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Faculty Publications

2020

 Abstract: Several theoretical studies suggest that coordination problems can cause arbitrageur crowding to push asset prices beyond fundamental value as investors feedback trade on each others' demands. Using this logic we develop a crowding model for momentum returns that predicts tail risk when arbitrageurs ignore feedback effects. However, crowding does not generate tail risk when arbitrageurs rationally condition on feedback. Consistent with rational demands, our empirical analysis generally finds a negative relation between crowding proxies constructed from institutional holdings and expected crash risk. Thus our analysis casts both theoretical and empirical doubt on crowding as a stand-alone source of tail risk.

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 Abstract: We study the implications of risk entanglements on international financial (FX) markets. Risk entanglement is a refinement of incomplete markets that some risks in asset markets cannot be singly traded. We show that in FX markets with entangled risks (i) there exist multiple pricing-consistent exchange rates, (ii) every exchange rate is affected by idiosyncratic risks, and (iii) exchange rates can be smooth while stochastic discount factors (SDFs) are volatile and almost uncorrelated. These results are in stark contrast to the case of complete markets or incomplete markets without risk entanglements.

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 Abstract: Corporate donations to charities affiliated with the board’s independent directors (affiliated donations) are large and mostly undetected due to lack of formal disclosure. Affiliated donations may impair independent directors’ monitoring incentives. CEO compensation is on average 9.4% higher at firms making affiliated donations than at other firms, and it is much higher when the compensation committee chair or a large fraction of compensation committee members are involved. We find suggestive evidence that CEOs are unlikely to be replaced for poor performance when firms donate to charities affiliated with a large fraction of the board or when they donate large amounts.

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2019

Abstract: The U.S. Federal Reserve purchased both agency mortgage-backed securities (MBS) and Treasury securities to conduct quantitative easing (QE). Using micro-level data, we find that banks benefiting from MBS purchases increase mortgage origination, compared to other banks. At the same time, these banks reduce commercial lending and firms that borrow from these banks decrease investment. The effect of Treasury purchases is different: either positive or insignificant in most cases. Our results suggest that MBS purchases caused unintended real effects and that Treasury purchases did not cause a large positive stimulus to the economy through the bank lending channel.

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Abstract: We use principal component analysis on 55 bilateral exchange rates of 11 developed currencies to identify two important global risk sources in FX markets. The risk sources are related to Carry and Dollar but are not spanned by these factors. We estimate the market prices associated with the two risk sources in the cross-section of FX market returns and construct FX market implied country-specific SDFs. The SDF volatilities are related to interest rates and expected carry trade returns in the cross-section. The SDFs price international stock returns and are related to important financial stress indicators and macroeconomic fundamentals. The first principal risk is associated with the TED spread, quantities measuring volatility, tail and contagion risks and future economic growth. It earns a relatively small implied Sharpe ratio. The second principal risk is associated with the default and term spreads and quantities capturing volatility and illiquidity risks. It further correlates with future changes in the long term interest rate and earns a large implied Sharpe ratio.

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2018

Abstract: Analyzing the period 1988--2006, we document that banks that are active in strong housing markets increase mortgage lending and decrease commercial lending. Firms that borrow from these banks have significantly lower investment. This is especially pronounced for firms that are more capital constrained or borrow from more-constrained banks. Various extensions and robustness analyses are consistent with the interpretation that commercial loans were crowded out by banks responding to profitable opportunities in mortgage lending, rather than with a demand-based interpretation. The results suggest that housing prices appreciations have negative spillovers to the real economy, which were overlooked thus far.

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Abstract: We use nearly 500 shifts in statutory corporate and personal income tax rates as natural experiments to assess the effect of corporate and personal taxes on capital structure. We find both corporate and personal income taxes to be significant determinants of capital structure. Based on ex-post observed summary statistics, across OECD countries, taxes appear to be as important as other traditional variables in explaining capital structure choices. The results are stronger among corporate tax payers, dividend payers, and companies that are more likely to have an individual as the marginal investor.

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 Abstract: This paper studies whether director appointments to multiple boards impact firm outcomes. To overcome endogeneity of board appointments, I exploit variation generated by mergers that terminate entire boards and thus shock the appointments of those terminated directors. Reductions of board appointments are associated with higher profitability, market-to-book, and likelihood of directors joining board committees. The performance gains are particularly stark when directors are geographically far from firm headquarters. I conclude that the effect of the shocks to board appointments is: (i) evidence that boards matter; and (ii) plausibly explained by a workload channel: when directors work less elsewhere, their companies benefit.

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2017

Abstract: We study the diffusion of techniques designed to identify causal relationships in corporate finance research. We estimate the diffusion started in the mid-nineties, lags twenty years compared to economics, and is now used in the majority of corporate finance articles. Consistent with recent theories of technology diffusion, the adoption varies across researchers based on individuals' expected net benefits of adoption. Younger scholars, holders of PhDs in economics, and those working at top institutions adopt faster. Adoption is accelerated through networks of colleagues and alumnis and is also facilitated by straddlers who cross-over from economics to finance. Our findings highlight new forces that explain the diffusion of innovation and shape the norms of academic research.

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Abstract: In September 2015 the crowd-funding site Kickstarter announced that it would adopt a new corporate form, that of a benefit corporation. Kickstarter is far from alone in this decision; in fact, it joined a growing list of tech firms that are moving towards adopting a benefit corporation designation. The result of the legal movement is that corporate governance across the nation is changing, impacting everything from business ethics training to Board decision making, with wide-ranging implications for the economy, environment, and civil society. Despite its growing popularity, though, the rationale behind the emergence of benefit corporations is an understudied question. In this article, we argue that benefit incorporation affects the very nature of the corporation by creating corporate common pool resources, and that the common pool resource theory provides a way to understand the puzzle and future of the movement. This approach is important because it re-situates the conversation, from a narrow view of the effect of the legislation on traditional corporate concepts to a broader view of the impact of the legislation. Furthermore, we consider the benefit corporation through the lens of Professor Elinor Ostrom’s Design Principles, offering a unique perspective through which to analyze if the design of state statutes and implementation by business entities meet criteria that would predict successful governance of the benefit corporation Common Pool Resources.

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Abstract: This paper constructs and analyzes various measures of trading costs in US equity markets covering theperiod 1926–2015. These measures contain statistically and economically significant predictive signals forstock market returns and real economic activity. We decompose illiquidity proxies into a component capturing aggregate volatility and a residual. The predictive content of these components differs in important ways. Specifically, we find strong evidence that the component of illiquidity uncorrelated with volatility forecasts stock market returns. Both the volatility and residual components of illiquidity contain information regarding future economic activity.

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Abstract: We use a multitude of tax reforms across OECD countries as natural experiments to estimate the market value of the tax benefits of debt financing. We report time-series evidence that tax reforms are followed by large changes in the value of corporate equity. However, the impact of tax reforms is greatly mitigated by the presence of leverage. The value of debt tax savings is greater among top tax payers, highly profitable firms, and in countries where tax laws are more strongly enforced. Importantly, the value of debt tax savings is in line with the benchmark implied by a traditional approach.

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2016

Abstract: Recent evidence of excessive comovement among stocks following index additions (Barberis, Shleifer, and Wurgler, 2005) and stock splits (Green and Hwang, 2009) challenges traditional finance theory. Based on a simple model, we show that the bivariate regressions relied upon in the literature often provide little or no information about the economic magnitude of the phenomenon of interest, and the coefficients in these regressions are very sensitive to time-variation in the characteristics of the return processes that are unrelated to excess comovement. Instead, univariate regressions of the stock return on the returns of the group it is leaving (e.g., non-S&P stocks) and the group it is joining (e.g., S&P stocks) reveal the relevant information. When we reexamine the empirical evidence using control samples matched on past returns and compute Dimson betas, almost all evidence of excess comovement disappears. The results in the literature are consistent with changes in the fundamental factor loadings of the stocks. One key element to understanding these striking results is that, in both the examples we study, the stocks exhibit strong returns prior to the event in question. We document the heretofore unknown empirical regularity that winner stocks exhibit increases in betas. Thus, much of the apparent excess comovement is just a manifestation of momentum.

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2015

Abstract: This study examines the performance impact of the relative quality of a CEO’s compensation peers (peers selected to determine a CEO’s overall compensation) and bonus peers (peers selected to determine a CEO’s relative-performance-based bonus). We use the fraction of peers with greater managerial ability scores (Demerjian, Lev, and McVay, 2012) than the reporting firm to measure this CEO’s relative peer quality (RPQ). We find that firms with higher RPQ tend to earn superior risk-adjusted stock returns and experience higher profitability growth compared with firms that have lower RPQ. These results cannot be fully explained by a CEO’s power, compensation level, intrinsic talent, nor by the board’s possible motivation to use peers to signal a firm’s prospect. Learning among peers and the increased incentive to work harder induced by the peer-based tournament, however, might contribute to RPQ’s positive performance effect. Preliminary evidence also shows that high RPQ is not associated with increased earnings management or increased risk-taking behaviors.

