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on Corporate Finance |
| By: | Chen, Jia (Peking University); Hou, Kewei (OH State University); Stulz, Rene M. (OH State University and ECGI, Brussels) |
| Abstract: | Using theories from the behavioral finance literature to predict that investors are attracted to industries with more salient outcomes and that therefore firms in such industries have higher valuations, we find that firms in industries that have high industry-level dispersion of profitability have on average higher market-to-book ratios than firms in low dispersion industries. This positive relation between market-to-book ratios and industry profitability dispersion is economically large and statistically significant and is robust to controlling for variables used to explain firm-level valuation ratios in the literature. Consistent with the mispricing explanation of this finding, we show that firms in less boring industries have a lower implied cost of equity and lower realized returns. We explore alternative explanations for our finding, but find that these alternative explanations cannot explain our results. |
| JEL: | G12 G14 G31 G32 |
| Date: | 2015–01 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:ohidic:2015-02&r=all |
| By: | Bakke, Tor-Erik (University of OK); Mahmudi, Hamed (University of OK); Fernando, Chitru S. (University of OK); Salas, Jesus M. (Lehigh University) |
| Abstract: | This study provides strong evidence of a causal effect of risk-taking incentives provided by option compensation on corporate risk management. We utilize the passage of FAS 123R, which required firms to expense options, to investigate how CEO option compensation affects the hedging behavior of oil and gas firms. Firms that did not expense options before FAS 123R significantly reduced option pay, which resulted in a large increase in their hedging intensity compared to firms that did not use options or expensed their options voluntarily prior to FAS 123R. |
| JEL: | G30 G32 G38 G39 |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:upafin:15-08&r=all |
| By: | Joseph P. Byrne; Marina-Eliza Spaliara; Serafeim Tsoukas |
| Abstract: | Using a large panel of unquoted UK firms over the period 2000-09, we examine the impact of firm-specific uncertainty on corporate failures. In this context we also distinguish between firms which are likely to be more or less dependent on bank finance as well as public and non-public companies. Our results document a significant effect of uncertainty on firm survival. This link is found to be more potent during the recent financial crisis compared with tranquil periods. We also uncover significant firm-level heterogeneity since the survival chances of bank-dependent and non-public firms are most affected by changes in uncertainty, especially during the recent global financial crisis. |
| JEL: | E44 F32 F34 G32 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:hwe:hwuedp:1506&r=all |
| By: | Subrata Sarkar (Indira Gandhi Institute of Development Research) |
| Abstract: | In recent years the comply-or-explain approach for enforcing corporate governance norms has gained ground in regulatory parlance. The comply-or-explain approach has the advantage of tailoring governance norms to specific characteristics of individual companies which is believed to lead to more efficient corporate governance outcomes compared to the "one size fits all" approach that is often argued to be inherent in the comply-or-else approach. Yet, the effectiveness of the comply-or-explain approach presupposes the existence of many institutional conditions like ownership and control structure of companies, responsibility and transparency of their financial operations, efficiency of stock markets, and ability and incentives of shareholders to assess corporate behavior, all of which could take a long time to evolve and could be challenging especially for emerging economies. This article critically examines the relative advantages of the comply-or-explain approach vis-…-vis the more traditional comply-or-else approach and identifies the specific institutional conditions which are required for its success in achieving effective governance of companies. |
| Keywords: | Corporate governance, strategic behavior, governance norms, enforcement, convergence |
| JEL: | D22 D82 G34 G38 |
| Date: | 2015–08 |
| URL: | http://d.repec.org/n?u=RePEc:ind:igiwpp:2015-022&r=all |
| By: | Jankensgård, Håkan (Department of Business Administration); Alviniussen, Alf (European Banking Authority); Oxelheim, Lars (Research Institute of Industrial Economics (IFN)) |
