The following papers have been accepted for publication in future issues.
Stock market average returns and Sharpe ratios are significantly higher on days when important macroeconomic news about inflation, unemployment, or interest rates is scheduled for announcement. The average announcement day excess return from 1958 to 2009 is 11.4 basis points versus 1.1 basis points for all the other days, suggesting that over 60% of the cumulative annual equity risk premium is earned on announcement days. The Sharpe ratio is ten times higher. In contrast, the risk-free rate is detectably lower on announcement days, consistent with a precautionary saving motive. Our results demonstrate a trade-off between macroeconomic risk and asset returns, and provide an estimate of the premium investors demand to bear this risk.
We study the empirical determinants of corporate ownership dynamics in a market where large shareholders are prevalent. We use a unique, hand-collected 20-year dataset on the ownership structure of Chilean companies. Controllers’ blockholdings are on average high -as in continental Europe, for instance- and quite stable over time. Controllers still make nontrivial changes to their holdings through issuance and block trades. In a typical year controllers’ blockholdings decrease (increase) by 5 percentage points or more in approximately 6% (7%) of firms. Few of these events are associated with changes in the identity of the controller although about half are correlated with changes in the size or composition of the board of directors. We find that the separation between controller’s voting and cash-flow rights reduces the likelihood of ownership dilution. Dilution is preceded by high stock returns, and predicts low stock returns in the future (particularly when done through issuance). Dilution does not seem to be followed by higher investment, debt growth, changes in profitability, or turnover in control.
This paper examines the characteristics and pricing of stocks that are actively traded by speculative retail investors. We find that stocks with high “retail trading proportion” (RTP) have strong lottery features and they attract retail investors who are known to exhibit a strong propensity to gamble with stocks. High levels of RTP also reflect active trading by risk-seeking “realization utility” investors. Stocks whose trading are dominated by speculative retail investors tend to be overpriced and earn significantly negative alpha. The average return difference between the top and the bottom RTP quintiles is about –0.60% per month. This negative RTP premium is stronger among stocks that have lottery features or are located in regions in which people exhibit a stronger propensity to gamble. Collectively, these results indicate that speculative retail trading importantly affect stock prices.
The trading of securities on multiple markets raises the question of each market’s share in the discovery of the informationally efficient price. We exploit salient distributional features of multivariate financial price processes to uniquely determine these contributions. In doing so, we resolve the main drawback of the widely used Hasbrouck (1995) methodology, which merely provides upper and lower bounds of a market’s information share. When these bounds diverge, as is the case in many applications, informational leadership becomes blurred. We show how tail dependence of price changes, which may emerge as a result of differences in market design, can be exploited to estimate unique information shares. Two empirical applications illustrate the benefit and practical use of the new methodology.
The trading of shares of the same firm in multiple markets has become common over the last thirty years, but there is little empirical evidence on the extent to which investors actively exploit multimarket environments. We introduce a volume-based measure of multimarket trading to address this question. Analyzing a large set of cross-listed firms, we find higher multimarket trading among markets with similar designs and strong enforcement of insider trading laws and for firms with higher institutional ownership. These findings are important for firms evaluating the benefits of cross-listing and for markets competing for order flow.
Using unique daily fund manager trade data, we examine the role of institutional trading in influencing firm performance. We show that short-horizon informed trading by multiple institutional investors effectively disciplines corporate management. Our focus is on short-term “swing” trades, sequences with three phases (e.g. buy-sell-buy). We find swing trades increase stock price informativeness, are profitable after costs, and improve market efficiency. This increase in stock price informativeness is associated with subsequent firm outperformance. Trades are most beneficial with optimal stock holdings that reflect the information acquisition incentives of investors as well as liquidity costs.
We test the relationship between takeover protection and voluntary disclosure in a setting of antitakeover laws in a firm’s state of incorporation. We find that firms incorporated in states with more antitakeover laws have higher levels of voluntary disclosure and stock market liquidity after correcting for the endogeneity of firms’ incorporation choice. Further tests do not support shareholder demands being the driving force for this association. Our findings are consistent with takeover protection and poor disclosure serving as substitute mechanisms for deterring takeovers. Therefore, as antitakeover statutes mitigate takeover pressures, they enhance managers’ incentives to disclose more in order to realize capital market benefits.
We compare investment policies across public and private firms in different institutional settings. Using a large cross-country dataset, we find that public listed firms are better positioned to take advantage of growth opportunities than private firms. Specifically, public listed firms exhibit higher investment sensitivity to growth opportunities than private firms. This differential, however, only exists in countries with well-developed stock markets. Further, the relative advantage public firms have at allocating capital depends on the degree of agency costs and reliance on external equity.
This paper presents the first empirical evidence showing that the marriage of a member of the controlling family adds value to public corporations. The results, based on a uniquely comprehensive dataset from Thailand, show that the family firm’s stock price increases when the partner is from a prominent business or political family. Abnormal returns tend to be higher for firms whose operation depends on extensive networks. In contrast, marriages to ordinary citizens are not associated with any abnormal returns. These findings are generally supportive of the value of networks in general and marriage in particular.
