Previous empirical studies on the benefits of “good” governance perform comprehensive and detailed analyses of corporate governance structures and regulations, but make no reference to the board’s intellectual capital, or knowledge, thereby substantially limiting the understanding of the role of corporate governance in organizational value creation. In the paper, Intellectual Capital, Corporate Governance, and Firm Value, which was recently made publicly available on SSRN, I address this gap.

I use the number of scientists on the board of directors as a proxy for the board’s intellectual capital and investigate the impact of directors-scientists on firm value in the population of publicly-listed U.S. firms. I expect a positive contribution of scientists to firm value in knowledge-intensive sectors, such as information technology, pharmaceuticals and chemical products, characterized by significant R&D activities, product innovation, and long-term projects. Boards with strong scientific expertise are more likely to make effective strategic R&D decisions and subsequently monitor these decisions effectively than boards with limited scientific experience. Directors with scientific background are also expected to have a longer decision horizon than other directors; the boards with strong scientific expertise are therefore more likely to select long-term projects that maximize the firm’s net present value instead of the projects that focus on current profits.

…continue reading: Intellectual Capital, Corporate Governance, and Firm Value

In our paper, External Networking and Internal Firm Governance, forthcoming in the Journal of Finance, we use panel data on S&P 1500 companies to identify external network connections between directors and CEOs. We observe network connections stemming from shared external board seats, prior employment in other firms, education, or charitable and leisure activities. We test whether these ties affect firm policies and performance.

A well-functioning board of directors provides both valuable advice to management and a check on its policies. An effective director should not just rubber stamp management’s actions, but should take a contrarian opinion when management’s proposals are not in the interest of the firm’s shareholders. Thus, it is important to identify director characteristics which affect their ability or willingness to bring valuable new information into the firm and to properly perform their monitoring role. Our results suggest that having directors with external network ties to the CEO may undermine the effectiveness of corporate governance.

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In our paper, The Party’s Over: The Role of Earnings Guidance in Resolving Sentiment-driven Overvaluation, which was recently made publicly available on SSRN, we show that an important link between investor sentiment and firm overvaluation is optimistic earnings expectations, and that management earnings guidance aids in resolving sentiment-driven overvaluation. Understanding the underlying process linking investor sentiment to overvaluation provides insight into investor psychology and difficult-to-predict bull and bear markets. Currently, there are multiple possible explanations for why uncertain stocks are overvalued during high sentiment periods. For example, investors may exhibit different preferences, such as reduced risk aversion, during high sentiment periods, which would lead them to overpay for stocks with high valuation uncertainty. Under this scenario, in subsequent months, a general shift in investing trends or psychology would lead to the gradual decline in prices. Alternatively, investors may engage in a more detailed thought process that involves unrealistic expectations of future firm earnings, where there is more potential to overestimate future earnings for uncertain firms. Under this scenario, in subsequent months, revisions in earnings guidance or other earnings news released by the overvalued firms should lead to predictable price declines. We focus on the second explanation, examining management earnings guidance to test the extent to which the correction of earnings expectations mitigates the overvaluation problem.

…continue reading: The Role of Earnings Guidance in Resolving Sentiment-driven Overvaluation

In our paper, Employee Stock Ownership Plans: Employee Compensation and Firm Value, which was recently made publicly available on SSRN, we investigate whether adopting a broad-based employee stock ownership plan enhances productivity by improving team incentives and co-monitoring. That is, does employee capitalism work? If so, how are gains divided between shareholders and employees?

We find that small ESOPs increase productivity. Unlike Jones and Kato (1995) on Japanese ESOPs, our evidence of productivity gains is based on the effects on two main beneficiaries of such gains: employees and shareholders. Because our evidence indicates both stakeholders gain from adopting small ESOPs, we infer employee share ownership increases the size of the economic pie by improving worker productivity.

This causal interpretation is substantiated by our evidence on how the division of productivity gains is related to employee mobility within an establishment’s industry and location of work place. We find that when labor mobility increases, increasing workers’ bargaining power vis-à-vis shareholders’, employees’ share of gains increases and stockholders’ share decreases.

…continue reading: Employee Stock Ownership Plans

In our forthcoming Journal of Finance paper, Overconfidence, Compensation Contracts, and Capital Budgeting, we study the interaction of managerial overconfidence and compensation in the context of a firm’s investment policy. To do so, we develop a capital budgeting problem in which a manager, using his information about the prospects of a risky project, must decide whether his firm should undertake the project or drop it in favor of a safer investment alternative.

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In the paper, Creditor Control Rights, Corporate Governance, and Firm Value, which was recently made publicly available on SSRN, we provide evidence that creditors play an active role in the governance of corporations well outside of payment default states. By examining the SEC filings of all U.S. nonfinancial firms from 1996 through 2008, we document that, in any given year, between 10 percent and 20 percent of firms report being in violation of a financial covenant in a credit agreement.

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In a recent M&A Update we addressed the practical challenges of using earnouts in private company M&A to bridge the final valuation gap in sale negotiations. An equally daunting set of obstacles applies to the implementation of the public M&A version of earnouts — Contingent Value/Payment Rights (CVRs). We use the term CVRs to refer to a variety of techniques that provide public company target shareholders with valuation protection or additional consideration based on post-closing events. This protection can take several forms:

…continue reading: CVRs — A Bridge Too Far?

In the paper, On the Optimality of Shareholder Control: Evidence from the Dodd-Frank Financial Reform Act, which was recently made publicly available on SSRN, we use three events involving the adoption of the SEC’s “proxy access” rule in 2010 as natural experiments to test the effects of allocating more direct control to shareholders on firm value. Of particular importance, all three events contained information that was plausibly surprising to the market. We use information about proposed changes to specific aspects of the rule, along with variation in stock ownership by known activist institutional investors, to identify the impact of shocks to control rights on shareholder value.

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Valuation is usually the fundamental issue in getting to agreement on a bank deal. Persistent high unemployment, the housing slowdown and significant and changing government policy have combined to exacerbate uncertainty over future performance of bank assets. This can create challenges for parties to get to agreement on how to value a bank’s balance sheet and accordingly on a deal price.

Some recent bank deals have brought back traditional solutions, seen in prior generations of bank deals, to bridge the valuation gap. To account for portfolio performance in the period between signing and closing, parties to recent deals have included purchase price adjustments tied to a target’s loan portfolio and/or shareholders’ equity. In other deals, the buyer has negotiated the ability to exit the deal if the target’s loan portfolio deteriorates beyond a specified level, or the target bank suffers a decline in core deposits below a threshold level – offering a potentially more objective exit trigger than the traditional “material adverse effect.”

…continue reading: Value Judgments: Tried and True Techniques Bridge Divergent Valuations

In the paper, Earnings Quality and International IPO Underpricing, forthcoming in The Accounting Review, we examine the impact of country-level earnings quality on IPO underpricing. When firms convert from private to public ownership through an initial public offering (IPO), they typically sell shares at a price that is below the market price that prevails once secondary market trading begins. This “underpricing” cost, which is prevalent in virtually every stock market around the world, is one of the largest costs that firms must bear when going public. Underpricing also varies widely between countries.

…continue reading: Earnings Quality and International IPO Underpricing