Knowledge that Transforms

We develop an international asset pricing model to measure the impact of investability constraints on asset pricing. For a sample of 18 emerging markets, we use Standard & Poor’s investable weight factor (IWF) to show a 26.33% reduction in the cost of equity capital when non-investable firms become partially investable, with a further 12.51% reduction when partially investable firms become unrestricted. We demonstrate the generality and usefulness of the IWF by examining stocks with global/American depositary receipts and foreign institutional holdings as alternate investability proxies. Our results provide strong evidence of the economic benefits of market liberalization policies.

We trace directors through time and across firms to study whether acquirers’ access to nonpublic information about potential targets via their directors’ past board service histories affects the market for corporate control. In a sample of publicly traded U.S. firms, we find acquirers about 4.5 times more likely to buy firms where their directors once served. Effects are stronger when the acquirer has better corporate governance, the interlocked director has a larger ownership stake at the acquirer, or the director played an important role during past service. The findings are robust to endogeneity of board composition and controls for contemporaneous interfirm interlocks.

We study the evolution and renegotiation of the cash-flow rights that venture capitalists (VCs) obtain in their portfolio companies. When company performance between financing rounds is poor, subsequent contracts contain stronger VC cash-flow rights, and existing VCs tend to either give new VCs senior claims or forfeit their existing rights altogether. These results are consistent with the importance of financing problems between different VCs and with theory predicting that financing frictions worsen with poor performance. A consequence is that VC cash-flow rights are frequently significantly diluted before exit, implying that VC investments are riskier than previously estimated.

We examine the impact of managerial entrenchment on firm value using a dynamic model with firm fixed effects. To estimate the model, we employ the long-difference technique, which is shown by our simulation to deliver the least biased estimates. Based on a large sample of U.S. companies, we document a significantly negative and causal effect of managerial entrenchment on firm value after taking into account omitted variables, reverse causality, and highly persistent endogenous variables. Additional analysis suggests that the causality running from managerial entrenchment to firm value is more pronounced than that for reverse causality.

We study the transmission of bank distress to nonfinancial firms from 34 countries during the 2007–2009 financial crisis using systemic and bank-specific shocks. We find that bank distress is associated with equity valuation losses and investment cuts to borrower firms with the strongest lending relationships with banks. The losses are not offset by borrowers’ access to public debt markets and are concentrated in firms with the greatest information asymmetry problems and weakest financial positions. Our findings suggest that public debt markets do not mitigate the effects of relationship bank distress during financial crises.

We use short interest as an investor-based measure of over- or undervaluation that distinguishes between the misvaluation and Q-theories of mergers. Using this measure, we find that misvaluation is a strong determinant of merger decision-making. Firms in the top quintile of short interest are 54% more likely to engage in stock acquisitions and 22% less likely to engage in cash acquisitions. Stock (but not cash) acquirers have higher short interest than their targets. Overall, our results suggest that the previously documented underperformance of stock acquirers and the overperformance of cash acquirers can be explained by misvaluation, as captured by short interest.

There is a generalized conviction that variation in dividend yields is exclusively related to expected returns and not to expected dividend growth, for example, Cochrane’s (2011) presidential address. We show that this pattern, although valid for the aggregate stock market, is not true for portfolios of small and value stocks, where dividend yields are related mainly to future dividend changes. Thus, the variance decomposition associated with the aggregate dividend yield has important heterogeneity in the cross section of equities. Our results are robust to different forecasting horizons, econometric methodology (long-horizon regressions or first-order vector autoregression), and alternative decomposition based on excess returns.

We examine the role of government in the labor–creditor relationship using the case of the Chrysler bankruptcy. As a result of the government intervention, firms in more unionized industries experienced lower event-window abnormal bond returns, higher abnormal bond yields, and lower cumulative abnormal bond returns. The results are stronger for firms closer to distress. We also observe the effect in firms in which labor bargaining power is stronger and those with larger pension liabilities. Overall, the results underline the importance of government as a significant force in shaping the agency conflict between creditors and workers.

The risk of securities class action litigation alters corporate savings and investment policy. Firms with greater exposure to securities litigation hold significantly more cash in anticipation of future settlements and other related costs. The result is due to firms accumulating cash in anticipation of lawsuits and not a consequence of plaintiffs targeting firms with high cash levels. The market value of cash is lower for firms exposed to litigation risk. Corporate investment decisions are also affected by litigation risk, as firms reduce capital expenditures in response. Our results are robust to endogeneity concerns and possible spurious temporal effects.

A growing literature finds that firm asset growth rates are negatively correlated with subsequent stock returns. We show that the poor post-deal returns that have been documented for stock acquisitions are more precisely explained by the return effects associated with systematically larger asset growth rates for stock deals. We find a similar result for other cross-sectional and time-series acquisition effects, including poor returns for glamour deals, weakly monitored deals, and deals done during high-valuation periods. We suggest that the distinguishing characteristic associated with poor performing acquisitions is simply their tendency to grow assets.