Companies that fail to file a 10-K or 10-Q on time are required by SEC Rule 12b-25 to file a Form NT (NT for non-timely), which provides a narrative explanation for the late filing. No analogous rule exists for earnings announcements, which often precede 10-K or 10-Q filings. For companies that are unable to report earnings by their expected date, therefore, managers face a decision – to keep silent or announce the delay. The SEC has also manifested interest in earnings delays: it recently announced a quantitative model that is expected to supply potential leads to its Division of Enforcement and lists earnings delays as a signal of earnings management.

In our paper, How Do Investors Interpret Announcements of Earnings Delays?, which was recently accepted for publication in the Journal of Applied Corporate Finance, we show that announcements of a delay in the reporting of earnings produce an average one-day abnormal stock return of approximately -6%. So, although announcements of a delay in the reporting of earnings are infrequent, they tend to be associated with a considerable reduction in firm value. In addition, delays precipitated by accounting issues or lacking an explanation result in more negative market reactions than delays related to business events, implementation of new accounting standards, or non-business reasons such as bad weather.

…continue reading: How Do Investors Interpret Announcements of Earnings Delays?

In our paper, Do Investors Understand ‘Operational Engineering’ before Management Buyouts?, which was recently made publicly available on SSRN, we use a sample of management buyouts (MBOs) from 1985-2005 and a matched subsample of post-MBO firms to examine three questions. First, we examine whether firms undertake different types of activities to lower earnings before MBOs. Second, to see whether outside investors and the market understand such ‘operational engineering’ activities, we study the impact of these activities on target firms’ stock returns and MBO deal characteristics including deal premium and likelihood of deal completion. Third, we examine the relation between pre-MBO earnings-reducing activities and the post-MBO operating performance.

With the Great Recession of 2007-2009 exposing deficiencies of the world’s most advanced financial markets, leveraged buyouts (LBOs) have ‘reemerged’ as a solution to the many challenges facing corporate sectors. Unlike publicly listed firms, LBO firms are characterized by concentrated ownership, active monitoring and high leverage. A growing strand of literature shows that LBO firms can create value through ‘financial, operational and governance engineering’ (Kaplan and Stromberg, 2009). In fact, Jensen (1989) argues that LBOs should replace publicly held corporations as the dominant corporate organizational form.

…continue reading: Do Investors Understand ‘Operational Engineering’ before Management Buyouts?

A hard-fought campaign is over and President Obama has been reelected. Should shareholders take notice? In brief, yes. In the paper, Corporate campaign contributions and abnormal stock returns after presidential elections, forthcoming in Public Choice, we explore the stock market performance of top corporate contributors after the elections that brought Bill Clinton and George W. Bush, respectively, to power. In both cases, the top contributors strongly outperformed the market.

We focus on campaign contributions by corporations before a presidential election and their stock market performance afterwards. From a rent-seeking perspective, companies can have an incentive to spend money for presidential candidates. And, as presidential hopefuls need to raise large sums, campaign contributions by companies and business associations are usually a welcome source of funds. After the 2010 Supreme Court ruling in Citizens United against FEC, which grants companies the same free speech rights (and thus spending in the political process) as those accorded to individuals, corporate campaign contributions are likely to become even more important in the future.

…continue reading: Corporate Campaign Contributions and Abnormal Stock Returns after Presidential Elections

In our paper, Insider Trading and Stock Splits, which was recently made publicly available on SSRN, we examine whether stock splits create value to shareholders. Inside traders capitalize on their edge in information. Typically, they buy before good news is released or sell before bad. Insiders have an even greater advantage if they can create news that moves a stock, even when no real news is available. There is strong evidence that this is precisely the strategy that inside traders in Vietnam have employed in recent years. They have purchased stock, and then announced stock splits. As is common in stock markets, these stock splits led to price rises, likely with help from manipulation. Quite suspiciously, all excess returns from split announcements had vanished in 240 trading days. This provides strong evidence that the splits were employed to create a bubble, rather than serving as value-creating corporate events.

