Threat Of Exit Research Articles

Blockholder exit threats in the presence of private benefits of control

Exit theory predicts a governance role of non-managerial blockholders’ exit threats; but this role could be ineffective if the managers’ potential private benefits exceed their loss in stock-price declines caused by non-managerial blockholders’ exit. We test this prediction using the Split-Share Structure Reform (SSSR) in China, which provided a large, exogenous, and permanent shock to the cost for non-managerial blockholders to exit. Using a difference-in-differences design combined with propensity-score matching, we find that firms whose non-managerial blockholders experience an increase in exit threat have a greater improvement in performance than those whose non-managerial blockholders experience no increase. The improvement is as much as 37.2% of the average pre-SSSR treatment sample operating performance. Moreover, the governance effect of exit threats becomes ineffective in the group of firms with the highest concern for private benefits of control. Finally, a battery of theory-motivated tests show that the documented effects are unlikely explained by non-managerial blockholder intervention or some well-known intended effects of SSSR.

Competition and innovation with selective exit: an inverted-U shape relationship?

This paper extends the approach of the inverted-U relationship between competition and innovation at the industry level introduced by Aghion and coauthors. We use data of Spanish manufacturing firms from the Survey of Business Strategies (ESEE) spanning 1990–2006, as well as external information on patents from the European Patent Office and US Patent Office. Instead of an inverted-U shape, we obtain an unambiguous positive relationship between competition and patents. To explain this positive relationship, we modify their theoretical model to introduce the possibility of inefficient firms facing the threat of exit when competition intensifies. The modified model may explain both a positive and an inverted-U relationship between competition and innovation. The estimated results also support the theoretical conjecture that competition induces firms’ exit that, in turn, explains our empirical finding of a negative relationship between competition and within-industry technological gap.

The Irrelevance of Brexit for the European Financial Market

Among participants in the global financial market, Brexit is commonly painted as an almost Apocalypse-like scenario. The threat of a British exit from the European Union arguably involves a significant disruption to financial integration in Europe, will threaten the pre-eminence of London as a global financial centre, and will impose significant costs on all market participants.This paper takes a different position on the significance of Brexit for the European financial market. I argue that, in reality, the impact of Brexit for financial services will be minuscule, if not irrelevant. Such optimism is grounded in the economic stakes for both sides, the UK and the EU27, in retaining the benefits of the European Single Market for financial services. Given the joint economic interests, a likely outcome of negotiations will be a solution that formally satisfies the 2016 referendum result, but in substance keeps Britain closely involved in the EU financial market. The paper borrows from past examples in EU financial market integration that saw ingenious creativity at work in facilitating a desired outcome within the existing complicated legal framework. These past experiences lead us to predict a similar approach being used for accommodating Brexit. The broader point is then that the EU financial services framework repeatedly witnesses a victory of politics or economics over law – that is, formal legal problems or structures are brushed aside when political necessities or economic exigencies so require.

Blockholder Exit Threats in the Presence of Private Benefits of Control: A Quasi-Experiment from China's Split-Share Structure Reform

Exit theory predicts a governance role of non-managerial blockholders’ exit threats; but this role could be ineffective if the managers’ potential private benefits exceed their loss in stock-price declines caused by non-managerial blockholders’ exit. We test this prediction using the Split-Share Structure Reform (SSSR) in China, which provided a large, exogenous, and permanent shock to the cost for non-managerial blockholders to exit. Using a difference-in-differences design combined with propensity-score matching, we find that firms whose non-managerial blockholders experience an increase in exit threat have a greater improvement in performance than those whose non-managerial blockholders experience no increase. The improvement is as much as 37.2% of the average pre-SSSR treatment sample operating performance. Moreover, the governance effect of exit threats becomes ineffective in the group of firms with the highest concern for private benefits of control. Finally, a battery of theory-motivated tests show that the documented effects are unlikely explained by non-managerial blockholder intervention or some well-known intended effects of SSSR.

