Corporate liquidity
S. Gryglewicz, L. Mancini, E. Morellec, E. Schroth, and P. Valta
Review of Financial Studies, 35, 3922-3972, 2022.
Theory has recently shown that corporate policies should depend on firms’ exposure to short- and long-lived cash flow shocks and the correlation between these shocks. We provide granular estimates of these parameters for Compustat firms using a new filter that uses only cash flow data and the theoretical restrictions of a canonical cash flow model. As predicted by theory, we find that the estimated parameters are strongly related to corporate liquidity and financing choices, that firms with a higher estimated correlation between shocks implement riskier policies, and that the sign of this correlation determines the cash flow sensitivity of cash.
Activism
Value creation in shareholder activism
R. Albuqurque, V. Fos, and E. Schroth
Journal of Financial Economics, 145, 153-178, 2022; Editor's Choice.
We measure value creation by activist investors via structural estimation of a model of the choice between passive investment and activism. Our estimates imply that average returns following activist intent announcements consist of 74.8% expected value creation, or treatment, 13.4% stock picking, and 11.8% sample selection effects. Higher treatment values predict improvements in firm performance and lower proxy contest probabilities, whereas abnormal announcements returns do not, suggesting that our estimate identifies more effective activism campaigns. The evidence demonstrates the importance of using the joint distribution of investment strategies and announcement returns to recover the expected returns and costs of activism.
Debt Renegotiation and Default
Debt Enforcement, Investment, and Risk Taking Decisions Across Countries
G. Favara, E. Morellec, E. Schroth, and P. Valta
Journal of Financial Economics 123(1), 22-41, 2017.
The prospect of an imperfect enforcement of debt contracts in default reduces shareholder–debtholder conflicts and induces leveraged firms to invest more and take on less risk as they approach financial distress. These predictions are confirmed using a large panel of firms across 41 countries with heterogeneous debt enforcement characteristics. The relation between debt enforcement and firms’ investment and risk depends on the firm-specific probability of default. A differences-in- differences analysis of firms’ investment and risk taking in response to bankruptcy reforms that make debt more renegotiable confirms the cross-country evidence.
Strategic Default and Equity Risk Across Countries
G.Favara, E. Schroth, and P. Valta
Journal of Finance 67(6), 2051-2095, 2012.
Equity beta and return volatility are lower in countries where the bankruptcy code favors debt renegotiations and for firms with more shareholder bargaining power relative to debt holders. These relations weaken as the country’s insolvency procedure favors liquidations over renegotiations. In the limit, when debt contracts cannot be renegotiated, equity risk is independent of shareholders’ incentives to default strategically. These findings support the hypothesis that the threat of strategic default can reduce the firm’s equity risk.
Block Holders and the Value of Control
The Value of Control and the Costs of Illiquidity
R. Albuquerque and E. Schroth
Journal of Finance, 70(4), 1405-1455, 2015.
We develop a search model of block trades that values the illiquidity of controlling stakes. The model considers several dimensions of illiquidity. First, following a liquidity shock, the controlling blockholder is forced to sell, possibly to a less efficient acquirer. Second, this sale may occur at a fire sale price. Third, absent a liquidity shock, a trade occurs only if a potential buyer arrives. Using a structural estimation approach and U.S. data on trades of controlling blocks of public corporations, we estimate the value of control, blockholders’ marketability discount, and dispersed shareholders’ illiquidity-spillover discount.
Quantifying Private Benefits of Control from a Structural Model of Block Trades
R. Albuquerque and E. Schroth
Journal of Financial Economics, 96(1), 33-55, 2010.
We study the determinants of private benefits of control in negotiated block transactions. We estimate the block pricing model in Burkart, Gromb and Panunzi (2000) explicitly accounting for both block premiums and block discounts in the data. The evidence suggests that the occurrence of a block premium or discount depends on the controlling block holder’s ability to fight a potential tender offer for the target’s stock. We find evidence of large private benefits of control and of associated deadweight losses, but also of value creation by controlling shareholders. Finally, we provide evidence consistent with Jensen’s free cash flow hypothesis.
Runs and financial fragility
Dynamic Debt Runs and Financial Fragility: Evidence from the 2007 ABCP Crisis
E. Schroth, G. Suárez, and L. Taylor
Journal of Financial Economics, 112(2), 164-189, 2014.
We use the 2007 asset-backed commercial paper (ABCP) crisis as a laboratory to study the determinants of debt runs. Our model features dilution risk: maturing short-term lenders demand higher yields in compensation for being diluted by future lenders, making runs more likely. The model explains the observed tenfold increase in yield spreads leading to runs and the positive relation between yield spreads and future runs. Results from structural estimation show that runs are very sensitive to leverage, asset values, and asset liquidity, but less sensitive to the degree of maturity mismatch, the strength of guarantees, and asset volatility.
Innovation and Financing Constraints
Cash Breeds Success: The Role of Financing Constraints in Patent Races
E. Schroth and D. Szalay
Review of Finance, 14(1), 73-118, 2009.
We develop a model of optimal contracting where firms finance their R&D expenditures with an investor who cannot verify their effort. In equilibrium, firms are more likely to win the more cash and assets they hold prior to the race, and the less cash and assets their rivals hold prior to the race. Evidence from US pharmaceutical patents awarded between 1975 and 1999 supports our thoretical predictions.
Financial Innovation
Advantageous Innovation in the Underwriting Market for Corporate Securities
H. Herrera and E. Schroth
Journal of Banking and Finance, 35(5), 1097-1113, 2011.
Investment banks that develop new corporate securities systematically lead the new underwriting market despite being imitated early by equally competitive rivals. We study how innovators and imitators set underwriting fees in order to identify empirically the source of this advantage. Using data of innovative securities since 1985, we do find that innovators set systematically higher fees than imitators. This premium decreases as more issues occur, and faster for later generation products. Imitation is also quicker for later generations. This evidence supports the hypothesis that the innovator has superior skills in structuring any given issue of the new security.
Innovation, Differentiation and the Choice of an Underwriter
E. Schroth
Review of Financial Studies, 19(3), 1041-1080, 2006.
Investment banks imitate other bank’s innovative corporate securities and compete with the innovator to underwrite new issues. This article uses data of all the corporate offerings of equity-linked and derivative securities in the Securities Data Company (SDC) to estimate the issuer’s demand of underwriting services provided by investment banks across different varieties of securities. It finds that the demand for the innovator’s variety is larger than the imitators’. This demand advantage decreases with time and faster for securities that appear later in a sequence of innovations. Imitation becomes less attractive later in the sequence as information from earlier deals spills-over to all banks.