Kathleen M. Kahle

When a buyback isn’t a buyback: open market repurchases and employee options

This paper examines how stock options have affected the decision to repurchase shares, the amount repurchased, and the market reaction to the repurchase announcement. I find that firms announce repurchases when executives have large numbers of options outstanding and when employees have large numbers of options currently exercisable. Once the decision to repurchase is made, the amount repurchased is positively related to total options exercisable by all employees, but independent of managerial options. These results are consistent with managers repurchasing both to maximize their own wealth and to fund employee stock option exercises. The market appears to recognize this motive, however, and reacts less positively to repurchases announced by firms with high levels of non-managerial options outstanding.

The Impact of Industry Classifications on Financial Research

Using approximately 10,000 firms jointly covered by Compustat and CRSP from 1974–1993, we find substantial differences in the SIC codes designated by the two databases. More than 36 percent of the classifications disagree at the two-digit level and nearly 80 percent disagree at the four-digit level. We examine the impact of these differences upon financial research in several ways. First, we show that the classification of utilities, financial firms, and conglomerate acquisitions are affected by the choice of CRSP vs. Compustat SIC codes. Second, we show that industry classification matters in financial research by illustrating that size- and industry-matched comparisons are more powerful than pure size matches. Third, we test the specification and power of Compustat vs. CRSP classifications by simulating a typical financial experiment in which sample firms are matched to control firms by industry. We find that: i) Compustat matched samples are more powerful than CRSP matched samples in detecting abnormal performance; ii) nonparametric tests outperform parametric tests; and iii) four-digit SIC code matches are more powerful than two-digit SIC code matches. These results are robust to the inclusion or exclusion of extreme values, and hold for both NYSE/AMEX and Nasdaq firms.

Insider Trading and the Long-Run Performance of New Security Issues

This paper uses insider trading around new security issues to provide evidence of managerial timing ability. I show that insider sales increase and purchases decrease prior to issues of information-sensitive securities (convertible debt and equity) by industrial firms. I then examine the relation between insider trading and subsequent stock returns. Although not all equity issues are motivated by overvaluation, those where managers sell prior to the issue are more likely to be. I find that industrial firms with abnormal insider selling underperform in the long run, whereas those with abnormal buying do not. There is no evidence of a relation between abnormal selling and future performance for utility offerings, however. Overall, the evidence is consistent with poor long-term performance being due to overvaluation.

Long-Run Performance and Insider Trading in Completed and Canceled Seasoned Equity Offerings

This paper provides evidence on managerial motives for raising equity by examining long-run performance and insider trading around canceled and completed seasoned equity offerings (SEOs). Insider selling increases prior to competed and canceled SEOs, but declines afferward only for canceled offerings. For completed SEOs, pre-filing insider trading is related to long-run performance after completion. For Canceled sEOs, pre-filing insider trading is related to stock performance between filing and cancellation. Finally, changes in dence is consistent with insiders exploiting windows of opportunity by attempting to issue overvalued equity and by canceling the issue when the market reaction to the announcement eliminates the overvaluation.

Financial Policies and the Financial Crisis: How Important Was the Systemic Credit Contraction for Industrial Corporations?

Although firm financial policies were affected by a credit contraction during the recent financial crisis, the impact of increased uncertainty and decreased growth opportunities was stronger than that of the credit contraction per se. From the start of the financial crisis (third quarter of 2007) to its peak (first quarter of 2009), both large and investment-grade non-financial firms show no evidence of suffering from an exceptional systemic credit contraction. Instead of decreasing their cash holdings as would be expected with a temporarily impaired credit supply, these firms increase their cash holdings sharply (by 17.8% in the case of investment-grade firms) after the fall of Lehman. Though small and unrated firms have exceptionally low net debt issuance at the peak of the crisis, their net debt issuance in the first year of the crisis is no different from the last year of the credit boom. In contrast, however, the net equity issuance of small and unrated firms is low throughout 2008, whereas an impaired credit supply by itself would have encouraged firms to increase their equity issuance. On average, the cumulative financing impact of the decrease in net equity issuance from the start to the peak of the crisis is approximately twice the cumulative impact of the decrease in net debt issuance. The decrease in net equity issuance and the increase in cash holdings are also economically important for firms with no debt.

Financial Policies, Investment, and the Financial Crisis: Impaired Credit Channel or Diminished Demand for Capital?

Though much of the narrative of the financial crisis has focused on the impact of a bank credit supply shock, we show that such a shock cannot explain important features of the financial and investment policies of industrial firms. These features are consistent with a dominant role for the increase in risk and the reduction in demand for goods that occurred during the crisis. The net equity issuance of small firms and unrated firms is abnormally low throughout the crisis, whereas an impaired credit supply by itself would have encouraged these firms to increase their net equity issuance. After September 2008, firms increase their cash holdings rather than use them to mitigate the impact of the credit supply shock. Firms that are more bank-dependent before the crisis do not reduce their capital expenditures more than other firms during the crisis. Finally, the evidence is strongly supportive of theories that emphasize the importance of collateral and corporate net worth in financing and investment policies, as firms with stronger balance sheets reduce capital expenditures less after September 2008.

Board Connectedness and Board Effectiveness

We examine the effect of the social connectedness of independent, non-co-opted directors on their ability to monitor and advise the firm. We begin by providing evidence that well-connected directors have greater protection from career concerns. We next examine the channels by which director connectedness may improve monitoring and find that audit committee connectedness has a positive effect on the quality of financial reporting. Further, better connected compensation committees are less likely to overpay the CEO. Finally, we examine the effect of well-connected directors on the firm’s information environment. We show that firms with highly connected boards have lower financing costs and higher payout ratios. We also find that better connected boards are better able to shield the firm from the negative impact of a competition shock. Our results are robust to multiple approaches to mitigate endogeneity. Overall, well-connected boards appear to be effective in promoting shareholders’ interests.

Eclipse of the Public Corporation or Eclipse of the Public Markets

Since reaching a peak in 1997, the number of listed firms in the U.S. has fallen in every year but one. During this same period, public firms have been net purchasers of

Director Connectedness: Monitoring Efficacy and Career Prospects

3.6 trillion of equity (in 2015 dollars) rather than net issuers. The propensity to be listed is lower across all firm size groups, but more so among firms with less than 5,000 employees. Relative to other countries, the U.S. now has abnormally few listed firms. Because markets have become unattractive to small firms, existing listed firms are larger and older. We argue that the importance of intangible investment has grown but that public markets are not well-suited for young, R&D-intensive companies. Since there is abundant capital available to such firms without going public, they have little incentive to do so until they reach the point in their lifecycle where they focus more on payouts than on raising capital.

Cash Holdings and CEO Turnover

We examine the effect of social connectedness of independent, non-co-opted audit committee directors, focusing on their ability to prevent corporate misconduct. We posit that directors with greater connectedness in the social network are better shielded from career concerns, suggesting that they have greater incentives to monitor. We find that 1) conditional on detected misconduct, well-connected directors have greater protection from labor market repercussions than less-connected directors; 2) audit committee connectedness has a positive effect on the quality of financial reporting; and 3) market reactions to the sudden loss of a highly connected director is significantly more negative than for less connected directors. Our results are robust to multiple approaches to mitigate endogeneity. Overall, well-connected boards appear to be effective in promoting shareholders’ interests.