Most recent developments in firm governance studies

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• Most recent developments in firm governance
  studies

Thanks go to Burcin Cole (McGill) for assistance
in preparing this overview
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• Kadyrzhanova, Rhodes-Kropf (2007)
• Use theory and derive cross-sectional predictions
  of a product market model of anti-takeover
  provisions.
• They find that the effect of anti-takeover
  provisions on shareholder value varies with the
  degree of industry concentration. Hence,
  governance reforms directed toward weakening
  takeover defenses may serve benefits for some
  firms but not for all. Main conclusion of their
  theory is that ATPs have greater value and more
  likely to be adopted in more concentrated
  industries. Their model delivers the following 3
  main empirically testable implications
• firms in concentrated industries are more likely
  to adopt antitakeover provisions
• antitakeover provisions lead to higher takeover
  premiums only in concentrated industries
• antitakeover provisions increase firm value only
  in concentrated industries.

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• Kadyrzhanova, Rhodes-Kropf (2007)
• For the tests, they first document ATPs clustered
  by industry and use a probit model in order to
  show that firms in concentrated industries are
  more likely to adopt ATPs than firms in less
  concentrated industries. Then, they regress
  takeover premiums and firm value on the
  interaction between ATP and concentration. The
  empirical results support their model.
• They use different ATP indices and a variety of
  controls for robustness.
• their concentration measure is CR4 (ratio of
  sales of the top 4 firms in an industry to total
  industry sales) provided by Bureau of Census.
• alternative measures such as 1) the
  Herfindahl-Hirschman Index (HHI) 2) import
  penetration (ratio of imports over imports plus
  domestic production) and 3) number of competitors
  are also used in tests for robustness checks.
• finally, for the endogeneity issue, they use
  industry concentration at IPO as the instrumental
  variable.

4

• Kadyrzhanova (2005)
• This paper develops a theory of predation based
  on imperfections in corporate control.
• She finds that in imperfectly competitive
  industries the industry leaders tend to have
  weaker governance than laggards, which is called
  leader-bias in corporate governance.
• due to this bias, the industry leaders can
  maintain their lead and secure monopoly rents by
  driving rivals out of the market.
• This leads to persistently monopolized markets,
  lower turnover, higher concentration, and up to
  thirty percent lower consumer welfare than in
  otherwise identical industries with full
  corporate control.

5

• Kadyrzhanova (2005)
• Her model characterizes the unique and symmetric
  Markov perfect equilibrium of an oligopolistic
  industry with imperfect corporate control.
• She explicitly models product market rivalry
  two-dimensionally and analytically demonstrates
  that imperfect corporate control encourages RD
  effort on the side of the leader and discourages
  RD effort on the side of the laggard.
• She empirically documents the existence of the
  bias for a sample of publicly traded companies in
  the US.
• Hence, she concludes that governance
  imperfections can be characterized as predatory
  as they lead to rival-weakening and exit-inducing
  behavior and improving corporate governance
  through public policy measures such as the
  Sarbanes-Oxley Act can be therefore
  pro-competitive.

6

• Giroud and Mueller (2007)
• They investigate whether the product market
  competition has an effect on managerial agency
  problems.
• More specifically they use the passage of 30
  business combination (BC) laws -which by reducing
  the fear of a hostile takeover weaken corporate
  governance and create more opportunity for
  managerial slack- and examine whether such laws
  have a different effect on competitive and
  non-competitive industries.
• For the analyses, they use differences-in-differen
  ces approach and estimate how the passage of BC
  laws affects firm performance differently
  depending on how competitive the firms industry
  is.
• Their measure of product market competition is
  Herfindahl-Hirschman index adopted from
  industrial organization theory studies (Curry and
  George (1983) and Tirole (1988)) and is based on
  3-digit SIC codes. For robustness checks, they
  also employ the Herfindahl index provided by the
  US Bureau of the Census. Also, for the measure of
  foreign competition they use the import
  penetration.

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• Giroud and Mueller (2007)
• They find that while firms in noncompetitive
  industries experience a substantial drop in
  performance after passing these laws, firms in
  competitive industries remain virtually
  unaffected.
• Hence, they conclude that managerial slack cannot
  survive in competitive industries. Moreover, they
  conduct event studies around the dates of the
  first newspaper reports about the BC laws. They
  find that while firms in non-competitive
  industries experience a significant decline in
  their stock prices, the stock price impact is
  small and insignificant in competitive
  industries.
• Overall, they conclude that empirical studies on
  corporate governance could benefit from including
  measures of industry competition, such as
  Herfindahl index, in their regressions and
  efforts to improve governance could benefit from
  focusing on firms in non-competitive industries.

