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Corporate Governance and Capital Allocations of Diversified firms

Corporate Governance and Capital Allocations of Diversified firms. Sheng-Syan Chen, National Taiwan University I-Ju Chen, Yuan Ze University Taiwan 2008 NTU Conference on Finance 2008/12/11. Introduction (1/2).

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Corporate Governance and Capital Allocations of Diversified firms

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  1. Corporate Governance and Capital Allocations of Diversified firms Sheng-Syan Chen, National Taiwan University I-Ju Chen, Yuan Ze University Taiwan 2008 NTU Conference on Finance 2008/12/11

  2. Introduction(1/2) The problems of asymmetric information and agency have significant impacts on the efficiency of corporate investment. (Jensen, 1986,1993; Stein, 2003; Bertrand and Mullainathan, 2003). 2

  3. Introduction(2/2) Diversified firms have serious agency problems, such as: Multi-tiered agency problems (Scharfstein and Stein, 2000) Power-bargaining activities (Rajan, Zingales, and Serves, 2000). Lead to diversification discounts (Berger and Ofek, 1995; Shin and Stulz, 1998; Scharfstein and Stein, 2000; Rajan et al., 2000). 3

  4. The Role of Governance Board: Fama and Jensen (1983) Ownership structure: Morck, Shleifer, and Vishny (1988), McConnell and Servaes, (1990); Hermalin and Weisbach, (1988); etc. Shleifer and Vishny (1986) CEO compensation: Jensen and Meckling (1976); Jensen and Murphy (1990); Bizjak, Brickley, and Coles (1993) Auditing role: Spira (1999);Healy and Palepu (2001) etc. Market for corporate control: Gompers, Ishii, and Metrick (2003) Durnev and Kim (2005) 4

  5. Research Questions If the governance is aimed to alleviate the agency problem, will we see the difference on the investment efficiencies of diversified firms with difference governance structure? Will the better-governed diversified firms allocate their funds efficiently and have higher market valuations ? 5

  6. Hypothesis Statements 6

  7. Hypothesis Statements H1：Better-governed diversified firms are relatively more effective in investment allocations. H2：Better-governed diversified firms have relatively higher firm valuations for diversified firms. H3：Better-governed diversified firms are relatively more effective in investment allocations and hence have relatively higher firm valuations. 7

  8. Five Dimensions on Governance Mechanisms 8

  9. Five Dimensions on Governance Mechanisms (1/4) 9

  10. Five Dimensions on Governance Mechanisms (2/4) 10

  11. Five Dimensions on Governance Mechanisms (3/4) 11

  12. Five Dimensions on Governance Mechanisms (4/4) 12

  13. Measuring investment allocations Rajan et al. (2000) Investment levels in individual segments： • unadjusted investment (UIR) = ratio of segment capital expenditures to segment sales. = • industry-adjusted investment (IAIR) = segment’s capital expenditure-to-sales ratio minus the median capital expenditure-to-sales ratio of single-segment firms in the same three-digit SIC industry. =

  14. Measuring investment allocations Investment levels in individual segments： • industry and firm-adjusted investment (IFAIR) = segment’s industry-adjusted investment minus the firm’s sales-weighted sum of industry-adjusted investment. = = IAIR- firm’s sales- weighted sum of IAIR = IFAIR where : sales-weight for segment j

  15. Firm-level measures of investment efficiency IFAIR • relative investment ratio (RINV) • Sj is the sales of segment j. • Wj is the sales of segment j divided by the firm total sales. • Ij is the capital expenditures of segment j. • is the capital expenditure-to-sales ratio of the median single-segment firm operating in the same three-digit SIC industry as firm j. • TS is the total sales of the firm. For j =1…k, the firm’s segments have an industry median q greater than the firm’s sales-weighted average q, while j=(n-k+1)…n indicates that the firm’s segments have an industry median q less than the firm’s sales-weighted average q.

