Kai Li

This dissertation is a collection of three essays that explore topics in empirical corporate finance. The first essay studies the quality of proxy advisors' recommendations. Using a comprehensive sample of say-on-pay recommendations from the two largest proxy advisors over the period 2012 – 2019, I document that proxy advisors fail to filter out industry-level returns that are presumably beyond the control of management in evaluating a CEO’s pay package. This finding contradicts the predictions of standard agency theory that CEOs should be evaluated on their relative performance in the presence of common shocks. I use adjustment for industry performance as the quality measure of recommendations. I find a decrease in quality (1) when proxy advisors are busy, and (2) when proxy statements and pay contracts are complex. My analysis suggests that proxy advisors’ capacity constraints are likely explanations for the limited applications of relative performance evaluations in their recommendations. The second essay, coauthored with Jan Bena, develops a novel measure of disagreement in voice between active and passive mutual funds using their proxy votes that captures shareholder conflicts in public firms. We show that the disagreement in voice between passive and active funds is associated with a decrease in firm value and suggest that the firm value loss is due to conflicting incentives between the two groups. The third essay, coauthored with Jan Bena and Guangli Lu, studies the impact of national culture on within-firm pay inequality using a unique administrative dataset covering closely-held immigrant-owned firms in Canada from 2001-2017. We find that within-firm pay inequality varies significantly with a firm owner’s country of origin. Firms owned by immigrants from more individualistic countries have higher pay inequality. Using a difference-in-differences analysis, we find a significant increase in within-firm pay inequality after the firm is taken over by immigrant owners from countries with higher within-firm-pay-inequality or more individualistic cultures.

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This thesis contains three essays on empirical finance. The first essay examines racial differentials in the most popular online home valuation algorithm and studies how the algorithmic valuation information affects racial price differentials in the U.S. housing market. I find that valuations from the algorithm display some racial differentials, but such differentials are much smaller in magnitude compared to the racial differentials in transaction prices. In addition, the availability of the algorithmic information significantly reduces racial differentials in transaction prices in terms of the overpayment of Black buyers relative to White buyers. The findings suggest that an algorithm exhibiting some racial differentials may still help reduce racial disparity in a market if its differentials are much smaller than those in transaction prices, cautioning against regulations targeting algorithms solely based on the existence of racial differentials from the algorithms. The second essay studies how housing prices react to an information shock due to the update in the home valuation algorithm studied in the first essay. I find that housing prices react gradually to the information shock. While the reaction in the first month is small, a 1% increase in the online valuations leads to a 0.65% increase in sale prices 12 months after the shock. The findings provide direct evidence that housing prices react gradually to information. I also examine the factors that affect the reactions. I find stronger reactions in ZIP Codes with higher average trading volumes, more homogenous homes, and lower education levels. The third essay, coauthored with Dale Griffin, Omrane Guedhami, and Kai Li, examines why corporate social responsibility (CSR) practices vary across countries and firms, and the value implications of such variation. We find that the cultural dimension of individualism is positively associated with firm-level CSR practices, with three country-level channels—freedom of the press, income inequality, and protection of equal rights—and three firm-level channels—managerial discretion, board diversity, and corporate transparency—linking individualism to CSR. We find a positive association between firm-level CSR practices and value, with three firm-level channels—cash flows, cash flow variability, and cost of equity—linking CSR practices to firm value.

