Kose John
Charles William Gerstenberg Professorship in Banking and Finance
New York University
Leonard N. Stern School of Business
44 West 4th Street, KCM 9-50
New York, NY 10012
Research
Selected Working Papers
Bitcoin's Fatal Flaw: The Limited Adoption Problem
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Bitcoin remains sparsely adopted even a decade after its birth. We demonstrate theoretically that this limited adoption arises as an inescapable equilibrium outcome rather than as a transient feature. We establish such a result for a wide class of blockchains that employ Proof-of-Work. Our results arise due to three features: (1) an artificial supply constraint, (2) free entry to the validator network, and (3) a need for consensus. Network delay precludes relaxing the supply constraint as a solution. Nonetheless, we demonstrate that permissioned blockchains may obtain widespread adoption, thereby highlighting the need for research on alternatives to Bitcoin.
The Public Blockchain Ecosystem: An Empirical Analysis
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This paper offers an organizing empirical framework to understand the largely unexplored public blockchain ecosystem. Our framework casts blockchains in terms of their key economic attributes rather than as a set of disparate objects. The framework takes inspiration from the blockchain trilemma, constructing empirical analogs for each of its three attributes: (i) scale, (ii) security, and (iii) decentralization. Our analysis uncovers an association between these attributes and blockchain consensus protocols. We establish that Proof-of-Work (PoW) blockchains dominate on decentralization; Delegated Proof-of-Stake (DPoS) blockchains dominate on scale, and blockchains using non-standard protocols dominate on security. We find that a small group of blockchains form the ecosystem's frontier, but no particular blockchain, not even Bitcoin, leads on all three attributes.
The Information Value of Corporate Social Responsibility
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Using a simple cheap-talk game, we theoretically demonstrate that corporate social responsibility (CSR) helps mitigate the CEO-board information asymmetry, leading to more informed advising and monitoring by the board. By optimally engaging in CSR, the board can take advantage of stakeholder information revelation and reduce its informational dependence on the CEO, which enables the shareholders to choose an ex ante higher level of board independence. For a sample of U.S. firms between 1999 and 2013, we find strong support for this strategic complementarity between board independence and the information value of CSR. Our results highlight a novel rationale for CSR – the information motive.
Selected Publications
Bank Integration and the Market for Corporate Control: Evidence from Cross-State Acquisitions
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How does bank integration affect the market for corporate control for nonfinancial firms? We provide causal evidence that interstate bank deregulation affects acquisitions mainly through reducing the information asymmetry between acquirers and targets, instead of increased credit supply. After deregulation, the likelihood of cross-state acquisitions significantly increases, and more so if the target borrows from an out-of-state bank, the target’s bank is acquired by an out-of-state bank, the target’s state has reciprocal interstate bank deregulation with the acquirer’s state, or the target is opaque. The reduced information asymmetry increases announcement returns for acquirers of out-of-state (particularly private) targets after deregulation.
Earthly Reward to the Religious: Religiosity and the Costs of Public and Private Debt
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We document that a firm’s culture, specifically, its religiosity, affects its cost of debt. Firms in higher-religiosity counties have higher credit ratings and lower debt costs. The impact of religiosity is stronger for firms with greater information asymmetry and during recessions. Further, religiosity has additional explanatory power for the cost of bank loans (but not the cost of public bonds) beyond its impact through ratings. This supports the argument that banks have superior abilities in pricing soft information, such as corporate culture. Finally, the impact of religiosity is stronger when the lender is a small bank.
Does Corporate Governance Matter More for High Financial Slack Firms?
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The effect of corporate governance may depend on a firm’s financial slack. On one hand, financial slack may be spent by managers for their private benefits; a high level is likely associated with severe agency conflicts. Thus corporate governance matters more for high financial slack firms (i.e., the wasteful spending hypothesis). On the other hand, financial slack provides insurance against future uncertainties; a low level may signal deviations from the best interests of shareholders. Then corporate governance is more effective for low financial slack firms (i.e., the precautionary needs hypothesis). We differentiate the two hypotheses using the passage of antitakeover laws to identify exogenous variation in governance. Consistent with the wasteful spending hypothesis, the laws’ passage has a larger negative impact on the operating and stock market performance of high financial slack firms. Further analysis shows that these firms do not invest more but become less efficient at cost management after the laws’ passage.
