Jianxin Daniel Chi

Understanding the Endogeneity between Firm Value and Shareholder Rights

I explore the relation between firm value and the shareholder rights-based Governance Index G, which has become a popular measure of governance quality among researchers and investors. I show that the relation is not spuriously driven by unobservable firm heterogeneity or an assortment of observable firm characteristics, such as firm growth potential and profitability. The causality seems to run from G to firm value, rather than from firm value to G. My results suggest that granting more rights to shareholders could be an effective way to reduce agency costs and enhance firm value. (This is the working paper version of the published paper in Financial Management, Winter 2005, Volume 34, Issue 4, p. 65-76.)

Why Has the Value of Cash Increased Over Time

We document a dramatic increase in the market valuation of cash holdings by U.S. firms from 1971 to 2010. The value of one dollar increases from

The Dynamics of Performance Volatility and Firm Valuation

0.35 in the 1970s to

The Time Horizon of Managerial Incentives and Firms' Information Environment Quality

0.97 in the 2000s, indicating that shareholders place much more value on cash in recent years. This increase in cash value is mainly driven by changes in firm characteristics of newly entering firms. However, changes in the characteristics of incumbent firms have also contributed partly to the increase in cash value. Improved monitoring environments, increased investment opportunities, and deleveraging can mostly explain the increase in cash value over time.

Short-Horizon Incentives and Stock Price Inflation

We construct a model to illustrate the dynamics of cash flow volatility and firm valuation. As a firm progressively invests into its growth opportunities, its book value increases and catches up with its market value, reducing the valuation multiple (Q). Cash flow volatility (CFV) decreases due to the diversification effect of investing into more market segments. We document a positive CFV-Q association, which varies with firm size, investment opportunities, and the correlation across market segments. Empirical findings strongly support the model predictions and are robust to alternative explanations offered by extant studies on firm growth, volatility, and valuation.

Overvaluation and Earnings Management

Managers whose equity-based incentives vest over a shorter time horizon appear to adopt strategies that reduce information environment quality and exacerbate information heterogeneity across investors. Firms with shorter-horizon managerial incentives are more likely to inflate reported earnings and deflate analysts’ earnings expectations. These firms also have greater analyst forecast dispersion, larger absolute forecast errors, and higher share turnover. Investors appear to at least partly understand incentive horizon issues because firms with shorter-horizon managerial incentives experience muted investor reaction to their earnings announcements and have statistically insignificant long-term abnormal stock returns. Overall, the results illustrate how the temporal structure of managerial incentives can influence managerial behavior and produce important capital market effects.

The Conditional Nature of the Value of Corporate Governance

Firms with short-horizon CEO incentives experience stock price inflation followed by reversal. Short-horizon CEOs exploit the price inflation by selling relatively more stock and making greater abnormal profits than long-horizon CEOs do. The stock price inflation is partly explained by greater earnings surprises and more positive investor reaction to the surprises. To sustain the inflated price, short-horizon firms are more likely to employ income-increasing discretionary accruals. The findings are consistent with recent theories linking short-horizon incentives to stock price inflation, suggest CEOs have some success in doing so, and shed light on the role earnings management plays in the process.Do managerial incentive horizons have capital market consequences? We find that they do when short-sale constraints are more binding. Firms experience significant stock price inflation when their CEOs have short horizon incentives. The short-horizon CEOs sell more shares at inflated prices and generate greater abnormal trading profits. The stock price inflation is partly explained by greater earnings surprises and more positive investor reaction to the surprises. To inflate stock prices, short-horizon firms are more likely to employ income-increasing discretionary accruals. Consistent with theoretical predictions, all these effects are attenuated or statistically insignificant when short-sale constraints are less binding.