Alex Edmans LBS Wharton NBER CEPR and ECGI Vivian Fang University of Minnesota Emanuel Zur University of Maryland June 19 th 2013 WFA 1 Background and Research Question Policy debate ID: 710522
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Slide1
The Effect of Liquidity on Governance
Alex Edmans, LBS, Wharton, NBER, CEPR, and ECGIVivian Fang, University of MinnesotaEmanuel Zur, University of MarylandJune 19th, 2013, WFA
1Slide2
Background and Research Question
Policy debate: does stock market liquidity improve or weaken corporate governance?
Policies
in the 1930s
promoted market liquidity.Some worries enhanced liquidity hinders governance.
2Slide3
Theoretical Framework
Traditional theories: Shleifer and Vishny (1986),
Burkart
,
Gromb, and Panunzi (1997), Kahn and Winton (1998), Bolton and von Thadden (1998)Under these theories, blockholders govern through “voice” (intervention)Liquidity results in “no governance” (1) by allowing cut and run: Coffee (1991), Bhide (1993) and (2) by stimulating insider trading:
Maug
(2002)
Liquidity encourages “voice” (1) by providing camouflage: Maug (1998) and (2) by increasing price informativeness Faure-Grimaud and Gromb (2004)
3
“Voice-B”
“Voice-G”Slide4
Theoretical Framework (Cont’d)
Recent theories: Admati and Pfleiderer
(2009),
Edmans
(2009), Edmans and Manso (2011)Under these theories, “exit” (threat of exit) is a governance mechanism in itselfLiquidity strengthens “exit” by (1) encouraging block formation: Edmans (2009)
and (2) by
stimulating information acquisition:
Edmans (2009), Edmans and Manso (2011)4“Exit”Slide5
Empirical Challenges
Many blockholders do not engage in “voice”.Diversification
reqts
for mutual funds; “Prudent
man” rules for pension funds (Del Guercio(1996)); Conflicts of interest (Agrawal (2011))We focus on hedge fund activists, as they haveFew conflicts and legal restrictionsThe full “menu” to choose from: “Voice”, “Exit”, or “No Governance”
High performance-based pay:
Clifford
and Lindsey (2011)5Slide6
Empirical Challenges (Cont’d)
The threat of exit or threat
of
voice
also exerts governance.Parrino, Sias, and Starks (2003): actual exit Norli, Ostergaard, and Schindele (2009): actual voiceLack of actual exit or voice does not necessarily mean no governance We use Schedule 13D (active) and 13G (passive) filingsCapture monitoring intent rather than instances of actual governance
Filings accurately represent the true monitoring intent
13G:
Legally prohibited from activism 13D: Onerous filing reqts / Target hostility / Worse credit / Reputation
6Slide7
Empirical Challenges (Cont’d)
Liquidity may be endogenousReverse causality/ Omitted control variables
We address the endogeneity issue
Reverse causality is less of a
concernWe study future governance events (Schedule 13 filings) Governance characteristics (future or contemporaneous) can be stickyDecimalization as an exogenous shock to liquidityMinimum tick size reduced from 1/16 dollar to 1 cent in early 2001Bid-ask spreads fell substantially market wide (Bessembinder 2003)
7Slide8
Main Findings
Liquidity increases the likelihood of block acquisition Conditional on block formation, liquidity encourages 13G over 13D
A 13G filing represents a governance mechanism
A positive market reaction, a positive holding-period return, and an improvement in operating performance; all stronger in more liquid firms
1) and 2) are stronger in firms with higher managerial sensitivity to priceUnconditional effect of liquidity on 13D filings is positive8Slide9
Contribution
Provide insight into the policy and theoretical debateLiterature on the effect of liquidity on firm outcomes
F
irm value:
Fang, Noe, and Tice (2009), Bharath, Jayaraman, and Nagar (2013)Voice: Norli, Ostergaard, and Schindele (2009), Gerken (2009)Literature on the role of hedge funds in governance Brav et al. (2008), Clifford (2008), Greenwood and Schor
(2009), Klein and
Zur (2009, 2011), Boyson and Mooradian (2011)9Slide10
Sample Selection
Data sourcesFactiva: 223 activist HFs for 1995-2010 (Brav et al. (2008))SEC’s EDGAR: Initial 13D/13G schedulesFiled
upon acquiring 5% if intend (do not intend) to engage in activism
CRSP: Daily price, return, and trading volume
Compustat: Firm-year financial data ExecuComp: Equity incentivesWe end up with88,742 firm-year obs. between 1995 and 2010 (Full sample)1,135 firm-year obs. have initial 13D/13G filings (HF sample)
10Slide11
Regressors
Measuring liquidity Amihud (2002) ratio; Fong, Holden, and Trzcinka (2011) measure-1 × natural logarithm of the two
illiquidity
measures
LIQAM= −ln(AMRATIO); LIQFHT= − ln(FHT) Higher values of LIQAM and LIQFHT correspond to higher liquidityControl Variables: Firm characteristics following Brav, Jiang, and Kim (2010); year and industry fixed effects11Slide12
Effect of Liquidity on Block Formation
12
Voice-G
Voice-BExitH1: Stock liquidity increases the likelihood that a hedge fund acquires a block.
