Cross-Border Mergers and Differences in Corporate Governance*
Laura T. Starks(Department of Finance, McCombs School of Business, The University of Texas at Austin)
Kelsey D. Wei(Naveen Jindal School of Management, University of Texass at Dallas)

We examine whether corporate governance differences affect firm valuation in cross-border mergers. We find that takeover premiums are decreasing in the quality of the foreign acquirer’s home country governance for deals completed with stock, suggesting that the acquirers compensate target shareholders for the resulting exposure to inferior corporate governance regimes. Correspondingly, we find that the acquiring firm stockholders’ abnormal returns at the merger announcement are increasing in the quality of corporate governance for stock offers. Finally, we find that foreign acquirers from countries with better corporate governance are more likely to make stock offers.

*The authors would like to thank Bernard Black, David Denis, Jay Hartzell, Murali Jagannathan, Srini Krishnamurthy, Adair Morse, David Ravenscraft, Hong Yan and seminar participants at Binghamton University, Georgetown University, University of North Carolina, University of Oklahoma, University of Washington and the FMA European Meeting for helpful comments. A previous version of this paper won the Best Paper Award at the 2004 FMA European meetings.

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Bailouts, Monitoring, and Penalties: An Integrated Framework of Government Policies to Manage the Too-Big-to-Fail Problem*
Ning Gong(Department of Finance, University of Melbourne)
Kenneth D. Jones(State Street Corporation)

This paper discusses optimal government bailout policy where the costs of systemic failures and moral hazard problems are considered. We find that a three-tiered bailout policy that includes an ex post monitoring and bailout scheme for financial institutions with large systemic impacts (‘too big to fail’) is optimal. The optimal policy also requires a randomized bailout for medium-impact institutions (‘Constructive Ambiguity’), and no bailout for institutions that have only minimal systemic consequences (‘too small to save’). However, in a volatile, innovative market environment where individual institutions may know more than the government regulator, monitoring error could contribute to risk taking, leaving the government regulator to always play a ‘catch-up’ role in revising policy. Moreover, the optimal bailout policy may not be time-consistent: institutions not deemed ‘too big to fail’ may still have an incentive to take excessive risks and expect to be bailed out in case of insolvency, primarily due to the short-term orientation of the government. Finally, because an institution’s systemic cost affects the probability of a bailout, we show that the boundary of an institution may be extended by the government subsidy.

*We would like to thank Rob Bliss, Sudipto Dasgupta (the Editor), Doug Foster, Ed Kane, Alfred Lehar, Tano Santos, Neil Stoughton, Myron Kwast, and participants at the Financial Integrity Research Network Research Day presentations in Brisbane, UNSW-Fudan Symposium on Asian Financial Crisis, Finlawmetrics 2009 at Bocconi University, 2010 IBEFA Conference in Portland, seminars at FDIC and Capital Markets and Monetary Policy Group at the IMF for helpful comments. An anonymous Associate Editor and a referee provided many constructive suggestions that considerably improved the paper.

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Financial Inflexibility and the Value Premium
Michael Poulsen(UQ Business School, The University of Queensland, St Lucia)
Robert Faff(UQ Business School, The University of Queensland, St Lucia)
Stephen Gray(UQ Business School, The University of Queensland, St Lucia)

This paper tests whether and to what extent the value premium is induced by financial inflexibility. In this context, financial flexibility refers to the ability of a firm to alter investment expenditure to mitigate exogenous shocks, so as to generate a smooth dividend stream. Consistent with a literature that identifies three related sources of inflexibility, we create a composite inflexibility index, based on the proportion of fixed assets and measures of total leverage and financial constraints. A positive relation is documented between inflexibility and the book-to-market ratio, and between the returns of inflexible firms and value firms. However, the value premium retains explanatory power independent of inflexibility, suggesting that it is not a proxy for inflexibility alone.

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The Relation between Physical and Risk-neutral Cumulants*
Huimin Zhao(Sun Yat-Sen Business School, Sun Yat-Sen University)
Jin E. Zhang(Department of Accountancy and Finance, Otago Business School, University of Otago)
Eric C. Chang(Faculty of Business and Economics, The University)

Variance swaps are natural instruments for investors taking directional bets on volatility and are often used for portfolio protection. The empirical observation on skewness research suggests that derivative professionals may also desire to hedge beyond volatility risk and there exists the need to hedge higher-moment market risks, such as skewness and kurtosis risks. We study two derivative contracts – skewness swap and kurtosis swap – which trade the forward realized third and fourth cumulants. Using S&P 500 index options data from 1996 to 2005, we document the returns of these swap contracts, i.e., skewness risk premium and kurtosis risk premium. We find that the both skewness and kurtosis risk premiums are significantly negative.

*We are especially grateful to Sudipto Dasgupta (Editor-in-Chief), an Associate Editor and an anonymous referee, whose helpful comments substantially improved the paper. We also acknowledge helpful comments from Long Chen, Jinghong Shu, Zhiguang Wang, and seminar participants at the University of Macau, the University of International Business and Economics, Sun Yat-Sen University, 2009 Financial Management Association (FMA) Annual Meeting in Reno, and 2010 China International Conference in Finance (CICF2010) in Beijing. H. Zhao has been supported by the Fundamental Research Funds for the Central Universities (Project No. 1209022), Guangdong Province University Key Project of Humanities and Social Sciences (Project No. 11ZGXM63002), and State Key Program of National Natural Science of China (Project No. 71231008). J. E. Zhang has been supported by an establishment grant from University of Otago. E. C. Chang has been partially supported by grants from the Research Grants Council of the Hong Kong Special Administrative Region, China (Project Nos. HKU 7403/06H and HKU 7179/07E).

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The Effects of Ownership Structure on Corporate Financing Decisions: Evidence from Stock Market Liberalization
Thomas O’Connor(Department of Economics, Finance, and Accounting, National University of Ireland Maynooth, Maynooth, Co. )
Thomas Flavin(Department of Economics, Finance, and Accounting, National University of Ireland Maynooth, Maynooth, Co.)

We analyze the impact of firm-specific stock market liberalization events on the capital structure and debt maturity decisions of firms from emerging market economies. We differentiate between firms based on their ownership structures at the time of liberalization and analyze their post-liberalization behavior regarding corporate financing decisions. Our empirical results show that single–class-share firms (typically with stronger corporate governance and better information environments) respond differently to their dual–class-share counterparts. Liberalization results in lower debt reliance for the former group while the latter lengthen the maturity of their debt portfolios.

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