Urban Agglomeration and CEO Compensation
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We examine the relation between the agglomeration of firms around big cities and chief executive officer (CEO) compensation. We find a positive relation among the metropolitan size of a firm’s headquarters, the total and equity portion of its CEO’s pay, and the quality of CEO educational attainment. We also find that CEOs gradually increase their human capital in major metropolitan areas and are rewarded for this upon relocation to smaller cities. Taken together, the results suggest that urban agglomeration reflects local network spillovers and faster learning of skilled individuals, for which firms are willing to pay a premium and which are therefore important factors in CEO compensation.
Employee Rights and Acquisitions
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This paper examines the outcomes and characteristics of corporate acquisitions from the perspective of stakeholder-shareholder agency conflicts. Using state variation in labor protections, we find that acquirers with strong labor rights experience lower announcement returns. Combined acquirer and target announcement returns are also lower in the presence of strong labor rights. Our findings remain statistically and economically significant after we control for a range of deal, firm, industry and state characteristics and explore various channels for the labor rights effect. Overall, the evidence indicates that employee-shareholder conflicts of interest reduce shareholder gains from acquisitions.
Takeovers and Divergence of Investor Opinion
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We test several hypotheses on how takeover premium is related to investors' divergence of opinion on a target's equity value. We show that the total takeover premium, the pre-announcement target stock price run-up, and the post-announcement stock price markup are all higher when investors have higher divergence of opinion. We obtain identical results with higher market-level investor sentiment. When divergence of opinion is higher, a firm is less likely to be a takeover target, although takeover synergy in successful takeovers is higher. Our results suggest that takeovers may play a role in explaining high contemporaneous stock prices in the presence of high divergence of investor opinion.
Does Geography Matter? Firm Location and Corporate Payout Policy
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We investigate the impact of geography on agency costs and firm dividend policies. We argue that remote firm location increases the cost of shareholder oversight of managerial investment decisions. We hypothesize that remotely located firms facing free cash flow problems precommit to higher dividends to mitigate agency conflicts. We find that remotely located firms pay higher dividends. As expected, the effect of geography on dividends is most pronounced for firms with severe free cash flow problems. Further, remotely located firms rely more on regular dividends instead of special dividends or share repurchases and decrease dividends less often.
The Effect of State Antitakeover Laws on Firm's Bondholders
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We examine how state antitakeover laws affect bondholders and the cost of debt, and report four findings. First, bonds issued by firms incorporated in takeover-friendly states have significantly higher at-issue yield spreads than bonds issued by firms in states with restrictive antitakeover laws. Second, firms in takeover friendly states have significantly higher leverage than their counterparts in restrictive law states. Third, bond issues are associated with negative average stock price reactions among firms in takeover-friendly states, but positive stock price reactions among firms in restrictive law states. Fourth, existing bond values increase, on average, upon the introduction of Business Combination antitakeover law. These results indicate that state antitakeover laws tend to decrease bond yields and increase bond values, which is the opposite of their effect on equity values. This, in turn, implies that state laws help mitigate the agency cost of debt by shielding bondholders from expropriation in takeovers. Overall, the empirical evidence suggests that the effect of antitakeover provisions on firm value must take into account the impacts of both bondholders and stockholders.
Takeovers and the Cross-Section of Returns
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This paper considers the impact of the takeover likelihood on firm valuation. If firms are more likely to acquire when there is more free cash or lower required rates of return, the targets become more sensitive to shocks to cash flows or the price of risk. Ceteris paribus, firms exposed to takeovers have different rates of return than protected firms. Using takeover likelihood estimates, we create a “takeover factor,” buying (selling) firms with a high (low) takeover likelihood, which generates “abnormal” returns. Several tests confirm that the takeover factor helps explaining cross-sectional differences in equity returns and is related to takeover activity.
Corporate Governance and Risk‐Taking
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Better investor protection could lead corporations to undertake riskier but value‐enhancing investments. For example, better investor protection mitigates the taking of private benefits leading to excess risk‐avoidance. Further, in better investor protection environments, stakeholders like creditors, labor groups, and the government are less effective in reducing corporate risk‐taking for their self‐interest. However, arguments can also be made for a negative relationship between investor protection and risk‐taking. Using a cross‐country panel and a U.S.‐only sample, we find that corporate risk‐taking and firm growth rates are positively related to the quality of investor protection.
