I'm spending the weekend in New York at CELS. Lots of interesting papers and presentations. Just to name a handful:
Marco Becht, Colin Mayer, & Hannes Wagner, Where Do Firms Incorporate? Deregulation and the Cost of Entry, which studies cross-border incorporation patterns in the EU after Centros, Uberseering, and Inspire Art, three recent ECJ decisions.
Kenneth Ayotte & Edward Morrison, Creditor Control and Conflict in Chapter 11, which investigates how creditors and creditor composition affect the conduct of Chapter 11 cases.
Vladimir Atanasov, Bernard Black, Conrad Ciccotello, & Stanley Gyoshev, How Does Law Affect Finance? An Examination of Financial Tunneling in an Emerging Market, which investigates the effects of legal change in Bulgaria relating to two types of financial tunneling: dilutive equity offerings and below-market freezeouts.
My co-author "Subbu" Subramanian at the Goizueta Business School (Emory) also did a great job presenting our paper: Krishnamurthy Subramanian, Frederick Tung, & Xue Wang, Law, Agency Costs, and Project Finance: An Empirical Analysis, a cross-country study showing the effects of legal rules on firms' choice between project finance and traditional corporate finance. Thanks to Kose John (Stern School) for great comments as our discussant.
Here's the abstract of our paper:
When corporations make large investments, what benefits do they derive from Project Finance vis-à-vis Corporate Finance? In this paper, we show that Project Finance contractually mitigates the agency costs stemming from managerial self-dealing. We argue that cash flows become verifiable in Project Finance because of the contractual arrangements made possible due to a single, discrete project that is legally separate from the sponsor.
We compare Project Finance loans with Corporate Finance loans across forty countries. We show, first, that Project Finance is more likely in countries where laws protecting against managerial self-dealing are weaker. We highlight the causal channel for this effect by showing that in such countries, Project Finance is disproportionately more likely in industries where free cash flows are higher. We use a 4-digit SIC level measure of free cash flow to assets across countries, as well as the US 4-digit SIC measure as an instrument for the cross-country measure. Second, since creditors’ threat to seize collateral deters borrower opportunism, we predict that stronger creditor rights mitigate the marginal effect of weaker protection against managerial self-dealing. We provide evidence for this prediction using exogenous country-level changes in creditor rights and using cross-country tests.
Apart from highlighting the corporate governance benefits of Project Finance vis-à-vis Corporate Finance, our study augments the law and finance literature by highlighting a micro channel through which legal origins can affect financing choices.
A handful of us corporate scholars have been beating the drum on the role of creditors in corporate governance (see, e.g.). We view creditors as an underappreciated influence for the monitoring of management and agency cost reduction. Now a trio of finance scholars has come out with an empirical paper detailing the important influence of bank creditors on firm investment policy. Their paper focuses on the use of capital expenditure covenants in bank loan agreements to affect investment policy of solvent public firms. From a conventional corporate governance perspective, investment policy would seem to be one of those areas especially within the expertise and discretion of firm management, and correspondingly immune to shareholder challenge. And yet, wouldn't it be nice if a properly incentivized monitor could curb managerial excess in this regard? This is exactly what Greg Nini, David C. Smith, and Amir Sufi find in Creditor Control Rights and Firm Investment Policy. Of special interest for corporate governance, they find evidence that bank-imposed capex restrictions may result in efficient levels of investment. In their sample, firms with a capex restriction showed large and statistically significant increases in firm value (as measured by market-to-book) and operating performance (as measured by return on assets) in the year after imposition of the restriction.
Here's the abstract:
We provide novel empirical evidence of a direct contracting channel through which firm financial policy affects firm investment policy. We examine a large sample of private credit agreements between banks and public firms and find that 32% of the agreements contain an explicit restriction on the firm's capital expenditures. Creditors are more likely to impose a restriction following negative borrower performance. Moreover, the effect of credit downgrades and financial covenant violations on the incidence of capital expenditure restrictions in new contracts is larger than the effect on interest spreads. We also find that restrictions cause a reduction in firm investment and that firms obtaining contracts with a new restriction experience subsequent increases in market valuation and operating performance. The evidence suggests that capital expenditure restrictions reduce inefficient excess investment by managers.
I'll be presenting Cross-Monitoring and Corporate Governance at Michigan in a few weeks. The paper, co-authored with Joanna Shepherd and Albert Yoon, offers empirical evidence that bank monitoring improves firm value and may substitute for good corporate governance. Here's the abstract:
We take the view that corporate governance must involve more than corporate law. Despite corporate scholars’ nearly exclusive focus on corporate law mechanisms for controlling managerial agency costs, shareholders are not the only constituency concerned with such costs. Given the thick web of firms’ contractual commitments, it should not be a surprise that other financial claimants may also attempt to control agency costs in their contracts with the firm. We hypothesize that this cross-monitoring by other claimants has value for shareholders.
