The Economics of Legal Uncertainty

Authors: Jiwon Lee, David Schoenherr, Jan Starmans

Abstract

In this paper, we study how legal uncertainty affects economic activity. We develop a parsimonious model with different types of legal uncertainty that reduce economic activity and that can be classified as idiosyncratic (i.e., diversifiable) or systematic (i.e., nondiversifiable). We test the model’s predictions using microlevel data on bankruptcy judges and corporate loans from Korea. Exploiting differences in judges’ debtor-friendliness combined with random judge assignment to restructuring cases and exogenous judge rotations in the judicial system, we compute time-varying court-level measures of debtor-friendliness and legal uncertainty. We first document that firms are more likely to file for restructuring in more debtor-friendly courts with lower legal uncertainty. We further show that legal uncertainty reduces the size of credit markets. The effects are driven by high-risk firms that are most sensitive to bankruptcy law. Examining interest rates, we find that credit supply is relatively more sensitive to systematic than to idiosyncratic sources of legal uncertainty relative to credit demand.

Outside Director Tenure Limit: The 2020 Korean Experiment

Authors: Minjae Kim, Sojung Kim, Woochan Kim

Abstract

This study investigates the impact of limiting outside directors' tenure on firms' market valuation and the voting behavior of these directors. We analyze the new rule implemented by the Korean government in 2020, which bars the reappointment of outside directors who have served more than six years at a particular firm and nine years within a specific business group. Our findings support the hypothesis that longer tenures entrench outside directors rather than enhance their experience. Firstly, the stock market reacts favorably to the announcement of the new rule for firms with long-tenured outside directors (LTODs) who are influenced by the tenure restriction. The effect is more pronounced in poorly governed firms. Secondly, outside directors dissent more frequently against management after the rule change. This occurs through the removal of LTODs who previously dissented less, the election of new outside directors who dissent more, and an increase in dissent rates among second-term outside directors.

The Global ESG Stewardship Ecosystem

Authors: Tim Bowley, Jennifer Hill

Abstract:

There is growing interest in the phenomenon of international or transnational corporate law. This development is marked by its complexity. It involves multidirectional processes of law development and transmission resulting from the initiatives of numerous state, international and private actors. Transnational developments are driving another remarkable feature of contemporary corporate governance practice – namely, the dramatic rise of stewardship concerning ESG issues, including climate change. These developments are underpinned by what our paper calls the “global ESG stewardship ecosystem”. This ecosystem involves a transnational network of different non-state actors, including globally-active institutional investors, international institutions and agencies, non-governmental organizations, investor networks and representative bodies, as well as the various service providers that support the governance activities of institutional investors. Although the “global ESG stewardship ecosystem” comprises a myriad of actors, institutional investors are at its core. They are critical to norm development and goalsetting, network creation and coordination and transmission of ESG stewardship. This ecosystem exerts significant influence, shaping ESG investor stewardship, not only “on the books”, but also “on the ground” in markets around the world, including developing markets. Our paper provides two important contributions to contemporary corporate governance discussion. First, it highlights the scale,
complexity and influence of the “global ESG stewardship ecosystem”. Second, it explores the implications of the ecosystem for a range of contemporary corporate governance theories and debates. Our analysis of the “global ESG stewardship ecosystem” challenges many assumptions of modern corporate governance, such as the supposed “rational reticence” of institutional investors, the nature of “agency capitalism”, the implications of common ownership, the role and potential of stewardship codes. Finally, the “global ESG stewardship ecosystem” revives the convergence-divergence debate in corporate governance and suggests that any convergence which is underway is likely to be complex and unpredictable.

The Rise of Anti-Activist Poison Pills

Author: Ofer Eldar, Tanja Kirmse, Michael D. Wittry

Abstract
We provide the first systematic evidence of contractual innovation in the terms of poison pill plans. In response to the increase in hedge fund activism, pills have changed to include anti-activist provisions, such as low trigger thresholds and actingin-concert provisions. Using unique data on hedge fund views of SEC filings as a proxy for the threat of activists’ interventions, we show that hedge fund interest predicts pill adoptions. Moreover, the likelihood of a 13D filing declines after firms adopt “antiactivist” pills, suggesting that pills are effective in deterring activists. The results are particularly strong for “NOL” pills that, due to tax laws, have a five percent trigger.
Our analysis has implications for understanding the modern dynamics of market discipline of managers in public corporations and evaluating policies that regulate defensive tactics.

Shareholder Rights and the Bargaining Structure in Control Transactions

Authors: Ryan Bubb, Emiliano Catan, Holger Spamann

Abstract

When there are many shareholders in a firm, they face collective action problems. One problem is that acquirers can pursue divide-and-conquer strategies such as two-tiered front-loaded bids. The solution to this in the theoretical literature and in judicial practice is a centralized bargaining agent, such as the firm's management, or a shareholder vote. We show that these methods are of limited usefulness, however, in addressing the agency problem between shareholders and managers. In the relationship between shareholders and centralized bargaining agent, the shareholders receive take-it-or-leave-it offers, such that the agent captures all the surplus. This in turn hampers efficient ex ante financing: Some firms can raise sufficient funds only if (the threat of) judicial remedies provides them (an expectation of) some surplus. In realistically imperfect judicial systems, this induces trade-offs with court errors and litigation costs.