Debtor-in-possession Financing and Bankruptcy Resolution: Empirical Evidence
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Debtor-in-possession (DIP) financing is unique secured financing available to firms filing for Chapter 11. Opponents of DIP financing argue that it leads to overinvestment. Alternatively, DIP financing can allow funding for positive net present value projects that increase the likelihood of reorganization and reduce time in bankruptcy. Using a large sample of bankruptcy filings, we find little evidence of systematic overinvestment. DIP financed firms are more likely to emerge from Chapter 11 than non-DIP financed firms. DIP financed firms have a shorter reorganization period; they are quicker to emerge and also quicker to liquidate. The reorganization period is even shorter when prior lenders provide the DIP financing.
Credit Raings, Collateral and Loan Characteristics: Implications for Yield
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This article studies how collateral affects bond yields. Using a large data set of public bonds, we document that collateralized debt has higher yield than general debt, after controlling for credit rating. Our model of agency problems between managers and claim holders explains this puzzling result by recognizing imperfections in the rating process. We test the model’s implications. Consistent with our model and in results new to the literature, we find the yield differential between secured and unsecured debt, after controlling for credit rating, is larger for low credit rating, nonmortgage assets, longer maturity, and with proxies for lower levels of monitoring.
On the Optimality of Resetting Executive Stock Options
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The practice of resetting strike prices on underwater executive stock options has drawn criticism for weakening managerial incentives. Our model shows that although the anticipation of resetting can negatively affect initial incentives, resetting can still be an important, value-enhancing aspect of compensation contracts, even from an ex-ante standpoint. In fact, we find that some resetting is almost always optimal. The relative advantages of resetting diminish with greater ability of managers to influence the resetting process, greater relative importance of external factors on stock performance, and lower costs of replacing incumbent managers.
A Theory of Bank Regulation and Management Compensation
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We show that concentrating bank regulation on bank capital ratios may be ineffective in controlling risk taking. We propose, instead, a more direct mechanism of influencing bank risk-taking incentives, in which the FDIC insurance premium scheme incorporates incentive features of top-management compensation. With this scheme, we show that bank owners choose an optimal management compensation structure that induces first-best value-maximizing investment choices by a bank's management. We explicitly characterize the parameters of the optimal management compensation structure and the fairly priced FDIC insurance premium in the presence of a single or multiple sources of agency problems.
Corporate Governance and Board Effectiveness
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This paper surveys the empirical and theoretical literature on the mechanisms of corporate governance. We focus on the internal mechanisms of corporate governance (e.g., corporate board of directors) and their role in ameliorating various classes of agency problems arising from conflicts of interests between managers and equityholders, equityholders and creditors, and capital contributors and other stakeholders to the corporate firm. We also examine the substitution effect between internal mechanisms of corporate governance and external mechanisms, particularly markets for corporate control. Directions for future research are provided.
Determinants of Organizational Form Changes: Evidence and Implications from Real Estate
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We study changes in the real estate industry among organizational forms with varying degrees of restrictiveness and document the associated changes in profitability, free cash flow, debt, dividends, and investment policies. All troubled firms in our sample move to a more flexible organizational structure, with subsequent reductions in dividends, improvements in performance, and increases in asset sales and investments. Healthy firms that move to a tighter structure have larger free cash flows before the change; they increase dividends, reduce free cash flows and improve profitability after the change. We document evidence of tax considerations in organizational changes.
Market Manipulation and the Role of Insider Trading Regulations
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We show that the regulation requiring corporate insiders to disclose their trades ex post creates incentives for informed insiders to manipulate the market by sometimes trading against their information. This allows them to increase their trading profits by maintaining their information advantage over the market for a longer period of time. Such manipulation lowers initial bid‐ask spreads. We show how the insider's likelihood of manipulation is affected by her information advantage, the number of other insiders, market liquidity, the early arrival of public information, and the choice of trade size. The short swing profit rule curtails this manipulation.
Bank Equity Stakes in Borrowing Firms and Financial Distress
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We derive the optimal financial claim for a bank when the borrowing firm’s uninformed stakeholders depend on the bank to establish whether the firm is distressed and whether concessions by stakeholders are necessary. The bank’s financial claim is designed to ensure that it cannot collude with a healthy firm’s owners to seek unnecessary concessions or to collude with a distressed firm’s owners to claim that the firm is healthy. To prove that a request for concessions has not come from a healthy firm/bank coalition, the bank must hold either a very small or a very large equity stake when the firm enters distress. To prove that a distressed firm and the bank have not colluded to claim that the firm is healthy, the bank may need to hold equity under routine financial conditions.
