Can debt capital create value in firms suspected of having extreme agency problems? And does it? A good laboratory for research is emerging markets, where managers and families routinely employ pyramid ownership structures to give themselves control rights that far exceed their proportional cash flow ownership. Shareholders in these countries generally suffer from ineffective legal protection (La Porta, Lopez-de-Silanes, Shleifer, and Vishny (hereafter LLSV) (1998)) and underdeveloped markets for corporate control. The combination of misaligned managerial incentives and weak external governance in emerging markets makes overinvestment or the outright diversion of corporate funds more likely [Johnson, La Porta, Lopez-de-Silanes, and Shleifer (2000)]. Thus, emerging markets provide a unique setting in which to test whether debt functions as an alternative governance mechanism.
The international investment community is aware of these shortcomings of emerging markets. Mark Mobius, manager since 1991 of the $1.2 billion Templeton Developing Markets Trust, comments that “corporate governance is not improving so why fight it? ... It’s too Herculean a task and it’s too embedded in the culture.” Minority shareholders in emerging market firms should welcome any alternative firm-level governance that debt can provide.
Controlling brush encroachment has been a problem for livestock producers utilizing native rangelands in the Southwestern United States for most of the 20th century (Scifres et al.). Increased returns from improved animal performance are usually too low for brush control to be economically feasible (McBryde, Conner, and Scifres; Whitson and Scifres; Upper Colorado River Authority; Dugas, Hicks, and Wright; Thurow and Hester).
In addition to increasing animal performance, brush control may increase off-site water yields via increases in surface run-off and percolation to underground aquifers (Meiman and Dils; Hibbert; Blackburn 1983, 1985; Upper Colorado River Authority; Whitson and Scifres). Ranchers, however, cannot fully capture the benefits associated with increased off-site water yields. Further, good estimates of these benefits have not been developed. In 1985, the Texas Legislature cited the relationship between reducing brush and increasing water yields as a rationale for passing the Texas Brush-Control Act to encourage brush control on private ranches (Texas State Legislature).
How does competition between sell-side analysts and firm insiders for price sensitive information affect market equilibrium and liquidity? In their theoretical papers, Fishman and Hagerty (1992) and Khanna, Slezak and Bradley (1994) predict that firm insiders and research analysts compete for price sensitive information. Without the presence of analysts, firm insiders have monopoly over information, allowing them to maximize the benefits from informational rents. This should have an impact on market equilibrium. As Holden and Subrahmanyam (1992) show, competition between informed agents wipes out any informational advantage, leading to deeper markets and more information revelation.
The empirical literature so far has focused exclusively on competition between analysts but has failed to investigate the competitive relationship between analysts and insiders and the resulting impact on market equilibrium. This paper aims to fill this gap in the literature. Unlike informed outsiders, insiders have access to better information about the firm’s prospects at no cost. This informational advantage should impact traders’ welfare and the trading process. The presence of an informed outsider should provide competition to insiders and reduce insiders’ trading profits. Most importantly, if the informed outsider’s information becomes public more rapidly relative to that of insiders, as Brennan and Subrahmanyam (1995) suggest, then analysts should create a more level-playing field for traders and generate a positive impact on liquidity and price discovery.
