Arcot, Sridhar
Rao (2007) Essays in Corporate Finance.
PhD Thesis, LSE-UK.
This thesis is divided into three chapters. Even
though the three chapters have different aims, they all concerned with
corporate finance. The first chapter concerns venture capital and chapters two
and three deal with corporate governance. The first chapter deals with a
special kind of security used in venture capital contracting -participating
convertible preferred stock. Participating Convertible Preferred (PCP) stock is
similar to convertible preferred stock but comes with participation rights.
Participating rights allow the holder to participate in earnings along with
common shareholders. PCPs play an important role in venture capital exits. The
two major forms of exit observed in venture capital are initial public
offerings (IPOs) and trade sale. Typically, a PCP stake is converted into
common equity during an IPO exit but not converted in case of trade sales. We
develop a model where VCs can signal the quality of their venture by costly
conversion. We show that PCPs have the required features to implement the
signaling mechanism. VCs signal by converting their PCP stake into common
equity, when they exit from the venture and in the process give up some of
their cash flow rights. We show that this can also help in alleviating the
problem of entrepreneurial effort. Finally, we derive empirical implications
for the two forms of exit. The second and third chapters are concerned with
corporate governance. Firstly, we examine the effectiveness of the "comply
or explain" approach to corporate governance in the UK. Using a unique database
of 245 non-financial companies for the period 1998 - 2004. we perform a
detailed analysis of both the degree of compliance with the provisions of the
corporate governance code of best practice (Combined Code), and the
explanations given in case of non-compliance. We rank the quality of
explanations based on their information content. We find an increasing trend of
compliance with the provisions of the Combined Code, but also a frequent use of
standard and uninformative explanations when departing from best practice. We
then use this data to analyze the extent of moral hazard problem in different
groups of companies and the role of monitoring in alleviating it. The third
chapter extends the above analysis. We use the dataset to identify well-
governed companies by accounting for heterogeneity in their governance choices
and investigate its association with performance. We find that companies that
depart from governance best practice because of genuine circumstances
outperform all others and cannot be considered badly-governed. On the contrary,
we find that mechanical adherence to best practice does not always lead to
superior performance. We thus argue that flexibility in corporate governance
regulation plays a crucial role, because companies are not homogenous entities.
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