Subset Of Firms Research Articles

Government as a Source of Equity Capital for Entrepreneurs: Evidence From Entrepreneurial Exits

ABSTRACTResearch Question/IssueWe examine the effect of government equity investment on the dollar value of entrepreneurial exits spanning 50 countries over the years 1990–2015.Research Findings/InsightsData on 8532 entrepreneurial exits indicate that, relative to exits in which the investor base is purely nongovernment, private firm exits with government equity investment have higher dollar exit values. Subsample analysis suggests that the exits via initial public offerings (IPOs) drive these results with an average associated increase in IPO proceeds of $192.49 million. The positive impact of government is more pronounced when access to entrepreneurial capital is limited and for limited partnership venture capital structures.Theoretical/Academic ImplicationsResearch on government equity investment has suggested inefficiencies that lead to the deterioration of corporate value. Conversely, government equity investment can provide a valuable source of capital to some firms when investors, for example, venture capitalists, are unable or unwilling to invest. Our paper sheds light on whether government equity investment can provide value to small private firms, a subset of firms that is typically financially constrained, and how they might enhance exit value.Practitioner/Policy ImplicationsOur results suggest that governments enhance value when they provide capital in times/places where capital is scarce and government investors do not actively manage entrepreneurial firms.

Corporate debt booms, financial constraints, and the investment nexus

SummaryHow do corporate debt booms affect investment? Using US firm‐level data over 1984Q1–2019Q4, and an instrument for firm‐specific debt booms that exploits systematic differences in firms' exposure to industry‐level debt booms, I find that debt booms cause investment growth to decline over the medium term. This result is driven by the financial constraints channel: Vulnerable firms experience a higher cost of debt in the short run, lower stock returns, and an increase in indicators proxying financial risk. Vulnerable firms also cut their investment spending after a debt boom, irrespective of their growth opportunities. Finally, I find that congestion effects from vulnerable firms on healthy firms are amplified during debt booms, stressing the risk that debt booms in a subset of firms may spill over to the rest of the economy.

Traceability Technology Adoption in Supply Chain Networks

Modern traceability technologies promise to improve supply chain management by simplifying recalls, increasing visibility, and verifying sustainable supplier practices. Initiatives leading the implementation of traceability technologies must choose the least-costly set of firms—or seed set—to target for early adoption. Choosing this seed set is challenging because firms are part of supply chains interlinked in complex networks, yielding an inherent supply chain effect: benefits obtained from traceability are conditional on technology adoption by a subset of firms in a product’s supply chain. We prove that the problem of selecting the least-costly seed set in a supply chain network is hard to solve and even approximate within a polylogarithmic factor. Nevertheless, we provide a novel linear programming-based algorithm to identify the least-costly seed set. The algorithm is fixed-parameter tractable in the supply chain network’s treewidth, which we show to be low in real-world supply chain networks. The algorithm also enables us to derive easily computable bounds on the cost of selecting an optimal seed set. We leverage our toolbox to conduct large-scale numerical experiments that provide insights into how the supply chain network structure influences diffusion. These insights can help managers optimize their technology diffusion strategy. This paper was accepted by Chung Piaw Teo, optimization. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.01759 .

IRS Enforcement and Voluntary Tax Disclosure

ABSTRACT Although voluntary tax disclosures can improve firms’ information environments and reduce financial statement users’ costs of processing complex tax information, they can also inform tax authorities about tax avoidance strategies. This study explores the content of voluntary tax disclosures during quarterly earnings announcements and conference calls to examine the effect of IRS enforcement on managers’ voluntary tax disclosure decisions. We estimate a negative relation between IRS enforcement and voluntary tax disclosures that is concentrated in the subset of firms with high levels of tax avoidance. These results are consistent with managers having concerns about the potential costs of voluntary disclosures to tax authorities. In supplemental analysis, we find results consistent with voluntary tax disclosures benefiting analysts, but at the cost of increasing IRS attention. Collectively, our results suggest an unintended negative effect of IRS enforcement on the information environment. Data Availability: Data are available from the sources cited in the text. JEL Classifications: H25; M41; M48.

