Knowledge that Transforms

We examine corporate tax avoidance of firms around addition to the S&P 500 index. We find that corporate tax avoidance for firms at high levels of tax avoidance decreases after index addition, whereas tax avoidance for firms at low levels of tax avoidance increases after index addition. We disentangle the impact of changing governance practices from that of declining investment opportunities. Our findings indicate that the changes in tax avoidance can be attributed to improving governance practices, specifically higher institutional ownership and executive compensations, and this impact is above and beyond the changes in growth opportunities of index firms.

We analyze the relation of private firms' CEO compensation with the probability of sale of a firm and its valuation at the time of the sale. Specifically, we study whether equity-based remuneration is consistent with compensating the CEO for effort related to selling the private firm, or with compensating for the illiquidity of the equity-based compensation for private firms. Using a sample of large private firms with public filings, we find that CEOs of IPO and acquired private firms have higher total and equity-based compensation than CEOs of firms that remain private. We also show that CEO compensation is positively related to the valuation premium of IPOs versus acquired firms.

This study analyses whether the effect of corporate diversification on a firm's market value depends on how this strategy is implemented. According to the real options approach, two opposite diversification strategies may be implemented: one based on fully exercising available options (assets-in-place diversification) and the other aimed at seeding new opportunities for future growth in multiple businesses (growth options diversification). We propose an index to measure these two diversification patterns and we explore their impact on firm market value for a sample of U.S. firms during 1998–2014. We find that as a firm's diversification strategy shifts towards a growth options pattern, it becomes a more value-enhancing strategy.

This paper investigates inorganic growth strategies in PE buyouts where the portfolio firm, which has been acquired in the initial buyout, serves as a platform for subsequent add-on acquisitions. We analyze a comprehensive sample of 9548 buyouts and 4937 add-on acquisitions spanning 16years of buyout activity in 86 countries. We find that the probability for add-on acquisitions is high if the PE sponsor is experienced and has reputational capital, if the portfolio firm is large, has M&A experience at entry and operates in an industry with moderate degree of fragmentation, as well as in case of favorable financing conditions. Similar factors also explain higher add-on productivity and faster add-on execution. On average, cross-border/industry diversifying inorganic growth strategies are most likely if the portfolio company already draws upon international/inter-industrial M&A experience at entry and if the PE sponsor frequently invests across borders/industries. Furthermore, our results indicate that add-on acquisitions increase the probability for exiting through IPO and secondary buyout. The effect on secondary buyouts is driven by deals where the subsequent PE owner continues the inorganic growth strategy of the previous buyout.

We use exchange-traded options to identify risks relevant to capital structure adjustments in firms. These forward-looking market-based risk measures provide significant explanatory power in predicting net leverage changes in excess of accounting data. They matter most during contractionary periods and for growth firms. We form market-based indices that capture firms' magnitudes of, and propensity for, net leverage increases. Firms with larger predicted leverage increases outperform firms with lower predicted increases by 3.1% to 3.9% per year in buy-and-hold abnormal returns. Finally, consistent with the quality, leverage, and distress risk puzzles, firms with lower predicted leverage increases are riskier but earn lower abnormal returns.

We investigate the effects of board busyness on firms' cost of debt by analyzing the relationship through a hostile takeover framework. We initially establish an inverse relationship between board busyness and firms' hostile takeover vulnerability. Next, we test the relationship between board busyness and the cost of debt. Our results suggest that as the level of board busyness increases, the cost of debt decreases. Economically, the cost of debt for firms whose board is comprised of 40% busy directors is about 30bps lower, compared to those without busy directors. Our results survive extensive robustness checks and provide a positive counterpoint to the negative correlation between board busyness and firm performance.

We explore the role of ambiguity, as opposed to risk, in explaining firms' corporate financial policies. We create text based measures of ambiguity and risk for U.S. firms between 1995 and 2013. Measured ambiguity is high in for instance high tech industries, whereas the risk measure is high for homogeneous goods. Using within-firm variation to identify effects we find that greater ambiguity is associated with greater cash holdings and more risk with a higher probability of derivatives use. The results are in line with a simple model of liquidity management with ambiguity averse agents.

The view that the independent directors of large banks should contribute to safeguarding the interests of bank creditors and taxpayers, by exercising a stringent risk oversight of bank executives, has gained ground in the aftermath of the 2007–2009 crisis. Using a cross-country sample of large banks for the period 2004–2014, we show that post 2009 an increase in board independence leads to more prudent bank risk-taking compared to the rest of the sample period. This effect materializes via independent boards favoring increases in bank capitalization and decreases in bank portfolio risk after the global crisis. Additional analyses demonstrate, however, that these results do not hold for all large banks in our sample but are confined to the group of banks benefiting from a government bailout during the crisis. In most large international banks board independence does not contribute to safeguarding the interests of bank creditors and taxpayers by constraining bank risk-taking.

In 2005, U.S. employers spent more than $500 billion on health insurance. I argue that firms invest in worker health to mitigate the depreciation in human capital that occurs when workers get sick, which increases the productivity of human and physical capital. Using firm-level health insurance data, I find firms that have higher labor productivity, spend more on research and development, and are larger invest more in health capital. Further, health capital investment positively affects firm value and overall productivity. To identify these effects, I instrument for insurance with state mandates and the number of persons covered by insurance contracts.

The empirical literature shows that firms overinvest in working capital and that these investments are economically inefficient. We decompose working capital investments in the cash conversion cycle and growth effects in the presence of x-inefficiency. We predict that reductions in the cash conversion cycle should increase shareholder value. Direct evidence follows from a case study of a listed company in Brazil, MRV. Changes in operations reduced CCC from 508days in 2012 to 351days in 2015, decreasing working capital requirements by US $1.02 billion. Indirect evidence comes from (1) a synthetic control comparing MRV's free cash flow to equity to its direct and distant competitors; (2) an event study of share prices, and (3) a dynamic cash flow estimation using Tobin's Q as the dependent variable. Outcomes suggest that CCC management, controlling for effects on operating margins, result in higher stock prices and profitability, and increased cash flow. The theoretical framework and results reconcile the literature and provide a rationale for the overinvestment and the inefficiency of working capital investments.