Working Papers

This page lists my current working papers.

1. Guo, L. and R. Masulis, August 2013, “Board Structure and Monitoring: New Evidence from CEO Turnover”. (Currently under review. Presented at the 2011 Mid-Atlantic Research Conference in Finance, Villanova University, 2011 Financial Management Association Meetings, the 2012 China International Conference in Finance, the 2012 Asian Financial Management Association Meetings, the 2012 ISB Summer Research Conference, the 2012 Conference on Empirical Legal Studies and the 2013 FIRS Conference in Dubrovnik.)

This paper uses the mandatory changes in board composition brought about by the new exchange listing rules following the passage of the Sarbanes-Oxley Act (SOX) to estimate the effect of overall board independence and nominating committee independence on forced CEO turnover. We find that firms that are forced to adopt a majority independent board or a fully independent nominating committee experience statistically significant increases in sensitivity of forced CEO turnover to firm performance after SOX relative to firms that are already in compliance with the two rules before SOX respectively. For a CEO in a hypothetical average firm of our sample that makes either board structure change, the increase in implied probability of the CEO being fired when firm performance falls from the 75th percentile to the 25th percentile of the sample is about 2 to 14 times higher in the post-SOX period than in the pre-SOX period. Furthermore, we find no evidence that the quicker firing of CEOs in the post-SOX period indicates premature firing. Rather, we find that stock and operating performance improves following these CEO firings. Thus our evidence suggests that greater representation of independent directors on board and/or nominating committee leads to more effective monitoring. Our finding that nominating committee independence significantly affects the quality of board monitoring has important policy implications given the intense debate on the costs and benefits of mandatory board regulations since the passage of SOX.

2. Johnson, W., J.K. Kang, R. Masulis and S. Yi, August 2013, “Supply-Chain Spillover Effects and the Interdependence of Firm Financing Decisions”. (Currently under review. Presented at the 2010 Conference on Empirical Legal Studies (CELS), 2010 Financial Management Association Meetings, the 2012 UBC Winter Finance Conference and the 2012 FIRS Conference.)

We analyze spillover effects of supplier equity financing decisions to assess the importance of major trading relationships in creating interdependent valuation effects. We find supplier issuance decisions have important negative spillover effects for large customers, which are more pronounced as information asymmetry or economic dependence of suppliers and customers rises, relationship-specific investment increases, or more valuable product guarantees are offered. Furthermore, customer incentives to maintain supplier relationships are undercut by supplier equity financing decisions, leading to shorter post-issuance trading relationships and larger declines in relationship-specific investments. Our results provide strong evidence of financial and investment policy interdependence across major supply chain members.

3. Li, X. and R. Masulis, August 2013, “Equity Ownership in IPO Issuers by Brokerage Firms and Analyst Research Coverage”. (Currently Under Review. Presented at the 2007 China International Finance Conference in Chengdu, 2007 Financial Management Association Meetings, the 2012 CAPANA Research Conference in Xian China, the 2013 European Skiance Meeting and the 2013 FIRS Conference in Dubrovnik.)

We examine the relation between brokerage firm research coverage and their equity ownership in IPO issuers due to earlier venture investments. A major concern of investors and regulators is that combining these activities can compromise the accuracy of analyst reports given brokerage firm incentives to support IPOs of issuers in which they are venture investors. Alternatively, equity ownership could enhance affiliated analysts’ credibility with investors and discourage affiliated analysts from providing booster shots to issuer stock prices. Equity ownership could also align brokerage firm interests with IPO issuers by inducing affiliated firms to provide research coverage of IPO issuers, especially by Institutional Investor all star analysts. Our results indicate that offering venture investment and analyst research under one roof benefits both issuers and IPO investors and does not create serious conflicts of interest between affiliated firms and investors. We find recommendations of affiliated analysts are less overly optimistic and produce larger abnormal announcement returns, especially for issuers with greater information asymmetry. Our results also yield several implications for the recent NASD and NYSE rules changes regarding equity ownership of IPO firms and affiliated analysts.

