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Abstract:
We survey research on corporate finance in Europe. The ambition is to provide the reader with an overview of what we learned, particularly since the beginning of the 1990s. We focus on two themes: (1) the practice and institutions in Europe are heterogeneous and different from those in the United States, and we identify areas where the gap seems to be narrowing; (2) we wish to draw some more general conclusions with respect to the law and finance paradigm that has dominated recent research on comparative institutional analysis, and the diversity of European institutions seems to present an ideal testing ground for this approach. We find that the ability of the law and finance approach to capture the relevant differences within Europe is often limited. We focus in particular on equity primary markets; privatizations; cross-listings; capital structure and payout policy; Mergers and acquisitions; business groups, pyramids and dual class shares; and valuation and the cost of capital.

Corporate Finance, Europe

Abstract:
We estimate a standard principal agent model with constant relative risk aversion and lognormal stock prices for a sample of 598 US CEOs. The model is widely used in the compensation literature, but it predicts that almost all of the CEOs in our sample should hold no stock options. Instead, CEOs should have lower base salaries and receive additional shares in their companies. For a typical value of relative risk aversion, almost half of the CEOs in our sample would be required to purchase additional stock in their companies from their private savings. The model predicts contracts that would reduce average compensation costs by 20% while providing the same incentives and the same utility to CEOs. We investigate a number of extensions and modifications of the standard model, but find none of them to be satisfactory. We conclude that the standard principal agent model typically used in the literature cannot rationalize observed contracts. One reason may be that executive pay contracts are suboptimal.

Executive compensation, stock options

Abstract:
In the period 1997-2004, Preussag, a diversified German conglomerate of old economy businesses, changed itself into TUI, a company focused almost entirely on tourism and logistics. This paper analyzes how this strategy was executed and how it contributed to Preussag's underperformance of the stock market. We collect 417 announcements of acquisitions, financial disclosures and other news and disentangle the impact of different parts of the company's strategy. We find that only the divestitures created value, that the strategy to invest in tourism destroyed value, and that the acquisition premiums Preussag paid were mostly unjustified. Bad luck like the events of September 11, 2001 cannot account for the poor performance of the stock. Poor management resulted from poor governance, combining a state-owned bank as the largest shareholder, board interlocks, and insufficient managerial incentives. The case shows how divestiture programs increase the liquid resources available to management beyond free operating cash flows and casts doubt on the positive governance role of institutional blockholders.

Corporate Governance, Large shareholders, Germany, Diversification, Mergers and Acquisitions

Abstract:
This paper analyzes the impact of insider trading legislation on corporate governance. In a context where large, dominant shareholders can monitor underperforming companies, managers have an incentive to give early warnings about adverse developments to dominant shareholders. This information is effectively a bribe to induce dominant shareholders to sell their stock and refrain from intervention. If insider trading is unregulated, dominant shareholders collude with management at the expense of small shareholders. The optimal regime forces the company to disclose all material information to the market. Private contracting between companies and shareholders leads to optimal insider trading regulation only if initial shareholders can enter a binding commitment, otherwise large shareholders and managers recontract at the expense of small shareholders. Enforcement also matters. European Union legislation requires inside information to be precise. Such a narrow definition creates a grey zone, where information is private but cannot be classified as inside information. As a result the effectiveness of corporate governance and firm value are reduced. Regulation in the US that treats shareholders with a stake exceeding 10% as insiders is potentially harmful.

Abstract:
We analyze the role of bankers on the boards of German non-financial companies for the period from 1994 to 2005. We find that banks that are represented on a firm's board promote their own business as lenders and as M&A advisors. They also seem to act as financial experts who help firms to obtain funding, especially in difficult times. We find little evidence that bankers monitor management and suggest that bankers on the board cause a decline in the valuations of non-financial firms. Banks' equity ownership declined sharply during our sample period and the German financial system lost some of its formerly distinctive features.

