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Featured research and insights

The Centre has funded over 30 world-class research projects across the Corporate Governance spectrum, including:


  • CEO Succession by James Dow

  • Corporate Social Responsibility and Shareholder Value by Henri Servaes

  • Pyramidal Ownership and Control Transfers in Family Firms by Paolo Volpin and others

  • Corporate Governance and Value Creation: Evidence from Private Equity by Viral Acharya and others

  • The Returns to Hedge Fund Activism: An International Study by Julian Franks and others.

 

To request a copy of any research papers, please contact Nicole Hergarten-Tucker, Executive Director:  nhergartentucker@london.edu



Research by year:
  • 2014

    The Returns to Hedge Fund Activism: An international study

    Marco Becht , Julian R. Franks , Jeremy Grant and Hannes F. Wagner

    This paper examines almost 1800 cases of shareholder activism across three regions, Asia, Europe and North America. We measure the block disclosure returns to activist announcements and to subsequent outcomes of the engagement, including changes to payout, boards, takeovers and other corporate restructurings. We compare the profitability of engagements with and without outcomes. There are large abnormal returns to shareholder activism at the block disclosure announcement of between 4.5 and 7.5 percent across the three continents. There are also large additional abnormal returns to the disclosure of outcomes from engagements, totalling 9.3 percent in Europe, and 6.6 percent in North America. The returns for Asia are much lower at 3 percent. Asia also has the lowest number of outcomes per engagement, with payout being the most common type. During the financial crisis activist returns declined significantly, primarily as a result of the lack of outcomes, particularly for takeovers. Overall, the paper shows that abnormal returns over the entire period of the engagement are significantly higher for engagements with outcomes compared with those without outcomes. These results suggest that the profitability of activism is based primarily on engagement with the target firm to achieve change rather than on “stock picking.”


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    The Ownership of Japanese Corporations in the 20th Century

    Julian R. Franks , Colin Mayer and Hideaki Miyajima


    Twentieth century Japan provides a remarkable laboratory for examining how an externally imposed institutional and regulatory intervention affects the ownership of corporations. In the first half of the century, Japan had weak legal protection but strong institutional arrangements. The institutions were dismantled after the war and replaced by a strong form of legal protection. This inversion resulted in a switch from Japan being a country in which equity markets flourished and ownership was dispersed in the first half of the century to one in which banks and companies dominated with interlocking shareholdings in the second half of the century.

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  • 2013

    The Mystery of Zero Leverage Firms

    Ilya Strebulaev and Baozhong Yang


    We present the puzzling evidence that, from 1962 to 2009, an average 10.2% of large public nonfinancial US firms have zero debt and almost 22% have less than 5% book leverage ratio. Zero-leverage behaviour is a persistent phenomenon. Dividend-paying zero-leverage firms pay substantially higher dividends, are more profitable, pay higher taxes, issue less equity, and have higher cash balances than control firms chosen by industry and size. Firms with higher Chief Executive Officer (CEO) ownership and longer CEO tenure are more likely to have zero debt, especially if boards are smaller and less independent. Family firms are also more likely to be zero-levered.

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    CEO Turnover in LBOs: The Role of Boards
    Francesca Cornelli and Oguzhan Karakas


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    The Mystery of Zero Leverage Firms

    Ilya Strebulaev and Baozhong Yang


    We present the puzzling evidence that, from 1962 to 2009, an average 10.2% of large public nonfinancial US firms have zero debt and almost 22% have less than 5% book leverage ratio. Zero-leverage behavior is a persistent phenomenon. Dividend-paying zero-leverage firms pay substantially higher dividends, are more profitable, pay higher taxes, issue less equity, and have higher cash balances than control firms chosen by industry and size. Firms with higher Chief Executive Officer (CEO) ownership and longer CEO tenure are more likely to have zero debt, especially if boards are smaller and less independent. Family firms are also more likely to be zero-levered.