Center‐Periphery Bargaining in the Age of Democracy

AbstractThis paper introduces the key concepts used in this special issue – center, periphery, and vertical bargaining – and inquires why some national groups within democratic states demand outright independence, while others mobilize for regional autonomy and still others settle for even less. It then specifies a theoretical framework that tries to explain cross‐sectional differences and temporal changes in both peripheral demands and central responses. The building blocks of that framework include cultural distinctiveness, credibility of the exit threat and central dependence on the periphery. As an empirical illustration, the paper discusses the case of the Bernese Jura in Switzerland, and then briefly introduces the contributions to this special issue.

What's in Your Portfolio? How Parents Rank Traditional Public, Private, and Charter Schools in Post-Katrina New Orleans’ Citywide System of School Choice

We examine the characteristics of schools preferred by parents in New Orleans, Louisiana, where a “portfolio” of school choices is available. This tests the conditions under which school choice induces healthy competition between public and private schools through the threat of student exit. Using unique data from parent applications to as many as eight different schools (including traditional public, charter, and private schools), we find that many parents include a mix of public and private schools among their preferences, often ranking public schools alongside or even above private schools on a unified application. Parents who list both public and private schools show a preference for the private sector, all else equal, and are willing to accept lower school performance scores for private schools than otherwise equivalent public options. These parents reveal a stronger preference for academic outcomes than other parents and place less value on other school characteristics such as sports, arts, or extended hours. Public schools are more likely to be ranked with private schools and to be ranked higher as their academic performance scores increase.

Institutional stock ownership and firms’ cash dividend policies: Evidence from China

Agency theory suggests that outside shareholders prefer higher dividend payouts in order to reduce the free cash flows of firms that are under the insiders’ control. Our study investigates the effects of mutual funds, typically the most important and influential type of outside shareholder, on firms’ dividend payouts in China during the period from 2003 to 2011. We find that mutual funds influence firms to pay higher cash dividends. The results are consistent with the predictions from exit theory. The effects are more pronounced in firms controlled by state and regional governments and in firms with relatively higher free cash flows. We also find evidence that the mutual funds’ effects are stronger when their investment horizon is longer and the ownership interest is larger. Other institutional investors, such as banks, insurance companies, and securities companies have a lower exit threat and do not have an influence on firms’ cash dividend payments or financial performances.

The Vulnerability of the Northern Ireland Settlement: British Irish Relations, Political Crisis and Brexit

The Good Friday Agreement of 1998 is the cornerstone of stability in Northern Ireland. It is, however, vulnerable to changes in British-Irish relations and priorities. This article argues that this is at the root of recent crises and political stalemate in Northern Ireland. It argues that future shocks – not least the threat of British exit from the EU – are likely to increase instability in Northern Ireland and in North-South relations.

The Wall Street Walk when Blockholders Compete for Flows

ABSTRACTEffective monitoring by equity blockholders is important for good corporate governance. A prominent theoretical literature argues that the threat of block sale (“exit”) can be an effective governance mechanism. Many blockholders are money managers. We show that, when money managers compete for investor capital, the threat of exit loses credibility, weakening its governance role. Money managers with more skin in the game will govern more successfully using exit. Allowing funds to engage in activist measures (“voice”) does not alter our qualitative results. Our results link widely prevalent incentives in the ever‐expanding money management industry to the nature of corporate governance.

'Take it or Leave it' Offers: Obstinacy and Endogenous Deadlines in Negotiations

A bargainer uses take or leave it offers to signal that he is not willing to make further concessions (commitment threat) and that he will leave the bargaining table unless his demand is accepted (exit threat). This paper investigates the impact of these threats on rational negotiators' equilibrium shares and behavior in a bilateral negotiation. The threats are credible because the negotiators are assumed to have the opportunity of mimicking obstinate types-who, for some reason, are constrained to implement their threats-and to build reputation on their obstinacy. The existence of the endogenous deadline option for one of the players has two main effects: (1) renders the deal unique and efficient, and (2) shifts the bargaining power towards the player who can influence the deadline.