Banks, Board of Directors, Corporate Governance, Germany

Abstract:
We investigate biases of valuation methods and document that these depend largely on the choice of error measure (percentage vs. logarithmic errors) used to compare valuation procedures. We analyze four multiple valuation methods (averaging with the arithmetic mean, harmonic mean, median, and the geometric mean) and three present value approaches (dividend discount model, discounted cash flow model, residual income model). Percentage errors generate a positive bias for most multiples, and they imply that setting company values equal to their book values dominates many established valuation methods. Logarithmic errors imply that the median and the geometric mean are unbiased while the arithmetic mean is biased upward as much as the harmonic mean is biased downward. The dividend discount model dominates the discounted cash flow model only for percentage errors, while the opposite is true for logarithmic errors. The residual income model is optimal for both error measures.

Valuation, Financial Ratios, Multiples, Dividend Discount Model, Discounted Cash Flow Model, Residual Income Model

Abstract:
We analyze how shareholders screen management proposals at annual general meetings. First, we use a simple model of strategic voting to develop a theoretical benchmark of effective information aggregation through voting. Then, we derive testable implications and provide structural estimates of the model parameters. The main conclusions are that shareholders vote strategically and that proposal screening increases value. Shareholders largely neutralize the lock-in effect of supermajority rules, thereby preventing the incorrect rejection of proposals.

shareholder meeting, proposal screening, strategic voting, supermajority rule

Abstract:
This paper studies how the use of alternative valuation methodologies affects investment performance for a sample of 53 German venture capitalists. We measure investment performance by the amount of investments they need to write off and by the number of companies they take public. We find that a significant number of investment managers use discounted cash flow (DCF) techniques, but only a minority appears to use a discount rate related to the cost of capital. The majority applies DCF using subjective discount rates. We present evidence that the use of DCF is correlated with superior investment performance only if applied in conjunction with an objectifiable discount rate. Also, funds that invest with a longer horizon perform better. The use of multiples is not significantly correlated with investment performance. We conclude that a focus on fundamental values confers an advantage.

Abstract:
This paper studies how the use of alternative valuation methodologies affects investment performance for a sample of 53 German venture capitalists. We measure investment performance by the amount of investments they need to write off and by the number of companies they take public. We find that a significant number of investment managers use discounted cash flow (DCF) techniques, but only a minority appears to use a discount rate related to the cost of capital. The majority applies DCF using subjective discount rates. We present evidence that the use of DCF is correlated with superior investment performance only if applied in conjunction with an objectifiable discount rate. Also, funds that invest with a longer horizon perform better. The use of multiples is not significantly correlated with investment performance. We conclude that a focus on fundamental values confers an advantage.

DCF, Performance, Valuation, Venture Capital, IPO

Abstract:
This paper analyzes optimal executive compensation contracts when managers are loss averse. We calibrate a stylized principal-agent model to the observed contracts of 595 CEOs and show that this model can explain observed option holdings and high base salaries remarkably well for a range of parametrizations. We also derive and calibrate the general shape of the optimal contract that is increasing and convex for medium and high outcomes and drops discontinuously to the lowest possible payout for low outcomes. We identify the critical features of the loss-aversion model that render optimal contracts convex.

Stock Options, Executive Compensation, Loss Aversion

Abstract:
In this paper we investigate how the enactment and enforcement of insider trading restrictions affect the way in which information about acquisitions is released before the actual acquisition announcement. We analyze a sample with almost 19,000 acquisition announcements from 48 countries. We find that insider trading legislation strongly affects the information revealed to the market in the runup phase before the announcement whereas the impact of subsequent enforcement actions by regulators is much weaker and insignificant in some tests. We conclude that market participants rationally anticipate law enforcement.

Insider Trading, Mergers and Acquisitions, Securities Law, Law and Finance

Abstract:
This paper analyzes the efficiency of shareholder voting as a mechanism to resolve differences of opinion and conflicts of interest among shareholders. Passing a proxy proposal or electing a dissident slate of directors requires the votes of a number of minority blockholders. If they vote strategically, they behave like one representative shareholder who solves a real option problem and is constrained to observe only a subset of all available information. The decision is improved if shareholders are allowed to communicate freely, but this does not overcome the incentive to misrepresent information in the presence of conflicts of interest. Then trading in a public market improves the allocation if two conditions are met: the voting process is not controlled by insiders and the market aggregates information accurately. Better information aggregation may lead to inferior results in insider controlled firms, and noisy information aggregation in the stock market may be worse than none at all. Announcement returns are better understood as option premia rather than wealth effects since positive announcement returns are consistent with proposals that are expected to reduce shareholder value. Empirical implications link the effectiveness of voting to trading volume and stock price volatility. The direction of stock price changes is not consistently related to the voting outcome or the effectiveness of shareholder voting.