This study examines the role that CEO overconfidence plays in an explanation of international mergers and acquisitions during the period 2000-2006. Using a sample of CEOs of Fortune Global 500 firms over our sample period, we find that CEO overconfidence is related to a number of critical aspects of international merger activity. Overconfidence helps to explain the number of offers made by a CEO, the frequencies of non-diversifying and diversifying acquisitions, and the use of cash to finance a merger deal. Although overconfidence is an international phenomenon, it is most extensively observed in individuals heading firms headquartered in Christian countries that encourage individualism while deemphasizing longterm orientation in their national cultures.
This article analyzes the effect of liquidity risk on the performance of equity hedge fund portfolios. Similarly to Avramov et al. (2007), we observe that, before accounting for the effect of liquidity risk, hedge fund portfolios that incorporate predictability in managerial skills generate superior performance. This outperformance disappears or weakens substantially for most Emerging Markets, Event Driven and Long/Short hedge fund portfolios once we account for liquidity risk. Moreover, we show that the Equity Market Neutral and Long/Short hedge fund portfolios’ “alphas” also entail rents for their service as liquidity providers. These results hold under various robustness tests.
We examine the effects of nonmonetary benefits on overall executive compensation from the perspective of the living environment at the firm headquarters. Companies in polluted, high crime-rate or otherwise unpleasant locations pay higher compensation to their CEOs than companies locating in more livable locations. This premium in pay for quality of life is stronger when firms face tougher competition in the managerial labor market, when the CEO is hired from outside, and when the CEO has short-term career concerns. Overall, the geographic desirability of the corporate headquarters is an effective substitute for CEO monetary pay.
We test the implications of anchoring bias associated with forecast earnings per share (FEPS) for forecast errors, earnings surprises, stock returns, and stock splits. We find that analysts make optimistic (pessimistic) forecasts when a firm’s FEPS is lower (higher) than the industry median. Further, firms with FEPS greater (lower) than the industry median experience abnormally high (low) future stock returns, particularly around subsequent earnings announcement dates. Firms with a high FEPS relative to the industry median are also more likely to engage in stock splits. Finally, split firms experience more positive forecast revisions, more negative forecast errors, and more negative earnings surprises after a stock split compared with those that do not split their stocks.
The large deviation of the actual return of a Leveraged Exchange-Traded Fund (LETF) from the leveraged multiple of the underlying index return has drawn considerable attention from investors, regulators, and the financial media. Despite this attention, the sources and fundamental determinants of the LETF return deviation remain unidentified. This study constructs a clear, unified, objective, and executable framework that addresses the behaviors, sources, and determinants of the LETF compounding and non-compounding deviations. Our theoretical predictions and empirical results hold the promise of guiding investors, regulators, financial advisors, and portfolio managers toward a thorough understanding of the return behavior of LETFs.
We study the impact of Sarbanes-Oxley Act on the relationship between corporate governance and company performance. We consider five measures of corporate governance during the period 1998-2007. We find a significant negative relationship between board independence and operating performance during the pre-2002 period, but a positive and significant relationship during the post-2002 period. Our most important contribution is a proposal of a governance measure, namely — dollar ownership of the board members — that is simple, intuitive, less prone to measurement error, and not subject to the problem of weighting a multitude of governance provisions in constructing a governance index.
Many applications in financial economics use data series with different starting or ending dates. This paper describes estimation methods, based on the generalized method of moments (GMM), which make use of all available data for each moment condition. We introduce two asymptotically equivalent estimators that are consistent, asymptotically normal, and more effcient asymptotically than standard GMM. We apply these methods to estimating predictive regressions in international data and show that the use of the full sample affects point estimates and standard errors for both assets with data available for the full period and assets with data available for a subset of the period. Monte Carlo experiments demonstrate that reductions hold for small-sample standard errors as well as asymptotic ones.
We show that contractual risk-taking incentives for CEOs increased at large U.S. commercial banks around 2000, when industry deregulation expanded these banks’ growth opportunities. Our econometric models indicate that CEOs responded positively to these incentives, especially at the larger banks best able to take advantage of these opportunities. Our results also suggest that bank boards responded to higher-than-average levels of risk by moderating CEO risk-taking incentives; however, this feedback effect is absent at the very largest banks with strong growth opportunities and a history of highly aggressive risk-taking incentives.
We consider whether sentiment affects the profitability of momentum strategies. We hypothesize that news that contradicts investors’ sentiment causes cognitive dissonance, slowing the diffusion of such news. Thus, losers (winners) become underpriced under optimism (pessimism). Shortselling constraints may impede arbitraging of losers and thus strengthen momentum during optimistic periods. Supporting this notion, we empirically show that momentum profits arise only under optimism. An analysis of net order flows from small and large trades indicates that small investors are slow to sell losers during optimistic periods. Momentum based hedge portfolios formed during optimistic periods experience long-run reversals.
We investigate how differences in regulation regarding banking-commerce integration and banking sector concentration influence loan spreads across 29 countries. Theoretical research posits conflicting effects based on agency costs, information asymmetry costs, and market power. Increased integration is associated with lower loan spreads in countries with low concentration, but moving to high levels of integration increases spreads in countries with high concentration. Starting from lower levels, an increase in integration is associated with an increase in informational efficiency that disappears at higher levels of integration. We also show that market concentration affects loan spreads differently under high, medium, and low integration regimes.
