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Paul Povel

Paul Povel

Judge James A. Elkins Professor of Finance

 

Research

Published Articles
Working Papers
Older Papers
 


 

 

 

 

Published Articles
 

Capital Structure Under Collusion (joint with Daniel Ferrés, Gaizka Ormazabal, and Giorgo Sertsios)

Published in: Journal of Financial Intermediation, Volume 45, 100854.

Download: This paper can be downloaded from the JFI website, or by clicking here.

Abstract: We analyze the financial leverage of firms that collude to soften product market competition by forming a cartel. We find that cartel firms have lower leverage during collusion periods. This is consistent with the idea that cartel firms strategically reduce leverage to make their cartels more stable, because high leverage makes deviations from a cartel agreement more attractive. Given that cartels have a large economic footprint, their study is also relevant for the capital structure literature, which has largely ignored the role of anti-competitive behavior.

 

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Competition for Talent under Performance Manipulation (joint with Iván Marinovic)
[An earlier version of this paper circulated as “Competition for Talent under Performance Manipulation: CEOs on Steroids”]

Published in: Journal of Accounting and Economics, Volume 64, Issue 1: August 2017, pp. 1-14.

Download: This paper can be downloaded from the JAE website, or by clicking here. The Internet Appendix with proofs and derivations can be downloaded by clicking here.
The January 2014 version (with a slightly different model) can be downloaded by clicking here.
The April 2013 version (model with a continuum of types) can be downloaded by clicking here.

Abstract: We study the effects of introducing competition for CEOs, assuming that the talent of CEOs is not observable and that they can misreport their performance. Without competition for talent, firms maximize their profits by offering inefficiently low-powered incentive contracts. Competition for talent removes those inefficiencies, but it leads to excessively high-powered incentive contracts, causing efficiency losses that can be more severe than the inefficiencies that competition mitigates. If misreporting is not a concern, however, then competition for talent has unambiguously positive effects on efficiency.

 

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An Experimental Analysis of Risk Shifting Behavior (joint with Pablo Hernández-Lagos and Giorgo Sertsios)
[An earlier version of this paper circulated as “Does Risk Shifting Really Happen? Results from an Experiment”]

Published in: Review of Corporate Finance Studies, Volume 61, Issue 1: March 2017, pp. 68-101.

Download: This paper can be downloaded from the RCFS website, or by clicking here.
This questionnaire (Spanish, with translation) can be downloaded here.

Abstract: We study risk-shifting behavior in a laboratory experiment, a setup that overcomes methodological hurdles faced by empiricists in the past. The participants are high-level managers. We observe risk shifting in a simple setup, but less in a setup with a continuation value. Reputation effects also reduce risk shifting. When combined, a continuation value and reputation effects eliminate risk shifting. Our findings shed light on environments in which risk-shifting is unlikely to happen, and why earlier studies produced conflicting results. In particular, our findings show that managers' concerns with their own reputations are an important factor that mitigates risk shifting.

 

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Boom and Gloom (joint with Giorgo Sertsios, Renáta Kosová and Praveen Kumar)  

Published in: Journal of Finance, Volume 71, Issue 5: October 2016, pp. 2287-2332.

Download: This paper can be downloaded from the JF website (alternative), or by clicking here.   The Internet Appendix (with additional proofs and model extensions) can be downloaded from the JF website, or by clicking here.

Abstract: We study the performance of investments made at different points of an investment cycle. We use a large data set covering hotels in the U.S., with rich details on their location, characteristics and performance. We find that hotels built during hotel construction booms underperform their peers. For hotels built during local hotel construction booms, this underperformance persists for several decades. We examine possible explanations for this long-lasting underperformance. The evidence is consistent with information-based herding explanations.

 

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Getting to Know Each Other: The Role of Toeholds in Acquisitions (joint with Giorgo Sertsios)

Published in: Journal of Corporate Finance, Volume 26: June 2014, pp. 201-224.

Download: This paper can be downloaded from the JCF website, or by clicking here.