Stock liquidity and managerial short-termism

Abstract We examine whether stock liquidity exacerbates or mitigates managerial short-termism. Utilizing earnings management as a proxy for managerial short-termism, we establish three major findings. First, firms with liquid stocks engage in less accrual-based and real earnings management. Second, the effect of stock liquidity on earnings management is amplified for firms with high levels of managerial pay-for-performance sensitivity. Third, the positive association between the intensity of earnings management and firm cost of capital is evident only for firms with low stock liquidity. Our findings are consistent with the threat of blockholder exit as the main governance channel through which stock liquidity discourages opportunistic earnings management and mitigates managerial short-termism.

The Power of Shareholder Votes: Evidence from Director Elections

In the U.S., votes in director elections are advisory but are often used by shareholders to express dissent. We examine whether these non-binding votes have consequences for directors and report affirmative evidence. Directors facing dissent are more likely to depart boards, especially if they are not lead directors or chairs of important committees. Directors facing dissent who do not leave are moved to less prominent positions in boards. These effects are more pronounced in firms with greater ownership by institutional investors who pose exit threats. Finally, we find evidence that directors facing dissent face reduced opportunities in the market for directors, consistent with the Fama and Jensen (1983) view of the disciplining role of the market for directors. We show that contrary to popular belief, shareholder votes have power and result in negative consequences for directors. We also find that the effects of dissent votes go beyond those of proxy advisor recommendations.

Blockholder Exit Threats in the Presence of Private Benefits of Control: A Quasi-Experiment from Chinaas Split-Share Structure Reform

Using the Split-Share Structure Reform (SSSR) in China as a quasi-experiment, we examine whether and how non-managerial blockholder exit threats discipline managers when private benefits of control (PBC) are prevalent. SSSR removed the selling restrictions on previously-dominant non-tradable shares, thereby providing a large, exogenous, and permanent shock to the cost for non-managerial blockholders to exit. However, because such exit potentially reduces non-managerial blockholders’ threats to control rights and managerial blockholders could benefit from the exit, it is ex ante uncertain whether exit threats would be effective in this setting. Using a difference-in-differences design, we find that the shock to exit threats, on average, improves firms’ operating performance. Specifically, we find that firms whose non-managerial blockholders experience a larger exit-threat increase have a greater improvement in performance than those whose non-managerial blockholders experience no or a smaller increase. Within the treatment sample, better performance is observed for firms whose managers’ wealth is more closely tied to stock prices. Our results are robust to numerous controls, different specifications, and alternative measures of operating performance. The findings suggest that exit threats discipline managers even when PBC are prevalent. Further cross-sectional analyses show that the governance effect of exit threats is weaker when PBC are a stronger concern. In particular, the governance effect for firms headquartered in coastal provinces and with less concentrated ownership (indicators for lower PBC) is significantly stronger than that for firms headquartered in inland provinces and with more concentrated ownership. Finally, we identify improvement in investment efficiency and reduction in agency costs as two potential channels through which the shock affects operating performance, and we show that the changes in performance occur around the time when the expectation of a future increase in blockholders’ exit threats is formed.

Tradable Block Ownership, Liquidity and Threat of Exit

Large shareholders may affect managerial decisions through the threat of selling their holdings and thereby negatively influencing price. The split-share structure of Chinese corporate ownership imposes restrictions on ownership and shares trading. Using these institutional features, we test the hypothesis that the presence of a blockholder who is potentially able to trade based on private information may help discipline management and improve information disclosures, thereby improving stock liquidity. Our results show that the exit threat is closely associated with shares’ tradability and to the extent that tradable (non-tradable) blockholders can discipline management through exit threats, they exert a positive (negative) liquidity effect through both real and information friction channels. These results are robust to the possible confounding effect of liquidity-induced tradable block ownership, as shown by the difference-in-differences analysis based on the split-share structure reform, which results in an exogenous shock to the level of tradable block shares. There is evidence that the liquidity effect of tradable block ownership displays an inverted U-shape relationship, implying that exit costs rise when more tradable shares are acquired.