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• Cremers, Nair and Peyer (2007)
• This paper tests for an empirical relationship
  between takeover defenses and industry
  competition. They find that firms in more
  competitive industries have more takeover
  defenses. They argue that firms choose their
  level of shareholder rights after comparing the
  costs of acquisition exposure (i.e. loss of
  customers) with synergistic benefits and hence it
  may be optimal to have weak shareholder rights in
  competitive markets.

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• Cremers, Nair and Peyer (2007)
• They first show that the previously documented
  finding that firms in competitive industries have
  more takeover defenses only hold for relationship
  (or durable goods) industries.
• Second, they show that the negative relation
  between firm performance and takeover defenses is
  reversed in relationship industries.
• Finally, they show that stock based compensation
  is higher in competitive environments with fewer
  firms, more domestic  competition and in
  relationship industries and argue that in
  industries where firm survival is important for
  customer choices, governance is more likely to be
  based on internal mechanisms (i.e., monitoring,
  incentives) rather than through takeover threats.
• For their analyses, they employ panel regressions
  with errors clustered at the industry level.
• They use industry median net profit margin (NPM,
  Gompers et al (2003) and Lerner (1934)) and
  Herfindahl index (and normalized Herfindahl
  Index) as proxies for product market competition
  and percentage of industry sales that is imported
  as a proxy for foreign competition. For the
  industry classifications they use 2-digit SIC
  codes for the main analysis and 48 Fama-French
  industries for robustness checks.

10

• Bris and Brisley (2006)
• This paper models a competitive industry using a
  Cournot model, where managers choose quantities
  and costs to maximize a combination of firm
  profits and private benefits from expropriation.
• They model corporate governance with a variable
  called governance slack - potentially a
  variable of choice for government- which is low
  when corporate governance is strong and high when
  other cost-based considerations have stronger
  influences on firm decisions. Expropriation
  depends on regulation the more corporate
  governance slack allowed by government, the
  greater the weight of expropriation in the
  managers objective function.
• By expropriating firm managers impose a cost on
  shareholders, and equilibrium they produce more
  than optimal.
• As a result, firm output increases and prices
  decrease which benefits consumers.
• Their model shows that for every economic system,
  depending on industry structure and the
  governments objective, there is an optimal level
  of expropriation that maximizes social welfare.
  Hence, they conclude that there is no universally
  optimal corporate governance system and sometimes
  it may be desirable to allow managers to
  expropriate from shareholders.

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• Bris and Brisley (2006)
• They also show that managers and controlling
  shareholders will not have an incentive to
  unilaterally and voluntarily initiate a reform
  unless the level of corporate governance slack in
  the economy is already low.
• This is because if one firm adopts stronger
  governance and overproduces less, this leaves
  room for non-adopting competitors to overproduce
  even more and expropriate more (free-rider
  problem), hence in equilibrium no firm moves
  first and reform does not take place.
• Therefore, a unilateral and voluntary improvement
  in a firms corporate governance only occurs when
  the domestic governance regime is already
  sufficiently protective, which implies that
  managers costs of moving to a stronger system
  are compensated by a large enough increase in
  firm profits.
• Finally they show the efficacy of cross-border
  mergers and suggest that in the absence of a
  formal change in the corporate governance system,
  the facilitation of cross-border mergers can
  provide an alternative mechanism to improve
  investor protection in some firms.

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• Allen and Carletti (2007)
• This paper develops a model of stakeholder
  governance in the context of an imperfectly
  competitive product market.
• Their model is a two-period duopoly model of
  differentiated products with price competition
  where firms put weight in their objective
  function on the effects of bankruptcy on
  stakeholders other than shareholders.
• They show that when firms put weight on
  stakeholders other than shareholders, this
  concern leads to a softening of competition so
  firms can charge higher prices and their profits
  as well as the total firm value can be increased.
  
• Although the consumers are worse off, this
  benefits workers and suppliers. In fact, since
  firm value is higher, even the shareholders may
  want to put in place governance structures that
  commit them to adopt a concern for other
  stakeholders.

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• Allen and Carletti (2007)
• They show that when firms anticipate a
  sufficiently large reaction from their rivals,
  firms can improve their shareholders welfare by
  voluntarily choosing to be stake-holder oriented.
  
• They also show that even though firms do not
  voluntarily adopt a stakeholder orientation, such
  governance structures may arise endogenously if
  consumers prefer to buy from firms that care
  about stakeholders other than shareholders.
• Finally, they find that firms in countries that
  are stakeholder friendly have greater incentive
  to oppose the entry of firms with
  shareholder-oriented governance structures than
  vice-versa.

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• Hermalin and Weisbach (2007)
• Provide a model to understand the role of
  transparency in corporate governance.
• They show that there are likely to be both costs
  and benefits to increased transparency, which
  leads to an optimum level beyond which increasing
  transparency lowers profits.
• They conclude that reforms that increase
  transparency can reduce firm profits, raise
  executive compensation, and inefficiently
  increase the rate of CEO turnover.