Econometric policy evaluation: A critique

This chapter discusses how applied researchers in corporate finance can address endogeneity concerns. We begin by reviewing the sources of endogeneity—omitted variables, simultaneity, and measurement error—and their implications for inference. We then discuss in detail a number of econometric techniques aimed at addressing endogeneity problems, including instrumental variables, difference-in-differences estimators, regression discontinuity design, matching methods, panel data methods, and higher order moments estimators. The unifying themes of our discussion are the emphasis on intuition and the applications to corporate finance.

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Endogeneity in Empirical Corporate Finance1

This paper analyzes the relationship between employee satisfaction and long-run stock returns. A value-weighted portfolio of the "100 Best Companies to Work For in America" earned an annual four-factor alpha of 3.5% from 1984-2009, and 2.1% above industry benchmarks. The results are robust to controls for firm characteristics, different weighting methodologies and the removal of outliers. The Best Companies also exhibited significantly more positive earnings surprises and announcement returns. These findings have three main implications. First, consistent with human capital-centered theories of the firm, employee satisfaction is positively correlated with shareholder returns and need not represent managerial slack. Second, the stock market does not fully value intangibles, even when independently verified by a highly public survey on large firms. Third, certain socially responsible investing ("SRI") screens may improve investment returns.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1448247_code393296.pdf?abstractid=985735&rulid=8649398&mirid=3

Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices

http://faculty.london.edu/aedmans/Rowe.pdf

This article investigates the effect of bank lending frictions on employment outcomes. I construct a new data set that combines information on banking relationships and employment at 2,000 nonfinancial firms during the 2008–9 crisis. The article first verifies empirically the importance of banking relationships, which imply a cost to borrowers who switch lenders. I then use the dispersion in lender health following the Lehman crisis as a source of exogenous variation in the availability of credit to borrowers. I find that credit matters. Firms that had precrisis relationships with less healthy lenders had a lower likelihood of obtaining a loan following the Lehman bankruptcy, paid a higher interest rate if they did borrow, and reduced employment by more compared to precrisis clients of healthier lenders. Consistent with frictions deriving from asymmetric information, the effects vary by firm type. Lender health has an economically and statistically significant effect on employment at small and medium firms, but the data cannot reject the hypothesis of no effect at the largest or most transparent firms. Abstracting from general equilibrium effects, I find that the withdrawal of credit accounts for between one-third and one-half of the employment decline at small and medium firms in the sample in the year

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The Employment Effects of Credit Market Disruptions: Firm-level Evidence from the 2008–9 Financial Crisis

This paper examines whether firms in noncompetitive industries benefit more from good governance than do firms in competitive industries. We find that weak governance firms have lower equity returns, worse operating performance, and lower firm value, but only in noncompetitive industries. When exploring the causes of the inefficiency, we find that weak governance firms have lower labor productivity and higher input costs, and make more value-destroying acquisitions, but, again, only in noncompetitive industries. We also find that weak governance firms in noncompetitive industries are more likely to be targeted by activist hedge funds, suggesting that investors take actions to mitigate the inefficiency. ECONOMISTS OFTEN ARGUE THATmanagersoffirmsincompetitiveindustrieshave strong incentives to reduce slack and maximize profits, or else the firm will go out of business. 1 Accordingly, the need to provide managers with incentives throughgoodgovernance—and thusthebenefitsofgoodgovernance—should be smaller for firms in competitive industries. In contrast, firms in noncompetitive industries, where lack of competitive pressure fails to enforce discipline on managers, should benefit relatively more from good governance. That firms with good governance have better performance on average is well established. In a seminal article, Gompers, Ishii, and Metrick (2003, GIM) find that a hedge portfolio that is long in good governance firms (“Democracy firms”) and short in weak governance firms (“Dictatorship firms”) earns a monthly alpha of 0.71%. Governance is measured using the G-index, which consists of 24 antitakeover and shareholder rights provisions. In addition to showing that good governance is associated with higher equity returns, GIM also show that it is associated with both higher firm value and better operating performance. 2 ∗ Giroud is at the NYU Stern School of Business. Mueller is at the NYU Stern School of Business, NBER, CEPR, and ECGI. We thank Cam Harvey (the Editor), an associate editor, two anonymous referees, and seminar participants at NYU, Yale, Michigan, Illinois, the WFA Meetings in San Diego (2009), and the Harvard Law School/Sloan Foundation Corporate Governance Research Conference (2009) for helpful comments. We are especially grateful to Wei Jiang and Martijn Cremers for providing us with data.

