Vikas Mehrotra

Corporate Focus and Value Creation Evidence from Spinoffs

We test a prediction from the corporate focus literature that cross-industry spinoff distributions, where the continuing and spunoff units belong to different two-digit Standard Industry Classification codes, create more value than own-industry spinoffs. Our results indicate significant value creation around the announcement of cross-industry spinoffs only. We then provide evidence on whether the value creation comes from operating performance improvements, or bonding benefits, or both, where bonding refers to a pre-commitment by managers to avoid cross-subsidizing relatively poor performing units within the firm. We find a significant improvement in operating performance for cross-industry spinoffs, and none for own-industry cases. We do not find strong evidence of bonding to explain spinoff-related value creation. Further, the operating performance improvement is associated with the continuing rather than the spunoff entity, consistent with the hypothesis that spinoffs create value by removing unrelated businesses and allowing managers to focus attention on the core operations they are best suited to manage.

Must Love Kill the Family Firm? Some Exploratory Evidence

Family firms depend on a succession of capable heirs to stay afloat. If talent and IQ are inherited, this problem is mitigated. If, however, progeny talent and IQ display mean reversion (or worse), family firms are eventually doomed. Since family firms persist, solutions to this succession problem must exist. We submit that marriage can transfuse outside talent and reinvigorate family firms. This implies that changes to the institution of marriage—notably, a decline in arranged marriages in favor of marriages for “love”—bode ill for the survival of family firms. Consistent with this, the predominance of family firms correlates strongly across countries with plausible proxies for arranged marriage norms.

Entrepreneurship and the Family Firm

Schumpeter views founding a family business dynasty as a key reward for entrepreneurship. However, inherited corporate control restricts the talent pool from which the business’s subsequent leaders are drawn, exposing a fundamental time inconsistency in Schumpeter’s thesis – what is good motivation ex ante, results in a higher cost of new entry ex post. Absent explicit mechanisms to inhibit blood successions, family loyalty perseveres in broad swathes of the world, particularly where formal institutions are weak, so groups of firms controlled by members of a family can coordinate strategies where independent firms cannot. Big Push development requires extensive inter-firm coordination, perhaps explaining the importance of large family business groups in emerging markets and economic history. Completed development erodes such advantages, so powerful business families might employ rent-seeking to slow or stop the pace of development to preserve a favorable status quo. Major crises that weaken such entrenched elites appear important to achieving and sustained high-income status and growth by creative destruction.

Changes in Management Ownership and the Valuation Effects of Equity Offerings

Seasoned equity issues trigger share price declines, and this is usually interpreted as evidence of signalling. We find that seasoned equity issues also typically result in much lower managerial ownership in U.S. firms. Jensen and Meckling (1976) predict a stock price decline when managerial ownership falls. We conduct several tests to distinguish agency explanations form signalling explanations, and conclude that both effects are present.

Competition and Market Structure of National Association of Securities Dealers Automated Quotations

In this paper, we study the relation among market structure, trading costs, and competition in National Association of Securities Dealers Automated Quotations (NASDAQ). In particular, we address the following questions: Do NASDAQ dealers exercise market power and extract economic rents in setting bid-ask spread? How persistent is the market power of dominant dealers? Our estimate of the rent is approximately ¢8.76, or 0.54% of stock price. The half-life of the persistence of this rent is approximately 20 months for the entire sample, while the half-life of younger stocks tend to be shorter than those of more mature stocks. Our result supports Schultz: NASDAQ dealers make markets only for stocks where they have competitive advantages in accessing order flow and in information. It might take a while before a market maker poses effective competition to existing dominant market makers. In the meantime, incumbent market makers are able to exercise market power and appear to earn abnormally large profits.

Cross-Shareholding, Returns and Entrenchment Behaviour Among Japanese Firms, 1990-2008

This paper is concerned with the nature of ownership, returns and corporate performance and investment behavior in the ‘post-bubble’ environment surrounding Japanese firms. Market participants have feared that ‘unwinding’ of cross-shareholding would have negative consequences for returns, on the assumption of a downward sloping demand curve for equities. We examine whether this is the case, but more importantly consider what consequences the changing nature of ownership might have for firm behavior. Interestingly, while overall unwinding of cross-holdings is indeed consistent with downward sloping demand curves for equities, controlling for endogeneity biases and focusing on holdings by financial institutions, we find the opposite result. We interpret this as evidence that at least one facet of the traditional ‘main-bank system’ of Japan is alive and well- namely that increased bank holdings can be viewed as intervention by banks in assistance of financially distressed firms. In terms of firm behavior, our results are consistent with the literature on entrenchment. That is, firms that are more closely cross-held by other firms (financial or non-financial) tend to invest more heavily in capital stock and research and development. This is consistent with the notion that firms that are less vulnerable to takeover tend to spend and invest more than their more takeover prone counterparts.

Disappearing Dividends: A Rational Explanation and Implications

This paper provides risk and information asymmetry-based explanations of the disappearing dividend puzzle first documented by Fama and French (2001). Dividends serve as signaling device and, under models of dividend signaling under information asymmetry, the cost of signaling increases with volatility of firms’ cash flows. Declining propensities to pay dividends imply that information asymmetries have become lower and/or cost of signaling has increased. We find evidence consistent with both. First, we find abnormal returns associated with dividend initiations have been declining over the years. We attribute this decline to increasing stock price informativeness: as stock prices become more informative, dividends contain lower information content, which in turn result in lower price reactions. Consistent with this, we find that firms with more informative stock prices are less likely to pay dividends. In addition, we also show that firms with higher (lower) information asymmetries are more (less) likely to pay dividends. Second, we find that firms with higher (lower) cash flow volatilities are less (more) likely to pay dividends. Our risk and information asymmetry proxies could explain a significant portion of the disappearing dividend trend.

Competition and Market Structure of NASDAQ

In this paper, we study the relation among market structure, trading costs, and competition in NASDAQ. In particular, we address the following questions: Do NASDAQ dealers exercise market power and extract economic rents in setting bid-ask spread? How persistent is the market power of dominant dealers? Our estimate of the rent is approximately 8.76¢, or 0.54% of stock price. The half-life of the persistence of this rent is approximately 20 months for the entire sample, while the half-life of younger stocks tend to be shorter than those of more mature stocks. Our result supports Schultz (2002): NASDAQ dealers make markets only for stocks where they have competitive advantages in accessing order flow and in information. It might take a while before a market maker poses effective competition to existing dominant market makers. In the meantime, incumbent market makers are able to exercise market power and appear to earn abnormally large profits.