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Corporate Governance and Market Liquidity

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Corporate Governance and Market Liquidity Powered By Docstoc
					       Corporate Governance and Market Liquidity

                                    Ariadna Dumitrescu1

                                    ESADE Business School




1
    The financial support of Banc Sabadell and UCEIF Foundation-Banco Santander is gratefully acknowledged.
                              Motivation
                              The Model
                                 Results
                              Conclusions


Liquidity affects corporate governance


  Liquidity affects corporate governance:

      Liquidity may lead investors to increase or reduce their
      holdings
         ◦   Admati et al. (1994)
         ◦   Bolton and Thadden (1998)
         ◦   Kahn and Winton (1998)
         ◦   Maug (1998)
      Higher market activity facilitates monitoring:
         ◦ Holmstrom and Tirole (1993)




                      Ariadna Dumitrescu    Corporate Governance and Market Liquidity
                        Motivation
                        The Model
                           Results
                        Conclusions




This Paper

How do endogenous disclosure of information and the
firm’s corporate governance affect its stock’s liquidity?




                Ariadna Dumitrescu    Corporate Governance and Market Liquidity
                           Motivation
                           The Model
                              Results
                           Conclusions




The Paper in a Nutshell

   This paper models the manager’s decision to payout dividends
   considering the effect his choice has on:
     1   His own compensation
     2   Shareholders’ decision to intervene
     3   His profits from insider trading
         and studies the effect this endogenous public signal has on the
         market performance of the firm’s stock.
   Main Results:
     1   Differences in liquidity can be explained by differences in
         corporate governance characteristics of the firm.
     2   The effect of corporate governance provisions aimed to
         improve financial transparency depends on the other corporate
         governance mechanisms in place.


                   Ariadna Dumitrescu    Corporate Governance and Market Liquidity
                            Motivation
                            The Model
                               Results
                            Conclusions


Outline



  1   Motivation


  2   The Model


  3   Results


  4   Conclusions




                    Ariadna Dumitrescu    Corporate Governance and Market Liquidity
                             Motivation
                             The Model
                                Results
                             Conclusions


Literature



      Corporate Governance
        ◦ Shleifer and Vishny (1997), La Porta et al. (2000), Tirole
          (2001), Gompers et al. (2003), Cremers and Nair (2005),
          Bebchuk and Cohen (2005)
      Market Microstructure
        ◦ Kyle (1985)
        ◦ Manove (1989), Leland (1992), Jain and Mirman (2000),
          Bhattacharya and Nicodano (2001), Medrano and Vives
                        e
          (2002), Caball´ and Dumitrescu (2010)




                     Ariadna Dumitrescu    Corporate Governance and Market Liquidity
                           Motivation    The Model
                           The Model     Manager’s Problem
                              Results    Shareholders’ Problem
                           Conclusions   The Equilibrium


The Model


  First Stage
    ◦ Manager
    ◦ Majority Shareholder owns a fraction of shares φ ∈ (0, 1]

  Second Stage
    ◦ Manager (insider)
    ◦ Liquidity Traders
    ◦ Market Maker



                   Ariadna Dumitrescu    Corporate Governance and Market Liquidity
                            Motivation    The Model
                            The Model     Manager’s Problem
                               Results    Shareholders’ Problem
                            Conclusions   The Equilibrium


First Stage Game


     Nature reveals the earnings y
     Manager
       ◦ observes the realized earnings y
       ◦ makes an earnings announcement v = y +
       ◦ chooses the dividends to be paid z (v ) = α + βv .


     Majority Shareholder decides whether to intervene or not.




                    Ariadna Dumitrescu    Corporate Governance and Market Liquidity
                          Motivation    The Model
                          The Model     Manager’s Problem
                             Results    Shareholders’ Problem
                          Conclusions   The Equilibrium


Manager’s payoff


     Manager receives a fixed salary W
     If no intervention takes place he receives a bonus payment
     (1 − a) R,
     where R is the expected payoff after dividends and manager’s
     wage W

                           R =v −W −z

     Manager makes profits from insider trading




                  Ariadna Dumitrescu    Corporate Governance and Market Liquidity
                             Motivation       The Model
                             The Model        Manager’s Problem
                                Results       Shareholders’ Problem
                             Conclusions      The Equilibrium


Manager’s problem
  Manager’s payoff if there is intervention

                UI = W + b((y − z − W ) − p)d.

  Manager’s payoff if there is no intervention

   UNI = W + (1 − a)(v − z − W ) + b(a(y − z − W ) − p)d.