| Abstract: | In this paper we challenge the role of Foreign Exchange Risk Management (FXRM) in corporate management. We believe it is fair to characterize FXRM, on the whole, as a legacy activity rather than something that reflects a realistic cost-benefit analysis at the enterprise-level. The Board of Directors, as the designated guardians of the interests of shareholders, has a key role in setting the firm on a path towards a cost-efficient and centralized FXRM that preserves the firm’s transparency and predictability towards the investor community. A policy conclusion from our analysis is that responsibility for FX policy should shift from the traditional Finance/Treasury orientation to a group risk function (e.g. a Chief Risk Officer) supported by a risk committee dedicated to integrated risk management. |
| Keywords: | Foreign exchange; Risk management; Transparency; Risk committee; Integrated risk management |
| JEL: | G30 G32 |
| Date: | 2015–08–21 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:iuiwop:1078&r=all |
| By: | Gehde-Trapp, Monika; Gündüz, Yalin; Nasev, Julia |
| Abstract: | Based on individual CDS transactions cleared by the Depository Trust & Clearing Corporation, we show that illiquidity strongly affects credit default swap premiums. We identify the following effects: First, transaction direction affects prices, as buy (sell) orders lead to premium increases (decreases). Second, larger transactions have a higher price impact. This finding stands in stark contrast to corporate bond markets. Third, traders charge higher premiums as a price for liquidity provision, not as compensation for asymmetric information. Fourth, buyside investors pay significantly higher prices than dealers for demanding liquidity. Last, inventory risk seems to matter little in explaining liquidity premiums. |
| Keywords: | CDS,illiquidity,temporary price impact,market power,immediacy,DTCC |
| JEL: | G12 G14 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cfrwps:1212r2&r=all |
| By: | Chernenko, Sergey (OH State University) |
| Abstract: | I study the incentives and performance of CDO collateral managers, asset management firms responsible for the selection of collateral in ABS CDOs that figured prominently in the 2007-2008 financial crisis. Specialized asset managers with few reputational concerns invest in riskier collateral and gain market share at the expense of more diversified investment managers. Controlling for observable deal characteristics, the IRR of specialized managers' CDOs is 5.8% lower. The results cannot be explained by greater optimism or lower expertise of specialized managers. Deals of specialized managers have smaller equity tranches and invest in higher yielding collateral securities from more recent vintages. This collateral suffers significantly larger losses, even controlling for at-issuance rating and spread. The results point to greater risk taking incentives as one downside of specialization in asset management. |
| JEL: | G01 G23 G32 |
| Date: | 2015–07 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:ohidic:2015-12&r=all |
| By: | Jagtiani, Julapa (Federal Reserve Bank of Philadelphia); Kotliar, Ian (?); Maingi, Raman Quinn (?) |
| Abstract: | There have been increasing concerns about the potential of larger banks acquiring community banks and the declining number of community banks, which would significantly reduce small business lending (SBL) and disrupt relationship lending. This paper examines the roles and characteristics of U.S. community banks in the past decade, covering the recent economic boom and downturn. We analyze risk characteristics (including the confidential ratings assigned by bank regulators) of acquired community banks, compare pre- and post-acquisition performance and stock market reactions to these acquisitions, and investigate how the acquisitions have affected SBL. Contrary to concerns, we find that the overall amount of SBL tends to increase after a large bank acquires a community bank. The ratio of SBL to assets does decline in the large acquiring banks but at a slower rate than the decline seen in surviving community banks. Further, community banks that were merged during the financial crisis were mostly in poor financial condition, had been rated as unsatisfactory by their regulators on all risk aspects, and would have been unlikely to continue lending. We found that community bank targets accepted smaller merger premiums (or even discounts) to be part of a large banking organization. Our results indicate that mergers involving community bank targets over the past decade have enhanced the overall safety and soundness of the banking system without adversely impacting SBL. This implies that a policy that discourages mergers between community banks and large banks is unwarranted and could potentially result in a weaker financial system and have an unintentional dampening effect on the supply of SBL. |
