Knowledge that Transforms

We show that hard to observe, indirect connections between a CEO and “independent” board members are associated with higher CEO compensation. While we find this result for the “friend of a friend” connection, we do not find it for direct connections, i.e. friends sitting on the board. We postulate that this differential result is caused by directors with readily observable connections to the CEO being wary of provoking outrage. In contrast we find both types of connections associated with reduced involuntary CEO turnover, suggesting that outrage is not as big a concern, e.g., compensation is the foci of stakeholders.

We examine the impact of local religious beliefs on organizational risk-taking behaviors using hedge funds as a new and unique setting. We find robust evidence that local religiosity is significantly negatively related to both total and idiosyncratic volatilities of hedge funds during 1996–2013. This relation is primarily driven by semi-directional funds, reversed for directional funds, and nonexistent for non-directional funds. Consistent with the local preference channel, the impact of local religiosity on risk-taking is only pronounced among funds for which local managers and investors are economically more important, namely young and small funds. Further, hedge funds located in more religious counties tend to hold less risky stocks and diversify their stock portfolios across industries, thus contributing to lower hedge fund risk-taking. Overall, our evidence suggests that local culture, in particular religiosity, may motivate hedge fund managers to reduce risk.

Based on a difference-in-differences approach, we find strong evidence that the initial enforcement of insider trading laws improves capital allocation efficiency. The effect is concentrated in developed markets and manifests shortly after the enforcement year. Further analysis shows that the improvement is positively associated with the increase in liquidity around the enforcement year and the opaqueness of the information environment before the enforcement year. The improvement is more pronounced for firms operating in more competitive markets, being more financially constrained, and with more severe agency problems. Finally, we find increased accounting performance after the enforcement and the increase is positively associated with the improvement in capital allocation efficiency. Overall, our evidence suggests that the initial enforcement of insider trading laws improves capital allocation efficiency by providing more information to guide managerial decisions and by reducing market frictions arising from information asymmetry and agency problems.

While there is extensive research on how option incentives in executive compensation relate to risk-taking by managers, the impact of capital structure on this relationship has received little empirical attention. Extant work suggests that heightened managerial career concerns arising from financial risk and monitoring by debt holders will result in leverage dampening the relationship between managerial risk-taking and equity-linked incentives. We empirically evaluate this contention and find that firm leverage is associated with a significant weakening of the positive relationship between option incentives in flow compensation and managerial risk-taking. This result holds after accounting for the endogeneity of the firm leverage and incentive compensation decisions, and is robust across alternative measures of managerial risk-taking and to using the firm's credit ratings instead of leverage. The attenuating effect of firm leverage arises from both the long-term and short-term components of debt and is significantly stronger during the financial crisis of 2007–2009. Overall, the evidence highlights the influence of capital structure on the relationship between option incentives and managerial risk-taking.

We construct a dynamic takeover law index using hand-collected data on legal provisions and empirically examine the effect of takeover regulation to protect shareholders on shareholder wealth for bidders and targets in a multi-country setting. We find that a stricter takeover law increases the wealth gains to the shareholders of the combined bidder and target firm, which suggests that stronger shareholder protection in the takeover bid process increases the efficiency of the takeover market. In contrast to our hypothesis, results show that stricter takeover law does not hurt bidders. Its effect on target announcement returns is significantly positive and economically large. Our findings on individual provisions suggest that the mandatory bid rule and ownership disclosure increase overall synergistic gains in takeovers, while the fair-price rule and squeeze-out rights may reduce them. Further results show that stricter takeover regulation increases competition in the market for corporate control and reduces the time to successful completion of a takeover bid, which explains increased combined wealth gains under stricter takeover regulation.

This paper examines the value of government ownership in Europe during the global financial crisis. This crisis was an exogenous shock for European firms, which allows us to observe an out-of-equilibrium effect on the costs and benefits of government ownership. Using a comprehensive sample of 4737 listed firms in 28 European countries over the period 2005–2009, we find that firms with government ownership experienced a smaller reduction in firm value than firms without government ownership. This effect was driven by firms located in countries where the risk of expropriation by the government is lower, that is, countries with less corruption and better investor protection.

We examine a potential link between culture and financial development by considering culture's influence on contract enforcement regulation. Specifically, we investigate the role of individualism in determining the variation in enforcement costs across countries. Individualism positively and significantly relates to efficient contract enforcement, an association that is independent of a particular political system. Interaction effects, however, suggest that democracy magnifies individualism's influence on the contract enforcement efficiency. These results provide insight into how culture can shape financial outcomes. It further suggests that culture serves as a constraint on policymakers, as any given policy or formal institutional structure will function very differently depending on the cultural environment.

Using an original dataset of fully monetized LBOs initiated from 1990 to 2006, we examine the emergence of an entrepreneurial transaction strategy focused on revenue growth and its incidence relative to more “classic” strategies focused on operating efficiencies. We additionally show how the conventional focus on returns measured at an IPO or acquisition frequently overstates actual realized returns to sponsors. Using this return data, we evaluate how “classic” and “entrepreneurial” strategies are associated with sponsors' equity returns. Among successful LBOs, LBOs that enhance operating efficiencies produce the highest “exit” returns; however, LBO sponsors commonly fail to monetize these returns due to delays associated with liquidating portfolio positions. In contrast, LBOs that focus on growing revenues are associated with higher fully realized equity returns, suggesting more sustainable value-creation for sponsors and their investors.

This paper examines the relationships between independence, director unobservable ability and firm performance. We develop an original empirical strategy based on the AKM model to estimate separately director fixed effects (as a measure of individual ability) and firm fixed effects. We show that board independence has an ambiguous impact on corporate performance because of two opposing forces: one related to the director nomination process, the other one related to board functioning. On one hand, we report that independence is positively correlated with individual fixed effects, an evidence consistent with a nomination process of independent directors based on individual ability. On the other hand, and regarding board functioning, we show that independence, netted out individual ability, is negatively correlated with firm performance suggesting that independent board members experience an informational deficit (as compared to affiliated directors).

We examine the effect of maintaining exclusive relationships with Government Owned Banks (GOBs) on real investment by publicly traded companies in India. Firms that maintain such exclusive relationships have an investment cash flow sensitivity that is almost 30% lower relative to other firms. GOB relationships also increase sensitivity of investment to Tobin's Q. Exclusive relationships with private banks increase cash flow sensitivity while exclusive relationships with foreign banks have no impact. The lower investment cash flow sensitivity by firms with exclusive GOB relationships is not the result of cherry picking of less constrained firms by GOBs. Rather, firms with exclusive GOB relationships are in worse financial condition relative to other firms – thus, GOBs appear to be doing reverse of cherry picking. Surprisingly, the results are driven by the large firms which benefit from GOB relationship and not the smaller firms which are the intended beneficiaries of government directed credit programs.