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We develop an international model of the design of institutions for regulating innovative activities of private corporations. Informational limitations faced by the social planner preclude complete contracting with private firms. Corporate innovation creates positive and negative externalities. The social planner in each country takes into account the legal system in place, and designs an umbrella of institutions that include a menu of organizational forms, liability structures, corporate taxes, and subsidies. We show that limited liability may be accompanied by excessive innovation. However, when the nonmonetized benefits are very high, private firms may be too conservative in innovation policies. Firms choose their organizational form and level of innovation consistent with private optimality. With the optimal institutional design for each country, we demonstrate that private innovation choices are aligned with social optimality. In particular, we show that the optimally designed corporate tax rate in each country is a decreasing function of its legal effectiveness. Using data from 63 countries over 2003-2018, we document supporting evidence. MNCs can take advantage of differential liability and corporate tax structures across national boundaries to circumvent institutional design constraints. However, when MNCs generate positive externalities to host countries, their governments may provide subsidies and incentives.Nous développons un modèle international de conception d’institutions de régulation des activités innovantes des entreprises privées. Les limitations informationnelles auxquelles est confronté le planificateur social empêchent la conclusion de contrats complets avec des entreprises privées. L’innovation d’entreprise crée des externalités positives et négatives. Le planificateur social de chaque pays prend en compte le système juridique en place et conçoit un ensemble d’institutions comprenant un menu de formes organisationnelles, de structures de responsabilité, d’impôts sur les sociétés et de subventions. Nous montrons que la responsabilité limitée peut s’accompagner d’une innovation excessive. Cependant, lorsque les avantages non monétisés sont très élevés, les entreprises privées peuvent être trop conservatrices dans les politiques d’innovation. Les entreprises choisissent leur forme organisationnelle et leur niveau d’innovation compatibles avec l’optimalité privée. Avec la conception institutionnelle optimale pour chaque pays, nous démontrons que les choix d’innovation privée sont alignés sur l’optimalité sociale. En particulier, nous montrons que le taux d’imposition des sociétés conçu de manière optimale dans chaque pays est une fonction décroissante de son efficacité juridique. En utilisant les données de 63 pays sur la période 2003–2018, nous donnons des preuves à l’appui. Les EMN peuvent tirer parti des structures de responsabilité et d’imposition des sociétés différentielles à travers les frontières nationales pour contourner les contraintes de conception institutionnelle. Cependant, lorsque les EMN génèrent des externalités positives pour les pays d’accueil, leurs gouvernements peuvent fournir des subventions et des incitations.Desarrollamos un modelo internacional de diseño de instituciones para regular las actividades innovadoras de las corporaciones privadas. Las limitaciones informativas enfrentadas por la planificación social descartan la contratación completa con firmas privadas. La innovación corporativa crea externalidades positivas y negativas. La planificación social en cada país toma en consideración el sistema legal establecido, y diseña una sombrilla de instituciones que incluye formas organizacionales, estructuras de responsabilidad, impuestos corporativos y subsidios. Mostramos que responsabilidad limitada puede estar acompañada de innovación excesiva. Sin embargo, cuando los beneficios no monetizados son altos, las empresas privadas pueden ser demasiado conservadoras en las políticas de innovación. Las empresas eligen su forma organizacional y el nivel de innovación en concordancia con la optimalidad privada. Con el diseño organizacional óptimo para cada país, demostramos que las elecciones de innovación privada están alineadas con la optimalidad social. En particular, mostramos que la tasa impositiva corporativa en cada país es una función descendente de su efectividad legal. Usando datos de 63 países durante 2003–2018, documentamos pruebas de apoyo. Las empresas multinacionales pueden tomar ventaja de los diferenciales de responsabilidad y las estructuras tributarias corporativas entre las fronteras nacionales para eludir limitaciones de diseño institucional. Sin embargo, cuando las empresas multinacionales generan externalidades positivas a los países anfitriones, sus gobiernos pueden proporcionar subsidios e incentivos.Desenvolvemos um modelo internacional de design de instituições para regular atividades inovadoras de empresas privadas. Limitações informacionais enfrentadas pelo planejador social impedem a contratação completa com empresas privadas. Inovação corporativa cria externalidades positivas e negativas. O planejador social em cada país leva em consideração o sistema legal em vigor e projeta um conjunto de instituições que inclui um menu de formas organizacionais, estruturas de responsabilidade, impostos corporativos e subsídios. Mostramos que a responsabilidade limitada pode ser acompanhada por excessiva inovação. No entanto, quando os benefícios não monetizados são muito altos, empresas privadas podem ser muito conservadoras em relação às políticas de inovação. Empresas escolhem sua forma organizacional e nível de inovação consistente com a otimização privada. Com o desenho institucional ótimo para cada país, demonstramos que escolhas privadas de inovação estão alinhadas com a otimização social. Em particular, mostramos que a alíquota de imposto corporativo idealizada em cada país é uma função decrescente de sua eficácia legal. Usando dados de 63 países durante 2003–2018, documentamos evidências de apoio. MNCs podem tirar proveito de diferenciada responsabilidade e de estruturas tributárias corporativas além de fronteiras nacionais para contornar restrições de design institucional. Entretanto, quando MNCs geram externalidades positivas para os países anfitriões, seus governos podem fornecer subsídios e incentivos.我们开发了用于规范私人公司创新活动的制度设计的国际模型。社会规划者所面临的信息限制排除了与私人公司的完整合同关系。企业创新带来积极和消极的外部影响。各国的社会规划者都会考虑到现行法律制度, 并设计一套包括组织形式、责任结构、公司税和补贴菜单的制度。我们表明, 有限责任可能伴随着过度创新。然而, 当非货币化收益很高时, 私营企业在创新政策上可能会过于保守。企业选择与私人最优性相一致的组织形式和创新水平。我们证明, 有了针对各国的最佳制度设计, 私人创新的选择与社会最优性平齐。特别是, 我们表明, 各国最佳设计的公司税率都是其法律效力的递减函数。通过使用2003–2018年间来自63个国家的数据, 我们记录了支持证据。跨国公司可以利用跨国差别责任和公司税收结构来规避制度设计约束。然而, 当跨国公司对东道国产生积极的外部影响时, 它们的政府可能会给与补贴和激励措施。.

