Michael L. Lemmon

Bio: Michael L. Lemmon is an academic researcher from University of Utah. The author has contributed to research in topics: Capital structure & Equity (finance). The author has an hindex of 52, co-authored 102 publications receiving 16797 citations. Previous affiliations of Michael L. Lemmon include Arizona State University & Hong Kong University of Science and Technology.

Ownership Structure, Corporate Governance, and Firm Value: Evidence from the East Asian Financial Crisis

Abstract: We study the effect of ownership structure on firm value during the East Asian financial crisis that began in July 1997. The crisis represents a negative shock to the investment opportunities of firms in these markets that raises the incentives of controlling shareholders to expropriate minority shareholders. Moreover, the large separation between cash flow and control rights that often arise from the use of pyramidal ownership structures and cross-holdings in these markets suggests that insiders have both the incentive and the ability to engage in expropriation. Using data from over 800 firms in eight East Asian countries, we find evidence consistent with this view. Tobin's Q ratios of those firms in which minority shareholders are potentially most subject to expropriation decline twelve percent more than Q ratios in other firms during the crisis period. A similar result holds for stock returns - firms in which minority shareholders are most likely to experience expropriation underperform other firms by about nine percent per year during the crisis period. Further, during the pre-crisis period we find no evidence that firms with a separation between cash flow rights and control rights exhibit performance changes different from firms with no such separation. All of these results are robust to controls for country and industry effects, as well as proxies for differences in risk across firms and the strength of the country's legal institutions. The evidence indicates that corporate ownership structure plays an important role in determining the incentives of insiders to expropriate minority shareholders during the times of declining investment opportunities. Our results add to the literature that examines the link between ownership structure and firm performance and provide additional guidance to policymakers engaged in the ongoing debate about the proper role and design of corporate governance features and legal institutions in developing economies.

Back to the Beginning: Persistence and the Cross‐Section of Corporate Capital Structure

Abstract: We find that the majority of variation in leverage ratios is driven by an unobserved time-invariant effect that generates surprisingly stable capital structures: High (low) levered firms tend to remain as such for over two decades. This feature of leverage is largely unexplained by previously identified determinants, is robust to firm exit, and is present prior to the IPO, suggesting that variation in capital structures is primarily determined by factors that remain stable for long periods of time. We then show that these results have important implications for empirical analysis attempting to understand capital structure heterogeneity.

Ownership Structure, Corporate Governance, and Firm Value: Evidence from the East Asian Financial Crisis

Abstract: We use a sample of 800 firms in eight East Asian countries to study the effect of ownership structure on value during the region's financial crisis. The crisis negatively impacted firms' investment opportunities, raising the incentives of controlling shareholders to expropriate minority investors. Crisis period stock returns of firms in which managers have high levels of control rights, but have separated their control and cash flow ownership, are 10-20 percentage points lower than those of other firms. The evidence is consistent with the view that ownership structure plays an important role in determining whether insiders expropriate minority shareholders. CONFLICT OF INTEREST BETWEEN CORPORATE INSIDERS (controlling shareholders and managers) and outside investors is central to the analysis of the modern corporation in which insiders have less than full ownership of the cash flow rights of the firm (Berle and Means (1932) and Jensen and Meckling (1976)). These analyses suggest that the firm's ownership structure is a primary determinant of the extent of agency problems between controlling insiders and outside investors, which has important implications for the valuation of the firm. The insiders who control corporate assets can potentially expropriate outside investors by diverting resources for their personal use or by committing funds to unprofitable projects that provide private benefits. By diverting resources for private benefit, controlling managers have the opportunity to increase their current wealth or perquisite consumption without bearing the full cost of their actions.1 Alternatively, by investing resources within the firm in positive NPV projects,

Book-to-Market Equity, Distress Risk, and Stock Returns

Abstract: This paper examines the relationship between book-to-market equity, distress risk, and stock returns Among firms with the highest distress risk as proxied by Ohlson’s ~1980! O-score, the difference in returns between high and low book-tomarket securities is more than twice as large as that in other firms This large return differential cannot be explained by the three-factor model or by differences in economic fundamentals Consistent with mispricing arguments, firms with high distress risk exhibit the largest return reversals around earnings announcements, and the book-to-market effect is largest in small firms with low analyst coverage ONE PROMINENT EXPLANATION OF THE book-to-market equity premium in returns is that high book-to-market equity firms are assigned a higher risk premium because of the greater risk of distress 1 Consistent with this view, Fama and French ~1995! and Chen and Zhang ~1998! show that firms with high bookto-market equity ~BE0ME! have persistently low earnings, higher financial leverage, more earnings uncertainty, and are more likely to cut dividends compared to their low BE0ME counterparts In contrast, Dichev ~1998! uses measures of bankruptcy risk proposed by Ohlson ~1980! and Altman ~1968! to identify firms with a high likelihood of financial distress and finds that these firms tend to have low average stock returns Dichev’s results appear to be inconsistent with the view that firms with high BE0ME earn high returns as a premium for distress risk 2

