November 10, 2007
Report from CELS
Posted by Fred Tung

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.


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