We study the design of institutions as a framework for regulating innovative activity in the private sector given the informational constraints faced by the social planner. Innovation in the private sector by financial institutions and manufacturing firms imposes important positive and negative externalities; the social impact of these private firms depends on the sharing rule between their owners and the society at large, which in turn, is governed by laws, regulations, and institutions in place. We propose a framework where the social planner puts in place a system of laws, organizational forms, and taxation within which firms optimize without invasive regulation. Since the legal regime affects the extent to which the owners of firms are held responsible for the negative externalities they impose, unlimited liability may discourage innovation in strong legal regimes. Limited liability, however, might be accompanied by excessive innovation. In this framework we consider an optimally designed structure of taxation, a menu of organizational forms, and the legal system. In this structure, firms choose their organizational forms and level of innovation consistent with private optimality, and we show that these private choices are aligned with social optimality. Optimally designed corporate tax rates are a decreasing function of legal effectiveness in the embedding economy. We highlight some stylized facts from cross-country data that support our results.

In this paper, we investigate the disciplining role of banks and bank debt in the market for corporate control. We find that relationship bank lending intensity and bank client network have positive effects on the probability of a borrowing firm becoming a target. This effect is enhanced in cases where the target and acquirer have a relationship with the same bank. Moreover, we utilize an experiment to show that the effects of relationship bank lending intensity on takeover probability are not driven by endogeneity. Finally, we also investigate reasons motivating a bank's informational role in the market for corporate control. The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.

We investigate whether the geographic dispersion of a firm affects corporate decision making. Our findings suggest that social factors work alongside informational considerations to make geography important to corporate decisions. We show that (i) geographically dispersed firms are less employee friendly; (ii) dismissals of divisional employees are less common in divisions located closer to corporate headquarters; and (iii) firms appear to adopt a 'pecking order' and divest out-of-state entities before those in-state. To explain these findings, we consider both information and social factors. We find that firms are more likely to protect proximate employees in soft information industries (i.e., when information is difficult to transfer over long distances). However, employee protection holds only when the headquarters is located in a less populated county, suggesting a role for social factors. Additionally, stock markets respond favorably to divestitures of in-state divisions. The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.

