Mergers and Acquisitions Accounting Can Explain the Diversification Discount

Abstract: I show that M&A accounting can explain the diversification discount as measured with Tobin's q. The typical M&A accounting procedure inflates the book value of assets and creates a mechanical drop in the common measure of acquirers' q. Because diversified firms are more acquisitive than standalones, their q is likely to be lower, generating a spurious diversification discount. After adjusting q for goodwill by excluding it from the book value of assets, I find no significant diversification discount in most specifications. As an alternative to the goodwill correction, I use the change in the M&A accounting rules in 2001 as a natural experiment to test my main hypothesis. Last, because goodwill is a lower bound for the difference between transaction price and target's book value, I estimate the magnitude of the total adjustment on a small sample of deals and find a diversification premium.

 

The Value of CEOs' Industry Expertise - Evidence from Mergers & Acquisitions (with Daniel Metzger)

Abstract: We study the impact of industry-specific human capital of CEOs on firm performance. We quantify the value of CEO industry-specific experience by using diversifying mergers and acquisitions announcements. In general, we find that industry experienced CEOs add value for their shareholders. The abnormal return is between 1.0% and 1.3% higher when the acquirer’s CEO has top management experience in the target’s industry. Moreover, analyzing potential mechanisms, we provide evidence that CEOs with industry experience in the target’s industry negotiate better terms and that this experience is particularly valuable in environments of high informational asymmetries (1.6% - 2.9%). The results also suggest that certain skills of CEOs are neither completely general nor firm-specific but rather specific to an industry.

 

Generalists vs. Specialists: Managerial Skills and CEO Pay

Abstract: We study whether the rise in CEO pay in the last decades in the U.S. can be explained by an increase in the relative importance of industry mobility and general managerial skills. Based on detailed information on CEOs’ past industry background, past experience as top executive, and educational training we construct an index of general managerial ability. We find a positive relation between this index and CEO pay using the sample of S&P 1,500 firms in the 1993-2007 period. To quantify the premium that generalist CEOs command, we introduce a new measure of a CEO’s excess pay as the difference between a CEO’s pay and the pay of a portfolio of other CEOs who are specialists in the industries that match the CEO’s past industry experience. We find that excess pay increases with the CEO’s industry mobility. In addition, we provide evidence that CEO pay increases when firms hire new CEOs from the external labor market. Furthermore, there is a significant additional pay premium for generalist CEOs running diversified firms. Our findings suggest that a rise in the importance of general relative to firm-specific managerial skills helps explain the rise in executive pay.

 

 Why are U.S. Firms Using More Short-Term Debt? (With Miguel Ferreira and Luis Laureano)

Abstract: We document a secular decrease in corporate debt maturity of US firms from 1976 to 2008. This decrease in debt maturity is driven by the smallest firms for which the average percentage of debt maturing in more than three years decreases from 49% in 1976 to 28% in 2008. For large firms, however, the decrease in average debt maturity is small. Firms with higher degree of information asymmetry play an important role in explaining the decrease in debt maturity. Agency costs of debt or agency problems between managers and shareholders do not seem to contribute to the decrease. Our results challenge the existing theories as changes in known determinants of debt maturity cannot account for most of the decrease in the use of long-term debt.

 

Core-business Expertise, Managerial Discretion and Corporate Diversification

Abstract: I test the hypothesis that diversification destroys value because managers lack expertise outside the core business. I develop diversification measures that capture both the importance of non-core business activity (sales-shift) and the unrelatedness to core-business (distance-to-core). I test two main implications: firms with more business activities outside the core business have lower value and the discount should be greater for firms with more activity in unrelated-to-core secondary segments. The evidence supports both hypothesis. I test more directly if the results are linked to a lack of managerial expertise by using an industry index of managerial discretion. I find that increasing non-core business sales weight by 10% decreases firm value up to 3%, if the firm has high managerial discretion. Finally I find no compensation premium for diversified firms and a positive correlation between managerial discretion and CEO compensation.

(under revision)

 

Other working papers:

Cash Holdings and Business Conditions, ( with Miguel Ferreira and Clara Raposo)

Abstract: We investigate the relation between business conditions and corporate liquidity decisions by US firms. We find strong evidence that financially constrained firms hold more cash during recessions and that business conditions are significant to constrained firms’ cash decisions. In contrast, we find weak evidence that financially unconstrained firms adjust cash holdings according to the business cycle. This asymmetric behaviour is more pronounced for changes in the short-term interest rate. Moreover, we find that firms increase the level of liquidity during periods of tighter credit conditions. Our findings support both the precautionary motive for holding cash and the pecking order theory.

 

 

Published teaching material:

Financas da Empresa, joint with Antonio Gomes Mota, Booknomics 2nd edition 2007 (in Portuguese)