An Empirical Analysis of Strategic Competition and Firm Values: The Case of R&D Competition
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We operationalize a firm's competitive strategy through a new empirical measure, and develop a framework for empirical analysis of the market value of strategic behavior. Using this framework, we study announcement effects of R&D spending. The announcing firm's stock prices are positively influenced by a change in spending, and negatively by our competitive strategy measure (CSM). Competitors' stock prices are positively influenced by the interaction between the market's reaction to the announcing firm and the CSM. Our results are consistent with positive effects of ‘accommodating’ competition with strategic substitutes, and nonpositive effects of ‘tough’ competition with strategic complements.
Asset Sales and Increase in Focus
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We find that asset sales lead to an improvement in the operating performance of the seller's remaining assets in each of the three years following the asset sale. The improvement in performance occurs primarily in firms that increase their focus; this change in operating performance is positively related to the seller's stock return at the divestiture announcement. The announcement stock returns are also greater for focus-increasing divestitures. Further, we find evidence that some of the seller's gains result from a better fit between the divested asset and the buyer.
Top‐Management Compensation and Capital Structure
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The interrelationship between top‐management compensation and the design and mix of external claims issued by a firm is studied. The optimal managerial compensation structures depend on not only the agency relationship between shareholders and management, but also the conflicts of interests which arise in the other contracting relationships for which the firm serves as a nexus. We analyze in detail the optimal management compensation for the cases when the external claims are (1) equity and risky debt, and (2) equity and convertible debt. In addition to the role of aligning managerial incentives with shareholder interests, managerial compensation in a levered firm also serves as a precommitment device to minimize the agency costs of debt. The optimal management compensation derived has low pay‐performance sensitivity. With convertible debt, instead of straight debt, the corresponding optimal managerial compensation has high pay‐to‐performance sensitivity. A negative relationship between pay‐performance sensitivity and leverage is derived. Our results provide a reconciliation of the puzzling evidence of Jensen and Murphy (1990) with agency theory. Other testable implications include (1) a relationship between the risk premium in corporate bond yields and top‐management compensation structures, and (2) the announcement effect of adoption of executive stock option plans on bond prices. The model yields implications for management compensation in banks and Federal Deposit Insurance reform. Our results explain the dynamics of top‐management compensation in firms going through financial distress and reorganization.
The Voluntary Restructuring of Large Firms in Response to Performance Decline
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Much of the research on corporate restructuring has examined the causes and aftermath of extreme changes in corporate governance such as takeovers and bankruptcy. In contrast, we study restructurings initiated in response to product market pressures by “normal” corporate governance mechanisms. Such “voluntary” restructurings, motivated by the discipline of the product market and internal corporate controls, will play a relatively more important role in the 1990s due to a weakening in the discipline of the takeover market. Our data suggest that the firms retrenched quickly and, on average, increased their focus. There is no evidence of abnormally high levels of forced turnover in top managers. There is, however, a significant and rapid cut of 5% in the labor force. Further, the cost of goods sold to sales and labor costs to sales ratios both decline rapidly, more than 5% in the first two years after the negative earnings. The firms cut research and development, increased investment, and also reduced their debt/asset level by over 8% in the first year after the negative earnings. We also document the reasons management and analysis reported for the negative earnings. Overwhelmingly the firms blame bad economic conditions and, to a lesser extent, foreign competition.
Insider Trading around Dividend Announcements: Theory and Evidence
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The informational role of strategic insider trading around corporate dividend announcements is studied based on the efficient equilibrium in a signalling model with endogenous insider trading. Insider trading immediately prior to the announcement of dividend initiations has significant explanatory power. For firms with insider selling prior to the dividend initiation announcement, the excess returns are negative and significantly lower than for the remaining firms (with no insider trading or just insider buying) as implied by our model. Another implication is that dividend increases may elicit a positive or negative stock price response depending on the firm's investment opportunities.
Troubled Debt Restructurings: An Empirical Study of Private Reorganization of Firms in Default
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This study investigates the incentives of financially distressed firms to restructure their debt privately rather than through formal bankruptcy. In a sample of 169 financially distressed companies, about half successfully restructure their debt outside of Chapter 11. Firms more likely to restructure their debt privately have more intangible assets, owe more of their debt to banks, and owe fewer lenders. Analysis of stock returns suggests that the market is also able to discriminate ex ante between the two sets of firms, and that stockholders are systematically better off when debt is restructured privately.
