Regulatory Fragmentation (with Joseph Kalmenovitz and Ekatarina Volkova). Journal of Finance, conditionally accepted
Regulatory fragmentation occurs when multiple federal agencies oversee a single issue. Using the full text of the Federal Register, the government’s official daily publication, we provide the first systematic evidence on the extent and costs of regulatory fragmentation. Fragmentation increases the firm’s costs while lowering its productivity, profitability, and growth. Moreover, it deters entry into an industry and increases the propensity of small firms to exit. These effects arise from redundancy and, more prominently, from inconsistencies between government agencies. Our results uncover a new source of regulatory burden, and we show that agency issues among regulators contribute to this burden.
ES Risks and Shareholder Voice (with Yazhou He and Bige Kahraman). Review of Financial Studies, forthcoming (2023)
We examine whether shareholder votes in environmental and social (ES) proposals are informative about firms’ ES risks. ES proposals are unique in that they nearly always fail. We examine whether mutual funds’ support for these failed proposals contains information regarding the ES risks that firms face. Higher support in failed ES proposals predicts subsequent ES incidents, the effects of these incidents on shareholder value, and firms’ overall stock returns. Examining the detailed records of fund votes, we find that agency frictions amongst a group of shareholders contribute to proposal failure.
The Blurring Lines between Private and Public Ownership. Handbook of Corporate Finance, edited by David Denis (2023).
As companies choose to stay private longer, they increasingly resemble their public counterparts. Along multiple dimensions, the shift from private to public status resembles a gradual transition rather than a regime shift. First, there is growing overlap between the sources of capital employed by private and public firms. Second, corporate governance structures such as the Board of Directors evolve over the years both preceding and following the IPO. As private firms become larger with more disperse ownership, their governance demands more closely resemble those of public firms; post-IPO dynamics are consistent with governance demands continuing to evolve over the firm’s life cycle. Third, while going public has been characterized as a means to obtain an acquisition currency, firms are increasingly growing via acquisition prior to the IPO. Macro-level changes reward economies of scale and scope, and the increased availability of capital to private firms facilitates acquisitions as a means to obtain rapid growth.
Bucking the Trend: Why do IPOs Choose Controversial Governance Structures and Why Do Investors Let Them? (with Laura Field). Journal of Financial Economics 146, 27-54 (2022).
While the percentage of mature firms with classified boards or dual class shares has declined by more than 40% since 1990, the percentage of IPO firms with these structures has doubled over this period. We test whether IPO firms implement these structures optimally or whether they are utilized to allow managers to protect their private benefits of control. Both shareholder voting patterns and changes in firm types going public suggest that the Agency Hypothesis best explains IPO firm’s use of dual class, particularly when there is a large voting-cash flow wedge. In contrast, among firms with high information asymmetry, classified board structures are better explained by the Optimal Governance hypothesis.
What's good for women is good for science: Evidence from the American Finance Association, with Renee Adams. Review of Corporate Finance Studies 11, 554 - 604 (2022).
Motivated by evidence that the largest differences in career outcomes arise within occupations, we examine a single occupation. With the support of the American Finance Association (AFA), we surveyed AFA members on the professional culture within finance. Individual experiences vary substantially, especially across men and women. Contrary to conventional narratives, differences in preferences play little role in explaining why women experience worse outcomes. Bias and discrimination have the largest effect. The consequences of non-inclusiveness extend beyond the personal to the entire field. Our findings suggest that institutions could potentially do more than they recognize to improve both diversity and science.
Investors' Attention to Corporate Governance, with Peter Iliev and Jonathan Kalodimos. Review of Financial Studies 34, 5581 - 5628 (2021).
Using unique data on investor views of EDGAR company filings, we document that many investors devote significant effort towards governance research. However, investors’ monitoring is focused disproportionately on large firms and firms with meetings outside the busy spring proxy season. Using an instrumental variables approach that isolates the drop of governance attention during the busy proxy season, we show that governance research is related to investors’ monitoring of firms, through both voice and exit. Moreover, governance research disciplines management into reduced investments and increased payouts. The concentration of attention results in joint monitoring of a relatively small subset of firms.
Does common ownership really increase firm coordination, with Katharina Lewellen. Journal of Financial Economics 141, 322 - 344 (2021).
A growing body of evidence concludes that common ownership caused cooperation among firms to increase and competition to decrease. We take a closer look at four approaches used to identify these effects. We find that the effects the literature has attributed to common ownership are caused by other factors, such as differential responses of firms (or industries) to the financial crisis. We propose a modification to one of the previously used empirical approaches, which is less sensitive to these issues. Using this to re-evaluate the link between common ownership and firm outcomes, we find little robust evidence that common ownership affects firm behavior.