Abstract: We analyze the role of toeholds (non-controlling but significant equity stakes) as a source of information for a bidder. A toehold provides an opportunity to interact with the target and its management and in the process get a better sense of the possible synergies from a merger or takeover. A bidder considering taking over a target will take a toehold beforehand if the informational benefits are large. Our model makes the following predictions: (i) a toehold is more beneficial if a target is opaque, i.e., if it is generally harder to value potential synergies with the target; (ii) a toehold is incrementally more beneficial if a bidder initially finds it harder than others to assess the value of potential synergies; (iii) that incremental benefit is less important, however, if the target is opaque; (iv) the benefits from having a toehold are smaller if the number of potential rival bidders is higher. We test these pre- dictions using a large sample of majority acquisitions of private and public companies for which we have information regarding whether the acquirer had a toehold in the target company prior to the majority acquisition. We find evidence consistent with our hypotheses, and thus with the idea that potential acquirers of a target use toeholds to improve their information about possible synergies with the target.

 

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Stapled Finance (joint with Raj Singh)

Published in: Journal of Finance, Volume 65, Issue 3: June 2010, pp. 927-953; finalist for the 2010 Brattle Group Prize.

Download: This paper can be downloaded from the JF website (alternative), or by clicking here.   The Internet Appendix (with additional proofs and model extensions) can be downloaded from the JF website, or by clicking here.

Abstract: Stapled Finance is a loan commitment arranged by a seller in an M&A setting. Whoever wins the bidding contest has the option (not the obligation) to accept this loan commitment. We show that stapled finance increases bidding competition, by subsidizing weak bidders, who raise their bids and thereby the price that strong bidders (who are more likely to win) must pay. The lender expects not to break even and must be compensated for offering the loan. This reduces but does not eliminate the seller's benefit. It also implies that stapled finance loans will show poorer performance than other buyout loans.

 

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Sale-Backs in Bankruptcy (joint with Raj Singh)

Published in: Journal of Law, Economics and Organization, Volume 23, Issue 3: October 2007, pp. 710-730..

Download: This paper can be downloaded from the JLEO website, or by clicking here.

Abstract: When bankrupt firms are sold, they are often repurchased by their former owner or manager. These insiders are by default better informed than outsiders about the true value of the firm or its assets, so other potential buyers must worry about overpaying if they win. The presence of insiders may thus have a chilling effect on the bidding. We ask how insiders should be treated in bankruptcy sales: Should they be allowed to submit bids? If so, under what conditions? We derive properties of an optimal sale procedure and show that it must be biased against insiders. Specifically, it should be harder for insiders to win with low bids than for outsiders. We show that the "market tests" that are routinely required in bankruptcy sales are sub-optimal, since they treat all potential buyers alike and forgo the benefits of biasing the procedure against insiders.

 

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Booms, Busts, and Fraud (joint with Raj Singh and Andrew Winton)

Published in: Review of Financial Studies, Volume 20, Issue 4: July 2007, pp. 1219-1254.

Download: This paper can be downloaded from the RFS website, or by clicking here.

Abstract: Firms sometimes commit fraud by altering publicly reported information to be more favorable, and investors can monitor firms to obtain more accurate information. We study equilibrium fraud and monitoring decisions. Fraud is most likely to occur in relatively good times, and the link between fraud and good times becomes stronger as monitoring costs decrease. Nevertheless, improving business conditions may sometimes diminish fraud. We provide an explanation for why fraud peaks towards the end of a boom and is then revealed in the ensuing bust. We also show that fraud can increase if firms make more information available to the public.

 

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The U-Shaped Investment Curve: Theory and Evidence (joint with Sean Cleary and Michael Raith)

Published in: Journal of Financial and Quantitative Analysis, Volume 42, Issue 1: March 2007, pp. 1-39 (lead article).

Download: This paper can be downloaded from the JFQA website, or by clicking here.

