Showing papers in "The Review of Corporate Finance Studies in 2020"

Feverish Stock Price Reactions to COVID-19

Abstract: Market reactions to the 2019 novel coronavirus disease (COVID-19) provide new insights into how real shocks and financial policies drive firm value. Initially, internationally oriented firms, especially those more exposed to trade with China, underperformed. As the virus spread to Europe and the United States, corporate debt and cash holdings emerged as important value drivers, relevant even after the Fed intervened in the bond market. The content and tone of conference calls mirror this development over time. Overall, the results illustrate how anticipated real effects from the health crisis, a rare disaster, were amplified through financial channels.

Resiliency of Environmental and Social Stocks: An Analysis of the Exogenous COVID-19 Market Crash

Abstract: The COVID-19 pandemic and the subsequent lockdown brought about an exogenous and unparalleled stock market crash The crisis thus provides a unique opportunity to test theories of environmental and social (ES) policies This paper shows that stocks with higher ES ratings have significantly higher returns, lower return volatility, and higher operating profit margins during the first quarter of 2020 ES firms with higher advertising expenditures experience higher stock returns, and stocks held by more ES-oriented investors experience less return volatility during the crash This paper highlights the importance of customer and investor loyalty to the resiliency of ES stocks

Banks as Lenders of First Resort: Evidence from the COVID-19 Crisis

Abstract: In March of 2020, banks faced the largest increase in liquidity demands ever observed. Firms drew funds on a massive scale from pre-existing credit lines and loan commitments in anticipation of cash flow disruptions from the economic shutdown designed to contain the COVID-19 crisis. The increase in liquidity demands was concentrated at the largest banks, who serve the largest firms. Pre-crisis financial condition did not limit banks’ liquidity supply. Coincident inflows of funds to banks from both the Federal Reserve’s liquidity injection programs and from depositors, along with strong pre-shock bank capital, explain why banks were able to accommodate these liquidity demands.

Banks' Non-Interest Income and Systemic Risk

Abstract: This paper examines the contribution of non-interest income to systemic bank risk. Using the ∆CoVaR measure of Adrian and Brunnermeier (2010) as our proxy for systemic risk, we find banks with a higher non-interest income to interest income ratio have a higher contribution to systemic risk. This suggests that activities that are not traditionally associated with banks (such as deposit taking and lending) are associated with a larger contribution to systemic risk. When we decompose total non-interest income into three components, we find trading income and investment banking and venture capital income to be significantly related to systemic risk. The economic impact on systemic risk of investment banking and venture capital income is higher than that of trading income. Finally we find the impact of non-interest income on systemic risk to be prevalent in the 1990 and 2007 financial crises (which were bank based) and not in the case before the 2001 high tech bubble bust. These effects occur one-year before each crisis and not during the recession, showing their countercyclical contribution to systemic risk build-up.

The COVID-19 Shock and Equity Shortfall: Firm-Level Evidence from Italy

Abstract: We employ a representative sample of 80,972 Italian firms to forecast the drop in profits and the equity shortfall triggered by the COVID-19 lockdown A 3-month lockdown generates an aggregate yearly drop in profits of about 10% of GDP, and 17% of sample firms, which employ 8 8% of the sample’s employees, become financially distressed Distress is more frequent for small and medium-sized enterprises, for firms with high pre-COVID-19 leverage, and for firms belonging to the Manufacturing and Wholesale Trading sectors Listed companies are less likely to enter distress, whereas the correlation between distress rates and family firm ownership is unclear

The Risk of Being a Fallen Angel and the Corporate Dash for Cash in the Midst of Covid

Abstract: Data on firm-loan-level daily credit line drawdowns in the United States expose a corporate “dash for cash” induced by the COVID-19 pandemic. In the first phase of the crisis, which was characterized by extreme precaution and heightened aggregate risk, all firms drew down bank credit lines and raised cash levels. In the second phase, which followed the adoption of stabilization policies, only the highest-rated firms switched to capital markets to raise cash. Consistent with the risk of becoming a fallen angel, the lowest-quality BBB-rated firms behaved more similarly to non-investment grade firms. The observed corporate behavior reveals the significant impact of credit risk on corporate cash holdings.

How Did COVID-19 Affect Firms’ Access to Public Capital Markets?

