Amar Gande

CEO Compensation at Financial Firms

Amar Gande et al. — Tue, 22 Mar 2011 06:30:55 PDT

We use a novel dataset of emergency capital provided by the U.S. Federal Reserve to eighty-three large financial firms during 2007-2010 in response to the recent financial crisis. We use the Federal emergency capital assistance as an ex-post measure of excessive risk-taking prior to the crisis, and examine whether CEO risk-taking incentives promoted excessive risk-taking among large financial firms. We find strong evidence that both the amount as well as the likelihood of capital assistance are increasing in CEO risk-taking incentives. We also present evidence that CEO compensation contracts may have embedded in them incentives for CEOs to take on excessive risks. We argue that Federal financial assistance is a better signal of the extent to which a financial firm is distressed in the crisis period compared to traditional measures of firm performance used in prior studies and we provide direct evidence consistent with this interpretation.

Why do U.S. securities laws matter to non-U.S. firms? Evidence from private class-action lawsuits

Amar Gande et al. — Tue, 22 Mar 2011 06:26:36 PDT

A continuing controversy is whether U.S. securities laws are enforced against foreign firms, since public enforcement actions by the SEC are infrequent and often result in insignificant penalties. We examine private enforcement actions of U.S. securities laws and find that 269 securities class-action lawsuits were filed against foreign firms from 1996 to 2008. We document the severity of the penalties imposed on foreign firms and show that while firms paid a total of $9 billion to settle lawsuits brought against them, the monetary penalties levied by the market are even larger. During the three-day period surrounding the lawsuit filing date, there is a significant negative stock price reaction of -6.16%, which translates to an average loss of $392 million dollars. Aggregating over all firms, the total dollar loss is $73 billion. We further find that even foreign firms without significant U.S. assets experience significant valuation losses. Our results provide evidence that enforcement actions of U.S. securities laws against foreign firms are neither uncommon nor economically insignificant events.

Bank entry, competition, and the market for corporate securities underwriting

Amar Gande et al. — Sat, 30 Oct 2010 05:03:24 PDT

This paper examines the competitive effects of commercial bank entry into the corporate debt underwriting market, particularly with respect to underwriter spreads, ex-ante yields, and market concentration. We find that underwriter spreads and ex-ante yields have declined significantly with bank entry, consistent with the market becoming more competitive. This effect is strongest among the lower-rated and smaller debt issues of which banks have underwritten a relatively greater share. The early evidence also indicates that bank entry has tended to decrease market concentration. Overall, our results suggest that bank entry has had a pro-competitive effect.

Bank underwriting of debt securities: modern evidence

Amar Gande et al. — Sat, 30 Oct 2010 04:55:48 PDT

This article examines debt securities underwritten by Section 20 subsidiaries of bank holding companies relative to those underwritten by investment houses. Consistent with a net certification effect for banks, bank underwriting of lower credit rated firms to whom the bank lends results in relatively higher prices (lower yields). We find no evidence of conflicts of interest even when an issue is used to repay bank debt. Further, banks bring a relatively larger proportion of small issues to the market. Contrary to the contention that universal banking stunts availability of finance to small firms, bank underwritings appear to benefit small firms.

Enhancing Security Value by Ownership Restrictions: Evidence from a Natural Experiment

Amar Gande et al. — Thu, 28 Oct 2010 15:03:41 PDT

We present new evidence from a natural experiment to show circumstances in which ownership restrictions can enhance value. Our evidence is based on multiple restricted bond issues by an emerging market issuer at 150 basis points lower than comparable bonds, resulting in a billion dollars saving. This is intriguing: how can an emerging market issuer with junk bond ratings obtain such low yields? We argue ownership restrictions enhance value since they enable an issuer to precommit to renegotiate efficiently with a favored clientele in the potential default states, thereby circumventing deadweight costs of prolonged negotiations, particularly when the restricted clientele also values the underlying collateral higher than other investors. Ownership restrictions can also result in a transfer of value from holders of unrestricted bonds to holders of restricted bonds because of implicit seniority of the latter. We empirically test and find support for both value enhancement and value transfer and show robustness to several alternative explanations. Our evidence suggests that firms can benefit from designing securities with ownership restrictions, by offering new securities exclusively to investors who value them the most.

Valuation effects of global diversification

Amar Gande et al. — Thu, 28 Oct 2010 14:28:10 PDT

This paper examines the effect of global diversification on firm value using a data set of US firms from 1994 to 2002. We document that global diversification enhances firm value. Specifically, we find that Tobin’s q, our proxy for firm value, increases with foreign sales (measured as a fraction of the firm’s total sales), even after we control for well-known determinants of firm value. In contrast, we find no such evidence for industrial diversification. We find evidence of both financial and real effects driving such a value enhancement from global diversification. Furthermore, we find that the valuation benefits from global diversification are higher if the firm diversifies into countries with creditor rights that are stronger than those of the United States. Our results are also robust to controlling for the firm’s endogenous choice to diversify across countries or across industries. Our study is anchored by the theories of both the financial and real dimensions of global diversification, and our results support both theories. Overall, our results provide a unifying view that global diversification benefits are driven by both the real and financial dimensions.

