Essays on corporate risk management

Abstract

My thesis consists of three chapters on corporate risk management. Each chapter touches on a research question related to a material risk that companies are facing nowadays. Specifically, I study whether and how cyber risk, environmental risk, and stock liquidity risk affect corporate policies. Understanding such emerging or longstanding risks is important in corporate finance research. The first chapter studies the externality of data breaches. I test whether peer firms respond to data breach events occurred to other firms in their industry. Exploiting malicious hackings targeting U.S. public firms from 2008 to 2018, I find that peer firms in the same four-digit SIC industry significantly increase IT investment following a hacking in their industry. The effect is stronger when more data records are lost and for firms that are more exposed to cyberattack, have higher risk management awareness (denoted by having a designated risk officer or a risk committee, or having previously discussed cyber risk in annual reports), and for the period after the 2011 SEC guidance on recommending more cyber risk disclosure. I find that board interlocking with breach firms is a channel for the relevant information (e.g., on the effects of hacking and the resulting corporate responses) to be transmitted from hacked firms to peer firms. Overall, peer firms respond to hackings in the same industry by taking precautionary actions to manage the potential cyberattack risk and/or the potential litigation and reputation risk. In this way, a negative event (i.e., a data breach) results in positive externalities to the industry and its stakeholders. The second chapter studies the real environmental consequences (i.e., toxic emissions) of corporate financial reporting incentives. Using plant-level data on toxic releases from the United States Environmental Protection Agency (US EPA), we first show that US firms that meet or just beat consensus EPS forecasts (indicating short-termism) make significantly more toxic release because they cut pollution abatement costs to boost earnings. Further, we investigate whether the positive relation between meeting benchmarks and pollution is attenuated for environmentally sustainable firms. To our surprise, we find the effect is stronger for firms with higher environmental ratings (but not firms with higher social or governance ratings) and higher environmentally sustainable institutional ownership. In addition to contributing to the real earnings management literature by documenting a negative externality of financial reporting incentives on the environment and society, our paper contributes to the ESG literature by showing a positive link between measures of corporate sustainability and managerial short-termism. The third chapter exploits the SEC’s 2016 randomized tick-size pilot as a negative shock to firms’ stock liquidity and study whether and how a firm’s M&As respond to stock liquidity shocks, which hitherto has not been examined in the literature. Our difference-in-differences analyses show that pilot firms experience a decrease in M&A intensity. Conditional on conducting an M&A, pilot firms also reduce the proportion of stock payment for M&A deals, are less likely to choose a large deal or a deal involving a public target, and they tend to reduce horizontal deals but increase vertical deals, and eventually, they are more likely to complete the deal, and garner more value gains (especially for firms that have better M&A performance before the pilot). Taken together, the evidence is consistent with the view that stock liquidity shocks lead firms to reduce the total intensity of M&A investment by cutting low-quality deals and lead firms to structure deals more carefully to limit the risk of acquisitions in time with lower stock liquidity.