Some special features of the Vietnam market, presumably found in markets of other countries that have weak enforcement practices, help to explain its vulnerability to such manipulation. First, in Vietnam, the State Securities Commission (SSC), the government’s agency enforcing the securities laws and regulating the securities industry, imposes strict restrictions and reporting requirements on the trading activity. However, these requirements are not followed and violations are punished, if at all, rarely and lightly. During the eleven-year history of Vietnam’s stock market, only one illegal insider trading case has been criminally prosecuted. Violators in other cases have paid a minimal fine, usually less than 10% of the illegal trading profits. Clearly, inside trading is a profitable activity. Second, Vietnam has many companies that are vulnerable to manipulation because they have substantial state ownership and low capitalizations, and thus few outside shareholders to arbitrage prices into line. (Limited participation by major investment firms in these types of companies and prohibitions on short sales inhibit arbitrage by others.) Management in state-owned firms often represents the state ownership in board of director and investor meetings. However, the government has no effective mechanism to supervise its representatives. Thus management in such firms has significant control power but a small share interest. Managements thus often elect to reward themselves through share trading rather than through creating value for the firms.

…continue reading: Insider Trading and Stock Splits

In our paper, The Credit Crisis Around the Globe: Why Did Some Banks Perform Better?, forthcoming in the Journal of Financial Economics, we investigate the determinants of the relative stock return performance of large banks across the world during the period from the beginning of July 2007 to the end of December 2008. Our study does not focus on why the crisis happened. Rather, it is an investigation of the validity of various hypotheses advanced in the literature and the press as to why banks performed so poorly during the crisis.

Analyses of the crisis that emphasize the fragility of banks financed with short-term funds raised in the money markets are strongly supported by our empirical work, as are analyses that emphasize the role of bank capital. We find that large banks with more Tier 1 capital, more deposits, and less funding fragility performed better. Banks from countries with current account surpluses fared significantly better during the crisis, while banks from countries with banking systems more exposed to the U.S. fared worse. These latter results show that macroeconomic imbalances and the traditional asset contagion channel are related to bank performance during the crisis.

…continue reading: Banks and the Global Credit Crisis

One of the most important ingredients to the process of price discovery in financial markets is the flow of new information, particularly apparent during times of market “crisis,” when it often seems that bad news is being reported simultaneously from multiple sources. While it is not surprising that firms’ news are affected by market and sector conditions (given the correlation of their cash flows), the timing of the announcements is suggestive that these disclosure decisions are not made independently. Indeed, recent empirical work suggests that corporate earnings warnings within an industry are clustered and that firms speed up their warnings in response to poor market conditions. Interestingly, however, such clustering is asymmetric in that good news does not generate such clustering, only bad news does. In the paper, Endogenous Information Flows and the Clustering of Announcements, forthcoming in the American Economic Review, my co-authors (Peter DeMarzo and Ilan Kremer, both of Stanford University) and I provide a theoretical explanation for this asymmetry.

…continue reading: Endogenous Information Flows and the Clustering of Announcements

In the paper, Is Carl Icahn Good for Long-Term Shareholders? A Case Study of Shareholder Activism, which was recently published in the Journal of Applied Corporate Finance, we examine the case of Carl Icahn, whose career as a shareholder activist now spans at least three decades. The increase in activist campaigns by entrepreneurial investors and hedge funds in the past decade has raised considerable debate about their benefits for average shareholders. Although critics have longed charged that the proposals for change by such active investors typically do not increase the longer-run efficiency and values of the targeted companies, more recent studies have provided evidence of success, both in terms of increasing the market value of such companies and achieving at least some of the investors’ expressed objectives.

…continue reading: Is Carl Icahn Good for Long-Term Shareholders?

In the paper, A Test of IPO Theories Using Reverse Mergers, which was recently made publicly available on SSRN, we investigate many of the current theories explaining why IPO returns are large and significantly positive on the issuance date. Reverse mergers are an alternative method to IPOs for going public, and announcement day price reaction to private reverse mergers is comparable to the initial day price reaction to IPOs. In a private reverse merger, a private firm goes public by exchanging their stock for the stock in a public firm. After a reverse merger there are new stockholders, but the private firm’s old stockholders own the majority of public stock in the surviving firm. When we use reverse mergers as an out-of-sample test, most of the theories developed thus far to explain the market’s reaction to IPOs appear to be invalid.