We examine bank loans for empirical evidence of the value of cross-monitoring. Our approach builds on prior empirical work on the value of good corporate governance, to which we add data on the presence of bank loans and their interactions with free cash flow, governance indices, and individual corporate governance provisions. We find strong evidence that bank monitoring adds value. In effect, bank monitoring can counteract somewhat the value-decreasing effects of managerial entrenchment. Bank monitoring may substitute for good corporate governance.
While the corporate finance literature has recognized that bank monitoring may benefit shareholders, corporate law scholars have not paid much attention to the potential value of cross-monitoring. Notable exceptions include Triantis and Daniels (WL), who published a paper in 1995 on creditors' role in a system of interactive corporate goverance, and Baird and Rasmussen, who've recently called our attention to the importance of creditor influence on management (here and here). Our paper tests the value of cross-monitoring empirically, interacting the presence of bank loans with governance indices (the G-index and E-index) and individual governance provisions, as well as with free cash flow. Comments appreciated!
I have never had to deal personally with the IRB research requirements, but I have heard colleagues who do empirical research complain about the hoops that one must go through to get approval for certain studies. Last week, I signed a consent form to allow a professor from another department on campus to assess my third-grade child in the area of language development at her school. I had to show the consent form to my empiricist colleagues just to make sure I wasn't imagining things. I can't imagine what non-academic parents thought about some of the boilerplate in the consent.
First, the letter stresses to me in three different sentences that my child must consent to being assessed. What if she were three? Or four? Then, the letter has to inform me of the "risks" and "benefits" of being part of the study.
Anticipated risks associated with this project are minimal and similar to everyday life, including the potential for boredom, frustration, or discomfort that can come with being assessed. Anticipated benefits include one-on-one attention from an adult who enjoys interacting with children, a small prize for your child, and access to a professional who specializes in language development.
Does the IRB require the small prize? How risky is boredom?
So begins Tracey George's post over at ELS, where she's guest blogging this week. She reminds us that few topics produce more downloads than a paper on law school rankings, and especially one that introduces a new ranking system. Last year, Tracey wisely wrote such a paper, ranking schools based on their empirical legal scholarship (ELS). 860 downloads as of today. Hmmm, not bad. I remember Emory doing relatively well in that ranking, so I circulated the abstract among my faculty when the paper first came out. Tracey has now revised the paper (and assured me that Emory would do even better in this revised version) and set up a tantalizing schedule of upcoming blogging episodes. Over the course of the week, she'll be discussing her three measures of institutional ELS success--professors with social science doctorates, professors with second appointments in social science departments, and articles in ELS-oriented publications. In the spirit of reality TV everywhere, she's going to make us wait until Friday to see the revised rankings. Stay tuned.
A new empirical paper has come out offering yet more evidence that firms generally treat corporate social responsibility as a tool for profit maximization: firms that anticipate economic benefits from CSR are more likely to do it. (See here, e.g.). Theory suggests that firms that need to resolve information asymmetry for their consumers may rely on CSR activities to do so. For example, firms selling difficult-to-evaluate goods may use CSR activities to signal product quality.
This recent study by Siegel and Vitaliano (both from RPI) offers confirmation of this prediction, showing that firms selling experience goods and credence goods are more likely to be socially responsible than firms selling search goods. (Search goods are goods that consumers can generally evaluate before they buy--clothing, for example. Experience goods and credence goods are more difficult to evaluate. Experience goods generally need to be used by the consumer before she can evaluate their quality. An automobile may be such a good. Credence goods are difficult to evalute even after the consumer has used the good. Vitamins or car repairs are examples.).
Siegel & Vitaliano show that firms selling a credence good are 23% more likely to engage in CSR; firms that sell experience goods are about 15% more likely to be socially responsible.
Pop Quiz: Which group is more likely to be currently working in a top 25 tenure-track university faculty positions:
(a) The "Moneyball" Group. Students who, ten years ago, were enrolled in top graduate programs in math, engineering and physical sciences, or
(b) The "Gifted" Group. Students who, twenty years ago, scored in the top 0.01% of their age cohort when taking the SAT at age 12.
Answer below the fold.
Counterintuitively -- at least to those of us steeped in Moneyball analysis -- is that the gifted group is more likely to secure a top 25 faculty position. See this paper. This finding is especially strong for females. And they achieve this success despite not working as long hours as the moneyball group. What makes the finding remarkable, of course, lots of folks from the gifted group go into law, business, or medicine rather than teaching, the most common path for the graduate students in top programs. Here's an interesting quote from the paper:
That the SAT can identify young adolescents who eventually achieve tenure-track positions at top universities at rates comparable to those of graduate students attending the top U.S. math, science, and engineering doctoral programs is truly remarkable. Moreover, 21.7% of the TS [talent search/gifted] participants who were in tenure-track positions in the top 50 U.S. universities were already full professors, compared with ‘‘only’’ 6.5% of GS [graduate student] participants.