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  • 2012

    Competition for Managers, Corporate Governance and Incentive Compensation

    Viral Acharya, Marc Gabarro and Paolo Volpin


    We propose a model in which better governance incentivizes managers to perform better and thus saves on the cost of providing pay for performance. However, when managerial talent is scarce, firms' competition to attract better managers reduces an individual firm's incentives to invest in corporate governance. In equilibrium, better managers end up at firms with weaker governance, and conversely, better-governed firms have lower-quality managers. Consistent with these implications, in a sample of US firms, we show that (i) better CEOs are matched to firms with weaker corporate governance and more so in industries with stronger competition for managers, and, (ii) corporate governance is more likely to change when there is CEO turnover, with governance weakening when the incoming CEO is better than the departing one.


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  • 2010

    Corporate Bond Default Risk: A 150 Year Perspective


    Ilya Strebulaev, Kay Giesecke, Francis Longstaff and Stephen Schaefer


    We study corporate bond default rates using an extensive new data set spanning the 1866–2008 period. We find that the corporate bond market has repeatedly suffered clustered default events much worse than those experienced during the Great Depression. For example, during the railroad crisis of 1873–1875, total defaults amounted to 36 percent of the par value of the entire corporate bond market. We examine whether corporate default rates are best forecast by structural, reduced-form, or macroeconomic credit models and find that variables suggested by structural models outperform the others. Default events are only weakly correlated with business downturns. We find that over the long term, credit spreads are roughly twice as large as default losses, resulting in an average credit risk premium of about 80 basis points. We also find that credit spreads do not adjust in response to realized default rates.


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    Corporate Governance Externalities

    Viral Acharya and Paolo Volpin

    When firms compete in the managerial labor market, the choice of corporate governance by a firm affects, and is affected by, the choice of governance by other firms. Firms with weaker governance offer managers more generous incentive compensation, which induces firms with good governance to also overpay their management. Due to this externality, overall level of governance in the economy can be inefficiently low. Poor governance can in fact be employed by incumbent firms to deter entry by new firms. Such corporate governance externalities have important implications for regulatory standards, ownership structure of firms, and the market for corporate control.


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    Corporate Bond Default Risk: A 150 Year Perspective

    Ilya Strebulaev, Kay Giesecke, Francis Longstaff and Stephen Schaefer

    We study corporate bond default rates using an extensive new data set spanning the 1866–2008 period. We find that the corporate bond market has repeatedly suffered clustered default events much worse than those experienced during the Great Depression. For example, during the railroad crisis of 1873–1875, total defaults amounted to 36 percent of the par value of the entire corporate bond market. We examine whether corporate default rates are best forecast by structural, reduced-form, or macroeconomic credit models and find that variables suggested by structural models outperform the others. Default events are only weakly correlated with business downturns. We find that over the long term, credit spreads are roughly twice as large as default losses, resulting in an average credit risk premium of about 80 basis points. We also find that credit spreads do not adjust in response to realized default rates.

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    Corporate Governance Externalities

    Viral Acharya and Paolo Volpin


    When firms compete in the managerial labor market, the choice of corporate governance by a firm affects, and is affected by, the choice of governance by other firms. Firms with weaker governance offer managers more generous incentive compensation, which induces firms with good governance to also overpay their management. Due to this externality, overall level of governance in the economy can be inefficiently low. Poor governance can in fact be employed by incumbent firms to deter entry by new firms. Such corporate governance externalities have important implications for regulatory standards, ownership structure of firms, and the market for corporate control.


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  • 2009

    Financial Tunneling and the Mandatory Bid Rule

    Jeremy Grant, Tom Kirchmaier and Jodie Kirshner


    In this paper we use clinical studies to document how dominant shareholders have circumvented mandatory bid rules to appropriate wealth from minority shareholders. Dominant shareholders are numerous in continental Europe. Creative compliance with mandatory bid rules reveals the failure of boards and regulators to protect minority shareholders and the difficulties of legislating in this area. We propose enhanced means for protecting their interests.