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Abstract: We examine signing bonuses awarded to executives hired for or promoted to Named Executive Officer (NEO) positions at S&P 1500 companies during the period of 1992–2011. Executive signing bonuses are sizeable and increasing in use, and are labeled by the media as “golden hellos.” We find that executive signing bonuses are mainly awarded at firms with greater information asymmetry and higher innate risks, especially to younger executives, to mitigate the executives’ concerns about termination risk. When termination concerns are strong, signing bonus awards are associated with better performance and retention outcomes.

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 Abstract: We compare the stock return forecasting performance of alternative payout yields. The net payout yield produces more accurate forecasts relative to alternatives, including the traditional dividend yield. This remains true even after excluding several years during the Great Depression when issuance was unusually high. The measure of cash flow used to form the yield matters economically. Long-term investors' hedging demand for stock is considerably reduced when net payout, rather than dividends, serves as the cash flow measure. An agent relying on an incorrect payout measure is willing to pay an economically significant "management fee" to switch to the optimal policy.

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Abstract: We examine institutional demand prior to well-known stock return anomalies and find that institutions have a strong tendency to buy stocks classified as overvalued (short leg of anomaly), and that these stocks have particularly negative ex post abnormal returns. Our results differ from numerous studies documenting a positive relation between institutional demand and future returns. We trace the difference to measurement horizon. We too find a positive relation at a quarterly horizon. However, the relation turns strongly negative at the one-year horizon used in anomaly studies. We consider several explanations for institutions’ tendency to trade contrary to anomaly prescriptions. Our evidence largely rules out explanations based on flow and limits-of-arbitrage, but is more consistent with agency-induced preferences for stock characteristics that relate to poor long-run performance.

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2014

 Abstract: This paper examines whether one of the most important participants in the takeover market, the institutional investors of target companies, suffers from the disposition effect; and if so, how this selling bias influences the takeover outcomes. I report robust evidence that target institutional investors are reluctant to realize losses. This bias further allows their sunk cost to affect both the takeover price and the deal success. My results are explained by neither the undervalued targets, nor the 52-week high price effect. They are most pronounced among targets whose investors have a strong propensity to hold on to loser stocks.

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2013

 Abstract: We use the deaths of directors and chief executive officers as a natural experiment to generate exogenous variation in the time and resources available to independent directors at interlocked firms. The loss of such key co-employees is an attention shock because it increases the board committee workload only for some interlocked directors - the 'treatment group'. There is a negative stock market reaction to attention busyness, the importane of their board roles, and their degree of independence magnify the treatment effect. Overall, directors busyness is detrimental to board monitoring quality and shareholder value.

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 Abstract: We investigate the impact of political institutions on corporate risk-taking. Using a large sample of non-financial firms from 77 countries covering the period from 1988 to 2008, we find that sound political institutions are positively associated with corporate risk-taking, and that this relation is stronger when government extraction is higher. In a subsample of 45 countries, we also find that politically connected firms engage in more risk-taking, which suggests that close ties to the government lead to less conservative investment choices. Our results are economically significant, and are robust to alternative risk-taking measures, various political institution proxies, cross-sectional and country-level regressions, and endogeneity concerns of political institutions. Our results have important implications for governments and corporate managers by providing direct relevance of political institutions to the corporate decision-making process. To encourage investment at the firm level, and hence innovation and overall growth, governments need to undertake the necessary reforms to control corruption and enforce contracts better, and thus decrease government predation and extraction.

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 Abstract: We use a multitude of tax reforms across OECD countries as natural experiments to estimate the market value of the tax benefits of debt financing. We report time-series evidence that tax reforms are followed by large changes in the value of corporate equity. However, the impact of tax reforms is greatly mitigated by the presence of leverage. The value of debt tax savings is greater among top tax payers, highly profitable firms, and in countries where tax laws are more strongly enforced. Importantly, the value of debt tax savings is in line with the benchmark implied by a traditional approach.

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Abstract: Using governance metrics based on antitakeover provisions and inside ownership, we find that firms with weaker corporate governance structures actually have smaller cash reserves. When distributing cash to shareholders, firms with weaker governance structures choose to repurchase instead of increasing dividends, avoiding future payout commitments. The combination of excess cash and weak shareholder rights leads to increases in capital expenditures and acquisitions. Firms with low shareholder rights and excess cash have lower profitability and valuations. However, there is only limited evidence that the presence of excess cash alters the overall relation between governance and profitability. In the US, weakly controlled managers choose to spend cash quickly on acquisitions and capital expenditures, rather than hoard it.

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Abstract: We study the causal effects of analyst coverage on corporate investment and financing policies. We hypothesize that a decrease in analyst coverage increases information asymmetry and thus increases the cost of capital; as a result, firms decrease their investment and financing. We use broker closures and broker mergers to identify changes in analyst coverage that are exogenous to corporate policies. Using a difference‐in‐differences approach, we find that firms that lose an analyst decrease their investment and financing by 1.9% and 2.0% of total assets, respectively, compared to similar firms that do not lose an analyst.

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2012

Abstract: This study uses the method of Cremers and Petajisto (2009) to separate active institutional investors from passive ones and shows that only active institutional investors are able to alleviate the anomalous comovement of stock returns. Focusing on two events directly linked to the excess comovement anomaly: S&P 500 Index additions and stock splits, I find that if an event stock has more active institutional investors trading in the post-event period, the anomalous comovement effect disappears. In contrast, if an event stock experiences a massive exit of active institutional investors, this market anomaly persists. Furthermore, the exit of active institutional investors also results in a strong price synchronicity effect. Overall, my findings support the notion that active investing is socially valuable in mitigating the influences of uninformed investors and enhancing stock market’s information efficiency in the long run.

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Abstract: We examine whether short sellers in the equity market provide valuable information to investors in the bond market. Using a sample of publicly traded bond data covering the period from 1988 to 2011, we find that firms with high short interest have lower credit ratings and are more likely to have their ratings downgraded. We also find that firms with highly shorted stocks are associated with higher bond yield spreads (about 24 basis points). Evidence of causality from short interest spikes and a natural experiment based on the SEC’s Regulation SHO pilot program confirms our findings. Overall, our results suggest that equity short sellers provide predictive information to creditors in the bond market.

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Abstract: The use of equity incentives is significantly greater in countries with stronger insider trading restrictions, and these higher incentives are associated with higher total pay. These findings are robust to alternative definitions of insider trading restrictions and enforcement, and to panel regressions with country fixed effects. We also find significant increases in top executive pay and the use of equity-based incentives in the period immediately following the initial enforcement of insider trading laws. We conclude that insider trading laws are one channel through which cross-country differences in pay practices can be explained.

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Abstract: We analyze a sample of over 3,600 ex ante explicit severance pay agreements in place at 808 firms and show that firms set ex ante explicit severance pay agreements as one component in managing the optimal level of equity incentives. Younger executives are more likely to receive explicit contracts and better terms. Firms with high distress risk, high takeover probability, and high return volatility are significantly more likely to enter into new or revised severance contracts. Finally, ex post payouts to managers are largely determined by the ex ante contract terms.

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2011

Abstract: This paper examines investment strategies of Sovereign Wealth Funds (SWFs), their effect on target firm valuation, and how both of these are related to SWF transparency. We find that SWFs prefer large and poorly performing firms facing financial difficulties. Their investments have a positive effect on target firms’ stock prices around the announcement date but no substantial effect on firm performance and governance in the long-run. We also find that transparent SWFs are more likely to invest in financially constrained firms and have a greater impact on target firm value than opaque SWFs. Overall, SWFs are similar to passive institutional investors in their preference for target characteristics and in their effect on target performance, and SWF transparency influences SWFs’ investment activities and their impact on target firm value.

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Abstract: This paper examines the use of derivatives and its relation with risk taking in the hedge fund industry. In a large sample of hedge funds, 71% of the funds trade derivatives. After controlling for fund strategies and characteristics, derivatives users on average exhibit lower fund risks (e.g., market risk, downside risk, and event risk), such risk reduction is especially pronounced for directional-style funds. Further, derivatives users engage less in risk shifting and are less likely to liquidate in a poor market state. However, the flow-performance relation suggests that investors do not differentiate derivatives users when making investing decisions.

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Abstract: Aggregate stock return volatility is both persistent and countercyclical. This paper tests whether it is possible to improve volatility forecasts at monthly and quarterly horizons by conditioning on additional macroeconomic variables. I find that several variables related to macroeconomic uncertainty, time-varying expected stock returns, and credit conditions Granger cause volatility. It is more difficult to find evidence that forecasts exploiting macroeconomic variables outperform a univariate benchmark out-of-sample. The most successful approaches involve simple combinations of individual forecasts. Predictive power associated with macroeconomic variables appears to concentrate around the onset of recessions.