How APIs Create Growth by Inverting the Firm

Traditional asset management strategy has emphasized building barriers to entry or closely guarding unique assets to maintain a firm’s comparative advantage. A new “inverted firm” paradigm, however, has emerged. Under this strategy, firms share data seeking to become platforms by opening digital services to third parties and capturing part of their external surplus. This contrasts with a “pipeline” strategy where the firm itself creates value. This paper quantitatively estimates the effect of adopting an inverted firm strategy through the lens of application programming interfaces (APIs), a key enabling technology. Using both public data and those of a private API development firm, we document rapid growth of the API network and connecting apps since 2005. We then perform difference-in-difference and synthetic control analyses and find that public firms adopting public APIs grew an additional 38.7% over 16 years relative to similar nonadopters. We find no significant effect from the use of APIs purely for internal productivity: the pipeline strategy. Within the subset of firms that adopt public APIs, those that attract more third-party complementors and those that become more central to the network see faster growth. Using variation in network centrality caused by API degradation, an instrumental variables analysis confirms a causal role for APIs in firm market value. Finally, we document an important downside of public APIs: increased risk of data breach. Overall, these facts lead us to conclude that APIs have a large and positive impact on economic growth and do so primarily by enabling an inverted firm strategy. This paper was accepted by D. J. Wu, information systems. Funding: This work was partially supported by Mulesoft and Apigee Corporation. Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2023.4968 .

Does tax enforcement disparately affect domestic versus multinational corporations around the world?

AbstractGlobal tax enforcement policies have received increased attention since the financial crisis, with much stated focus on curbing perceived harmful tax practices of multinational corporations. Yet there is a dearth of evidence on possible differential effects of home‐country tax enforcement on multinationals. We take a step toward filling this void in the tax policy discussion by examining whether there is a differential relation between changes in home‐country enforcement and the tax avoidance of domestic versus multinational corporations. Using OECD data on 50 countries from 2005 to 2019, we find increases in home‐country enforcement are associated with lower levels of tax avoidance for domestic firms than for multinational corporations. Using a subset of firms from the Bureau van Dijk database, we find that multinationals avoid more tax in foreign countries when home‐country enforcement increases. Results are stronger for multinationals with a higher proportion of subsidiaries in low‐tax countries and when enforcement spending is low. These findings have implications for policy‐makers and highlight the importance of coordinated enforcement efforts across jurisdictions—such as the recently proposed global minimum tax—to successfully curb multinationals' worldwide tax avoidance.

Executive Compensation Limits and Executive Turnover

We explore the consequences of limiting executive pay on voluntary executive turnover by exploiting a Chinese government policy restricting executive pay at a subset of firms. Affected firms experience an increase in voluntary executive turnover, with executives increasingly moving to firms not bound by the pay policy. Executives that leave are of higher quality as suggested by their stronger stock and accounting performance in the year prior to the turnover. Affected firms suffer firm value losses, especially when talented executives leave. Our findings demonstrate the importance of compensation contracts in retaining executives and suggest a need for regulatory caution, since mandated constraints aimed at trying to “fix” executive pay can hurt firm value and ultimately, hurt shareholders. This paper was accepted by Suraj Srinivasan, accounting. Funding: S. Silveri acknowledges research support in the form of a summer research grant from the Fogelman College of Business and Economics at the University of Memphis. This research support does not imply endorsement of the research results by either Fogelman College or the University of Memphis. K. Wang is grateful for the financial support provided by the Tsinghua University Initiative Scientific Research Program and the research project of the Institute for State-Owned Enterprises, Tsinghua University. L. Zhao is grateful for the financial support provided by the Asia Research Center in Nankai University [Project AS2206]. Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2023.4812 .

Sluggish investment, crisis and firm heterogeneity

Abstract The stagnation of investments and its causes have attracted great attention in the recent economic debate. In this paper, we show that during the Great Recession, the flattening of the capital formation rate at the firm level is not due to lower average propensity to invest. Rather, it is the result of growing heterogeneity of choices among firms. While a subset of firms is oriented towards increasing investments, another group substantially divest. The result is a polarization of conducts that tend to cancel each other out, resulting in a flattening of aggregate investment. We argue that this asymmetry in firm’s decisions depends on two main factors. The first one is the diversity of corporate strategies, which firms have developed in the past. The second driver is managerial discretion, that plays an important role in the adoption of specific investment/divestment trajectories when faced with a recession. The results of our empirical analysis provide strong support for our hypotheses: after controlling for contextual and firm-specific structural, financial and demographic variables, corporate strategies and managerial discretion in the allocation of liquid assets explain large part of the heterogeneity in investment decisions during the recession. Policy implications are discussed.

Advantageous symmetric cross-ownership and mergers

We model an industry where a subset of firms is interlinked via a reciprocal and symmetric share exchange agreement. Under quantity competition, a merger aiming at acquisition of market power can be reproduced by the same firms under a symmetric cross-ownership scheme. Under linear demand, a non-controlling symmetric cross-ownership scheme is always advantageous to its members if at least ( 2 − 2 ) ( 1 + n ) firms in an n -firm industry participate. The threshold drops to ( 1 + n ) / 2 for relatively low levels of cross-ownership. Cross-ownership schemes require fewer participants than mergers to be advantageous and can be more profitable than equal size mergers. Unlike mergers, a unique stable scheme exists. • Cournot mergers can be reproduced by symmetric and reciprocal cross-ownership. • Passive cross-ownership is unprofitable if less than half of industry participates. • Cross-ownership requires fewer participants than a merger to be advantageous. • Passive cross-ownership may be more profitable than an equal size merger. • Unlike the non-existence of stable mergers, a unique stable cross-ownership scheme exists.

