I explain the standard carried interest contract as a mechanism to induce incentive compatible fund leverage while also satisfying LP return objectives. Fee, leverage and target return data from private equity real estate (PERE) funds are used to calibrate the model. Steps in the modeling process include developing a tradeoff model of fund capital structure that pits alpha against the costs of financial distress. Financial distress costs are shown to create endogenous upper bounds on fund debt levels. GPs with convex incentive fee payoff functions limit debt, even in the absence of distress costs. I also analyze how catch-up fee provisions arise endogenously to generate larger fees for high-skill fund managers.
The available evidence suggests that common ownership - the phenomenon that publicly traded stock is increasingly held by the same diversified investors, especially index fund managers is much more pervasive in the US than in Europe. However, the ownership data situation in these jurisdictions is vastly different. In the US, institutional investors have to disclose periodically all their equity holdings on Form 13F, while no such disclosure exists in most other jurisdictions, including the EU and its Member States. The question, therefore, arises whether observed differences reflect actual differences or simple measurement error. In this paper, I develop a framework to quantify the extent to which US ownership statistics hinge on 13F filings. While 13F data greatly improve US coverage of institutional ownership in general, I show that the relevance of this extra coverage varies across different measures of common ownership. Most notably, firm-pairwise profit weights are hardly affected and tend to even decrease at the margin. Qualitatively, the observation that there is much more common ownership in the US than in Europe holds even if ownership information exclusively available via 13F filings is disregarded.
This study documents a significant negative relationship between policy uncertainty and venture capital (VC) investment in startups across emerging venture capital markets (i.e., outside the United States). The adverse effect of policy uncertainty is exacerbated for younger and early-stage startups. By contrast, the effect is attenuated for startups that have headquarters in cities with a high concentration of global VC investment, in countries with more developed stock markets, or if the VC is led by a bank or a corporate entity. Using close national elections and term limits to alleviate endogeneity concerns, we find that the baseline results continue to hold. Furthermore, we also find that policy uncertainty reduces the amount of cross-border VC investment. Finally, this study provides evidence that uncertainty increases the number of financing rounds, decreases the fraction of investment amount during the first round, and reduces the likelihood of successful exit through acquisition.
A dual-class firm structure, in which one class of shares confers more votes per share than the other, creates a gap between voting rights and cash flow rights. In this paper, we examine the quality of the financial reports of dual- versus single-class firms publicly traded in the U.S. over the 2012-2017 period, as measured by persistence and predictive ability of earnings and cash flows. The results are based on comprehensive information from financial statements analyzed using across-sample and within-sample tests. An additional external indicator of financial restatement filings is also used to support the results. The findings demonstrate that the quality of financial reports is higher for dual-class firms than for single-class firms and increases over time. This suggests that the freedom from market pressures is stronger than agency costs, encouraging founders to provide investors with higher-quality information in exchange for superior voting rights. The results uncover important and counterintuitive evidence about the existence of a tradeoff between the dilution of voting rights and enhancement of the credibility of information provided to investors.
In this study, we examine the systemic spillovers from an accounting scandal on corporate governance in an emerging market, India. Though accounting failures proliferate across the world, their systemic effects have been examined only in developed markets. Yet, given legal and market failures, systemic effects can be more pronounced in emerging markets. We study the systemic effects of an accounting scandal on board independence and monitoring by independent directors (IDs) in other firms unrelated to the scandal. For identification, we undertake difference-in-differences tests that utilize cross-sectional differences in the probability of a hidden accounting fraud. Following the prominent accounting scandal in India in January 2009, IDs resigned in large numbers. The percentage of IDs and expert IDs on boards decreased significantly, which affected de jure and de facto board independence respectively. On the positive side, board monitoring as measured by number of board meetings and attendance of independent directors increased.
This paper studies liquidity risk at the six largest U.S. banks. The starting point is the stress tests performed under the Liquidity Coverage Ratio (LCR) regulation, which compare a bank's liquid assets to its loss of cash in a stress scenario that regulators say is based on the 2008 financial crisis. These tests find that all of the large banks could endure a liquidity crisis for 30 days without running out of cash. This paper argues, however, that some of the assumptions in the LCR stress scenario are not pessimistic enough to capture what could happen in a crisis like 2008. The paper then proposes changes in the dubious assumptions and performs revised stress tests. For 2019 Q4, the revised tests suggest that all of the banks are at risk of running out of cash in less than 30 days. This negative finding is most clear-cut for Goldman Sachs and Morgan Stanley.