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Abstract: I find that firms experiencing increases in import competition significantly reduce their leverage ratios by issuing equity and selling assets to repay debt. Using import tariffs and foreign exchange rates as instrumental variables for import penetration, I show that these results are not manifestations of endogenous relations between import competition and leverage. The results are consistent with traditional tradeoff models of capital structure that predict a positive relation between book leverage and future expected profitability. Further evidence suggests that import competition affects leverage through changes in the tradeoff between the tax benefits of debt and the costs of financial distress.

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Abstract: Institutional trading arrangements often involve the portfolio manager delegating the task of trade execution to a separate division within the firm. We model the agency conflict that arises in this setting and show that optimal performance benchmarks often create an incentive to execute orders contrary to concurrent information flow. We hypothesize that aggregate contrarian trading resulting from widespread application of such benchmarks leads to delays in the assimilation of information in security prices. Using institutional trading data, we document the hypothesized contrarian trading pattern and relate the pattern to price-adjustment delays in the response of individual stocks to index futures returns. The evidence supports the assertion that delegated institutional trading contributes to these delays.

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Abstract: This study provides empirical evidence on the role of disclosure in resolving agency conflicts in delegated investment management. For certain expenditures fund managers have alternative means of payment which differ greatly in their opacity: payments can be expensed (relatively transparent); or bundled with brokerage commissions (relatively opaque). We find that the return impact of opaque payments is significantly more negative than that of transparent payments. Moreover, we find a differential flow reaction that confirms the opacity of commission bundling. Collectively, our results demonstrate the importance of transparency in addressing agency costs of delegated investment management.

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2010

This paper examines the use of derivatives and its relation with risk-taking in the hedge fund industry. From a large sample of hedge funds, 71% of the funds trade derivatives. After controlling for fund strategies and characteristics, derivatives users on average exhibit lower fund risks, such as market risk, downside risk, and event risk; such risk reduction is especially pronounced for directional-style funds. Further, derivatives users engage less in risk shifting and are less likely to liquidate in a poor market state. However, the flow-performance relation suggests that investors do not differentiate derivatives users when making investing decisions.

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We provide new evidence linking board characteristics and performance. We employ a sample of index funds to isolate the operational component of performance, thereby minimizing investment policy effects in our performance measures. Using manually collected governance data from the mutual fund industry covering the period from 1998 to 2007, we find an inverse relation between board size and fund performance. We also find evidence supporting our hypotheses that organizational form (whether the fund sponsor is publicly or privately held) as an internal governance mechanism plays an important role in determining operational performance. Specifically, we find that board size, the presence of fund sponsor officers, and boards comprised of all independent directors are related to operational performance when the sponsor is publicly held. For privately held firms, board structure is insignificantly related to performance. Overall, the results are consistent with the notion that there may not be a single optimal board structure that is applicable to all funds, attempts to regulate board attributes should be considered with caution, and sponsor level factors are important board structure considerations.

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We provide new evidence linking board characteristics and performance. We employ a sample of index funds to isolate the operational component of performance, thereby minimizing investment policy effects in our performance measures. Using manually collected governance data from the mutual fund industry covering the period from 1998 to 2007, we find an inverse relation between board size and fund performance. We also find evidence supporting our hypotheses that organizational form (whether the fund sponsor is publicly or privately held) as an internal governance mechanism plays an important role in determining operational performance. Specifically, we find that board size, the presence of fund sponsor officers, and boards comprised of all independent directors are related to operational performance when the sponsor is publicly held. For privately held firms, board structure is insignificantly related to performance. Overall, the results are consistent with the notion that there may not be a single optimal board structure that is applicable to all funds, attempts to regulate board attributes should be considered with caution, and sponsor level factors are important board structure considerations.

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2009

This paper evaluates the ability of bond funds to market time nine common factors related to bond markets. Timing ability generates nonlinearity in fund returns as a function of common factors, but there are several non-timing-related sources of nonlinearity. Controlling for the non-timing-related nonlinearity is important. Funds' returns are more concave than benchmark returns, and this would appear as poor timing ability in naive models. With controls, the timing coefficients appear neutral to weakly positive. Adjusting for nonlinearity the performance of many bond funds is significantly negative on an after-cost basis, but significantly positive on a before-cost basis.

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2007

This paper examines whether self-described market timing hedge funds have the ability to time the U.S. equity market. We propose a new measure for timing return and volatility jointly that relates fund returns to the squared Sharpe ratio of the market portfolio. Using a sample of 221 market timing funds during 1994-2005, we find evidence of timing ability at both the aggregate and fund levels. Timing ability appears relatively strong in bear and volatile market conditions. Our findings are robust to other explanations, including public information-based strategies, options trading, and illiquid holdings. Bootstrap analysis shows that the evidence is unlikely to be attributed to luck.

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2006

We examine a sample of 125 equity mutual funds that closed to new investment between 1993 and 2004. We find that funds close following a period of superior performance and abnormal fund inflows. Fund managers raise their fees when they close to compensate managers for losses in income due to the restrictions in size imposed by the fund closure decision. Managers reopen when fund size declines. However, they do not earn superior returns after re-opening, suggesting that the fund closure decision does not provide information about superior fund managers.

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2005

We examine whether mutual funds change their names to take advantage of current hot investment styles, and what effects these name changes have on inflows to the funds, and to the funds' subsequent returns. We find that the year after a fund changes its name to reflect a current hot style, the fund experiences an average cumulative abnormal flow of 28 percent, with no improvement in performance. The increase in flows is similar across funds whose holdings match the style implied by their new name and those whose holdings do not, suggesting that investors are irrationally influenced by cosmetic effects.

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2004

We examine the relation between the cost of debt financing and a governance index that contains various antitakeover and shareholder protection provisions. Using firm-level data from the Investors Research Responsibility Center for the period 1990 through 2000, we find that antitakeover governance provisions lower the cost of debt financing. Segmenting the data into firms with strongest management rights (strongest antitakeover provisions) and firms with strongest shareholder rights (weakest antitakeover provisions), we find that strong antitakeover provisions are associated with a lower cost of debt financing while weak antitakeover provisions are associated with a higher cost of debt financing, with a difference of about thirty-four basis points between the two groups. Overall, the results suggest that antitakeover governance provisions, although not beneficial to stockholders, are viewed favorably in the bond market.

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We examine the links among IPO underpricing, post-IPO analyst coverage, and the likelihood of switching underwriters. Our findings indicate a significant positive relation between underpricing and analyst coverage by the lead underwriter. This positive association is robust to controls for other determinants of underpricing previously documented in the literature and to controls for the endogeneity of underpricing and analyst coverage. In addition, after controlling for other potential determinants of switching underwriters, we find that the probability of switching underwriters between IPO and SEO is negatively related to the unexpected amount of post-IPO analyst coverage. We interpret these findings as consistent with the hypothesis that underpricing is, in part, compensation for expected post-IPO analyst coverage.

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We study the price effects of firms added to and deleted from the S&P 500 index and document an asymmetric price response: there is a permanent increase in the price of added firms but no similar decline for deleted firms. These results are at odds with extant explanations of the effects of S&P 500 index changes which imply a symmetric price response to additions and deletions. A possible explanation for asymmetric price effects arises from changes in investor awareness. Results from our empirical tests support the thesis that changes in investor awareness contribute to the asymmetric price effects of S&P 500 index additions and deletions.

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We investigate the contribution of option markets to price discovery, using a modification of Hasbrouck's (1995) “information share” approach. Based on five years of stock and options data for 60 firms, we estimate the option market's contribution to price discovery to be about 17% on average. Option market price discovery is related to trading volume and spreads in both markets, and stock volatility. Price discovery across option strike prices is related to leverage, trading volume, and spreads. Our results are consistent with theoretical arguments that informed investors trade in both stock and option markets, suggesting an important informational role for options.

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2003

We argue that short sellers affect prices in a significant and systematic manner. In particular, we contend that speculative short sales contribute to the weekend effect: the inability to trade over the weekend is likely to cause these short sellers to close their speculative positions on Fridays and reestablish new short positions on Mondays causing stock prices to rise on Fridays and fall on Mondays. We find evidence in support of this hypothesis based on a comparison of high short-interest stocks and low short-interest stocks, stocks with and without actively traded options, IPOs, zero short-interest stocks, and highly volatile stocks.