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    Corporate Governance and Value Creation: Evidence from Private Equity

    Viral  Acharya, Conor Kehoe and Moritz Hahn


    We examine deal-level data on private equity transactions in the UK initiated during the period 1996 to 2004 by mature private equity houses. We un-lever the deal-level equity return and adjust for (un-levered) return to quoted peers to extract a measure of "alpha" or abnormal performance of the deal. The alpha is significantly positive on average and robust during sector downturns. In the cross-section of deals, higher alpha is related to greater improvement in EBITDA to Sales ratio (margin) and greater growth in EBITDA multiple during the private phase, relative to that of quoted peers. In particular, deals with higher alpha either grow their margins more substantially, and/or grow multiples more substantially, whilst expanding their revenues only in line with the sector. Based on interviews with general partners involved with the deals, we find that deals with higher alpha and higher margin growth are associated with greater intensity of engagement of private equity houses during the early phase of the deal, employment of value-creation initiatives for productivity and organic growth, and complementing top management with external support. Overall, our results are consistent with mature private equity houses creating value for portfolio companies through active ownership and governance.


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    Ownership: Evolution and Regulation

    Julian Franks, Colin Mayer and Stefano Rossi


    This article is the first study of long-run evolution of investor protection and corporate ownership in the United Kingdom over the twentieth century. Formal investor protection emerged only in the second half of the century. We assess the influence of investor protection on ownership by comparing cross-sections of firms at different times in the century and the evolution of firms incorporating at different stages of the century. Investor protection had little impact on dispersion of ownership: even in the absence of investor protection, rates of dispersion of ownership were high, associated primarily with mergers. Preliminary evidence suggests that ownership dispersion in the United Kingdom relied more on informal relations of trust than on formal investor protection.


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    The Life Cycle of Family Ownership: A Comparative Study of France, Germany, Italy and the UK

    Julian Franks, Colin Mayer, Paolo Volpin and Hannes F. Wagner



    Equity Markets and Institutions: The Case of Japan

    Julian Franks, Hideaki Miyajima and Colin Mayer


    Corporate ownership and financing in Japan in the 20th century are striking. In the first half of the 20th century equity markets were active in raising more than 50% of the external financing of Japanese companies. Ownership was dispersed both by the standards of other developed economies at the time and even by those of the UK and US today. In the second half of the 20th century, bank finance dominated external finance and interlocking shareholdings by banks and companies became widespread. The change from equity to bank finance and from an outsider system of public equity markets to an insider system of private equity in the middle of the 20th century coincided precisely with a marked increase in investor protection. Informal institutional arrangements rather than formal investor protection explain the existence of equity in the first half of the century - business co-ordinators in the early 20th century and zaibatsu later. Insider ownership in the form of bank ownership and cross-shareholdings emerged in the second half of the century as a response to the equity financing needs of fast growing firms and the financial restructuring of failing firms.


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    Private Equity versus Plc Boards in the U.K.: A Comparison of Practices and Effectiveness

    Viral Acharya, Conor Kehoe and Michael Reyner  


    We interview 20 executives in the UK who have been members of both PE and PLC boards of relatively large companies. The main difference we find in PE and PLC board modus operandi is in the single-minded value creation focus of PE boards versus governance compliance and risk management focus of PLC boards. PE boards see their role as leading the strategy of the firm through intense engagement with top management; in contrast, PLC boards "accompany" the strategy of top management. PE boards report almost complete alignment in objectives between executive and non-executive directors, whereas the PLC boards report lack of complete alignment and focus on management of broader stakeholder interests. Finally, PE board members receive information that is primarily cash-focused and undergo an intensive induction during the due diligence phase. In contrast, PLC board members collect more diverse information and undergo a more structured (formal) rather than an intense induction.

