Self-Selection Models in Corporate Finance

Abstract

Corporate finance decisions are not made at random, but are usually deliberate decisions by firms or their managers to self-select into their preferred choices. This chapter reviews econometric models of self-selection. The review is organized into two parts. The first part reviews econometric models of self-selection, focusing on the key assumptions of different models and the types of applications they may be best suited for. Part 2 reviews empirical applications of selection models. We cover several applications in the areas of corporate investment, financing, and financial intermediation. We find that self-selection is a rapidly growing area in corporate finance, partly reflecting its recognition as a pervasive feature of corporate finance decisions, but more importantly, the increasing recognition of selection models as unique tools for understanding, modeling, and testing the role of private information in corporate finance.

The adoption of poison pills and managerial entrenchment: Evidence from Japan

“…To investigate the hypothesis discussed above, we first specify a statistical model of a firm's decision to announce the introduction of a poison pill, based on Nayak and Prabhala (2001) and Li and Prabhala (2007). Suppose that firm i announces the introduction of a poison pill if variable P OI i is positive, where P OI i is interpreted as the net benefit from the announcement.…”

Corporate fraud culture: Re‐examining the corporate governance and performance relation

“…However, it is very likely that a firm's propensity for corporate fraud is related to unobservable firm characteristics, such as firm culture and management style. In this paper, we use the Heckman (1979) correction for sample selection bias to account for the propensity of corporate fraud based upon private (unobservable) information (Li and Prabhala, 2007). We offer the search for the unobservable as the major innovation of this paper; that is, this study incorporates the dynamic GMM panel model with private corporate fraud information.…”

Bank Reputation in the Private Debt Market

“…In contrast, the certification hypothesis implies a negative impact of reputation on spread and covenants. 12 See also Li and Prabhala (2005) for a general discussion on the use of this type of models in corporate Finally, note that in all the regressions we include controls for market conditions such as Nasdaq Composite Index (in natural log), industry dummies (using in total 12 categories) and year dummies. Tables 2 and 3).…”

“…While instrumental variables are not needed in Heckman regressions due to the non-linear specification, we nevertheless use a different specification than in the second regression equation. In practice, an identification problem may still arise if the non-linearity is not large enough (Li and Prabhala, 2005). We therefore the variables Sales (as measure for borrower size) and the Previous Loan Dummy as instrumental variables.…”