Information revelation through regulatory process: Interactions between the SEC and companies ahead of the IPO, with Roni Michaely and Ekatarina Volkova. Review of Financial Studies 33, 5510-5554 (2020).
The regulator plays an active role in the IPO process via its pre-IPO communications with firms, writing 3.8 comment letters per company. To evaluate the regulator's input, we analyze these communications between the SEC and firms using LDA-analysis and KL-divergence. Main topics of SEC concerns map closely into the regulator's stated mandate: companies increase prospectus disclosures within precise topics of SEC concern. Questions related to revenue recognition are most informative about company valuation. These concerns are not independently uncovered by investors. This dynamic process of information disclosure results in increased transparency, but at a cost of delays in going public.
Venturing beyond the IPO: Financing of Newly Public Firms by Pre-IPO Investors, with Peter Iliev. Journal of Finance 75, 1527-1577 (2020).
Contrary to conventional wisdom, we document that approximately 15% of VC-backed firms raise additional capital from VCs in the one to five years after they go public. We posit two explanations for why firms revert to VC financing after the IPO. First, VCs have a comparative advantage in overcoming firm-level information asymmetry, enabling them to issue capital at more viable prices than other investors when information asymmetries are high. Second, agency conflicts driven by non-linearities in VCs’ payoff functions, combined with the liquidity of public firms, motivate these investments. Analyses of firm characteristics, VC characteristics, and returns to both the VC investors and external shareholders suggest that information asymmetry drives these investments. These investments are value-increasing for both the VCs and for the underlying companies.
Mutual Fund Investments in Private Firms, with Sungjoung Kwon and Yiming Qian. Journal of Financial Economics 136, 407-443 (2020).
Historically a key advantage of being a public firm was broader access to capital, from a disperse group of shareholders. In recent years, such capital has increasingly become available to private firms as well. We document a dramatic increase over the past twenty years in the number of mutual funds participating in private markets and in the dollar value of these private firm investments. We evaluate several factors that potentially contribute to this trend: firms seeking extra capital to postpone public listing; mutual funds seeking higher risk-adjusted returns and IPO allocations; and, VCs seeking new investors to substantiate higher valuations. Results provide the strongest support for the first two factors.
Informed Trading by Advisor Banks? a look at options holdings ahead of mergers, with Marco Rossi and Zhongyan Zhu. Review of Financial Studies 32, 605 - 645 (2019).
Within an investment bank, there is a tension between the investment banking and asset management divisions: the former possesses substantial private information while the latter seeks information. Information is arguably infeasible to completely safeguard, raising the possibility of leaks, either deliberate or inadvertent. To the extent that there is information leakage, we conjecture that it will be observed in the options market, as options represent a relatively cheap means to leverage private information. Empirical evidence is consistent with trading departments of the advisor banks having an information advantage, and leveraging this advantage through options rather than stock.
The Information Advantage of Underwriters in IPOs, with Yao-Min Chiang and Yiming Qian. Management Science 65, 5449-5956 (2019).
Using a unique dataset of dealer-level trading data in bookbuilding IPOs, we find strong evidence that lead underwriter trades in IPO firms are significantly related to subsequent IPO abnormal returns. This relation is concentrated among issues in which underwriters’ information advantage is likely greater, specifically among IPOs with higher information asymmetry or subject to higher investor sentiment and among underwriters with the most industry experience. In contrast, we find no similar relation for trades by other syndicate members, who are not involved in due diligence or pricing, or around auction IPOs, which are characterized by less underwriter involvement. Our results are consistent with the joint hypothesis that underwriters of bookbuilding IPOs gain unique insight on the values of these client firms, and that they trade on this information advantage.
Are All Perks Solely Perks? Evidence from Corporate Jets. with Lian Fen Lee and Susan Shu. Journal of Corporate Finance 48, 460-473 (2018).
While shareholders have strong incentives to limit value-destroying perquisite consumption, it is challenging to identify such perquisites. Many corporate assets that enable forms of perquisite consumption also provide operational benefits. Corporate jets represent a potent example. We find business-related flights increase firm performance. Our results also highlight the channels through which jet use can either enhance or destroy firm value. Consistent with the benefits of information gathering and monitoring, firms with soft and complex information that is difficult to transmit remotely are more likely to fly to company subsidiaries and plants, and these flights positively affect firm value. In contrast, among firms with weak governance structures where flights are more likely motivated by agency factors, jet use is more likely to be value-decreasing. The ability to differentiate has important implications in today's activism environment.
