Corporate Immunity to the COVID-19 Pandemic

Ross Levine is Professor of Finance at the University of California, Berkeley. This post is based on a paper authored by Professor Levine; Wenzhi Ding, Research Postgraduate Student at the University of Hong Kong; Chen Lin, the Stelux Professor in Finance at the University of Hong Kong; and Wensi Xie, Assistant Professor at the Chinese University of Hong Kong Business School. Related research from the Program on Corporate Governance includes What Matters in Corporate Governance? by Lucian Bebchuk, Alma Cohen, and Allen Ferrell.

Which corporate characteristics make companies more “immune” to COVID-19? The COVID-19 pandemic has triggered remarkably heterogeneous stock price movements among firms within the same country and industry. For example, the average U.S. manufacturing firm saw stock prices fall by 29% over the first quarter of 2020 with a standard deviation of 24%.

In this paper, we examine the relationship between pre-2020 corporate characteristics and stock price reactions to COVID-19. Using data on over 6,000 firms across 56 economies during the first quarter of 2020, we consider five pre-2020 firm traits: (1) basic financial conditions, such as cash holdings, leverage, and profitability, (2) global supply chain and customer exposure to COVID-19, such as the degree to which a firms’ inputs are purchased from and products sold in countries differentially exposed to COVID-19, (3) engagement in corporate social responsibility (CSR), such as relations with employees, suppliers, customers, and the communities in which firms operate, (4) corporate governance, such as executive control of the board, antitakeover provisions, and executive compensation systems, and (5) ownership structure, such as the extent to which hedge funds, families, non-financial corporations, and institutional investors hold large stakes in firms. We believe that our study is the first to assess cross-firm stock price reactions to COVID-19 as functions of these pre-shock traits. In all of our empirical models, we include country × time and industry × time fixed effects to capture time-varying country and industry level trends.

Basic financial conditions

Given the pandemic-induced strains on corporate cash-flows and the tightening of global liquidity constraints, heterogeneity in firms’ access to cash and credit may influence market valuations of firms as the pandemic spread.

Firms with more cash, less debt, and larger profits were more resilient to COVID-19 than otherwise similar firms. Comparing two otherwise similar firms in the same industry and country, our estimates suggest that the high-Leverage firm (one standard deviation greater pre-2020 leverage than a similar low-Leverage firm) would experience an extra 10% (of sample mean weekly stock returns) extra drop in its stock prices in response to the same COVID-19 shock.

Global supply chains

While policy makers and industry practitioners have stressed the role of global supply chain disruptions on markets, we empirically evaluate firms’ stock prices and their exposure to COVID-19 through their global supply chains and the location of their customers. We find that the pandemic-induced declines in stock prices have been greater among firms with more exposure to the COVID-19 pandemic through their international supply chains and customers.

Corporate Social Responsibility (CSR)

By building good relationships with stakeholders, CSR can boost corporate immunity. The corporation is a nexus of contracts between shareholders and other stakeholders, including workers, suppliers, customers, and communities. These contracts include both explicit agreements that are enforced by formal legal systems and implicit agreements that rely on trust. Accordingly, a corporation’s performance and resilience depends on the trust that it establishes with vital stakeholders. Firms can strengthen their connections with these stakeholders through CSR activities, such as creating safe workplaces, engaging in ethical business practices, providing enduring, reliable services to customers, and investing in the local environment and community. Such CSR activities build loyalty and signal a firm’s commitment to satisfying implicit contracts, which in turn boosts stakeholders’ willingness to make adjustments to support the business during times of duress.

We discover that CSR strengthened corporate resilience to COVID-19. Firms that conducted more CSR activities prior to the pandemic enjoyed better stock price performance than otherwise similar firms in the same industry and country. The estimated impact is economically large. Consider two otherwise similar firms in the same industry and economy. One has a pre-2020 CSR measure—that we quantify using data from Thomson Reuters—at the 25th percentile of the distribution of CSR activities, and the other is at the 75th percentile. Our estimates suggest that the average stock returns of the high-CSR firm would decline by 2 percentage points less than the low-CSR firm in response to exposure to same COVID-19 shock, e.g., the average growth of COVID19 cases. Ceteris paribus, these estimates suggest that the stock price reaction to COVID19 for the high-CSR firm would be 19% less than the low-CSR firm.

Corporate boards and executive entrenchment and compensation

Corporate governance can also influence resilience to COVID-19. For example, given uncertainty about the magnitude and duration of the pandemic, markets might put a premium on flexibility, including mergers and acquisitions and leadership changes. Thus, corporations with pre-existing antitakeover devices or other governance structures that protect executives would experience harsher stock price reactions to the pandemic. Theories of tunneling also suggest that periods of great uncertainty and tumult can hinder monitoring and create opportunities for insiders to extract greater resources and rents at the expense of other shareholders.

We find that markets penalized firms with more entrenched executives. Corporations that have more anti-takeover provisions experienced greater stock price declines. In valuing corporate resilience to COVID-19, markets have favorably valued flexibility, including mergers, acquisitions, and leadership changes, and governance structures that limit tunneling. We do not find evidence that corporate stock price reactions to COVID-19 vary systematically with board structure or executive compensations systems.

Corporate ownership

Ownership can also influence corporate resilience. To the extent that a large proportion of a firm’s owners have both deep-pockets and a long-run commitment to the firm, such as a large corporation with a strategic interest in the firm, this could influence the firm’s ability to weather the COVID-19 shock. Thus, stock prices might fall less among firms with a large, corporate blockholder than among otherwise similar firms. In contrast, research highlights two interrelated features of hedge funds that could contribute to large, nonfundamental stock price movements in the firms in which they are large blockholders: hedge funds often employ quantitative trading strategies that can trigger “overcrowding” and fire sale effects on prices and they often use short-term funding to lever their positions, which can trigger rapid sales when there are liquidity disruptions. Thus, adverse news about COVID-19 cases might induce stock prices to fall more among firms with a large, hedge fund blockholder.

We find that ownership matters. First, firms’ stock prices fall by less when firms are owned more by nonfinancial corporate blockholders. This suggests that when owners have long-run strategic interests in and commitments to a firm, such as a corporate owner, markets positively price that characteristic when evaluating the impact of COVID-19. Second, when a larger proportion of a firm’s stock is held by a hedge fund, stock prices fall more in response to COVID-19 cases. This suggests that the combination of the quantitative trading strategies and leverage of hedge funds can contribute to sharp price movements in response to COVID-19.

The complete paper is available for download here.

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