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We investigate the impact of founding-family ownership structure on the agency cost of debt. We find that founding-family ownership is common in large, publicly traded firms and is related, both statistically and economically, to a lower cost of debt financing. The evidence also indicates that the relation between founding-family holdings and debt costs is non-monotonic; debt costs first decrease as family ownership increases but then increase with increasing family ownership. However, irrespective of the level of family holdings, we find that family firms enjoy a lower cost of debt than non-family firms. These results are consistent with the hypothesis that continued founding-family ownership in publicly traded firms reduces the agency costs of debt. Additional analysis reveals that when a family member serves as the firm's CEO, the cost of debt financing is higher than if an outsider is CEO, but still lower than in non-family firms. Overall, the results are consistent with the idea that founding-family firms have incentive structures that result in fewer agency conflicts between equity and debt claimants, suggesting that bond investors view founding-family ownership as an organizational structure that better protects their interests.

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We examine the determinants of debt issuance in 10 major currencies by large U. S. firms. Using the fraction of foreign subsidiaries and tests exploiting the disaggregated nature of our data, we find strong evidence that firms issue foreign currency debt to hedge their exposure both at the aggregate and the individual currency levels. We also find some evidence that firms choose currencies in which information asymmetry between domestic and foreign investors is low. We find no evidence that tax arbitrage, liquidity of underlying debt markets, or legal regimes influence the decision to issue debt in foreign currency.

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2002

The literature provides conflicting evidence on the relation between corporate international activity and the cost and level of debt financing. Based on this evidence, we explore the impact of firm international activity on debt financing. Using a market-based sample of U.S. firms, we find significant evidence of a non-monotonic relation between firm international activity and both the cost and level of debt financing. Specifically, we find that, contrary to prior research, firm international activity is associated with a 13% reduction in the cost of debt and a 30% increase in the level of debt financing.

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2001

This article examines whether insiders use private information to time the exercises of their executive stock options. Before May 1991, insiders had to hold the stock acquired through option exercise for 6 months. Exercises from that regime precede significantly positive abnormal stock performance, suggesting the use of inside information to time exercises. By contrast, we find little evidence of such timing since insiders have been able to sell acquired shares immediately. Now, such timing should show up as negative abnormal stock returns after option exercise. However, we find negative stock performance only after exercises by top managers at small firms.

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Recent research suggests that firm internationalization is associated with greater exchange rate risk and a higher cost of equity capital. However, there is no research on the relation between the level of firm international activity and the cost of debt financing. This study offers the first such empirical evidence using non-provisional public debt. Based on a sample of 2,194 U.S. firm-year observations, we find that firms with greater levels of international activity have better credit ratings. We also find that the cost of debt financing is inversely related to the degree of firm internationalization beyond that incorporated in credit ratings. These results suggest that rating agencies do not fully incorporate firm international activity in their analysis resulting in a downward bias in credit ratings for international firms. In aggregate, the results imply that failing to incorporate firm international activity in debt pricing leads to potential omitted variable problems.

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This paper demonstrates a tradeoff between the risk-shifting and hedging incentives of firms and identifies conditions under which each dominates. A firm may have the incentive to hedge in a multi-period context, even if no such incentive exists in a single-period one. Unrestricted access to swaps in the presence of asymmetric information about firm type and the swapping motive would lead to unbounded speculation resulting in breakdowns in swap and debt markets. Price-based methods are unable to control this and market makers have to rely upon additional exposure information or credit enhancement devices to preserve equilibrium.

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We consider the patterns in the predictability of interest rates expectations hypothesis (EH), and attempt to account for them with affine models. We make the following points: (i) Discrepancies in the data from the EH take a particularly simple form with forward rates: as theory suggests, the largest discrepancies are at short maturities. (ii) Reasonable estimates of one-factor Cox-Ingersoll-Ross models imply regressions on the opposite side of the EH than we see in the data: regression slopes are greater than one (iii) Multifactore affine models can nevertheless approximate both departures from the EH and other properties of interest rates.

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2000

We examine the incidence of corporations lowering the exercise prices of their executive stock options. These options can be viewed as a combination of a down-and-out call option and a down-and-in call option with the exercise price equal to the barrier. Using barrier option pricing theory, we find that at a minimum this features adds 7-10 percent to the value of the options on the grant date. We also examine the market, industry and firm-specific performance of a sample of 37 firms and 53 reset events. The period covered was 250 days before and after the day on which the firm reset the exercise prices of its executive stock options. The evidence strongly supports the conclusion that resetting the exercise price follows a period of poor firm-specific performance. The magnitude of the reduction in the exercise price was positively related to the firm's stock price performance and using a value- weighted market portfolio, it was negatively related to the market's performance. No evidence supports the contention that lowering the exercise price brings an end to the firm's problems and leads to an increase in shareholder wealth. Though the direct dollar impact at the time of the reset is relatively small to the shareholders, it is not insignificant to management. Allowing for the possibility of resetting after a stock price decline can create a perverse incentive under certain circumstances for managers to deliberately drive the stock price down further. In addition management has a greater incentive to engage in high risk projects than it would have with ordinary non- esettable options. These incentives and our results that the resets are indeed done, sometimes repeatedly, following poor firm-specific performance suggest that resetting is not in the best interests of shareholders, who should certainly question this practice.

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This article is an exploratory examination of the benefits and risks associated with opening of stock markets. Specifically, we estimate changes in the level and volatility of stock returns, inflation, and exchange rates around market openings. We find that stock returns increase immediately after market opening without a concomitant increase in volatility. Stock markets become more efficient as determined by testing the random walk hypothesis. We find no evidence of an increase in inflation or an appreciation of exchange rates. If anything, inflation seems to decrease after market opening as do the volatility of inflation and volatility of exchange rates.

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1999

A rational analysis of analyst behavior predicts that analysts immediately and without bias incorporate information into their forecasts. Several studies document analysts' tendency to systematically underreact to information and are inconsistent with rationality. Other studies indicate that analysts systematically overreact to new information or that they are systematically optimistic. This study discriminates between these three hypotheses by examining the interaction between the nature of information and the type of reaction by analysts. The evidence indicates that analysts underreact to negative information, but overreact to positive information. These results are consistent with systematic optimism in response to information.

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Weekly returns of stock portfolios exhibit substantial autocorrelation. Analytical studies suggest that nonsynchronous trading is capable of explaining from 5 to 65 percent of the autocorrelation. The varying importance of nonsynchronous trading in these studies arises primarily from differing assumptions regarding nontrading periods of stocks. We simulate the effects of nonsynchronous trading by sampling stock returns from a return generating process using transactions data to obtain the precise time of each stock?s last trade. We find that simulated weekly portfolio returns exhibit autocorrelations that are roughly 25 percent that of their observed (CRSP) weekly returns.

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1998

We find that option listings are associated with a decrease in the variance of the pricing error, a decrease in the adverse selection component of the spread, and an increase in the relative weight placed by the specialist on public information in revising prices for the underlying stocks. We also find that there is a decrease in the spread and increases in quoted depth, trading volume, trading frequency, and transaction size after option listings. Overall, our results suggest that option listings improve the market quality of the underlying stocks.

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Theories of asset pricing suggest that the amortized cost of the spread is relevant to investors' required returns. The amortized spread measures the spread's cost over investors' holding periods and is approximately equal to the spread times share turnover. We examine amortized spreads for Amex and NYSE stocks over the period 1983–1992. We find that stocks with similar spreads can have vastly different share turnover, and thus, a stock's amortized spread cannot be predicted reliably by its spread alone. Consistent with theories of transaction costs, we find stronger evidence that amortized spreads are priced than we find for unamortized spreads.
An empirical examination of the amortized spread

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1997

We investigate share price responses to the formation of 345 strategic alliances spanning 1983–1992. The average stock price response is positive, with no evidence of wealth transfers. This is true for horizontal alliances (involving partner firms in industries with the same three-digit SIC codes) as well as non-horizontal alliances. For horizontal alliances, more value accrues when the alliance involves the transfer or pooling of technical knowledge than with nontechnical alliances. Finally, partnering firms tend to display better operating performance than their industry peers over the five-year period surrounding the year in which an alliance is formed.

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We analyze the effect of privatization on the performance of British Airways by examining the privatization's impact on airfares and competitors' stock prices. We find that stock prices of U.S. competitors fell a significant 7% upon British Airways' privatization, implying expectation of a more competitive British Airways. Closer rivals of British Airways experienced a greater drop in stock price than more distant rivals. Further, airfares in markets served by British Airways fell significantly upon privatization. The results suggest that a change from government to private ownership improves economic efficiency.

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1994

We investigate the relation between trading activity, the measurement of security returns, and the evolution of security prices by examining estimates of systematic risk surrounding equity offerings and share repurchases. In contrast to prior studies, we find no evidence of changes in systematic risk following either equity offerings or share repurchases after correcting for biases caused by infrequent trading and price adjustment delays. Moreover, changes in ordinary least squares beta estimates are significantly related to contemporaneous changes in trading activity. Our results have implications for studies interested in the properties of security returns, particularly those examining periods in which trading activity changes.