| JEL: | G21 G28 G34 |
| Date: | 2014–10 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:upafin:14-17&r=all |
| By: | Beltratti, Andrea (Bocconi University); Stulz, Rene M. (OH State University and ECGI, Brussels) |
| Abstract: | From 2010 to 2012, the relation between bank stock returns from European Union (EU) countries and the returns on sovereign CDS of peripheral (GIIPS) countries is negative. We use days with tail sovereign CDS returns of peripheral countries to identify the effects of shocks to the cost of borrowing of these countries on EU banks from other countries. A CDS tail return affects banks with greater exposure to the country experiencing that return more, but it has an impact on banks regardless of exposure. Shocks to peripheral countries that are more pervasive impact the returns of banks from countries that experience no shock more than shocks to small individual peripheral countries. In general, the impact of tail returns is asymmetric in that banks suffer less from adverse shocks to peripheral countries than they gain from favourable shocks to such countries. |
| JEL: | F34 G12 G15 G21 H63 |
| Date: | 2015–04 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:ohidic:2015-06&r=all |
| By: | Michi NISHIHARA (Graduate School of Economics, Osaka University Swiss Finance Institute, École polytechnique fédérale de Lausanne); Takashi SHIBATA (Graduate School of Social Sciences, Tokyo Metropolitan University) |
| Abstract: | This paper considers a dynamic model in which shareholders of a firm in distress have a choice of whether to proceed to debt restructuring or direct liquidation at an arbitrary time. In the model, we show the following results. Fewer asset sales, lower financing, debt renegotiation, and running costs, a lower premium to the debt holders, a lower cash flow volatility, and a higher initial coupon increase the shareholdersf incentive to choose debt restructuring to avoid full liquidation. In the debt renegotiation process, the shareholders arrange the coupon reduction and use equity financing to retire a part of the debt value to the debt holders. The timing of debt restructuring always coincides with that of liquidation without debt renegotiation. Most notably, the shareholders do not prefer asset sale in debt restructuring even if they face high financing costs. The possibility of debt renegotiation in the future increases the initial leverage ratio in the optimal capital structure. |
| Keywords: | Preemption; real options; asset sale; debt renegotiation; liquidation; capital structure. |
| JEL: | C73 G31 G33 |
| Date: | 2015–08 |
| URL: | http://d.repec.org/n?u=RePEc:osk:wpaper:1522&r=all |
| By: | Berardi, Simone; Tedeschi, Gabriele |
| Abstract: | This paper aims to shed light on the emergence of systemic risk in credit systems. By developing an interbank market with heterogeneous financial institutions granting loans on different network structures, we investigate what market architecture is more resilient to liquidity shocks and how the risk spreads over the modeled system. In our model, credit linkages evolve endogenously via a fitness measure based on different banks strategies. Each financial institution, in fact, applies a strategy based on a low interest rate, a high supply of liquidity or a combination of them. Interestingly, the choice of the strategy in uences both the banks' performance and the network topology. In this way, we are able to identify the most effective tactics adapt to contain contagion and the corresponding network topology. Our analysis shows that, when financial institutions combine the two strategies, the interbank network does not condense and this generates the most efficient scenario in case of shocks. |
| Keywords: | interbank market,dynamic network,fitness model,network resilience,bank strategy |
| JEL: | G01 G02 D85 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:fmpwps:47&r=all |
| By: | Stulz, Rene M. (OH State University and ECGI, Brussels) |
