Sandy Klasa

Refinancing Risk and Cash Holdings

Although a firm’s use of shorter-term debt can potentially help it to reduce agency costs of debt and align managers’ interests with those of shareholders, the use of this type of debt increases the firm’s refinancing risk. We hypothesize that firms with debt that has a shorter maturity hold larger cash reserves to reduce important costs they could incur if they have difficulty refinancing their debt. Using a simultaneous equations framework that accounts for the joint determination of cash holdings and debt maturity, we find that firms that shorten (lengthen) the maturity of their debt increase (decrease) their cash holdings. Additionally, we document that U.S. firms have markedly shortened the maturity of their debt over the 1980-2008 period and that this can explain a large fraction of the increase in the cash holdings of these firms over this period. We also show that the market value of a dollar of cash holdings is higher for firms whose debt has a shorter maturity. Further, the inverse associations between the maturity of a firm’s debt with the level and market value of its cash holdings are more pronounced during periods when credit market conditions are tighter and refinancing risk is consequently higher. Finally, we show that larger cash holdings help to mitigate underinvestment problems resulting from refinancing risk. Overall, our findings suggest that refinancing risk is a key determinant of corporate cash holdings. * We thank Malcolm Baker, Travis Box, Murillo Campello, Amar Gande, Kathy Kahle, Swaminathan Kalpathy, and seminar participants at McGill University, Texas Tech University, Virginia Tech University, the University of Arizona, and the 2011 University of Innsbruck – Financial Markets and Risk conference for helpful comments. We also thank Douglas Fairhurst for excellent research assistance.

Why Do Controlling Families of Public Firms Sell Their Remaining Ownership Stake

I investigate what leads controlling families of publicly traded firms to sell their remaining ownership stake. The sale of a controlling stake is best explained in the context of theories of the firm related to optimal risk bearing, the separation of ownership and management expertise, the CEO succession process, and the monitoring provided by outside blockholders. A timing explanation is only marginally supported. The sale of a controlling stake is not explained by insufficient financial resources to fully invest in growth opportunities. This study offers insights into the final stage of the process in which entrepreneurs sequentially sell their firm to outside parties and also identifies the nature of costs of concentrated ownership.

Are Ex-Ante CEO Severance Pay Contracts Consistent with Efficient Contracting?

Efficient contracting predicts that ex-ante severance pay contracts are offered to CEOs as protection against downside risk and to encourage investment in risky positive net-present-value projects. Consistent with this prediction, we find that ex-ante contracted severance pay is positively associated with proxies for a CEO’s risk of dismissal and costs the CEO would incur from dismissal. Additionally, we show that the contracted severance payment amount positively impacts CEO risk-taking and the extent to which a CEO invests in projects that have a positive net-present-value. Overall, our findings imply that ex-ante severance pay contracts are consistent with efficient contracting.

The Use of Escrow Contracts in Acquisition Agreements

Many private stand-alone firm and subsidiary acquisition deals make use of escrow contracts, whereby a fraction of the total sale proceeds is placed in an escrow account. These contracts give the bidder the opportunity to lay claim on these funds subsequent to the acquisition if the seller fails to meet specific terms of the acquisition agreement or it is found that negative information about the target was hidden from the bidder. We hypothesize that escrow contracts are an efficient contracting mechanism that helps buyers and sellers to manage acquisition-related transaction risk and mitigate information asymmetry problems. Supporting our hypothesis, we show using hand-collected data that the likelihood an escrow contract is used in a private stand-alone firm or subsidiary acquisition is higher when buyer and seller transaction risk or information asymmetry about the value of the target is larger. Further, we document that escrow contracts enable sellers to obtain a higher sale price and that the use of these contracts positively impacts the extent to which a private firm or subsidiary acquisition results in value creation for the bidder.