This article studies the interaction between takeover defenses and competition. We find that firms in more competitive industries have more takeover defenses. This suggests that product market competition can be a substitute for the market for corporate control, with more information available in competitive markets making monitoring less costly. A novel instrument for the incentives of stakeholders in the product market to monitor is provided by the nature of the relationship between the firm and its customers. For firms in industries with long-term relationships with customers and suppliers, these stakeholders have greater incentives to monitor. We document that stronger competition is linked to more defenses only in these “relationship” industries. Finally, we discuss the implications for the design of other governance mechanisms.

We investigate the effects of shareholder governance mechanisms on bondholders and document two new findings. First, the impact of shareholder control (proxied by large institutional blockholders) on credit risk depends on takeover vulnerability. Shareholder control is associated with higher (lower) yields if the firm is exposed to (protected from) takeovers. In the presence of shareholder control, the difference in bond yields due to differences in takeover vulnerability can be as high as 66 basis points. Second, event risk covenants reduce the credit risk associated with strong shareholder governance. Therefore, without bond covenants, shareholder governance, and bondholder interests diverge. , Oxford University Press.

We investigate the effects of shareholder governance mechanisms on bondholders and document two new findings. First, the impact of shareholder control (proxied by large institutional blockholders) on credit risk depends on takeover vulnerability. Shareholder control is associated with higher (lower) yields if the firm is exposed to (protected from) takeovers. In the presence of shareholder control, the difference in bond yields due to differences in takeover vulnerability can be as high as 66 basis points. Second, event risk covenants reduce the credit risk associated with strong shareholder governance. Therefore, without bond covenants, shareholder governance, and bondholder interests diverge. , Oxford University Press.

We investigate how the market for corporate control (external governance) and shareholder activism (internal governance) interact. A portfolio that buys firms with the highest level of takeover vulnerability and shorts firms with the lowest level of takeover vulnerability generates an annualized abnormal return of 10% to 15% only when public pension fund (blockholder) ownership is high as well. A similar portfolio created to capture the importance of internal governance generates annualized abnormal returns of 8%, though only in the presence of “high” vulnerability to takeovers. The complementarity effect exists for firms with lower industry-adjusted leverage and is stronger for smaller firms.

This paper considers the impact of takeover (or acquisition) likelihood on firm valuation. If firms are more likely to acquire during times when they have free cash and/or when the required rate of return is low, takeover targets become more sensitive to shocks to aggregate cash flows and/or to the price of risk. Thus, ceteris paribus, firms that are exposed to takeovers will have a different rate of return from firms that are protected from takeovers. Using estimates of the likelihood that a firm will be acquired, we create a takeover-spread portfolio that buys firms with a high likelihood of being acquired and shorts firms with low likelihood of being acquired. Relative to the Fama-French model, the takeover-spread portfolio generates annualized abnormal returns of up to 12% between 1980 and 2004. Further, the takeover-spread portfolio is shown to be important in explaining cross-sectional differences in equity returns. Additionally, using a two-beta model that distinguishes cash flow shocks from discount rate shocks, we show that firms more likely to be taken over have higher betas on the aggregate cash factor. Finally, we provide an explanation for the existence of abnormal returns associated with governancespread portfolios (Gompers, Ishii and Metrick, 2003 and Cremers and Nair, 2005), and relate the takeover-spread portfolio returns to takeover activity in the economy.

This paper studies the interaction between takeover defenses and product market competition. We find that firms in more competitive industries have more takeover defenses. This is the opposite result from what one would expect if takeover defenses always constitute an inefficient outcome that increases agency costs and managerial entrenchment. A novel explantion is provided by considering the nature of the relationship between the firm and the product (or labor) market. For firms in industries where a long-term relationship with customers and employees is vital, the disruption caused by takeovers could severely negatively impact the stakeholders. In particular, in a competitive environment, this could lead shareholders to optimally choose more takeover defenses to prevent such customers and employees from going to their closest competitor ex ante. We provide empirical evidence that stronger competition is linked to more defenses only in relationship industries, where the previously found negative relation between takeover defenses and firm performance is reversed. Our results cannot be explained by competition being a substitute for the market for corporate control. Finally, we discuss the implications of this framework for the design of various governance mechanisms. In conclusion, the paper provides a rationale for why shareholders themselves might want weak shareholder rights.