| Abstract: | This paper examines how governance and risk management affect risk-taking in banks. It distinguishes between good risks, which are risks that have an ex ante private reward for the bank on a stand-alone basis, and bad risks, which do not have such a reward. A well-governed bank takes the amount of risk that maximizes shareholder wealth subject to constraints imposed by laws and regulators. In general, this involves eliminating or mitigating all bad risks to the extent that it is cost effective to do so. The role of risk management in such a bank is not to reduce the bank's total risk per se. It is to identify and measure the risks the bank is taking, aggregate these risks in a measure of the bank's total risk, enable the bank to eliminate, mitigate and avoid bad risks, and ensure that its risk level is consistent with its risk appetite. Organizing the risk management function so that it plays that role is challenging because there are limitations in measuring risk and because, while more detailed rules can prevent destructive risk-taking, they also limit the flexibility of an institution in taking advantage of opportunities that increase firm value. Limitations of risk measurement and the decentralized nature of risk-taking imply that setting appropriate incentives for risk-takers and promoting an appropriate risk culture are essential to the success of risk management in performing its function. |
| JEL: | G21 G32 |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:upafin:14-09&r=all |
| By: | Alice Nsenkyire (Eastern Mediterranean University, North Cyprus); Glenn P. Jenkins (Queen’s University, Canada and Eastern Mediterranean University, North Cyprus); Mikhail Miklyaev (Eastern Mediterranean University, North Cyprus); Octave Semwaga (Eastern Mediterranean University, North Cyprus) |
| Abstract: | In April 2012, Kinazi Cassava Plant was established as a government initiative to produce high quality cassava flour, and other value added cassava products. After the successful establishment of the cassava flour plant in Ruhango district, KCP now plans to diversify into cassava starch production to feed the emerging manufacturing industries such as the pharmaceuticals, food processing, breweries, textiles etc. both domestically and for exportation. The study assesses the financial and economic viability, the stakeholder impact and the risk inherent in establishing the Kinazi Cassava Starch Plant in Rwanda. The deterministic results from the analysis indicate that the project sponsors will earn a rate of return greater than the opportunity cost of funds. Additionally, large net economic benefits will accrue to Rwanda in the form of tax revenue generated directly and indirectly through the export sales of cassava starch. The identified stakeholders who benefit from the project are the owners of the project, the government and labour who benefit in the form of profits, tax revenue and higher wages respectively. The risk analysis conducted revealed that changes in certain critical input variables (real exchange rate, real price of cassava tubers, price of cassava starch, investment cost over-run and production capacity utilization) cause project outcomes to increase or decrease significantly. |
| Keywords: | Financial analysis, economic analysis, risk analysis, cassava starch production, Rwanda |
| JEL: | D61 N57 G32 |
| Date: | 2015–10 |
| URL: | http://d.repec.org/n?u=RePEc:qed:dpaper:282&r=all |
| By: | Pan, Yihui (University of UT); Wang, Tracy Yue (University of MN, Twin Cities); Weisbach, Michael S. (OH State University) |
| Abstract: | Uncertainty about management appears to affect firms' cost of borrowing and financial policies. In a sample of S&P 1500 firms between 1987 and 2010, CDS spreads, loan spreads and bond yield spreads all decline over the first three years of CEO tenure, holding other macroeconomic, firm, and security level factors constant. This decline occurs regardless of the reason for the prior CEO's departure. Similar but smaller declines occur following turnovers of CFOs. The spreads are more sensitive to CEO tenure when the prior uncertainty about the CEO's ability is likely to be higher: when he is not an heir apparent, is an outsider, is younger, and when he does not have a prior relationship with the lender. The spread-tenure sensitivity is also higher when the firm has a higher default risk and when the debt claim is riskier. These patterns are consistent with the view that the decline in spreads in a manager's first three years of tenure reflects the resolution of uncertainty about management. Firms adjust their propensities to issue external debt, precautionary cash holding, and reliance on internal funds in response to these short-term increases in borrowing costs early in their CEOs' tenure. |
| JEL: | G32 G34 M12 M51 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:ohidic:2014-14&r=all |
| By: | Michaely, Roni; Popadak, Jillian; Vincent, Christopher |
| Abstract: | Corporate leverage has decreased markedly in the U.S. since 1992. In contrast to press coverage of hedge funds increasing debt, increases in institutional investments, primarily by mutual funds, account for part of this deleveraging. We use implied mutual fund trades constructed from individual-investor flows as exogenous variation in institutional ownership for estimation. Supporting the hypothesis institutions contributed to deleveraging, our estimates increase significantly after regulatory reforms incentivized stronger institutional governance. Firms deleverage by reducing debt and transitioning to debt associated with enhanced monitoring and efficiency. Counterfactual simulations indicate aggregate leverage would have been eight percentage points higher without institutions' influence. |