…continue reading: A Test of IPO Theories Using Reverse Mergers

In our paper, Does Shareholder Proxy Access Improve Firm Value? Evidence from the Business Roundtable Challenge, which was recently made publicly available on SSRN, we use a natural experiment to assess the shareholder wealth implications of shareholder proxy access. We study stock returns on October 4, 2010, when the SEC unexpectedly delayed proxy access for U.S. public companies. The October 4 announcement makes a particularly useful event for empirical work because it was both material and unexpected. We identify firms most likely to be affected by proxy access as those with significant ownership by institutions with a history of attempts to change corporate policy (“activist institutions”).

…continue reading: Does Shareholder Proxy Access Improve Firm Value?

In our paper, “Thirty Years of Corporate Governance: Firm Valuation & Stock Returns”, which we recently presented at the Seminar in Law, Economics, and Organization here at Harvard Law School, we introduce a comprehensive corporate governance database starting in 1978 and ending in 1989, which tracks for a sample of approximately 1,000 unique firms whether these firms had any of the 24 corporate governance variables that constitute the G-Index of Gompers, Ishii and Metrick (2003). The computation of this index for the 1990-2006 period is based on data compiled by the IRRC (Investor Responsibility Research Center). The G-Index is a composite of the twenty-four variables, adding one point if any of the provisions is present, where a higher score indicates more restrictions on shareholder rights or a greater number of anti-takeover measures. The E-Index of Bebchuk, Cohen, and Ferrell (2009) is based on six of the twenty-four G-Index provisions. By combining our dataset with the IRRC database which covers the 1990-2006 time period, we obtain comprehensive corporate governance data for the 1978-2006 time period. The importance of having data for the 1978 – 1989 period is underscored by the fact that this period is characterized by widespread corporate governance changes, while after 1990 such changes largely cease. Further, four out of the six E-Index provisions (supermajority merger, classified board, poison pill and golden parachute) experienced dramatic increases in their incidence during the 1978-1989 period, with their incidences remaining relatively stable thereafter. In addition to the introduction of our database, our paper addresses two questions: what is the relationship between governance and firm valuation and what is the relationship between governance and abnormal stock returns over the 1978-2006 time period.

Turning to the central issue of the relationship between governance and firm valuation, we find a robust statistically significant negative association between poor governance and firm valuation over the 1978-2006 period. In particular, the inclusion of firm fixed effects in pooled panel regressions mitigates the endogeneity of firms adopting governance provisions depending on their heterogeneous circumstances. Using both firm and year fixed effects, we document a robust negative and economically meaningful association between the G-Index and Tobin’s Q. This finding survives various robustness checks. The economic magnitude of the association seems meaningful. For example, over the full time period and using firm and year fixed effects, the coefficient of the G-Index equals -0.011 implies that a one standard deviation increase of the G-Index (3.0) is associated with a decrease in firm value of about 3.3%. We find, however, no evidence in support of the “reverse causation” explanation for this negative association in the 1978-1989 period, i.e. that firms with lower firm value tended to adopt more G- and E-Index provisions. In fact, we find that the higher valued firms tended to adopt more provisions, although this relationship disappears once firm and year fixed effects are included. The “reverse causation” may play a (economically very minor) role in explaining changes in firms’ corporate governance in the 1990-2006 time period.

Turning to the relationship between firm valuation and abnormal stock returns, Gompers, Ishii and Metrick (2003) document that firms with higher (lower) G-Index scores have lower (higher) subsequent stock returns. Our longer time period, and the time variation in corporate governance arrangements, enables us to make a number of findings that bear on the literature that developed from this finding. We document that for the full 1978-2007 time period, whether using value-weighted or equally-weighted portfolios, that there are positive, strongly statistically significant positive abnormal returns (using the Fama-French-Cahart four-factor model) associated with going long good corporate governance firms and shorting those with poor governance (whether proxying the quality of corporate governance by the G- or E-Index). Second, we find that abnormal returns for equally-weighted portfolios over the 1978-2007 period is robust to industry-adjusting. However, the abnormal returns of the value-weighted portfolios are not robust to industry-adjusting. Third, our analysis of returns suggest that governance seems to matter most for smaller capitalization stocks and that the association between governance and abnormal returns generally appears to decline over our time period. We interpret our governance-related abnormal return findings as consistent with ‘learning,’ i.e., investors learned gradually over time the importance of good governance, which is reflected in the fact that abnormal returns were largest in the beginning of our time period and then generally declined thereafter.

The full paper is available for download here.