Abstract: We analyze how the availability of internal funds affects a firm's investment. We show that under fairly standard assumptions, the relation is U-shaped: investment increases monotonically with internal funds if they are large but decreases if they are very low. We discuss the trade-off that generates the U-shape, and argue that models predicting an always increasing relationship are based on restrictive assumptions. Using a large dataset, we find strong empirical support for our predictions. Our results qualify conventional wisdom about the effects of financial constraints on investment behavior, and help to explain seemingly conflicting findings in the empirical literature.

 

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Takeover Contests With Asymmetric Bidders (joint with Raj Singh)

Published in: Review of Financial Studies, Volume 19, Issue 4: Winter 2006, pp. 1399-1431.
Reprinted in: J.H. Mulherin (Ed.), “Mergers and Acquisitions,” Edward Elgar, 2012.

Download: This paper can be downloaded from the RFS website, or by clicking here

Abstract: Target firms often face bidders that are not equally well informed. This reduces the competition between the bidders, since a less well informed bidder fears the winner's curse more. We analyze how a target should optimally be sold in the presence of asymmetric bidders. We show that a sequential procedure can extract the highest possible transaction price. The target first offers an exclusive deal to a better informed bidder, without considering a less well informed bidder. If rejected, the target either offers an exclusive deal to the less well informed bidder, or a modified first-price auction. Deal protection devices can be used to enhance a target's commitment to the procedure.

 

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Financial Constraints and Product Market Competition: Ex-ante vs. Ex-post Incentives (joint with Michael Raith)

Published in: International Journal of Industrial Organization, Volume 22, Issue 7: September 2004, pp. 917-949.

Download: This paper can be downloaded from the IJIO website, or by clicking here

Abstract: This paper analyzes the interaction of financing and output market decisions in a duopoly in which one firm is financially constrained and can borrow funds to finance production costs. Two ideas have been analyzed separately in previous work: some authors argue that debt strategically affects a firm's output market decisions, typically making it more aggressive; others argue that the threat of bankruptcy makes debt financing costly, typically making a firm less aggressive. Our model integrates both ideas; moreover, unlike most previous work we derive debt as an optimal contract. Compared with a situation in which both firms are unconstrained, the constrained firm produces less, while its unconstrained rival produces more; prices are higher for both firms. Both firms' outputs depend on the constrained firm's internal funds; the relationship is U-shaped for the constrained firm and inversely U-shaped for its unconstrained rival. The unconstrained rival has a higher market share, not because of predation but because of the cost disadvantage of the financially constrained firm.

 

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Optimal Debt with Unobservable Investments (joint with Michael Raith)

Published in: RAND Journal of Economics, Volume 35, Issue 3: Autumn 2004, pp. 599-616.

Download: This paper can be downloaded from the RJE website, or by clicking here
The Web-Appendix for the published article (with extra proofs) can be downloaded by clicking here

Abstract: We study financial contracting when both an entrepreneur's investment and the resulting revenue are unobservable to an outside investor. We show that a debt contract is always optimal; repayment is induced by a liquidation threat that increases with the extent of default. Moreover, when the entrepreneur's decision concerns the scale of his project, a contract that minimizes liquidation losses is optimal. When the decision concerns managerial effort or project risk, however, it may be optimal to write a contract with a greater threat of liquidation, to induce the entrepreneur to exert more effort or to choose a less risky project.

 

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Using Bidder Asymmetry to Increase Seller Revenue (joint with Raj Singh)

Published in: Economics Letters, Volume 84, Issue 1: July 2004, pp. 17-20.

Download: This paper can be downloaded from the EL website, or by clicking here

Abstract: We construct the optimal selling mechanism in a pure common value environment with two bidders that are not equally well informed. With an optimal mechanism, the seller benefits from bidder asymmetry: her expected revenue increases if the bidder asymmetry increases.

 

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Multiple Banking as a Commitment Not to Rescue

Published in: Research in Finance, Volume 21: 2004, pp. 175-199.

