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HFRC Working Paper Series

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Corporate Governance

Foreign bias in institutional portfolio allocation: The role of social trust

Wolfgang Drobetz, Marwin Mönkemeyer, Ignacio Requejo, Henning Schröder
HFRC Working Paper Series | Version 05/2022
Using a large sample of institutionally managed portfolios, we study the role of social trust in the equity allocations of 8,088 investors from 33 countries over the 2000-2017 period. The negative relation between social trust and foreign bias suggests that institutional investors from high-social trust countries are less prone to underinvesting in foreign equity. Our results provide credence to an information-based explanation, indicating that social trust reduces foreign bias by compensating the lack of information about foreign markets. The negative relation between social trust and foreign bias does not hold unconditionally, but only relates to host countries with weak formal institutional frameworks. The informal institution of social trust can offset the lack of formal country-level institutions in international portfolio decisions. Social trust helps investors accomplish greater cross-country portfolio diversification.

Board ancestral diversity and voluntary greenhouse gas emission disclosure

Johannes Barg, Wolfgang Drobetz, Sadok El Ghoul, Omrane Guedhami, Henning Schröder
HFRC Working Paper Series | Version 01/2022
Prior research suggests that the disclosure of greenhouse gas (GHG) emissions—a primary cause of climate change—affects firm valuation. In this paper, we provide new insights into the determinants of the voluntary disclosure of GHG emissions. We show that board ancestral diversity has a positive and statistically significant effect on a firm’s scope and quality of voluntary GHG emission disclosure. This effect is robust to controlling for several other dimensions of board diversity as well as to addressing endogeneity and sample selection. Additional analysis suggests that board ancestral diversity has a higher impact on GHG emission disclosure in firms with low institutional ownership and high corporate complexity. We interpret these findings as consistent with the view that board diversity enhances monitoring and advising.

Foreign institutional investors, legal origin, and corporate greenhouse gas emissions disclosure

Wolfgang Drobetz, Simon Döring, Sadok El Ghoul, Omrane Guedhami, Henning Schröder
HFRC Working Paper Series | Version 10/2021
The disclosure of corporate environmental performance is an increasingly important element of a firm’s ethical behavior. We analyze how the legal origin of foreign institutional investors affects a firm’s voluntary carbon disclosure. Using a large sample of firms from 36 countries, we show that foreign institutional ownership from civil law countries improves the scope and quality of a firm’s greenhouse gas emissions reporting. This relation is robust to addressing endogeneity and selection biases. The effect is more pronounced in firms from non-climate-sensitized countries, for which the gap between firms’ environmental standards and investors’ environmental targets is potentially larger, and in less international firms. Firms with a higher level of voluntary carbon disclosure also exhibit higher valuations.

Do foreign institutional investors affect international contracting? Evidence from bond covenants

Paul Brockman, Wolfgang Drobetz, Sadok El Ghoul, Omrane Guedhami, Ying Zheng
HFRC Working Paper Series | Version 08/2021
We examine the impact of foreign institutional shareholders on the prevalence of restrictive bond covenants using a sample of 959 Yankee bonds from 29 countries over the period 2001–2019. We find a significantly negative relation between foreign institutional ownership and debt covenants. This inverse relation is strongest for U.S. institutional ownership of foreign-issued Yankee bonds, and for covenants designed to mitigate such opportunistic behavior as claims dilution and wealth transfers. We also show that the inverse relation between U.S. institutional ownership and restrictive debt covenants is moderated by country- and firm-level variables related to corporate governance, information asymmetry, and agency costs of debt. Additional analyses show that U.S. institutional ownership has a significant pricing effect on Yankee bond investors by lowering the issuer’s cost of borrowing.

Institutional investment horizons, corporate governance, and credit ratings: International evidence

Hamdi Driss, Wolfgang Drobetz, Sadok El Ghoul, Omrane Guedhami
HFRC Working Paper Series | Version 01/2021
Using a comprehensive set of firms from 57 countries over the 2000–2016 period, we examine the relation between institutional investor horizons and firm-level credit ratings. Controlling for firm- and country-specific factors, as well as for firm fixed effects, we find that larger long-term (short-term) institutional ownership is associated with higher (lower) credit ratings. This finding is robust to sample composition, alternative estimation methods, and endogeneity concerns. Long-term institutional ownership affects ratings more during times of higher expropriation risk, for firms with weaker internal governance, and for those in countries with lower-quality institutional environments. Additional analysis shows that long-term investors can facilitate access to debt markets for firms facing severe agency problems. These findings suggest that, unlike their short-term counterparts, long-term investors can improve a firm’s credit risk profile through effective monitoring.

