In September 2008, the U.S. Securities and Exchange Commission (SEC) temporarily banned most short sales in nearly 1,000 financial stocks. In our paper, Shackling Short Sellers: The 2008 Shorting Ban, forthcoming in the Review of Financial Studies, we examine the ban’s effect on market quality, shorting activity, the aggressiveness of short sellers, and stock prices. For the most part, financial economists consider short sellers to be the “good guys,” unearthing overvalued companies and contributing to efficient stock prices. Even as late as the summer of 2007, regulators in the United States seemed to share this view, as they made life easier for short sellers by repealing the New York Stock Exchange’s (NYSE’s) uptick rule and other short-sale price tests that had impeded shorting activity since the Great Depression (see Boehmer, Jones, and Zhang (2009) for an analysis of this event). However, short sellers are often the scapegoats when share prices fall sharply, and regulators in the United States did a sharp U-turn in 2008, imposing tight new restrictions on short sellers as the financial crisis worsened. In September 2008, the U.S. Securities and Exchange Commission (SEC) surprised the investment community by adopting an emergency order that temporarily banned most short sales in nearly 1,000 financial stocks. In this paper, we study changes in various liquidity measures, the rate of short sales, the aggressiveness of short sellers, and in stock prices before, during, and after the shorting ban. We compare banned stocks to a control group of nonbanned stocks to identify these effects.

…continue reading: Shackling Short Sellers: The 2008 Shorting Ban

There are two main sources of confusion in the public corporate governance debate. One is the confusion about the role of public policy in corporate governance. The other is a lack of empirical knowledge among commentators about the corporate landscape and the way that today’s stock markets influence the conditions for exercising long term and value creating corporate governance. This paper tries to mitigate some of this confusion and to increase awareness in both respects.

In terms of public policy it is important to understand that the general corporate governance discussion usually takes place on two different levels. And both are legitimate. One is concerned with the everyday workings of individual companies: how they organize their internal procedures, staff their company organs and build their corporate culture. Much of this is unique to the company in question. The choices to be made are often a matter of business judgment and are seldom in a domain where policy makers and regulators have any specific expertise.

…continue reading: Who Cares? Corporate Governance in Today’s Equity Markets

Is there a competition for corporate charters in Europe? Corporate and comparative scholars have been discussing the similarities between the Delaware-led competition in the United States with the slowly emerging market for corporate legal forms in the European Union.

In my recent paper, Corporate Mobility in the European Union – a Flash in the Pan? An empirical study on the success of lawmaking and regulatory competition, recently made available on SSRN, I provide new empirical evidence on the development of the market for incorporations in Europe, and on the impact of national law reforms.

Since the seminal Centros case in 1999, European entrepreneurs have been allowed to select foreign legal forms to govern their affairs. While much academic effort has been spent to evaluate the early market reactions to this case-law, effectively opening up the European market, relatively little attention has been devoted to subsequent developments. This is surprising, since the various national lawmakers’ responses to the wave of entrepreneurial migration offer a rare glimpse on the effects of regulatory competition and subsequent business’ reaction, as well as on the relevance and effects of lawmaking and regulatory responses to market pressure.

…continue reading: Corporate Mobility and Regulatory Competition in Europe

In our paper, Financial Reporting Quality of U.S. Private and Public Firms, forthcoming in The Accounting Review, we use a new database that contains accounting data for a large sample of U.S. private firms and provide an investigation of financial reporting quality (FRQ) of U.S. private versus public firms. Private firms are an important source of economic growth in the United States and elsewhere. In the aggregate, non-listed firms have about four times more employees, three times higher revenues, and twice the amount of assets than do listed firms (Berzins, Bøhren, and Rydland 2008). In 2008, Forbes reported that the 441 largest private companies in the United States accounted for $1.8 trillion in revenues and employed 6.2 million people. Despite their obvious importance to the U.S. economy, there is limited research on private firms in general, and almost no prior research related to the financial reporting quality (FRQ) of such firms.

…continue reading: Financial Reporting Quality of U.S. Private and Public Firms

In my paper Inside Debt and Mergers and Acquisitions, forthcoming in the Journal of Financial and Quantitative Analysis, I examine the link between CEO inside debt holdings and corporate risk-taking in M&A activities and its implications for bondholder, shareholder, and firm value. M&As are among the largest and most readily observable forms of corporate investment, which tend to intensify the inherent conflict of interests among shareholders, bondholders, and managers. Manager’s pension benefits and deferred compensation are debt-like compensation since they represent fixed obligations by the company to make future payments to corporate insiders/managers (hence, these are usually referred to as “inside debt”). Inside debt is expected to align manager interests with those of external debtholders and alleviate managers’ risk-taking incentive since inside debt is typically unsecured and unfunded, and if the firms go bankrupt, managers have equal claims as those of other unsecured creditors. Therefore, M&As provide a unique ground for testing the potential effects of debt-like compensation on corporate investment and financing strategies and the implications of the stakeholders’ interests.

…continue reading: Inside Debt and Mergers and Acquisitions

A recent book by Josh Lerner and a recent article in the Journal of Public Economics has asserted that government venture capital programs in Europe have displaced or crowded out private venture capital. The result of work such as this has been to place pressure on government bodies around the world to remove or replace their existing governmental programs. In the aftermath of the financial crisis, venture capital markets around the world themselves have been in crisis. So, it is particularly timely to address the issue of whether or not government venture capital programs in regions such as Europe really have in fact crowded out private venture capital programs.

