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Abstract:
In both the scholarly literature on boards of directors and the public debate over corporate governance, there is little explicit recognition that the size and structure of boards have evolved endogenously over time. We argue that the size and structure of boards are determined by tradeoffs involving the incremental information that directors bring to boards versus the incremental coordination costs and free rider problems engendered by their additions to boards. Our hypotheses lead to predictions that firm size and growth opportunities are important determinants of the size and structure of boards. Using a unique sample of 81 publicly traded U.S. firms that survived over the period of 1935 through 2000, we find strong support for the hypotheses. Board size is directly related to firm size and inversely related to proxies for growth opportunities, whereas insider representation is inversely related to firm size and directly related to proxies for growth opportunities. The results validate the perspective that board size and structure are endogenously determined in ways consistent with value maximization.

Board Size, Board Composition, Endogeneity, Firm Size, Growth Opportunities and Tangibility of Assets.

Abstract:
Gompers, Ishii, and Metrick (2003) and Bebchuk, Cohen, and Ferrell (2004) document that valuation multiples during the 1990s are significantly related to indices purporting to measure the quality of a firm's governance structure. We test whether causation runs from governance to valuation or vice versa. We find that (i) valuation multiples during the early 1980s, a period preceding the adoption of the provisions comprising the governance indices, are highly correlated with valuation multiples during the 1990s, (ii) valuation multiples during the early 1980s are significantly related to governance indices during the 1990s, and (iii) after controlling for valuation multiples during 1980-1985, no significant relation exists between contemporaneous valuation multiples and governance indices during the 1990s. The results support the hypothesis that causation runs from valuation to governance, not vice versa.

Governance, governance index, causality

Abstract:
Since the revelation of accounting scandals at Enron, Worldcom, and several other high profile companies ("Enron et al.") five years ago, there has been unprecedented public focus on U.S. corporate governance. A common view, articulated by many journalists, politicians, and public pundits is that these scandals were indicative of a crisis that eroded investor confidence in U.S. corporations. This paper makes the argument that the increase in resources allocated to securities enforcement and the substantial penalties meted out to executives convicted of accounting fraud have dramatically reduced the incentive to engage in Enron-like behavior.

Abstract:
Since the revelation of accounting scandals at Enron, Worldcom, and several other high profile companies ("Enron et al.") five years ago, there has been unprecedented public focus on U.S. corporate governance. A common view, articulated by many journalists, politicians, and public pundits is that these scandals were indicative of a crisis that eroded investor confidence in U.S. corporations. This paper makes the argument that the increase in resources allocated to securities enforcement and the substantial penalties meted out to executives convicted of accounting fraud have dramatically reduced the incentive to engage in Enron-like behavior.

Corporate governance, sarbanes oxley regulation

Abstract:
This paper empirically examines whether the Sarbanes-Oxley Act of 2002 ("SOX") discourages risk-taking by publicly traded U.S. companies. Several provisions of SOX are likely to have this effect, including an expanded role for independent directors, an increase in director and officer liability, and rules related to internal controls. We find that several measures of risk-taking decline significantly for U.S. companies as compared with U.K. firms after SOX. The declines are related to several firm characteristics, including pre-SOX board structure, firm size, and R&D expenditures. In addition, the likelihood of initial public offerings ("IPOs") occurring in the U.S. versus the U.K. declined significantly after SOX, with the decline being significantly higher for R&D intensive industries. Overall, the evidence supports the proposition that SOX discourages risk-taking by public U.S. companies.

Sarbanes-Oxley, Legislative policy, Corporate risk taking, Investment policy

Abstract:
This paper documents an increase in implied volatility of acquiring firms around acquisition announcements and a strong inverse relation between bidder returns and changes in the implied volatility of acquiring firms around acquisition announcements. We develop and test several hypotheses that seek to explain this relation. Strong support is found for the disagreement hypothesis, which posits that the market is more confident about its judgment in cases of positive bidder returns, when it agrees with the acquiring firms’ managers that the deals are value-creating, than it is in cases of negative bidder returns, when it disagrees with the acquiring firms’ managers. We do not find empirical support for the feedback hypothesis, which posits that changes in implied volatility cause the bidder returns through a mechanical risk and return relation, or the leverage hypothesis, which posits that bidder returns cause the change in implied volatility through a change in financial leverage.

Acquisitions, implied volatility, uncertainty, bidder returns

Abstract:
We examine the relation between bidder returns and the probability of CEO turnover in acquiring firms. Using a sample of 714 acquisitions during 1990 to 1998, we find that 47% of CEOs of acquiring firms are replaced within five years, including 27% by internal governance, 16% by takeovers, and 4% by bankruptcy. A significant inverse relation exists between bidder returns and the likelihood of CEO turnover. This relation is not associated with governance structure. It also is not significantly different in stock versus cash acquisitions, which appears to be inconsistent with Shleifer and Vishny's theory of stock market driven acquisitions.