| Keywords: | Finance, Financial Stability, Corporate Leverage, Institutional Investors, Mutual Funds, Hedge Funds, Corporate Governance, Agency Costs, Capital Structure, Debt Structure |
| JEL: | E44 G3 G32 G34 G38 K22 |
| Date: | 2015–08–15 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:66128&r=all |
| By: | Verani, Stephane (Board of Governors of the Federal Reserve System (U.S.)) |
| Abstract: | Which financial frictions matter in the aggregate? This paper presents a general equilibrium model in which entrepreneurs finance a firm with a long-term contract. The contract is constrained efficient because firm revenue is costly to monitor and entrepreneurs may default. The cost of monitoring firms and the entrepreneurs' outside options determine the significance of moral hazard relative to limited enforcement for financial contracting. Calibrating the model to the U.S. economy, I find that the relative welfare loss from financial frictions is about 5 percent in terms of aggregate consumption with moral hazard, while it is 1 percent with limited enforcement. Reforms designed to strengthen contract enforcement increase aggregate consumption in the short-run, but their long-run effects are modest when monitoring costs are high. Weak contract enforcement contributes to aggregate fluctuations by amplifying the effect of aggregate technological shocks, but moral hazard does not. |
| Keywords: | Business cycles; financial contracting; financial development; firm dynamics; limited enforcement; private information |
| JEL: | D82 E32 G32 L14 |
| Date: | 2015–08–14 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2015-63&r=all |
| By: | Arnold, Marc; Westermann, Ramona |
| Abstract: | This paper analyzes the impact of debt renegotiation outside corporate distress on renegotiation patterns, corporate policies, and firm value. We study a structural model of a levered firm that can renegotiate covenant protected debt at investment and upon corporate distress. Renegotiation at investment reduces the agency costs of debt because it induces a firm value maximizing investment financing policy and mitigates the overinvestment problem. Incorporating renegotiation outside corporate distress is crucial to explain empirical frequency patterns of debt renegotiation and the relation between observed covenant structures and firm characteristics. It also offers a rich set of novel empirical predictions. |
| Keywords: | Debt Covenants, Corporate Investment, Renegotiation, Capital Structure |
| JEL: | D92 E44 G12 G32 G33 |
| Date: | 2015–07 |
| URL: | http://d.repec.org/n?u=RePEc:usg:sfwpfi:2015:14&r=all |
| By: | Brown, Jeffrey A. (Oliver Wyman); McGourty, Brad (Oliver Wyman); Schuermann, Til (Oliver Wyman) |
| Abstract: | We trace the development of model risk management in U.S. banking against the backdrop of the growing importance of complex financial models in banks, the recognition of model risk, the emergence of model validation as a response to model risk, and the contribution of failures in model risk management to the Great Financial Crisis. We recognize that while substantial progress has been made in the management of model risk, the challenges have grown, including the increasing reliance by the regulators on models. |
| JEL: | G12 G21 |
| Date: | 2015–01 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:upafin:15-01&r=all |
| By: | English, William B. (Federal Reserve Board); Van den Heuvel, Skander J. (Federal Reserve Board and University of PA); Zakrajsek, Egon (Federal Reserve Board) |
| Abstract: | Because they engage in maturity transformation, a steepening of the yield curve should, all else equal, boost bank profitability. We re-examine this conventional wisdom by estimating the reaction of bank stock returns to exogenous fluctuations in interest rates induced by monetary policy announcements. We construct a new measure of the mismatch between the repricing time or maturity of bank assets and liabilities and analyze how the reaction of stock returns varies with the size of this mismatch and other bank characteristics. The results indicate that bank stock prices decline substantially following an unanticipated increase in the level of interest rates or a steepening of the yield curve. A large maturity gap, however, significantly attenuates the negative reaction of returns to a slope surprise, a result consistent with the role of banks as maturity transformers. Share prices of banks that rely heavily on core deposits decline more in response to policy-induced interest rate surprises, a reaction that primarily reflects ensuing deposit disintermediation. Results using income and balance sheet data highlight the importance of adjustments in quantities--as well as interest margins--for understanding the reaction of bank equity values to interest rate surprises. |