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This article examines the effect of issuing debt with and without “poison put” covenants on outstanding debt and equity claims for the period 1988 to 1989. The analysis shows that “poison put” covenants affect stockholders negatively and outstanding bondholders positively, while debt issued without such covenants has no effect. The study also finds a negative relationship between stock and bond returns for firms issuing poison put debt. These results are consistent with a “mutual interest hypothesis,” which suggests that the issuance of poison put debt protects managers and, coincidentally, bondholders, at the expense of stockholders.

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This article documents the effect on share value of listing on the New York Stock Exchange and reports the results of a joint test of Merton's (1987)investor recognition factor and Amihud and Mendelson's (1986) liquidity factor as explanations of the change in share value. We find that during the 1980s stocks earned abnormal returns of 5 percent in response to the listing announcement and that listing is associated with an increase in the number of shareholders and a reduction in bid‐ask spreads. Cross‐sectional regressions provide support for both investor recognition and liquidity as sources of value from exchange listing.

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1993

1992

This paper investigates the behavior of stock and option prices around block trades in stocks. The results indicate that for both uptick and downtick block trades the stock prices adjust within a fifteen minute period after the block trade. Moreover, for uptick blocks there is no evidence of any stock price reaction before the block trade. However, the adjustment of stock price for downtick blocks begins about fifteen minutes before the block trade. We also find that option price behavior differs considerably from stock price behavior. Specifically, our results suggest that options exhibit abnormal price behavior starting thirty minutes before the block and ending one hour after the block. The pattern is more pronounced for downtick blocks and for put options. We interpret this abnormal price behavior of options before the block trade as consistent with intermarket frontrunning.

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Over the two-year period prior to the bankruptcy announcement, insider trading is significantly greater for OTC bankrupt firms, but not for exchange-listed firms, than for an industry-size matched sample of nonbankrupt firms. In addition, the level of insider selling increases over the final five months leading to the first public announcement of OTC firms. Finally, firms displaying the most negative price reaction over the announcement period are found to have a significantly larger proportion of insider selling than other firms.

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Long-term performance plans are theoretically adopted to better align the interests of the managers and stockholders by redirecting managerial decision-making toward the long-term performance of the corporation. This study reports significant positive excess returns around the announcement of performance plan adoption, which is consistent with the view that such plans would reduce the agency problem. In addition, this study finds an association between the adoption of long-term performance plans and subsequent growth in profitability suggesting that long-term performance plans may have been successful in motivating an enhancement in the accounting measures of profitability used to reward managers under the plan. Finally, the excess returns around the announcement of performance plan adoption are found to be positively correlated with subsequent change in growth of earnings per share, the most commonly used accounting performance measure.

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1991

Examination of 1,600 seasoned equity offerings reveals little evidence that underwriters systematically set offer prices below the market price on the major exchanges, though they may do so for NASDAQ issues. Quick round-trip transactions in seasoned offerings are not profitable, but subscribing to an offering and holding the stock for 30 days seems to be very profitable, especially in the NASDAQ market. In addition to seasoned offerings, we analyze 250 issues of new classes of preferred stock. These issues are not underpriced.

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1990

The traditional view of the futures clearinghouse as an insurer that eliminates the need for customers to evaluate default risk is inaccurate. A clearinghouse member default in 1985 confirms that the clearinghouse only guarantees payment from member to member, not from customer to customer or member to customer. Thus, non-defaulting customers are subject to losses as a result of the action of individuals with whom thay have no contractual obligations. This study models the behavior of customers choosing a futures commission merchant (FCM) given the current legal position of the clearinghouse. In a single-period model with symmetric information, customers can eliminate their exposure to defaults of other customers or of their FCM only by choosing to trade through "boutique" (undiversified) FCMs. In practice, monitoring and rebalancing costs may impede the attainment of zero default risk. However, FCM diversification remains an important factor in customer choice of an FCM. When setting capital requirements, clearinghouses and government regulators need to consider the implications of diversification for both customer and market protection.

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Prior studies report lower issue costs for shelf registered debt and conclude that the benefits of increased underwriter competition can be realized by those firms using this registration procedure. This study re-examines the purported superiority of issuing debt via shelf registration, and finds that the savings in issue costs displayed by earlier studies can be attributed to a self selection bias and not the method of registration.

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A fundamental statistical test of serial independence is developed and applied to daily stock returns. Let xt be the deviation of the daily return on a stock from its sample mean after any autocorrelation present has been removed. If xt is serially independent, then the cumulative sum of xt over time is the position of a one-dimensional random walk on a line. The empirical distribution of step lengths over a large sample allows the distribution of the largest absolute excursion in a T-step walk to be calculated by repeated simulation. The observed maximal excursions are found to be significantly smaller than one would expect, based on serial independence and the observed distribution of step lengths. It is concluded that these daily stock returns are not serially independent and that the market value of the corporations studied has a tendency to return to an interval around the trend value.
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1988

While it has been known for some time that, under uncertainty, the original version of the Fisher hypothesis is not precisely correct, empirical researchers have largely ignored this fact. Such an omission has possibly resulted in erroneous conclusions concerning other hypotheses; most notably the impact of prices on the real economy. This paper clarifies some of the previous interpretations of the existing empirical literature and provides a theoretical version of the relation between prices and interest rates. Empirical tests based on both the Livingston survey data and data from time‐series forecasting models provide support for the Fisher effect and the hypothesis that only covariance risk is priced in the Treasury bill market.

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In this paper, we extend earlier work on hedging models so that uncertainty about both deposit supply and loan demand is incorporated as well as random rates of return on loans and CD's. Our model suggests that the optimal forward position is the sum of three ratios that should be estimated simultaneously. Using bank‐specific data, the optimal hedge ratios are estimated in both the pre‐deregulation and deregulation subperiods. Our results show that previous studies of bank hedging with interest rate futures have greatly overstated (a) the volume of short futures positions that banks should take and (b) the degree of homogeneity of optimal hedge ratios across the banking system. Similarly, deregulation has not uniformly affected the interest rate risk borne by different institutions.

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1987

This paper considers the maturity intermediation and intertemporal lending decisions of risk‐averse financial intermediaries. In particular, the maturity mismatch problem and the fixed‐versus‐variable‐rate lending decision are modeled when the major source of risk involves uncertain future interest rates. The results imply that the strategy of matching the maturity of assets and liabilities is not generally optimal or even minimum risk. This is due primarily to the “built‐in” hedge that the intermediary has as a result of rolling over short‐term loans while continuing to finance long‐term loans. Intertemporal dependencies between loan demand and costs (or both) also have an effect on the optimal degree of maturity mismatching and provide one rationale for making loans at rates below current marginal cost.

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1986

This article examines the interest rate risk characteristics of a general class of floating rate securities, which includes Chance's securities as a special case. The calculation of duration for Chance's securities is zero, as it should be. Securities in the broader class can have durations that are negative or longer than the period of time that must elapse before the payments can reflect changes in market interest rates. The effect on duration of changes in the parameters of the function relating interest rate shocks to the payments and changes in the slope of the term structure are examined.

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This paper considers the maturity intermediation and intertemporal lending decisions of risk‐averse financial intermediaries. In particular, the maturity mismatch problem and the fixed‐versus‐variable‐rate lending decision are modeled when the major source of risk involves uncertain future interest rates. The results imply that the strategy of matching the maturity of assets and liabilities is not generally optimal or even minimum risk. This is due primarily to the “built‐in” hedge that the intermediary has as a result of rolling over short‐term loans while continuing to finance long‐term loans. Intertemporal dependencies between loan demand and costs (or both) also have an effect on the optimal degree of maturity mismatching and provide one rationale for making loans at rates below current marginal cost.

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1985

Rule 415 allows a firm to register all the securities it reasonably expects to sell over the next two years and then, at the management's option, to sell those securities over these two years whenever it chooses. This paper examines whether equity offerings made under Rule 415 (shelf offerings) differ in issuing costs from equity offerings not sold under this rule. We find that shelf offerings cost 13% less for syndicated issues and 51% less for nonsyndicated issues. We also investigate the empirical relevance of the market overhang argument which suggests that shelf registrations depress the price of the registering firm's shares more than traditional registrations. Our data does not support the market overhang argument.

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1984

When raising new equity capital managers have historically rejected the direct offer method favoring instead the seemingly more expensive underwritten public issue. This paper provides a resolution for this equity financing paradox by demonstrating empirically that firms which engage in direct offers enjoy a comparative cost advantage that is more than sufficient to account for the absolute reported cost differences between the two methods of equity financing.

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Controversy surrounds the Securities and Exchange Commission's (SEC) Rule 415 that went into effect in March 1982 and remained an experiment until it was permanenty adopted for large firms in November 1983. Rule 415allows a company to register all the securities it plans to issue over the next two years and then to sell someor all of the securities whenever it chooses. This procedure is known as a shelf registration. The purposes of Rule 415 are to simplify the registration of new corporate securities and to allow more flexibility in the way issues are underwritten.

