social capital, pays off when the overall level of trust in corporations and markets suffers a negative shock.
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The Adverse Effect of Information on Governance and Leverage
Christian Laux, Gyöngyi Lóránth & Alan Morrison
Management Science, forthcoming
Abstract:
We study the effect that internal information systems have on a firm’s leverage and corporate governance choices. Information systems lower governance costs by facilitating more targeted interventions. But they also generate asymmetric information between firms and their investors. As a result, firms may attempt to signal their superior quality by assuming more leverage. In some circumstances, this can reduce governance incentives and result in inferior outcomes. Investors anticipate this effect, and it renders information systems inefficient.
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Does Corporate Social Responsibility Benefit Society?
Jun Li & Di (Andrew) Wu
University of Michigan Working Paper, February 2017
Abstract:
In short, it depends on the ownership type. We construct an event-based outcome measure of firm-level environmental, social, and governance (ESG) impact for public and private firms globally from 2007 to 2015 using data from RepRisk. Then, we measure the societal impact of corporate social responsibility (CSR) engagements using participation in the United Nations Global Compact as a proxy. We demonstrate a striking difference between public and private firms: while private firms significantly reduce their negative ESG incident levels after CSR engagements, public firms fail to do so. We attribute this difference to the conflicts of interest between shareholders and stakeholders, which are more pronounced in public firms than private firms. We empirically validate this interpretation through examination of scenarios with varying levels of conflict intensity. We find that for issues types with higher conflict intensity such as collective bargaining, supply-chain-related issues, and controversial products and services, the performance gap between public and private firms is even more severe. For issue types with lower conflict intensity such as tax evasion, executive compensation, and overuse and wasting of resources, the performance gap is smaller and even public companies may do better post-commitment. Moreover, the performance gap is also wider for upstream firms than for downstream firms in supply chains. We also rule out a host of alternative interpretations related to time trends and endogeneity issues. Our results show that existing CSR engagements may not necessarily lead to better societal outcomes, and that policy interventions aimed at aligning the interests of different parties can potentially improve the overall outcome.
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The Delaware Trap: An Empirical Study of Incorporation Decisions
Robert Anderson
Pepperdine University Working Paper, February 2017
Abstract:
One of the most enduring debates in corporate law centers on why Delaware has become the dominant state in the market for corporate charters. Traditionally, two perspectives dominated the debate, the “race to the top” perspective that sees competition among states as driving legal rules toward efficiency and the “race to the bottom” perspective that sees competition among states as driving legal rules toward the interests of corporate managers. The two dominant perspectives have struggled to explain why approximately half of companies incorporate in Delaware, while the other half incorporate in their home states. Whether the choices are attributable to the quality of state law or to characteristics of the companies themselves or both has given rise to a large, but inconclusive empirical literature. This Article uses a large dataset of corporate financings to shed new light on this mystery and uncovers strong evidence that some of the strongest factors in incorporation choice are factors unrelated to either the quality of state law or the characteristics of individual companies. Instead, the data strongly suggest that demographic markers of sophistication, such as choice of law firm and headquarters location, predict the jurisdictional choice about as well as state law or the business attributes of companies. Companies with more demographic markers of sophistication tend to choose Delaware incorporation, and companies with fewer demographic markers of sophistication tend to choose home-state incorporation. The finding persists even when other attributes of the company are controlled for, such as its industry classification, the amount of money raised, or whether the company is public or private. Indeed, the sophistication factors arguably predict Delaware incorporation as well or better than any factors documented in the vast literature on state competition for corporate charters. The findings have important implications for the state “race-to-the-top” debate in corporate law. At a minimum the results in this Article make it clear that the choice of legal representation is an important missing variable in models of incorporation decisions. The fact that the choice of law firms drives the jurisdictional choice has far broader implications. If law firms drive the jurisdictional choice they may steer companies toward states that serve the law firms’ own interests without regard to the quality of legal rules or the needs of the client. When the state chosen is Delaware, as it often is, there are few alternative jurisdictions that shareholders and managers can agree on. As a result, companies inadvertently fall into a “governance trap” from which reincorporation out of state is nearly impossible. This interpretation would suggest that Delaware’s carefully calibrated positioning in the charter market has largely eliminated meaningful competition among the states for the quality of corporate law.