Download: This paper can be downloaded from the RiF website, or by clicking here

Abstract: We show why investors may prefer not to be a firm's unique lender, even if they are in a strong bargaining position. Some firms need additional funds after a first investment: providing additional funds is rational after the first investment is sunk, but together the two investments are unprofitable. A unique lender will always provide additional funds and make losses. Two creditors can commit not always to provide funds: inefficient negotiations over debt forgiveness may end with a project's liquidation, which is harmful ex post, but helpful ex ante, if it keeps entrepreneurs with nonpromising projects from initially requesting funds.

 

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Optimal ‘Soft’ or ‘Tough’ Bankruptcy Procedures

Published in: Journal of Law, Economics and Organization, Volume 15, Issue 3: October 1999, pp. 659-684.

Download: This paper can be downloaded from the JLEO website, or by clicking here

Abstract: This paper studies optimal bankruptcy laws in a framework with asymmetric information. The key idea is that the financial distress of a firm is not observed by its lenders for quite a while. As early rescues are much cheaper than late rescues, it may pay if the creditors are forgiving in bankruptcy, thereby inducing the revelation of difficulties as early as possible. Either `tough' or `soft' bankruptcy laws can be optimal, depending on the parameters. This implies that mandatory one-size-fits-all bankruptcy procedures cannot be optimal. `Hybrid' procedures, which try to combine elements of `soft' and `tough' procedures, are found to be redundant, and possibly harmful. Absolute Priority Rules may be helpful as a part of `tough' procedures, but their introduction is (partly) inconsistent with the design of `soft' procedures. The paper also reinterprets much of the evidence on the performance of Chapter 11, the `rather soft' U.S. reorganisation procedure, questioning many negative conclusions.

 

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Working Papers

 

Lying to Speak the Truth: Selective Manipulation and Improved Information Transmission (joint with Günter Strobl)

Download: This paper can be downloaded by clicking here

Abstract: We analyze a principal-agent model in which an effort-averse agent can manipulate a publicly observable performance report. The principal cannot observe the agent's cost of effort, her effort choice, and whether she manipulated the report. An optimal contract links compensation to the eventually realized output and, in certain situations, to the (possibly manipulated) report. We show that the optimal contract may incentivize selective manipulation of an unfavorable report by an agent who exerted a high level of effort. Doing so can convert a "falsely" negative report into a positive one, thereby making the report more informative about the agent's effort choice.

 

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Older Papers

 

The Information Content of Put Warrant Issues (joint with Scott Gibson and Raj Singh)

Download: This paper can be downloaded by clicking here.

Abstract: We analyze why firms may want to issue put warrants, i.e., promises to repurchase their own shares at a given price in the future. We describe four alternative explanations, one of which is novel: that put warrants are issued by firms that wish to signal their good future prospects to their investors (who undervalue the firms in the eyes of their managers). We test the validity of the four alternative explanations, using a new, hand-collected data set on put warrant issues in the U.S. between 1993 and 1999. We find evidence that is inconsistent with three of the four explanations. Only the signaling explanation is consistent with the empirical evidence. Put warrant issuers strongly outperform their peers in the years after the put warrant issues; they enjoy valuable and improving investment opportunities, and they invest heavily. Put warrant issuers are thus very different from other firms with ongoing open market share repurchase programs.

 

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Optimal Investment Under Financial Constraints: the Roles of Internal Funds and Asymmetric Information (joint with Michael Raith)

This paper was superseded by The U-shaped Investment Curve: Theory and Evidence

 

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Core Allocations For a Salary-Adjustment Process With Worker Offers

Download: This paper can be downloaded by clicking here.

Abstract: This paper extends the set of feasible algorithms for finding core allocations in a job-matching game. In Kelso and Crawford, Econometrica 1982, firms make offers to the workers. The reverse case of algorithms in which the workers make the offers was not analysed as it was expected to lead to technical difficulties. In fact, such algorithms can easily be constructed. They are similar to the ones described by Kelso and Crawford, and the same assumptions are critical.

 

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