Entrepreneurship, Finance, Governance and Ethics

The actions behind the “Great Recession” have done a lot of damage to the ability of the average investor to trust both corporate executives and Wall Street. Given the riskiness of investing in private equity, private firms are particularly vulnerable to the risk aversion of investors. For this reason, maintaining trust may be particularly useful to private firms. Using a dataset that spans 33 countries from 1998 to 2004, this paper examines the impact of the perception of ethical behavior at the country level on the performance and outcome of private firms. Using two separate sources for country-level perception of ethics, this paper finds that both the performance and the outcome of the private firm are positively influenced by the level of perceived ethics in their country. The paper further finds that these benefits come without adding cost to the entrepreneurial firm (as well as its pre-issue investors) when it goes public.

The paper uses a new, hand-collected dataset of 93 private equity backed buyouts and 96 PLCs that became financially distressed over the period 1995–2008 to investigate empirically whether private equity owned companies (buyouts) in financial distress (Receivership/Administration) have better recovery rates for secured debt than their publicly owned (PLC) counterparts and, if so, why. We find that the recovery rates of buyouts (amount recovered in proportion to secured debt outstanding) are in fact about twice that of PLCs during this period. Administration, surprisingly, has no effect on debt recovery rates but seems significantly to reduce the time to recovery. A larger number of creditors which in theory should reduce recovery rates, again has no impact, nor does company size. Intriguingly, however, higher leverage consistently reduces the recovery rate as (we hypothesise) more leveraged buyouts need to have recourse to lower quality assets for security. Finally, the time in recovery is negatively related to the date of distress onset (later years have shorter durations) and to the size of the firm (a concave relationship).

This chapter presents results from an empirical study concerning post-investment value-added services provided by philanthropic venture capitalists to their backed social enterprises. Results show that the most important activity consists in the provision of strategic advice for organizational development. Philanthropic venture capitalists act as advisors and mentors of social entrepreneurs. Also, findings show how important is facilitating access to future potential funders on the side of the social enterprise.

This chapter summarizes recent research on the role of law, culture and corruption on venture capital (VC) fund structure, governance and performance. Evidence from studies that involve a multitude of countries is primarily considered. The evidence across most studies is broadly consistent with the view that legal protection enables superior compensation arrangements in limited partnerships where the interests of general partners and limited partners is aligned. More corrupt countries, by contrast, have less efficient compensation structures. The evidence further indicates that better legal systems facilitate contract performance. Finally, the evidence show countries with higher levels of corruption have higher levels of returns, suggesting that fund managers are able to alleviate the effects of corruption in investee companies. In our concluding comments we discuss venture capital around the world and its future development in relation to law, corruption and culture.

The UK Alternative Investment Market (AIM) was launched in 1995 and has been a great success. In this chapter we examine the development of AIM and its attraction for both UK and overseas companies seeking a UK listing. We detail the structural characteristics of AIM examining the role played by the nominated advisor (NOMAD), and the corporate governance requirements for AIM companies. We highlight the distribution of companies on AIM from various overseas countries and from various industries. The key corporate governance disclosures drawn from annual reports pre and post AIM Rule 26 are discussed in mini-case studies based on four AIM companies, two being incorporated in the UK and two non-UK incorporated. We also contextualise AIM comparing it to other junior markets globally. Finally we have some concluding comments about AIM and its future development.

This Chapter explores the duties that controlling shareholders have towards minority shareholders, either directly or indirectly. Whereas controlling shareholder’s rights are quite vast, their duties tend to be very limited. This Chapter affirms that a balance between controlling shareholders’ rights and duties is needed and analyzes the equilibrium developed in two legal systems: the US common-law system and the French civil law system. Whereas controlling shareholders seem to be assigned more duties in France than in the US, enforcement rules and case laws mitigate this fact.

We consider for the first time the impact of fund regulation on the international distribution of investment funds. We study the 2001 UCITS Directive of the European Union, which was put in place to mitigate fraud and promote investor confidence throughout Europe. We examine the impact of UCITS on international distributions of European investment funds over the 2002–2009 period. We show that the UCITS regulatory structure has significantly facilitated cross-border fund distributions, albeit UCITS has had less success for facilitating distributions among smaller fund promoters. Also, UCITS funds, especially UCITS equity funds, have lost some of their advantage in terms of cross-border distribution during the period of the recent financial crisis. Further, we show there has been a growing interest in UCITS over time outside Europe, notably in Asia.

We consider the problem of an investor who wishes to allocate her wealth according to some socially responsible (SR) criteria. The reduction in the investment set opportunity produces a cost for the investor which we call “cost of sustainability”. On the other hand, the investor is aware that the financial performances of some actively managed SR portfolios may be better or comparable to those of conventional portfolios. For this reason, the investor decides to entrust her wealth to a portfolio manager able to produce accurate forecasts of SR asset returns. The investor’s task is threefold: (a) hiring a manager who can offset the cost of sustainability; (b) setting a bonus to compensate the manager for the investment restriction; (c) attracting only the best and more motivated managers. We provide a solution to these problems and apply our results to data consisting of S&P500 firms screened by KLD scores.

