The importance of governance and risk management in corporate finance: An empirical analysis of financing and interest rate risks

The dissertation deals with corporate governance and risk management from an empirical corporate finance perspective. Three specific aspects are scrutinized in detail: (1) the governance role of capital structure and ownership structure as well as their respective contribution to firm value, (2) the importance of corporate governance in the process of equity capital increases, and (3) the management of interest rate risk by means of forecasting target rate changes by monetary policy authorities. First, the literature review reveals that capital structure and ownership structure constitute important components of the overall corporate governance framework of the firm. Based on the prevailing separation of ownership and control in (listed) corporations, the chapter focuses on the resulting agency problems and provides an overview of how capital and ownership structure can alleviate these problems. Mitigating agency problems can be accomplished for example through increasing leverage in order to put pressure on the management to generate the required minimum cash flows or by incentivizing managers through managerial share ownership. The main contribution of this chapter is the finding that managers cannot generate firm value simply by setting an optimal capital and ownership structure. Instead, corporate financial policies are jointly optimized in equilibrium and additionally depend on the prevailing level of alternative internal and external corporate governance mechanisms and provisions. In this context, the chapter emphasizes the importance of endogeneity and the relevance of accurately accounting for it in empirical investigations in this research field. Finally, open issues in the literature and avenues for future research are addressed. Second, the role of governance in the context of seasoned equity offerings of real estate companies is scrutinized. Using a 4-factor model event study, average decreases in shareholder value of one percent are documented upon announcement of seasoned equity offerings. Further analyses illustrate that companies with a rather concentrated ownership structure, lower leverage, and less disposable cash experience less negative announcement effects. Therefore, the results suggest that firms with good corporate governance, as indicated by concentrated ownership which facilitates effective monitoring, and a lower probability of overinvestment problems, as indicated by lower cash amounts on firms’ balance sheets, are less likely suspected of squandering the offering proceeds. The chapter therefore concludes that investors evaluate the potential for active monitoring by shareholders on the one hand and the risk of empire building by the management on the other hand when they assess the impact of capital increases. Thus, companies with sound corporate governance and investment policy suffer lower losses in shareholder value. Moreover, the analysis reveals that firms were consistently able to issue equity, even during periods of financial turmoil such as the financial crisis. This is a positive signal for both managers and regulators. Third, the final chapter highlights the risk management perspective of the dissertation by focusing on interest rate changes. The rapid deterioration of credit market conditions during the global financial crisis has emphasized that interest rate risk management is essential. A suitable instrument for this purpose is presented in this chapter which studies target interest rate decisions by the Federal Reserve. These monetary policy decisions significantly affect interest rates on debt markets and thus the financing opportunities of companies (e.g. Kuttner 2001; Swanson/Williams 2014). In order to predict changes of the federal funds target rate, market expectations of future monetary policy are recovered using the prices of federal funds derivatives. Subsequently, changes of these expectations upon the release of macroeconomic news, such as employment or inflation data, are studied using event study methodology. The analysis reveals the following important findings. Prior to 2007, changes in monetary policy expectations are generally consistent with a Taylor rule in which employment-related news dominate whereas inflation-related announcements only have a minor impact. However, the findings change significantly with the beginning of the financial crisis and the approach of the zero lower bound in 2007 and 2008. Monetary policy expectations hardly react to macroeconomic announcements anymore. This suggests that market participants expected a considerable period of monetary policy without any target rate changes irrespective of the macroeconomic development. This seems reasonable due to the overall negative economic outlook by that time and a target rate virtually at zero percent. The results provide new evidence for the existence of different US monetary policy regimes depending on the state of the economy. The onset of the financial crisis seems to have triggered a regime switch. Thus, the chapter also illustrates the importance of adapting interest rate forecasting tools to account for possible policy regime switches, asymmetric distribution of future interest rates, and unconventional monetary policy measures. Only in this way, reasonable expectations of future interest rates can be formed and firms are enabled to manage interest rate risk accordingly.