Knowledge that Transforms

Corporate cash reserve has an adverse selection effect. Specifically, if investors know a company does not have to issue to invest, an attempt to do so sends a strong signal of overvaluation. This notion has not been explicitly studied in the extant empirical literature, despite its intuitiveness. Using a sample of acquisitions solely financed by stock to exclude the potential complications of free cash flow, I find that announcement returns are lower for a bidder with a higher excess cash reserve. This effect is stronger in hot equity market years or when a bidder's standalone value is more difficult to evaluate. I also find evidence supporting the idea that targets request cash payment to remove “lemon” bidders in normal (non-hot equity market) years, but accept too many stock offers in hot equity market years. After acquisitions, high-excess-cash-reserve bidders operationally outperform low-excess-cash-reserve bidders. Further, they spend more funds on reducing debt but not more on investments, compared with low-excess-cash-reserve bidders. Combined, these results show that cash reserve has information costs. Further, they highlight the importance of the two-sided information asymmetry framework of Rhodes-Kropf and Viswanathan (2004) in describing merger outcomes without resorting to behavioral or agency explanations.

China has some unique institutional features. For example, the shares of listed firms are segmented into negotiable and nonnegotiable ones. The controlling shareholders, usually connected to the government, hold nonnegotiable shares. We examine how these institutional features affected cash dividend payments in China during the period 1994–2006. We find that dividend payments are positively associated with the proportion of nonnegotiable shares in a firm and the proportion of nonnegotiable shares held by the controlling shareholder; moreover, the 2001 China Securities Regulatory Commission stipulation requiring cash dividend payments does not benefit negotiable shareholders. However, we also find that dividend payments are downside flexible, and controlling shareholders cannot force firms to pay or to pay more dividends when firms' earnings decline significantly. The conventional factors, especially profitability or the capability to pay, still play an important role in determining the dividend policy. The propensity to pay and the payout ratio in China are not high compared to those of other countries.

The paper analyzes the strategic waiting tendencies of IPO firms. Our game theoretic model shows why some high-quality firms may strategically delay their initial public offering until a favorable signal about the economic conditions is generated by other issuing firms. Survival analysis suggests that IPOs in the highest quality decile have significantly higher median waiting days (since the start of a rising IPO cycle) than the IPOs in the lowest decile. During the early stages of an expanding IPO cycle the average firm quality is lower than in its later stages. We find supporting evidence also from the IPOs of future S&P 500 firms.

We analyze a firm's choice between spin-offs, equity carve-outs, and tracking stock issues and the role of institutional investors in corporate restructuring. We model a firm with two divisions. Insiders have private information about firm value and face an equity market with retail and institutional investors. We show that restructuring increases information production by institutional investors (relative to that about the consolidated firm): the highest increase in information production arises from spin-offs, the next highest from carve-outs, and the lowest from tracking stock issues. Insiders with the most favorable private information implement spin-offs; those with less favorable private information implement carve-outs; those with even less favorable private information implement tracking stock issues; and those with unfavorable private information remain consolidated. We explain the positive announcement effect and increase in analyst coverage associated with all three forms of restructuring. Our model also generates a number of novel testable predictions for firms' choice between spin-offs, carve-outs, and tracking stock issues, and for institutional trading around these three forms of restructuring.

We examine how the rent-seeking incentives of local government motivate private firms11In this paper “private firms” refers to listed non state-owned-enterprises, the ultimate controlling shareholder of which is an individual. listed in China to establish political connections, and whether such connections lead to more concentrated corporate control structures. Our results show that such firms are more likely to establish political connections in regions in which the local economy is less market-oriented or in which the government has more discretion in allocating economic resources. This is consistent with the notion that the presence of incentives for government officials to engage in rent seeking motivates private firms to look for alternative safeguards through political connections. We also find that the controlling owners of politically connected firms tend to concentrate their shareholdings and dominate the board of directors by occupying the position of either chairman or CEO, which supports the conjecture that a concentrated control structure facilitates rent seeking through political connections and allows the controlling owner to retain all of the benefits arising from connections with politicians.

We examine the impact of securities class action lawsuits on firms' investment and financing choices. Firms which overinvest are more likely to be sued. After a lawsuit, firms on average decrease overinvestment activity, and they decrease payouts while increasing leverage, cash holdings, and firm-specific risk. Additionally, we find some evidence that firms decrease diversification post-suit. Overall, these changes are consistent with a post-suit decrease in agency problems which lead to significant changes in real investment policies. The evidence is consistent with the notion that security class action lawsuits draw attention to agency problems which are then at least partly resolved.

While the literature shows that perks can affect firm values positively or negatively, we argue that firms with higher perks are more likely to be associated with a lower quality of financial reporting, which, in turn, can affect the informativeness of stock prices. Based on hand-collected data on perks from Chinese listed firms, we find that firms with lower perks are associated with higher informativeness of stock prices (or lower R-square). Moreover, the positive association between perks and R-square is shown to be weaker for firms with higher financial reporting quality through audit and earnings quality measures.

We examine the determinants of corporate cash management policies across a broad sample of international firms. We document that firms in countries with strong legal protection of minority investors are more likely to decrease their cash holdings in response to an increase in cash flow than are firms in countries with weak legal protection. This relationship is most pronounced for firms that are financially constrained and those with high hedging needs. More importantly, we do not find evidence that financial development plays an incremental impact on the cash flow sensitivity of cash, after controlling for the effect of legal protection. Therefore, we argue that the legal protection of investors (rather than financial development) represents the first-order effect in influencing international firms' cash management policies. The results are robust to alternative specifications. In general, our findings reinforce the importance of country-level legal protection of investors in mitigating the effects of firm-level financial constraints and hedging needs on corporate cash management policies.

During mergers and acquisitions, the CEOs of the acquiring firms are likely to cancel the deal if the market does not react favorably to its announcement. Using a sample of French acquisition announcements during the period from 2000 to 2005, this paper studies the conditions in which CEOs are more willing to listen to investors. Furthermore, according to the strong networks developed through French elite schools' alumni and board ties, the well-connected CEOs are more likely to complete any deal in spite of a negative market reaction to acquisition announcements.

This paper considers the ownership structure of family firms to determine whether family control alleviates or exacerbates investment–cash flow sensitivity in the Euro zone. We find that family-controlled corporations have lower investment–cash flow sensitivities. Further, our results show that this reduced sensitivity is mainly attributable to family firms with no deviations between cash flow and voting rights and to family firms in which family members hold managerial positions. We also find that second largest shareholders affect family firms' sensitivity and are associated with either monitoring (non-family second blockholders) or collusion (family second blockholders). Overall, family control seems to mitigate investment inefficiencies that derive from capital market imperfections.