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    The Internal Governance of Firms

    Viral Acharya, Stewart Myers and Raghuram Rajan


    We develop a model of internal governance where the self-serving actions of top management are limited by the potential reaction of subordinates. Internal governance can mitigate agency problems and ensure that firms have substantial value, even with little or no external governance by investors. Internal governance works best when both top management and subordinates are important in generating cash flow. External governance, even if crude and uninformed, can complement internal governance and improve efficiency. This leads to a theory of investment and dividend policy, where dividends are paid by self-interested CEOs to maintain a balance between internal and external control. Our paper can explain why firms with limited external oversight, and firms in countries with poor external governance, can have substantial value.


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    Creditor Rights and Corporate Risk-taking

    Viral Acharya, Yakov Amihud and Lubomir Litov

    We analyze the link between creditor rights and firms' investment policies, proposing that stronger creditor rights in bankruptcy reduce corporate risk-taking. In cross-country analysis, we find that stronger creditor rights induce greater propensity of firms to engage in diversifying acquisitions, which result in poorer operating and stock-market abnormal performance. In countries with strong creditor rights, firms also have lower cash flow risk and lower leverage, and there is greater propensity of firms with low-recovery assets to acquire targets with high-recovery assets. These relationships are strongest in countries where management is dismissed in reorganization, and are observed in time-series analysis around changes in creditor rights. Our results question the value of strong creditor rights as they have an adverse effect on firms by inhibiting management from undertaking risky investments.

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    Returns to Investor Activism

    Marco Becht, Julian Franks, Colin Mayer and Stefano Rossi

    This article reports a unique analysis of private engagements by an activist fund. It is based on data made available to us by Hermes, the fund manager owned by the British Telecom Pension Scheme, on engagements with management in companies targeted by its UK Focus Fund. In contrast with most previous studies of activism, we report that the fund executes shareholder activism predominantly through private interventions that would be unobservable in studies purely relying on public information. The fund substantially outperforms benchmarks and we estimate that abnormal returns are largely associated with engagements rather than stock picking.

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    Another Option for Determining the Value of Corporate Votes

    Oguzhan Karakas

    This paper proposes a new method using option prices to measure the value of the voting right attached to a stock. The method consists of synthesizing a non-voting share using put-call parity, and comparing its price to that of the underlying stock. Empirically, I find this measure of the value of a voting right to increase around shareholder meetings, particularly for those which are contested. The measure is also more frequently positive for activist hedge fund targets. I estimate the mean (median) annualized value of a voting right to be 1.23% (0.86%) of the underlying stock price.


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  • 2008

    Cross-country Variations in Capital Structures: The Role of Bankruptcy Codes

    Viral Acharya, Kose John and Rangarajan K. Sundaram


    We investigate the impact of bankruptcy codes on firms’ capital-structure choices. We develop a theoretical model to identify how firm characteristics may interact with the bankruptcy code in determining optimal capital structures. A novel and sharp empirical implication emerges from this model: that the difference in leverage choices under a relatively equity-friendly bankruptcy code (such as the US’s) and one that is relatively more debt-friendly (such as the UK’s) should be a decreasing function of the anticipated liquidation value of the firm’s assets. Using a large database of firms from the US and the UK over the period 1990 to 2002, we subject this prediction to extensive empirical testing, both parametric and non-parametric, using different proxies for liquidation values and different measures of leverage. We find strong support for the theory; that is, we find that our proxies for liquidation value are both statistically and economically significant in explaining leverage differences across the two countries. On the other hand, many of the other factors that are known to affect within-country leverage (e.g., size) cannot explain across-countries differences in leverage.

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    Rewriting History

    Christopher Malloy, Alexander Ljungqvist and Felicia Marston


    We document widespread ex post changes to the historical contents of the I/B/E/S analyst stock recommendations database. Across a sequence of seven downloads of the entire I/B/E/S recommendations database, obtained between 2000 and 2007, we find that between 6,594 (1.6%) and 97,579 (21.7%) of matched observations are different from one download to the next. The changes, which include alterations of recommendation levels, additions and deletions of records, and removal of analyst names, are non-random in nature: They cluster by analyst reputation, brokerage firm size and status, and recommendation boldness. The changes have a large and significant impact on the classification of trading signals and back-tests of three stylized facts: The profitability of trading signals, the profitability of changes in consensus recommendations, and persistence in individual analyst stock-picking ability.


