On Inference When Using State Corporate Laws for Identification
Harvard Law School John M. Olin Center Discussion Paper No. 1024 (2019)
33 Pages Posted: 17 Dec 2019 Last revised: 2 Jan 2020
Date Written: December 6, 2019
A popular research design identifies the effects of corporate governance by (changes in) state laws, clustering standard errors by state of incorporation. Using Monte-Carlo simulations, this paper shows that conventional statistical tests based on these standard errors dramatically overreject: in a typical design, randomly generated “placebo laws” are “significant” at the 1/5/10% level 9/21/30% of the time. This poor coverage is due to the extremely unequal cluster sizes, especially Delaware's concentration of half of all incorporations. Fixes recommended in the literature fail, including degrees-of-freedom corrections and the cluster wild bootstrap. The paper proposes a permutation test for valid inference.
Keywords: Anti-Takeover Laws, Corporate Governance, Cluster-Robust Inference, Monte Carlo, Placebo Laws, Permutation Test
JEL Classification: C12, G34, G38, K22
Suggested Citation: Suggested Citation