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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Do Venture Capital Firms Benefit from a Presence on Boards of Directors of Mature Public Companies?

Iftekhar Hasan Arif Khurshed Abdulkadir Mohamed Fan Wang

in: Journal of Corporate Finance, 2018

Abstract

This paper examines the benefits to venture capital firms of their officers holding directorships in mature public companies in terms of fundraising and investment performance. Our empirical results show that venture capital firms raise more funds, set higher fund-raising targets, and are more likely to successfully exit their investments post-appointment of their officers to boards of directors of S&P 1500 companies. Directorship status in mature public firms provides venture capital firms with enhanced networks, visibility, and credibility, all of which facilitate their fundraising activities. In addition, the knowledge, expertise, and experience acquired through holding directorships in mature public firms are beneficial for their portfolio companies, as measured by the likelihood of successful exits.

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Private Benefits of Control and Bank Loan Contracts

Chih-Yung Lin Wei-Che Tsai Iftekhar Hasan Le Quoc Tuan

in: Journal of Corporate Finance, 2018

Abstract

This paper investigates whether or not private benefits of control by managers and large shareholders influence the financing cost of firms. Evidence shows that lending banks demand a significantly higher loan spread, higher fees, shorter loan maturity, smaller loan size, stricter covenants, and greater collateral on firms with greater private benefits of control. Results are stronger for firms with weak corporate governance quality, supporting the agency cost viewpoint. Such evidence implies that banks consider higher private benefits of control as a type of agency problem when they make lending decisions.

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Should Banks Diversify or Focus? Know Thyself: The Role of Abilities

Bill Francis Iftekhar Hasan A. Melih Küllü Mingming Zhou

in: Economic Systems, No. 1, 2018

Abstract

The paper investigates whether diversification/focus across assets, industries and borrowers affects bank performance when banks’ abilities (screening and monitoring) are considered. The initial results show that diversification (focus) at the asset, industry and borrower levels is expected to decrease (increase) returns. However, once banks’ screening and monitoring abilities are controlled for, the effect of diversification/focus either gets weaker or disappears. Further, in some cases, these abilities enhance banks’ long-run performance, but in others they prove to be costly, at least, in the short run. Thus, the level of monitoring and screening abilities should be taken into consideration in understanding, planning and implementing diversification/focus strategies.

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State Enforceability of Noncompete Agreements: Regulations that Stifle Productivity!

S. Anand Iftekhar Hasan P. Sharma Haizhi Wang

in: Human Resource Management, No. 1, 2018

Abstract

Noncompete agreements (also known as covenants not to compete [CNCs]) are frequently used by many businesses in an attempt to maintain their competitive advantage by safeguarding their human capital and the associated business secrets. Although the choice of whether to include CNCs in employment contracts is made by firms, the real extent of their restrictiveness is determined by the state laws. In this article, we explore the effect of state‐level CNC enforceability on firm productivity. We assert that an increase in state level CNC enforceability is detrimental to firm productivity, and 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 tends to become more long‐term oriented. Results based on hierarchical linear modeling analysis of 21,134 firm‐year observations for 3,027 unique firms supported all three hypotheses.

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Differences Make a Difference: Diversity in Social Learning and Value Creation

Yiwei Fang Bill Francis Iftekhar Hasan

in: Journal of Corporate Finance, 2018

Abstract

Prior research has demonstrated that CEOs learn privileged information from their social connections. Going beyond the importance of the number of social ties in a CEO's social network, this paper studies the value generated from a diverse social environment. We construct an index of social-network heterogeneity (SNH) that captures the extent to which CEOs are connected to people of different demographic attributes and skill sets. We find that higher CEO SNH leads to greater firm value through the channels of better corporate innovation and diversified M&As. Overall, the evidence suggests that CEOs' exposure to human diversity enhances social learning and creates greater growth opportunities for firms.

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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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