Essays in empirical corporate finance: covenant violations, market timing and product market competition

This thesis comprises of three chapters. The first essay is sole-authored and is titled `Creditor Control Rights and Managerial Risk Shifting.' The second essay is titled `Creditor Control Rights and Product Market Competition' and is joint work with Professor Matthew T. Billett and MiaoMiao Yu. The third essay is sole-authored and is titled `Merger Waves, Pseudo Market Timing, and Post-Merger Performance.' Chapter one examines agency conflicts around violations of bank loan covenants. Recent evidence shows that corporate policies change significantly following financial covenant violations. These changes are attributed to increased creditor influence over borrowing firms in ways that benefit both shareholders and debtholders. In this essay, I investigate whether shareholders engage in activities counter to creditors' interests following violations. I find that the expected negative relation between volatility and investment reverses for firms once they violate a covenant, consistent with risk-shifting behavior. This behavior is more pronounced in firms with high CEO portfolio sensitivity to stock return volatility and firms with high CEO equity ownership. Moreover, I document a significant increase in firm risk in the year following the violation. Overall, these findings suggest that even in the presence of increased creditor control risk shifting still occurs. The prior conclusions that shareholder-debtholder incentives are congruent at violations do not appear to be the case. Chapter two documents that debt covenants have a profound impact on firms' product market behavior. By examining financial covenant violations from 1996 to 2007, we show that once firms violate a covenant, they experience a substantial decrease in their market share. We also show that firms exhibit poor long-term abnormal returns following covenant violations. In contrast, their rivals grow market share and exhibit significantly positive abnormal returns after their peer firm violates a covenant. Overall, these findings suggest that creditor influence over firms have dramatic effects on product market outcomes and rival firm behavior. Chapter three questions whether managers time the market when they make merger decisions. Merger and acquisition waves seem to correspond with market tides, cresting with bull markets. A contentious debate exists over whether this trend indicates managerial market timing ability. Pseudo market timing, introduced by Schultz (2003, Journal of Finance 58, 483-517), provides an alternative hypothesis to explain abnormal performance following events even when managers cannot time the market. I find that acquiring firms which use stocks as the method of payment exhibit negative long-run abnormal returns in event-time, but not in calendar time. Simulations reveal that even when ex ante expected abnormal returns are zero (i.e. managers have no market timing ability), median ex post performance for acquirers is significantly negative when event-time is used. These findings support pseudo market timing as an explanation for acquiring firm underperformance in the context of stock mergers.