We examine whether insiders’ pledging of company stock as collateral for personal loans influences a company’s debt contracting. We attempt to identify causality through difference-in-differences analyses of an unexpected legislative change that exogenously reduced board directors’ pledging incentives. We find that firms with higher initial pledging levels, which subsequently experienced a significant decline in pledging ratios due to the regulation, benefited from lower loan spreads and less stringent non-price loan terms. We further hypothesize and provide evidence that the positive impact of insider pledging on corporate borrowing costs is less pronounced in closely held firms. Examining the mechanisms, we find that share pledging is positively related to earnings management, firm risk-taking behaviors, and agency problems. Overall, these findings suggest that banks perceive insider share pledging as engendering significant risks.

We find an overall negative relation between CEO inside debt holdings and the cost of equity capital. Such a negative relation holds in an instrumental-variable analysis, a test using changes in variables due to CEO turnover events, a test using seasoned equity offering (SEO) underpricing as an alternate cost of equity measure, and a difference-in-differences test based on the implementation of Internal Revenue Code Section 409A Final Regulations. Additionally, the negative relation between inside debt and the cost of equity capital is nonlinear, suggesting the existence of optimal inside debt compensation that can minimize cost of capital. The negative relation is less pronounced in firms with pre-funded executive pension plans and in firms that provide executives with the pension lump-sum option. We also provide evidence that inside debt lowers the cost of equity more for excessively levered firms. Collectively, these findings suggest that shareholders value the beneficial role of CEO debt-like compensation in constraining excessive managerial risk taking.

We study how the information conveyed by fair value (FV) reporting is considered during an initial public offering (IPO). By examining how pre-IPO FV earnings are perceived by underwriters and investors, we document numerous original findings. First, IPOs with higher FV earnings have higher initial valuations and subsequent price revisions, indicating that underwriters and institutional investors value the information conveyed by FV reporting. Second, there is a significantly negative relation between FV earnings and post-IPO initial returns, whereas no such relation exists between non-FV earnings and initial returns. Third, we document robust positive associations between FV earnings and various measures of post-issue long-run stock performance. Fourth, we confirm the informational content of FV earnings by showing their predictive power for future earnings. We interpret these findings as supportive of the underreaction hypotheses, whereby aftermarket investors underreact to the information contained in FV reporting in the short run and gradually recognize the value of such information in the long run. We perform numerous tests to confirm the robustness of our results, including a test to address potential sample selection bias using the adoption of IFRS for small- and medium-sized entities (SMEs) as an exogenous determinant of FV reporting. Taken together, our findings advance our understanding of how fair value information is considered during an IPO issuance.

In this study we analyze how CEO risk incentives affect the efficiency of research and development (R&D) investments. We examine a sample of 843 cases in which firms increase their R&D investments by an economically significant amount over the period of 1995–2006. We find that firms with higher sensitivity of CEO compensation portfolio value to stock volatility (vega) are more likely to have large increases in R&D investments. More importantly, we find that high-vega firms experience lower abnormal stock returns and lower operating performance compared to their low-vega counterparts following the R&D increases. Our main results hold in a variety of robustness tests. The results are consistent with the conjecture that high-vega compensation portfolios may induce managers to overinvest in inefficient R&D projects and therefore hurt firm performance.

We examine the effect of firm-level political risk on debt choices and find: (i) firms with higher political risk display a preference for private debt over public debt; (ii) the magnitude of this preference varies with the aggregate policy uncertainty; (iii) politically risky firms indeed receive less favorable terms in the bond market. To explain such findings, we show that private lenders have several advantages in serving politically risky borrowers. First, to the extent that lenders cannot perfectly foresee the adoption of new government policies, private lenders' expertise in implementing the reorganization process is important to limit their potential loss. Second, politically risky borrowers must undertake significant operation adjustments facing rising policy uncertainty. Private lenders can gather accurate information and closely monitor these adjustments. Last, as the severity of political risk varies with aggregate policy uncertainty, there exists an implicit contract between a borrower and its relationship bank, whereby a borrower accepts less favorable terms during normal times in exchange for the bank's support during difficult times. Taken together, this study advances our understanding of how cross-sectionally heterogeneous political risk influences corporate debt choice.