4. Kwan, A., R. Masulis and T. McInish, August 2013, “Trading Rules, Competition for Order Flow and Market Fragmentation”. (Currently under review. Presented at the 2012 Conference on Market Microstructure Effects of the Rise of Dark Pools at the University of South Australia, the 2012 FMA Doctoral Consortium and the 2013 Symposium on Financial Econometrics and Market Microstructure in Melbourne.)

We investigate competition between traditional stock exchanges and new alternative trading systems, or ‘dark pools’, using an important difference in regulatory treatment. SEC imposed minimum pricing increments constrain some stock spreads, causing large queues of limit orders. Dark pools benefit some traders by allowing them to trade ahead of existing limit order queues with minimal price improvement. Using a regression discontinuity design, we find spread constraints significantly affect trading venue competitiveness. The ability to circumvent time priority of displayed limit orders is one cause of the rapid rise in dark pool market share and the fragmentation of U.S. equity markets.

5. Masulis, R. and S. Mobbs, May 2013, “Reputation Incentives of Independent Directors: Impacts on Board Monitoring and Adverse Firm Actions”. (Presented at the 16th New Zealand Finance Consortium, Auckland, 2012 and the 5th Annual FSU SunTrust Conference and accepted for presentation at the 2013 American Law and Economics Association Annual Meeting and 2013 European Finance Association Meetings.)

We find a large body of evidence that independent director reputation incentives can vary across directors and can significantly influence important board decisions and firm outcomes. Firms with a greater proportion of independent directors where the board is one of their most prestigious are associated with a lower likelihood of firm actions known to hurt director reputations including exchange initiated delisting, bond covenant violations, earnings management or restatements, being subject to shareholder class action lawsuits, dividend reductions and CEO option back dating. These firms are also associated with CEO compensation contracts that are more sensitive to stock performance, but also higher CEO total compensation. We find evidence that greater reputation incentives are associated with a propensity to grow and defend the empire, which provides some evidence of the countervailing incentives arising from reputation concerns. These results are generally robust to various methods of filtering out firm size effects from our primary reputation measures. The evidence indicates that director reputation concerns can have significant influence on key board decisions important to shareholders.

6. Masulis, R. and S. Reza, June 2013, “Agency Problems of Corporate Philanthropy”. (Presented at the 2012 ISB Summer Research conference and the 2013 FIRS Conference in Dubrovnik.)

Agency theory and optimal contracting theory offer competing views of corporate philanthropic activities. Testing these competing theories, we find that the choice and level of corporate giving is positively associated with CEO personal ties to charities and is negatively associated with the strength of corporate governance. Furthermore, corporate giving is unrelated to firm characteristics most likely to be associated with the firm realizing benefits from charitable giving. These findings are robust to a natural experiment which exogenously increases a CEO’s personal cost of consuming private benefits. Further, these results hold even among firms most likely to benefit from corporate giving. Consistent with agency theory, we show that corporate giving also reduces stock returns by lowering the marginal dollar value of cash. Yet, we fail to find evidence that CEO compensation is adjusted for the private benefits of corporate giving. We find evidence that CEOs use firm donations to support their preferred and affiliated charities and to strengthen their social ties to independent directors by having the firm support their charity preferences. Lastly, negative average stock price reaction to initial disclosures of charity awards where executives and directors have personal ties further supports the predictions of agency theory. Overall, our results support the conclusion that CEOs often advance their own personal interests when firms contribute and suggest that the observed firm value reduction is due to managerial misuse of corporate resources.

7. Masulis, R. and S. Zhang, August 2013, “Compensation Gaps among Top Executives: Evidence of Tournament Incentives or Productivity Differentials?” (Presented at the 2011 Midwest Finance Association Meetings, the 2011 Financial Management Association Meetings, the 2012 Northern Finance Association Meetings, the 2013 American Finance Association Meetings and accepted for presentation at the 2013 European Finance Association Meetings.)