Abstract:
This paper argues that there is a trade-off between efficiency and fairness in minority freezeouts and that the focus on fairness (minority shareholder rights) may be misplaced. The model discusses alternative rules for valuing minority shares in freezeouts. Appraisals can be based on the stock price, publicly available information, or private information disclosed by the majority shareholder. Those valuation rules that enhance economic efficiency pay minority shareholders less than what their shares are intrinsically worth. Economic efficiency is worse if minority shareholders extract higher premia in freezeouts. Moreover, all freezeout rules induce inefficient takeovers caused by overbidding. Bidders overpay for some shares in order to obtain a valuable freezeout option, which sometimes remains unexercised. The real problem is the freeze-in problem, as minority shareholders are left with lower-valued shares. Efficiency can be restored through a mandatory bid rule.

Freezeouts, freeze-in, valuation, takeovers, shareholder rights, adverse selection, mandatory bids

Abstract:
This paper discusses the merits of two-class voting procedures where voters are separated into classes that vote separately. A prominent example are Chapter 11 bankruptcy proceedings, where claim-holders who decide on a workout proposal are divided into classes, and the approval of the proposal needs a majority of the votes in each class. Some political mechanisms employ a similar process. We analyze two-class voting in a context where voters have conflicts of interest as well as differences of opinion regarding a proposal. We investigate how voting mechanisms aggregate information dispersed among voters. We find that two-class voting provides a significant improvement over single-class voting in all those situations where voters have significant conflicts of interests, and where the electorate is relatively evenly divided between different interest groups. Then voting in homogeneous groups provides voters with protection against expropriation and allows them to reveal their information through voting. However, two-class voting is inefficient for relatively homogenous electorates.

Information Aggregation, Voting, Corporate Control, Bankruptcy

Abstract:
We evaluate accounting-based methods to estimate the implied cost of capital using a simulation approach. We create a model economy where the true cost of capital is known and calibrate it to the Compustat universe. We then compare the true cost of capital to the implied cost of capital estimates from ten different models proposed in the literature. We find that almost all models provide positively biased estimates of the cost of capital. Accuracy varies greatly across models but is typically low, although most models capture a significant part of the variation in the true cost of capital. All implied cost of capital methods distort the true cost of capital by underestimating the cost of capital when it is low and overestimating the cost of capital when it is high. We trace this distortion effect to the growth of future earnings assumed by the implied cost of capital methods. Finally, we explore different ways of combining implied cost of capital methods and make suggestions for improving the quality of these models.

Implied cost of capital, valuation, residual income, abnormal earnings growth, simulation

Abstract:
We analyze how 15,000 US top executives exercise their stock options. We run a horse race of competing explanatory approaches to identify the main variables that influence executives' timing decisions. We find that the time value of the option, characteristics of managers' option portfolios, and institutional factors (vesting dates, blackout periods) have a first-order impact on exercise behavior. Behavioral factors (e.g., trends in past stock prices) and timing based on inside information also influence stock option exercises, but are quantitatively less important. While there is evidence for some behavioral biases, managers seem to see through investor sentiment and apply useful heuristics for choosing among their exercisable options.

Stock options, early exercise decisions, executive compensation

Abstract:
We perform an experiment where subjects bid for the right to participate in a vote and where the theoretical value of the voting right is zero if subjects are fully rational. We find that experimental subjects are willing to pay for the right to vote, except if the collective decision has no impact on their individual welfare. Models of rational voting behavior are consistent with our results only if individuals are overconfident and also severely overestimate how often they are pivotal and how often other players make mistakes. Alternatively, individuals might ignore pivotality and simply value being part of a group that exercises power.