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The Private Ordering Solution to Multiforum Shareholder Litigation
Roberta Romano & Sarath Sanga
Journal of Empirical Legal Studies, March 2017, Pages 31–78
Abstract:
This article analyzes a private ordering solution to multiforum shareholder litigation: exclusive forum provisions in corporate charters and bylaws. These provisions require that all corporate-law-related disputes be brought in a single forum, typically a court in the statutory domicile. Using hand-collected data on the 746 U.S. public corporations that have adopted the provision, we examine what drives the growth in these provisions and whether, as some critics contend, their adoption reflects managerial opportunism. We find that nearly all new Delaware corporations adopt the provision at the IPO stage, and that the transition from zero to near-universal IPO adoption over 2007–2014 is driven by law firms. Characteristics of individual companies appear to play little or no role in adoption decisions. Instead, the pattern of adoption follows what can be described as a light-switch model, in which law firms suddenly switch from never adopting to always adopting the provision in the IPOs they advise. For post-IPO (or “midstream”) adoptions, we compare corporate governance features of adopters to a matched sample of nonadopters to test the hypothesis that midstream bylaw adoption reflects managerial opportunism. If the hypothesis were correct, then we would expect to find that the midstream adopters exhibit poor corporate governance compared to nonadopters (using the metrics of good governance practices as identified by critics of the provisions). We find, however, that there are either no significant differences in governance or that it is adopters that have higher-quality governance features. We also find no significant differences in governance and ownership structures between firms whose boards adopt the provisions as bylaws and those who obtain shareholder approval. The absence of significant differences across firms using disparate adoption procedures suggests that the method of adopting an exclusive forum provision — whether with or without shareholder approval — should not be a matter of import for investors.
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Credit Default Swaps, Exacting Creditors and Corporate Liquidity Management
Marti Subrahmanyam, Dragon Yongjun Tang & Sarah Qian Wang
Journal of Financial Economics, forthcoming
Abstract:
We investigate the liquidity management of firms following the inception of credit default swaps (CDS) markets on their debt, which allow hedging and speculative trading on credit risk to be carried out by creditors and other parties. We find that reference firms hold more cash after CDS trading commences on their debt. The increase in cash holdings is more pronounced for CDS firms that do not pay dividends and have a higher marginal value of liquidity. For CDS firms with higher cash flow volatility, these increased cash holdings do not entail higher leverage. Overall, our findings are consistent with the view that CDS-referenced firms adopt more conservative liquidity policies to avoid negotiations with more exacting creditors.
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CEO Inside Debt Incentives and Corporate Tax Sheltering
Sabrina Chi, Shawn Huang & Juan Manuel Sanchez
Journal of Accounting Research, forthcoming
Abstract:
This paper examines the relation between CEO inside debt holdings (pension benefits and deferred compensation) and corporate tax sheltering. Because inside debt holdings are generally unsecured and unfunded liabilities of the firm, CEOs are exposed to risk similar to that faced by outside creditors. As such, theory (Jensen and Meckling [1976]) suggests that inside debt holdings negatively impact CEO risk-appetite. To the extent that corporate tax shelters will likely result in high cash flow volatility in the future, we expect that inside debt holdings will curb CEOs from engaging in tax shelter transactions. Consistent with the prediction, we document a negative association between CEO inside debt holdings and tax sheltering. Additional analyses suggest that the effect of inside debt on tax sheltering is more (less) pronounced in the presence of high default risks and liquidity threats (cash-out options in pension packages). Overall, our results highlight the importance of investigating the implication of CEO debt-like compensation for corporate tax policies.
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Short Selling Governance and Intrafirm Resource Allocation
James Albertus et al.