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This thesis contains three essays on entrepreneurship and close-held firms. The first essay examines the feedback role of crowdfunding, a new financing method that allows entrepreneurs to raise finance online directly from the public. Using a novel dataset from Kickstarter, I show that crowdfunding outcome signals to entrepreneurs the product market potential of their projects and guides entrepreneurs’ subsequent commercialization decisions. Exploiting weather-induced variation in pledged funds within unfunded projects (which receive no financing), I find that entrepreneurs who received more pledging are more likely to complete and commercialize their projects. Consistent with the real option value of crowdfunding feedback, entrepreneurs on Kickstarter launch riskier projects when crowdfunding becomes more costly relative to alternative financing. These results highlight the role of crowdfunding in improving the information environment faced by early-stage entrepreneurs. The second essay, co-authored with Jan Bena, studies how product market competition affects firms’ ownership structures. Using a large sample of closely held firms in eighteen European countries, we show that firms operating in more competitive environments have lower inside ownership and that the stakes of their outside shareholders are more dispersed. These results are explained by competition increasing the need to raise external equity and reducing private control benefits. Our findings suggest that, by changing corporate ownership structure, competition mitigates incentive misalignment among shareholders, leading to better firm performance and gains in economic efficiency. The third essay studies the effect of shareholder excess control rights on creditors. I show that excess control rights can benefit creditors despite its negative effect previously documented on minority shareholders. Using a sample of U.S. dual-class firms, I find that dual-class firms take less business and financial risk than similar single-class firms, consistent with controlling insiders’ emphasis on long-term survival to access ongoing private benefits of control. Such risk avoidance translates into lower borrowing costs for dual-class firms. Further, lenders seem to be able to use specific covenants to prevent potential expropriations by controlling insiders. These results suggest that the overall effect of excess control rights on firm value may not be as negative as we previously thought.

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This dissertation explores the differences in informational asymmetries between private and public firms in the U.S. to study the role of collateral in firms’ financial policies. The first essay examines public and private firms’ leverage choices. I find that private firms’ leverage is about 3.8 times higher than that of public firms and that asset tangibility has a much larger impact on the leverage decisions of private firms than it does on those of public firms. Moreover, during the recent financial crisis, private firms increased both their leverage and their net leverage compared to public firms. The second essay studies the use of trade credit in public and private firms. Here I examine how tangible assets affect the use of trade credit. I also analyze how their holdings of trade credit and bank debt change during a credit supply shock. I find that private firms’ with higher levels of tangible assets rely less on trade credit and that they more likely to substitute trade credit for bank debt. The third essay compares and characterizes debt maturity and debt structure choices in public and private firms. I show that tangible assets help private firms to increase the maturity of their liabilities and help private firms to specialize in the type of debt they employ. I also analyze how their debt maturity structure and debt composition change during a credit supply shock. I find that the maturity of their liabilities shortened during the crisis. Moreover, private firms experienced an increase in the long-term debt due after one year compared to public firms. Overall, the evidence suggests that under asymmetric information, asset tangibility is the key determinant of private firms’ ability to access debt markets, to rely less on trade credit, and to extend the maturity of their liabilities, especially during bad times.

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This dissertation contains three studies.Chapter 2 investigates interactions between antitakeover provisions and managerial ownership, two corporate governance mechanisms. Antitakeover provisions weaken the incentive effect of managerial ownership and magnify its entrenchment effect, and thus will decrease the effect of managerial ownership on firm value. I show that thevalue effect of managerial ownership crucially depends on the strength of antitakeover provisions. For firms with weak antitakeover provisions, managerial ownership enhances firm value, unless managers have very high ownership. For firms with strong antitakeover provisions, however, increasing managerial ownership always destroys firm value. Also, managerial ownership significantly decreases with the strength of antitakeover provisions. These findings support the hypotheses that antitakeover provisions decrease the value effect of managerial ownership and affect managers' compensation contract.Chapter 3 proposes a model to investigate the role of informationprecision in IPO pricing. The model shows that more precise information will exert more influence on the offer price. In strong support of the model, I find that the proportion of the industry return during the waiting period that is incorporated into the offer price increases with a proxy for precision of the industry return as a measure of the change in the IPO firm's value during the waiting period. This study enhances our understanding of the partial adjustment phenomenon: noisy information will be partially incorporated into the offer price.Chapter 4 shows that young male CEOs appear to be combative: they arefour percent more likely to be acquisitive and, having initiated an acquisition, they are over 20 percent more likely to withdraw an offer. Furthermore, a young target male CEO istwo percent more likely to force a bidder to resort to a tender offer. We argue that this combative nature is a result of testosterone levels that are higher in young males. Testosterone is a hormone associated with male dominance seeking. The acts of attempting or resisting an acquisition can be viewed as striving to achieve dominance. We argue that the evidence reported in this paper is consistent with the presence of a significanthormone effect in M&As.