Blockholder Ownership and Corporate Control: The Role of Liquidity

Employing an instrumental variable approach based on the regulatory change of tick sizes, I examine the link between the liquidity of a firm's equity and activism by large shareholders. I find that liquidity increases the likelihood of block formation. Blockholders of more liquid securities take smaller stakes that do not precommit them to monitor. I find evidence that the threat of exit from a block can discipline managers and that this threat is more effective when liquidity is higher. While liquidity increases exit from existing blocks, I find no evidence that share illiquidity forces blockholders to actively monitor.

Blockholder Ownership and Corporate Control: The Role of Liquidity

Employing an instrumental variable approach based on the regulatory change of tick sizes, I examine the link between the liquidity of a firm's equity and activism by large shareholders. I find that liquidity increases the likelihood of block formation. Blockholders of more liquid securities take smaller stakes that do not precommit them to monitor. I find evidence that the threat of exit from a block can discipline managers and that this threat is more effective when liquidity is higher. While liquidity increases exit from existing blocks, I find no evidence that share illiquidity that forces blockholders to actively monitor.

Blockholder Exit Threats and Financial Reporting Quality

Recent theoretical and empirical studies suggest that blockholders (shareholders with ownership ≥ 5%) exert governance through the threat of exit. Blockholders have strong incentives to gather private information and sell their shares when managers are perceived to underperform. To prevent blockholders from selling their shares and the firm from suffering a stock price decline, managers align their actions with the interests of shareholders. As a result of the greater manager-shareholder alignment, managers’ actions are more likely to be in shareholders’ best interest, and consequently there is less need for managers to manipulate earnings. Consistent with these predictions from economic theory, we find evidence that as exit threat increases, firms have higher financial reporting quality. Theory also predicts that the impact of blockholders’ exit threat on financial reporting quality should increase as the manager’s wealth is tied more closely to the stock price, and this is what we find. Our study contributes to the research on the impact of shareholders on financial reporting quality and to an emerging literature on the impact of blockholders in financial markets. Blockholders play an important role in managers’ reporting outcomes through their actions as informed investors.

Governance Through Threat of Voice and Threat of Exit: Complements or Substitutes?

An activist shareholder who can discipline management through the threat of intervention and threat of exit endogenously determines what form of governance prevails in equilibrium. We specify conditions that lead to adoption of each form of governance as well as conditions under which these choices coincide with the most effective form of governance. Conditions encouraging the activist to establish a large toehold position discourage exit equilibria and encourage intervention equilibria. Whether stock liquidity enhances governance depends on which form of governance is most effective and whether the liquidity arises during the toehold-acquiring or the activism phase of the blockholder's activity.

Does Stock Liquidity Affect Incentives to Monitor? Evidence from Corporate Takeovers

We test whether stock liquidity affects acquirer returns through its hypothesized effect on institutional monitoring. We find that firms with lower stock liquidity have higher acquirer gains for takeovers of private targets, but not for takeovers of public targets. The negative relation between liquidity and acquirer gains is stronger when the threat of disciplinary trading (exit) by institutions is weaker and acquirers have higher agency costs. Acquirers of private targets with lower stock liquidity are more likely to withdraw deals and experience higher involuntary CEO turnover following value-destroying acquisitions. Our results support the hypothesis that stock liquidity weakens institutions' incentives to monitor management decisions, except in those cases where the disciplining effect of the threat of exit may be particularly high.

Eurozone sovereign debt restructuring: keeping the vultures at bay

The eurozone debt crisis has stimulated lively debate on mechanisms for sovereign debt restructuring. The immediate threat of exit and the break-up of the currency union may have abated; but the problem of dealing with significant debt overhang remains. After considering two broad approaches—institutional versus contractual—we look at a hybrid solution that combines the best of both. In addition to debt contracts with collective action clauses, this includes a key amendment to the Treaty establishing the European Stability Mechanism, together with innovative state-contingent contracts and a special purpose vehicle to market them.