On Inference When Using State Corporate Laws for Identification

On Inference When Using State Corporate Laws for Identification

Holger Spamann

Series number :

Serial Number: 
644/2019

Date posted :

January 02 2020

Last revised :

January 02 2020
SSRN Share

Keywords

  • Anti-Takeover Laws • 
  • Corporate governance • 
  • Cluster-Robust Inference • 
  • Monte Carlo • 
  • Placebo Laws • 
  • Permutation Test

A popular research design identifies the effects of corporate governance by (changes in) state laws, clustering standard errors by state of incorporation.

Using Monte-Carlo simulations, this paper shows that conventional statistical tests based on these standard errors dramatically overreject: in a typical design, randomly generated “placebo laws” are “significant” at the 1/5/10% level 9/21/30% of the time. This poor coverage is due to the extremely unequal cluster sizes, especially Delaware's concentration of half of all incorporations. Fixes recommended in the literature fail, including degrees-of-freedom corrections and the cluster wild bootstrap. The paper proposes a permutation test for valid inference.

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