The recent behavioral literature has shown that individual investors hold concentrated portfolios, trade excessively, and exhibit a preference for local stocks. These results are puzzling because in all three instances portfolio distortions could reflect either an informational advantage or psychological biases. In this study, using a demographics-based proxy for smartness, we show that the portfolio distortions of “smart” investors reflect an informational advantage that generate high risk-adjusted returns. In contrast, the distortions of “dumb” investors arise from psychological biases because they experience low risk-adjusted performance. When we do not condition on the level of portfolio distortions, the average net performance of smart investors is below passive benchmarks, but smart investors outperform dumb investors by about 3 percent annually on a risk-adjusted basis. Further, among investors with high portfolio distortions, smart investors outperform passive benchmarks by about 2 percent and the smart-dumb performance differential is over 5 percent. We also show that a portfolio of stocks with smart investor clientele outperforms the dumb clientele portfolio by about 3.50 percent annually. Taken together, these results suggest that both behavioral and information-based explanations for portfolio distortions are appropriate, but they apply to groups of dumb and smart investors, respectively.
We present a theory of the linkages between corporate governance, corporate finance and the real sector of an economy. Using a structural model of industry equilibrium with endogenous entry, we show that poor corporate governance leads to low levels of competition, and to firms with high insider ownership and leverage. In contrast, good corporate governance promotes the adoption of more efficient technologies and development of sectors more exposed to moral hazard. We use our model to study equity market liberalization, and show that liberalizations facilitate entry and adoption of more productive technologies, especially in countries with good corporate governance.
When managing risk, frequently only imperfect hedging instruments are at hand. We show how to optimally cross-hedge risk when the spread between the hedging instrument and the risk is stationary. At the short end, the optimal hedge ratio is close to the cross-correlation of the log returns, whereas at the long end, it is optimal to fully hedge the position. For linear risk positions we derive explicit formulas for the hedge error, and for non-linear positions we show how to obtain numerically efficient estimates. Finally, we demonstrate that even in cases with no clear-cut decision concerning the stationarity of the spread it is better to allow for mean reversion of the spread rather than to neglect it.
Model selection, i.e., the choice of an asset pricing model to the exclusion of competing models, is an inherently misguided strategy when the true model is unavailable to the researcher. This paper illustrates the advantages of a model pooling approach in characterizing the cross section of stock returns. The optimal pool combines models using the log predictive score criterion, a measure of the out-of-sample performance of each model, and consistently outperforms the best individual model. The benefits to model pooling are most pronounced during periods of economic stress and it is a valuable tool for asset allocation decisions.
We test whether asymmetric preferences for losses versus gains affect the prices of cash flow versus discount rate risk. We construct a return decomposition distinguishing cash flow and discount rate betas in up and down markets. Using U.S. data we find that downside cash flow and discount rate betas carry the largest premia. Downside cash flow risk is priced consistently across different samples, periods, and return decomposition methods. It is the only component of beta with significant out-of-sample predictive ability. Downside cash flow premia mainly occur for small stocks, while large stocks are compensated for symmetric cash flow related risk.
We study after-hours trading, price contributions and price discovery following quarterly earnings announcements released outside of the normal trading hours. For S&P 500 stocks from 2004-2008, after-hours trading is heightened on announcement days. A significant portion of the price change and price discovery occurs immediately after the earnings releases. Prices in after-hours trading show a large degree of informational efficiency, further demonstrating the importance of price discovery in after-hours trading. We also provide evidence suggesting that firms prefer after-hours earnings announcements as trades are mainly from informed traders, and those trades are relied upon to convey information to the general public.
In this paper we study the economic value and statistical significance of asset return predictability, based on a wide range of commonly used predictive variables. We assess the performance of dynamic, unconditionally efficient strategies, first studied by Hansen and Richard (1987) and Ferson and Siegel (2001), using a test which has both an intuitive economic interpretation and known statistical properties. We find that using the lagged term spread, credit spread, and inflation, significantly improves the risk-return tradeoff. Our strategies consistently out-perform efficient buy-and-hold strategies, both in-sample and out-of-sample, and also incur lower transactions costs than traditional conditionally efficient strategies.
Lenders will often restructure a loan rather than foreclose on a property because it is less value-destroying. A loan modification primarily entails a change in the loan rate, principal balance and/or remaining time to maturity. We analyze optimal loan modification schemes in a stochastic home price and stochastic interest-rate environment. Lenders maximize their loan values by managing the value of the borrower’s option to default on the loan and prepayment option. In the presence of negative equity, controlling for the borrower’s ability to pay, loan modifications via rate reductions and maturity extensions result in a higher probability of re-default by homeowners even after modification of their loans. In contrast, loan write-downs (the Principal Principle), not a favored recipe, and sometimes prohibited by covenants, are value-maximizing for the lender. Once negative equity has been tackled by principal write-downs, rate reductions are optimal. A useful structuring device, the shared appreciation mortgage, enhances the ability to pay, mitigates adverse selection, and reduces the present value of expected deadweight foreclosure costs.
