Tag: Capital allocation


The Real Effects of Share Repurchases

Mathias Kronlund is Assistant Professor of Finance at the University of Illinois at Urbana-Champaign. This post is based on an article authored by Professor Kronlund; Heitor Almeida, Professor of Finance at the University of Illinois at Urbana-Champaign; and Vyacheslav Fos, Assistant Professor of Finance at Boston College.

Companies face intense pressure from activist shareholders, institutional investors, the government, and the media to put their cash to good use. Existing evidence suggests that share repurchases are a good way for companies to return cash to investors, since cash-rich companies tend to generate large abnormal returns when announcing new repurchase programs. However, some observers argue that the cash that is spent on repurchase programs should instead be used to increase research and employment, and that the recent increase in share repurchases is undermining the recovery from the recent recession and hurting the economy’s long-term prospects. Repurchases have also been cited as an explanation for why the increase in corporate profitability in the years after the recession has not resulted in higher growth in employment, and overall economic prosperity.

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Executive Pay, Share Buybacks, and Managerial Short-Termism

Ira Kay is a Managing Partner at Pay Governance LLC. This post is based on a Pay Governance memorandum by Mr. Kay, Blaine Martin, and Chris Brindisi. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here), The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here), and Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

The past year has seen extensive criticism of share buybacks as an example of “corporate short-termism” within the business press, academic literature, and political community. The critics of share buybacks claim that corporate managers, motivated by flawed executive incentive plans (stock options, bonus plans based on EPS, etc.) and supported by complacent boards, behave myopically and undertake value-destroying buybacks to mechanically increase their own reward. In turn, so the criticism goes, the cash used for share buybacks directly cannibalizes long-term value-enhancing strategies such as capital investment, research and development, and employment growth, thereby damaging long-term stock price performance and the value of US markets. [1]

Pay Governance has conducted unique research using a sample of S&P 500 companies over the 2008-2014 period that brings additional perspective to this debate.

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On Secondary Buyouts

François Degeorge is Professor of Finance at the University of Lugano This post is based on an article authored by Professor Degeorge; Jens Martin, Assistant Professor of Finance at the University of Amsterdam; and Ludovic Phalippou, Associate Professor of Finance at Saïd Business School, Oxford University.

Twenty years ago, private equity (PE) firms seeking to exit sold their portfolio companies to another company in the same industry or organized an IPO. Nowadays, 40 percent of PE exits occur through secondary buyouts (SBOs), transactions in which a PE firm sells a portfolio company to another PE firm. The rise of SBOs has elicited concerns among PE investors (the limited partners with stakes in private equity funds): Does the rise of SBOs mean that PE firms have run out of investment ideas? Do SBOs create or destroy value for investors? Our paper, On Secondary Buyouts, forthcoming in the Journal of Financial Economics, provides answers to these questions.

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ISS 2016 Proxy Voting Policy

Holly J. Gregory is a partner and co-global coordinator of the Corporate Governance and Executive Compensation group at Sidley Austin LLP. The following post is based on a Sidley update by Ms. Gregory, John P. Kelsh, Thomas J. Kim, Rebecca Grapsas, and Claire H. Holland.

Institutional Shareholder Services (ISS) is seeking feedback on policy questions as part of its process for updating its policies for the 2016 proxy season. Corporate issuers should consider communicating company views on proxy voting issues by participating in the survey, which can be accessed here. [1] Feedback is due by September 4, 2015 at 5:00 p.m. ET. Survey results are scheduled to be released in September and draft policy revisions are scheduled to be released for comment in late September or early October.

Survey topics provide an early indicator of potential areas for policy revision. This year’s questions signal that ISS may refine its position on:

  • Proxy access bylaw features
  • Director overboarding
  • Defensive governance provisions adopted pre-IPO or by a board without shareholder approval
  • Sunset provisions for net operating loss poison pills
  • Equity compensation of non-employee directors
  • Use of adjusted metrics in incentive programs
  • Say-on-pay in relation to disclosure by externally-managed issuers
  • Use of financial metrics and financial ratios to assess capital allocation decisions, share buybacks and board stewardship

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Mutual Fund Flows When Managers Have Foreign-Sounding Names

Oliver Spalt is Professor of Behavioral Finance at Tilburg University. This post is based on an article authored by Professor Spalt; Alok Kumar, Professor of Finance at the University of Miami; and Alexandra Niessen-Ruenzi.

In our paper What’s in a Name? Mutual Fund Flows When Managers Have Foreign-Sounding Names, forthcoming in the Review of Financial Studies, we show that name-induced stereotypes affect the investment choices of U.S. mutual fund investors. Managers with foreign-sounding names have about 10% lower annual fund flows, and this effect is stronger among funds with investor clienteles that are more likely to be suspicious of foreigners ex ante.

Our results are based on a novel, hand-collected dataset that contains measures of foreignness of a large sample of mutual fund managers. Specifically, we conduct an online survey in which we present US residents with almost 4,000 actual fund manager names for actively managed US equity funds that appear in the CRSP database from 1993 to 2011. We then ask survey participants to rate for each name, whether or not it sounds foreign to them. Using their responses, we obtain for each fund a measure of whether the name of its manager sounds foreign to an investor when heard, read in a fund prospectus, or when it is found on a mutual fund web site. We hypothesize that the perceived foreignness of a name might trigger social biases such as discrimination and stereotyping and, thus, influence the investment decisions of mutual fund investors. We match our new dataset with the universe of actively managed US equity funds in the CRSP database to test this hypothesis.