Institutional ownership and firm performance in the global shipping industry

Wolfgang Drobetz, Sebastian Ehlert, Henning Schröder
Transportation Research Part E: Logistics and Transportation Review | 01/2021 | Forthcoming
We examine the effect of institutional investors on the valuation of listed shipping firms. Institutional investors have a positive influence on the market value of shipping firms, confirming that institutional ownership is a “universal” corporate governance mechanism. This valuation effect is more pronounced in firms dominated by institutional investors with a short-term investment horizon. It is also stronger in firms with high stock liquidity, suggesting that short-term investors, through the threat of exit, are able to mitigate agency conflicts and improve corporate governance. Investment regressions indicate that shipping firms with a larger fraction of short-term investors are better able to exploit growth opportunities.

The economics of law enforcement: Quasi-experimental evidence from corporate takeover law

Gishan Dissanaike, Wolfgang Drobetz, Paul P. Momtaz, Jörg Rocholl
Journal of Corporate Finance | 12/2020 | Forthcoming
This paper examines the impact of takeover law enforcement on corporate acquisitions. We use the European Takeover Directive as a natural experiment, which harmonizes takeover law across countries, while leaving its enforcement to the discretion of individual countries. We exploit this heterogeneity in enforcement quality across countries in a difference-in-differences-in-differences model, while employing an overall inductive research approach, following Karpoff and Whittry’s (2018) recommendation. We find that acquirer returns increase in countries with improvements in takeover law, driven by better target selection and lower cost of financing. The increase in acquirer returns is lower in weak enforcement jurisdictions, which we identify by developing a novel Takeover Law Enforcement Index (TLEI). The findings show that takeover law can mitigate agency conflicts, but its true value depends on its enforcement. Our results are strongly robust to alternative model specifications.

Institutional investment horizons and firm valuation around the world

Wolfgang Drobetz, Simon Döring, Sadok El Ghoul, Omrane Guedhami, Henning Schröder
Journal of International Business Studies | 09/2020 | Forthcoming
Using a comprehensive dataset of firms from 34 countries, we study the effect of institutional investors’ investment horizons on firm valuation around the world. We find a positive relation between institutional ownership and firm value that is driven by short-horizon institutional investors. Accounting for the interaction between investors’ investment horizon and nationality, we show that foreign short-horizon institutions, which are more likely to discipline managers through the threat of exit rather than engaging in monitoring made costly by the liability of foreignness, are the investor group with the strongest effect on firm value. Reinforcing the threat of exit channel, we find that the value-enhancing effect of short-horizon investors is stronger in the presence of multiple short-horizon investors, who are more likely to engage in competitive trading. The positive valuation effect of short-horizon investors is stronger when stock liquidity is high, which makes the exit threat more credible, and in firms prone to free cash flow agency problems. Overall, our results are consistent with short-horizon institutional investors, especially foreign institutional owners, affecting firm value by disciplining managers through a credible threat of exit.

Cross-country determinants of institutional investors’ investment horizons

Wolfgang Drobetz, Simon Döring, Sadok El Ghoul, Omrane Guedhami, Henning Schröder
Finance Research Letters | 06/2020 | Forthcoming
Using a large dataset of firms from 35 countries, we study the country-level determinants of institutional investors’ investment horizons. We show that an equity investor-friendly institutional environment is more important for long-term investors, while short-term investors seem to be less concerned about the quality of the financial and legal environment. Beyond the financial and legal structure, the cultural environment and economic policy uncertainty in a country are other important determinants of investor horizons. These findings improve our understanding of cross-country differences in the corporate governance role, i.e., engagement vs. exit, of institutional investors.

Antitakeover provisions and firm value: New evidence from the M&A market

Wolfgang Drobetz, Paul P. Momtaz
Journal of Corporate Finance | 06/2020
New evidence from acquisition decisions suggests that antitakeover provisions (ATPs) may increase firm value when internal corporate governance is sufficiently strong. We document that, in Germany, firms with stronger ATPs, and particularly supermajority provisions, are better acquirers. Managers of high-ATP firms create value in acquisitions by making governance-improving deals. They are more likely to engage in acquisitions that reduce their own entrenchment level and less likely to invest in declining industries. The empirical evidence is consistent with a short-termist interpretation. Takeover threats can induce myopic investment decisions, which ATPs can mitigate. They lead managers to engage more often in value-creating long-term and innovative investing, and increase a firm's sensitivity to investment opportunities. Our findings contribute to a growing literature challenging conventional wisdom that the agency-increasing effect of ATPs empirically dominates the myopia-eliminating effect, suggesting that a more contextual view of the value implications of ATPs is necessary.

