Kose John

Corporate Governance and Board Effectiveness

This paper surveys the empirical and theoretical literature on the mechanisms of corporate governance. We focus on the internat mechanisms of corporate governance (e.g., arising from conflicts of interests between managers and equityholders, equityholders and creditors, and capital contributors and other stakeholders to the corporate firm. We also examine the substitution effect between internal mechanisms of corporate governance and external mechanisms, particularly markets for corporate control. Directors for future research are provided.

Troubled debt restructurings*1: An empirical study of private reorganization of firms in default

Abstract This study investigates the incentives of financially distressed firms to restructure their debt privately rather than through formal bankruptcy. In a sample of 169 financially distressed companies, about half successfully restructure their debt outside of Chapter 11. Firms more likely to restructure their debt privately have more intangible assets, owe more of their debt to banks, and owe fewer lenders. Analysis of stock returns suggests that the market is also able to discriminate ex ante between the two sets of firms, and that stockholders are systematically better off when debt is restructured privately.

Asset Sales and Increase in Focus

We find that asset sales lead to an improvement in the operating performance of the sellers remaining assets in each of the three years following the asset sale. The improvement in performance occurs primarily in firms that increase their focus; this change in operating performance is positively related to the sellers stock return at the divestiture announcement. The announcement stock returns are also greater for focus-increasing divestitures. Further, we find evidence that some of the sellers gains result from a better fit between the divested asset and the buyer.

On the optimality of resetting executive stock options

Recent empirical work has documented the tendency of corporations to reset strike prices on previously-awarded executive stock option grants when declining stock prices have pushed these options out-of-the-money. This practice has been criticized as counter-productive since it weakens incentives present in the original award.We find that although the anticipation of resetting will typically result in a negative effect on initial incentives, resetting can still be an important, value-enhancing aspect of compensation contracts, even from an ex-ante standpoint. Indeed, we find a precise sense that some resetting is almost always optimal. We also characterize the conditions that affect the relative optimality resetting. We find, for example, that the relative advantages of resetting decrease as managerial ability to influence the resetting process increases, as the relative importance of external (industry-or economy-wide) factors in return generation increase, and as the direct or indirect cost of replacing the incumbent manager decrease. Our analysis, in summary, that the case against resetting is quite weak.

Universal banking and firm risk-taking☆

Abstract This paper analyzes the welfare implications of banks taking equity stakes in firms under conditions of imperfect information and moral hazard. Two cases of bank control over investment decisions are analyzed. In the first, the bank does not control the investment decisions of the firm. Here, the investment efficiency is higher and bank risk is lower for an optimal positive level of bank equity holdings. However, in the case when the bank has veto power over investment proposals by the firm, there is a trade off between increased investment efficiency and increased bank risk.

Risk-shifting incentives of depository institutions: A new perspective on federal deposit insurance reform

Abstract We characterize the risk-shifting incentives of a depository institution as arising fundamentally from the existence of limited liability and the associated convex payoff to equity-holders. This risk incentive feature is unchanged by deposits being insured, and hence excessive risk-taking by depository institutions is not solely attributable to the flat rate insurance premium. Consequently, the incentive problem cannot be resolved through a risk-based insurance premium, contrary to the prevailing view. We propose a solution that eliminates risk-shifting through an optimal tax structure and specify a corresponding insurance premium that is revenue neutral from the social planners (regulators) standpoint. The solution is derived in the context of a social objective function that trades off the benefits of liquidity services by banks and the unique informational role of bank loans with the costs of investment distortions engendered by risk-shifting.

Debtor-in-Possession Financing and Bankruptcy Resolution: Empirical Evidence

Debtor-in-Possession (DIP) financing is a unique form of enhanced secured financing that is granted to firms filing for reorganization under Chapter 11 of the US Bankruptcy Code. Opponents of DIP financing argue that such financing can lead to overinvestment, i.e., excessive investment in risky, (even negative NPV) projects. Alternatively, DIP financing can allow funding for positive NPV projects. Related to this is the question of whether DIP financing is related to a quicker resolution of the bankruptcy process. We examine these issues empirically. Using a large sample of bankruptcy filings, we find little evidence of systematic overinvestment. DIP financed firms are more likely to emerge from the Chapter 11 process than non-DIP financed firms. Interestingly, DIP financed firms have a shorter reorganization period; they are quicker to emerge and also quicker to liquidate. The time spent in bankruptcy is even shorter when the DIP lender also has a prior lending relationship with the firm.