We document the role of geographic dispersion on corporate decision-making. Our findings include: (i) geographically dispersed firms are less employee friendly; (ii) dismissals of divisional employees are less common in divisions located closer to corporate headquarters; and (iii) firms appear to adopt a "pecking-order" and divest out-of-state entities before in-state. To explain these findings, we consider both information and social factors. We find that firms are more likely to protect proximate employees in soft information industries (i.e. when information is difficult to transfer over long distances). However, employee protection only holds when headquarters is located in a less-populated county suggesting a role for social factors. Additionally, stock markets respond favorably to divestitures of in-state divisions. Our findings suggest that social factors work alongside informational considerations in making geographic dispersion an important factor in corporate decision-making.

We document the role of geographic dispersion on corporate decision-making. First, we find that geographically dispersed firms are less employee-friendly. Second, using division-level data, employee dismissals are less common in divisions located close to corporate headquarters. Third, firms are reluctant to divest in-state divisions. To explain these findings we consider two mechanisms. First, we investigate whether proximity is related to internal information flows. We find that firms are geographically concentrated when information is more difficult to transfer over long distances (soft information industries). Additionally, the protection of proximate employees is stronger in such soft information industries. Second, we investigate how proximity to employees affects managerial alignment with shareholder objectives. We document that the protection of proximate employees only holds when headquarters is located in less-populated counties suggesting concern for proximate employees. Moreover, stock markets respond favorably to divestitures of close divisions, especially for these smaller-county firms. Our findings suggest that social factors work alongside informational considerations in making geographic dispersion an important factor in corporate decision-making.

In product markets where customers care about firm survival, strong shareholder power, by affecting the likelihood that the firm will be acquired, can have detrimental implications on firm performance. We use a framework where firms choose their level of shareholder rights after comparing the costs of acquisition exposure, i.e, the loss of customers, with the synergistic benefits of an acquisition to generate two testable implications. First, we show that it is optimal to have weak shareholder rights in competitive markets. Second, we show that the link between weak shareholder rights and competition is stronger when the number of firms in the industry is lower. Using data on shareholder rights in the corporate charter, we find that indeed firms have stronger shareholder rights in concentrated industries and that this link is stronger in industries with fewer firms. Additionally, the link between concentration and shareholder rights is stronger in industries characterized by long-term customer relationships. We also document that weak shareholder rights are associated with worse performance only in non-competitive industries. We then discuss the implications of this framework for the design of various governance mechanisms. In conclusion, the paper provides a rationale for why shareholders themselves might not want strong shareholder rights.

In a setting where corporate investment imposes positive externalties, the social impact of corporations depends on the sharing rule between the owners of the corporation and non-financial claimants. We examine the role of law and organizational form in altering the sharing rule. Since the legal regime affects the extent to which corporate owners are held responsible for the negative externalties they impose, unlimited liability may discourage investment in strong legal regimes. Limited liability, however, might be accompanied by excessive investment. We highlight the role of the government in altering the sharing rule due its claim through corporate taxation and investigate the relation between law and corporate taxation. We find that corporate tax rates are are a decreasing function of legal strength. Finally, we document supporting evidence using cross-country data.

This paper considers the impact of the takeover channel on firm valuation. We usethe idea that takeover activity responds to investor expectations of future rate of return and hence to state variable(s) related to the time variation in risk premia. Thus firms with higher exposure to takeovers, due to higher expectations of receiving a takeover premium, have a higher exposure to the state variable that dictates time variation in risk premia. Consequently, the difference in the returns between firms that differ in their takeover vulnerabilities can be used to used to proxy these state variables. To do so, we create a takeover-spread portfolio that buys firms with low cash-adjusted-leverage(cheaper targets) and shorts firms with high cash-adjusted-leverage and show that sucha portfolio generates annualized abnormal returns of up to 11.20% between 1980 and2003. Also, abnormal returns associated with governance-spread portfolios (Gompers,Ishii and Metrick, 2003 and Cremers and Nair, 2004) decrease significantly once the assetpricing model includes this cash-adjusted-leverage factor. Finally, we propose a new takeover factor to proxy for the risk due to changes in these risk-premia related state variables, which is shown to be important in explaining cross-sectional differences in equity returns. The paper shows why investors require a higher rate of return on firms exposed to takeovers and yet value them higher than firms protected from takeovers.