Bank incentives, economic specialization, and financial crises in emerging economies

Amar Gande et al. — Tue, 26 Oct 2010 16:45:42 PDT

We model the vulnerability of an economy to a financial crisis as arising from the interaction of the degree of economic specialization and bank debt financing. The probability of a financial crisis is shown to increase in the degree of economic specialization. Bank debt financing has the beneficial effect of lowering the degree of economic specialization by increasing access to financing of investment opportunities that would not have been financed due to wealth constraints of entrepreneurs (financial access effect). However, bank debt financing induces risk-shifting incentives (leverage effect). The net effect on the probability of a financial crisis depends on which of these two effects dominates. We show that commonly employed mechanisms in managing financial crises, particularly bailouts, induce an additional agency cost by distorting bank incentives to concentrate loans in specific sectors (bank debt concentration effect). We propose a tax-based ex ante solution mechanism that simultaneously induces optimal investment and eliminates the bank debt concentration effect. Implementation issues and empirical/policy implications are also discussed.

Bank Debt versus Bond Debt: Evidence from Secondary Market Prices

Edward I. Altman et al. — Tue, 26 Oct 2010 16:29:42 PDT

This paper uses a new data set of daily secondary market prices of loans to analyze the specialness of banks as monitors. Consistent with a monitoring advantage of loans over bonds, we find the secondary loan market to be informationally more efficient than the secondary bond market prior to a loan default. Specifically, we find that secondary market loan returns Granger cause secondary market bond returns prior to a loan default. In contrast, secondary market bond returns do not Granger cause secondary market loan returns prior to a loan default.

Are banks still special when there is a secondary market for loans?

Amar Gande et al. — Tue, 26 Oct 2010 15:43:18 PDT

When a borrowing firm's existing loans trade for the first time in the secondary loan market, it elicits a significant positive stock price response by the borrowing firm's equity investors. We show that underlying this response is the impact of loan sales in alleviating a borrowing firm's financial constraints. In particular, we show in a differences-in-differences framework that firms that are smaller, younger, without a bond rating or that are distressed are more likely to benefit from loan sales as compared to other borrowers. We also find that new loan announcements are associated with a positive stock price announcement effect even when prior loans made to the same borrower already trade on the secondary market. Overall, we conclude that the role of banks, in terms of their specialness to borrowers, has changed due to their ability to create an active secondary loan market while simultaneously maintaining their traditional specialness as monitors and information producers for outside agents.

News spillovers in the sovereign debt market

Amar Gande et al. — Tue, 26 Oct 2010 11:44:43 PDT

We study the effect of a sovereign credit rating change of one country on the sovereign credit spreads of other countries from 1991 to 2000. We find evidence of spillover effects; that is, a ratings change in one country has a significant effect on sovereign credit spreads of other countries. This effect is asymmetric: positive ratings events abroad have no discernable impact on sovereign spreads, whereas negative ratings events are associated with an increase in spreads. On average, a one-notch downgrade of a sovereign bond is associated with a 12 basis point increase in spreads of sovereign bonds of other countries. The magnitude of the spillover effect following a negative ratings change is amplified by recent ratings changes in other countries. We distinguish between common information and differential components of spillovers. While common information spillovers imply that sovereign spreads move in tandem, differential spillovers are expected to result in opposite effects of ratings events across countries. Despite the predominance of common information spillovers, we also find evidence of differential spillovers among countries with highly negatively correlated capital flows or trade flows vis-á-vis the United States. That is, spreads in these countries generally fall in response to a downgrade of a country with highly negatively correlated capital or trade flows. Variables proxying for cultural or institutional linkages (e.g., common language, formal trade blocs, common law legal systems), physical proximity, and rule of law traditions across countries do not seem to affect estimated spillover effects.

Shareholder-Initiated Class Action Lawsuits: Shareholder Wealth Effects and Industry Spillovers

Amar Gande et al. — Tue, 26 Oct 2010 09:31:49 PDT

This paper documents significantly negative stock price reactions to shareholder initiated class action lawsuits. We find that shareholders partially anticipate these lawsuits based on lawsuit filings against other firms in the same industry and capitalize part of these losses prior to a lawsuit filing date. We show that the more likely a firm is to be sued, the larger is the partial anticipation effect (shareholder losses capitalized prior to a lawsuit filing date) and smaller is the filing date effect (shareholder losses measured on the lawsuit filing date). Our evidence suggests that previous research that typically focuses on the filing date effect understates the magnitude of shareholder losses, and such an understatement is greater for firms with a higher likelihood of being sued.