Abstract: We find that bond issues have substantially increased since the onset of the COVID-19 crisis in calendar week 12 (March 16–20) for bonds rated A or higher, but surprisingly also for bonds rated BBB or lower In contrast to existing evidence on bond maturities in economic downturns, we document that maturities exceed those of bonds issued before by the same firms as well as the average maturities during normal times Determinants of corporate bond spreads substantially differ between COVID-19 and normal times Most prominently, asset tangibility has a highly significant negative effect on spreads during normal times During COVID-19, this is reversed, especially in industries heavily affected by lockdown measures, reflecting the inflexibility associated with fixed assets A different picture emerges for equity issues, which slowed considerably during the first 4 weeks of the pandemic, before accelerating again Capital raised during COVID-19 via equity issues is approximately 5% of capital raised via bond issues

The COVID-19 pandemic crisis and corporate finance

Abstract: The COVID-19 pandemic can be considered the third major shock to have hit the United States and the global economy in the first two decades of this century. First, we experienced the September 11, 2001, terror attacks, then the 2008–2009 Financial Crisis, and now the COVID-19 pandemic. Each of these crises confronted the global economy, and the financial system in particular, with different challenges, with the COVID19 crisis likely to be the worst. According to the World Bank (2020), the global economy is expected to shrink by 5.2% this year, representing the deepest global recession since the Second World War. The human loss due to the COVID-19 pandemic continues to be horrific. As of the time this note is written (August 2020), there have been more than 22 million cases of COVID-19 worldwide, and almost 800,000 deaths. The economic cost has also been severe. For example, at the end of July 2020, it is estimated that gross domestic product (GDP) in the second quarter of 2020 fell by 9.5% in the United States, compared to the previous quarter, and by 10.1% in Germany. The social costs, of lost employment and the resultant negative impact on the well-being of individuals and communities, cannot be emphasized enough. Job postings for the United States tanked by 40% in April 2020 compared to the same month in 2019, then slowly recovered, but still stood at -20% as of July 2020. Job postings in July 2020 are (approximately) at -40% in France, -35% in Italy, -50% in Spain, -55% in the United Kingdom, and -25% in Germany, compared to the same month in 2019 (Financial Times 2020).

Identifying the Real Effects of Zombie Lending

Abstract: The policy response to COVID-19 includes the provision of credit guarantees to firms, a provision that may generate zombie lending According to the recent literature, the relative performance of healthy firms deteriorates as the fraction of zombies increases We argue that this literature faces a serious identification problem, because firm performance is often used to define zombies (sometimes implicitly) We show that, under general conditions for the distribution of firm performance, the correlation between healthy firm performance and zombies is a mechanical consequence of an increase in the fraction of zombies with no causal meaning

Managerial Attributes, Incentives, and Performance

Abstract: This paper examines the relative importance of observed and unobserved firm- and manager-specific heterogeneities in determining the primary aspects of contract design and the implications of thee associated incentives for firm policy, risk, and performance. We focus on the sensitivity of managerial wealth to stock price (delta) and the sensitivity of expected managerial wealth to stock volatility (vega) for named executive officers. First, following Graham, Li, and Qiu (2010), who apply the econometric approach of Abowd, Karmarz, and Margolis (1999) to executive pay level, we decompose the variation in executive incentives into time variant and invariant firm and manager components. We find that manager fixed effects and observable firm attributes combined supply 80-90% of explained variation in managerial delta and vega. Second, accommodating unobserved firm and manager heterogeneity and controlling for matching of executives to firms alters parameter estimates and corresponding inference on observed firm and manager characteristics, most notably board independence, firm risk, and market-to-book. Third, we explore the economic content of the estimated executive delta and vega fixed effects. There is a strong empirical association between the executive delta and vega fixed effects and attributes of managers and firms that are seen to proxy for manager human capital and risk aversion and firm marginal revenue product in application of manager skill. Moreover, larger CEO delta fixed effects are associated with higher Tobin’s Q and ROA. Larger CEO vega fixed effects are associated with riskier corporate policies, including higher R&D, lower capital expenditures, and lower fixed assets, as well as higher aggregate firm risk.

The Mutual Friend: Dual Holder Monitoring and Firm Investment Efficiency

Abstract: We investigate the influence of simultaneous equity holdings by creditors (dual holders) on investment efficiency. Such creditors have stronger incentives and power to monitor firm investment as they have cash flow and control rights from both debt and equity sides. We provide evidence that dual holders, particularly noncommercial bank dual holders, significantly mitigate overinvestment. For high growth firms and those subject to debt overhang, dual holders also alleviate underinvestment. Equity value increases at the presence of dual holders. Our results indicate that by improving firm investment efficiency, dual holders not only make creditor investments safer but also create value for shareholders.Received March 26, 2019; editorial decision September 17, 2019 by Editor Isil Erel.

