Essays in corporate finance

The interaction of corporate governance mechanisms and the financing and investment corporate policies has attracted significant academic attention at least since Jensen and Meckling (1976). In the first two of my dissertation essays I explore the linkage between the governance mechanisms and managerial incentives to undertake value-enhancing investments and the implications of these investment choices for corporate financing policy. In the third essay I take a somewhat different direction in studying portfolio manager performance evaluation.; In the first dissertation essay I study the relationship between the financing policy and the governance mechanisms of the firm. Prior research has often taken the view that entrenched managers tend to avoid debt. Contrary to this view, I find that firms with weak shareholder rights, as measured by the Gompers et al. (2003) governance index, actually use more debt finance and have higher leverage ratios. I provide an explanation by showing that entrenched managers choose conservative (safe) investment policies and thus trade-off expected bankruptcy costs with tax shields of debt at higher leverage levels. Consistent with this, I find evidence that firms with weak shareholder rights have lower bond yields when issuing debt and enjoy higher credit ratings. To address the potential endogeneity of the governance index, I use the exogenous shock to corporate governance generated by the adoption of state anti-takeover laws and find that managers increase leverage when they are less vulnerable to takeovers.; In the second dissertation essay (joint with Kose John and Bernard Yeung) we theoretically examine how the investor protection environment affects corporate managers' incentives to take value-enhancing risks, and test the predictions of the model. In our model, the manager chooses higher perk consumption when investor protection is low. Since perks represent a priority claim held by the manager, lower investor protection leads the manager to implement a sub-optimally conservative investment policy, effectively aligning her risk-taking incentives with those of the debt holders. By the same token, higher investor protection is associated with riskier investment policy and faster firm growth. We test these predictions in a large Global Vantage panel. We find strong empirical confirmation that corporate risk-taking and firm growth rates are positively related to the quality of investor protection.; In the third essay (joint with Malcolm Baker, Jessica Wachter and Jeffrey Wurgler) we measure the stock-picking skill of mutual fund managers based on the returns realized around the subsequent earnings announcements of the stocks that they hold and trade. Relative to standard methodologies, this approach exploits the most informative segments of the returns data and ameliorates the joint hypothesis problem inherent in tests of stock-picking skill. Consistent with skilled trading, we find that, on average, stocks that funds buy earn significantly higher returns at subsequent earnings announcements than stocks that they sell. According to our measures of skill, certain funds perform persistently better than others, and the best performers tend to have a growth objective, large size, high turnover, and use incentive fees to motivate managers.