Do oligopolistic firms benefit from being forced to act non‐strategically?

AbstractThe present study seeks to answer the question of whether acting non‐strategically can benefit firms. In a static Cournot framework, if a subset of firms are constrained to the equilibrium level of output, being non‐strategic will have no impact on profits of neither constrained nor strategic firms and provided that sufficiently large number of firms are restricted, a marginal quantity contraction can be to their benefit. In contrast, using a dynamic Cournot framework, we find that the constraint set at the equilibrium level or moderately deviated from it, leads to increased profits for all firms irrespective of the number of non‐strategic ones.

Coordinated Effects in Merger Review

Coordinated effects are merger-related harms that arise because a subset of postmerger firms modify their conduct to limit competition among themselves, particularly in ways other than explicit collusion. We provide a measure of the risk of such conduct by examining the individual rationality of participation by subsets of firms in market allocation schemes. This measure of risk for coordinated effects distinguishes markets that are at risk from those that are not and distinguishes mergers that increase risk from those that do not. A market’s risk for market allocation by a subset of firms varies with the degree of outside competition, symmetry and strength of the subset of firms, buyers’ power, and vertical integration. We make precise the widely used but rarely rigorously defined notion of a maverick firm and provide foundations for a maverick-based approach to coordinated effects. In addition, we identify previously unrecognized trade-offs between unilateral and coordinated effects.

Heterogeneity and state dependence in firms’ access to bank credit

This paper investigates firms’ access to bank credit in eleven euro area countries over the periods 2014–2019. Exploiting firm-level longitudinal data, we analyse loan demand and credit rationing probabilities, accounting for sample selection, unobserved heterogeneity and state dependence. Empirical results show that small and informationally opaque businesses, with deteriorated public support and credit history, face greater difficulties in obtaining bank loans. Furthermore, we provide evidence of a significant degree of state dependence in access to credit. In particular, firms that have already experienced credit restrictions are more likely to face further constraints, while enterprises that applied for bank financing in the past seem to have easier access to credit. Focusing on the subset of firms actually needing additional bank financing, we also find that past credit restrictions significantly reduce their current demand, providing evidence of a significant discouragement effect.

Attracting multinationals: Additional hurdles under firm selection

We consider a country comprising monopolistic exporters, and a government seeking to boost their efficiency. With this goal, the government provides a multinational with incentives to relocate production in the country, which benefits exporters through productivity spillovers. Our setting highlights the additional difficulties to attract multinationals when the most efficient exporters benefit relatively more from spillovers. Specifically, this makes the policy more effective in enhancing aggregate productivity, by reallocating market share towards more productive firms. However, it simultaneously makes attracting multinationals harder, due to more pronounced increases in competition in the exporting market. Intuitively, the result underscores that multinationals could strategically avoid relocating production in a country if this potentially creates a pool of highly efficient competitors. Thus, those countries that have a subset of firms with outstanding capabilities and hence could potentially benefit more from this policy, are also the ones that could face additional hurdles to implement it.

Is idiosyncratic volatility related to returns? Evidence from a subset of firms with quality idiosyncratic volatility estimates

The empirical relation between idiosyncratic volatility (IVOL) and returns is mixed. Ang et al. (2006, 2009) report a negative relation using lagged realized IVOL, but Fu (2009) shows that this measure is a poor proxy for expectations and proposes using forecasts from EGARCH models which results in a positive relation. However, recent studies show that this positive relation disappears when using out-of-sample EGARCH models to generate the forecasts. We show that expected IVOL proxies used in the prior literature are noisy and propose using combinations of out-of-sample IVOL forecasts generated by different EGARCH models that pass basic diagnostic tests. For the sample for which these high-quality proxies can be created, we find a significant positive relation with returns. The magnitude is both statistically and economically meaningful as firms with expected idiosyncratic volatility of one standard deviation above the mean have expected returns that are approximately 3.4% to 4.1% higher per year.

