Economic Theories on Corporate Law - Dictionary of Arguments
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Corporate Law/Economic theories/Gelbach/Klick: One area of law and economics where empirical work has been slow to adopt the modern quasi-experimental approach is corporate law and economics. In this area, the standard approach to empirical inquiry involves the use of event studies to deduce the effect of various public policies or internal corporate governance mechanisms on firm value.*
Event studies/model: Event studies in this literature generally follow a fairly simple recipe. A researcher identifies the timing of the event of interest and assumes that the effect of this event will be capitalized into the value of the asset in question,
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appealing to the assumption of semi-strong market efficiency. The researcher then estimates a time series model of the asset’s returns based upon the historical relationship between the asset’s returns and other covariates, usually including some proxy for the market return. Based upon this model, the researcher predicts the asset’s return at the time of the event. The researcher then calculates the excess return for the event date, which is the difference between the actual return at the time of the event and the predicted counterfactual return. This excess return is then standardized to account for the volatility of the asset (i.e., the excess return is normalized by dividing by some measure of volatility of the asset’s return such as the standard deviation of non-event day excess returns), and statistical inferences are made. (see Bhaghat and Romano 2002)(3), (see Gelbach, Helland, and Klick, 2013)(4).
Event studies: Expressed this way, it is easy to see that event studies are functionally equivalent to estimating a simple before-and-after time series model with no comparison group.
Manne’s hypothesis/hostile takeover: It has also been used by Jonathan Klick and Robert Sitkoff to study Henry Manne’s market-for-corporate-control hypothesis (Klick and Sitkoff, 2008)(5). This hypothesis states that for publicly held firms, the possibility of a hostile takeover will discipline a firm’s managers, forcing them to maximize firm value even if the firm’s board is less than perfect in its monitoring. Klick and Sitkoff exploit the political economy dynamics that surrounded an attempt to sell the controlling interest in the Hershey Company in 2002.
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Results from Klick and Sitkoff’s study offer credible support for the Manne hypothesis, even though they amount to standard before-and-after analysis, because the events in question did not appear to be confounded by any other systematic changes.
Literature: As Vladimir Atanasov and Bernard Black discuss in a recent literature review, it is rare for empirical research in corporate finance, including research done by law and economics scholars, to focus on the kinds of natural experiments (...). (Atanasov and Black, 2014)(6). >Economic models/Gelbach/Klick.
Comparison: While comparison groups are sometimes used indirectly for so-called falsification tests, or as general control variables, it is rare that they are used to generate difference in differences estimates. One notable exception is provided by Michael Greenstone, Paul Oyer, and Annette Vissing-Jorgensen (2006)(7), who re-examine the issue of mandatory disclosure that had previously been studied at least as far back as George Stigler’s famous 1964 study (Stigler, 1964)(8). Contrary to findings in much of the previous literature that had not employed counterfactual comparison groups, these authors found that mandatory disclosure had significant effects on the returns of the affected firms.
* Fama et al. (1969)(1) is often credited as the first event study. However, as noted by Newhard (2014), Armen Alchian had performed one in 1954 while he was working at Rand to deduce the fusion fuel being used in the newly developed hydrogen bomb using stock prices of firms providing the candidate fuels. This paper was never published since it was deemed a threat to national security.
1. Fama, Eugene, Lawrence Fisher, Michael C. Jensen, and Richard Roll (1969). “The Adjustment of Stock Prices to New Information.” International Economic Review 10(1): 1–21.
2. Newhard, Joseph Michael (2014). “The Stock Market Speaks: How Dr. Alchian Learned to Build the Bomb.” Journal of Corporate Finance 27: 116–132.
3. Bhagat, Sanjai and Robert Romano (2002). “Event Studies and the Law: Part I: Technique and Corporate Litigation.” American Law and Economics Review 4(1): 141–168.
4. Gelbach, Jonah, Eric Helland, and Jonathan Klick (2013). “Valid Inference in Single-Firm Single-Event Studies.” American Law and Economics Review 15(2): 495–541.
5. Klick, Jonathan and Robert Sitkoff (2008). “Agency Costs, Charitable Trusts, and Corporate Control: Evidence from Hershey’s Kiss-Off.” Columbia Law Review 108(4): 749–838.
6. Atanasov, Vladimir and Bernard Black (2014). “Shock-Based Causal Inference in Corporate Finance Research.” Northwestern Law and Economics Research Paper 11-08.
7. Greenstone, Michael, Paul Oyer, and Annette Vissing-Jorgenson (2006). “Mandated Disclosure, Stock Returns, and the 1964 Securities Acts Amendments.” Quarterly Journal of Economics 121(2): 399–460.
8. Stigler, George J. (1964). “Public Regulation of the Securities Markets.” Journal of Business 37(2): 117–142.
Gelbach, Jonah B. and Jonathan Klick „Empirical Law and Economics“. In: Parisi, Francesco (ed) (2017). The Oxford Handbook of Law and Economics. Vol 1: Methodology and Concepts. NY: Oxford University Press._____________Explanation of symbols: Roman numerals indicate the source, arabic numerals indicate the page number. The corresponding books are indicated on the right hand side. ((s)…): Comment by the sender of the contribution. Translations: Dictionary of Arguments The note [Author1]Vs[Author2] or [Author]Vs[term] is an addition from the Dictionary of Arguments. If a German edition is specified, the page numbers refer to this edition.
Francesco Parisi (Ed)
The Oxford Handbook of Law and Economics: Volume 1: Methodology and Concepts New York 2017