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Corporate finance
In this section, the reports deal with articles on corporate finance: capital structure, corporate financial policy, IPOs, share buybacks, CEO compensations, stock options, managerial incentives, debt issuance, tax issues, the empirical studies etc..

Are CEOs Rewarded for Luck? The Ones without Principals Are

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Are CEOs Rewarded for Luck? The Ones without Principals Are

Marianne Bertrand and Sendhil Mullainathan

CEO pay is generally viewed in the context of principal of agency models. Simple models of contracting suggest that shareholders will not reward CEOs for observable luck which is defined as changes in firm performance that are beyond the CEO’s control.

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The Structure and Pricing of Corporate Debt Covenants

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The Structure and Pricing of Corporate Debt Covenants


Michael Bradley and Michael R. Roberts


Agency Theory of Covenants (ATC) provides a rationale for the presence of covenants in debt contracts. The central theme of this theory is the conflict of interest between shareholders and bondholders, which results in actions by managers that have a negative impact on the value of the firm’s outstanding debt as well as the total value of the firm. The theory predicts that small, highly levered, volatile firms, with highly liquid assets and significant information asymmetries would be more likely to include covenants in their debt agreements.

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Financial Contracting with Optimistic Entrepreneurs

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Financial Contracting with Optimistic Entrepreneurs:  Theory and Evidence

By Augustin Landier and David Thesmar

This paper by Augustin Landier and David Thesmar examines and documents the implications of the fact that entrepreneurial private benefits can take the form of optimistic expectations in the framework of financial contracting.

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Bottom-Up Corporate Governance

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Bottom-Up Corporate Governance
 
Augustin Landier, David Sraer, David Thesmar

Worldwide in tune with corporate governance practices practioners and regulators are emphasizing the significance of independent board directors .The findings of academic literature regarding the efficiency of independent boards are mixed. Some studies find that independent board of directors seems to pay more attention to corporate performance when it comes to CEO turnover or compensation. Studies have also found out that investor friendly corporate governance provisions boost the price of firms’ assets by making them more vulnerable to takeovers. However studies could not prove that independent boards improve profitability or even the value of corporate assets.

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Stock Market Driven Acquisitions

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by Andrei Shleifer and Robert W Vishny

One of the striking aspects of mergers and acquisitions as a phenomena is the wave pattern of mergers .A number of contextual developments like high economic growth, recovery from an economic downturn, rising stock market and new technologies alter the competitive advantage of firms or open up new markets and trigger mergers.

This study by Andrei Shleifer and Robert W Vishny proposes a theory of acquisition related to the neoclassical theory. In this theory, transactions are driven by stock market valuations of the merging firms. The fundamental assumption of the model is that financial markets are inefficient, so some firms are valued incorrectly. In contrast, managers are completely rational, understand stock market inefficiencies, and take advantage of them, in part through merger decisions. Mergers in this model are a form of arbitrage by rational managers operating in inefficient markets The key ingredients of the model are the relative valuations of the merging firms and the market’s perception of the synergies from the combination. The model explains who acquires whom, the choice of the medium of payment, the valuation consequences of mergers, and merger waves.

The empirical implications of the analysis are discussed in three parts. a) The theory in light of the available empirical evidence on short- and long-run stock returns is examined b) The relationship between the aggregate merger activity and the stock market by considering the three U.S. merger waves in the last 40 years is examined 3) Some of the untested implications of the model is reviewed.

The model results yield the following predictions .1) Acquisitions are disproportionately for stock when aggregate or industry valuations are high, and for cash when they are low 2) The volume of stock acquisition increases with the dispersion of valuations among firms.3) Targets in cash acquisitions earn low prior returns, whereas bidders in stock acquisitions earn high prior returns 4) Bidders in stock acquisitions exhibit signs of overvaluation, such as earnings manipulation and insider selling 5) Long-run returns to bidders are likely to be negative in stock acquisitions, and positive in cash acquisitions.6) Despite negative long-run returns, acquisitions for stock serve the interest of long-term shareholders of the bidder 7) Acquiring a firm in another industry may yield higher long-run returns than a related acquisition. 8)  Management resistance to some cash tender offers is in the interest of shareholders. 9) Managers of targets in stock acquisitions are likely to have relatively short horizons or, alternatively, get paid for agreeing to the deal.

This model of stock market driven acquisitions can be grouped in the emerging field of behavioral corporate finance, which sees corporate policies   such as debt and equity issuance, share repurchases, dividends, and investment as a response to market mispricing. Many empirical studies are consistent with this viewpoint. There appears to be a powerful incentive for firms to get their equity overvalued, so that they can make acquisitions with stock. The benefit of having a high valuation for making acquisitions also points to an incentive to raise a firm’s stock price even through earnings manipulation, which is increasingly becoming prevalent.

Shleifer, Andrei and Vishny, Robert W., "Stock Market Driven Acquisitions" (June 2001). Available at SSRN: http://ssrn.com/abstract=278563 or DOI: 10.2139/ssrn.278563

Also in the Journal of Financial Economics, December 2003.

See also {ln:Investor Sentiment in the Stock Market}.

 


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