We examine aggregate idiosyncratic volatility in 23 developed equity markets, measured using various methodologies, and we find no evidence of upward trends when we extend the sample utill 2008. Instead, idiosyncratic volatility appears to be well described by a stationary autoregressive process that occasionally switches into a higher-variance regime that has relatively short duration. We also document that idiosyncratic volatility is highly correlated across countries. Finally, we examine the determinants of the time-variation in idiosyncratic volatility. In most specifications, the bulk of idiosyncratic volatility can be explained by a growth opportunity proxy, total (U.S.) market volatility, and in most but not all specifications, the variance premium, a business cycle sensitive risk indicator.
Open market share repurchase announcements are commonly associated with equity undervaluation, but their signal about firm value can often be misleading. We conjecture that executives who buy shares of their firm before an announcement add credibility to the undervaluation signal. Consistent with this hypothesis, we find that announcement returns are positively related to past insider purchases, especially for firms that are priced less efficiently. Firms whose insiders bought more shares are also more likely to complete their repurchase plans. Finally, we find that insider purchases predict post-announcement stock returns.
Well performing default predictions show good discrimination and calibration. Discrimination is the ability to separate defaulters from non-defaulters. Calibration is the ability to make unbiased forecasts. We derive novel discrimination and calibration statistics to verify forecasts expressed in terms of probability under dependent observations. The test statistics’ asymptotic distributions can be derived in analytic form. Not accounting for cross correlation can result in the rejection of actually well performing predictions as shown in an empirical application. We demonstrate that forecasting errors must be serially uncorrelated. As a consequence, our multi-period tests are statistically consistent.
This paper presents the first theoretical analysis of the choice of firms between preparing and not preparing the equity market in advance of a possible dividend cut. In our model, a firm has assets in place that will generate an intermediate cash flow, and a growth opportunity. Firm insiders have private information about the intermediate cash flow as well as about the net present value of its growth opportunity. We characterize the firm’s equilibrium choice between preparing and not preparing the market, as well as dividend-cut decision (subsequent to the realization of its intermediate cash flow). In equilibrium, firms in temporary financial difficulties but good long-term growth prospects are more likely to prepare the market in advance of dividend cuts, while those with permanently declining earnings are less likely to prepare the market. Our analysis generates several testable predictions, not only for the propensity of firms to prepare the market prior to dividend cuts, but also for the announcement effect (on the market preparation day, the dividend cut day, and the combined announcement effect over both days) as well as for the long-run operating, dividend payment, and stock return performance of prepared versus non-prepared dividend cutting firms.
Current attempts to reform financial markets presume that shareholder empowerment benefits shareholders. We investigate the wealth effects associated with the SEC’s rule to facilitate director nominations by shareholders. Our results are not in line with shareholder empowerment creating value: the average daily abnormal returns surrounding events that increase (decrease) the probability of passage of the proposal are significantly negative (positive). Furthermore, given an increase in the probability of passage of the proposal, firms whose shareholders are more likely to use the rule to nominate directors experience more negative abnormal returns.
Using a new variable based on a model of dividend smoothing, we find dividend growth is highly predictable and cash flow news contributes importantly to return variability. Cash flow betas derived from this predictability are central to explaining the size effect in the cross section of returns. However, they do not explain the value effect; this is explained by noise betas. We also find that the relative importance of cash flow news in explaining recent stock price run-ups and subsequent falls increases when cash flow news is estimated directly.
This paper examines the impact of financial sponsor competition on corporate buyers. We find that corporate acquirers who purchase targets that financial buyers also bid on outperform corporate acquirers who buy targets bid on by corporate firms only. Deal characteristics, acquirer abilities, and observable target characteristics cannot explain this difference in returns. Corporate acquirers have higher returns when they follow a first bid by a financial buyer rather than a first bid by another corporate buyer. The results suggest that financial bidders identify targets with high potential for value improvement and winning corporate bidders are competent in exploiting this potential.
This paper analyses the loss allocation to First, Second and Third Loss Positions in European collateralized debt obligation transactions. The quality of the underlying asset pool plays a predominant role for the loss allocation. A lower asset pool quality induces the originator to take a higher First Loss Position, but, in a synthetic transaction, a smaller Third Loss Position. The share of expected default losses, borne by the First Loss Position, is largely independent of asset pool quality, but lower in securitizations of corporate loans than in those of corporate bonds. Originators with a good rating and low Tobin’s Q prefer synthetic transactions.
The Prevalence of the Disposition Effect in Mutual Funds’ Trades
Gjergji Cici
U.S. equity mutual funds, on average, prefer realization of capital losses to capital gains. Nevertheless, a substantial fraction exhibits the disposition effect of realizing gains more readily than losses. My analysis suggests that learning effects have reduced the manifestation of the disposition effect over time, implying that academic research has influenced industry practices. When funds experience outflows and are managed by teams of portfolio managers they are more susceptible to selling disproportionately more winners than losers. Disposition-driven behavior affects investment style, causing lower market betas and characteristics of value-oriented and contrarian styles but has no observable effect on fund performance.
Sell-Side Information Production in Financial Markets
Zhaohui Chen and William J. Wilhelm, Jr.
