Perspectives on Corporate Finance Research

1. Perspectives on Corporate Finance Research Ronald Masulis Vanderbilt University FMA PhD Seminar 2007

2. Research Trends (1) • More corporate governance research is coming! • Optimal board structure • Deeper understanding of CEO employment contracts and compensation • Focus on relationships among various governance mechanisms • More cross country and non-US company analysis • Analysis of the relations between corporations and government officials and organizations • New analysis of the influence of corporations on the passage of laws and regulations • Relationships between corporations and financial institutions, especially banks and other institutions that are major creditors or equity holders • Greater integration of law & economics with corporate finance – Law Matters!

3. Research Trends (2) • Corporate bonds will gain greater visibility – new databases are available • Bond returns and bond covenants are likely to garner much more attention • More bond return event studies • Relation between bond prices and stock prices and risk arbitrage • Corporate bond offerings and flotation costs • Security choice decisions are going to be explored more deeply • Development of better solutions to selection bias and endogeneity issues • Journals are going to continue to demand more auxiliary evidence to distinguish among hypotheses that have the same qualitative implications

4. Basic Research Recommendations • Know the relevant institutional details intimately • Read extensively on legal, economic, accounting implications of your research topic • Talk to practitioners about your hypotheses • Understand the economic incentives of all the participants • Are you sure that you are studying only one economic process? • Know the major theories and evidence in the existing literature • Survey papers are often helpful • Make your own summaries of important papers • Look for conflicting theoretical predictions • Know the strengths and weaknesses of datasets you are using • Are you using the most accurate and complete dataset available? • Cross check random samples of this dataset against original sources - if unsure • Have you checked the outliers for accuracy? • Outliers can warn you that something is missing in your statistical model • What are the distributional properties of the key variables you are using? • Do your datasets allow you to ask important question not previously analyzed?

5. Be a Sophisticated User of Statistics • The more statistical techniques you know, the more tools you have available in your research toolbox • Know their strengths and weaknesses well! • Know the underlying distributional assumptions • Know the setting where they have been used before • Know the setting where their use has been criticized • Be able to pick the best statistical method for the problem at hand • Don’t just replicate what is already being done • Innovate by using an approach not used in the literature before, but one that has advantages over the existing approaches • Keep watch for new developments • Watch for the introduction of new techniques in the top journals • Read up on the newest econometrics texts

6. Experimental Design & Robustness • How effective is the experimental or statistical design of your study? • Differences in differences approach can be more powerful than many other methods • Can you bring auxiliary evidence to bear to differentiate theories that have the same predictions? • Have you checked your results for reliability using robust techniques? • Adding and dropping control variables • Alternative definitions of dependent variables & key explanatory variables • Non-linear specifications • Median regressions • Winsorizing the data • Trimming extreme outliers • Converting quantitative variables into • Indicator variables • Focusing on top and bottom halves, quartiles or quintiles • Have you worried about selection bias in the data and endogeneity of key explanatory variables?

7. Looking for Empirical Research Topics • Try to articulate your tentative hypothesis very precisely • Is it really an economically important question to the field? • Does it advance our understanding of economic processes? • Is your study going to be interesting regardless of what you find? • How general can your conclusions be? • How generally applicable are your research methods going to be? • New research opportunities • New capital markets • New securities and financial claims • New databases (e.g. corporate and municipal bond prices) • New hypothesis or economic theories • New laws or regulations (A useful new experiment?) • New statistical techniques • Combining several databases (matching across databases can be costly) • Existing studies are seriously flawed and you have a new approach? • Consider starting with a pilot study – test for feasibility and potential problems with your planned approach

8. Finding a Good Topic • Bridging related fields can offer many of benefits • Cross fertilization and transfers of technologies across fields • It can give you new perspectives on a problem • New theories and statistical methods developed in related fields can often be profitably adopted • Macroeconomics and asset pricing theory • Macroeconomics and corporate investment & financing decisions • Financial accounting and market efficiency • Political science and corporate finance • Industrial organization and corporate investment decisions • Law & economics and corporate governance • Econometrics and asset pricing theory • Look for major theories with conflicting predictions • Look for clean experiments where most confounding issues are held constant

9. Be Entrepreneurial • Look for new datasets • Cultivate practitioners for access to proprietary data – it may take a long time to gain their confidence • Look for datasets that have not been used before • Build your own datasets • Consider combining a number of unrelated datasets • What economically important questions have not been adequately studied? • Is there are large, growing financial market that has not been studied? • Do prior empirical studies find contradictory results? • What might be the reasons? Bad economic model, statistical problem, poor data? • Constantly try to learn more about the institutional details in the fields you are researching • Take advantage of opportunities to talk to practitioners & regulators • Continually learn more about the databases you have access to • What are the full set of variables in the dataset? • How complete are the data fields? • How reliable are the various variables in the dataset?

