Knowledge that Transforms

We introduce the topic of this Special Issue of the Journal of Corporate Finance on corporate governance of a multinational enterprise with a particular emphasis on the theoretical and empirical gaps in prior finance and international business studies associated with corporate governance problems and the effectiveness of governance solutions in the context of diverse institutional settings. We integrate analysis of the accepted articles with existing research on international corporate governance and global strategy. Overall, the work in this area continues to emphasize the importance of institutions, legal environment and culture in all aspects of global enterprises. We conclude the article with suggestions for future research in this rapidly expanding and important area of global business.

Why do firms pay their workers with variable pay? The standard explanation appeals to a problem that the worker faces, e.g., agency. We develop a model of variable pay endogenously driven by the capital structure problem of the firm, and not a worker related problem. If workers face a low probability of job termination, firms use more variable pay, and more leverage. This can have important implications for understanding compensation practices in organizations. We provide empirical evidence consistent with firms using variable pay to increase leverage.

The Chinese IPO market has introduced the private oversight of sponsors under tight government control. We examine the performance of IPOs that are managed under private sector oversight, known as the sponsorship system. Using buy-and-hold returns, operating performance measures, Fama-French five factor models, propensity score matching, and triple DiD (DDD), we find that long-term performance is better under the sponsorship system. Additionally, we find that IPOs with reputable sponsor institutions and reputable sponsor representatives perform better. Relatedly, the CSRC takes less time to review the admission documents prepared by reputable-sponsor institutions. Regulatory action taken by the CSRC is shown to be effective, as the number of IPO businesses declines for sanctioned sponsor institutions, and the IPOs managed by them perform better once they have received a penalty.

We examine how firms' dividend policy affects the initial compensation of their newly appointed CEOs. We focus on newly appointed CEOs to isolate the effect of dividends on compensation and to provide new insights into an aspect largely neglected by compensation research. We show that the dividend payout is positively related to new CEO compensation. Further, the positive effect of dividends is stronger for firms with no dividend cuts over the past two, three and four years, firms with relatively high institutional ownership, and those with strong boards, consistent with new CEOs receiving higher pay as compensation for greater dividend pressure.

We contribute to the corporate social responsibility (CSR) literature by investigating whether the CSR of acquirers impacts mergers and acquisitions (M&A) completion uncertainty. Using arbitrage spreads following initial acquisition announcements as a measure of deal uncertainty, we document –for an international sample of 726 M&A operations spanning the 2004–2016 period– a negative association between arbitrage spreads and acquirers' CSR. Specifically, we show arbitrage spreads are reduced by 1.10 percentage points for each standard deviation unit-increase in the acquirer's CSR score. Findings are qualitatively similar when we focus on individual CSR dimensions (environmental, social, and governance). Our results suggest the CSR of acquirers is an important determinant of the way market participants assess the outcome of M&As worldwide.

In 2011, German legislators passed the latest reform to German Insolvency Law (ESUG). ESUG mandates that creditors of larger firms can exert more influence on the appointment of the insolvency administrator, resulting in a shift of power from shareholders to creditors. Based on difference-in-differences estimation, we find that larger firms reduced financial leverage by about 4–7 percentage points relative to control firms. Furthermore, after the enactment of ESUG, larger firms spend less money on investment and pay higher interest rates. Overall, the evidence is consistent with the view that German creditor protection has become too strong.

We introduce a new model for optimal internal capital allocation, which would allow banks to maximize their Return on Risk-Adjusted Capital (RORAC) under regulatory and capital constraints. We extend the single period model of Buch et al. (2011) to a multi-period model and improve its forecasting accuracy by including the debt effect and Bayesian learning innovations. The empirical application shows that our model significantly improves the RORAC of a sample of banks listed in the S&P 500 index.

We document significantly lower valuations for government contractors in the United States. While contracting with government agencies reduces firms’ cost of equity, it significantly lowers their sales growth. These findings are contingent on economic conditions; negative valuations dissipate as operating performance improves during economy- and industry-wide recessions. The overall negative valuation effect of government contracts holds only for government contractors in strategically unimportant industries, as strategically important contractors have higher valuations, driven by better operating performance regardless of economic conditions. This is the first study examining the relationship between government procurement and corporate valuation. It also adds to the growing body of literature on politically connected firms by analyzing government contractors as a related‑but‑separate channel of governmental influence on the corporate world.

We revisit the link between bailouts and bank risk taking. Bailout expectations create moral hazard – increase bank risk taking. However, when an individual bank’s success depends on both its effort and the overall stability of the banking system, bailouts that shield banks from contagion may increase their incentives to invest prudently and so reduce bank risk taking. This systemic insurance effect is more important when bailout rents are low while contagion risk is high. The optimal policy is then to make bailouts not difficult, but “effective” : associated with lower rents. We further show that, besides better bank resolution, a powerful means to reduce bailout rents is higher ex ante bank capital, since it implies a larger bank equity cushion that can be expropriated in a resolution. This highlights an important complementarity between bank capital regulation and bailouts as tools to enhance financial stability.

We provide theoretical and empirical arguments in favor of a diminishing marginal premium for market risk. In capital market equilibrium with binding portfolio restrictions, investors with different risk aversion levels generally hold different sets of risky securities. Whereas the traditional linear relation breaks down, equilibrium can be described or approximated by a concave relation between expected return and market beta, and a concave relationship between market alpha and market beta. An empirical analysis of U.S. stock market data confirms the existence of a significant concave cross-sectional relation between average return and estimated market beta. We estimate that the market risk premium is at least four to six percent per annum, substantially above traditional estimates. A practical implication for active portfolio managers is that the alpha of “betting against beta” strategies seems dominated by the medium-minus-high-beta spread rather than the low-minus-medium-beta spread. The success of such strategies thus largely depends on underweighting or short selling high-beta stocks.