Voting, dual-class shares, paradox of voting, experimental economics, instrumental voting, expressive voting

Abstract:
We present an experimental study of a risky sequential bargaining to model negotiations in risky joint ventures that proceed through multiple stages. Our example is the production of a movie that may give rise to a sequel, so actors and producers negotiate sequentially. We compare the predictions of alternative theoretical approaches to understanding such a game. The game theoretic solution predicts (assuming risk neutrality) that actors are willing to accept wages below their outside option for first films in order to capture the gains from winning lucrative sequel contracts. This prediction is strongly rejected by the data. The data are better explained by either equity theory (equal splits) or by a game theoretic model where actors have uncertain risk aversion. The parameters of the game are calibrated to match data on 99 movies for 1989 available from a case study.

Bargaining, risk, joint ventures, game theory

Abstract:
This paper analyzes stealth trading by corporate insiders in US equity markets. Stealth trading is the practice to break up trades into sequences of smaller trades. We find that stealth trading is pervasive and distinguish two explanations. The first argues that insiders break up trades in order to conceal private information about the fundamental value of the stock, whereas the second holds that insiders act like discretionary liquidity traders who want to reduce the tem-porary price impact from trading large stakes. We find some, but inconsistent evidence for information-based explanations, but strong and unambiguous evidence for liquidity-based ex-planations. These conclusions hold across subsamples for transactions before and after the Sarbanes-Oxley act and for NASDAQ as well as NYSE stocks.

Stealth Trading, Insider Trading, Sarbanes-Oxley

Abstract:
The accepted theoretical models of executive compensation contracts all seem to imply that optimal remuneration packages should contain a relative performance element. The puzzle is that the empirical literature has found remarkably little relative performance evaluation. This paper aims at resolving this puzzle by introducing the notion that the manager can trade on assets other than her own company's stock. Then the manager's portfolio strategy always adjusts for the risks of her compensation contract and she replaces the firm's benchmark with a - home-made - benchmark. She chooses exactly the weights and the compensation of the benchmark that would otherwise be chosen in an optimal contract. In many cases this is possible without short selling any assets. To the extent that performance benchmarks are correlated with traded assets they are redundant for the optimal contract. Accounting benchmarks are exempt from this verdict since they may help to insure the manager against risks that are not related to traded assets. This may help to understand the presence of relative performance elements in annual bonus plans.

Executive Compensation

Abstract:
We investigate if the proxy voting process transmits valuable information from shareholders to management. A simple strategic voting model is developed and tested in a large sample of management proposals. The evidence suggests that voting is strategic in the sense that shareholders take into account the information of the other shareholders when making their voting decisions. The structural estimation suggests that strategic voting saves up to 30% of the value at stake in a proposal compared to naive voting strategies, especially for voting on governance proposals. The data also suggest that super majority requirements are never optimal. We conclude that shareholder meetings have an advisory function in addition to the disciplining role typically emphasized in the literature.

Abstract:
We analyze the role of bankers on the boards of German non-financial companies for the period from 1994 to 2005. We find that banks that are represented on a firm's board promote their own business as lenders and as M&A advisors. They also seem to act as financial experts who help firms to obtain funding, especially in difficult times. We find little evidence that bankers monitor management and suggest that bankers on the board cause a decline in the valuations of non-financial firms. Banks’ equity ownership declined sharply during our sample period and the German financial system lost some of its formerly distinctive features.

G21, G34

Abstract:
We analyze how shareholders screen management proposals at annual general meetings. First, we use a simple model of strategic voting to develop a theoretical benchmark of effective information aggregation through voting. Then, we derive testable implications and provide structural estimates of the model parameters. The main conclusions are that shareholders vote strategically and that proposal screening increases value. Shareholders largely neutralize the lock-in effect of supermajority rules, thereby preventing the incorrect rejection of proposals.

D72, G34

Abstract:
This paper presents a theory of initial public offerings based on the idea that the optimal ownership structure of a company changes over the life cycle of the firm. Insiders take the company public when they have lost the comparative advantage over outsiders in gathering information to evaluate the firm's growth prospects. The size of the share sold to the public depends on the relative abilities of the market and insiders to gather this information and on the frictions in the going-public process. Intermediaries help to reduce these frictions and lead to a more efficient allocation if IPOs are conducted more frequently. Discrimination between different classes of investors may be beneficial. Learning by the market about projects in a new industry can lead to a clustering of new issues (hot issue markets).

