Three essays on corporate finance

Abstract

By exploiting the local randomness in close-call votes, this paper finds a causal impact of passing a governance-related proposal on the cost of stock option protection against downside tail risks. In a local regression discontinuity (RD) analysis, firms that narrowly pass the majority threshold show a lower ex-ante tail risk based on implied volatility smirk and model-free implied skewness (MFIS) than those that narrowly fail. This impact is strengthened for firms with weaker corporate governance, higher information transparency, and worse operating performance. Evidence from option trading suggests that the change in ex-ante tail risk mainly comes from trading activities in put options. In additional tests, I observe that this impact mainly comes from proposals that aim to remove management entrenchment provisions, and the impact is unique in the option market that can not be explained by realized tail risk. Evidence from financial restatement as an extreme case strengthens the link between governance proposal voting and ex-ante tail risk. Overall, this paper observes how the stock option market responds to shareholder activism through shareholder proposals and sheds light on the cross-sectional determinants of option prices.