Creditor Control of Corporate Acquisitions – with David Becher and Greg Nini. 2022. Review of Financial Studies 35(4): 1897-1932.
We examine the impact of creditor control rights on corporate acquisitions. Nearly 75% of loan agreements include restrictions that limit borrower acquisition decisions throughout the life of the contract. Following a financial covenant violation, creditors use their bargaining power to tighten these restrictions and limit acquisition activity, particularly deals expected to earn negative announcement returns. Firms that do announce an acquisition after violating a financial covenant earn 1.8% higher stock returns, on average, and do not pursue less risky deals. We conclude that creditors use contractual rights and the renegotiation process to limit value-destroying acquisitions driven by managerial agency problems.
Shareholder Litigation Risk and the Information Environment: Revisiting Evidence from Two Natural Experiments – with Audra Boone and Eliezer Fich. 2023. Journal of Corporate Finance, Forthcoming.
A court case that reduced securities class action litigation risk led to less frequent voluntary disclosure but did not significantly alter information asymmetry among market participants. Conversely, state laws that reduced derivative litigation risk led to more frequent voluntary disclosure but resulted in significantly higher information asymmetry. To reconcile these differences, we highlight that 10b-5 securities class actions address disclosure, while derivative suits can address broader corporate wrongdoing, leading to differential effects on firm operations. Our results suggest that the observed effect of derivative litigation risk on the information environment is primarily driven by concomitant changes in firm operations.
Revise and Resubmit at the Journal of Finance
The annual proportion of U.S. public firms that reported a financial covenant violation fell roughly 70% between 1997 and 2019. To understand this trend, we develop an estimable model of covenant design that depends on the ability to discriminate between distressed and non-distressed borrowers and the relative costs associated with screening incorrectly. We find the drop in violations is best explained by an increased willingness to forego early detection of distressed borrowers in exchange for fewer inconsequential violations, which we attribute mostly to a shift in the composition of public firms and partly to heightened investor sentiment during the 2010s.
Revise and Resubmit at the Journal of Financial and Quantitative Analysis
I show that a tariff policy change that increased trade with China led to a decline in U.S. public listing rates and elevated industry concentration. Consistent with heterogeneous firm models of trade, the shock impeded the entry and performance of small domestic manufacturers but did not adversely impact large multinationals. In addition, stock price reactions to the tariff policy change and threat of reversal imply that trade liberalization creates or destroys value depending on firm size. These findings suggest that recent trends in the U.S. public equity market are driven, in part, by fundamental changes in the global competitive landscape.
A Culture of Discrimination: Evidence on the Causes and Consequences of Civil Rights Litigation Against U.S. Corporations – with Casey Dougal and Irena Hutton
Between 1992 and 2018, U.S. public corporations faced over 38,000 federal civil rights lawsuits. We find that the frequency of discrimination litigation varies with societal attitudes toward race and gender and intensifies after a rightward shift in local news slant. However, studying two well-established natural experiments, we find no evidence that economic forces provide a source of discipline. Consequences are small: shareholder value drops by $8.25 million, on average, around a lawsuit, with no effect on CEO turnover. We conclude that corporate discrimination is largely determined by the cultural values of employees, rather than a firm’s economic environment.
Using a novel measure of exposure to federal regulations, we study the impact of firm-level regulatory burden on M&A activity. Firms respond to increased regulation by engaging in more M&A activity, on average, but the effect hinges crucially on firm size. Large firms increase acquisition investment and earn higher announcement returns. In contrast, small firms become more likely to sell out, particularly to strategic acquirers that have a high degree of regulatory overlap. Overall, our findings uncover an unintended consequence of federal regulation that advantages large firms and influences the composition of U.S. industries.
How Well Do Financial Covenants Detect Distress? – with Greg Nini and David Smith
We find that lenders today rely on less restrictive financial covenants than 20 years ago, driven by a sharp decline in the use of balance sheet-based covenants that is not accompanied by a decrease in cash-flow based covenants. To understand this trend, we develop a novel measure of ex-ante covenant quality based on the ability to discriminate between distressed and non-distressed borrowers. Our evidence suggests that the shift from balance sheet to cash flow covenants enabled lenders to rely on fewer, but higher quality, covenants that better discriminate between borrowers and substantially reduce the expected number of false positive violations.