42 research outputs found
Essays in Corporate Finance
No full textMy dissertation includes three papers on empirical corporate finance. In the first paper, “Skin in the Game: Risk of Environmental Pollution and Executive Compensation”, I use major toxic chemical spills as shocks to environmental pollution and examine the consequent effects on executive compensation of firms whose headquarters are in the vicinity of these spills. I find that firms exposed to these pollution shocks experience significant increases in executive risk-taking incentives (vega) and pay-performance sensitivity (delta) without significant changes in executive total pay. Meanwhile, managers of these firms increase corporate cash holdings to sub-optimal levels, which is costly for shareholders. Overall, the empirical patterns bolster the alignment hypothesis that risk of environmental pollution may exacerbate manager-shareholder conflicts and escalate the need for alignment compensation contracts.
The second paper, “Environmental Pollution and Business Activity: Evidence from Toxic Chemical Spills”, is a joint work with Buvaneshwaran Venugopal and Vijay Yerramilli. We use major toxic chemical spills as pollution shocks to their local neighborhoods and examine the consequent effects on local business activity. A key finding is that pollution shocks contribute to increases in business concentration in their local economy by hurting smaller establishments while benefiting the largest establishments. Highlighting the importance of heightened health risk perceptions, we show that these effects are also present for establishments that are located in areas far from the spill sites but which are exposed to the same television news coverage as areas close to spill sites. We identify two likely explanations for these persistent adverse effects on local business activity: worsening of credit frictions and migration of population and income away from counties exposed to major toxic chemical spills.
The third paper, “Product Market Competition, Mergers and Acquisitions, and Shareholder Wealth”, coauthored with Praveen Kumar and Vijay Yerramilli, examines the effects of industry-specific product market competition shocks on merger and acquisition (M\&A) activity and shareholder wealth, using a trade policy change that led to surge of import competition for US manufacturing industries. Unlike the well-known negative effect of this shock on US manufacturing employment, we find a significant positive effect on cross-industry acquisitions. In contrast to results in the existing M\&A literature, there is a reallocation of value-creation and wealth towards acquiring shareholders relative to target shareholders of public firms, and this wealth reallocation is stronger in diversification mergers between vertically unrelated firms
Essays in Dynamic Corporate Finance
No full textThis dissertation consists of two essays on dynamic models in corporate finance. In the first essay, I estimate a dynamic investment model for business groups in which their pyramidal ownership structure generates an agency problem between controlling and minority shareholders. In the model, the controlling shareholder can transfer resources across group firms using intra-group loans, allowing risk sharing and reducing the need for external financing. In a sample of Chilean business groups, I perform counterfactual experiments in which I compare group-affiliated firms with equivalent non-group firms. I find that for the average business group the incremental value of the internal capital market represents roughly 1.5-1.7% of the firm equity value. Although the controlling shareholder gets a larger portion of the value gains, minority shareholders also benefit from these internal transactions.
In the second essay, we estimate a structural model of investment for a firm exposed to output price risk, which can be hedged using derivatives. In our model, we endogenize the cost of debt, which is affected by the firm's risk management policies. Hedging, therefore, creates value for the company by reducing the cost of debt. Additionally, since hedging has the effect of reducing the variability of the cash flows generated by the firm, it also creates value by exploiting convex costs and concave payoffs in our model. Using a dataset with detailed information on the derivative positions of upstream oil and gas firms during 1996-2013, we estimate the model via the simulated method of moments (SMM). We estimate that the value of hedging is 7.67% of assets. Roughly, half of this value is a result of the effect of hedging on the cost of debt, the rest of the value being related with other non-linearities in the model. Comparative statics exercises suggest that the variables that most affect hedging policies are the volatility of internal cash flows, capital adjustment costs, costs of equity financing, and the risk premium/discount in the derivatives market. Consequently, the value created by hedging is also most sensitive to these variables, and especially to the cost of equity financing and the risk premium/discount in the derivatives market.Finance, Department o
Essays on Angel Investors and Early-Stage Startups
No full textThis dissertation contains three essays on angel investors and early-stage startups. In the first essay, I show that social connections between angels and entrepreneurs, obtained via schools, past employment and ethnicity, positively influence investment decisions of angels, and the subsequent performance of startups. Social connections, irrespective of the ranking of schools or employers in which they were formed, are crucial for securing early-stage financing, particularly in markets with higher information asymmetry. Connected seed-stage startups are more likely to survive longer, raise more series A funds and attract venture capital investments than their unconnected peers.
