Tracy Yue Wang

Corporate Financial Distress and Bankruptcy: A Survey

This survey provides a synthetic and evaluative survey of issues in corporate financial distress and bankruptcy. This area has moved into a public domain as a result of the recent global financial crisis that witnessed failures of many venerable institutions that got rescued by the government. Hence, this survey highlights the resolution mechanisms not only in the private domain but also in the public domain, and it uses corporate finance paradigms to interpret some of the far-reaching developments in financial distress of systemic nature. This surveys theoretical anchor is a framework for the delineation of economic distress and financial distress. The difficulty in disentangling the dichotomy has been a central challenge in the empirics relating to financial distress, corporate bankruptcy, and the use of apparently cost-effective private mechanisms for resolving financial distress. This review devotes ample space on the discussion of conditions under which privatization of bankruptcy succeeds and fails, and the recent empirics on the subject. The review also grapples with the efficiency of bankruptcy codes and regimes, given the frequent usage of court-supervised mechanisms. The fundamental efficiency question about the bankruptcy law is whether the law effectively rehabilitates economically efficient but financially distressed firms and liquidates economically inefficient firms. This survey provides an ongoing debate in law and in economic theories about the efficiency of the U.S. bankruptcy code. Moreover, it examines a linkage between financial distress and corporate governance, which has received growing attention. The review goes beyond the United States to take a look at comparative bankruptcy codes around the world with a focus on bankruptcy reform issues in emerging economies. Finally, this survey takes us into a public domain and systemic financial distress. This is inspired by the recent global financial crisis. Is the standard bankruptcy procedure (e.g., those embedded in Chapters 11 and 7) sufficient for resolving systemic financial distress? The review attempts to answer this question in the context of the recently adopted landmark legislation, particularly the Dodd-Frank Acts Title II (Receivership), which governs the resolution of systemically critical institutions.

CEO Investment Cycles

This paper documents the existence of a CEO Investment Cycle, in which disinvestment decreases over CEO tenure while investment increases, leading to “cyclical�? firm growth in assets as well as in employment. The estimated variation in investment rate over the CEO cycle is of the same order of magnitude as the differences caused by business cycles or financial constraints. This investment cycle appears to reflect CEOs’ preference for investment growth, which leads to increasing investment quantity and decreasing investment quality over time as the CEO gains more control over his board.

CEO Investment cycles

This paper documents the existence of a CEO investment cycle, in which disinvestment decreases over a CEOs tenure, while investment increases, leading to “cyclical” firm growth in assets and employment. The estimated variation in investment rate over the CEO investment cycle is of the same order of magnitude as the differences caused by business cycles or financial constraints. Results from a number of tests generally support the view that the investment cycle is caused by agency problems, leading to increasing investment quantity and decreasing investment quality over time as the CEO gains more control over his board.Received February 17, 2015; accepted October 1, 2015 by Editor David Denis.

Competition and Corporate Fraud Waves

Our paper examines the effect of product market competition on firms’ incentives to misreport financial information to investors. We examine three specific channels through which product market competition can affect the information environment in an industry and individual firms’ incentives to misreport information. We show that the lack of product market sensitivity to individual firm information tends to encourage fraud commission. The use of relative performance evaluation (i.e., industry benchmarking) in managerial retention decisions also encourages fraud. The lack of information collection about individual firms tends to decrease the probability of fraud detection and increase the probability of fraud commission. All three channels are more likely to be present in more competitive industries, implying that fraud propensity is on average higher in those industries. We show that fraud can help explain the predictable busts in competitive industries. Post-boom poor performance in competitive industries is largely concentrated in firms that are likely to have committed fraud during the booms. The underlying reason is twofold. First, fraud propensity is more cyclical in more competitive industries. Second, the consequence of fraud in competitive industries is particularly bad following booms. Our results suggest that the dynamic of fraud can amplify the cyclical fluctuations in the real economy, particularly in competitive industries.

Product Market Interactions and Corporate Fraud

We examine three information channels through which product market interactions in an industry can affect firms’ incentives to misreport financial information to investors. We find that lower product market sensitivity to individual firm’ information and greater use of relative performance evaluation encourage the commission of financial fraud. Less collection of information about individual firms decreases the probability of fraud detection and increases the probability of fraud commission. We also examine dynamic effects of fraud. Our results suggest that, in fragmented industries, fraud can amplify cyclical fluctuations in the real economy.

First Year in Office: How Do New CEOS Create Value?

Career concerns and possible “escalation of commitment” bias imply that replacing key decision makers is often necessary for effective re-optimization on poor prior investment decisions. Thus, examining firm actions immediately post CEO turnover can shed important light on the error correction process in a corporation. We find that the probability that a poorly performing business segment will be terminated almost doubles when the CEO who established it steps down. More generally, corrective actions such as operational downsizing tend to follow CEO turnover, while expansion and other corporate policy changes do not. Management shakeup greatly facilitates the correction process, especially after CEO turnover. The higher intensity of corrective actions and their positive value impact post CEO turnover hold pervasively, whether the pre-turnover firm and industry conditions are good or bad, and even for turnovers due to the death and retirement of the department CEOs. The intensity and value impact of post-turnover corrective actions can also explain the well documented performance difference between new insider and outsider CEOs. Our study suggests that a main source of value creation associated with CEO turnover is the facilitation of error correction and re-optimization. We also identify institutional frictions that can hinder error correction at CEO turnover.

Does Uncertainty About Management Affect Firms' Costs of Borrowing?

Uncertainty about management appears to affect firms’ cost of borrowing and financial policies. In a sample of S&P 1500 firms between 1987 and 2010, CDS spreads, loan spreads and bond yield spreads all decline over the first three years of CEO tenure, holding other macroeconomic, firm, and security level factors constant. This decline occurs regardless of the reason for the prior CEO’s departure. Similar but smaller declines occur following turnovers of CFOs. The spreads are more sensitive to CEO tenure when the prior uncertainty about the CEO’s ability is likely to be higher: when he is not an heir apparent, is an outsider, is younger, and when he does not have a prior relationship with the lender. The spread- tenure sensitivity is also higher when the firm has a higher default risk and when the debt claim is riskier. These patterns are consistent with the view that the decline in spreads in a manager’s first three years of tenure reflects the resolution of uncertainty about management. Firms adjust their propensities to issue external debt, precautionary cash holding, and reliance on internal funds in response to these short-term increases in borrowing costs early in their CEOs’ tenure.