Nishant Dass

Board Expertise: Do Directors from Related Industries Help Bridge the Information Gap?

We investigate the importance of board expertise by analyzing the role of “directors from related industries�? (DRIs) on a firm’s board. DRIs are officers and/or directors of companies in the upstream (supplier) or downstream (customer) industries of the firm. About 40% of firm-years in our sample have at least one DRI. We propose and test information, market structure, and agency hypotheses about when DRIs are likely to add value. Consistent with the information hypothesis, DRIs are present when the information gap is more severe, such as in innovative firms/industries and in firms with less informative stock prices. Consistent with the market structure hypothesis, DRIs are also more likely in firms with larger market share and in more concentrated or vertically integrated industries. After correcting for endogeneity, DRIs have an economically significant impact on firm value and performance – especially when information problems are worse and boards have relatively greater power to monitor managers. Hence, a possible explanation for DRIs not being sought more widely is managerial resistance to monitoring by a better informed board. Finally, DRIs appear to enhance the ability of firms to handle negative industry shocks, suggesting that they narrow the information gap.

Trade Credit, Relationship-Specific Investment, and Product-Market Power

We rely on a model with incomplete contracts and bargaining power to argue that trade credit (TC) can serve as a commitment device for making relationship-specific investments (RSIs). Unlike existing theories, we explain within a single theoretical framework why TC is affected by firms’ bargaining power and by the specialized nature of transacted goods. Using a large panel of publicly listed firms and innovation-based proxies for RSI, we find strong support for the model’s predictions: TC increases in upstream firm’s RSI and downstream firm’s market power. Endogeneity concerns are addressed by using the passage of innovation-increasing state laws to instrument for RSI and import penetration to instrument for bargaining power.

Allocation of Decision Rights and the Investment Strategy of Mutual Funds

The literature suggests that while decentralized decision making can allow for greater specialization in an organization, it heightens the cost of coordinating decisions. The mutual fund industry—in particular, sole- and team-managed balanced funds—provides an ideal setting to test the specialization versus coordination trade-off, as information on decision structures and fund actions is easily obtained. We show that sole-managed balanced funds, with centralized decision rights, exhibit significant market timing that requires reallocation across asset classes. However, consistent with coordination difficulties between managers specializing in particular asset classes, no market timing is evident in team-managed balanced funds. Team-managed funds exhibit greater returns from specialization, in the form of better security selection performance than sole-managed funds. These results hold cross-sectionally and for funds that switch management structures. The overall returns across different management structures are similar, indicating a market equilibrium. Investor flows reward market-timing performance for sole- but not team-managed funds.

The Influence of Directors from Related Industries in Shaping Firm Policies

Does the specific background and expertise of outside directors influence corporate policies? While the literature recognizes that directors contribute to firm value through their monitoring and advisory functions, the precise manner and extent to which directors’ expertise affects the firm’s operational and financial decisions is not well understood. We analyze this issue by identifying a group of directors that are likely to have considerable knowledge about the firm’s industry: directors from related upstream (supplier) or downstream (customer) industries (DRIs). We then investigate the impact of DRIs on specific corporate policies. We find that firms with DRIs benefit from: (1) shorter cash-conversion cycles, (2) lower inventory, (3) lower accounts receivable and, (4) higher accounts payable. We also find that firms with DRIs are less financially constrained as indicated by their lower cash-to-cash flow sensitivities. In addition, the investment to cash flow sensitivity is also lower with DRIs, thereby suggesting that they reduce investment distortions within firms. Further, investment responds less to stock prices (measured by Tobin’s Q) in firms with DRIs when the stock prices are not very informative – suggesting that DRIs act as alternative conduits of information. In a similar vein, we find that firms with DRIs utilize their production factors more efficiently (as measured by labor and total factor productivity), thus signifying that the industry expertise of DRIs helps the firm better anticipate industry conditions and trends.

Syndicated Loans: The Role of Covenants in Mitigating Lender Disagreements

We study the role of covenants in syndicated bank loans. We argue that, in addition to being a device for monitoring the borrower, covenants can help mitigate conflicts of interest between the lead-arranger and participating banks in the syndicate. Such disagreements can arise when, for instance, a lead-arranger has the incentive to support a poorly performing borrower and offer loan modification – while other syndicate lenders do not. We develop a simple model and find empirical support for its predictions that covenants are less likely to be present: (i) in non-syndicated versus syndicated loans; (ii) when the leads loan allocation is greater and (iii) when participating bank affiliates hold substantial equity in the borrower. Consistent with this evidence, we find that lead arrangers are more likely to syndicate with banks that hold borrower equity through affiliated entities.

Geographic Clustering of Corruption in the U.S.

We test the hypothesis that U.S. corporations headquartered in states with greater public corruption are also prone to more unethical behavior when operating abroad. We exploit passage of Foreign Corrupt Practices Act (FCPA) that curtailed bribery of foreign officials and find firms in corrupt states, especially those exporting to more corrupt countries, suffer greater performance decline following FCPA, suggesting larger loss from anticipated bribery restrictions. Controlling for industry, firms in corrupt states are more likely to be targets of FCPA enforcement actions. They are also more likely to have paid foreign bribes, as disclosed during pre-FCPA investigations.

Venture Capital Investment Strategies Under Financing Constraints: Evidence from the 2008 Financial Crisis

This paper employs the 2008 financial crisis as an empirical setting to examine how investment strategies of venture capitalists (VCs) vary in the presence of a liquidity supply shock, and what the performance implications of these strategies are for their portfolio startups. We show that while, on aggregate, funded startups receive no less financing during the financial crisis than in non-crisis times, VCs allocate relatively more resources to startups operating in the VCs’ core sectors. We show that this skew allocation follows from VCs choosing to double down on their core-sector investing, rather than by a changed mix of investors or startups during the financial crisis. These effects are strongest for early-stage startups, for which information problems are most severe. Furthermore, these results are driven by the investment strategies of more-experienced VCs. Building on these findings, we find superior ex post performance among crisis-funded portfolio startups operating in more-experienced VCs’ core sectors.

The Role of Covenants in Mitigating Conflicts of Interest Within Lending Syndicates

We study the role of covenants in syndicated bank loans. We argue that, in addition to being a device for monitoring the borrower, covenants can help mitigate conflicts of interest between the lead arranger and participating banks in the syndicate. Such disagreements can arise when, for instance, a lead arranger has the incentive to support a poorly performing borrower and/or offer loan modifications while other syndicate lenders may prefer to discipline the borrower by accelerating the loan or enforcing default. We develop a simple model reflecting such conflicts and find empirical support for its predictions that covenants are less likely to be present: (i) in non-syndicated versus syndicated loans; (ii) when the leads loan allocation is greater; and (iii) when participating bank affiliates hold substantial equity in the borrower. Consistent with this evidence, we find that lead arrangers are more likely to syndicate with banks that hold borrowers equity through affiliated entities.

Catering with Multiple Maturities

We study how firms choose their debt maturity structure. We argue that because of lower information-gathering costs, institutional investors prefer to invest in firms with bonds outstanding across multiple maturities. We show that, in segmented markets, this preference for firms with bonds of multiple maturities generates excess demand by institutional investors for these bonds. This greater demand is especially due to larger institutions, and mostly insurance companies. This results in lower bond yields, both in the primary as well as the secondary bond markets. Aware of these benefits, firms respond by issuing bonds across the spectrum of maturities. However, geographical segmentation of financial markets constrains the ability of the firms to exploit such a strategy.