| JEL: | E43 E52 G21 |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:upafin:14-05&r=all |
| By: | Hermalin, Benjamin E. (University of CA, Berkeley); Weisbach, Michael S. (OH State University) |
| Abstract: | A manager's shareholders, board of directors, and potential future employers are continually assessing his ability. A rich literature has documented that this insight has profound implications for corporate governance because assessment generates incentives (good and bad), introduces assorted risks, and affects the various battles that rage among the relevant actors for corporate control. Consequently, assessment (or learning) is a key perspective from which to study, evaluate, and possibly even regulate corporate governance. Moreover, because learning is a behavior notoriously subject to systematic biases, this perspective is a natural avenue through which to introduce behavioral and psychological insights into the study of corporate governance. |
| JEL: | D81 D83 G34 M12 |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:ohidic:2014-04&r=all |
| By: | Andreasen, Eugenia (University of Santiago of Chile); Schindler, Martin (Joint Vienna Institute); Valenzuela, Patricio (University of Chile) |
| Abstract: | Using a novel panel data set for international corporate bonds and capital account restrictions in advanced and emerging economies, we find that restrictions on capital inflows produce a substantial and economically meaningful increase in corporate bond spreads. By contrast, we find no robust significant effect of restrictions on outflows. The effect of capital account restrictions on inflows is particularly strong for bonds maturing in the short-term, issued by small firms and in countries with underdeveloped financial markets. Additionally, the paper shows that capital account restrictions on inflows have a greater effect during periods of financial distress than during periods of financial stability. These results are suggestive of a causal interpretation of the estimated effects and establish a novel channel through which capital controls affect economic outcomes. |
| JEL: | F30 F40 G10 G30 |
| Date: | 2015–01 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:upafin:15-02&r=all |
| By: | Andreasen, Eugenia (University of Santiago of Chile); Valenzuela, Patricio (University of Chile) |
| Abstract: | This paper shows that financial openness significantly affects corporate and sovereign credit ratings, and that the magnitude of this effect depends on the level of development of the domestic financial market. Issuers located in less financially developed economies stand to benefit the most from opening up their capital accounts, whereas the impact of this effect decreases as the level of development of the domestic capital market improves. |
| JEL: | F34 G15 G38 |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:upafin:15-06&r=all |
| By: | Allen, Franklin (University of PA); Carletti, Elena (Bocconi University); Marquez, Robert (University of CA, Davis) |
| Abstract: | In a model with bankruptcy costs and segmented deposit and equity markets, we endogenize the cost of equity and deposit finance for banks. Despite risk neutrality, equity capital earns a higher expected return than direct investment in risky assets. Banks hold positive capital to reduce bankruptcy costs, but there is a role for capital regulation when deposits are insured. Banks may no longer use capital when they lend to firms rather than invest directly in risky assets. This depends on whether the firms are public and compete with banks for equity capital, or private with exogenous amounts of capital. |
| JEL: | G21 G32 G33 |
| Date: | 2014–05 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:upafin:14-08&r=all |
| By: | Christina Atanasova; Evan Gatev Daniel; Daniel Shapiro |
| Abstract: | Small companies have important economic significance as the most dynamic, innovative and risk-taking sector of the economy. So why do small-cap companies offer only limited corporate governance provisions? Christina Atanasova, Evan Gatev, and Daniel Shapiro find that small companies are incentivised to improve governance by being offered the carrot of easier access to equity financing. |
| Date: | 2014–09–01 |
| URL: | http://d.repec.org/n?u=RePEc:vuw:vuwcrt:380200&r=all |