The Macroeconomics of Corporate Debt

Abstract: The 2020 COVID-19 crisis can spur research on firms’ corporate finance decisions and their macroeconomic implications, similar to the wave of important research on banking and household finance triggered by the 2008 financial crisis What are the relevant corporate finance mechanisms in this crisis? Modeling dynamics and timing considerations are likely important, as is integrating corporate financing considerations into modern quantifiable macroeconomics models Recent empirical work, including articles in this special issue, on the drag from debt in the COVID-19 crisis provides a first glimpse into the new research agenda

How Do Laws and Institutions Affect Recovery Rates for Collateral

Abstract: Using unique internal bank data on ex ante appraised liquidation and market values of assets pledged as collateral in sixteen countries, we show that laws and institutions that strengthen creditor protection increase expected recovery rates for collateral. Stronger creditor protection increases expected recovery rates for movable collateral relative to immovable collateral and shifts the composition of collateral toward movable assets, thereby increasing debt capacity through both higher loan-to-values and attenuating the creditor's liquidation bias. Our results suggest that the recovery rate for collateral is an important first-stage mechanism through which creditor protection can improve contracting efficiency and enhance access to credit. Received September 17, 2018; editorial decision July 9, 2019 by Editor Andrew Ellul.

Tournament Incentives and Acquisition Performance

Abstract: This paper examines the impact of promotion-based tournament incentives on corporate acquisition performance. Measuring tournament incentives as the compensation ratio between the CEO and other senior executives, we show that acquirers with greater tournament incentives experience lower announcement returns. Further analysis shows that the negative effect is driven by the risk-seeking behavior of senior executives induced by tournament incentives. Our results are robust to alternative identification strategies. Our evidence highlights that senior executives also play an influential role in acquisition decisions in addition to the CEO.

Corporate Inversions: Going beyond Tax Incentives

Abstract: We study tax and nontax incentives for corporate inversions in a hand-collected data set of 691 inversions out of 11 home countries into 45 host destinations over the 1996–2013 period. Even though lower tax rates generally attract inversions, only 2 of 5 firms invert into tax havens, and two-thirds of firms invert into host destinations with lower statutory tax rates than those faced at home. Moreover, firms invert to geographically close destinations with similar governance standards. Using staggered country-pair-level policy changes as experiments, we find that host-country governance may explain why not all firms invert.Received December 6, 2018; Editorial decision August 12, 2019 by Editor Andrew Ellul.

Stock Market Information and Innovative Investment in the Supply Chain

Abstract: We investigate whether suppliers adjust innovative supply chain investment following stock market signals about customers’ economic prospects. We show that suppliers increase R&D and investment in customer-related patents after positive market reactions to customers’ new product announcements. A battery of falsification tests suggest that spurious factors are unlikely to explain our results. Market signals about customers appear more important when information asymmetry is greater, when suppliers face greater competitive threats, and when suppliers are financially unconstrained. Our evidence suggests that the stock market can be a viable source of information to mitigate supply chain frictions.

Cross-Country Competitive Effects of Cross-Listings

Abstract: 59 p. ; Includes bibliographical references (pp. 36-40). ; "November 2017" ; The authors "thank Laurent Barras, Arnold Cowan, Andrew Karolyi, Naveen Khanna (WFA session chair and discussant), Lawrence Kryzanowski, Darius Miller, Michael Schill, Sheri Tice, as well as participants of the 2014 NFA Meetings in Ottawa, 2015 Western Finance Association Meetings in Seattle and seminars at Hong Kong Polytechnic University and University of Western Ontario for useful comments. This paper has been previously circulated under the title of “Do Foreign Listings in the U.S. Affect U.S. Firms?” The authors acknowledge financial support from the Institut de Finance Mathematique de Montreal and Social Sciences and Humanities Research Council of Canada.

How Do Executives Exercise Their Stock Options

Abstract: We analyze a large data set of stock option exercises for a large data set of almost 200,000 option packages for more than 16,000 US top executives and analyze their motivations for the early exercise of their stock options. We estimate a hazard model to identify the main variables that influence executives´ timing decisions and find that behavioral factors (e.g. , trends in past stock prices), institutional factors (vesting dates, grant dates, blackout periods) an inside information strongly influence the timing of stock option exercises. By contrast, we find little support for the influence of variables proposed by utility-based models.

Tough Love: The Effects of Debt Contract Design on Firms’ Performance

Abstract: I investigate whether restrictive loan covenants disrupt or improve firms’ operating performance. Using an instrumental variables approach to address the endogenous relationship between covenant strictness and firms’ efficiency, I find that stricter loan covenants lead to an increase in profitability and firm value even when firms do not violate a covenant. Stricter covenants improve performance only in firms with managerial agency conflicts: those without large shareholder ownership, facing softer competition in their product market, or with weaker shareholder rights. The evidence suggests that by designing stringent contracts ex ante, creditors create positive externalities in poorly governed firms through managerial incentives. Received December 7, 2018; editorial decision May 31, 2019 by Editor Uday Rajan. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.