Carnegie Mellon University Working Paper, February 2017
Abstract:
We exploit Regulation SHO as a natural experiment to investigate the effects of short selling threats on intrafirm capital allocation. Using detailed data on the foreign operations of multinationals, we find that the marginal effect on aggregate investment masks a significant effect on intrafirm reallocation. Managers reallocate investment and R&D expenditures across borders toward productive subsidiaries and R&D centers, respectively. Treated firms shifted 30% more capital toward foreign subsidiaries with strong recent performance. These results provide new evidence on the scope and potential benefits of governance by short sellers and demonstrate the importance of cross-border spillovers of capital markets regulation.
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The Limitations of Stock Market Efficiency: Price Informativeness and CEO Turnover
Gary Gorton, Lixin Huang & Qiang Kang
Review of Finance, March 2017, Pages 153-200
Abstract:
There is a tenuous link between market efficiency and economic efficiency in that stock prices are more informative when the information has less social value. We investigate this link in the context of CEO turnover. Our theoretical model predicts that, when the board’s monitoring intensity and the informed trader’s information decision are jointly endogenized, stock price informativeness is negatively related to the board’s monitoring effort. Our empirical tests provide supporting evidence for this negative effect. Moreover, using the passage of the Sarbanes–Oxley Act (SOX) as a quasi-natural experiment, we find that SOX, while strengthening corporate governance, has a negative effect on stock price informativeness, especially among firms with complex organizational structures.
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Insider Trading and the Short-Swing Profit Rule
Stephen Lenkey
Journal of Economic Theory, May 2017, Pages 517–545
Abstract:
The short-swing profit rule is a federal statute that requires insiders to forfeit any trading profit earned from a combined purchase and sale that occurs within a six-month period. Using a multi-period strategic rational expectations equilibrium framework, I demonstrate that the rule tends to reduce both the amount of insider trading and the amount of profit earned by an informed insider from information-based trades because the rule imposes a constraint on the insider's dynamic trading strategy. Nevertheless, the rule increases the insider's welfare at the expense of uninformed investors (outsiders) because the rule inhibits risk sharing, which leads to an ex ante wealth transfer from outsiders to the insider.
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Michael Barnett, Julia Hartmann & Robert Salomon
Academy of Management Discoveries, forthcoming
Abstract:
Corporate social responsibility (CSR) has been shown to provide insurance-like protection that buffers firms from losses when they are sued. But does CSR also buffer firms from being sued? We conduct a study of 408 U.S. firms over the period 2002 to 2011 and find that, indeed, firms with greater CSR were less likely to be sued. Yet despite suffering fewer lawsuits, we also find that firms with greater CSR were more likely to set aside provisions for litigation. Together, these findings suggest that CSR's buffering benefits may extend beyond just helping firms to suffer less harm from negative events, to include helping to protect firms from suffering negative events in the first place. Moreover, high CSR firm's tendency toward transparency may be what drives the extension of these protective benefits. We call for more research on the scope and conditions under which CSR buffers firms from harm.
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Institutional Trading and Hedge Fund Activism
Nickolay Gantchev & Chotibhak Jotikasthira
Management Science, forthcoming
Abstract:
This paper investigates the role of institutional trading in the emergence of hedge fund activism — an important corporate governance mechanism. We demonstrate that institutional sales raise a firm’s probability of becoming an activist target. Furthermore, by exploiting the funding circumstances of individual institutions, we establish that such effects occur through a liquidity channel, i.e., the activist camouflages his purchases among other institutions’ liquidity sales. Additional evidence supports our conclusion. First, activist purchases closely track institutional sales at the daily frequency. Second, such synchronicity is stronger among targets with lower expected monitoring benefits, suggesting that gains from trading with other institutions supplement these benefits in the activist’s targeting decision. Finally, we find that institutional sales accelerate the timing of a campaign at firms already followed by activists rather than attract attention to unlikely targets. Taken together, our findings offer a novel empirical perspective on the liquidity theories of activism; while activists screen firms on the basis of fundamentals, they pick specific targets at a particular time by exploiting institutional liquidity shocks.