Advantageous Symmetric Cross-Ownership

We model an industry where a subset of firms is interlinked via a reciprocal and symmetric share exchange agreement. A merger aiming at acquisition of market power can be reproduced by the same firms under a symmetric cross-ownership scheme. Both concentration and market power indices increase due to cross-ownership. Under linear demand, a non-controlling symmetric cross-ownership scheme is always advantageous to its members if at least 0.58 (1+n) firms in an n-firm industry participate. The threshold drops to (1+n)/2 for relatively low levels of cross-ownership. Cross-ownership schemes require fewer participants than mergers to be advantageous and can always be more profitable than mergers, unless a merger involves more than 88 per cent of industry firms.

Corporate debt booms, financial constraints and the investment nexus

Does corporate debt overhang affect investment over the medium term? To uncover this association, I measure debt overhang with a concept of debt accumulation or debt boom, and combine leverage with liquid assets to capture financial constraints. Using a large US firm-level panel over 1985 Q1–2019 Q1, I find that debt overhang leads financially vulnerable firms to cut permanently back on investment: a 10 percentage point increase in the three-year change in the leverage ratio is associated with lower investment growth of 5 percentage points after five years compared to the most resilient firms. I also find that vulnerable firms experience weaker intangible capital growth in the aftermath of debt booms. Finally, I find that general equilibrium effects dominate, stressing the risk that firm-specific debt booms in a subset of firms may spill over to the rest of the economy.

Corporate credit booms, financial constraints, and the investment nexus

Does corporate debt overhang affect investment over the medium term? To better uncover this association, I argue that we need to measure debt overhang with a concept of debt accumulation or debt boom, and to combine leverage with liquid assets to capture financial constraints. Using firm-level data for a large panel of US non-financial firms over 1985Q1-2019Q1, I find that debt overhang leads financially vulnerable firms – high debt and low liquid asset holdings – to cut back on investment: a 10 p.p. increase in the three-year change in the leverage ratio is associated with 5% lower capex investment after five years compared to the most resilient firms. I also find that vulnerable firms experience weaker intangible capital growth in the aftermath of debt booms. Finally, I find that general equilibrium effects dominate, stressing the risk that firm-specific debt booms in a subset of firms may spill over to the rest of the economy.

Investors' Misweighting of Firm‐Level Information and the Market's Expectations of Earnings

ABSTRACTPrior studies use fundamental earnings forecasts to proxy for the market's expectations of earnings because analyst forecasts are biased and are available for only a subset of firms. We find that as a proxy for market expectations, fundamental forecasts contain systematic measurement errors analogous to those in analysts' biased forecasts. Therefore, these forecasts are not representative of investors' beliefs. The systematic measurement errors from using fundamental forecasts to proxy for market expectations occur because investors misweight the information in many firm‐level variables when estimating future earnings, but fundamental forecasts are formed using the historically efficient weights on firm‐level variables. Thus, we develop an alternative ex ante proxy for the market's expectations of future earnings (“the implied market forecast”) using the historical (and inefficient) weights, as reflected in stock returns, that the market places on firm‐level variables. A trading strategy based on the implied market forecast error, which is measured as the difference between the implied market forecast and the fundamental forecast, generates excess returns of approximately 9 percent per year. These returns cannot be explained by investors' reliance on analysts' biased forecasts. Overall, our results reveal that market expectations differ from both fundamental forecasts and analysts' forecasts.

Tradeoff Theory and Leverage Dynamics of High-Frequency Debt Issuers*

Abstract We test whether high-frequency net-debt issuers (HFIs)—public industrial companies with relatively low issuance costs and high debt-financing benefits—manage leverage toward long-run targets. Our answer is they do not: (1) the leverage–profitability correlation is negative even in quarters with leverage rebalancing; (2) the speed-of-adjustment to target leverage deviations is no higher for HFIs than for low-frequency net-debt issuers; and (3) under-leveraged HFIs do not speed up rebalancing activity in significant investment periods. Thus, even in the subset of firms most likely to follow dynamic trade-off theory, the theory does not appear to hold.

IQ from IP: Simplifying search in portfolio choice

Using a novel database that tracks web traffic on the Security Exchange Commission's EDGAR server between 2004 and 2015, we show that institutional investors gather information on a very particular subset of firms and insiders, and their surveillance is very persistent over time. This tracking behavior has powerful implications for their portfolio choice and its information content. An institution that downloaded an insider trading filing by a given firm last quarter increases its likelihood of downloading an insider trading filing on the same firm by more than 41.3 percentage points this quarter. Moreover, the average tracked stock that an institution buys generates annualized alphas of over 12% relative to the purchase of an average non tracked stock. We find that institutional managers tend to track top executives and to share educational and locational commonalities with the specific insiders they choose to follow. Collectively, our results suggest that the information in tracked trades is important for fundamental firm value and is only revealed following the information-rich dual trading by insiders and linked institutions.