We study decisions to sell nonexcludable private information in the presence of a trading opportunity. Sell-side agents heighten competition among agents who buy their signals to combine with their own for proprietary trading purposes and thereby promote financial market efficiency. This result holds even when the sell-side production technology is not unique. But sell-side information is subject to underinvestment if producers do not internalize the benefits. The model suggests that fee-based compensation for corporate advisory services diminishes this problem and that market efficiency is undermined by forces steering investment-banking resources toward proprietary trading.
Idiosyncratic Return Volatility and the Information Quality Underlying Managerial Discretion
Changling Chen, Alan Guoming Huang, and Ranjini Jha
Variation in idiosyncratic return volatility from 1978 to 2009 is attributable to discretionary accrual volatility and the correlation between pre-managed earnings and discretionary accruals reflective of information quality across firms. These results are robust to controls for firm operating uncertainty, growth options, business cycle variations, and firm age and industry effects, and highlight the importance of managerial discretion in determining idiosyncratic volatility.
Leverage Expectations and Bond Credit Spreads
Mark J. Flannery, Stanislava (Stas) Nikolova, and Özde Öztekin
Bond credit spreads reflect the issuer’s expected default probability. In an efficient market, spreads will reflect both the issuer’s current risk and investors’ expectations about how that risk might change in the future. Collin-Dufresne and Goldstein (2001) show analytically that a firm’s expected future leverage importantly influences the appropriate spread on its bonds. We confirm this insight empirically, and then use capital structure theory to construct proxies for investors’ expectations about future leverage changes. We find that expected future leverage does significantly affect bond yields, above and beyond the effects of contemporaneous leverage. Expectations formed under the trade-off, pecking order and credit-rating theories of capital structure all receive some empirical support, suggesting that investors view them as complementary when pricing corporate bonds.
Paying Attention:
Overnight Returns and the Hidden Cost of Buying at the Open
Henk Berkman, Paul D. Koch, Laura Tuttle, and Ying Zhang
Using 13 years of intraday data for U.S. stocks, we find a strong tendency for positive returns during the overnight period followed by reversals during the trading day. This behavior is driven by an opening price that is high relative to intraday prices. We find this temporary price inflation at the open is concentrated among stocks that have recently attracted the attention of retail investors, and these high attention stocks have high levels of net retail buying at the start of the trading day. In addition, we document that the sensitivity of opening prices to retail investor attention is more pronounced for stocks that are difficult to value and costly to arbitrage, and is greater during periods of high overall retail investor sentiment. The additional implicit transaction costs for retail traders who buy high attention stocks near the open frequently exceed the effective half spread.
Heterogeneous Beliefs and Risk Neutral Skewness
Geoffrey C. Friesen, Yi Zhang, and Thomas S. Zorn
This study tests whether investor belief differences affect the cross-sectional variation of risk-neutral skewness, using data on firm-level stock options traded on the CBOE from 2003 to 2006. Using well known proxies for heterogeneous beliefs, we find that stocks with greater belief differences have more negative skews, even after controlling for systematic risk and other firm-level variables known to affect skewness. This result also goes beyond the net price pressure hypothesis suggested by Bollen and Whaley (2004). Factor analysis identifies latent variables linked to systematic risk and belief differences. The belief factor explains more variation in the risk-neutral density than the risk-based factor. Our results suggest that belief differences may be one of the unexplained firmspecific components affecting skewness described in Dennis and Mayhew (2002).
Customer Order Flow, Intermediaries, and Discovery of the Equilibrium Risk-Free Rate
Albert J. Menkveld, Asani Sarkar, and Michel van der Wel
Macro announcements change the equilibrium risk-free rate. We find that treasury prices reflect part of the impact instantaneously, but intermediaries rely on their customer order flow after the announcement to discover the full impact. This customer flow informativeness is strongest when analyst macro forecasts are most dispersed. The result holds for 30-year treasury futures trading in both electronic and open-outcry markets. We further show that intermediaries benefit from privately recognizing informed customer flow, as their own-account trading profitability correlates with customer order access.
Are CFOs’ Trades More Informative than CEOs’ Trades?
Weimin Wang, Yong-Chul Shin, and Bill B. Francis
We investigate whether trades made by CFOs reveal more information about future stock returns than those by CEOs. We find that CFOs earn statistically and economically higher abnormal returns following their purchases of company shares than CEOs. During 1992-2002, CFOs earned an average 12-month excess return that is 5% higher than that by CEOs. The superior performance by CFOs occurs notwithstanding controls for risk factors, and persists even after their trades are publicly disclosed. Further analysis shows that CFO purchases are associated with more positive future earnings surprises than CEO purchases, suggesting that CFOs incorporate better information about future earnings.
The Log-Linear Return Approximation, Bubbles, and Predictability
Tom Engsted, Thomas Q. Pedersen, and Carsten Tanggaard
We study in detail the log-linear return approximation introduced by Campbell and Shiller (1988a). First, we derive an upper bound for the mean approximation error, given stationarity of the log dividend-price ratio. Next, we simulate various rational bubbles which have explosive conditional expectation, and we investigate the magnitude of the approximation error in those cases. We find that surprisingly the Campbell-Shiller approximation is very accurate even in the presence of large explosive bubbles. Only in very large samples do we find evidence that bubbles generate large approximation errors. Finally, we show that a bubble model in which expected returns are constant can explain the predictability of stock returns from the dividend-price ratio that many previous studies have documented.