We propose a new methodology to integrate Socially Responsible (SR) standards in the process of investment decisions. We use SR scores of companies in the S&P500 and in the Domini Social Index (DSI) to define the level of SR of a portfolio. We model this as a linear combination of the SR scores of the single stocks with coefficients given by the portfolio’s weights. We form portfolios that minimize the tracking error from the DSI while improving the SR level. The analysis of the performances of the portfolios show that the improvement of the SR is usually possible at a small cost in terms of tracking error, and that the improved portfolios produced, in most of the cases, better financial performances than the benchmark.

We examine the determinants of equity ownership by outside directors as well as the relationship between ownership and operating performance. Unlike previous studies of equity ownership by directors, we use hand-collected data on firm-level policies requiring director ownership for S&P 500 firms during the years 2003 and 2005. Ownership requirements allow us to shed further light on the determinants of director holdings and to separate voluntary from mandatory holdings of directors. If ownership requirements reflect optimal ownership levels (from the firm’s perspective), they provide a useful identification tool in the examination of ownership-performance relationships. Our primary findings are that mandatory holdings are unrelated to future performance; this is consistent with the theory that ownership requirements reflect optimal ownership levels. By contrast, voluntary holdings are positively and significantly related to future performance, suggesting that they perform an incentivizing role for management.

Another wave of corporate scandals has hit the market in the last decade, reviving attention to the effect of these events on shareholder value, corporate governance and stock market reactions. Given this evidence a growing body of research has investigated the determinants of frauds, the effects of frauds on investors and stakeholders wealth and tried to identify channels and tools to early detect frauds and therefore reduce the loss in social welfare. This chapter provides a comprehensive view on the state of the current research on these issues and provides suggestions for future research.

Strategic corporate responses to climate change and environmental challenges do not seem to be the primary domain of corporate management. In the short-run, such decisions are generally not consistent with executive incentives and often not seen as profit maximizing. Nevertheless, as some climate change responses may indeed be firm value maximizing, such decisions can be expected to reflect the nature of a firm’s corporate governance. Based on an analysis of 500 of the largest U.S. firms, we show empirically that this is indeed the case. Specifically, this study documents that institutional ownership and board entrenchment seem to significantly influence climate change and environmental impact mitigation policies of large firms.

This study investigates whether mutual fund ownership deters corporate fraudulent behavior among Chinese listed firms. While the existing literature on corporate fraud in China focuses mainly on the impact of internal governance mechanisms, limited attention has been paid to the effect of external governance mechanisms. In China where investor protection and legal enforcement are relatively weak, mutual fund ownership is expected to enhance the effectiveness of the stock market to deter managerial expropriation. This is because mutual funds are institutional investors that have more resources and expertise than individual investors to monitor firm executives. However, the impact of mutual fund ownership in deterring fraudulent activities is expected to be greater among Chinese listed firms under private control than state control. This is because privately controlled firms receive less financial support from the government and are more reliant on external funding via the capital market. We confirm empirically the aforementioned assertions. Our findings imply that mutual fund ownership and state ownership generate offsetting corporate governance effects.

While institutional shareholders are shown to be effective monitors in curbing executive compensation in mature capital markets, this study presents findings from Chinese stock markets, and indicates the possible collusion between institutional shareholders (e.g. mutual funds) and executives in publicly listed companies. Mutual funds in China fail to serve as an effective monitor of executive compensation, suggesting that ethics seems to play no part when mutual funds and the management of listed companies extract their self-interests. Further analysis also demonstrates that, while bank-affiliated mutual funds are not better monitors than non-bank-affiliated ones, joint-equity-bank-affiliated ones are more effective monitors than state-owned-bank-affiliated ones.

We assess to what extent Chinese MBOs of listed corporations enable a balance to be achieved in terms of facilitating growth while maintaining the interests of other (minority) shareholders. Using novel, hand-collected data from 19 MBOs of listed corporations in China, we examine to what extent boards of directors are changed to bring in executive and outside directors with the skills to grow as well as restructure a business, and to what extent outside directors become involved in actions to develop the business versus actions relating to fostering the interests of all shareholders. We find little evidence that outside board members have the skills to add value to the MBO firms. Boards appear to focus mainly on related-party transactions with some more limited attention to growth strategies. Outside directors do not seem to openly disagree with incumbent managers on the disclosure of their actions but may express their views and exert pressure behind the scenes.

To find the impact of multiple large shareholders on dividend payments, this chapter examines the association between cash dividends and the shareholders balancing mechanism (SBM) using the exogeneity and endogeneity assumptions of corporate ownership structure. This chapter identifies, in the case of China, whether paying cash dividends is a means of protection or the expropriation of minority shareholders’ interests. With 4,810 observations from companies listed on the Shanghai Stock Exchange over the period 2004–2008, the authors find significant negative associations between cash dividend payments and the SBM of non-controlling large shareholders under the exogeneity assumption, and the SBM of tradable shareholders under the endogeneity assumption. The findings suggest that cash dividends are used as a manner of tunneling by the controlling shareholder. This chapter also shows that the SBM of non-controlling shareholders has a significant positive effect on cash dividends, especially for companies paying high and abnormal dividends. The results imply that in China’s capital market, cash dividend payments are not only expropriations of minority shareholders’ interests by the controlling shareholder, but also by the coalition of controlling and non-controlling large shareholders. The findings confirm the tunneling and joint expropriation incentive of corporate dividend policy, and suggest that the presence of multiple large shareholders doesn’t always alleviate firm's agency costs and protect the benefits of minority shareholders.