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The group of issues that falls under the heading of bank capital adequacy has received a great deal of attention from academics, regulators, and bankers in recent years and is likely to continue as a subject for debate for many years to come. Although the traditional questions debated in the literature on capital adequacy are important and remain unresolved, this paper is not directed at them. Instead, the approach here is to examine how bank regulators operating within the existing legal structure of regulation can pursue optimal policies with respect to the regulation of bank capital.

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1982

When raising new equity capital managers have historically rejected the direct offer method favoring instead the seemingly more expensive underwritten public issue. This paper provides a resolution for this equity financing paradox by demonstrating empirically that firms which engage in direct offers enjoy a comparative cost advantage that is more than sufficient to account for the absolute reported cost differences between the two methods of equity financing.

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1981

This paper provides evidence of excess returns earned by investors in acquired firms prior to the first public announcement of planned mergers. The study is distinguished from earlier merger studies in its use of daily holding period returns for the 194 firms sampled. The results confirm statistically what most traders already know. Impending merger announcements are poorly held secrets, and trading on this nonpublic information abounds. Specifically, leakage of inside information is a pervasive problem occurring at a significant level up to 12 trading days prior to the first public announcement of a proposed merger.

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1980

1979

1978

1977

1975

1972

1970

Abstract: We characterize jump dynamics in stock market returns using a novel series of intraday prices covering almost 90 years. Jump dynamics vary substantially over time. Trends in jump activity relate to secular shifts in the nature of news. Unscheduled news often involving major wars drives jump activity in early decades, whereas scheduled news and especially news pertaining to monetary policy drives jump activity in recent decades. Jump variation measures forecast excess stock market returns, consistent with theory. Results support models featuring a separate jump factor such that risk premium dynamics are not fully captured by volatility state variables.

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 Abstract: Are all covenants equally effective at reducing the bondholder-shareholder conflict? Examining the most frequently used bond covenants, we document that four out of 24 restrictions are associated with significantly higher bankruptcy risk. The use of these Default Indicating covenants can be partly explained by faulty contract design, greater recovery in bankruptcy, or within-creditor conflicts. Firms that use In-House Counsel to help structure their bond issue and those that use Big 4 Auditors are also less likely to include Default Indicating covenants in their bonds. Further tests show that the use of these Default Indicating covenants is associated with higher bond and CDS spreads. Overall, the results help explain the prior evidence on the relation between covenant use and the cost of debt.

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Abstract: The purpose of this poster is to describe a study that was undertaken to determine if an individual’s mood is associated with the individual’s responses to a set of CRRA questions. It was thought that if such an association exists, then it is likely that Loewenstein et al.’s (2001) “risk-as-feelings” hypothesis may be a more appropriate description of the way investors formulate risk preferences compared to a purely analytical model. Further, if an association between mood and CRRA does exist this means that financial planners should take care to evaluate measures of client CRRA in light of client emotional characteristics.

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Abstract: We study the effect of investor horizons on a comprehensive set of corporate decisions. We argue that monitoring by long-term investors generates decision making that maximizes shareholder value. We find that long-term investors strengthen governance and restrain managerial misbehaviors such as earnings management and financial fraud. They discourage a range of investment and financing activities but encourage payouts. Innovation increases, in quantity and quality. Shareholders benefit through higher profitability that the stock market does not fully anticipate, and lower risk.

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Abstract: Voluminous research documents marketing’s ability to produce results. However, there is limited direct evidence relating firm marketing expenditure to profitability, or marketing efficiency. The challenge arises from poor data availability on marketing decisions in firms and questionable surrogates commonly used in place of marketing expenditure. In response, we collect actual marketing expenditure data in a representative sample of firms and investigate the relationship between marketing intensity and common measures of current and future performance. We find the impact to be positive. We contrast these results with findings based on selling, general and administrative expense (SG&A), which is a popular marketing proxy. We show that using SG&A may lead to questionable inferences about the impact of marketing spending on accounting performance. We propose an alternate, less noisy, approximation to total marketing expenditure and investigate the focal relationship among our sampled firms which do not disclose their marketing costs.

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Abstract: Using a large sample of over 1,000 students from a major, land-grant, public university in Massachusetts, we examine the financial literacy level of college students, and its implications on the repayment of student debt. We find low levels of financial literacy (39.5%), particularly among female (26%), minority (24%) and first-generation (33%) students. Based on survey responses, we show that students with a deficit in financial literacy are more likely to underestimate future student loan payments; 38.2% of low-literacy students underestimate future payments by more than $1,000 annually, while high financial literacy reduces the probability of significant payment underestimation by 17-18 percentage points. Furthermore, we find evidence of a financial literacy wage gap as students with low financial literacy expect significantly lower starting salaries than their high-literacy peers. As a result, low-literacy students are more vulnerable to unexpected, adverse shocks on their payment-to-income ratios that can impair their future creditworthiness and undermine their ability to service debt post-graduation.

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Abstract: We examine the link between firms’ advertising and their tax avoidance. By generating customer awareness, advertising helps shape firm image and reputation among customers. Such benefits of advertising would diminish if the firm is viewed as a greedy tax dodger. Greater customer awareness generated by higher advertising spending also increases the likelihood that customers would find out tax-aggressive behaviors of the firm. Thus, firms that spend more on advertising may want to be less tax-aggressive. Consistent with this argument, we find that firms with a greater extent of advertising spending have fewer tax-sheltering activities, smaller book-tax differences, and higher cash-effective tax rates. The negative effect of advertising on tax avoidance is stronger for firms that are less known, more opaque, or that have lower institutional holdings. We control for other factors affecting tax avoidance, including corporate governance and social responsibility ratings. We also use the instrumental variable method, propensity score matching, and change regressions to address endogeneity concerns. Our results remain statistically and economically significant.

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Abstract: We hypothesize that greater information asymmetry causes greater losses to debtholders. To test this, we identify exogenous increases in information asymmetry using the loss of an analyst that results from broker closures and broker mergers. We find that the loss of an analyst causes the cost of debt to increase by 25 basis points for treatment firms compared to control firms, and the rate of credit events (e.g., defaults) is roughly 100-150% higher. These results are driven by firms that are more sensitive to changes in information (e.g., less analyst coverage). The evidence is broadly consistent with both financing and monitoring channels, although only a financing channel explains the impact of the loss of an analyst on firms' cost of debt.

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Abstract: Outliers represent a fundamental challenge in empirical finance research. We investigate whether the routine techniques used in finance research to identify and treat outliers are appropriate for the data structures we observe in practice. Specifically, we propose a multivariate identification strategy that can effectively detect outliers. We also introduce an estimator that minimizes the bias outliers cause in both cross-sectional and panel regressions and provide outlier mitigation guidance. Using replications of four recently published studies in premier finance journals, we show how adjusting for multivariate outliers can lead to significantly different results.

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Abstract: Theoretical predictions and empirical results are ambiguous about existence of seasonality in futures markets. This paper examines one prominent seasonality, i.e. the weekend effect in futures markets and presents rational and behavioral reasons for its existence. Specifically, we document a weekend effect (Friday’s return minus the following Monday’s return) in futures markets. The weekend effect occurs partly because of asymmetric risk between long and short positions around weekends; the weekend effect increases when short positions are relatively more risky. In addition, we find that both lagged and contemporaneous changes in investor sentiment are related to the weekend effect. These results are consistent with the literature on investor sentiment that finds that mood improves on Fridays but deteriorates on Mondays.

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Abstract: We find that earnings announcements that follow equity issues and buyback announcements have predictable market reactions. Four-factor abnormal returns to earnings following buyback announcements are higher by 5.1% than similar returns to earnings following equity issues over the (-1,+30) window; the difference is 2.2% when unadjusted returns are used. The evidence is consistent with the notion that markets do not fully reflect information that is embedded in voluntary corporate actions. The drift in these returns is unrelated and distinct from the post-earnings announcement drift. For example, we find positive drift for firms making buyback announcements even when they exhibit negative earnings surprises and find negative drift for firms issuing equity even when they show positive earnings surprises. Since the study looks at short periods around earnings announcements, it does not suffer from benchmarking errors that may influence long-horizon returns.

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Abstract: Prior literature finds information is reflected in option markets before stock markets using daily and weekly trading volume, but evidence is mixed at the intraday level. Using novel intraday signed option volume data, we develop a composite option trading score (OTS) and document its stock return predictability throughout the day. We find OTS in the first 30 minutes of market open predicts stock returns during the remainder of the trading day, where predictability is greater for stocks with higher transaction costs. Moreover, OTS is a significantly stronger predictor of intraday stock returns after overnight earnings news releases. The evidence suggests option trading in the 30 minutes after the opening bell has predictive power for intraday stock returns.