Long-Term Effects of a Financial Crisis: Evidence from Cash Holdings of East Asian Firms
Kyojik “Roy” Song and Youngjoo Lee
We investigate the long-term effect of the Asian financial crisis on corporate cash holdings in eight East Asian countries. The median cash to assets ratio for the Asian firms almost doubles from 6.7% in 1996 to 12.1% in 2006, and the sudden increase in cash holdingsis pervasive regardless of financial constraints. The Asian firms build up cash holdings by decreasing investment activities such as capital expenditures and acquisitions after the crisis.We find that the increase in cash holdings is not explained by changes in firm characteristics but by change in the firms’ demand function for cash, which indicates that the crisis has systematically changed the firms’ cash holding policies. Specifically, the firms’ increased sensitivity to cash flow volatility is one of the main factors to explain the higher level of their cash holdings in the post-crisis period.These findings are partially consistent with the precautionary motive of cash holdings in that financial crisis can make the management policies of firms very conservative even after the economy recovers from the crisis.
The Desire to Acquire and IPO Long-Run Underperformance
James C. Brau, Robert B. Couch, and Ninon K. Sutton
We analyze 3,547 IPOs from 1985 through 2003 to determine the impact of acquisition activity on long-run stock performance. The results show that IPOs that acquire within a year of going public significantly underperform for one- through five-year holding periods following the first year, whereas non-acquiring IPOs do not significantly underperform over these time frames. For example, the mean three-year style-adjusted abnormal return is -15.6% for acquirers and 5.9% for non-acquirers. Our cross-sectional and calendar-time results suggest that the acquisition activity of newly public firms plays an important and previously unrecognized role in the long-run underperformance of IPOs.
A New Method to Estimate Risk and Return of Non-Traded
Assets from Cash Flows: The Case of Private Equity Funds
Joost Driessen, Tse-Chun Lin, and Ludovic Phalippou
We develop a new methodology to estimate abnormal performance and risk exposure of non-traded assets from cash flows. Our methodology extends the standard internal rate of return approach to a dynamic setting. The small-sample properties are validated using a simulation study. We apply the method to a sample of 958 private equity funds. For venture capital funds, we find a high market beta and underperformance before and after fees. For buyout funds, we find a relatively low market beta and no evidence for outperformance. We find that self-reported net asset values significantly overstate fund values for mature and inactive funds.
The Performance of Investment Bank Affiliated Mutual Funds:
Conflicts of Interest or Informational Advantage?
(Grace) Qing Hao and Xuemin (Sterling) Yan
Using a comprehensive sample of U.S. mutual funds from 1992 to 2004, we find strong evidence that investment bank affiliated funds underperform unaffiliated funds. Consistent with the conflict of interest hypothesis, we find that affiliated funds hold disproportionately large amounts of stocks of their IPO and SEO clients. Moreover, worse performing clients are more likely to be held by affiliated funds. Our results are robust to alternative risk-adjustments, portfolio weighting schemes, and regression methodologies. Overall, our findings are consistent with the idea that investment banks use affiliated funds to support underwriting business at the expense of fund shareholders.
Stocks, Bonds, and Long-Run Consumption Risks
Henrik Hasseltoft
I evaluate whether the so-called long-run risk framework can jointly explain key features of both equity and bond markets as well as the interaction between asset prices and the macroeconomy. I nd that shocks to expected consumption growth and time-varying macroeconomic volatility can account for the level of risk premia and its variation over time in both markets. The results suggest a common set of macroeconomic risk factors operating in equity and bond markets. I estimate the model using a simulation estimator which accounts for time-aggregation of consumption growth and utilizes a rich set of moment conditions.
Equity Mispricing and Leverage Adjustment Costs
Richard S. Warr, William B. Elliott, Johanna Koëter-Kant, and Özde Öztekin
We find that equity mispricing impacts the speed at which firms adjust to their target leverage and does so in predictable ways depending on whether the firm is over- or underlevered. For example, firms that are above their target leverage and should therefore issue equity (or retire debt), adjust more rapidly toward their target when their equity is overvalued. However, when a firm is undervalued, but needs to reduce leverage, the speed of adjustment is much slower. Our findings support the role of equity mispricing as an important factor that alters the cost of making capital structure adjustments.
Repurchases, Reputation, and Returns
Alice Adams Bonaimé
This paper examines whether a firm’s reputation is a determinant of repurchase completion rates (the ratio of actual to announced repurchases) and whether the stock market discounts announcements made by less reputable firms. Prior completion rates are positively correlated with current completion rates and announcement returns, suggesting consistency in repurchases and implying a reputational effect. Further, a nascent literature regarding accelerated share repurchases finds them to be more credible than open market repurchases. I show that the probability of announcing an accelerated share repurchase is greater for firms likely to be concerned about reputation because of low past completion rates.
Do Pension-Related Business Ties Influence Mutual Fund Proxy Voting? Evidence from Shareholder Proposals on Executive Compensation
Rasha Ashraf, Narayanan Jayaraman, and Harley E. Ryan, Jr.
