The problem of causality in corporate governance research: The case of governance indexes and firm valuation

In recent years the problem of the determination of causality has become an increasingly important question in the field of corporate governance. This paper reviews contemporary literature on the topic and finds that the current approach is to attempt to determine causality empirically and that the problem remains unresolved. After explaining the reasons why it is not possible to attempt to determine causality using real world data without falling prey to a logical fallacy, this paper discusses an approach to deal with the problem. In particular, the paper argues that the appropriate approach for the problem is to build theories, with causality featuring as a part of those theories, and then to test those theories both for logical and empirical consistency

Corporate governance and transaction cost economics: A study of the equity governance structure

This paper examines the Transaction Cost Economics (TCE) theory of capital structure and finds that for the case of equity the usual TCE logic is not fully worked out. In particular, an analysis of the key issue of bilateral dependency between the firm and its shareholders is absent. To fill this gap in the literature, the paper further develops the theory of the equity governance structure by taking account of the concept of bilateral dependency over the lifecycle of the firm. The paper finds that, both theoretically and empirically, contractual hazards are indeed mitigated for the case of fast growing young firms which are dependent on shareholders to finance future growth. In contrast, for the case of mature firms, which in virtue of their large free cash flows are independent from shareholders, contractual safeguards are altered to the disadvantage of shareholders and consequently managerial discretion costs increase

Optimal Taxation With Heterogeneous Firms

We study steady state optimal taxation in a context where firms differ in productivity and they decide whether to produce or not after comparing after-tax profits vis-à-vis an outside alternative option. The government taxes capital income, firms’ profits and labor income, but does not tax the alternative outside option. In this context, taxation might distort the firms’ decisions to participate in production (extensive margin) as well as their factor allocations once they decide to produce (intensive margin). We find that the government has incentives to subsidize costs to induce firms into production. The optimal capital income tax is negative while the corporate tax rate is positive and the sign of labor income tax is ambiguous.

Why has the literature on corporate governance and firm performance yielded mixed results?

This paper reviews the empirical literature on corporate governance and firm performance and finds that it has yielded mixed results. The paper argues that a primary reason for this situation is that the relevant theories have not been applied to the class of phenomena they were designed to explain. In particular, the literature that focuses on ownership structure and firm performance employs entrepreneurial agency theories of the firm but applies them to managerial firms where ownership is separated from control. This is evidenced by the fact that firms in which managerial ownership is close to zero percent are included in the samples. Conversely, empirical work centered on the relationship between board composition and firm performance (which relies on managerial agency theories of the firm) not only does not make sure that the firms in their samples are characterized by the separation of ownership and control, but it also ignores the alternative managerial agency theory concerning the agency costs of free cash flows. Additionally, the paper maintains that other approaches, such as that which studies the relationship between indices of anti-takeover provisions and firm performance, do not rely on any particular theory and for this reason are beset by problems of interpretation. The paper concludes with recommendations for avoiding the drawbacks and achieving future progress

The lifecycle of the firm, corporate governance and investment performance

According to firm lifecycle theory the agency costs of free cash flows are not transitory problems, but are a recurrent issue once firms reach a certain stage in their lifecycle. In particular, as firms mature their cash flows increase substantially while their investment opportunities decline and, to prevent retrenchment, managements need to invest in negative net present value projects. However, too much overinvestment leads to low firm valuation and potentially a hostile takeover. This paper extends firm lifecycle theory by arguing that to neutralize the threat of takeover, managements of maturing firms and their boards of directors progressively deploy antitakeover provisions which allow them to overinvest safely and prevent a decline in the size of their corporations. Firm lifecycle theory is also tested empirically. In this respect, a contribution of this paper is to develop a new empirical index that permits the identification of mature corporations with governance problems due to agency costs of free cash flows. The empirical results show that as firms mature agency costs of free cash flows increase, more antitakeover provisions are put into place and firms invest in projects with returns below their cost of capital

Merger waves and the Austrian business cycle theory

Following standard Austrian School theory, in this paper I identify merger waves as parts of Austrian type business cycles. As indicated by Mises, Rothbard and Hayek, when loan rates are reduced below their natural level through bank credit expansion this falsifies the monetary calculation of capitalist-entrepreneurs. As a result, new investments are initiated that calculation showed were not profitable before the interest rate reduction. On the other hand, the fall in interest rates falsifies households’ appraisals of their income and wealth, which turns them overly optimistic and causes them to over-consume, save less and go into debt. As a consequence of these developments the economy does not have enough resources for the completion of the new projects and businesses must increasingly withdraw the resources from other companies. I conclude that the increase in investment activity and the accompanying “resource crunch” cause a merger wave that helps prolong the boom phase of the cycle. The merger wave ends when the credit expansion is not sufficient to sustain the economic boom (which usually occurs when central banks finally let interest rates rise again and an overextended financial system tightens credit standards) and the bust phase begins. On the other hand, if the newly created fiduciary media does not enter the economy through the loan market to finance business investment, there should be no pronounced and sustained increase in merger activity followed by an economic bust

Process of fixation, imobilization and mineralization of ammonium in soil using N-15

The organic and inorganic forms of soil nitrogen and how they participate in the process of fixation, immobilization and mineralization of ammonium in soils were evaluated, after different periods of incubaton, utilizing two soils, a Lithic Haplustoll and a Typic Eutrorthox. The results obtained permit to suggest that : 1) The method for determination of the ammonium fixing capacity based on the extraction with 2N KC1, is considered to be subject to interferences of other soil fractions capable of retaining ammonium. 2) The increase in exchangeable ammonium content is related to the decrease in amino acids and hydrolyzable ammonium. 3) The immobilization and mineralization processes are still held under mil microbial. The forms more affected by this condition are amino acids and hydrolyzable ammonium.As formas de nitrogênio do solo e a maneira em que as mesmas participam dos processos de fixação, imobilização e mineralização do amônio no solo foram avaliadas após diferentes períodos de incubação, utilizando dois solos, um Lithic Haplustoll e um Typic Eutrorthox. As formas analisadas através do conteúdo de nitrogênio e da relação isotópica 15N/14N foram: amônio trocável, amônio fixado, aminoácidos, hexosaminas, hidroxiaminoácidos, amônio do hidrolisado e nitrogênio total do hidrolisado. Verificou-se que: 1) o método que emprega a extração com KC1 2N para determinar a capacidade de fixação do amônio adicionado, está sujeito a erros provocados pela interferência de outras funções do solo, na fixação de amônio; 2) o aumento no conteúdo de amônio trocável está relacionado com a diminuição dos aminoácidos e do amônio do hidrolisado dos solos e 3) os processos de retenção e liberação do nitrogênio do solo continuam em condições de atividade microbiana nula, sendo as formas mais afetadas aminoácidos e amônio do hidrolisado