–
(1)
(2)
(3)
(4)
(5)
(6)
Dependent Variables
BLOCK
t+1
(=1 if 13D Filing or 13G Filing; 0 if no block acquisition
)
LIQAM
t
0.079
***
0.171
***
(0.013)
(0.021)
LIQFHT
t
3.975
***
3.902
***
(0.747)(1.064) DECIMAL 0.299***0.544*** (0.024)(0.064)Controls Included Included IncludedYear and Industry FE Included Included IncludedNumber of Obs. Used88,74288,74288,74288,74288,74288,742Pseudo R20.0030.0520.0030.0460.0130.044
0.5% v.s. 1.3% unconditional probability
=1 if post decimalization; 0 otherwiseSlide13
Effect of Liquidity on Block Formation
(Cont’d)
13
DECIMAL
may capture confounding events around 2001Tick size reduction should have a bigger impact on stocks with lower price. We split sample by LOWPRC.
DECIMAL
is only significant in the subsample with
LOWPRC=1. Narrow testing window helps to focus on the Δ we intend to capture.We show Δ in liquidity from t-1 to t+1 positively predicts the block formation in t+2, with t indicating the decimalization year.Slide14
Voice-G
Voice-B
Exit
H2: Conditional upon acquiring a block, stock liquidity reduces the likelihood that the hedge fund files a 13D rather than a 13G.
Effect of Liquidity on Governance Mechanisms
14
(1)
(2)
(3)
(4)
(5)
(6)
Dependent Variables
13Dvs13G
t+1
(=1 if 13D Filing; 0 if 13G Filing
)
LIQAM
t
-0.152
***
-0.169
***
(0.046)
(0.064)
LIQFHT
t
-4.047
*
-6.662
**
(2.456)(3.260) DECIMAL -0.295***-0.492** (0.084)(0.236)Controls Included Included IncludedYear and Industry FE Included Included IncludedNumber of Obs. Used1,1351,1351,1351,1351,1351,135Pseudo R20.0070.0960.0020.0920.0080.087
7
%
v.s
. 43% unconditional probability
DECIMAL
is
again only
significant in the subsample with
LOWPRC
=1. Slide15
Voice-G
Voice-B
Exit
H3a: A 13G filing leads to a positive event-study return, particularly among liquid firms.
Is 13G Filing a Governance Event?
15
(1)
(2)
(3)
(4)
(5)
Pooling
Low LIQAM
High LIQAM
Low LIQFHT
High LIQFHT
Testing
CAR_VW(-1, +1)
>0
0.008
***
(0.002)
0.004
(0.004)
0.012
***
(0.003)
0.004
(0.004)
0.012
***
(0.003)
Number of Obs. Used
630
315
315
315
315
Unlikely to be explained by undervaluation
Multivariate regression results are
consistent. Switching from
below-LIQAM-median subsample
to
above increases CAR_VW by
1.7%.
Results
are similar if using 3
-day CAR over CRSP equal-weighted index.3-day CAR over CRSP value-weighted indexSlide16
Voice-G
Voice-B
Exit
H3b: A 13G filing leads to a positive holding-period return, particularly among liquid firms.
Is 13G Filing a Governance Event? (Cont’d)
16
(1)
(2)
(3)
(4)
(5)
Pooling
Low LIQAM
High LIQAM
Low LIQFHT
High LIQFHT
Testing
HOLDINGRET_VW
>0
0.053
***
(0.017)
0.015
(0.026)
0.092
***
(0.022)
0.019
(0.025)
0.088
***
(0.023)
Number of Obs. Used
523
262
261
262
261
Holding period raw return over CRSP value-weighted index
Results
are similar if using
holding period raw return over
CRSP equal-weighted index
.Slide17
Voice-G
Voice-B
Exit
H3c: A 13G filing leads to an increase in operating performance, particularly among liquid firms.