We examine the relation between mutual fund votes on shareholder executive compensation proposals and pension-related business ties between fund families and the firms. In unconditional tests, we find that fund families support management when they have pension ties to the firm. We find no relation when we stratify by fund family in conditional tests, which suggests that fund families with pension ties vote with management at both client and non-client firms. We confirm this result in an analysis of non-client firms. Overall, our results suggest that pension-related business ties influence fund families to vote with management at all firms.
The Value of Active Investing: Can Active Institutional Investors Remove Excess Comovement of Stock Returns?
Pengfei Ye
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.
Clean Sweep: Informed Trading through
Intermarket Sweep Orders
Sugato Chakravarty, Pankaj Jain, James Upson, and Robert Wood
An intermarket sweep order (ISO) is a limit order that automatically executes in a designated market center even if another market center is publishing a better quotation. An investor submitting an ISO must satisfy order-protection rules by concurrently submitting orders to the markets with better prices. We find that ISOs represent 46% of trades and 41% of volume in our sample. ISO trades have significantly larger information share despite their small trade size relative to non-ISO trades. Post trade return analysis suggests that informed institutions are the main users of ISO trades.
The Dividend Initiation Decision of Newly Public Firms: Some Evidence on Signaling with Dividends
Jayant R. Kale, Omesh Kini, and Janet D. Payne
We track the dividend initiation decisions of a sample of 6,588 firms that went public during the period 1979-2005 and find that 873 of them initiated dividends. Our primary objective is to determine whether information signaling can explain the dividend initiation (DI) decision. We find that variables suggested by the dividend-signaling models of John and Williams (1985) and Allen, Bernardo, and Welch (2000) are significant determinants of the DI decision and the associated announcement-period stock price effect. We also find support for the residual, agency, tax, clientele, transactions costs, catering, and life cycle explanations of dividend policy.
Volatility Trading: What Is the Role of the Long-Run Volatility Component?
Guofu Zhou and Yingzi Zhu
In this paper, we study an investor’s asset allocation problem with a recursive utility and with tradable volatility that follows a two-factor stochastic volatility model. Consistent with Liu and Pan (2003) and Egloff, Leippold, and Wu’s (2009) finding under the additive utility, we show that volatility trading generates substantial hedging demand, and so the investor can benefit substantially from volatility trading. However, unlike existing studies, we find that the impact of elasticity of intertemporal substitution on investment decisions is of first-order importance in the two-factor stochastic volatility model when the investor has access to the derivatives market to optimally hedge the persistent component of the volatility shocks. Moreover, we study the economic impact of model and parameter misspecifications and find that an investor can incur substantial economic losses if he uses an incorrect one-factor model instead of the two-factor model or if he incorrectly estimates one of the key parameters in the two-factor model. In addition, we find that the elasticity of intertemporal substitution is a more sensible description of an investor’s attitude toward model and parameter misspecifications than the risk aversion parameter.
Asset Liquidity and Stock Liquidity
Radhakrishnan Gopalan, Ohad Kadan, and Mikhail Pevzner
We study the relation between asset liquidity and stock liquidity. Our model shows that the relation may be either positive or negative depending on parameter values. Asset liquidity improves stock liquidity more for firms which are less likely to reinvest their liquid assets, i.e., firms with less growth opportunities and financially constrained firms. Empirically, we find a positive and economically large relation between asset liquidity and stock liquidity. Consistent with our model, the relation is more positive for firms which are less likely to reinvest their liquid assets. Our results also shed light on the value of holding liquid assets.
It’s All in the Timing: Simple Active Portfolio Strategies that Outperform Naïve Diversification
Chris Kirby and Barbara Ostdiek
DeMiguel et al. (2009) report that naïve diversification dominates mean-variance optimization in out-of-sample asset allocation tests. Our analysis suggests that this is largely due to their research design, which focuses on portfolios that are subject to high estimation risk and extreme turnover. We find that mean-variance optimization often outperforms naïve diversification, but turnover can erode its advantage in the presence of transactions costs. To address this issue, we develop two new methods of mean-variance portfolio selection—volatility timing and reward to- risk timing—that deliver portfolios characterized by low turnover. These timing strategies outperform naïve diversification even in the presence of high transactions costs.
Corporate Governance and Innovation
Matthew O’Connor and Matthew Rafferty
We use Tobin’s q models of investments to estimate the relationship between corporate governance and the level of innovative activity. Simple OLS models suggest that poor governance reduces innovative activity. However, OLS results are sensitive to controlling for serial correlation, unobserved effects, or using instrumental variables to control of simultaneity. Controlling for these effects substantially reduces or eliminates the relationship between governance and innovation activity.
Financial Strength and Product Market Competition: Evidence from Asbestos Litigation
Charles J. Hadlock and Ramana Sonti
We study the role of financial strength on product market competition by examining exogenous shocks to a firm’s liability structure arising from asbestos litigation. We find that exogenous increases (decreases) in asbestos liabilities are interpreted by the market as negative (positive) news for a firm’s close competitors. These reactions are magnified in events in which one asbestos-tainted firm goes bankrupt and other asbestos-tainted stocks fall on the news. For smaller competitors, market reactions are more pronounced in more concentrated industries.Our findings support the general hypothesis that increases in fixed liabilities lead to more aggressive product market interactions.
