three essays in corporate finance

Three Essays in Corporate Finance Dissertation Presented in Partial Fulfillment of the Requirements for the Degree Doctor of Philosophy in the Graduate School of The Ohio State University By Jérôme P. A. Taillard, Dipl. Graduate Program in Business Administration The Ohio State University 2010 Dissertation Committee: René M. Stulz, Advisor Bernadette A. Minton Karen H. Wruck Ruediger Fahlenbrach c  Copyright by Jérôme P. A. Taillard 2010 ABSTRACT In my dissertation, I …rst contribute to the capital structure literature by esti- mating the potential impact of …nancial distress on a …rm’s real business op erations. Secondly, I contribute to the ownership structure literature, and more broadly to the …eld of corporate governance, by revisiting the relationship between managerial ownership and …rm performance. In corporate …nance, a common empirical challenge is to disentangle the rela- tionship of interest from other potential confounding e¤ects. In particular, omitted variables can bias classic econometric estimations and, more generally, cast doubt on any causal inferences being made by researchers. These endogeneity concerns are potentially severe within the context of my research and one of the main contribu- tions of my work is to devise two novel empirical approaches to circumvent, at least partially, the issue of endogeneity. In my …rst essay, I analyze a comprehensive sample of defendant …rms that found themselves exposed to an unexpected wave of asbestos litigation in the wake of two U.S. Supreme Court decisions. Since these legal liabilities are unrelated to current operations, …rms that are in …nancial distress due to their legal woes provide a natural experiment to study the impact of …nancial distress on a …rm’s operational perfor- mance. When analyzing …rms su¤ering from this exogenous shock to their …nances, I …nd little evidence of negative spillover e¤ects (“indirect”costs) of …nancial distress. ii That is, the competitive position of the distressed …rms is not adversely impacted by their weakened …nancial situation. Furthermore, I …nd empirical support for a signi…cant disciplinary e¤ect of …nancial distress as these …rms actively restructure and refocus on core operations. In my second and third essays, I focus on the relationship between managerial ownership and …rm performance using a large panel dataset of U.S. …rms over the period 1988-2004. In the second essay, I reconcile some of the extant literature by showing that the relationship is sensitive to the …rm size characteristics of the sample b eing used. In particular, I recover the classic hump-shaped relationship when focusing only on the largest …rms (e.g. Fortune 500 …rms), while the relationship turns negative when the sample is comprised of smaller …rms. The negative relationship among smaller …rms is consistent with entrenchment ar- guments given that managerial ownership is on average much higher for small …rms. Second, I …nd that for lower levels of managerial ownership, the negative relation- ship is driven by older …rms that have on average less liquid stocks. This …nding is consistent with …rms that do not perform well enough to create a liquid market for their stock, and hence have to keep high levels of insider ownership in order to avoid a negative price impact that would result from a reduction of their stake. Lastly, these results could also be suggestive of endogeneity concerns. I investigate this issue further in my third essay. Principal-agent models predict that managerial ownership and …rm performance are endogenously determined by exogenous changes in a …rm’s contracting environ- ment. Changes in the contracting environment are, however, only partially observed, iii and the standard statistical techniques used to address endogeneity may be ine¤ective in this corporate setting. In my third essay, together with my coauthor Phil Davies, we develop a novel econometric approach to control for the in‡uence of time-varying unobserved variables related to a …rm’s contracting environment. Using the same large panel dataset of U.S. …rms over the period 1988-2004, we …nd no evidence of a systematic relation between managerial ownership and performance. iv To my parents, Wendy and André v ACKNOWLEDGMENTS I wish to thank my dissertation committee members Bernadette Minton, Karen Wruck, Ruediger Fahlenbrach and, in particular, my advisor Professor René Stulz for their guidance and patience, and for sharing their wisdom and knowledge with me. I want to thank also Michel Dubois for nurturing my initial interest in …nance and for encouraging me to pursue Graduate studies, and also Greg Allenby for sharing his passion for Bayesian statistics. I want to thank my family for their unconditional love and encouragement through- out this academic venture. My parents, Wendy and André, have always been there for me and their love has given me the strength needed to accomplish this dissertation. My brother Serge and my grandmother Iris have also provided unwavering moral support over the years. I thank them all for helping me …nd the balance necessary to succeed in the long run. Among friends and colleagues, I would like to thank …rst Mamata, who stood by my side throughout and has always encouraged me to go forward. I’ll always be grateful for having made this journey with her. I would also like to thank Chuan Liao and Taylor Nadauld from my PhD cohort, and Patrick Huguenin and David Ardia in Switzerland. The co-author on my third chapter, Phil Davies, deserves a special mention. I am very thankful for his support and feel blessed to have found such a good friend. vi There are many other people who have also helped along the way, including Anil Makhija, Robyn Scholl and the entire Finance Faculty and sta¤ at the Fisher College of Business. I cannot cite them all here but I do want to thank them collectively for all their encouragements, time and e¤ort. vii VITA May 24, 1979 . . . . . . . . . . . . . . . . . . . . . . . . Born — La Chaux-de-Fonds, Switzer- land 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Diploma in Mathematics applied to Fi- nance — University of Neuchâtel 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Certi…cate of Study in Economics — Gerzensee, Switzerland FIELDS OF STUDY Major Field: Business Administration Concentration: Finance viii TABLE OF CONTENTS Page Abstract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ii Dedication . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vi Vita . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . viii List of Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xii List of Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiv Chapters: 1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2. Thriving in the midst of …nancial distress? An analysis of …rms exposed to asbestos litigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 2.2 Asbestos mass tort litigation . . . . . . . . . . . . . . . . . . . . . 11 2.2.1 The asbestos litigation crisis after Amchem (1997) and Ortiz (1999) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 2.3 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 2.4 Financial impact of litigation on defendant …rms . . . . . . . . . . 16 2.4.1 Measuring the …nancial impact of litigation beyond insurance coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 2.4.2 Litigation exposure and …nancial distress . . . . . . . . . . . 19 2.5 Analysis of …nancially distressed …rms due to asbestos litigation . . 24 2.5.1 Characteristics of …nancially distressed …rms . . . . . . . . . 24 ix [...]... bankruptcy in August 1982 but stopped its asbestos-producing operations only in 1983, selling the unit at a loss in 1985 while still in bankruptcy 12 against many …rms at a time (see White (2002a)) By that time, asbestos personal injury claims accounted for up to a third of all civil …lings for some courts (see Hensler (2002)) Due to the potentially crippling e¤ect of losing against thousands of claimants in. .. their current business operations Strikingly, only 15 out of the 30 …rms with the most signi…cant asbestos liabilities report severe …nancing constraints due to asbestos litigation (in bold in Table 2.3) The other …rms display several signs that show they are not constrained in their …nancing during the period of analysis For instance, Crane, RPM International, Dow Chemical or Honeywell increase dividends... following queries (*: denotes stemming): 1 The word “asbestos” within 500 words of the word “litigation” 2 The word “asbestos” within 20 words of the word “liabilit*” 3 The word “asbestos” in item 3 of part I of 10-Ks (i.e in Legal Proceedings) 4 The word “asbestos” in the Management’ Discussion Section s 5 The word “asbestos” within 500 words of “commitment*” or “contingenc*” in item 8 of Part II (i.e in. .. First, I investigate how these …rms manage to reestablish their sources of …nancing Banks become the lenders of last resort during the crisis Three …rms are able to renegotiate their debt in out-of-court …nancial restructurings In the 12 other cases, Chapter 11 is used to obtain an easier access to new capital by giving new creditors seniority over the existing ones Strikingly, all Chapter 11 …lings of... abatement of asbestos in their buildings, including real estate …rms I also discard certain industries, namely: utilities, which are inappropriate due to their regulated nature, asbestos abatement …rms due to the potential impact of litigation on their core operations and tobacco …rms due to their own litigious products Financial services …rms and in particular insurance carriers and reinsurers that covered... events For instance, Lamont (1997) and more recently Rauh (2006) …nd that …rms’ investment policies can be sensitive to an exogenous shock to cash ‡ ows, thus highlighting one potential indirect cost of …nancing constraints on real activities Using an intra-…rm litigation setting, Cutler and Summers (1988) and Bhagat, Bhagat, Brickley, and Coles (1994) hypothesize that a combined market value loss in excess... exhausted, at least partially, its insurance coverage Insurers’insolvency, in particular among the providers of excess insurance layers, is reported as a cause for loss of full coverage in 20% of the cases Among the insured …rms reporting a net out‡ or liability, about 65% of them mention being in litigation with their ow insurance carriers to determine the extent of coverage under the policies contracted... businesses obtain a Debtor -In- Possession (DIP) …nancing (see Dahiya, Kose, Puri, and Ramirez (2003)) and all partial …lings (of tainted subsidiary) obtain a renewed credit facility After a decline at the onset of distress, operating performance recovers over the crisis period At the resolution of distress, operating performance is on average back to its pre-distress levels or higher, both on a nominal... di¤erent estimates of the indirect costs of distress Weiss and Wruck (1998) …nd massive value destruction in Eastern Airline’ bankruptcy s and Pulvino (1999) …nds evidence of signi…cant …re sales in the airline industry Maksimovic and Phillips (1998) …nd no evidence of reduced e¢ ciency in plant productivity during bankruptcy and Andrade and Kaplan (1998) also …nd a neutral e¤ect on …rms in …nancial distress... consequences from the litigation An investigation of the mitigating devices available to defendant …rms reveals several interesting …ndings First, beyond the traditional legal recourse of settling and …ghting claims in court, …rms are often completely shielded by their product 2 In sharp contrast, tobacco litigation also a¤ects the defendant …rms’ product market as the tobacco industry still produces the litigious . Three Essays in Corporate Finance Dissertation Presented in Partial Fulfillment of the Requirements for the Degree Doctor of Philosophy in the Graduate School of. the indirect costs of distress. Weiss and Wruck (1998) …nd massive value destruction in Eastern Airline’s bankruptcy and Pulvino (1999) …nds evidence of signi…cant …re sales in the airline industry endo- geneity may be ine¤ective in this corporate setting (see Coles, Lemmon, and Meschke (2007)). The typical unobservable variable in this context is managerial productivity. By driving both …rm performance