We explore the determinants of compensation gaps between a firm’s CEO and its other senior executives by comparing two competing theories based on optimal contracting, namely tournament theory and productivity theory. We find little evidence that firms design their executive compensation policies in a manner consistent with tournament theory. Our strongest evidence against tournament theory is found when internal tournament incentives should be especially strong, such as in firms most likely to conduct a succession contest for selecting their next CEO, prior to CEO turnovers, especially planned CEO retirements and in industries where human capital is highly firm specific. Empirically, we find that tournament predictions have weak explanatory power in these samples. In contrast, we find substantial evidence that executive compensation is strongly linked to measures of executive productivity and that productivity differentials among senior executives explain a large part of the cross sectional and time series variability of firm level compensation gaps.

8. Masulis, R., P. Swan and B. Tobiansky, August 2013, “Do Wealth Creating Mergers Really Hurt Acquirer Shareholders?” (Presented at the 2011 FIRS Conference, the 2011 China International Conference, the 2011 Chulalongkorn Accounting and Finance Symposium, the 2011 Australasian Finance Banking Conference, the 2012 American Finance Association Meetings and the 2012 ISB NALSAR Vanderbilt Law and Business Conference.)

We examine the expected economic benefits of mergers and acquisitions. We conclude that both signaling and revelation biases are responsible for the commonly reported finding that on average takeovers are harmful to bidder shareholder wealth. After accounting for these two biases that lead to a sizeable price fall on the bid announcement we demonstrate that bidders generally benefit from takeovers capturing on average 67% of the economic gains from the transaction in cash bids and 91% in stock bids. By studying bids that fail for exogenous reasons, which are largely free of signaling and revelation biases, we confirm the neoclassical view that takeovers are positive NPV projects for a typical bidder. We base this conclusion on two important findings. First, on a failed acquisition announcement, the combined bidder and target value falls on average, indicating that both target and bidder suffer significant negative abnormal returns. Second, bidders share in a significant portion of the economic benefits of a successful acquisition, reflected in a significant positive relationship between bidder and target stock returns utilizing a 60-day initial bid announcement window and a 100-day period following the bid termination announcement. Over the same window, exogenously failed cash bidders significantly underperform successful cash bidders by 10.7% and exogenously failed stock bidders significantly underperform successful stock bidders by an added 15.5%, leading to combined underperformance in failed stock bids of 26.2%.

9. Guo, L. and R. Masulis, February 2013, “Information Quality and CEO Turnover”. (Accepted for presentation at the 2013 Conference on Empirical Legal Studies (CELS).)

This study measures the information quality of stock returns and accounting earnings and provides persuasive evidence that the information quality of firm performance measures is significantly related to CEO turnover-performance sensitivity. Using a Bayesian learning framework, our results indicate that when firm performance measures have poorer information quality, this reduces a corporate board’s ability to quickly identify low ability CEOs requiring removal, which weakens CEO turnover-performance sensitivity. This information quality effect is mainly concentrated in firms with relatively new CEOs, where the board tends to know less about the CEO and thus have more to learn from firm performance. Our results suggest that while internal governance quality appears to be more important in explaining turnover-performance sensitivity of firms with relatively established CEOs, information quality is more important in explaining turnover-performance sensitivity of firms with less seasoned CEOs, who have shorter track records and are not entrenched.

10. Masulis, R., P. Pham, J. Zein and S. Dash, May 2013, “Does Group Affiliation Facilitate Access to External Financing? Evidence from IPOs by Family Business Groups”. (Presented at the 2010 Financial Management Association Meetings, the 2011 Frontiers in Finance Conference in Banff, the 2011 Finance and Corporate Governance Conference in Melbourne (awarded the best corporate finance paper), the 2012 Asian Financial Management Association Meetings, and the 2013 Asian Bureau of Finance and Economic Research Conference.)