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Capital Allocation and Delegation of Decision-Making Authority within Firms

The following post comes to us from John GrahamCampbell Harvey, and Manju Puri, all of the Finance Area at Duke University.

In our paper, Capital Allocation and Delegation of Decision-Making Authority within Firms, forthcoming in the Journal of Financial Economics, we use a unique data set that contains information on more than 1,000 Chief Executive Officers (CEOs) and Chief Financial Officers (CFOs) around the world to investigate the degree to which executives delegate financial decisions and the circumstances that drive variation in delegation. Our results can be grouped into four themes.

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Firm Boundaries Matter

The following post comes to us from Amit Seru, Professor of Finance at the University of Chicago.

Do firm boundaries affect the allocation of resources? This question had spawned significant research in economics since it was raised in Coase (1937). A large body of work has focused on comparing the resource allocation in conglomerates relative to stand-alone firms to shed light on this issue. Theoretically, there are competing views on this aspect. On the one hand, Alchian (1969), Wiliamson (1985), and Stein (1997), among others, have put forth the view that conglomerates, by virtue of exerting centralized control over the capital allocation process, may do a better job in directing investments than the external capital markets. On the other hand, the “dark side” view of internal capital markets argues that problems of corporate socialism are more prevalent in conglomerates making them less efficient in resource allocation (Rajan, Servaes, and Zingales, 2000; Scharfstein and Stein, 2000).

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The Role of the Media in Corporate Governance

The following post comes to us from Baixiao Liu of the Department of Finance at Florida State University, and John McConnell, Professor of Finance at Purdue University.

In an open capital market economy, guided by market signals, firms (and their managers) play an important role in the allocation of capital. Zingales (2000) proposes that the media may also play a role, perhaps positive, perhaps negative, in guiding firms (and their managers) in making capital allocation decisions. Dyck and Zingales (2002) develop this idea more fully. Given that the media collect, aggregate, disseminate, and amplify information, and to the extent that this information affects managers’ reputations, they propose that managers are sensitive to the way in which the media report and comment upon their decisions. Managers may even be sensitive to whether the media reports on their decisions at all. After all, a bad decision that goes unnoticed may be no worse than a good decision that goes equally unnoticed.

In our paper, The Role of the Media in Corporate Governance: Do the Media Influence Managers’ Capital Allocation Decisions?, forthcoming in the Journal of Financial Economics, we investigate whether, and to what extent, managers of publicly-traded U.S. corporations are sensitive to public news media in making one specific type of capital allocation decision. To wit: the decision of whether to complete or abandon a large proposed corporate acquisition that is accompanied by a negative stock market reaction at the announcement (“value-reducing acquisition attempt”). More specifically, we investigate whether the likelihood that a value-reducing acquisition attempt is abandoned is related to the level of media attention given to the attempt and to the tone of media coverage regarding the acquirer’s attempt at the time of the acquisition announcement.

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Resource Allocation within Firms and Financial Market Dislocation

The following post comes to us from Gregor Matvos and Amit Seru, both of the Booth School of Business at the University of Chicago.

Do firm boundaries mediate the effect of shocks to the financial intermediation sector? When the functioning of the intermediation sector is impaired – as was the case in the recent financial crisis – shocks can be transmitted to the broader economy since funds may not flow to highest value use without incurring significant cost. This issue has been extensively explored in the credit channel literature (e.g., Kashyap and Stein [2000]; Bernanke and Blinder [1988; 1992], and Bernanke and Gertler [1995]). However, unlike what is assumed in this literature, firms may be able to reallocate resources internally – for instance, between divisions in different industries – to ameliorate the effect of financial shocks. If so, external credit market conditions will impact the nature of resource allocation inside firms and between industries differently than they would in an economy with no internal capital markets. Diversified firms constitute a large part of economies around the world; therefore, resource allocation within firms can be of significant importance. In this paper we propose that firms shift resources between industries in response to shocks to the financial sector. We estimate a structural model to quantify the forces driving this reallocation decision, and show that these forces dampen shocks to the financial sector in economically significant ways.

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Considering Causes and Remedies for Declining IPO Volume

Editor’s Note: The following post comes to us from Jay R. Ritter, Cordell Professor of Finance at the University of Florida’s Warrington College of Business Administration. This post is based on Professor Ritter’s testimony before the Senate Committee on Banking, Housing, and Urban Affairs, available here.

I will first give some general remarks on the reasons for the low level of U.S. IPO volume this decade and the implications for job creation and economic growth, and then make some suggestions on the specific bills that the Senate is considering.

First, there is no doubt that fewer American companies have been going public since the tech stock bubble burst in 2000, and the drop is particularly pronounced for small companies. During 1980-2000, an average of 165 companies with less than $50 million in inflation-adjusted annual sales went public each year, but in 2001-2011, the average has fallen by more than 80%, to only 29 small firm IPOs per year. The patterns are illustrated in Figure 1.

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