Empower Women by Index Membership: Evidence from a Unique Experiment from Japan

Authors: Vikas Mehrotra, Lukas Roth, Yusuke Tsujimoto, Yupana Wiwattanakantang

Abstract:

In 2017, Government Pension Investment Fund of Japan (GPIF), the world’s biggest sovereign fund, adopted the MSCI Empowering Women Index (WIN), created by Morgan Stanley. To qualify for the prestigious index membership, firms must meet certain criteria for the advancement of women in their workforce, particularly in the management cadres. Inclusion in the WIN index is structured loosely as a tournament—only the top 50% in each industry category of the MSCI IMI Top 700 firms (roughly corresponding to the S&P 500 in the U.S.) are included. Focusing on firms around the inclusion threshold allows us to employ a difference-in-differences methodology to test for real social effects of the WIN index creation. Firms around the threshold competing for index inclusion show significant improvements in not only women’s participation in the workforce but also in in the Csuite compared to firms farther away from the inclusion threshold. Interestingly, WIN Index firms also display an increase in paternity leaves suggesting a shift into a more women friendly corporate culture. WIN index firms also gain institutional ownership. Overall, the change in corporate social behaviour is not at the expense of lower operating profitability or valuation.

Supply Chain Risk: Changes in Supplier Composition and Vertical Integration

Author: Nuri Ersahin, Mariassunta Giannetti, Ruidi Huang

Abstract

Using textual analysis of earnings conference calls, we quantify firms’ supply chain risk and its sources. Our proxy for supply chain risk exhibits large cross-sectional and time-series variation that aligns with reasonable priors and is unprecedently high during the Covid-19 pandemic. Controlling for the first moment of supply chain shocks, we find that firms that experience an increase in supply chain risk increase investment and establish relationships with closer and domestic suppliers and with suppliers that are industry leaders. In addition, firms that do not face financial constraints become more likely to engage in vertical mergers and acquisitions.

Governance Transparency and Firm Value: Evidence from Korean Chaebols

Authors: Akash Chattopadhyay, Sa-Pyung Sean Shin, Charles C.Y. Wang

Abstract

We examine Korean business groups' transition from opaque circular-shareholding structures to (relatively simple) pyramidal-shareholding structures between 2011 and 2018. When firms were removed from ownership loops, chaebol families' control and incentive conflicts in them were unaffected. Yet these firms' values declined, especially when controllers had greater incentive conflicts. We show these changes are explained by a resolution of uncertainty about controllers' incentives ("governance transparency'"), which increases earnings responsiveness and enables investors to update priors about the severity of agency issues across group firms. Combined, these two channels result in value increases for some group firms but declines in others.

Corporate Governance and Firm Value

Authors: Emiliano Catan, Marcel Kahan

For decades, scholars have turned to empirical evidence to resolve theoretical debates about the impact of corporate governance on firm value. Initially, the most common empirical technique to evaluate corporate governance was the short-term event study. More recently, short-term event studies have been supplemented, if not replaced, by three techniques – longer-term event studies, calendar time portfolio regressions, and Q (and other accounting-based ratio) regressions – that examine the effect of corporate governance changes over a longer term. We argue that one should apply a fair amount of skepticism in evaluating empirical studies that purport to discern the effect of corporate governance on firm value. Q regressions are theoretically unfounded and can often lead to biased results. Results derived from standard Q regressions thus shed no light on corporate governance controversies. While event studies and calendar time portfolio regressions are greatly superior to Q regressions, these methodologies have their own shortcomings, which need to be kept in mind in interpreting their results.

Innovation: The Bright Side of Common Ownership?

Authors: Miguel Anton, Florian Ederer, Mireia Gine, Martin C Schmalz

Abstract

A firm has inefficiently low incentives to innovate when other firms benefit from its innovative activity and the innovating firm does not capture the full surplus of its innovations. We provide conditions under which common ownership of firms mitigates this impediment to corporate innovation. Common ownership increases innovation when technological spillovers are sufficiently large relative to product market spillovers. Otherwise, the business stealing effect of innovation dominates and common ownership reduces innovation. Empirically, product market spillovers (as measured by Jaffe/Mahalanobis proximity in product market space) decrease the effect of common ownership on innovation inputs and outputs, whereas technology spillovers (proximity in patent space) increase the effect. The sign and magnitude of the relationship between common ownership and corporate innovation varies considerably across the universe of firms depending on the relative strength of product market and technology spillovers. When product market spillovers are relatively large, an increase from the 25th to the 75th percentile of common ownership is associated with a decrease of -8.4% in citation-weighted patents. But when technology spillovers are relatively large, the same increase in common ownership is associated with an increase of +12.5% in citation-weighted patents. Our results inform the debate about the welfare effects of increasing common ownership among U.S. corporations.

Common Ownership Directors

Authors: Ofer Eldar, Yaron Nili, James Pinnington

Abstract

Although there is evidence that common ownership of public firms may affect various outcomes, the mechanism through which common owners affect corporate strategy remains unclear. Using data on overlapping directors and institutional shareholding from 2000 to 2019, we show that common ownership across firms in the same industry is associated with a higher probability that they share a director. The results are particularly strong for institutions with lower portfolio turnover and longer investment horizons. However, we find little relationship using common ownership by the “Big Three” fund families (BlackRock, Vanguard, and State Street). Our results hold across various measures of common ownership, different definitions of competitors, and a variety of robustness checks. Overall, we present a mechanism through which common ownership may affect managerial incentives.