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In this thesis, I examine a few corporate finance topics, including mergers and acquisitions, CEO compensations, and corporate governance. The first paper studies the effect of managerial horizon on acquisition activities. Managers with a long horizon emphasize firms’ long-term value, whereas short-horizon executives are concerned about firms’ value in the short run. The paper’s main predication is that acquiring firms managed by short-horizon executives have higher abnormal returns at acquisition announcements, less likelihood of using equity to pay for the transactions, and worse post-merger stock performance in the long run. I construct two proxies for managerial horizon based on the CEO’s career concern and compensation scheme, and provide empirical evidence supporting the above prediction. The second paper examines optimal compensation contracts when executives can hedge their personal portfolios. In a simple principal-agent framework, I predict that the CEO’s pay-performance sensitivity decreases with the executive hedging cost. Empirically, I find evidence supporting the model’s prediction. Providing further support for the theory, I show that shareholders also impose high sensitivity of CEO wealth to stock volatility and increase financial leverage to resolve the executive hedging problem. Moreover, executives with lower hedging costs hold more exercisable in-the-money options, have weaker incentives to cut dividends, and pursue fewer corporate diversification initiatives. Overall, the ability to hedge firm risk undermines executive incentive and enables managers to bear more risk, thus affecting governance mechanisms and managerial actions. The third paper investigates the causes and consequences of sharp CEO pay cuts. We find that a large CEO pay cut is not uncommon and is typically triggered by poor stock performance. Good corporate governance structures strengthen the link between poor performance and CEO pay cut. On average, CEOs respond to their pay cut by curtailing capital expenditures, reducing R&D expenses, and allocating funds to reduce leverage. For most firms, performance improves and the CEO’s pay is restored. Together, our results show that the possibility of these compensation cuts provides ex ante incentives for CEOs to exert effort to avoid poor performance and ex post incentives to improve poor performance once pay is cut.

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In this thesis, I investigate the role of investor attention in financial markets by examining themedia’s coverage of corporate earnings news. The first paper studies the potential impact ofinformation in the financial press by identifying systematic differences between aggregatecorporate earnings news coverage in the Financial Times, Wall Street Journal, and the NewYork Times, and measures of expected coverage based on contemporaneous earningsinformation flows as reported in JJBIEIS. I find that publication-specific estimates of “excess”aggregate positive or negative coverage exhibit strong serial correlation, consistent with mediabias. Furthermore, unexplained negative (positive) weekly coverage predicts positive (negative)returns for small-stock indices and the equal-weighted NYSE, suggesting that the effects ofpredictability in financial news coverage are economically significant and may be related toinformational inefficiency with respect to smaller firms.The second paper examines media coverage decisions to identify the determinants ofinvestor attention with respect to events and firms. Using ex ante predicted probability of mediacoverage (PMC) with respect to earnings news as a measure of attention in this context, I studythe returns experienced by low-attention stocks from 1984 and 2005. As in prior studies, I findhigh risk-adjusted returns for “neglected” stocks, which appears to be highly consistent with,e.g., Merton’ s (1987) investor recognition hypothesis, or an information risk setting (Easley etal. (2002)). However, in examining the event-specific determinants of media coverage, I findevidence of a significant “negativity bias” in attention: holding other factors constant, bad newsis more likely to attract coverage than is good news regarding an otherwise-identical firm.Given recent evidence in the literature regarding stock-price underreaction to low-attentionevents, this suggests asymmetric investor attention as a potential explanation for an apparentneglected firm premium in the cross-section of stock returns. Consistent with this hypothesis, Ifind that the excess returns to low-PMC portfolios are attributable to drift in the stock prices oflow-attention “good news” firms, while low-attention “bad news” firms appear to be efficientlypriced.

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