Prior to 2009, women made up about 8% of the directors of US corporate boards. That proportion has since risen to 19% in 2019 among public firms, while private firms have not witnessed notable improvement. This study highlights the general lack of board turnover, i.e., long tenure enjoyed by the incumbents, as a key factor in the slow adjustment. Proxy contests (contested board elections) resulting from shareholder activism, by increasing the board turnover rate, have contributed to improved gender diversity on the boards of the target companies, despite the fact that activist directors are no more gender-diverse compared to new directors added to the boards in the absence of such contests.
Corporate insiders engage in shadow trading when they use private information pertaining to their own firm to trade in the shares of economically connected companies. We develop a model to analyze the consequences of shadow trading on corporate investment choices and derive four main findings. First, when a firm permits shadow trading it can externalize on shareholders of connected companies part of the cost of its insiders' compensation. Second, shadow trading can give insiders and shareholders incentives to prefer greater corporate risk-taking. Third, under certain conditions the prospect of shadow trading profits can lead both insiders and shareholders to prefer negative-expected-value projects over positive-expected-value ones. Fourth, when shareholders are unaware of the manager's engagement in shadow trading, the manager's strategic project choice can be inefficient for the firm and can increase stock price volatility. We then discuss the policy implications of our findings.
We investigate whether the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009 influenced the debt structure of consumers. By debt structure, we mean the proportion of total available credit from credit cards for each consumer.The act enhances disclosures of contractual and related information and restricts card issuers’ ability to raise interest rates or charge late or over-limit fees, primarily affecting non-prime borrowers. Using the credit history via the Federal Reserve Bank of New York/Equifax Consumer Credit Panel during 2006–2016, we find that the average ratio of credit limit on cards to total consumer debt declined for non-prime borrowers in comparison to prime borrowers after the introduction of the CARD Act. The decline did not occur before the bill was first introduced in Congress; it took place afterward and continued through the end of our sample period. The results suggest that the CARD Act likely had an adverse effect on non-prime borrowers.
In corporate law policymaking, there is considerable attention to stock market short-termism. Public discourse pins some noticeable part of the blame for climate change, environmental damage, and mistreatment of stakeholders on stock market short-termism. Presidential candidates raise the issue and castigate the stock market for short-termism; and it's regularly invoked to justify securities regulation proposals and corporate case-law decisions. Here I examine the extant economic empirical work on stock market short-termism to assess whether it supports making stock market short-termism actionable in a major way for policy purposes. I evaluate it in two dimensions: first to see whether a consensus emerges from the work (none does) and second to see whether the work is conceptually structured to reveal its economy-wide severity. The latter conceptual point - the difficulty in scaling much corporate research to ascertain whether there's an economy-wide problem - affects not just the stock market short-termism inquiry. The typical research effort seeks to measure whether a local treatment induces more local short-termism, not whether the economy-wide impact is severe. But evaluating short-termism's economy-wide impact is essential for policymaking; policymakers must consider whether the economy is failing to invest or cutting back on R&D because of a stock market afflicted with a truncated time horizon. Local findings (of the impact on a subset of firms with a particular characteristic, such as short-vesting stock options, rapid stock market trading, or hedge fund activism) need not scale to economy-wide results; some local results will do so only serendipitously; and, finally, there are structural reasons why for stock market short-termism one should expect economy-wide results not to match local results. More than most corporate law issues, the short-termism problem faces a high failure-to-scale hurdle.
We develop a model of freeze-out merger and tender offers and test it in an economy where merger and tender regulation are extremely different. Using a relatively large sample of 329 freeze-out offers in Israel during 2000-2019, we document evidence consistent with the model. We also find that tender offers: 1) are the preferred technique; 2) offer lower premiums; and 3) suffer from a relatively large (40%) offer rejection rate. These findings deviate from U.S. evidence, and are partly due to differences in the tender offer procedures. Thus, our study illustrates that the tender offer procedure is a delicate one, and explains why Delaware has often amended it.
