Law and Finance

This research 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 Cluster
Institutions and Social Norms

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Professor Stefano Colonnello, PhD
Professor Stefano Colonnello, PhD
Mitglied - Department Financial Markets
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Refereed Publications

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Corporate Misconduct and the Cost of Private Debt: Evidence from China

Xian Gu Iftekhar Hasan Haitian Lu

in: Comparative Economic Studies, 2019

Abstract

Using a comprehensive dataset of corporate lawsuits in China, we investigate the implications of corporate misconduct on the cost of private debt. Evidence reveals that firms involved in litigations obtain subsequent loans with stricter pricing terms, 15.1 percent higher loan spreads, than non-litigated borrowers. Strong political connection and repeated relationship help to flatten the sensitivity of loan pricing to litigation. Nonbank financial institutions react in stronger manner to corporate misconduct than traditional banks in pricing loans. Overall, we show that private debt holders care about borrowers’ wrongdoing in the past.

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CEO Investment of Deferred Compensation Plans and Firm Performance

Domenico Rocco Cambrea Stefano Colonnello Giuliano Curatola Giulia Fantini

in: Journal of Business Finance & Accounting, No. 7, 2019

Abstract

We study how US chief executive officers (CEOs) invest their deferred compensation plans depending on the firm's profitability. By looking at the correlation between the CEO's return on these plans and the firm's stock return, we show that deferred compensation is to a large extent invested in the company equity in good times and divested from it in bad times. The divestment from company equity in bad times arguably reflects CEOs' incentive to abandon the firm and to invest in alternative instruments to preserve the value of their deferred compensation plans. This result suggests that the incentive alignment effects of deferred compensation crucially depend on the firm's health status.

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The Economic Impact of Changes in Local Bank Presence

Iftekhar Hasan Krzysztof Jackowicz Oskar Kowalewski Łukasz Kozłowski

in: Regional Studies, No. 5, 2019

Abstract

This study analyzes the economic consequences of changes in the local bank presence. Using a unique data set of banks, firms and counties in Poland over the period 2009–14, it is shown that changes strengthening the relationship banking model are associated with local labour market improvements and easier small and medium-sized enterprise access to bank debt. However, only the appearance of new, more aggressive owners of large commercial banks stimulates new firm creation.

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Trust in Banks

Zuzana Fungáčová Iftekhar Hasan Laurent Weill

in: Journal of Economic Behavior & Organization, 2019

Abstract

Trust in banks is considered essential for an effective financial system, yet little is known about what determines trust in banks. Only a handful of single-country studies discuss the topic, so this paper aims to fill the gap by providing a cross-country analysis on the level and determinants of trust in banks. Using World Values Survey data covering 52 countries during the period 2010–2014, we observe large cross-country differences in trust in banks and confirm the influence of several sociodemographic indicators. Our main findings include: women tend to trust banks more than men; trust in banks tends to increase with income, but decrease with age and education; and access to television enhances trust, while internet access erodes trust. Additionally, religious, political, and economic values affect trust in banks. Notably, religious individuals tend to put greater trust in banks, but differences are observed across denominations. The holding of pro-market economic views is also associated with greater trust in banks.

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The Role of Auditors in Merger and Acquisition Completion Time

Salim Chahine Iftekhar Hasan Mohamad Mazboudi

in: International Journal of Auditing, No. 3, 2018

Abstract

Using a sample of 664 merger and acquisition (M&A) transactions and office‐level audit data, this study investigates the role of auditors in M&A completion time. We find that having a common auditor for both acquirer and target firms in M&A transactions increases the completion time of such transactions because the exposure to higher litigation and reputational costs outweighs the information‐access advantage of common auditors. However, auditors' past experience in M&A transactions helps reduce completion time and costs. These results are robust to having Big N auditors at both ends as well as to various acquirer, target, and deal characteristics.

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Working Papers

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Firm-level Employment, Labour Market Reforms, and Bank Distress

Moritz Stieglitz Ralph Setzer

in: ECB Working Paper Series, No. 2334, 2019

Abstract

We explore the interaction between labour market reforms and financial frictions. Our study combines a new cross-country reform database on labour market reforms with matched firm-bank data for nine euro area countries over the period 1999 to 2013. While we find that labour market reforms are overall effective in increasing employment, restricted access to bank credit can undo up to half of long-term employment gains at the firm-level. Entrepreneurs without sufficient access to credit cannot reap the full benefits of more flexible employment regulation.

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Firm-level Employment, Labour Market Reforms, and Bank Distress

Ralph Setzer Moritz Stieglitz

in: IWH Discussion Papers, No. 15, 2019

Abstract

We explore the interaction between labour market reforms and financial frictions. Our study combines a new cross-country reform database on labour market reforms with matched firm-bank data for nine euro area countries over the period 1999 to 2013. While we find that labour market reforms are overall effective in increasing employment, restricted access to bank credit can undo up to half of long-term employment gains at the firm-level. Entrepreneurs without sufficient access to credit cannot reap the full benefits of more flexible employment regulation.

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Benign Neglect of Covenant Violations: Blissful Banking or Ignorant Monitoring?

Stefano Colonnello Michael Koetter Moritz Stieglitz

in: IWH Discussion Papers, No. 3, 2019

Abstract

Theoretically, bank‘s loan monitoring activity hinges critically on its capitalisation. To proxy for monitoring intensity, we use changes in borrowers‘ investment following loan covenant violations, when creditors can intervene in the governance of the firm. Exploiting granular bank-firm relationships observed in the syndicated loan market, we document substantial heterogeneity in monitoring across banks and through time. Better capitalised banks are more lenient monitors that intervene less with covenant violators. Importantly, this hands-off approach is associated with improved borrowers‘ performance. Beyond enhancing financial resilience, regulation that requires banks to hold more capital may thus also mitigate the tightening of credit terms when firms experience shocks.

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Effectiveness and (In)Efficiencies of Compensation Regulation: Evidence from the EU Banker Bonus Cap

Stefano Colonnello Michael Koetter Konstantin Wagner

in: IWH Discussion Papers, No. 7, 2018

Abstract

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.

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Internal Governance and Creditor Governance: Evidence from Credit Default Swaps

Stefano Colonnello

in: IWH Discussion Papers, No. 6, 2017

Abstract

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.

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