Essays in corporate governance and financial institutions

This thesis consists of three essays studying questions in corporate governance and financial institutions. The first essay develops a dynamic agency model to examine how activist shareholders (such as hedge funds) influence corporate governance. I show that while activism enhances shareholder value ex-post, it destroys shareholder value ex-ante by undermining shareholders’ ability to commit. Existing shareholders respond to the threat of activism by replacing performance pay with monitoring after poor performance and relying less on deferred compensation. When the threat of activism is low, a rise in the activism level results in increased ex-post interventions and CEO turnover, while a high threat of activism leads to such stringent monitoring that interventions become unnecessary and the need for CEO turnover is redundant. The second essay examines how ESG-concerned shareholders (such as impact funds) promote corporate social responsibility through governance mechanisms, such as ESGlinked executive compensation, and the resulting effects on corporate investment decisions. I demonstrate that whether there exists a precise measure of ESG performance (ESG opacity) is essential in determining firm policies. With low ESG performance opacity, firms often increase financial investment and abatement following solid past performance, accompanied by high pay-for-performance sensitivity. With high ESG performance opacity, abatement can be non-monotonic in past performance, especially when the firm is operated by a green manager. I also show that after a poor performance, a firm might exhibit higher pollution levels under a green manager’s operation, as shareholders can use pollution to punish the green manager. The third essay studies the impact of nonbank expansion in the mortgage market on banks’ lending portfolios. Employing a difference-in-differences approach based on regulatory changes that reduce nonbank lending costs, we find: 1) Nonbank expansion decreases bank mortgage market share amid no changes in total mortgage lending. 2) Diversified banks increase credit supply and offer lower rates to small business lending in counties with more nonbank expansion. 3) Within bank and county credit reallocation increases local small business entry and employment in tradable sectors. We develop a model showing that frictions in cross-county capital allocation can drive these results.