Initial Public Offerings: A synthesis of the literature and directions for future research, with Roni Michaely and Ekatarina Volkova. Foundations and Trends in Finance 11, 154-320 (2017).
The purpose of this chapter is to provide an overview of the IPO literature since 2000. The fewer numbers of companies going public in recent years has raised many questions regarding the IPO process, in both academic and regulatory circles. As we all strive to understand these changes in the market, it is especially important to understand the dynamics underlying the IPO process. If the process of going public is too costly or the IPO mechanism is plagued by too many conflicts of interest among the various intermediaries, then private companies may rationally choose other methods of raising capital. In a related vein, it is imperative that new regulations not be based on research focusing solely on large, more mature firms. Newly public firms have unique characteristics, and an increased understanding of such issues will contribute positively to well-functioning public markets and further growth of the entrepreneurial sector.
We also provide a detailed guide to researchers on how to obtain a research-quality sample of IPOs, from standard data sources. Related to this, we tabulate important corrections to these standard data sources.
Are Mutual Funds Active Voters, with Peter Iliev. Review of Financial Studies 28, 446 – 485 (2015).
Mutual funds vary greatly in their reliance on proxy advisory recommendations. Over 25% of funds rely almost entirely on Institutional Shareholder Services (ISS) recommendations, while other funds place little weight on them. Funds with higher benefits and lower costs of researching the items up for vote are less likely to rely on ISS. These actively voting funds are less likely to vote in a “one-size-fits-all” manner, and they earn higher alphas, consistent with benefits from this allocation of resources. For the underlying firms, the presence of actively voting funds mitigates the influence of ISS and helps sway shareholder votes toward value-maximizing outcomes.
Are Busy Directors Detrimental, with Laura Field and Anahit Mkrtchyan.Journal of Financial Economics, 109, 63 – 82 (2013).
Busy directors have been widely criticized as being ineffective. However, we hypothesize that busy directors offer advantages for many firms. While busy directors may be less effective monitors, their experience and contacts arguably make them excellent advisors. Among IPO firms, which have minimal experience with public markets and likely rely heavily on their directors for advising, we find busy boards to be common and to contribute positively to firm value. Moreover, these positive effects of busy boards extend to all but the most established firms. Benefits are lowest among Forbes 500 firms, which likely require more monitoring than advising.
When do Banks Listen to their Analysts? Evidence from Mergers and Acquisitions, with David Haushalter. Review of Financial Studies, 24, 321 – 357 (2011).
We examine the conflicts of interest and the flow of information between divisions of financial institutions. Using data on analyst recommendations and stockholdings of investment banks advising acquirers in mergers, we find evidence that information from investment banking flows to other divisions of the bank. Specifically, following a merger announcement, changes in a bank’s stockholdings of the acquirer are positively associated with changes in recommendations by its analyst. This relationship, however, does not exist before the merger announcement. Additional tests show that the relationship between stockholdings and recommendations following a merger announcement is strongest when conflicts of interest for analysts are likely the smallest.
The Variability of IPO Initial Returns, with Micah Officer and G. William Schwert. Journal of Finance 65, 425 – 465 (2010).
The monthly volatility of IPO initial returns is substantial and fluctuates dramatically over time. Moreover, the monthly volatility of initial returns is significantly positively correlated with monthly mean initial returns. This contrasts strongly with the strong negative correlation between the mean and volatility of secondary-market returns. Consistent with IPO theory, our empirical findings suggest that information asymmetry about the firm’s market value drives this positive correlation. Specifically, months in which a greater portion of the offerings are for companies for which information asymmetry is likely to be a problem tend to have higher average initial returns and a higher volatility of initial returns. Moreover, information asymmetry proxies are able to explain much of the positive correlation between average initial returns and the variability of initial returns, and the same proxies are significantly associated with both the level and dispersion of initial returns at the firm level.
Discussion of‘Shareholder litigation and changes in disclosure behavior’. Journal of Accounting and Economics 47, 157-159 (2009).
Rogers and VanBuskirk [2008. Shareholder litigation and changes in disclosure behavior. Journal of Accounting and Economics 40, 3–73] examine changes in sued firms’ disclosure policies between the pre-lawsuit and post-lawsuit periods. They find that these firms decrease the magnitude and precision of disclosures following the lawsuits. The authors conclude that managers of sued firms perceive disclosure to contribute to (rather than decrease) the probability of being sued. While the evidence showing that the magnitude and precision of disclosure decreases post-lawsuit appears to be robust, I raise some questions about what we learn from this finding.