In the second essay, we show that syndication is widespread in the angel investment market, even among seed-stage startups. Angels that successfully lead seed-stage startups to the next financing stage experience an increase in the quantity, quality, and geographic spread of their co-investment connections relative to their unsuccessful peers, and are rewarded with more new investment opportunities, both as lead investors and participants. Success begets more success, making it more likely that other seed-stage startups of a successful angel also progress to the next financing stage. Overall, our results highlight that reputation for good performance enhances the network capital of angel investors.
In the third essay, we investigate the board formation decisions of early-stage startup firms and how these decisions relate to future performance. An individual is more likely to be appointed as the first outside director if he/she is a seed-stage investor, shares a past professional connection with the founders, or possesses expertise not possessed by the founders. All else equal, a start-up is more likely to attract future directors and future investors that share a past professional connection with the early-stage director. Overall, start-ups that form early-stage boards raise larger amounts in later-stage rounds, are more likely to attract funding from prominent investors and venture capitalists, and are more likely to exit successfully especially through IPOs. All these effects are stronger if the early-stage director is also a seed-stage investor in the startup, except that investor-directors lower the likelihood of exit through the IPO route.Finance, Department o
Essays on Mergers & Acquisitions and Corporate Investment
No full textThis dissertation consists of three essays on mergers and acquisitions (M&As) and corporate investment. In the first essay, I examine the divergence of investor opinions about target firm values after the announcement of M&A deals ("investor disagreement"). I create three measures of investor disagreement using the target firm's trading volume, bid-ask spread, and stock return volatility during a two-week window following a deal announcement. I find that investor disagreement is positively associated with deal complexity, and negatively with the offer premium. Deals with larger investor disagreement are more likely to be renegotiated, to feature slower completion time, and to fail, even after controlling for announcement returns and merger arbitrage spreads. Consistent with the divergence of opinion theory, a trading strategy that invests in target firms with low investor disagreement yields positive abnormal returns. Overall, my results highlight the importance of investor disagreement in predicting M&A outcomes.
The second essay shows that M&A deals that are announced when the bidder's relative value (ratio of bidder's equity value to target's equity value) is closer to its 52-week high feature higher offer premium, lower (higher) announcement returns for the bidding (target) firm, and are more likely to fail, all else equal. Yet, bidders in such deals also experience large abnormal returns in the two-year period surrounding the announcement. Our results suggest that bidders strategically choose announcement timing to exploit relative misvaluation, and cast doubt on the idea that announcement returns represent the gains to long-term shareholders of bidding firms.
In the third essay, I examine how the effect of uncertainty on capital investment varies between focused firms and conglomerate segments. One of the advantages of conglomeration is that segments have access to the conglomerate's internal capital market and are thus less likely to be financially constrained. Consistent with the idea that uncertainty exacerbates financial frictions, I find that industry-level uncertainty has a negative effect on the investment of focused firms but has no statistically significant effect on the investment of conglomerate segments. Further analysis suggests that corporate diversification may improve the efficiency of capital investment decisions under uncertainty.Finance, Department o
Essays in Household Finance
No full textThis dissertation consists of three essays on household finance. In the first essay, I analyze the impact of changes to collateral value on borrowers' default decision on auto loans using two types of natural experiments in Sri Lanka. Changes in vehicle import tax rates and loan-to-value ratio caps on auto loans generated plausibly exogenous variation in the resale value of vehicles already pledged as collateral. Using proprietary auto loan performance data, I estimate that a 10% drop in the collateral value corresponds to a 44% increase in the default rate. I also find that collateral value is more important for borrowers with higher outstanding loan balances. In the second essay, we use a unique feature of California’s property tax system to empirically identify the effect of selling homeowners’ past property tax payments on their choice of listing price. Although past property taxes are sunk costs, we find that they have a significant positive effect on the sellers’ choice of listing price, which is inconsistent with rational models of decision making. This effect is stronger when sellers expect to sell at a loss relative to their purchase price, for high-valued properties, and in zip codes with lower housing transaction volumes. Interestingly, the sunk-cost effect is also stronger for sellers with higher mortgage debt, especially when they expect to incur a loss on the sale. The effect of property taxes on listing price is mostly transmitted to the selling price, which is consistent with the idea that buyers use listing prices as anchors to assess property values. Overall, our results suggest that sunk costs