Similarly, regarding the attainment of doctorate degrees:
Doctoral-level degrees (Ph.D., M.D., or J.D.) were earned by 51.7% and 54.3% of male and female TS [talent search] participants, respectively, and 79.7% and 77.1% of male and female GS [graduate student] participants. Because the latter were identified as graduate students, their higher rates of doctoral degrees would be expected; in fact, it is remarkable that the GS-TS difference is not more marked. Selection before age 13 on the basis of one high SAT score resulted in the identification of a population that, 20 years later, earned doctorates at 50 times the base-rate expectation of 1% for the general population and at two thirds the rate of enrollees in prestigious doctoral programs.
The big picture is that both groups do very well in terms of professional and lifestyle satisfaction.
one of the subjects of this 20-year study (on the "gifted" side), and
it's neat, after answering many surveys over the years, to see some of the results. The authors didn't include law students
in their graduate student sample, so it's not necessarily clear how one
might extend these findings to, say, the AALS meat market. A prior study noted, unsurprisingly, that those of us
from the talent search who have gone into law or law teaching have done
I'm reminded of the documentaries from Michael Apted's "7 Up" series, which track a number of subjects every seven years from the 1960s to the present day. "Give me the child until he is seven, and I will show you the man," says Apted (based on a Jesuit motto). The SMPY study suggests that here in the US, give the child an SAT at age 12 and I will show you the best professors. Any theories as to why this is so? Is it nature? Nurture? Class? This high percentage of gifted/talent search participants with at least one immigrant parent suggests to me that it's nurture.
I am at the SEALS annual conference and getting a chance to see some interesting panels as well as workshops for new law professors. One panel I attended focused on new developments in empirical legal research. Although the work in which people were engaged sounded interesting, each panelist asked the question, should young scholars engage in such research? The answer appeared to be no, with some qualifications. There were essentially four reasons why people responded no to the query.
First, the research takes a long time, too long for people on a tenure clock.
Second, data that is not public is extremely hard to get, feeding into the first problem and potentially undermining the saliency of the study.
Third, the finished written product is generally not that long and possibly too scientific for traditional scholarship, making it difficult to place the article in a traditional law review, and hence potentially undercutting the weight given to the article during tenure review.
Fourth, for purposes of external reviews associated with tenure and promotion, it is difficult to find outside people who can evaluate the work. And apparently if you find someone with a social science background who understands how to conduct empirical research, there is the possibility that she will be overly critical if the law professor fails to appropriately defend her methodology for the study.
Alas, there were some who encouraged young scholars to pursue empirical research saying that it was rewarding, that young scholars could develop a theory piece first so that they were not relying solely on their empirical article for tenure purposes, and that young scholars can team up with people from other disciplines to help with the research and writing. Of course this last point raises the concern that during the tenure process some may discount the work because they could not discern which portion of it should be attributed to the young scholars.
Overall, there was a strong and I think familiar undercurrent against taking on this kind of research as a young scholar.
A new paper by Bhagat and Bolton questions some of the generally accepted conclusions of the prior art on corporate governance indices, as well as offering some new conclusions.
Corporate governance indices have become a preferred method of capturing corporate governance quality. Gompers, Ishii, & Metrick (GIM) proposed the first index in 2003—their “G-index,” which assessed firms’ corporate governance quality based on their adoption or non-adoption of twenty-four governance provisions tracked by the IRRC. Characterizing firms as tending toward either democracy or dictatorship, GIM found a negative relation between dictatorship and firm value, as measured by Tobin’s Q. In addition, constructing portfolios of dictator and democracy firms, they found that democracy portfolios outperformed dictator portfolios by a statistically significant margin.
Following GIM, Bebchuk, Cohen, and Ferrell (BCF) devised their “E-index” (“E” for entrenchment). They took only six of the factors used by GIM, arguing that these six did all the entrenching work, and that an index composed of these six—pills, staggered boards, limits on charter amendments, limits on bylaw amendments, supermajority requirements for mergers, and golden parachutes—would have better predictive value than the G-index. Like GIM, BCF found that entrenchment was negatively correlated with firm Tobin’s Q, and that portfolios with low entrenchment had better stock returns that portfolios with high entrenchment.
Now come Bhagat and Bolton, with Corporate Governance Indices. They look at seven different governance measures, including not only the G-index and E-index, but also board stock ownership, CEO-chair separation, board independence, Brown and Caylor’s Gov-Score index, and an index created by The Corporate Library. They rely primarily on accounting measures of firm performance, eschewing stock market measures on the theory that they are subject to investor anticipation: long-term returns might not show a significant correlation with governance even if one exists. Among their interesting findings:
a. While better governance as measured by the G-index, the E-index, and other metrics is positively correlated with contemporaneous and subsequent operating performance (using accounting measures like ROA), none correlate with future stock performance, contrary to GIM and BCF.
b. Given poor firm performance, better governed firms as measured by the G-index and E-index are less likely to experience disciplinary management turnover despite poor performance.
An interesting study.
My colleagues, Beth Mertz and Stewart Macaulay, are blogging about the New Legal Realism Project with Bob Nelson of the American Bar Foundation over at the Empirical Legal Studies Blog. Beth offered the first post today, but this will be worth repeated visits.