  Manager’s strategy is

                           z (v ) = α + βv ,

  is chosen in order to maximize his expected payoff

                   z ∗ (v ) = arg max E U v .
                                          x

                     Ariadna Dumitrescu       Corporate Governance and Market Liquidity
                              Motivation        The Model
                              The Model         Manager’s Problem
                                 Results        Shareholders’ Problem
                              Conclusions       The Equilibrium


Shareholder’s problem
  Shareholder’s revenue if there is intervention
                                                              ξπ
                SI = φ(z + b(y − W − z)) −                       .
                                                               2
  Shareholder’s revenue if there is no intervention

                  SNI = φ(z + ab(y − W − z)).

  Shareholder’s strategy is

                           π (z) = δ + γz,

  is chosen in order to maximize his expected revenue

                    π ∗ (z) = arg max E S z .
                                            π

                     Ariadna Dumitrescu         Corporate Governance and Market Liquidity
                           Motivation    The Model
                           The Model     Manager’s Problem
                              Results    Shareholders’ Problem
                           Conclusions   The Equilibrium


Second Stage Game

     Kyle (1985)
     Manager and liquidity traders submit their orders d(V (y , z))
     and ω, respectively.

     Market maker sets the price conditional on the total order flow

            p (u, z) = Ez [ V (y , z)| u] = µ (z) + λ (z) u

     where the total order flow is


                         u = d(V (y , z)) + ω.



                   Ariadna Dumitrescu    Corporate Governance and Market Liquidity
                             Motivation    The Model
                             The Model     Manager’s Problem
                                Results    Shareholders’ Problem
                             Conclusions   The Equilibrium


The Equilibrium
  There is a unique linear equilibrium where the optimal dividend
  payout policy is
                x (v ) = α + βv ,
  and shareholders’ intervention strategy is
                π (z) = δ + γz,

                    v       C          K
                α=    − W − (σ + 1) − (σ − 1)
                    2       2          2
                                 1
                            β=
                                 2
                         1 σ−1
                   δ=σ−         (v − W − K σ)
                         C σ+1
                              1 σ−1
                          γ=
                              C σ+1
                     Ariadna Dumitrescu    Corporate Governance and Market Liquidity
                             Motivation    The Model
                             The Model     Manager’s Problem
                                Results    Shareholders’ Problem
                             Conclusions   The Equilibrium


The Equilibrium (2)
  The demand of the manager in financial markets is
              d (V (y , z)) = ρ (z) V (y , z) − V (z) ,
  and the equilibrium price is
                     p (u, z) = µ (z) + λ (z) u,
  where
                           1                      Vω (Vy + Vε )
    ρ (z) =
               2 (π (z) + a (1 − π (z)))              Vy Vε
   µ (z) = V (z, e)
               1   V V |z                                              Vy Vε
   λ (z) =                = (π (z) + a (1 − π (z)))                              .
               2    Vω                                             Vω (Vy + Vε )

                     Ariadna Dumitrescu    Corporate Governance and Market Liquidity
                             Motivation      Expected Dividend and Intervention Probability
                             The Model       Market Performance
                                Results      Disclosure and Market Performance
                             Conclusions     Corporate Governance and Market Performance


Expected Dividend and Intervention Probability



  The expected dividend report is
                                           C          K
       E (z) = E (x) = y − W −               (σ + 1) − (1 − σ) .
                                           2          2
  The expected intervention probability is
                                           1          1       K
       E (π (z)) = δ + γE (z) =              (σ + 1) + (1 − σ) .
                                           2          2       C




                     Ariadna Dumitrescu      Corporate Governance and Market Liquidity
                            Motivation    Expected Dividend and Intervention Probability
                            The Model     Market Performance
                               Results    Disclosure and Market Performance
                            Conclusions   Corporate Governance and Market Performance


Market Liquidity



  Market depth = the volume of trading needed to move the prices
  by one unit


           1                1                      Vω (Vy + Vε )
               =                                                 .
         λ (z)   (π (z) + a (1 − π (z)))               Vy Vε




                    Ariadna Dumitrescu    Corporate Governance and Market Liquidity
                              Motivation    Expected Dividend and Intervention Probability
                              The Model     Market Performance
                                 Results    Disclosure and Market Performance
                              Conclusions   Corporate Governance and Market Performance


Price Volatility




  We measure the volatility as the variance of the price.