As pointed out in this Economist article and in my recent commentary and my review article, the idea that government programs crowding out private venture capital in Josh Lerner’s book and in the Journal of Public Economics is based on empirical measures that are completely flawed. The empirical tests supporting crowding out are based on methodologies that rank the Austrian and Hungarian venture capital markets as being the best in the Europe, and the U.K. venture capital market as being the worst in Europe (I am not kidding).

…continue reading: Measuring the Effectiveness of Public Policy Towards Venture Capital

In our paper, Looking in the Rear View Mirror: The Effect of Managers’ Professional Experience on Corporate Cash Holdings, which was recently made publicly available on SSRN, we study the role of managers’ professional experience in financial decision making, focusing on one of the most debated corporate policies in recent years – cash savings.

We focus our analysis on corporate cash policies because firms hold unprecedented, increasing levels of cash. In 1980, firms held $234.6 billion (in 2011 dollars) in cash, amounting to 12% of assets. By 2011, the amount of cash grew to $1,500 billion, or 22% of assets. The predominant approach to understanding corporate cash holdings is the precautionary savings motive. According to this motive, firms hold liquid assets to hedge against future states of nature in which adverse cash flow shocks, coupled with external finance frictions, may lead to underinvestment or default. While prior research shows that the precautionary savings motive explains much of the cash policy of firms, some suggest that managers are overly conservative in their decision to hold high levels of cash.

Motivated by psychological evidence, which shows that past experience affects individual decision-making, we argue that managers may behave conservatively because they experienced financial difficulties in their professional career. To test this hypothesis, we collect detailed data on managers’ employment histories and construct four measures of experience at firms that faced financial difficulties. These measures capture financial constraints and adverse shocks to cash flows and stock returns. To separate firm and CEO effects, the measures are based on prior employment at other firms.

…continue reading: The Effect of Managers’ Professional Experience on Corporate Cash Holdings

In our paper, Bias and Efficiency: A Comparison of Analyst Forecasts and Management Forecasts, we compare the forecast characteristics of analyst forecasts and management forecasts. Frequently, analysts and managers provide similar type of information to investors, namely forecasts. Since managers and analysts have different incentives and different information sets, we empirically test whether those differences are manifested in their forecast characteristics. Specifically, we compare the bias, a systematic deviation of management and analyst EPS forecasts from the actual realized EPS, and efficiency, the ability of managers and analysts to incorporate prior publicly available information in their forecasts.

When comparing management forecasts and analyst forecasts, it is important to consider the implications of the difference in incentives and information available to analysts and managers. Since prior literature documents an optimistic bias in analyst forecasts, we expect that, given management incentives and cognitive biases, management forecasts will be at least as biased as analyst forecasts. In addition, since companies’ managers are exposed to private information, we expect management forecasts to better incorporate prior available information.

We find several striking results. First, we find that prior stock returns do not predict management forecast errors while they predict analyst forecast errors. Furthermore, while we find an optimistic bias in a broad sample of both management forecasts and analyst forecasts, the optimistic bias in analyst forecasts disappears in months in which management forecasts are issued. The bias is still apparent for these firms when managers do not provide forecasts.

…continue reading: Bias and Efficiency: Comparison of Analyst Forecasts and Management Forecasts

Variation in firms’ corporate governance is an important topic of debate in the governance literature. One of the main questions is whether weak and/or incomplete public institutions in emerging economies dictate the governance quality of local firms. The most recent scholarship on the subject has generally argued that country characteristics strongly predict governance (Krishnamurti, Sevic, and Sevic (2006)). Doidge, Karolyi, and Stulz (2007) find that country variables explain 39-73% of governance variance while firms explain only 4-22%. Moreover, they argue that firm characteristics explain almost none of the governance variation in “less-developed countries.” In our paper, Which Does More to Determine the Quality of Corporate Governance in Emerging Economies, Firms or Countries?, which was recently made publicly available on SSRN, we offer a new understanding of firm and country characteristics’ contribution to emerging economies’ governance.

…continue reading: Firms, Countries, and Quality of Corporate Governance in Developing Countries

The Basel Committee has made significant revisions to the Basel III Liquidity Coverage Ratio (“LCR”). The revised LCR standards allow banks to use a broader range of liquid assets to meet their liquidity buffer and relax some of the run-off assumptions that banks must make in calculating their net cash outflows. The revised standards also clarify that banks may dip below the minimum LCR requirement during periods of stress. The Basel Committee expects national regulators to implement the LCR on a phased-in basis beginning on January 1, 2015. The Basel Committee will also press ahead with its review of the Basel III Net Stable Funding Ratio (“NSFR”).

While the Federal Reserve has expressed its intent to implement some version of the LCR and other Basel III liquidity standards in the United States, the scope, timing and nature of U.S. implementation is currently unclear. This memorandum and the accompanying tables explore key aspects of the revised LCR standards and issues relating to their implementation in the United States.

…continue reading: Basel Committee Revises Basel III Liquidity Coverage Ratio