Although the literature has identified important benefits associated with group affiliation, the channels through which business groups provide support to members remain relatively unexplored. Using IPO data from 44 countries, we investigate how family groups create financing advantages for young member firms by facilitating their entry into the equity capital market. Our evidence suggests that internal capital accumulated by a group in the form of retained earnings can enable new members to go public by bridging significant funding gaps associated with costly external financing. Consistent with this channel of group support, we also find that group-affiliated IPOs tend to possess firm characteristics generally associated with serious external financing constraints and that they are better able to go public under weak IPO market conditions and incur lower flotation costs compared to independent firms. After listing, group affiliation continues to benefit IPO firms by enabling them to overcome adverse external capital market conditions. Our results are most pronounced for affiliated firms controlled through pyramids, consistent with the theory that this organizational structure provides a mechanism for controlling families to leverage their internal capital and alleviate external financing constraints of affiliated new ventures.

11. Banerjee, S. and R. Masulis, March 2013, “Ownership, Investment and Governance:  The Costs and Benefits of Dual Class Shares”. (Presented at the 2012 FIRN Art of Finance Conference in Hobart.)

In this paper we show that dual-class shares can be an answer to agency conflicts rather than the result of agency conflicts. When a firm issues voting shares to raise funds, an incumbent manager’s control rights are diluted. This increases the risk that an incumbent could lose control of the firm and therefore, could lose the associated benefits of control. We show that sometimes it is optimal for the incumbent to forgo positive NPV investments in an effort to maximize his expected wealth. Non-voting shares allow a firm to raise funds without diluting manager’s control rights; hence, it can alleviate the underinvestment problem. But non-voting shares facilitate entrenchment and therefore, reduces value-enhancing takeover activities. Also, non-voting shares dilute dividends per share. We obtain conditions under which the benefit of using non-voting shares, that is, higher firm value due to higher investment outweighs the entrenchment and dividend dilution costs. Others have shown that deviations from “one share-one vote” can be optimal, but our study is the first to integrate the dual-class decision into the rich body of research on capital structure and underinvestment. Our model produces a number of new empirical predictions.

12. Masulis, R. and S. Simsir, August 2013, “Deal Initiation in Mergers and Acquisitions”. (Accepted for presentation at the 2013 Chulalongkorn Accounting and Finance Symposium.)

This study investigates deal initiation in the context of mergers and acquisitions. We investigate how bidder and target initiated merger offers differ. Our analysis reveals that target financial or economic weakness, target financial constraints and economy wide shocks are important motives for target-initiated deals. We also find that average bid premiums, target cumulative abnormal returns (CAR) measured around the merger announcement dates and the deal value to EBITDA multiples of target-initiated deals is significantly lower than in bidder-initiated deals. However, this gap cannot be explained by weaker financial conditions of targets immediately prior to merger announcements. After adjusting for self-selection, we find evidence that the private information held by target firms is the main driver of the lower premiums observed in target-initiated deals. Supporting this perspective, the premium gap between bidder- and target-initiated deals widen when the information asymmetry between the merging firms gets higher.

13. Kim, S. and R. Masulis, June 2013, “Order Imbalance Around Seasoned Equity Offers”. (Presented at the 2010 Financial Management Association Meetings, the 2011 Melbourne Finance Down Under Conference, the 2011 FIRS Conference and the 2012 Midwest Finance Association Meetings.)

Using market microstructure data, we study the determinants of the buying/selling pattern around seasoned equity offerings (SEOs) and their effect on underpricing. We find that the trading pattern around SEOs is slightly positive before the issue date and heavily negative after the SEO, and this pattern is distinctly different from what has been inferred from stock returns. The large negative order imbalances mostly occurred during the late 90s in NASDAQ market, where 86% of underwriters are also market makers and market depth is shallow. The abnormal order imbalances appear to be the result of underwriter market making activities. We also find that SEO underpricing is correlated with the post-issue-date negative order imbalances. The selling pressure on stock returns is estimated as 20% of SEO underpricing, indicating a significant portion of SEO underpricing is related to market making risk.

