Xin Chang

Audit quality, auditor compensation and initial public offering underpricing

We jointly study the impact of audit quality on auditor compensation and initial public offering (IPO) underpricing using a sample of Australian firms going public over the period 1996-2003. We find that quality (Big Four) audit firms earn significantly higher fees than non-Big Four auditors, and audit quality is positively associated with IPO underpricing. The positive relation between audit quality and underpricing is more pronounced for small issues, IPOs underwritten by non-prestigious underwriters, and those that are not backed by venture capitalists. Taken together, our results suggest that quality auditors serve as a signalling device that enhances post-issue market value of equity.

Cross-Sectional Determinants of Post-IPO Stock Performance: Evidence from China

This paper examines the cross-sectional determinants of post-IPO long-term stock returns in China. We document that the aftermarket P/E ratio has the most robust negative association with post-IPO stock returns. The negative relation indicates that the market corrects the aftermarket overvaluation of IPO firms in the long run. Underwriter reputation has a positive effect on post-IPO stock returns, while board size has a negative impact, consistent with the views that reputable underwriters mitigate the information asymmetry in IPO pricing and over-sized boards reduce the effectiveness of corporate governance. However, we find little evidence indicating that the equity ownership structure is significantly associated with post-IPO stock returns.

Managerial Entrenchment and Firm Value: A Dynamic Perspective

We examine the impact of managerial entrenchment on firm value using a dynamic model with firm fixed effects. To estimate the model, we employ the long-difference technique, which is shown by our simulation to deliver the least biased estimates. Based on a large sample of U.S. companies, we document a significantly negative and causal effect of managerial entrenchment on firm value after taking into account omitted variables, reverse causality, and highly persistent endogenous variables. Additional analysis suggests that the causality running from managerial entrenchment to firm value is more pronounced than that for reverse causality.

Monte Carlo Simulations and Capital Structure Research

The evolution of the debt ratio under alternative types of managerial behavior can generate non-standard leverage processes. This creates problems for statistical inference in empirical capital structure research. We argue in this paper that when the data generating process is not standard, a useful way to evaluate the appropriateness of inferences and the empirical methodology is via Monte Carlo simulations that mimic the data generating process under alternative assumptions about managerial behavior. We illustrate with several examples.

Innovation and Productivity Growth: Evidence from Global Patents

We explore the relation between a country’s patents and its economic and productivity growth. Consistent with patents reflecting important innovations, a one standard deviation increase in patent stock leads to a 1.58% (1.52%) elevation in GDP (TFP) growth. Patent stock has a stronger impact on growth than other previously documented determinants, including human capital and capital stock. The effect of private firms’ patents on both GDP and TFP growth are double that of public firms. These results support a growing innovation literature, which uses various patent variables as proxies for firm-level innovation, and contends that private firms are more innovative.

Employees as Creditors: The Disciplinary Role of Pension Deficits in the Market for Corporate Control

This paper examines the disciplinary role of corporate pension deficits in the market for corporate control. We find that companies with larger pension deficits are less likely to engage in diversifying mergers, experience higher merger announcement returns, pay lower premiums to targets, and use a higher percentage of cash in their payment. These results are more evident for acquirers with pension plans that are dominated by actively working employees or collectively bargained by employees. Our findings indicate that corporate pension deficits provide employees with strong incentives to monitor managerial performance and influence managers to make value-enhancing investment decisions.

Multiplicative Risk Prudence

We examine the optimal saving decision of individuals who face a multiplicative risk. An individual is defined to be multiplicative risk prudent if multiplying a pure risk to her future wealth raises her optimal savings. We show that an individual is multiplicative risk prudent if and only if her relative risk prudence uniformly exceeds two. Our result suggests a more restrictive assumption that needs to be imposed on preferences for individuals to be risk prudent.

Credit Default Swaps and Corporate Innovation

We show that credit default swap (CDS) trading on a firm’s debt positively influences its technological innovation output measured by patents and patent citations. This positive effect is more pronounced in firms relying more on debt financing or being more subject to continuous monitoring by lenders prior to CDS trade initiation. Moreover, after CDS trade initiation, firms pursue more risky and original innovations and generate patents with higher economic value. Further analysis suggests that CDSs improve borrowing firms’ innovation output by enhancing lenders’ risk tolerance and borrowers’ risk taking in the innovation process rather than by increasing R&D investment. Taken together, our findings reveal the real effects of CDSs on companies’ investments and technological progress.

Innovation, Managerial Myopia, and Financial Reporting

We examine the impact of accounting conservatism on corporate innovation. We find that firms that exhibit a higher degree of accounting conservatism generate fewer patents. Their patents also generate fewer citations and lower economic benefits. These effects of accounting conservatism on innovation are more pronounced when firms’ need for innovation is higher, when the product development cycle is longer, when managers have higher pay sensitivity to accounting performance, or when managers are more myopic. Overall, our findings suggest that accounting conservatism curbs corporate innovation by exacerbating the effects of managerial myopia.We examine the impact of financial reporting on corporate innovation. We find that firms that exhibit more conservative financial reporting generate fewer patents. Their patents also result in fewer citations and lower economic benefits. These effects of conservative financial reporting on innovation are more pronounced when firms have greater need for innovation, when the product development cycle is longer, or when managers are more myopic. Overall, our findings suggest that conservative financial reporting curbs corporate innovation by exacerbating the effects of managerial myopia. Our results are robust to a host of controls for endogeneity.

External Financing of Last Resort? Bank Lines of Credit as a Source of Long-Term Finance

Based on U.S. 10-K filings, we investigate the use of lines of credit as sources of long-term finance. We find that long-term debt representing drawdowns of credit lines constitutes 11% of a typical listed firm’s book value of assets. Consistent with credit lines serving as liquidity buffers and financing sources of last resort, long-term drawdowns are more likely when other sources of external capital are not easily accessible due to unfavorable external equity and long term bond market conditions. They are also more likely when firms are expected to spend more on capital expenditures and acquisitions (consistent with maturity matching).