Is 13G Filing a Governance Event? (Cont’d)
17
13G firms
Control firms
DiD
estimator
T-statistics of
DiD
Low LIQAM Subsample
∆EBITDA/ASSET
-0.021
-0.017
-0.004
-0.35
∆CFO/ASSET
-0.007
-0.019
0.012
1.08
High LIQAM Subsample
∆EBITDA/ASSET
0.011
-0.022
0.033
**
2.55
∆CFO/ASSET
-0.003
-0.019
0.016
1.33
Low LIQFHT Subsample
∆EBITDA/ASSET-0.025-0.021-0.004-0.38∆CFO/ASSET-0.021-0.0200.000-0.02High LIQFHT Subsample ∆EBITDA/ASSET0.015-0.0180.033***2.67∆CFO/ASSET0.011-0.0180.029**2.43
Change in operating performance from year
t-1
to
t+1Slide18
Effect of Liquidity on Block Formation:
Role of WPS
18
Voice-GVoice-BExitH4a: The effect of liquidity on the probability of block acquisition is stronger in firms with higher managerial sensitivity to price.
–
–
(1)
(2)
(3)
Dependent Variables
BLOCK
t+1
(=1 if 13D Filing or 13G Filing; 0 if no block acquisition
)
LIQAM
t
0.180
*
(0.101)
LIQAM
t
×WPS
t
0.019
*
(0.010)
LIQFHT
t
8.326
*
(5.042)
LIQFHT
t ×WPSt 0.049** (0.021) DECIMAL 0.508*** (0.079)DECIMAL×WPSt 1.480* (0.816)WPSt0.002*0.020**-0.534 (0.001)(0.009)(0.588)Controls, Year and Industry FEIncludedIncludedIncludedNumber of Obs. Used24,64524,64524,645Pseudo R20.0870.0860.086Scaled wealth performance sensitivity (WPS) of Edmans, Gabaix, and Landier (2009)= Total Delta / Annual PaySlide19
Effect of Liquidity on Governance:
Role of WPS
19
Voice-GVoice-BExitH4b: The effect of liquidity on the probability of filing choices is stronger in firms with higher managerial sensitivity to price.
–
–
(1)
(2)
(3)
Dependent Variables
13Dvs13G
t+1
(=1 if 13D Filing; 0 if 13G Filing
)
LIQAM
t
0.722
(0.927)
LIQAM
t
×HIGHWPS
t
-2.390
*
(1.298)
LIQFHT
t
7.337
(11.494)
LIQFHT
t
×HIGHWPSt -38.281* (22.928) DECIMAL 0.852 (0.751)DECIMAL×HIGHWPSt -0.854* (0.463)HIGHWPSt0.017-0.0090.373 (0.171)(0.188)(0.509)Controls, Year and Industry FEIncludedIncludedIncludedNumber of Obs. Used322322322Pseudo R20.1610.1570.156A dummy to indicate above-median-WPSSlide20
Effect of Liquidity on HF Activism
20
Liquidity
increases the likelihood that a HF acquires a
block (H1);Conditional on BA, liquidity increases the likelihood of 13G over 13D (H2). Which effect dominates? Voice-G
Voice-B
Exit
H5: Stock liquidity increases the unconditional likelihood that a hedge fund files Schedule 13D.
–
(1)
(2)
(3)
Dependent Variables
13DFILING
t+1
(=1 if 13D Filing; 0 if 13G Filing or no block acquisition
)
LIQAM
t
0.103
***
(0.026)
LIQFHT
t
3.851
***
(1.435)
DECIMAL
0.309
***
(0.088)
Controls
IncludedIncludedIncludedYear and Industry FEIncludedIncludedIncludedNumber of Obs. Used88,74288,74288,742Pseudo R20.0400.0380.0360.14% v.s. 0.6% unconditional probabilitySlide21
Conclusion
21
Liquidity increases the likelihood of block acquisition
Conditional on block formation, liquidity encourages 13G over 13D
A 13G filing represents a governance mechanismA positive market reaction, a positive holding-period return, and an improvement in operating performance; all stronger in more liquid firms1) and 2) are stronger in firms with higher managerial sensitivity to priceUnconditional effect of liquidity on 13D filings is positive
Liquidity improves
blockholder
governance