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.
Losing Control? The 20-Year Decline in Loan Covenant Violations – with Greg Nini and David Smith
Revise and Resubmit at the Journal of Finance
The annual proportion of U.S. public firms that report a financial covenant violation fell nearly 70% between 1997 and 2016. To understand this trend, we develop a model of covenant design that shows the optimal threshold varies with covenants’ ability to discriminate between distressed and non-distressed borrowers and with the relative costs associated with screening incorrectly. We document a steady improvement in covenants’ ability to identify distressed borrowers. However, the dramatic fall in violations is best attributed to an increased willingness to forego early detection of marginally distressed borrowers in exchange for fewer inconsequential violations, particularly since 2008-09.
Where Have All the IPOs Gone? Trade Liberalization and the Changing Nature of U.S. Corporations
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 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.
Shareholder Litigation Risk and the Information Environment: Revisiting Evidence from Two Natural Experiments – with Audra Boone and Eliezer Fich
Revise and Resubmit at the Journal of Corporate Finance
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.
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.
Does Regulatory Exposure Create M&A Synergies? – with Eliezer Fich and Joseph Kalmenovitz
We study the impact of regulation on acquisition investment, using a novel firm-level measure of exposure to all federal regulations. Highly regulated companies issue more acquisition bids, invest more in those transactions, and earn higher M&A announcement returns. Moreover, highly regulated acquirers exhibit better long-term performance, greater M&A synergies, and a significant reduction in their regulatory exposure after merger completion. The benefits are stronger in deals with small transaction values and in those involving private targets. Overall, our findings uncover a new link between M&A and regulation, highlighting synergy opportunities which materially affect corporate investment choices.
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.