14. Masulis, R., C. Ruzzier, S. Xiao and S. Zhao, June 2012, “Do Independent Expert Directors Matter?” (Presented at the 2012 Delaware Corporate Governance Symposium and accepted for presentation at the 2013 Financial Management Association Meetings.)

The generally weak correlation between board independence and firm performance is a major empirical puzzle. One possible explanation is: director independence alone is not enough. To explore this possibility, we examine the full employment histories of independent directors at S&P 1500 companies. We define an independent expert director or independent director with industry experience (IDIE) as an independent director who has worked in the same 2-digit SIC industry as the company where he/she serves as an independent director. We show the proportion of IDIEs on a board is positively and significantly correlated with firm performance. We find the higher the proportion of IDIEs, the more cash holdings. Firms with IDIEs have higher CEO payperformance sensitivity, higher CEO turnover-performance sensitivity, and more patents with more citations. Stock market investors react positively to IDIE appointments. We also find the higher the CEO power, the less likely IDIEs will be on board.

15. Li, X. and R. Masulis, January 2012, “How Do Venture Investments by Different Classes of Financial Institutions Affect the Equity Underwriting Process?” (Presented at the 2008 American Economic Association Meetings, 2008 EFM Symposium on IPOs at Oxford University, the 2008 FIRS Conference and the 2008 Financial Management Association Meetings.)

Over the 1993-2000 period, a majority of U.S. venture-backed IPOs have venture backing by financial institutions. Each class of financial institutions has its own asset expertise, investment criteria and access to proprietary information on private firms, which we exploit evaluating whether venture investments by commercial banks, investment banks and insurance companies have independent effects on the equity underwriting process. We also examine whether these effects are a function of investment size and whether the effects differ for debt (loans) and equity investments. We find that each class of financial institutions making venture investments in a firm going public is associated with evidence of lower adverse selection risk; namely reduced underpricing and absolute offer price revisions and stronger long-term operating performance. The impacts of debt or equity investments by separate classes of financial institutions are largely additive. Moreover, the size of financial institution ownership in an issuer is more informative than the presence of financial institution investors. This body of evidence is consistent with equity holdings and loans by each class of financial institutions providing independent certification of issuer quality.

16. Ivanov, V. and R. Masulis, February 2011, “Corporate Venture Capital and Corporate Governance in Newly Public Firms”. (Presented at the 2007 European Finance Association Meetings and the 2007 Financial Management Association Meetings.)

We examine IPOs of startups backed by corporate venture capitalists (CVCs) and the propensity of CVC parents to establish strategic alliance with these startup firms. We investigate the differences in the governance structures of venture capital (VC) backed IPO firms. A major difference in objectives between CVCs and traditional venture capitalists (TVCs) is that CVCs often invest for strategic reasons and their parent firms frequently enter into various forms of strategic business relations with their portfolio firms which persist well beyond the IPO. We argue that such strategic alliances can have a significant impact on the governance structure of CVC backed firms, both when they go public and in the following years. Using a sample of VC backed IPOs, we evaluate several hypotheses concerning a CVC’s role in the corporate governance of newly public firms. We find that strategic CVC backed IPOs have weaker CEOs and a larger proportion of independent directors on their boards and compensation committees compared to a matched sample of TVC backed IPO firms. CVC backed IPO firms also have a higher frequencies of staggered boards and forced CEO turnovers. Comparing the corporate governance of IPO firms having strategic alliances with CVC parents with TVC backed IPOs with outside strategic alliances, we find strategic CVC investors have a mean ownership stake of 16.4% compared to 2.2% for outside strategic partners and the strategic CVCs hold significantly more board seats than other strategic alliance partners, both pre- and post-IPO. Finally, these two subsamples of IPO issuers have similar frequencies of takeover defenses.


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