Review of Finance - recent issues

Editorial Statistics

Pagano, M., Zechner, J. — 2009-04-14

Special issue on banking Preface

Allen, F., Boot, A., Pagano, M., Udell, G. — 2009-04-14

Financial Integration and Firm Performance: Evidence from Foreign Bank Entry in Emerging Markets

Giannetti, M., Ongena, S. — 2009-04-14

While the positive growth effects of financial integration are extensively documented, little is known of its impact on small and young firms. This paper aims to fill this void relying on a panel of 60,000 firm-year observations on listed and unlisted companies in Eastern European economies to assess the differential impact of foreign bank lending on firm growth and financing. Foreign lending stimulates growth in firm sales, assets, and use of financial debt even though the effect is dampened for small firms. More strikingly, young firms benefit most from foreign bank presence, while businesses connected to domestic banks or to the government suffer. Overall, our findings suggest that foreign banks can help to mitigate connected-lending problems and to improve capital allocation.

The Impact of Organizational Structure and Lending Technology on Banking Competition

Degryse, H., Laeven, L., Ongena, S. — 2009-04-14

We investigate how bank organization shapes banking competition. We show that a bank's geographical lending reach and loan pricing strategy is determined by its own and its rivals’ organizational structure. We estimate the impact of organization on the geographical reach and loan pricing of a large bank. We find that the reach of the bank is smaller when rival banks are large and hierarchically organized, have superior communication technology, have a narrower span of organization, and are closer to a decision unit with lending authority. Rival banks’ size and the number of layers to a decision unit soften spatial pricing.

Banks, Distances and Firms' Financing Constraints

Alessandrini, P., Presbitero, A. F., Zazzaro, A. — 2009-04-14

Bank deregulation and progress in information technology altered the geographical diffusion of banking structures and instruments, and reduced operational distance between banks and local economies. Although, the consolidation of the banking industry promoted the geographical concentration of banking decision-making centres and increased functional distance between local banking systems and local borrowers. This paper focuses on the impact that these spatial diffusion-concentration phenomena had on the financing constraints of Italian firms over the period 1996–2003. Our findings show that greater functional distance stiffened financing constraints, especially for small firms, while smaller operational distance did not always enhance credit availability.

Bank Market Power and SME Financing Constraints

Carbo-Valverde, S., Rodriguez-Fernandez, F., Udell, G. F. — 2009-04-14

Some studies find that market power is associated with credit availability (information hypothesis); others find that less competitive banking markets lead to more credit rationing (market power hypothesis). Empirical research has relied solely on concentration as a measure of market power. The industrial organization literature, however, argues that a structural competition indicator such as the Lerner index is a superior measure. We test the information hypothesis and the market power hypothesis using these two alternative measures of market power and find that they generally give conflicting results. However, we also offer evidence suggesting that both views can be reconciled.

Cross-Selling Lending and Underwriting: Scope Economies and Incentives

Laux, C., Walz, U. — 2009-04-14

We highlight the implications of combining underwriting services and lending for the choice of underwriters and for competition in the underwriting business. We show that cross-selling can increase underwriters' incentives, and we explain three phenomena: first, that cross-selling is important for universal banks to enter the investment banking business; second, that cross-selling is particularly attractive for highly leveraged borrowers; third, that less-than-market rates are no prerequisite for cross-selling to benefit a bank's clients. In our model, cross-selling reduces rents in the underwriting business.

A Welfare Analysis of Regulation in Relationship Banking Markets

Carlin, B. I., Rob, R. — 2009-04-14

The increasing dependence of individuals on debt financing raises several welfare considerations that we analyze in this paper. We develop a dynamic, competitive model of relationship banking to determine how regulation influences borrowing and lending behavior, and analyze how it affects welfare in the market. We characterize the lending regimes that arise based on public policy, and evaluate the optimal choice by the government to induce particular lending practices to arise. Finally, we consider the effect that a credit reporting agency has on the market. In the paper, we highlight the new empirical implications that the model generates.

Editorial Statistics

Pagano, M., Zechner, J. — 2009-01-12

Resolving Macroeconomic Uncertainty in Stock and Bond Markets

Beber, A., Brandt, M. W. — 2009-01-12

We establish an empirical link between the ex-ante uncertainty about macroeconomic fundamentals and the ex-post resolution of this uncertainty in financial markets. We measure macroeconomic uncertainty using prices of economic derivatives and relate this measure to changes in implied volatilities of stock and bond options when the economic data is released. Higher macroeconomic uncertainty is associated with greater reduction in implied volatilities following the news release. It is also associated with increased volume and decreased open interest in option markets after the release, consistent with market participants using financial options to hedge or speculate on macroeconomic news.

Do Shareholders Vote Strategically? Voting Behavior, Proposal Screening, and Majority Rules

Maug, E., Rydqvist, K. — 2009-01-12

We analyze how shareholders screen management proposals at annual general meetings. First, we use a simple model of strategic voting to develop a theoretical benchmark of effective information aggregation through voting. Then, we derive testable implications and provide structural estimates of the model parameters. The main conclusions are that shareholders vote strategically and that proposal screening increases value. Shareholders largely neutralize the lock-in effect of supermajority rules, thereby preventing the incorrect rejection of proposals.