CEO, Turnover, Acquisition, Governance, and Control

Abstract:
The U.S. defense industry provides a natural experiment for examining how changes in growth opportunities affect the level and structure of corporate debt. Compared with other firms, the growth opportunities of defense firms increased substantially during the Reagan defense buildup of the early 1980s, but then declined significantly with the end of the cold war and associated defense budget cuts in the late 1980s and early 1990s. We examine how the level and structure of corporate debt changed for a sample of 61 defense firms and a benchmark sample of 61 manufacturing firms during 1980-1995, a period spanning the changes in growth opportunities. The debt levels of weapons manufacturers, which were most affected by the changes in growth opportunities, increased significantly as their growth opportunities declined. In addition, these firms lengthened the maturity structure of their debt, decreased the ratio of private to public debt, and decreased the use of senior debt as their growth opportunities declined. The results complement other studies that have found cross-sectional relations between proxies for growth opportunities and leverage variables and validate the prominent role played by growth opportunities in the theory of corporate finance.

Growth opportunities, debt policy, maturity structure, defense industry

Abstract:
In 1987, the USAir Group acquired Piedmont Aviation for $1.6 billion in a cash tender offer. Prior to the merger, comparably sized USAir and Piedmont were among the most profitable carriers in the industry. Almost immediately after the integration of the two airlines, USAir became the industry's least profitable carrier and came close to bankruptcy. This paper concludes that the major source of the value destruction in the merger was USAir's workforce integration strategy. The decision to buy labor peace by extending USAir's more generous pay scales and work rules to Piedmont employees accounts for roughly 80% of the $2.5 billion post-merger decline in the USAir's equity value. More generally, we conjecture that the integration of workforces is especially difficult in airline mergers and find evidence consistent with the conjecture. We interpret the USAir-Piedmont case as evidence consistent with Williamson's (1985) argument that the boundaries of the firm are limited in part by considerations of internal equity.

Abstract:
Christie and Schultz find that bid-ask spreads are wider and odd-eighth quotes less frequent in the Nasdaq market versus the NYSE and AMEX. They suggest that collusion among market makers may account for these results, while others offer efficiency-based explanations. This paper attempts to distinguish the "collusion hypothesis" from "efficiency hypothesis" by examining trade and quote data from 19C-3 stocks, which trade in both the Nasdaq and NYSE markets. We find that spreads are significantly wider and spread revisions are significantly less frequent in the Nasdaq market compared with the NYSE, suggesting that microstructure imperfections, not collusion, may account for the wider spreads on Nasdaq. We also compare trade and quote data for the Nasdaq 19c-3 stocks with stocks with comparable trading volume that trade only on Nasdaq. We find that spreads are narrower and both odd-eight quotes and spread revisions are more frequent for the Nasdaq stocks which trade in both the Nasdaq and NYSE markets. While this result is consistent with the collusion hypothesis, we also find that pricing errors induced by microstructure considerations in the Nasdaq market are smaller for stocks that also trade simultaneously in the Nasdaq and NYSE markets. The results suggest that allegations of collusion are premature until the effects of microstructure considerations on spreads and quotes are better understood.

Abstract:
This paper examines the bidding behavior of investors who participated in the voucher scheme used to privatize 988 Czech enterprises. In the first round of the privatization scheme, the Czech authorities set a uniform price for all companies, creating a natural experiment for testing several hypotheses concerning the determinants of share demand in the voucher scheme. Share demand is expected to measure relative values of shares, a prediction supported by a positive and significant relation between share demand and stock market prices. Also, consistent with predictions regarding the determinants of value, we find that share demand is related to proxies for agency costs and the expected costs of financial distress. These findings are supported by other tests in which we use prices in the voucher scheme and stock market prices as alternative measures of relative values. Of particular interest is the finding that share demand is directly related to the percentage shares held by insiders; this result is relevant for the debate in former communist countries over whether privatization programs should restrict insider holdings. The investment performance of individuals does not differ significantly from the investment performance of institutional funds, suggesting that individuals did not transfer their investment points to funds unless they believed that funds were better able to assess the value of firms. The results suggest rational investor behavior, despite the absence of Czech financial markets for decades.

Abstract:
Deregulation provides a natural experiment for examining how governance adapts to structural change in the business environment. We investigate the evolution of governance structure--ownership concentration, compensation policy, and board composition--in the U.S. airline industry during a 22- year period surrounding the Airline Deregulation Act of 1978. Consistent with theory, we find that after deregulation 1) equity ownership is more concentrated; 2) CEO pay increases; 3) stock option grants to CEOs increase; and 4) board size decreases. Airlines governance structures gravitate toward the system of governance mechanisms used by unregulated firms. The adaptation process is gradual, however, suggesting that it is costly to alter organizational capital. We also present evidence on the relation between governance structure and firm survival.