Does Corporate Diversification Destroy Value

Abstract: We analyze several hundred firms that expand via acquisition and/or increase their reported number of business segments. The average combined market reaction to acquisition announcements is positive but, according to the Berger and Ofek (1995) method for valuing conglomerates, the excess values of the acquiring firms decline after the diversifying event. For our sample, half or more of the reduction in excess value occurs because the firms acquire already-discounted business units, and not because combining firms destroys value. We also show that firms that increase their number of business segments due to pure reporting changes do not exhibit reductions in excess value. Our results suggest that the standard assumption that conglomerate divisions can be benchmarked to typical stand-alone firms should be carefully reconsidered.

Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches

Abstract: In both corporate finance and asset pricing empirical work, researchers are often confronted with panel data. In these data sets, the residuals may be correlated across firms and across time, and OLS standard errors can be biased. Historically, the two literatures have used different solutions to this problem. Corporate finance has relied on clustered standard errors, while asset pricing has used the Fama-MacBeth procedure to estimate standard errors. This paper examines the different methods used in the literature and explains when the different methods yield the same (and correct) standard errors and when they diverge. The intent is to provide intuition as to why the different approaches sometimes give different answers and give researchers guidance for their use.

Estimating the Value of Political Connections

Abstract: While political connections have been widely discussed in the literature on corruption, little work has been done to assess the value of these connections. This paper uses the Jakarta Stock Exchange's reaction to news about former President Suharto's health to address this issue. By examining the difference in share price reactions of firms with varying degrees of political exposure, a market valuation of the proportion of a firm’s value derived from political connections is inferred. The implied value is very high, suggesting that as much as a quarter of a firm’s share price may be accounted for by political connections. (JEL D21, G14)

Testing Trade-Off and Pecking Order Predictions About Dividends and Debt

Abstract: Confirming predictions shared by the trade-off and pecking order models, more profitable firms and firms with fewer investments have higher dividend payouts. Confirming the pecking order model but contradicting the trade-off model, more profitable firms are less levered. Firms with more investments have less market leverage, which is consistent with the trade-off model and a complex pecking order model. Firms with more investments have lower long-term dividend payouts, but dividends do not vary to accommodate shortterm variation in investment. As the pecking order model predicts, short-term variation in investment and earnings is mostly absorbed by debt. The finance literature offers two competing models of financing decisions. In the trade-off model, firms identify their optimal leverage by weighing the costs and benefits of an additional dollar of debt. The benefits of debt include, for example, the tax deductibility of interest and the reduction of free cash flow problems. The costs of debt include potential bankruptcy costs and agency conflicts between stockholders and bondholders. At the leverage optimum, the benefit of the last dollar of debt just offsets the cost. The tradeoff model makes a similar prediction about dividends. Firms maximize value by selecting the dividend payout that equates the costs and benefits of the last dollar of dividends. Myers (1984) develops an alternative theory known as the pecking order model of financing decisions. The pecking order arises if the costs of issuing new securities overwhelm other costs and benefits of dividends and debt. The financing costs that produce pecking order behavior include the transaction costs associated with new issues and the costs that arise because of management’s superior information about the firm’s prospects and the value of its risky securities. Because of these costs, firms finance new investments first with retained earnings, then with safe debt, then with risky debt, and finally, under duress, with equity. As a result, variation in a firm’s leverage

Market Timing and Capital Structure

Abstract: It is well known that firms are more likely to issue equity when their market values are high, relative to book and past market values, and to repurchase equity when their market values are low. We document that the resulting effects on capital structure are very persistent. As a consequence, current capital structure is strongly related to historical market values. The results suggest the theory that capital structure is the cumulative outcome of past attempts to time the equity market. IN CORPORATE F INANCE, “equity market timing” refers to the practice of issuing shares at high prices and repurchasing at low prices. The intention is to exploit temporary f luctuations in the cost of equity relative to the cost of other forms of capital. In the efficient and integrated capital markets studied by Modigliani and Miller ~1958!, the costs of different forms of capital do not vary independently, so there is no gain from opportunistically switching between equity and debt. In capital markets that are inefficient or segmented, by contrast, market timing benefits ongoing shareholders at the expense of entering and exiting ones. Managers thus have incentives to time the market if they think it is possible and if they care more about ongoing shareholders. In practice, equity market timing appears to be an important aspect of real corporate financial policy. There is evidence for market timing in four different kinds of studies. First, analyses of actual financing decisions show that firms tend to issue equity instead of debt when market value is high, relative to book value and past market values, and tend to repurchase equity when market value is low. 1 Second, analyses of long-run stock returns fol