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An Empirical Assessment of Empirical Corporate Finance

Jeffrey L. Coles

David Eccles School of Business, University of Utah; Arizona State University (ASU) - Finance Department

Zhichuan Frank Li

University of Western Ontario - Ivey School of Business

January 2, 2012

We empirically evaluate 20 prominent contributions to a broad range of areas in the empirical corporate finance literature. We assemble the necessary data and then apply a single, simple econometric method, the connected-groups approach of Abowd, Karmarz, and Margolis (1999), to appraise the extent to which prevailing empirical specifications explain variation of the dependent variable, differ in composition of fit arising from various classes of independent variables, and exhibit resistance to omitted variable bias and other endogeneity problems.

In particular, we identify and estimate the role of observed and unobserved firm- and manager-specific characteristics in determining primary features of corporate governance, financial policy, payout policy, investment policy, and performance. Observed firm characteristics do best in explaining market leverage and CEO pay level and worst for takeover defenses and outcomes. Observed manager characteristics have relatively high power to explain CEO contract design and low power for firm focus and investment policy. Estimated specifications without firm and manager fixed effects do poorly in explaining variation in CEO duality, corporate control variables, and capital expenditures, and best in explaining executive pay level, board size, market leverage, corporate cash holdings, and firm risk. Including manager and firm fixed effects, along with firm and manager observables, delivers the best fit for dividend payout, the propensity to adopt antitakeover defenses, firm risk, board size, and firm focus. In terms of source, unobserved manager attributes deliver a high proportion of explained variation in the dependent variable for executive wealth-performance sensitivity, board independence, board size, and sensitivity of expected executive compensation to firm risk. In contrast, unobserved firm attributes provide a high proportion of variation explained for dividend payout, antitakeover defenses, book and market leverage, and corporate cash holdings. In part, these results suggest where empiricists could look for better proxies for what current theory identifies as important and where theorists could focus in building new models that encompass economic forces not contained in existing models.

Finally, we assess the relevance of omitted variables and endogeneity for conventional empirical designs in the various subfields. Including manager and firm fixed effects significantly alters inference on primary explanatory variables in 17 of the 20 representative subfield specifications.

Number of Pages in PDF File: 111

Keywords: Empirical corporate finance, Corporate governance, Capital structure, Dividend policy, Executive compensation, Delta, Vega, Corporate control, Antitakeover protections, Mergers and acquisitions, Board of directors, Leverage, Cash balances, Investment policy, Firm focus, R&D, Firm performance

JEL Classification: G3, G30, G31, G32, G34, G35, C23, C58, J31, J33

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Date posted: March 18, 2011 ; Last revised: January 3, 2013

Suggested Citation

Coles, Jeffrey L. and Li, Zhichuan Frank, An Empirical Assessment of Empirical Corporate Finance (January 2, 2012). Available at SSRN: http://ssrn.com/abstract=1787143 or http://dx.doi.org/10.2139/ssrn.1787143

Contact Information

Jeffrey L. Coles (Contact Author)
David Eccles School of Business, University of Utah ( email )
David Eccles School of Business
Salt Lake City, UT 84112
United States
801-587-9093 (Phone)
Arizona State University (ASU) - Finance Department ( email )
W. P. Carey School of Business
P.O. Box 873906
Tempe, AZ 85287-3906
United States
480-965-4475 (Phone)
480-965-8539 (Fax)
Zhichuan Frank Li
University of Western Ontario - Ivey School of Business ( email )
1151 Richmond Street North
London Ontario, Ontario N6A 3K7
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