Anil K. Makhija

Deregulation, disintermediation, and agency costs of debt: evidence from Japan

Abstract Many Japanese firms reduced dependence on banks following financial deregulation in the 1980s. The financial architecture of Japanese firms after liberalization provides an opportunity to investigate the choice of financing with public bonds versus monitored bank loans. Examination of accounting and stock price data for a sample of Japanese firms in the late 1980s suggests that debt structure is related to variables that serve as proxies for agency costs of debt. In particular, we find that the proportion of bond debt is inversely related to growth opportunities, while the proportion of bank debt is positively related to growth opportunities.

The Impact of Firm Ownership Structure on Voluntary Disclosure: Empirical Evidence from Czech Annual Reports

We investigate the impact of ownership structure on the extent of voluntary financial disclosure by examining the cross-sectional variation in the extent of disclosure by newly privatized Czech firms. Owners derive benefits directly from the firm (private benefits of control) and from changes in share values in the capital market. Both these benefits are affected by disclosure. Consistent with owners attempts to maximize their total benefits, we find that the extent of disclosure is positively related to investment fund ownership at low levels of fund ownership but is negatively related to investment fund ownership at high levels of fund ownership.

Executive Compensation and Corporate Performance in Electric and Gas Utilities

We study how the composition of the board of directors and incentives from direct shareholdings affect firm performance in a sample of large, publicly traded firms. We use an instrumental variables approach that controls directly for endogeneity of both shareholdings and board composition. We find no evidence that cross-sectional patterns in board composition are correlated with cross-sectional patterns in performance. This result is consistent with a number of different explanations, all of which suggest that potential regulation of board composition would not be beneficial. Similar to the previous literature, we find a nonmonotonic relation between ownership and performance. Our results suggest that this relation is not a product of the endogeneity of shareholdings. Finally, we find that firm performance suffers if the CEO stays on too long (beyond 15 years).

Can Diversification Create Value? Evidence from the Electric Utility Industry

Despite SEC and state-level resistance, and contrary to the trend pursued by other firms, many electric utilities have diversified into non-electric and unregulated businesses. Moreover, this failure to focus has been rewarded with higher firm values, again contrary to the discounts documented in the literature for other diversifying firms. Prior literature has questioned whether these premiums (or discounts) can be attributed to diversification per se. Rather, these premiums could arise from the characteristics of the diversifying firms, which have then endogenously chosen to diversify. In a new approach, where regulation can make the diversification decision largely exogenous, we examine the investment policies of the comparable electric-segments in the diversifying and non-diversifying utilities. We find that single segment electric utilities over-invest compared to diversifying utilities, which explains their diversification premiums and implies that diversification can create value by opening up new investment opportunites.

Fairness Opinions in Mergers and Acquisitions

Fairness opinions provided by investment banks advising on mergers and acquisitions have been criticized for being conflicted in aiding bankers further their goal of completing the deal as opposed to aiding boards (and shareholders) by providing an honest appraisal of deal value. We find empirical support for this criticism. We find that shareholders on both sides of the deal, aware of the conflict of interest facing advisors, rationally discount deals where advisors provide fairness opinions. The reputation of the advisor serves to mitigate this discount, while the contingent nature of advisory fees appears to have no impact. Furthermore, consistent with the criticism of fairness opinions, we find evidence suggesting that fairness opinions are sought by boards for the legal cover they provide against shareholders unhappy with the deals terms. Thus, altogether our findings suggest that investment bankers and boards may be complicit in using fairness opinions to further their own interests at an expense to shareholders.

The Impact of Shareholder Power on Bondholders: Evidence from Mergers and Acquisitions

Takeovers result in the transfer of bondholders claims from the target to the acquiring firm, providing a setting to examine the impact of shareholder power on bondholders. We find that excess returns to target bondholders at M & A announcements are positively related to the holdings of the top 5 acquirer institutional owners, a measure of shareholder power. This supports the view that stronger shareholder power, through superior monitoring of managers, can be beneficial to bondholders as well. Our findings are robust to various proxies for shareholder power, adjustments for endogeneity, controls for target shareholder power, and other controls for firm and deal characteristics that have been shown to affect bondholders wealth during takeovers.

The Impact of Competition and Corporate Structure on Productive Efficiency: The Case of the U.S. Electric Utility Industry, 1990-2004

In this study, we present empirical evidence on the productive efficiency of electric utilities in the United States over the period, 1990-2004. This is a period marked by major attempts to introduce competition in the industry with the expectation that it will lead firms to improve their productive efficiency and ultimately to lower consumer prices. The actual experience has been surprising, since electricity prices have either fallen little or even risen sharply in some states. Relying on recent advances in the estimation of productive efficiency, we find that firms in jurisdictions that adopted competitive mechanisms have lower productive efficiency compared to firms in jurisdictions where rate-of-return regulation was retained. Furthermore, we provide evidence that firms in states that adopted competition have experienced decreases in productive efficiency, while firms in states with traditional regulation saw increases in efficiency over time. Since the introduction of deregulation has brought greater discretion to managers, we also examine the impact of various organizational choices on productive efficiency. Interestingly, the separation of the generation function from other functions, a hallmark of the effort to deregulate the industry, is associated with an adverse impact on productive efficiency. These findings question the claim that competition necessarily fosters higher productive efficiency. Alternatively, true competition may have been circumvented.

Empirical evidence on determinants of capital structure

Based on received financial theory, we empirically examine the role of the following firm-specific determinants of leverage: bankruptcy costs, growth, variability, non-debt tax shields, collateral value, profitability, and size. For our sample, to focus on firm-specific aspects, we purposely use pooled time-series cross-sectional data from a single industry (electric and gas utilities) for the twenty-year period, 1975–1994. Our findings largely support theory, with the important exception of variability. We find that leverage is positively related with variability, contrary to the literature. We conjecture that this seemingly perverse relationship may be due to the yet unrecognized effect of variability: firms with greater variability of earnings have a greater chance that their non-debt tax shields may prove to be inadequate, and are therefore expected to take on higher levels of leverage.

Global Corporate Governance

Advances in Financial Economics Vol 19 is peer reviewed and focusses on International Corporate Governance.

Adoptions and Eliminations of Economic Profit Plans and Internal Capital Markets Efficiency

Internal capital markets of diversified firms have been associated with inefficient allocation of investment funds across divisions, leading to value losses. Utilizing a sample of diversified firms that adopted or eliminated Economic Profit Plans (EPPs) between 1990 and 2009, we show that adoptions of those plans (that reward profitability, but penalize excessive capital investment) mitigate investment distortions and lead to value gains. Following the adoption of EPPs, diversified firms start allocating investment funds based on growth opportunities of their divisions. EPP adopters lower their divisional investment levels, especially in segments with below-average growth opportunities. The overall investment allocation efficiency improves, and the diversification discount diminishes after the adoption of EPPs. However, EPPs appear to be used only as temporary tools for assessing corporate performance. The plans are adopted primarily by firms expected to immediately generate plan bonuses for management, and they are frequently eliminated by firms with bad accounting performance, and low managerial bonuses. The study contributes to the literature on organizational efficiency, internal capital markets and on the importance of measures based on economic profits or residual income.