  16. Firm-level measures of investment efficiency IFAIR • relative value added by allocation (RVA) • absolute value added by allocation (AVA) IAIR

  17. Studied Periods Robust Check Number of available governance / Compustat observations 17

  18. Selected Samples Collect financial data from Compustat for all firms in fiscal year 2005. Corporate governance data are collected from : RiskMetric (formerly IRRC) Directors datasets, Thomson Reuters (Institutional), Compustat Executive Compensation and Gompers, Ishii, and Metrick’s (2003) governance index. Insider ownership and blockholder ownership are hand collected from SEC proxy statement. 18

  19. SampleDistributions (1/2) 19

  20. SampleDistributions (2/2) 20

  21. Descriptive Statistics 21

  22. Research Design Investigate whether the efficiency in capital allocations among divisions of diversified firms is associated with governance structure. Study the role of governance mechanisms in terms of capital allocation efficiency in a multivariate framework. Analyze the capital allocations within diversified firms under different governance structure. Examine the relationship among the value discount, investment efficiency, and the governance structure. 22

  23. Investment Efficiency for Multi-segment Firms Stratified by Governance Mechanisms Allocation (1/2) 23

  24. Investment Efficiency for Multi-segment Firms Stratified by Governance Mechanisms Allocation (2/2) 24

  25. Empirical Results From univariate analysis, we get the preliminary results that diversified firms with following characteristics efficiently allocate their funds : higher board independence, Less board busyness, higher holdings of 18 public pension funds and outside director ownership, higher quality of audit committee, and less takeover protection 25

  26. Research Design Investigate whether the efficiency in capital allocations among divisions of diversified firms is associated with governance structure. Study the role of governance mechanisms in terms of capital allocation efficiency in a multivariate framework. Analyze the capital allocations within diversified firms under different governance structure. Examine the relationship among the value discount, investment efficiency, and the governance structure. 26

  27. Regression of Investment Efficiency (RINV)on Governance Mechanisms (1/3) 27

  28. Regression of Investment Efficiency (RINV)on Governance Mechanisms(2/3) 28

  29. Regression of Investment Efficiency (RINV)on Governance Mechanisms (3/3) 29

  30. Empirical Results Whether the difference in firm investment efficiency is associated with the effectiveness in investment allocations among divisions of diversified firms under different governance structure ? 30

  31. Research Design Investigate whether the efficiency in capital allocations among divisions of diversified firms is associated with governance structure. Study the role of governance mechanisms in terms of capital allocation efficiency in a multivariate framework. Analyze the capital allocations within diversified firms under different governance structure. Examine the relationship among the value discount, investment efficiency, and the governance structure. 31

  32. Allocation of Funds in the DiversifiedFirm Stratified by Gompers et al. (2003) Governance Index (GOV) (1/3) 32

  33. Allocation of Funds in the DiversifiedFirm Stratified by Gompers et al. (2003) Governance Index (GOV) (2/3) 33

  34. Allocation of Funds in the DiversifiedFirm Stratified by Gompers et al. (2003) Governance Index (GOV) (3/3) 34

  35. Research Design Investigate whether the efficiency in capital allocations among divisions of diversified firms is associated with governance structure. Study the role of governance mechanisms in terms of capital allocation efficiency in a multivariate framework. Analyze the capital allocations within diversified firms under different governance structure. Examine the relationship among the value discount, investment efficiency, and the governance structure. 35

  36. Excess Value, Efficiency of Investments, & Corporate Governance 36

  37. Robust Check 1 investment efficiencies - RINV: relative investment ratio RVA: relative value added by allocation AVA: absolute value added by allocation 37

  38. Robust Check 2 38

  39. Conclusions (1/2) + + 39

  40. Conclusions(2/2) 40

  41. Contributions Complete investigation the role of governance in capital allocation among divisions of diversified firms. Provide the empirical evidence that governance structure is crucial to the efficiencies of investment allocations among the divisions of diversified firms. Comprehensively investigates the importance of each governance mechanism by linking to the capital allocations and valuations of diversified firms. 41

  42. Comments Welcome. 42

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