Initial public offerings, going public, underwriting

Abstract:
The paper investigates the hypothesis that the separation of ownership and control is made viable by an organizational structure that separates decision making from monitoring. The paper analyses the choice of organizational form and contrasts a hierarchy where executive management is monitored and remunerated by a director who acts as a supervisory agent, and an entrepreneurial firm in which all control rights are concentrated in the hands of a single agent. It is shown how the organizational form affects the allocation and the tradeoff between risk-sharing and incentives. The model predicts that the hierarchy is a dominant choice in environments where monitoring information is precise, whereas the entrepreneurial firm is a better choice if productive efforts are difficult to monitor. Also, more efficient hierarchies have a lower correlation between shareholder value and managerial compensation. The paper shed some light on the decision to go private and on the reverse-LBO phenomenon.

Abstract:
This paper investigates the role of large institutional investors for monitoring the management of companies. The focus is on the fact that large shareholders face a conflict in the use of their information. They cannot trade on some information which is subject to insider trading legislation. As a precaution they do not acquire it in the first place in order to not jeopardize their trading strategy. As a result they stay less informed, thereby reducing their effectiveness as monitors. The paper investigates this dilemma and the efficiency implications of insider trading legislation in a simple information economy where the large shareholder is a mutual fund. The size of the fund is determined endogenously in equilibrium and is too small to provide optimal monitoring incentives. The main results are that appropriate insider trading legislation can increase efficiency through forcing disclosure of private information, and that the definition of inside information has to be sufficiently broad. The paper also shows that high market liquidity enhances monitoring activities.

Abstract:
This paper investigates the effect of fund managers' performance evaluation on their asset allocation decisions. We derive optimal contracts for delegated portfolio management and show that they always contain relative performance elements. We then show that this biases fund managers to deviate from return-maximising portfolio allocations and follow those of their benchmark (herding). In many cases the trustees of the fund who employ the fund manager prefer such a policy. We also show that fund managers in some situations ignore their own superior information and "go with the flow" in order to reduce deviations from their benchmark. We conclude that incentive provisions for portfolio managers are an important factor in their asset allocation decisions.

Abstract:
Author's description of his paper:This paper analyzes the role of corporate boards and compares them with other governance mechanisms of the firm. The analysis is based on the assumption that managers may resist profitable restructuring decisions in order to protect their investments in firm specific human capital. Outside directors and investors can monitor managers' decisions at a cost and motivate them through adjusting their compensation schemes. If information is not too costly for outsiders, directors are the optimal institution to constrain managerial decisions, and managers become less entrenched if independent directors' compensation is more closely aligned to the value of the firm. In firms where the scope for profitable divestments is small, external control through debtholders or the market for corporate control is optimal. If information is costly to transfer, it is best to leave managerial decision making unconstrained. This paper discusses a model that combines internal and external control mechanisms in a firm in which assets can have alternative uses that are in some states more profitable than the current one. However, restructuring a firm in order to realize the gains from alternative uses affects managers adversely since they invest in firm-specific human capital. Managers can be motivated to restructure the firm through their compensation scheme. Alternatively, investors can acquire costly information on the firm and interfere with managers' decisions. The main focus is on independent directors, who review and monitor contracts and managers' compensation. If information is not too costly, directors are the optimal institution to check managerial discretion and the degree of managerial entrenchment depends on the compensation of independent directors. However, if directors fail to exercise control over management properly, takeovers or creditor control become second best solutions. If information is costly to transfer, unchecked managerial control may be optimal.

Abstract:
This paper discusses a model which combines internal and external control mechanisms in a firm in which assets can have alternative uses which are in some states more profitable than the current. However, restructuring a firm in order to realise the gains from alternative uses affects managers adversely since they invest in firm-specific human capital. Several institutions which can regulate the agency relationship between shareholders and managers are discussed. The main focus is on independent directors, who are not part of executive management. Their function is to review and monitor contracts and managers' compensation. Independent directors constitute a potentially better organizational form to check managerial discretion than do constraints from debt or the market for corporate control. However, if directors fail to exercise control over management, takeovers or creditor control become second-best solutions.