Shareholder Rights, Boards, and CEO Compensation

Fahlenbrach, R. — 2009-01-12

I analyze the role of executive compensation in corporate governance. As proxies for corporate governance, I use board size, board independence, CEO-chair duality, institutional ownership concentration, CEO tenure, and an index of shareholder rights. The results from a broad cross-section of large U.S. public firms are inconsistent with recent claims that entrenched managers design their own compensation contracts. The interactions of the corporate governance mechanisms with total pay-for-performance and excess compensation can be explained by governance substitution. If a firm has generally weaker governance, the compensation contract helps better align the interests of shareholders and the CEO.

Managerial Incentives and Corporate Fraud: The Sources of Incentives Matter

Johnson, S. A., Ryan, H. E., Tian, Y. S. — 2009-01-12

Operating performance and stock return results imply that managers who commit fraud anticipate large stock price declines if they were to report truthfully, which would cause greater losses for managerial stockholdings than for options because of differences in convexity. Fraud firms have significantly greater incentives from unrestricted stockholdings than control firms do, and unrestricted stockholdings are their largest incentive source. Our results emphasize the importance of the shape and vesting status of incentive payoffs in providing incentives to commit fraud. Fraud firms also have characteristics that suggest a lower likelihood of fraud detection, which implies lower expected costs of fraud.

Option Compensation and Industry Competition

Stoughton, N. M., Wong, K. P. — 2009-01-12

Compensation policy has become one of the most important ingredients of corporate governance. In this paper we take a new look at the issue, by contrasting the use of options with that of stock. We do this by integrating the repricing or resetting aspect of options with that of industrial structure. We show that industry competition may play an important role in dictating which form of compensation is optimal. When aggressive competition for key professional staff is an issue, the flexibility of options may actually become a disadvantage and therefore pure stock compensation may survive as an equilibrium. Thus compensation trends may be partly explained by trends in the nature of the competitive environment.

Estimating the Costs of International Equity Investments

Sercu, P., Vanpee, R. — 2008-10-17

Generalizing Cooper-Kaplanis (1994), we estimate implied costs that reconcile international portfolios with InCAPM predictions. Costs depend on home- and host-country characteristics and on interactions; we estimate risk tolerance rather than pre-specifying it; and we control for currency risk, inflation hedging, fixed-interest investments, round-tripping and omitted countries. Estimates for developed markets are lower than reported before, but those for new markets are quite high: 2001-2004 inward shadow costs range from 0.01 %p.a. (US) to 37 (Indonesia). We find that equity home bias is related to a mixture of risks and frictions, such as information asymmetries, institutional factors and explicit costs.

A Dynamic Analysis of Growth via Acquisition

Margsiri, W., Mello, A. S., Ruckes, M. E. — 2008-10-17

Firms can grow through internal investment or through acquisition. While internal growth takes time, an acquisition provides cash flows immediately. The opportunity to grow internally affects the price of an acquisition as it is a fall-back option for the acquirer should negotiations break down. Assuming investors do not have full information about the time a firm requires to grow internally, acquirers earn positive returns before the announcement of an acquisition, and there are negative stock price reactions to acquisition announcements. This research provides predictions about how pre-announcement price run-up and negative announcement returns relate to integration costs and synergies from acquisition.

The Optimality of Uniform Pricing in IPOs: An Optimal Auction Approach

Bennouri, M., Falconieri, S. — 2008-10-17

This paper uses an optimal auction approach to investigate the conditions under which uniform pricing in IPOs is optimal. We show that the optimality of a uniform price in IPOs depends crucially on whether the (optimal) allocation rule is restricted. These restrictions may stem from the retail investors' budget constraint and/or from the institutional investors' preferences. We show that the main determinant of the optimality of a uniform pricing rule is the existence and the shape of the retail investors' budget constraint. In contrast, institutional investors' preferences are shown to mainly affect the optimal allocation rule.

Which Investors Leave Money on the Table? Evidence from Rights Issues

Rantapuska, E., Knupfer, S. — 2008-10-17

This study documents patterns of investor behavior around Finnish rights issues. We find that shareholders of issuing companies lost at least 9.9 million in aggregate from 1995 to 2002 by exercising rights too early, selling rights in the open market below their intrinsic value, or leaving rights unexercised. At the investor level, the losses are modest. For example, the median household investor suffered a loss of 135 from not exercising or selling the rights. Investors with small portfolios, inactive trading history, those who know neither of the official languages in Finland, or who are living abroad leave money on the table the most.

Should Insider Trading be Prohibited when Share Repurchases are Allowed?

Buffa, A. M., Nicodano, G. — 2008-10-17

This paper considers share repurchases as the way long-term shareholders preserve their ability to use corporate information for speculative purposes when insider trading regulation is enforced. This use of corporate information increases the adverse selection losses of short-term shareholders. Thus, buy-back programs reduce their incentive to invest in stocks that back the most productive technology, leading to a socially inefficient equilibrium. It follows that insider trading should not be banned when share repurchases are allowed. More generally, the paper argues that the regulation of insider trading and repurchases can not be considered in isolation, and analyzes their interplay.