10. Take a Multidimensional Focus • Look at a problem from the perspective of each significant player in the problem • For example: • CEO and senior management • Board of directors (inside, outside, independent, gray) • Stockholders (individual, corporate, institutional – ST or LT) • Founders (director, CEO, family member, blockholder) • Blockholders (corporate, individual, institutional) • Creditors (senior, junior, secured, unsecured) • Customers (monopoly, oligopoly, competitive markets) • Supplier (specialized firm specific products, general goods) • Consider the incentives of supporting players • Financial Institutions • Information producers • Regulators

11. Finding Interesting Theoretical Topics • What’s wrong with existing theories? • Which predictions are supported? • Which predictions are rejected? • Can several specific theories be capture in a more general theory? • How reasonable are the assumptions when measured against practice? • Can a more realistic assumption be incorporated into an existing model? • Is it likely to change the model’s properties? • How sensitive are the predictions of major theoretical models to their assumptions? • Are there some major innovations in basic economic theory that could be applied to your area of research?

12. Importance of a Good Introduction • Researchers put more effort into an article’s introduction than into almost anything else. • You need to be able to motivate very busy people to read your research! • What are the key issues you are addressing? • Why is it economically important? • What are your new contributions? • What are your significant new findings? • What are the economic magnitudes of your key findings? • What are the important economic implications of your evidence? • What is learned about important institutional details and typical patterns found in the economic phenomenon being studied • Use active verbs • What can readers learn that can improve their own research?

13. Become a Better Writer • An important part of being a successful researcher is to write in a clear, careful and concise manner. • If your paper is poorly written or organized, a referee is immediately disposed to reject your paper. • Turgid writing obscures your findings and will undercut your impact. • Marketing matters – excite people about reading your paper – if they don’t read it – then they are unlikely to ever cite it. • Keep a collection of well written papers to inspire and guide you. • Good writers tend to read good literature on a consistent basis.

14. Benefits of Co-authorship • Can increase speed to completion • Potentially more time, energy, budget and insights • Exploit comparative advantages in • Knowledge of the data • Knowledge of institutional detail and economic literature • Knowledge of needed statistical techniques • Learn more quickly how to be a better researcher or successful author • Advantages of co-authoring with experienced researchers in your early years • Know how to write persuasively and professionally • Know how to respond to a referee’s report • Better chance to present in conferences • Potentially better access to practitioners • Knows the political landscape

15. Be a Diplomat! • Your lifetime job is to improve on the existing literature. • There is always a positive way of highlighting your contribution, while at the same time indicating the weaknesses in prior work – watch how it is done in the articles you read. • But be diplomatic – the person you criticize could be your referee, the person who evaluates your next conference submission or maybe your next dean. • You are likely to keep seeing these same researchers for the rest of your career – so why make an enemy when you don’t need to? • Some journals have an implicit policy of not publishing papers that directly undercut their well cited articles. • You are not always going to be right – this profession is one that is based on constant learning and improvement. • Once you start publishing – you will be grateful if future researchers are gentle in highlighting the weaknesses of your prior work. • Remember a better approach is just around the corner – even for your best work.

16. What’s the Real Publication Standard? • You need to recognize that when a paper that came before yours was first conceived, the state of the arts was much less advanced. • Thus, you are likely to underestimate the insights that the paper had to offer to the field when it was accepted for publication. • This can give you a false sense of how easy it is to publish papers in top tier outlets. • It is not easy to publish in the top journals - for almost everyone – it takes determination and continued humility to learn from your mistakes.

17. Don’t Over Reach! • Many research papers interpret their evidence to be much stronger than it really is. • Many studies draw stronger conclusions than are really supported by their evidence • This over reaching can seriously undercut your credibility with careful readers and your referee • Be very careful about drawing policy implications from your work • Since most studies are based on limited samples and a historic period – this makes generalizing conclusions to an entire population hazardous and unjustifiably heroic