Institutional Versus Individual Investment in IPOs: The Importance of Firm Fundamentals, with Laura Field. Journal of Financial and Quantitative Analysis 44, 489-516 (2009).
Consistent with institutions having an advantage over individuals, we find that newly public firms with the highest levels of institutional investment significantly outperform those with the lowest levels. While prior literature has attributed much of institutions’ higher returns around various corporate events to private information, we find that much of the difference simply reflects better interpretation of readily available public information. Individuals disproportionately invest in the types of firms that earn significantly lower abnormal returns over the long-run. Individuals either disregard or misinterpret the relevance of readily available public information, and as a result, they bear the brunt of IPO underperformance.
Executive Stock Options and IPO Underpricing, with Kevin J. Murphy. Journal of Financial Economics 85, 39-65 (2007)
In about one-third of US IPOs between 1996 and 2000, executives received stock options with an exercise price equal to the IPO offer price rather than a market-determined price. Among firms with such “IPO options”, 58% of top executives realize a net benefit from underpricing: the gain from the options exceeds the loss from the dilution of their pre-IPO shareholdings. If executives can influence either the IPO offer price or the timing and terms of their stock option grants, there should be a positive relation between IPO option grants and underpricing. We find no evidence of such a relation. Our results contrast sharply with the emerging literature on managerial self-dealing at shareholder expense.
Does Disclosure Deter or Trigger Litigation?, with Laura Field and Susan Shu. Journal of Accounting and Economics 39, 487-507 (2005)
Securities litigation poses large costs to firms. The risk of litigation is heightened when firms have unexpectedly large earnings disappointments. Previous literature presents mixed evidence on whether voluntary disclosure of the bad news prior to regularly scheduled earnings announcements deters or triggers litigation. We show that the counterintuitive finding in prior literature that disclosure triggers litigation could be driven by the endogeneity between disclosure and litigation. Using a simultaneous equations methodology, we find no evidence that disclosure triggers litigation. In fact, consistent with economic arguments, our evidence suggests that disclosure potentially deters certain types of litigation.
Is the IPO Pricing Process Efficient?, with G. William Schwert. Journal of Financial Economics 71, 3-26 (2004)
This paper investigates underwriters’ treatment of public information throughout the IPO pricing process. Two key findings emerge. First, we find that public information is not fully incorporated into the initial filing range. This finding suggests that the midpoint of the filing range is not an unbiased predictor of the final offer price, as prior literature has assumed. Second, public information is not fully incorporated into the offer price, suggesting an inefficiency in the IPO pricing process. However, further examination shows that these statistically significant relations are relatively small in economic terms. In other words, underwriters do fully incorporate most public information throughout the pricing process.
Why Does IPO Volume Fluctuate So Much? Journal of Financial Economics 67, 3-40 (2003)
IPO volume fluctuates substantially over time. This paper compares the extent to which the aggregate capital demands of private firms, the adverse-selection costs of issuing equity, and the level of investor optimism can explain these fluctuations. Empirical tests include both aggregate and industry-level time-series regressions using proxies for the above factors and an analysis of the relation between post-IPO stock returns and IPO volume. Results indicate that firms’ demands for capital and investor sentiment are important determinants of IPO volume, in both statistical and economic terms. Adverse selection costs are statistically significant, but their economic effect appears small.
Litigation Risk and IPO Underpricing, with Susan Shu. Journal of Financial Economics 65, 309-336 (2002)
We examine the relation between litigation risk and IPO underpricing and test two aspects of the litigation-risk hypothesis: (1) firms with higher litigation risk underprice their IPOs by a greater amount as a form of insurance (insurance effect) and (2) higher underpricing lowers expected litigation costs (deterrence effect). To adjust for the endogeneity bias in previous studies, we use a simultaneous equation framework. Evidence provides support for both aspects of the litigation-risk hypothesis.
IPO Market Cycles: Bubbles or Sequential Learning? with G. William Schwert. Journal of Finance 57, 1171-1200 (2002)
Both IPO volume and average initial returns are highly autocorrelated. Further, more companies tend to go public following periods of high initial returns. However, we find that the level of average initial returns at the time of filing contains no information about that company’s eventual underpricing. Both the cycles in initial returns and the lead-lag relation between initial returns and IPO volume are predominantly driven by information learned during the registration period. More positive information results in higher initial returns and more companies filing IPOs soon thereafter.