/pdf/corporate-governance-product-market-competition-and-equity-2cg293d699.pdf

Corporate Governance, Product Market Competition, and Equity Prices

By reducing the fear of a hostile takeover, business combination (BC) laws weaken corporate governance and create more opportunity for managerial slack. Using the passage of BC laws as a source of variation in corporate governance, we examine if these laws have a different effect on firms in competitive and non-competitive industries. We find that while firms in non-competitive industries experience a significant drop in performance after the laws' passage, firms in competitive industries experience virtually no effect. While consistent with the general notion that competition mitigates managerial agency problems, our results are, in particular, supportive of the (stronger) Alchian-Friedman-Stigler hypothesis that competitive industries leave no room for managerial slack. When we examine which agency problem competition mitigates, we find evidence in support of a "quiet-life" hypothesis. While capital expenditures are unaffected by the passage of the BC laws, input costs, wages, and overhead costs all increase, and only so in non-competitive industries. We also conduct event studies around the dates of the first newspaper reports about the BC laws. We find that while firms in non-competitive industries experience a significant stock price decline, firms in competitive industries experience a small and insignificant price impact.

/pdf/does-corporate-governance-matter-in-competitive-industries-43fmx9ipe1.pdf

Does Corporate Governance Matter in Competitive Industries

https://www.nber.org/system/files/working_papers/w14877/w14877.pdf

Does corporate governance matter in competitive industries

This paper examines the hypothesis that firms in competitive industries should benefit relatively less from good governance, while firms in non-competitive industries--where lack of competitive pressure fails to enforce discipline on managers--should benefit relatively more. Whether we look at the effects of governance on long-horizon stock returns, firm value, or operating performance, we consistently find the same pattern: The effect is monotonic in the degree of competition, it is small and insignificant in competitive industries, and it is large and significant in non-competitive industries. By implication, the effect of governance (in non-competitive industries) reported in this paper is stronger than what has been previously reported in Gompers, Ishii, and Metrick (2003, "GIM") and subsequent work, who document the average effect across all industries. For instance, GIM’s hedge portfolio - provided it only includes firms in non-competitive industries -earns a monthly alpha of 1.47%, which is twice as large as the alpha reported in GIM. The alpha remains large and significant even if the sample period is extended until 2006. We also revisit the argument that investors in the 1990s anticipated the effect of governance, implying that the alpha earned by GIM’s hedge portfolio is likely due to an omitted risk factor. We find that while investors were indeed not surprised on average, they underestimated the effect of governance in non-competitive industries, the very industries in which governance has a significant effect in the first place.

Proximity to plants makes it easier for headquarters to monitor and acquire information about plants. In this article, I estimate the effects of headquarters’ proximity to plants on plant-level investment and productivity. Using the introduction of new airline routes as a source of exogenous variation in proximity, I find that new airline routes that reduce the travel time between headquarters and plants lead to an increase in plant-level investment of 8% to 9% and an increase in plants’ total factor productivity of 1.3% to 1.4%. The results are robust when I control for local and firm-level shocks that could potentially drive the introduction of new airline routes, when I consider only new airline routes that are the outcome of a merger between two airlines or the opening of a new hub, and when I consider only indirect flights where either the last leg of the flight (involving the plant’s home airport) or the first leg of the flight (involving headquarters’ home airport) remains unchanged. Moreover, the results are stronger in the earlier years of the sample period and for firms whose headquarters is more time-constrained. In addition, they also hold at the extensive margin, that is, when I consider plant openings and closures.

/pdf/proximity-and-investment-evidence-from-plant-level-data-3z3072ckkw.pdf

Xavier Giroud

Papers

Corporate Governance, Product Market Competition, and Equity Prices

Does Corporate Governance Matter in Competitive Industries

Does corporate governance matter in competitive industries

Corporate Governance, Product Market Competition, and Equity Prices

Proximity and Investment: Evidence from Plant-Level Data*