affect prices in the housing market. In the third essay, we show that modest differences in the interest rate at loan origination can have long-lasting effects on mortgagors. We use monthly fluctuations in the national mortgage rate at loan origination to study small changes in interest rates across home purchases made in the same year, in the same area, and which eventually reach similar levels of negative equity. A 50bp higher national rate at origination corresponds to an extra $550 in payments per year and, during the bust, an increase in defaults of 68-88 bp within 12 months of reaching negative equity. The effect is large relative average default rates of 3.78% (5.39%) for homes with 10\% (30%) negative equity. Consistent with liquidity constraints, the magnitude of the effect is relatively constant across different levels of negative equity. The national mortgage rate is not correlated with worse borrower credit quality. During the boom, smaller mortgage payments result in increased consumption of non-durables and services from 2001-2007, while total expenditure is unchanged. If intermediaries resist large concessions to borrowers, small concessions may be more effective.Finance, Department o
Manager-Auditor Negotiations
No full textIn this dissertation, I address two central research questions. First, I open the black box of manager–auditor negotiations to examine how financial statements are endogenously shaped through strategic interaction under information asymmetry. Second, I investigate how this negotiation process affects financial reporting quality. I develop a two-round negotiation game in which the manager, possessing private information about earnings, makes an initial offer and a potential counteroffer. The auditor, facing potential overstatement penalties, responds strategically while retaining the option to extend the audit—a costly activity for both parties. This framework allows auditor conservatism and managerial conservatism to emerge endogenously. I show that the manager–auditor negotiation leads to conditional overstatement or understatement and produces a non-monotonic, asymmetric pattern in financial reporting quality. Additionally, the model predicts a discontinuity in the distribution of reported earnings. These results offer new theoretical insights into the micro-foundations of auditing and yield testable implications for empirical research on financial reporting quality and earnings distribution
The Effect of Sarbanes-Oxley on the Debt Contracting Value of Accounting Information
No full textThis paper investigates whether and how the Sarbanes-Oxley Act (SOX) changed the way that banks use accounting information to price corporate loans. SOX reformed corporate governance and disclosure, intending to improve reporting transparency. The targeted beneficiaries of this improved reporting transparency were investors and shareholders, but SOX also may have affected the decision usefulness of accounting information to private lenders, such as banks. I refer to accounting information’s usefulness to creditors, i.e. its ability to indicate the level of credit risk, as its debt contracting value (DCV) and proxy it with loan interest spread’s sensitivity to key accounting metrics, such as ROA, interest coverage, leverage, and net worth. The tests show that, on average, the DCV of key accounting metrics, most notably ROA, declined in the period following a borrower’s compliance with the requirements of SOX Section 404. Investigation of this decline finds that it cannot be explained by borrowers that disclose deficiencies in internal control over financial reporting, but is instead primarily driven by changes in how borrowers manage earnings. The study also finds that a reduction in auditor-provided tax services is related to lower DCV of ROA and leverage. Conversely, a reduction in other unspecified nonaudit services is related to higher DCV of net worth. These findings suggest that SOX has mixed implications for accounting information’s usefulness to private lenders.Accountancy and Taxation, Department o
Determinants of Firms’ Capital Structure Choice, Their Credit Ratings and the Leverage-Rating Relation
No full textBoth theory and practice seem to agree that firms adjust their capital structure to stay in close proximity to a target leverage ratio. However, this target leverage ratio is not accounted for as a determinant of leverage in existing empirical work. In the first chapter, I calculate the deviation of actual leverage from target leverage and use it as a determinant of firm’s leverage along with a set of other control variables that are traditionally used in the literature. I find that the addition of deviations from target leverage more than doubles the explanatory power compared to existing empirical specifications. Using standardized regression coefficients I show that the deviation from target leverage ratios is the most important determinant of firms’ capital structure.
In the second chapter, I study firms’ credit ratings. Capital structure choice as measured by firms’ leverage ratio is an essential parameter in rating models. The endogeneity of firms’ leverage in rating estimation has recently come to consideration but has not received the attention it should have. My study shows that the corrected impact of leverage is about ten times more than the other determinants.
In the final chapter, I study the endogeneity of leverage-rating relation. I estimate leverage-rating relation simultaneously using three-stage least squares. I find that change in rating is the most important factor for change in leverage (two to five times more than the control variables) and vice versa change in leverage is the most important factor for change in rating (three to nine times more than the control variables).Economics, Department o