                      1 Vy Vε
          Var (p) =             (π (z) + a (1 − π (z)))2 .
                      2 Vy + Vε




                      Ariadna Dumitrescu    Corporate Governance and Market Liquidity
                             Motivation    Expected Dividend and Intervention Probability
                             The Model     Market Performance
                                Results    Disclosure and Market Performance
                             Conclusions   Corporate Governance and Market Performance


Price Informativeness



  Informativeness of prices = reduction in the variance of the payoff
  after conditioning on price


                 Var (V (y , z)) − Var ( V (y , z)| p)
                1 Vy Vε
              =           (π (z) + a (1 − π (z)))2 .
                2 Vy + Vε




                     Ariadna Dumitrescu    Corporate Governance and Market Liquidity
                            Motivation    Expected Dividend and Intervention Probability
                            The Model     Market Performance
                               Results    Disclosure and Market Performance
                            Conclusions   Corporate Governance and Market Performance


Expected Insider Trading Profit




  The expected insider profit of the manager


                                                                   Vω Vy Vε
    E (V (y , z) − p) d = (π (z) + a (1 − π (z)))                           .
                                                                   Vy + Vε




                    Ariadna Dumitrescu    Corporate Governance and Market Liquidity
                                              Motivation          Expected Dividend and Intervention Probability
                                              The Model           Market Performance
                                                 Results          Disclosure and Market Performance
                                              Conclusions         Corporate Governance and Market Performance


Disclosure and Market Performance
                                              Comparative Statics − Depth
                     2.85



                      2.8



                     2.75



                      2.7
      Market Depth




                     2.65



                      2.6



                     2.55



                      2.5



                     2.45
                            1   1.1   1.2    1.3    1.4     1.5        1.6     1.7    1.8     1.9      2
                                                      Variance of ε
                                      Ariadna Dumitrescu          Corporate Governance and Market Liquidity
                                               Motivation      Expected Dividend and Intervention Probability
                                               The Model       Market Performance
                                                  Results      Disclosure and Market Performance
                                               Conclusions     Corporate Governance and Market Performance


Disclosure and Market Performance
                                               Comparative Statics − Depth
                      1.44




                     1.435
      Market Depth




                      1.43




                     1.425




                      1.42




                     1.415
                             1   1.1   1.2    1.3    1.4     1.5    1.6     1.7     1.8    1.9      2
                                                       Variance of ε
                                       Ariadna Dumitrescu      Corporate Governance and Market Liquidity
                                               Motivation      Expected Dividend and Intervention Probability
                                               The Model       Market Performance
                                                  Results      Disclosure and Market Performance
                                               Conclusions     Corporate Governance and Market Performance


Disclosure and Market Performance
                                               Comparative Statics − Depth
                     1.421




                      1.42




                     1.419
      Market Depth




                     1.418




                     1.417




                     1.416




                     1.415




                     1.414
                             1   1.1   1.2    1.3    1.4     1.5    1.6     1.7     1.8    1.9      2
                                                       Variance of ε
                                       Ariadna Dumitrescu      Corporate Governance and Market Liquidity
                                      Motivation       Expected Dividend and Intervention Probability
                                      The Model        Market Performance
                                         Results       Disclosure and Market Performance
                                      Conclusions      Corporate Governance and Market Performance


Monitoring Costs
                                      Comparative Statics − Depth
                     2.41




                      2.4




                     2.39
      Market Depth




                     2.38




                     2.37




                     2.36




                     2.35




                     2.34
                        0.5             1                          1.5                      2
                                            Cost of monitoring ξ
                              Ariadna Dumitrescu       Corporate Governance and Market Liquidity
                                              Motivation      Expected Dividend and Intervention Probability
                                              The Model       Market Performance
                                                 Results      Disclosure and Market Performance
                                              Conclusions     Corporate Governance and Market Performance


Ownership Concentration
                                              Comparative Statics − Depth
                     2.45




                      2.4




                     2.35
      Market Depth




                      2.3




                     2.25




                      2.2




                     2.15




                      2.1
                            0   0.1   0.2    0.3    0.4     0.5     0.6    0.7     0.8    0.9      1
                                                      Ownership φ
                                      Ariadna Dumitrescu      Corporate Governance and Market Liquidity
                                              Motivation         Expected Dividend and Intervention Probability
                                              The Model          Market Performance
                                                 Results         Disclosure and Market Performance
                                              Conclusions        Corporate Governance and Market Performance


Bonus Scheme
                                              Comparative Statics − Depth


                      2.3




                     2.25
      Market Depth




                      2.2




                     2.15




                            0   0.1   0.2    0.3    0.4       0.5       0.6   0.7     0.8    0.9      1
                                                           Fraction a
                                      Ariadna Dumitrescu         Corporate Governance and Market Liquidity
                           Motivation
                           The Model
                              Results
                           Conclusions


Conclusions



     Endogenous disclosure of information may increase the
     asymmetry of information in the financial markets.
     Shareholders reduce agency costs through monitoring but may
     also reduce stock liquidity by creating information asymmetry
     problems.
     The effect of corporate transparency on market liquidity
     depends on the effectiveness of the other corporate
     governance mechanisms in place.




                   Ariadna Dumitrescu    Corporate Governance and Market Liquidity

				
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