Corporate governance convergence in the European M&A market

Wolfgang Drobetz, Paul P. Momtaz
Finance Research Letters | 01/2020
Cross-border acquisitions lead to improvements in shareholder rights and more dispersed ownership structures in a large sample of intra-European takeovers. These findings are evidence of corporate governance convergence toward the Anglo-Saxon system through cross-border takeovers. However, we find no support for the corporate governance motive hypothesis in cross-border acquisitions even after accounting for potential sample selectivity. Although acquirers have significantly better shareholder rights than their targets, there are no robust marginal bidder wealth effects for firms that acquire either weaker or stronger governance foreign targets. Instead, bidder wealth effects in cross-border acquisitions are better explained by acculturation costs.

Investment and financing decisions of private and public firms

Wolfgang Drobetz, Malte Janzen, Iwan Meier
Journal of Business Finance and Accounting | 12/2018
We examine differences in the allocation of cash flow between Western European private and public firms. Public firms have a higher investment‐cash flow sensitivity than comparable private firms. This difference is not attributable to more severe financing constraints of public firms. Instead, because differences in investment‐cash flow sensitivities are only observed for the unexpected portion of firms’ cash flow, the empirical evidence supports an agency‐based explanation. Similar patterns are observable for the expected and unexpected portion of firms’ shareholder distributions. Our results are driven by firms from countries with low ownership concentration and more liquid stock markets, where shareholders have lower incentives to monitor. The results are also more pronounced for public firms with low industry Tobin's q and high free cash flow, which are more prone to suffer from agency problems.

Industry expert directors

Wolfgang Drobetz, David Oesch, Markus Schmid, Felix von Meyerinck
Journal of Banking and Finance | 07/2018
We analyze the valuation effect of board industry experience and channels through which industry experience of outside directors relates to firm value. Our analysis shows that firms with more experienced outside directors are valued at a premium compared to firms with less experienced outside directors. Additional analyses, including a quasi-experimental setting based on director deaths, mitigate endogeneity concerns. The association between having directors with more industry experience and higher firm value is more pronounced for firms with larger investment programs, larger cash reserves, and during crises. In contrast, it is weaker in more dynamic industries, i.e., industries that rank high in terms of sales growth, R&D expenditures, merger activities, competitive threat, and product market changes, where the value of previously acquired experience is likely to be diminished. Overall, our findings are consistent with board industry experience being a valuable corporate governance mechanism.

Corporate finance in Germany: Structural adjustments and current developments

Wolfgang Bessler, Wolfgang Drobetz
Journal of Applied Corporate Finance | 01/2016
For a very long time, the financing of German companies was dominated by German universal banks, which functioned as sources of both capital-as equity holders as well as providers of loans-and corporate governance. Although internal finance (retained earnings) has always been and will remain the most important source of finance, several recent developments have forced German companies to search for alternatives to their traditionally heavy dependence on bank lending. As a result, the composition of external finance has changed, with substantial net contributions of corporate bond and equity offerings. Furthermore, both the equity ratios and cash holdings of German companies have increased over the years. Thus, although the German financial system still exhibits many differences from those in the U.S. and U.K., the financing patterns of German companies have to some extent converged with those of their peers from Anglo-American market-based financial systems. The growth in recent years of German capital markets-and of German companies' reliance on them-has led to important changes in both German and European corporate governance, including the evolution of a common European market for corporate control that is still in its early stages.

The returns to hedge fund activism in Germany

Wolfgang Bessler, Wolfgang Drobetz, Julian Holler
European Financial Management | 01/2015
Recent regulatory changes in the German financial system shifted corporate control activities from universal banks to other capital market participants. Particularly hedge funds took advantage of the resulting control vacuum by acquiring stakes in weakly governed and less profitable firms. We document that, on average, hedge funds increased shareholder value in the short‐ and long‐run. However, more aggressive hedge funds generated only initially higher returns and their outperformance quickly reversed, whereas non‐aggressive hedge funds ultimately outperformed their aggressive peers. These findings suggest that aggressive hedge funds attempt to expropriate the target firm's shareholders by exiting at temporarily increased share prices.

