Corporate governance and capital allocations of diversified firms
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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

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

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


Introduction 2 2

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


The role of governance

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


Research questions

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


Corporate governance and capital allocations of diversified firms

Hypothesis Statements

6


Hypothesis statements

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


Five dimensions on governance mechanisms

Five Dimensions on Governance Mechanisms

8


Five dimensions on governance mechanisms 1 4

Five Dimensions on Governance Mechanisms (1/4)

9


Five dimensions on governance mechanisms 2 4

Five Dimensions on Governance Mechanisms (2/4)

10


Five dimensions on governance mechanisms 3 4

Five Dimensions on Governance Mechanisms (3/4)

11


Five dimensions on governance mechanisms 4 4

Five Dimensions on Governance Mechanisms (4/4)

12


Measuring investment allocations

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.

    =


Measuring investment allocations1

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


Firm level measures of investment efficiency

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.


Firm level measures of investment efficiency1

Firm-level measures of investment efficiency

IFAIR

  • relative value added by allocation (RVA)

  • absolute value added by allocation (AVA)

IAIR


Studied periods

Studied Periods

Robust

Check

Number of available governance / Compustat observations

17


Selected samples

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


Sample distributions 1 2

SampleDistributions (1/2)

19


Corporate governance and capital allocations of diversified firms

SampleDistributions (2/2)

20


Descriptive statistics

Descriptive Statistics

21


Research design

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


Investment efficiency for multi segment firms stratified by governance mechanisms allocation 1 2

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

23


Investment efficiency for multi segment firms stratified by governance mechanisms allocation 2 2

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

24


Empirical results

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


Research design1

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


Corporate governance and capital allocations of diversified firms

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

27


Regression of investment efficiency rinv on governance mechanisms 2 3

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

28


Regression of investment efficiency rinv on governance mechanisms 3 3

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

29


Empirical results1

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


Research design2

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


Corporate governance and capital allocations of diversified firms

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

32


Corporate governance and capital allocations of diversified firms

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

33


Corporate governance and capital allocations of diversified firms

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

34


Research design3

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


Excess value efficiency of investments corporate governance

Excess Value, Efficiency of Investments, & Corporate Governance

36


Robust check 1

Robust Check 1

investment efficiencies -

RINV: relative investment ratio

RVA: relative value added by allocation

AVA: absolute value added by allocation

37


Robust check 2

Robust Check 2

38


Corporate governance and capital allocations of diversified firms

Conclusions (1/2)

+

+

39


Conclusions 2 2

Conclusions(2/2)

40


Contributions

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


Corporate governance and capital allocations of diversified firms

Comments Welcome.

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