Although existing theories predict a causal link between firm opaqueness and firm cash holdings, the lack of an exogenous and clean measure of informational frictions hinders the precise identification of this link. Using the discontinuous requirement of financial reporting introduced by Section 404 of the Sarbanes-Oxley (SOX) Act, we identify a causal effect of informational frictions on cash holdings. We show that firms that comply with Section 404 and provide more reliable information to the financial markets reduce their holdings of cash or liquid assets compared to observationally similar firms. In the cross-section, the reduction in the cash ratio is more pronounced among firms that face financial constraints and have weaker governance. This is consistent with the fact that such firms incur a high opportunity cost for funds and is consistent with the view that SOX reduces agency conflicts through increased controls. Finally, firms that comply with Section 404 and hold less cash exhibit higher R\&D expenditures relative to non-compliant firms. This difference sheds light on the opportunity costs of holding cash.
How does securitization affect the risk of the loans that are originated for securitization? While the standard view is that the originate-to-distribute (OTD) model weakens the originator's screening incentives and leads to higher risk, theories on reputation suggest that an originator's concern about its ability to return to the market would prevent lax screening. In a model with reputational concerns, OTD model of securitization and pooling of loans, we analyze how loan securitization dilutes reputation-driven incentives to screen. With sufficiently strong reputational concerns there may be an overinvestment in screening even relative to the no-securitization case, so the OTD model does not suffice for securitization to increase risk. However, when multiple loans are pooled together and securitized, reputational incentives to screen become weaker with an increase in the size of the loan pool being securitized. Moreover, there is a mutually reinforcing feedback effect between the originator's screening incentives and the incentives of investors to acquire information about the quality of the loan pool, so investors are also less informed about larger loan pools. For sufficiently large loan pools, securitization reduces idiosyncratic risk but increases systematic risk.
The race by American companies to change their incorporation to countries with lower corporate tax rate has reached fever pitch. Using a comprehensive sample of U.S. companies that reincorporate overseas (“invert”) between 1996 and 2013 and a matched set of U.S. incorporated multinational firms, we study the benefits and costs of such transactions. On the benefit side, we find that inverted firms have 7%-8% lower effective tax rate, mainly on account of the lower marginal tax rate in their country of incorporation. On the cost side, we find that inverted firms have higher bid-ask spread, their stock has less institutional ownership and investors put a lower value on the cash on their balance sheet. We also find inverted firms to have more concentrated institutional share ownership structure. Overall, our results highlight both the benefits and costs of inversions.
How do changes to stock price informativeness affect the mix of long-term and short-term pay? Using two exogenous shocks to price informativeness: the reduction in analyst coverage due to closure of brokerage houses and mutual-fund flow driven price pressure, we find that firms increase the duration of top executive pay following a decrease in price informativeness. We document a 10% increase in pay duration following brokerage house closures -- concentrated in firms with less entrenched management and those with low initial analyst coverage. The increase in duration following mutual-fund flow driven price pressure is more modest at 2.5% and occurs both with inflow and outflow driven price pressure and is larger for firms that experience price pressure over a longer period. The increase in pay duration occurs both from a decrease in the cash component of pay and through an increase in the vesting period of stock and option awards. Our evidence is consistent with board of directors reacting to changes in price informativeness in designing executive pay.