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Abstract: By assuming that stochastic discount factor (SDF) M be a proper but unspecified function of state variables X, we show that this function M(X) must solve a simple second-order linear differential equation specified by state variables' risk-neutral dynamics. Therefore, this assumption determines the most general possible SDFs and associated preferences that are consistent with the given risk-neutral state dynamics and interest rate. From a consistent SDF solution then follow the corresponding state dynamics in the data-generating measure. Our approach offers novel flexibilities to extend several popular asset pricing frameworks: affine and quadratic interest rate models, as well as models built on linearity-generating processes. We illustrate the approach with an international asset pricing model in which (i) interest rate has an affine dynamic term structure and (ii) the forward premium puzzle is consistent with consumption-risk rationales, the two asset pricing features previously deemed conceptually incompatible.

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Abstract: We introduce a covariance and spread (i.e., exchange rate forward discount) adjusted carry factor that prices the cross-section of FX market returns, where many other single and multi-factor models fail. Both the covariance matrix of exchange rate growths and forward discounts contain important information for pricing, which is not captured by well-known factors. The conditional covariance matrix and forward discounts are time-varying and forecast future realized currency returns.

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 Abstract: The pension annuity buyout market continues to experience very strong growth, with record deal volumes being reported. Cantor, Hood, and Power (2017) document a large variation in stock market reaction to annuity buyout announcements. The fundamental question remains however: Does the equity market care about these transactions? In Cantor, Hood, and Power (2018), we hope to further understand the market’s view of pension annuity buyout transactions. We argue that the funded status of the pension fund and the motivation for the buyout could drive the market’s reaction. By expanding our sample and gathering data on funded status, we can test the market’s reaction based on the funded status of the plan prior to the announcement. In addition, we examine the credit market’s reaction to the buyouts. We argue that the equity and debt markets may have a different reaction to the news, conditional on the funded status and credit quality of the company. Our research has important implications for plan sponsors considering whether a pension annuity buyout is an effective transaction. Moreover, our research is relevant for investors who are trying to interpret the impact of these transactions on a company’s value.

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 Abstract: Analyzing the period 1988--2006, we document that banks that are active in strong housing markets increase mortgage lending and decrease commercial lending. Firms that borrow from these banks have significantly lower investment. This is especially pronounced for firms that are more capital constrained or borrow from more-constrained banks. Various extensions and robustness analyses are consistent with the interpretation that commercial loans were crowded out by banks responding to profitable opportunities in mortgage lending, rather than with a demand-based interpretation. The results suggest that housing prices appreciations have negative spillovers to the real economy, which were overlooked thus far.

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 Abstract: Recent research suggests that improper identification of outliers can lead to distorted inference. We investigate this issue by examining the role that multivariate outliers play in research outcomes using the Chen, Hong, Huang, and Kubik (2004) study. We find that the documented negative relation between scale and return performance in the actively managed mutual fund industry is an artifact of extreme observations. A manual examination of the most influential observations with verifications against outside sources shows that these outliers are largely bad data. Removing the errors reduces the point estimates on the effect of fund size, rendering it economically and statistically insignificant. Further analysis employing regressions that mitigate outlier-induced bias and extending the sample through 2014 confirm our findings. Our evidence contributes to the recent research on the importance of outlier identification in finance research.

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Abstract: We examine the effect of aggregate cash flow news and discount rate news on momentum returns. We find that momentum profits are higher following aggregate positive cash flow news, even in down markets or low sentiment periods. This finding expands on the evidence in Cooper et al. (2004) that momentum is significant only when past market returns are non-negative and in Antoniou et al. (2013) that momentum is weaker when sentiment is pessimistic. We find that the higher momentum profits during aggregate positive cash flow news periods are primarily driven by the losers continuing to underperform in subsequent periods. Our findings are consistent with the Hong and Stein (1999) model in the sense that gradual diffusion of contradictory news is accentuated when change in wealth is positive and relatively more permanent.

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 Abstract: Over the past several years, numerous companies have chosen to execute annuity buyouts as a method of de-risking their pension plans. The prevailing wisdom is that shareholders reward these transactions through increases in the share price when the transaction is executed. This logic is commonly employed by advisors and consultants to prompt plan sponsors to do an annuity buyout. We employ an event-study methodology to empirically test how the stock market reacts to annuity buyout announcements. We also examine whether the market reaction is different for small firms, those with high levels of credit risk, and large relative deal sizes. While our sample size is limited, we find for risky companies that the market views an annuity purchase as a negative signal and the share price is not rewarded. For large investment grade companies, the market views an annuity purchase more positively and the share price earns a small, but temporary, premium.

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Abstract: We study the effect of investor horizons on a comprehensive set of corporate decisions. We argue that monitoring by long-term investors generates decision making that maximizes shareholder value. We find that long-term investors strengthen governance and restrain managerial misbehaviors such as earnings management and financial fraud. They discourage a range of investment and financing activities but encourage payouts. Innovation increases, in quantity and quality. Shareholders benefit through higher profitability that the stock market does not fully anticipate, and lower risk.

Link to article

  •  
    • Abstract: As the American coal industry attempts to rebound, it is imperative that governments ensure that taxpayers and the public are protected against future and past environmental harms caused by a broken financial-assurance system. By analyzing the bankruptcies of coal giants Peabody, Alpha, and Arch, it is apparent that self-bonding is no longer working as an effective financial assurance mechanism. With many coal companies now being unable to cover their reclamation costs, governments have an opportunity to fix this broken system by requiring more stringent financial assurance. Governments must adapt and turn to more effective, sustaining alternative financial assurance mechanisms such as trust funds to help fund future reclamation costs. Additionally, most states would, at the very least, be prudent to increase their bond amounts in line with North Dakota if they do not want their taxpayers to be on the hook for future environmental costs regarding oil and natural gas wells. In summary, it would be advantageous for governments to not only perform an exhaustive review of their financial assurance mechanisms in the natural resources industries but also amend these practices to better protect their taxpayers from potential environmental harms and costs down the road.

Abstract: We examine the effect of aggregate cash flow news and discount rate news on momentum returns. We find that momentum profits are higher following aggregate positive cash flow news, even in down markets or low sentiment periods. This finding expands on the evidence in Cooper et al. (2004) that momentum is significant only when past market returns are non-negative and in Antoniou et al. (2013) that momentum is weaker when sentiment is pessimistic. We find that the higher momentum profits during aggregate positive cash flow news periods are primarily driven by the losers continuing to underperform in subsequent periods. Our findings are consistent with the Hong and Stein (1999) model in the sense that gradual diffusion of contradictory news is accentuated when change in wealth is positive and relatively more permanent.

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Abstract: On January 20, 2016, the Supreme Court released its slip opinion in Campbell-Ewald Co. v. Gomez addressing derivative immunity. This was the first time in seventy-six years that the Court expounded upon this common law doctrine. In fact, its very existence has been questioned since its controversial inception in Yearsley v. W.A. Ross Construction Co. Subsequently, courts have languished in a state of confusion as to when a federal contractor providing a service can claim immunity. Courts have historically borrowed indiscriminately from among the different immunity doctrines in extending immunity to these private entities. This prior lack of any defined test or path of reasoning for extending immunity to these contractors has contributed to the false impression that the courts are extending immunity beyond its necessary limits. This Article distinguishes between the different theories the courts have utilized in the past to extend immunity to third parties and explains the resulting common law test for qualified immunity that can be discerned from the Court's limited analysis in Campbell-Ewald Co.

 Abstract: Upon examining the language used in recent SEC filings, we find that severance agreements are often paid whether or not the CEO leaves the firm due to a change in control. We hypothesize that since severance agreements compensate CEOs in the event of termination, CEOs with these agreements will have an incentive to increase firm risk and decrease effort. Consistent with this hypothesis, we document a significant positive relation between the use of severance agreements and the cost of debt (10% higher yield spreads for firms with severance agreements). The results hold after controlling for the probability of takeover, the probability of CEO turnover, and whether the firm has investment or non-investment grade debt. These results can be explained by an increase in firm risk and a higher likelihood of CEO turnover associated with severance agreements. Overall, the evidence suggests that the effects of severance agreements extend beyond takeovers, and that these additional implications are primarily negative for the firm and for debt holders in particular.

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Abstract: We hypothesize that greater information asymmetry causes greater losses to debtholders. To test this, we identify exogenous increases in information asymmetry using the loss of an analyst that results from broker closures and broker mergers. We find that the loss of an analyst causes the cost of debt to increase by 25 basis points for treatment firms compared to control firms, and the rate of credit events (e.g., defaults) is roughly 100-150% higher. These results are driven by firms that are more sensitive to changes in information (e.g., less analyst coverage). The evidence is broadly consistent with both financing and monitoring channels, although only a financing channel explains the impact of the loss of an analyst on firms' cost of debt.

