Law and Finance
This research group belongs to the IWH Research Cluster Institutions and Social Norms. The group studies the role of corporate governance for firm value and policies, with a focus on firm-creditor relationships and legal institutions. We plan to investigate these issues along three lines of research. First, we look at how financial and legal innovations impact firm-creditor relationships. In a project, we examine how the possibility to hedge against credit risk on a firm’s debt through credit default swaps (CDS) may alter such relationships by reducing creditors’ incentives to monitor the firm. The second line of research explores theoretically and empirically how the dynamics of debtor-creditor conflicts shape managerial incentives, and how these in turn influence the firm's cost of debt. The third line of research relates to the role of the court system for firms. The outcome of a legal dispute has two main sources: The applicable laws and the courts that enforce them. We shed light on the role of courts in determining the impact of legal conflicts on firm value.
Research ClusterInstitutions and Social Norms
Covenants not to Compete: The Ties That Stifle Productivity
in: Human Resource Management, forthcoming
Covenants not to compete (CNCs) are frequently used by many businesses in an attempt to impede the departure of their human capital and continually retain their competitive edge. However, empirical evidence regarding the net impact of CNCs on the firm is largely inconclusive. Theorizing that CNCs impose restrictions on employee mobility and thus reduce their motivation to expand their human capital, we examine the impact of CNCs on firm productivity. We also explore the moderating effects of job opportunity concentration in a firm’s home state, and long-term executive compensation. We hypothesize that the enforceability of CNCs is negatively associated with firm productivity. This relationship becomes stronger as comparable job opportunities become more concentrated in a firm’s home state. On the other hand, this negative relationship is weakened as employee compensation becomes more long-term oriented. Results of hierarchical linear modeling analyses of 21680 observations for 3379 firms supported all three hypotheses.
The Impacts of Intellectual Property Rights Protection on Cross-Border M&As
in: Quarterly Journal of Finance, No. 3, 2017
We investigate the impacts of improved intellectual property rights (IPR) protection on cross-border Mergers and Acquisitions performance. Using multiple measures of IPR protection and based on generalized difference-in-differences estimates, we find that countries with better IPR protection attract significantly more hi-tech cross-border Mergers and Acquisitions activity, particularly in developing economies. Moreover, acquirers pay higher premiums for companies in countries with better IPR protection, and there is a significantly higher acquirer announcement effect associated with these hi-tech transactions.
Direct and Indirect Risk-taking Incentives of Inside Debt
in: Journal of Corporate Finance, August 2017
We develop a model of compensation structure and asset risk choice, where a risk-averse manager is compensated with salary, equity and inside debt. We seek to understand the joint implications of this compensation package for managerial risk-taking incentives and credit spreads. We show that the size and seniority of inside debt not only are crucial for the relation between inside debt and credit spreads but also play an important role in shaping the relation between equity compensation and credit spreads. Using a sample of U.S. public firms with traded credit default swap contracts, we provide evidence supportive of the model's predictions.
The Risk‐Taking Channel of Monetary Policy in the U.S.: Evidence from Corporate Loan Data
in: Journal of Money Credit and Banking, No. 1, 2017
To study the presence of a risk-taking channel in the U.S., we build a comprehensive data set from the syndicated corporate loan market and measure monetary policy using different measures, most notably Taylor (1993) and Romer and Romer (2004) residuals. We identify a negative relation between monetary policy rates and bank risk-taking, especially in the run up to the 2007 financial crisis. However, this effect is purely supply-side driven only when using Taylor residuals and an ex ante measure of bank risk-taking. Our results highlight the sensitivity of the potency of the risk-taking channel to the measures of monetary policy innovations.
The Effect of Board Directors from Countries with Different Genetic Diversity Levels on Corporate Performance
in: Management Science, No. 1, 2017
We link genetic diversity in the country of origin of the firms’ board members with corporate performance via board members’ nationality. We hypothesize that our approach captures deep-rooted differences in cultural, institutional, social, psychological, physiological, and other traits that cannot be captured by other recently measured indices of diversity. Using a panel of firms listed in the North American and UK stock markets, we find that adding board directors from countries with different levels of genetic diversity (either higher or lower) increases firm performance. This effect prevails when we control for a number of cultural, institutional, firm-level, and board member characteristics, as well as for the nationality of the board of directors. To identify the relationship, we use—as instrumental variables for our diversity indices—the migratory distance from East Africa and the level of ultraviolet exposure in the directors’ country of nationality.
Effectiveness and (In)Efficiencies of Compensation Regulation: Evidence from the EU Banker Bonus Cap
in: IWH Discussion Papers, No. 7, 2018
We study if the regulation of bank executive compensation has unintended consequences. Based on novel data on CEO and non-CEO executives in EU banking, we show that capping the variable-to-fixed compensation ratio did not induce executives to abandon the industry. Banks indemnified executives sufficiently for the shock to retain them by raising fixed and lowering variable compensation while complying with the cap. At the same time, banks‘ risk-adjusted performance deteriorated due to increased idiosyncratic risk. Collateral damage for the financial system as a whole appears modest though, as average co-movement of banks with the market declined under the cap.
Pricing Sin Stocks: Ethical Preference vs. Risk Aversion
in: IWH Discussion Papers, No. 20, 2017
We develop a model that reproduces the return and volatility spread between sin and non-sin stocks, where investors trade off dividends with the ethical assessment of companies. We relax the assumption of boycott behaviour and investigate the role played by the dividend share of sin stocks on their return and volatility spread relative to non-sin stocks. We empirically show that the dividend share predicts a positive return and volatility spread. This pattern is reproduced by our model when dividends and ethicalness are complementary goods and investors are sufficiently risk averse.
Internal Governance and Creditor Governance: Evidence from Credit Default Swaps
in: IWH Discussion Papers, No. 6, 2017
I study the relation between internal governance and creditor governance. A deterioration in creditor governance may increase the agency costs of debt and managerial opportunism at the expense of shareholders. I exploit the introduction of credit default swaps (CDS) as a negative shock to creditor governance. I provide evidence consistent with shareholders pushing for a substitution effect between internal governance and creditor governance. Following CDS introduction, CDS firms reduce managerial risk-taking incentives relative to other firms. At the same time, after the start of CDS trading, CDS firms increase managerial wealth-performance sensitivity, board independence, and CEO turnover performance-sensitivity relative to other firms.
Direct and Indirect Risk-taking Incentives of Inside Debt
in: IWH Discussion Papers,
We develop a model of managerial compensation structure and asset risk choice. The model provides predictions about the relation between credit spreads and different compensation components. First, we show that credit spreads are decreasing in inside debt only if it is unsecured. Second, the relation between credit spreads and equity incentives varies depending on the features of inside debt.
Empty Creditors and Strong Shareholders: The Real Effects of Credit Risk Trading
in: IWH Discussion Papers, No. 10, 2016
Credit derivatives give creditors the possibility to transfer debt cash flow rights to other market participants while retaining control rights. We use the market for credit default swaps (CDSs) as a laboratory to show that the real effects of such debt unbundling crucially hinge on shareholder bargaining power. We find that creditors buy more CDS protection when facing strong shareholders to secure themselves a valuable outside option in distressed renegotiations. After the start of CDS trading, the distance-to-default, investment, and market value of firms with powerful shareholders drop by 7.9%, 7%, and 8.8% compared to other firms.