Corporate Finance.

The NBER's Corporate Finance Program, met on November 21 in Cambridge. Organizers Holger Mueller, NBER and New York University, and Joshua Rauh, NBER and University of Chicago, chose these papers to discuss:

Martijn Cremers, Yale University, and Yaniv Grinstein, Cornell University, "The Market for CEO Talent: Implications for CEO Compensation"

Discussant: Xavier Gabaix, New York University and NBER

C. Fritz Foley, Harvard University and NBER; Dhammika Dharmapala, University of Connecticut; and Kristin Forbes, MIT and NBER, "The Unintended Consequences of the Homeland Investment Act: Implications for Financial Constraints, Governance, and International Tax Policy"

Discussant: Heitor Almeida, University of Illinois and NBER

Viral Acharya, New York University; Raghuram Rajan, University of Chicago and NBER, and Stewart C. Myers, MIT and NBER, "The Internal Governance of Firms"

Discussant: Jeremy C. Stein, Harvard University and NBER

Josh Lerner, Harvard University and NBER, and Ulrike Malmendier, University of California, Berkeley and NBER, "With a Little Help from My (Random) Friends: Success and Failure in Post-Business School Entrepreneurship"

Discussant: Simon Johnson, MIT and NBER

Philippe Aghion, Harvard University and NBER; John Van Reenen, London School of Economics and NBER; and Luigi Zingales, University of Chicago and NBER, "Innovation and Institutional Ownership"

Discussant: David S. Scharfstein, Harvard University and NBER

Todd Gormley, Washington University in St. Louis, and David Matsa, Northwestern University, "Growing Out of Trouble ? Legal Liability and Corporate Responses to Adversity"

Discussant: Antoinette Schoar, MIT and NBER

Gerard Hoberg, University of Maryland; and Gordon M. Phillips, University of Maryland and NBER, "Product Market Synergies and Competition in Mergers and Acquisitions"

Discussant: Paul Tetlock, Columbia University

Cremers and Grinstein study the market for CEO talent in public U.S. corporations from 1993-2005. They find large fragmentation of CEO talent pools. In particular, about 68 percent of new CEOs are former employees of their own firm ("insider CEOs") and 86 percent are former employees in firms belonging to the same industry (including insider CEOs). Talent pool structure explains several compensation practices: CEO compensation is only benchmarked against other firms, and pay-for-luck is prevalent only when the industry has a small percentage of insider CEOs. Finally, the authors study the importance of talent pools. Finding little support when incorporating the fragmentation of CEO talent pools, they offer a reinterpretation of the Gabaix-Landier results.

The Homeland Investment Act of 2004 provided for a one-time tax holiday on the repatriation of foreign earnings, thereby allowing U.S. multinationals to access earnings retained abroad at a lower cost. Firms responded to this act by significantly increasing repatriations from foreign affiliates. Dharmapala, Foley, and Forbes analyze the impact of the tax holiday on firm behavior. They find that repatriations did not lead to an increase in investment, employment, or R and D--even for the firms that lobbied for the tax holiday stating these intentions. Instead, a $1 increase in repatriations was associated with an increase of approximately $1 in payouts to shareholders. These responses are consistent with the view that the domestic operations of U.S. multinationals were not financially constrained and that U.S. multinationals are reasonably well-governed. The results also have significant implications for understanding the impact of the U.S. corporate tax system on the behavior of multinational firms.

Acharya, Myers, and Rajan develop a model of internal governance where the self-serving actions of top management are limited by the potential reaction of subordinates. The authors find that internal governance can mitigate agency problems and ensure firms have substantial value, even without any external governance. Internal governance seems to work best when both top management and subordinates are important to value creation. The authors then allow for governance provided by external financiers and find situations where external governance, even if crude and uninformed, complements internal governance in improving efficiency. Interestingly, this allows the development of a theory of dividend policy, where dividends are paid by self-interested CEOs to maintain a balance between internal and external control. Finally, the authors explore how the internal organization of firms may be structured to enhance the role of internal governance. Young firms with limited external oversight, and firms in countries with poor external governance, can have substantial value, and improving external governance may not be a panacea for all governance problems.

A central question in the entrepreneurship literature is how to encourage entrepreneurship and whether peers affect the decision to become an entrepreneur. Lerner and Malmendier exploit the fact that Harvard Business School assigns students into sections, which have varying representation of former entrepreneurs. They find that the presence of entrepreneurial peers strongly predicts subsequent entrepreneurship rates of their peers who did not have an entrepreneurial background, but in a more complex way than the literature has previously suggested. A higher share of students with an entrepreneurial background in a given section leads their peers to lower rather than higher subsequent rates of entrepreneurship. However, the decrease in entrepreneurship is entirely driven by a reduction in unsuccessful entrepreneurial ventures. The relationship between the shares of pre-HBS and successful post-HBS peer entrepreneurs is insignificantly positive. Sections with few prior entrepreneurs have a considerably higher variance in their rates of unsuccessful entrepreneurs. The authors argue that these results are consistent with intra-section learning, where the close ties between section-mates lead to insights about the merits of business plans.

Aghion, Van Reenen, and Zingales find that institutional ownership in publicly traded companies is associated with more innovation (measured as cited-weighted patents), even after they control for possible endogeneity of institutional ownership. To explore the mechanism through which this link arises, the authors build a model that nests managerial laziness with career-concern considerations, where institutional ownership increases the incentives managers have to innovate by reducing the career risk of innovative projects. While the lazy-manager hypothesis predicts a substitution effect between institutional ownership and product market competition, the career-concern hypothesis allows for complementarity. The effect of institutional investors on innovation increases with product market competition, supporting the career-concern model. This model is also supported by the authors' finding that that CEOs are less likely to be fired in the face of profit downturns when institutional ownership is higher.

Gormley and Matsa measure how a typical firm responds when a chemical to which its workers are exposed is newly identified to be a carcinogen. While there is no evidence of a pre-existing trend, the authors find that firms, particularly those more vulnerable to the realization of an adverse shock, tend to undertake aggressive growth and increased acquisitions after experiencing the liability shock. The acquisitions appear to be targeted at diversifying the firms' assets by acquiring large businesses with relatively high operating cash flows, recent growth, and total payouts. These deals are associated with high takeover premiums and negative abnormal returns. These findings are broadly inconsistent with the perfect capital markets model, but fit well with an agency model where managers have career concerns. In support of the agency model, the authors find that total assets grow most among firms with weak external governance, high management ownership, or low institutional ownership, whereas firms with strong external governance, low management ownership, or high institutional ownership instead increase their payouts to shareholders. These results suggest that agency conflicts may be exacerbated when firms are closer to financial distress.

Hoberg and Phillips examine how product similarity and competition influences mergers and acquisitions and the ability of firms to exploit product market synergies. Using novel text-based analysis of firm 10K product descriptions, they find three key results: 1) Firms are more likely to enter restructuring transactions when the language describing their assets is similar to all other firms, consistent with their assets being more re-deployable. 2) Targets earn lower announcement returns when similar alternative target firms exist. 3) Acquiring firms in competitive product markets experience increased profitability, higher sales growth, and increased changes in their product descriptions when they buy target firms that are similar to them and different from rival firms. The authors' findings are consistent with similar merging firms exploiting synergies to create new products and increase their product differentiation relative to ex-ante rivals.