Market Manipulation and the Role of Insider Trading Regulations

The authors show that the regulation requiring corporate insiders to disclose their trades ex post creates incentives for informed insiders to manipulate the market by sometimes trading against their information. This allows them to increase their trading profits by maintaining their information advantage over the market for a longer period of time. Such manipulation lowers initial bid-ask spreads. The authors show how the insiders likelihood of manipulation is affected by her information advantage, the number of other insiders, market liquidity, the early arrival of public information, and the choice of trade size. The short swing profit rule curtails this manipulation. Copyright 1997 by University of Chicago Press.

Payout Policy, Agency Conflicts, and Corporate Governance

This paper examines the role of corporate governance for payout policy design from the perspective of pre-commitment. We test the effect of external and internal corporate governance on the design of payout policy and use of pre-commitment, level and structure of cash distributions, and firm dividend and repurchase behavior. We argue that firms use pre-commitment to dividend payments to mitigate the agency conflict due to poor governance. We argue that there is an important distinction between dividends and repurchases from the perspective of pre-commitment. Managers that deviate from the chosen dividend policy incur a cost due to a strong negative market response, which reinforces the pre-commitment role of dividends. On the other hand, the market treats share repurchases as more flexible, irregular payouts made at the managers discretion, which makes repurchases less effective at mitigating the agency conflict. Therefore, a standalone repurchase policy is not sufficient to mitigate the governance failure, introducing the need for dividend pre-commitment as part of payout policy. Empirically, we find that weak governance is associated with a greater emphasis on dividend pre-commitment in total payout composition. Firms with weak governance are also significantly less likely to use standalone repurchase policies as opposed to a dividends - only or a mixed dividends - repurchases payout policy. Costly dividend pre-commitment presents few benefits to well-governed managers. Instead, they either store excess cash in the firm or distribute it through repurchases. We find that the type of monitoring mechanism is relevant for predicting discretionary payouts. Given the generally strong investor protection level in the US, poorly monitored managers are not immune from firing and they will follow a costly dividend policy. Consistent with the proposed explanation, we find that firms with weak corporate governance on average pay higher dividends. The relation between dividends and governance is stronger for firms with high free cash flow. Managers faced with a high takeover threat (external monitoring) are more likely to repurchase and tend to repurchase more on average. On the other hand, strong internal governance (board, institutional blockholder) allows more accurate following of managerial actions and is associated with fewer cash distributions of any kind, including repurchases.

Cross-Country Variations in Capital Structures: The Role of Bankruptcy Codes

We conduct a theoretical and empirical investigation of the impact of bankruptcy codes on firms’ capital-structure choices. In our theoretical framework, costs of financial distress are endogenously determined as a function of the bankruptcy code. Anticipated liquidation values emerge as the key variable in the capital structure-bankruptcy code link: among other things, the theory predicts that the difference in leverage between a debt-friendly bankruptcy code (such as the UK’s) and a more equity-friendly code (such as the US’s) should be a monotone function of liquidation values. We examine empirical support for the theory by comparing leverages in the US and the UK for the period 1990 to 2002. Our tests use two (inverse) proxies of liquidation values: asset-specificity of the firm, and the fraction of the firm’s assets that are intangibles. We find the theory is strongly backed by the data. The results are robust to considerations such as employing net leverage (debt net of cash holdings) and controlling for other firm characteristics that affect leverage.We develop a theoretical model of capital structure choice in which a central role is played by the bankruptcy code under which a company operates. We show that capital structure choices are substantially influenced by asset-specificity: firms with high assetspecificity will use a higher degree of leverage under a debt-friendly bankruptcy code than under an equity-friendly code, but the reverse is true for firms with low asset-specificity. Moreover, the dierence between the optimal debt levels under the two codes is itself an increasing function of the degree of asset-specificity. We test our model’s implications by comparing leverage ratios at the industry level in the US to those in the UK during the period 1990 to 2002. We find that our theoretical predictions are strongly confirmed by the data. Our results clarify and extend previous crosscountry empirical studies (notably Rajan and Zingales, 1995) that found mixed evidence on the relationship between the bankruptcy code and capital structure when data was aggregated over all industries.