Corporate social responsibility disclosure: The case of international shipping

Wolfgang Drobetz, Anna Merika, Andreas Merikas, Mike G. Tsionas
Transportation Research Part E: Logistics and Transportation Review | 11/2014
Based on practices and legislation in the shipping industry, we construct a corporate social responsibility (CSR) disclosure index for listed shipping companies. We use Markov Chain Monte Carlo (MCMC) techniques for Bayesian inference, and we estimate the marginal effects of firm characteristics on CSR disclosure for each firm. Our results show a positive relationship between CSR disclosure and financial performance for each firm in our international sample. Firm size, financial leverage, and ownership structure are also associated with CSR disclosure. Our findings suggest that a majority of listed shipping companies have integrated CSR practices into their strategic planning and operations.

Information asymmetry and financing decisions

Wolfgang Bessler, Wolfgang Drobetz, Matthias C. Grüninger
International Review of Finance | 03/2011
This study conducts tests of the pecking order theory using an international sample with more than 6000 firms over the period from 1995 to 2005. The high correlation between net equity issuances and the financing deficit discredits the static pecking order theory. Rather than analyzing the predictions of the theory, we test its core assumption that information asymmetry is an important determinant of capital structure decisions. Our empirical results support the dynamic pecking order theory and its two testable implications. First, the probability of issuing equity increases with less pronounced firm‐level information asymmetry. Second, firms exploit windows of opportunity by making relatively larger equity issuances and build up cash reserves (slack) after declines in firm‐level information asymmetry. Firms from common law countries use parts of their proceeds from an equity issuance to redeem debt and to rebalance their capital structure. These findings are consistent with a time‐varying adverse selection explanation of firms' financing decisions.

Information asymmetry and the value of cash

Wolfgang Drobetz, Matthias C. Grüninger, Simone Hirschvogl
Journal of Banking and Finance | 09/2010
This study investigates the market value of corporate cash holdings in connection with firm-specific and time-varying information asymmetry. Analyzing a large international sample, we test two opposing hypotheses. According to the pecking order theory, adverse selection problems make external financing costly and imply a higher market value of a marginal dollar of cash in states with higher information asymmetry. In contrast, the free cash flow theory predicts that excessive cash holdings bundled with higher information asymmetry generate moral hazard problems and lead to a lower market value of a marginal dollar of cash. We use the dispersion of analysts’ earnings per share forecasts as our main measure of firm-specific and time-varying information asymmetry. Extending the valuation regressions of Fama and French [Fama, E.F., French, K.R., 1998. Taxes, financing decisions, and firm value. Journal of Finance 53, 819–843], our results support the free cash flow theory and indicate that the value of corporate cash holdings is lower in states with a higher degree of information asymmetry.

An integrated framework of corporate governance and firm valuation

Stefan Beiner, Wolfgang Drobetz, Markus Schmid, Heinz Zimmermann
European Financial Management | 02/2006
Recent empirical research shows evidence of a positive relationship between the quality of firm‐specific corporate governance and firm valuation. Instead of looking at one single corporate governance mechanism in isolation, we construct a broad corporate governance index and apply five additional variables related to ownership structure, board characteristics, and leverage to provide a comprehensive description of firm‐level corporate governance for a representative sample of Swiss firms. To control for potential endogeneity of these six governance mechanisms, we develop a system of simultaneous equations and apply three‐stage least squares (3SLS). Our results support the widespread hypothesis of a positive relationship between corporate governance and firm valuation.

Corporate governance and expected stock returns: Evidence from Germany

Wolfgang Drobetz, Andreas Schillhofer, Heinz Zimmermann
European Financial Management | 06/2004
Recent empirical work shows evidence for higher valuation of firms in countries with a better legal environment. We investigate whether differences in the quality of firm‐level corporate governance also help to explain firm performance in a cross‐section of companies within a single jurisdiction. Constructing a broad corporate governance rating (CGR) for German public firms, we document a positive relationship between governance practices and firm valuation. There is also evidence that expected stock returns are negatively correlated with firm‐level corporate governance, if dividend yields are used as proxies for the cost of capital. An investment strategy that bought high‐CGR firms and shorted low‐CGR firms earned abnormal returns of around 12% on an annual basis during the sample period.