We investigate the effects of shareholder governance mechanisms on bondholders and document two new findings. First, the impact of shareholder control (proxied by large institutional blockholders) on credit risk depends on takeover vulnerability. Shareholder control is associated with higher (lower) yields if the firm is exposed to (protected from)takeovers. In the presence of shareholder control, the difference in bond yields due to differences in takeover vulnerability can be as high as 66 basis points. Second, event risk covenants reduce the credit risk associated with strong shareholder governance. Therefore, without bond covenants, shareholder governance and bondholder interests diverge.

This paper investigates the effect of shareholder control on bondholder wealth. While stronger shareholder control can benefit bondholders by disciplining managers, it also increases the likelihood of events that can hurt bondholders, e.g. hostile takeovers. We hypothesize that shareholder control can have contrasting effects on bond yields depending on the takeover vulnerability of a firm. Using the presence of an institutional blockholder to proxy for shareholder control and firm-level anti-takeover provisions to proxy for takeover vulnerability, we find that shareholder control is associated with lower yields if the firm is protected from takeovers. We also find that shareholder control is associated with higher yields if the firm is exposed to takeovers. The contrasting effects of shareholder control on yields are the strongest for firms that are small and have low leverage. In the presence of shareholder control, the difference in bond yields due to differences in takeover vulnerability can be as high as 93 basis points. Further, the results are insignificant for a sub-sample of firms where the bondholders are protected from takeovers through the poison put covenant. Bond ratings also appear to incorporate a similar effect of shareholder control on bondholders Finally, we find that a bond pricing model that does not account for shareholder control generates an annualized abnormal return of 1% to 1.4% for portfolios that long firms with both strong shareholder control and high takeover vulnerability and short firms without either shareholder control or takeover vulnerability. Combined, these results suggest that the use of different governance mechanisms, such as shareholder monitoring and takeover vulnerability, depends on a firm s capital structure and that bond-pricing models should account for shareholder control.

In this paper, we investigate the disciplining role of banks and bank debt in the market for corporate control. We find that relationship bank lending intensity and bank client network have positive effects on the probability of a borrowing firm becoming a target. This effect is enhanced in cases where the target and acquirer have a relationship with the same bank. Moreover, we utilize an experiment to show that the effects of relationship bank lending intensity on takeover probability are not driven by endogeneity. Finally, we also investigate reasons motivating a bank's informational role in the market for corporate control.

CEO compensation varies widely, even within industries. In this paper, we investigate whether differences in skill explain these differences in CEO pay. Using the idea that skilled CEOs should be more likely to continue prior good performance and more likely to reverse prior poor performance, we develop a new methodology to detect whether skill is related to pay. We find that highly paid CEOs are more skilled than their less well paid peers when pay is performancebased and when there is a large shareholder. This detected link between pay and skill is strong even when we examine industry-wide declines: highly paid CEOs are more likely to reverse the firm's fortunes. We also examine CEO turnovers and show that the firm's post-turnover performance is related to differences between the two CEO's pay levels. These results highlight conditions where pay and skill are linked, and hence identify firms where high pay appears to have no justification.

This paper investigates how corporate governance affects managerial incentives inside the firm. While the internal organization of a firm affects competition between lower level managers to become the CEO, performance-based CEO dismissal and replacement alters the incentives due to this competition. I show that optimal governance mechanisms that dismiss CEOs are more likely to be accompanied by an outside replacement and such governance mechanisms make managerial competition more productive. However, strong governance may also reduce managerial incentives to acquire skill to become the CEO. As lower level managers have a greater impact on firm performance and increase in number, strong governance is optimal.