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  • 2007

    Corporate Governance of Pension Plans: The U.K. Evidence

    Joao F. Cocco and Paolo Volpin

    For this study of the governance of defined-benefit pension plans in the United Kingdom, the governance measure was equal to the proportion of trustees of the pension plan in 2002 who were also executive directors of the sponsoring company. The findings indicate that pension plans of indebted companies with a higher proportion of insider than independent trustees invest a higher proportion of pension plan assets in equities and that the sponsors contribute less to the plan and have a larger dividend payout ratio. This evidence supports the agency view that insider trustees act in the interests of shareholders of the sponsor, not necessarily in the interests of pension plan members.


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    The Small World of Investing: Board Connections and Mutual Fund Returns

    Christopher Malloy, Andrea Frazzini and Lauren Cohen


    This paper uses social networks to identify information transfer in security markets. We focus on connections between mutual fund managers and corporate board members via shared education networks. We find that portfolio managers place larger bets on firms they are connected to through their network, and perform significantly better on these holdings relative to their non-connected holdings. A replicating portfolio of connected stocks outperforms a replicating portfolio of non-connected stocks by up to 8.4% per year. Returns are concentrated around corporate news announcements, consistent with mutual fund managers gaining an informational advantage through the education networks. Our results suggest that social networks may be an important mechanism for information flow into asset prices.

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    Offsetting the implicit incentives: Benefits of Benchmarking in Money Management

    Anna Pavlova, Suleyman Basak, Alex Shapiro


    Money managers are rewarded for increasing the value of assets under management. This gives a manager an implicit incentive to exploit the well-documented positive fund-flows to relative-performance relationship by manipulating her risk exposure. The misaligned incentives create potentially significant deviations of the manager's policy from that desired by fund investors. In the context of a familiar continuous-time portfolio choice model, we demonstrate how a simple risk management practice that accounts for benchmarking can ameliorate the adverse effects of managerial incentives. Our results contrast with the conventional view that benchmarking a fund manager is not in the best interest of investors.

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    Private Equity : Boom or Bust?

    Viral Acharya, Julian Franks and Henri Servaes


    The authors offer a number of suggestions for increasing the transparency of this market. First, bankers' incentives to engage in effective ex-ante screening and ex-post monitoring of deals have been weakened, which may have led to excessive lending while encouraging buyers to overpay. Consistent with this possibility, the authors provide new evidence that some recent transactions have occurred at very low EBITDA-to-capital ratios, financed with high levels of debt that recall those of the late 1980s and early 1990s. The private equity or leveraged buyout (LBO) market in Europe and the U.S. has grown enormously over the last two decades, from $7.5 billion in 1991 to $500 billion in 2006. Much of the financing of recent transactions has come in the form of syndicated debt, which is dispersed after origination to many non-bank financial institutions. This financing practice has two important possible consequences: First, bankers' incentives to engage in effective ex-ante screening and ex-post monitoring of deals have been weakened, which may have led to excessive lending while encouraging buyers to overpay. Consistent with this possibility, the authors provide new evidence that some recent transactions have occurred at very low EBITDA-to-capital ratios, financed with high levels of debt that recall those of the late 1980s and early 1990s. Second, there is a scarcity of information about the identity of the ultimate holders of the LBO debt, and as a consequence of the resulting uncertainty, a few defaults of major LBO deals could cause a drying up of new funding for financial institutions. The end result could be that the veil covering the repackaging of LBO debt converts a small shock to the LBO sector into a liquidity crisis for its financiers. Such liquidity problems could in turn affect not the financing and re-financing of just LBO deals, but other as set classes as well, including lending by banks to public firms. The authors offer a number of suggestions for increasing the transparency of this market


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