For several years, merger freezeouts were invariably subject to entire fairness review, a demanding standard of judicial review that enables courts to revise the price of a transaction when the price is challenged by the shareholders of the selling company. But this changed in 2013. In an attempt to incentivize the simultaneous use of independent director approval and majority-of-the-minority conditions, the Delaware Chancery Court held in In re MFW Shareholders Litigation (2013) that when a merger freezeout is subject to those procedural protections, the transaction would subsequently be reviewed under the deferential business judgment rule rather than under entire fairness. This paper examines the impact of MFW on transactional practice and deal outcomes. The results show that majority-of-the-minority conditions increased significantly after the opinion, from an incidence rate below 40% to a rate of more than 80%. Special committees were already the norm before 2013 and their incidence did not change after MFW. The increase in majority-of-the-minority conditions, however, was not followed by significant changes in deal premiums, target returns, changes from the controller's first offer to the final offer, or deal completion rates. The results therefore suggest that deferential judicial review is an effective way to incentivize procedural protections in freezeout transactions and that the increase in shareholder approval conditions did not come at the cost of higher frustration rates. In addition, the results suggest that procedural protections and entire fairness review seem to have a similar effect on the gains of the target shareholders. Taken together, these results present an assessment of MFW in particular and also shed light on the role of shareholder voting in freezeout transactions more generally.
Large business enterprises, from the railroad barons of nineteenth century America to Amazon and Google today, are often perceived as important for economic performance and, at the same time, as potential abusers of their political and economic power. In this study, we compare the experiences of four countries that implemented policies to curb the influence of one type of large corporate entities â?? pyramidal business groups: The US in the 1930s; Japan during the American occupation (1945-1952); Korea following the Asian crisis (late 1990s); and Israel in the last decade (2010-2018). Novel regulatory measures, applied consistently in the US and Japan, where the extreme political circumstances were very favorable to economic reform, led to the demise of pyramidal business groups in these countries. Israel, where the reforms did not follow a severe crisis, also used specifically-designed regulatory tools over a decade-long period, resulting in a significant decline in the number and size of business groups. Korea, after experimenting with variety of regulatory measures, chose to rely primarily on corporate governance-focused reforms to curb the influence of the chaebol, but with limited effects; groups continue to dominate the Korean economy. Our findings point to the importance of specifically-designed regulatory tools, applied consistently over time, against the backdrop of a pro-reform political climate.
By constructing a unique dataset of deregulation laws from 38 countries and utilizing yearly variation in law passage for these markets, we causally identify the effects of legalizing open market share repurchases. After legalization, treasury shares and stock repurchases increase, while dividend, cash holding, capital expenditure, and acquisitions decrease, leading to an increase in post-legalization stock returns and firm value. The effects are weaker in countries with trading restrictions, in countries with lower net tax rates on dividends, for firms with higher target payout ratios, and for financially constrained firms. No macro variables are found to predict the timing of legalization.
The Securities and Exchange Commission (SEC) is considering the pros and cons of (i) moving to semi-annual reporting from quarterly reporting, and/or (ii) making quarterly reporting less burdensome by allowing more qualitative disclosures. We exploit the start of less-burdensome and more frequent reporting by the Financial Conduct Authority (FCA) in 2007 and the end of the requirement in 2014 in the United Kingdom to examine corporate and capital market behavior. After the imposition of more frequent reporting in 2007, we find (i) a dramatic decline in the number of companies that issue reports with quantitative information (defined as including both sales and earnings numbers for the quarter), (ii) a substantial increase in companies announcing managerial guidance for the upcoming year's earnings or sales, and (iii) an increase in analyst following for all sample companies. Companies that voluntarily moved back from more frequent to semi-annual reporting after 2014 have experienced a reduction in analyst coverage. However, we find that the imposition of more frequent reporting and the end of such a requirement have virtually no impact on firms' investment decisions.
A Contracting Model of Entire Fairness: An Analysis of Divestitures of Parent-Held Control Blocks
Why do half of S&P 500 firms have duality, that is, a CEO who is also the Chair of the Board? We show theoretically that duality can play an important role in the competition for CEOs. Empirically, we document that duality changes are concentrated at times when new CEOs are hired and firms are more likely to offer duality to CEOs with greater ability. This finding is robust to different measures of CEO ability and types of succession plans. We also show that the correlation between duality and CEO ability is stronger in industries that feature a greater competition for CEOs.