Information Content of Insider Trading around Corporate announcements: The Case of Capital Expenditures
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There is gathering evidence of insider trading around corporate announcements of dividends, capital expenditures, equity issues and repurchases, and other capital structure changes. Although signaling models have been used to explain the price reaction of these announcements, a usual assumption made in these models is that insiders cannot trade to gain from such announcements. An innovative feature of this paper is to model trading by corporate insiders (subject to disclosure regulation) as one of the signals. Detailed testable predictions are described for the interaction of corporate announcements and concurrent insider trading. In particular, such interaction is shown to depend crucially on whether the firm is a growth firm, a mature firm, or a declining firm. Empirical proxies for firm technology are developed based on measures of growth and Tobin's q ratio. In the underlying “efficient” signaling equilibrium, investment announcements and net insider trading convey private information of insiders to the market at least cost. The paper also addresses issues of deriving intertemporal announcement effects from the equilibrium (cross‐sectional) pricing functional. Other announcement effects relate the intensity of the market response to insider trading, variance of firm cash flows, risk aversion of the insiders, and characteristics of firm technology (growth, mature, or declining).
Risk-Shifting Incentives and Signalling Through Corporate Capital Structure
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This paper examines optimal corporate financing arrangements under asymmetric information for different patterns of temporal resolution of uncertainty in the underlying technology. An agency problem, a signalling problem and an agency‐signalling problem arise as special cases. The associated informational equilibria and the optimal financing arrangements are characterized and compared. In the agency‐signalling equilibrium the private information of corporate insiders at the time of financing is signalled through capital structure choices which deviate optimally from agency‐cost minimizing financing arrangements, which in turn induce risk‐shifting incentives in the investment policy. In the pure signalling case the equilibrium is characterized by direct contractual precommitments to implement investment policies which are riskier than pareto‐optimal levels. Empirical implications for debt covenants and the announcement effect of investment policies and leverage increasing transactions on existing stock and bond prices are explicitly derived.
Efficient Signalling with Dividends and Investments
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An efficient signalling equilibrium with dividends and investments or, equivalently, dividends and net new issues of stock is constructed, and its properties are identified. Because corporate insiders can exploit multiple signals, the efficient mix must minimize dissipative costs. In equilibrium, many firms both distribute dividends and deviate from first‐best investment. Also, the impact of dividends on stock prices is positive. By contrast, the announcement effect of new stock is negative for firms with private information primarily about assets in place and positive for firms with inside information mainly about opportunities to invest.
Dividends, Dilution, and Taxes: A Signalling Equilibrium
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A signalling equilibrium with taxable dividends is identified. In this equilibrium, corporate insiders with more valuable private information optimally distribute larger dividends and receive higher prices for their stock whenever the demand for cash by both their firm and its current stockholders exceeds its internal supply of cash. In equilibrium, many firms distribute dividends and simultaneously issue new stock, while other firms pay no dividends. Because dividends reveal all private information not conveyed by corporate audits, current stockholders capture in equilibrium all economic rents net of dissipative signalling costs. Both the announcement effect and the relationship between dividends and cum‐dividend market values are derived explicitly.
Risky Debt, Reputation and Investment Incentives in a Sequential Equilibrium
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The agency relationship of corporate insiders and bondholders is modeled as a dynamic game with asymmetric information. The incentive effect of risky debt on the investment policy of a levered firm is studied in this context. In a sequential equilibrium of the model, a concept of reputation arises endogenously resulting in a partial resolution of the classic agency problem of underinvestment. The incentive of the firm to underinvest is curtailed by anticipation of favorable rating of its bonds by the market. This anticipated pricing of debt is consistent with rational expectations pricing by a competitive bond market and is realized in equilibrium. Some empirical implications of the model for bond rating, debt covenants, and bond price response to investment announcements are explored.
Efficient Funds in a Financial Market with Options: A New Irrelevance Proposition
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Under the same assumptions that Ross used to assert the existence of an efficient fund (on which a spanning set of options can be written) we prove that almost any portfolio is an efficient fund. From a constructive point of view, a randomly chosen vector of portfolio weights yields an efficient fund. When the Ross assumptions are relaxed, a limited notion of efficiency‐maximal efficiency‐is the best attainable. The maximally efficient funds are also everywhere dense in the portfolio space. Some implications are discussed and illustrative examples given.