Three Essays On Financial Policy Of A Firm

Larkin, Yelena. 2012. Three Essays On Financial Policy Of A Firm. Doctoral Dissertation, Cornell University.

The first chapter of the dissertation analyzes how characteristics of a firm's brand affect financial decisions by using a proprietary database of consumer brand evaluation. It demonstrates that positive consumer attitude alleviates financial frictions by providing more net debt capacity, as measured by higher leverage and lower cash holdings. Brand perception reduces the overall riskiness of a firm, as strong consumer evaluations translate into lower future cash flow volatility, higher Z-scores, and better performance during recession. Creditors favor strong brands by demanding lower yields on corporate public bonds. The results are more pronounced among small firms and non-investment grade bonds, contradicting a number of reverse causality and omitted variables explanations. The second chapter develops a framework that shows how exactly market timing and trade-off forces coexist. The idea is that market timing benefits dominate trade-off costs when firms are close to their target leverage, but become offset by the rebalancing considerations when firms are farther away. Two sets of empirical results support the validity of the framework. First, the sensitivity of equity issuances to past stock performance is the highest among firms close to the target leverage. Second, the long-run performance of equity issuers is also a function of their deviation from target leverage. The lower the leverage of issuing firms is relative to the target, the worse their after-issuance returns are, consistent with higher market timing incentives compared to other issuers. The third chapter studies whether investors value dividend smoothing stocks differently by exploring the implications of dividend smoothing for firms' expected returns and their investor clientele. First, it demonstrates that dividend smoothing is associated with lower average stock returns in both univariate and multivariate settings. Some of this return differential can be attributed to lower risk, captured by return comovement among high (low) smoothing firms. Second, the chapter shows that institutional investors, and specifically, mutual funds, are more likely to hold dividend smoothing stocks. Last, firms that smooth their dividends issue equity more frequently. Together, these results are consistent with the role of dividend smoothing in mitigating the impact of agency conflicts on the cost of capital.

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Essays in Corporate Finance

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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An Essay in Corporate Finance: Managerial Incentives, Financial Constraints and Ownership Concentration.

Protopapa, Marco (2009) An Essay in Corporate Finance: Managerial Incentives, Financial Constraints and Ownership Concentration. PhD Thesis, LSE-UK.

I investigate the role of internal discipliners in the form of optimal equity ownership for the purpose of committing the management to the pursuit of shareholder value in the presence of separation between ownership and control. By rooting the conflicts of interests between managers and shareholders upon the control of internal funds, a simple model allows to analyze the link between profit uncertainty, growth options and decisional powers. I derive implications for the optimal degree of equity concentration, the effect of firm fundamentals on the allocation of income and control rights, and the pay for luck phenomenon. First, optimal equity ownership is positively related to the short-term performance of the firm and negatively related to both its growth options and riskiness. Second, optimal equity ownership is negatively related to the probability of the firm being financially constrained, in the sense that the level of desired investment exceeds internally available resources. Furthermore, I also show that straight debt alone does not implement the second best, in absence of a large shareholder. Finally, I show that, in presence of financial constraints, pay for luck is associated in equilibrium to a lower optimal degree of ownership concentration. In other words, pay for luck and looser governance, as implemented by the internal discipliner of equity concentration; emerge as the equilibrium result of a constrained incentive problem.

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Essays in Macroeconomics and Corporate Finance.

Perez, Ander (2008) Essays in Macroeconomics and Corporate Finance. PhD Thesis, LSE-UK.

This thesis consists of three essays at the intersection of macroeconomics and corporate finance. The broad theme that links the three chapters is the study of how endogenous borrowing constraints that affect firms and financial intermediaries influence aggregate investment. In Chapter I, the existing theoretical framework studying how financial constraints in firms may make economies more sensitive to shocks (the 'financial accelerator') is extended to take account of firms' precautionary investment behavior when they anticipate future liquidity constraints. This behavior is at the source of a powerful amplification mechanism of shocks, and is also able to account for the documented dynamics of the composition of investment across the business cycle: in particular how risky, illiquid investment as a share of total investment fluctuates both at the firm and at the aggregate level. Chapter II studies how the public supply of liquidity affects the private creation of liquidity by firms (inside liquidity), and how this interacts with firms' demand for liquidity to influence investment and capital accumulation. The conditions under which government debt may boost or reduce private investment are shown to depend on three channels: (1) a crowding-in effect, by enhancing aggregate liquidity, (2) a crowding-out effect, by reducing the collateral value of entrepreneurial assets and (3) a redistributive effect. The model also shows how a production economy with endogenous liquidity can help resolve some important asset pricing puzzles. Finally, the business cycle properties of the model are studied. Chapter III shows how recent developments in financial markets may have made economies less vulnerable to banking crises as they widen access to liquidity, but by relaxing financial constraints facing financial intermediaries, they imply that, should a crisis occur, its impact could be more severe than previously. These effects may be reinforced by greater macroeconomic stability. Finally, financial intermediaries are shown to under-insure and over-borrow from a constrained-efficient viewpoint.

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Empirical Studies on Financial Intermediation and Corporate Policies

This thesis investigates the impact of financial intermediaries on capital structures, corporate governance structures and the performance of firms. Throughout the world, financial intermediaries have powerful and influential positions in financial markets. The intermediaries have both the incentives and the means to influence the financial policies of the firms and initiate governance changes in underperforming management teams. On the contrary, investors have limited ability to exercise control, even though they provide debt and equity financing to firms. This thesis comprises four empirical studies. In the first study, the author analyses the impact of information asymmetry between the U.S. firms and their lenders on firms’ choice of debt maturity. The second study shows how firm-bank relations in the form of shared board positions and equity ownerships influence capital structure decisions of Dutch firms. The following examination in the third study of Dutch managerial and supervisory board turnover further demonstrates the strong position of financial institutions in disciplining underperforming management. The fourth and final analysis in this thesis relates the dispersion in analyst forecasts to the differences in investor opinions and investigates how the heterogeneity of investor beliefs affects prices of European stocks.

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