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Abstract: We examine whether media news reflect the extent to which issuing firms manage their earnings prior to their equity carve-outs (ECOs). We posit that managers will strategically respond to media requests prior to their equity offerings in order to signal their type and differentiate themselves from others. We find that media news at the time of the ECO is negatively related to earnings management during the year prior to the ECO date. However, when we examine the nature of media news (informative vs uninformative), we find that earnings management is negatively (positively) related to informative (uninformative) media news. Moreover, while price revision is positively related to both informative and uninformative media news, ECO underpricing is positively related to uninformative media news and negatively related to informative media news. This suggests that uninformative news induces investor sentiment during the first day of trading, whereas informative news reduces the asymmetric information between issuing firms and outside investors. Consistently, we document that long-run ECO performance decreases with earnings management and uninformative news, but is positively related to informative news. Our results highlight the importance of the nature of news in media coverage for issuers seeking to differentiate themselves from those managing their earnings prior to equity offerings, evidence consistent with signaling.

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Abstract: Indexing has experienced substantial growth over the last two decades because it is an effective way of holding a diversified portfolio while minimizing trading costs and taxes. In this paper, we focus on one negative externality of indexing: the effect on efficiency of stock prices. Based on a sample of large and liquid U.S. stocks, we find that greater indexing leads to less efficient stock prices, as indicated by stronger post-earnings-announcement drift and greater deviations of stock prices from the random walk. We conjecture that reduced incentives for information acquisition and arbitrage induced by indexing and passive trading are probably the main causes for degradation in price efficiency.

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Abstract: Using bank level measures of competition and co-dependence, we show a robust negative relationship between bank competition and systemic risk. Whereas much of the extant literature has focused on the relationship between competition and the absolute level of risk of individual banks, in this paper we examine the correlation in the risk taking behavior of banks. We find that greater competition encourages banks to take on more diversified risks, making the banking system less fragile to shocks. Examining the impact of the institutional and regulatory environment on bank systemic risk shows that banking systems are more fragile in countries with weak supervision and private monitoring, greater government ownership of banks, and with public policies that restrict competition. We also find that the negative effect of lack of competition can be mitigated by a strong institutional environment that allows for efficient public and private monitoring of financial institutions.

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 Abstract: We investigate the impact of the Sarbanes-Oxley (SOX) Act on the cost of debt through its effect on the reliability of …financial reporting. Using Credit Default Swap (CDS) spreads and a structural CDS pricing model, we calibrate a …firm-level corporate opacity parameter in the pre- and post-SOX periods. Our analysis shows that corporate opacity and the cost of debt decrease significantly after SOX. The median …firm in our sample experiences an 18 bp reduction on its …five-year CDS spread as a result of lower opacity following SOX, amounting to total annual savings of $ 844 million for the 252 …firms in our sample. Furthermore, the reduction in opacity tends to be larger for …firms that in the pre-SOX period have lower accrual quality, less conservative earnings, lower number of independent directors, lower S&P Transparency and Disclosure ratings, and are more likely to benefit from SOX-compliance according to Chhaochharia and Grinstein’s (2007) criteria.

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Abstract: The paper develops a new measure for the probability of informed trading, which can be estimated from the observed quotes and depths. This measure (PROBINF) represents the specialist's ex-ante estimate of the probability of informed trading. We find that PROBINF exhibits a strong and robust relationship with the observed level of insider trading and with measures of the price impact of trades. Moreover, the time series pattern of our measure in an intra-day analysis around earnings announcements is consistent with previous findings and with expectations regarding informed trading. An important advantage of PROBINF is that it can be estimated for each quote, and thus can be used to measure short term (e.g. intra-day, daily etc.) changes in informed trading and information asymmetry around events such as merger and acquisition announcements, share repurchases, stock splits, dividend announcements and index additions and deletions.

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Abstract: We examine the effect of liability protection on the compensation of directors and on takeover outcomes. Consistent with the hypothesis that directors require additional compensation if they bear liability, we find that director compensation is higher for firms that provide less liability protection. Examining takeovers, we find evidence that takeovers of firms with protected directors are less likely to succeed. Moreover, firms with protected directors are more likely to accept a lower bid premium, and this finding is consistent with protected directors having reduced incentives to negotiate for the highest possible price during the acquisition. Overall, the results are consistent with the notion that director liability provisions have a significant impact both on director compensation and director duty.

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Abstract: Prior SEC inquiries concerning self-dealing in securities lending programs suggest potential conflicts of interest when funds employ lending agents that are affiliated with their sponsor. We posit that the level of self-dealing is potentially greater, and mutual funds’ securities lending returns are lower, when funds employ sponsor affiliated lending agents. Using a manually collected U.S. index mutual fund sample, we find that funds with sponsor affiliated lending agents have lower annual returns on lent securities and that securities lending returns are significantly higher when funds administer their own lending programs. We also find that mutual funds boards of directors provide a monitoring role in the securities lending market. Specifically, we document that multiple board of director appointments, more director fund ownership, higher board independence, and lower excess director compensation are associated with higher lending returns. Overall, the evidence has implications for mutual fund boards as they consider lending proposals from affiliated agents and for future regulatory actions.

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Abstract: We consider perpetual Bermudan options, which have no expiration and can be exercised every T time units. We use the Green's function approach to write down an integral equation for the value of a perpetual Bermudan call option on an expiration date; this integral equation leads to a Wiener–Hopf problem. We discretize the integral in the integral equation to convert the problem to a linear algebra problem, which is straightforward to solve, and this enables us to find the location of the free boundary and the value of the perpetual Bermudan call. We compare our results to earlier studies which used other numerical methods.

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Abstract: We examine whether mutual funds and hedge funds herd after each other and the associated impacts on stock prices. We find strong evidence that mutual funds herd into or out of stocks following the herd of hedge funds: mutual funds’ herding measure is positively related to last quarter’s hedge fund herding. In contrast, hedge funds do not follow mutual funds. Mutual funds’ following of hedge funds leads to a sharp price reversal in the next quarter, whereas hedge fund herding itself does not destabilize prices. Further, a mutual fund’s following intensity increases with its past performance. The top 30 percent of mutual funds most active in following hedge funds do so persistently and drastically increase their herding subsequent to intense herding by hedge funds. They are also the group driving the above price reversals. Overall, our evidence is consistent with the reputational incentives of mutual fund herding and the associated price destabilization effects.

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Abstract: Berk and Green (2004) argue that investment inflow at high-performing mutual funds eliminates return persistence because fund managers face diminishing returns to scale. Our study examines the role of trading costs as a source of diseconomies of scale for mutual funds. We estimate annual trading costs for a large sample of equity funds and find that they are comparable in magnitude to the expense ratio; that they have higher cross-sectional variation that is related to fund trade size; and that they have an increasingly detrimental impact on performance as the fund's relative trade size increases. Moreover, relative trade size subsumes fund size in regressions of fund returns, which suggests that trading costs are the primary source of diseconomies of scale for funds.

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 Abstract: This roundtable session was organized to answer the question:“What can I do as a finance professor to increase the personal financial capability of my students and others in my community?” The panelist for this roundtable were chosen as “best in class” examples of professors who have developed programs and curricula on their campuses that promote financial literacy by lifting the level of an individual’s financial acumen and decision making ability. Each panelist presents a unique and compelling model for enhancing the financial wellbeing of students on their campus. The success of these programs highlights the level of demand at universities for personal finance education, financial counseling, and financial wellbeing support on our campuses.

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 Abstract: We examine the relation between organizational structure (public vs private) and managerial turnover in a large sample of U.S. offered mutual funds. Consistent with the hypothesis that publicly traded firms focus more on shorter term performance, we find that public sponsors are more sensitive to prior fund performance when making replacement decisions and experience smaller post turnover performance improvements. Additional testing suggests a higher likelihood of fund manager replacement when mutual funds are team managed and when fund boards more independent. Overall, our results indicate that organizational form plays a pivotal role in the managerial labor market for mutual funds.

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Abstract: Equity ownership by public pension funds (PPFs) has been widely used in the existing literature (see, among others, Cremers and Nair, 2005; and Dittmar and Mahrt-Smith, 2007) to measure the strength of shareholder monitoring/governance. This paper raises caution about such practices by illustrating that there is an inverted-U shape relationship between PPF ownership and firms' future performance, as measured by short-term and long-term stock returns and operating performance: during 1985 to 2005, future performance first increases, then declines in aggregate equity ownership by PPFs. These results suggest: First, shareholder value considerations and political interests/pressures co-exist for PPF managers. Second, PPFs' presence is consistent with shareholders value maximization when they have moderate influence on firm management, whereas excessive PPF ownership facilitates PPF managers' pursuits for political interests and destroys shareholder value. Finally, it is necessary to impose an upper bound to PPF ownership in using it to proxy for the strength of shareholder monitoring/governance.

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