Sources of Gains in Corporate Mergers: Refined Tests from a Neglected Industry
David A. Becher, J. Harold Mulherin, and Ralph A. Walkling
Our work provides refined tests of the existence and source of merger gains in a neglected industry: utilities. While excluded from traditional analyses, utilities offer fertile ground for a detailed analysis of the traditional theories of synergy, collusion, hubris and anticipation. The analysis of utilities provides methodological advantages and is important from for public policy reasons. We find that utility mergers create wealth for the combined bidder and target. These positive wealth effects are consistent with both the synergy hypothesis and the collusion hypothesis. To distinguish between the hypotheses, we study the stock price returns to industry rivals across several dimensions specifically related to collusion: deregulation, horizontal mergers, geography, and withdrawn deals. We also examine the impact of mergers on consumer prices. The results are consistent with synergy and inconsistent with collusion. Analysis of industry rivals that subsequently become targets also rejects the collusion hypothesis and is consistent with the anticipation hypothesis.
The Performance of Corporate-Bond Mutual Funds: Evidence Based on Security-Level Holdings
Gjergji Cici and Scott Gibson
This is the first study of corporate-bond mutual fund performance that examines detailed security-level holdings and returns. The new database allows us to decompose the costs and benefits of active management. In contrast to prior research on equity funds that shows evidence of stock-selection ability, we do not find evidence consistent with bond fund managers, on average, being able to select corporate bonds that outperform other bonds with similar characteristics. We find neutral to weakly positive evidence of ability to time corporate bond characteristics. Overall results show that the costs of active management on average appear larger than the benefits.
Inefficient Labor or Inefficient Capital? Corporate Diversification and Productivity around the World
Todd Mitton
I study the relation between corporate diversification and labor productivity in a sample of over 500,000 firms from 46 countries. Across the entire sample, greater diversification is associated with significantly lower labor productivity. The negative relation between diversification and labor productivity is not stronger in countries with more-burdensome employment regulation, but it is significantly stronger in countries with better financial development. In addition, the negative relation is stronger in industries with high capital/labor ratios. Overall, the results suggest that the lower productivity in diversified firms is due more to the misallocation of capital than to the inefficient use of labor.
Risk-Return Tradeoff in U.S. Stock Returns Over the Business Cycle
Henri Nyberg
In the empirical finance literature findings on the risk-return tradeoff in excess stock market returns are ambiguous. In this study, we develop a new QR-GARCH-M model combining a probit model for a binary business cycle indicator and a regime switching GARCH-in-mean model for excess stock market return with the business cycle indicator defining the regime. Estimation results show that there is statistically significant variation in the U.S. excess stock returns over the business cycle. However, consistent with the conditional ICAPM, there is a positive riskreturn relationship between volatility and expected return independent of the state of the economy.
The Cross Section of Expected Returns with MIDAS Betas
Mariano González, Juan Nave, and Gonzalo Rubio
This paper explores the cross-sectional variation of expected returns for a large cross section of industry and size/book-to-market portfolios. We employ mixed data sampling (MIDAS) to estimate a portfolio’s conditional beta with the market and with alternative risk factors and innovations to well-known macroeconomic variables. The market risk premium is positive and significant, and the result is robust to alternative asset pricing specifications, and model misspecification. However, the traditional two-pass ordinary least squares (OLS) cross-sectional regressions produce an estimate of the market risk premium that is a negative, and even significantly different from zero. Using alternative procedures, we compare both beta estimators. We conclude that beta estimates under MIDAS present lower mean absolute forecasting errors and generate a better out-of-sample performance of the optimized portfolios relative to OLS betas.
Rights Offerings, Subscription Period, Shareholder Takeup, and Liquidity
Balasingham Balachandran, Robert Faff, Michael Theobald, and Tony van Zijl
We examine the role of shareholder takeup in rights offerings on the subscription period price reaction and liquidity. Our results indicate that takeup information is reflected in price adjustments over the subscription period and that quality-related information disclosed on the rights announcement date further impacts upon prices in this period. Higher shareholder takeup improves liquidity. We do find some evidence of inefficiencies in the adjustment process over the subscription period which, in part, is consistent with a model where markets are characterized by overconfident investors and which also articulates with takeup information arriving in the market.
Term Structure Estimation with
Survey Data on Interest Rate Forecasts
Don H. Kim and Athanasios Orphanides
The estimation of dynamic no-arbitrage term structure models with a flexible specification of the market price of risk is beset by severe small-sample problems arising from the highly persistent nature of interest rates. We propose using survey forecasts of a short-term interest rate as an additional input to the estimation to overcome the problem. To illustrate the methodology, we estimate the 3-factor affine-Gaussian model with US Treasury yields data and demonstrate that incorporating information from survey forecasts mitigates the small sample problem. The model thus estimated for the 1990-2003 sample generates a stable and sensible estimate of the expected path of the short rate, reproduces the well-known stylized patterns in the expectations hypothesis tests, and captures some of the short-run variations in the survey forecast of the changes in longer-term interest rates.
Survival of Overconfidence
in Currency Markets
Thomas Oberlechner and Carol Osler
This paper tests the influential hypothesis, typically attributed to Friedman (1953), that irrational traders will be driven out of financial markets by trading losses. The paper’s main finding is that overconfident currency dealers are not driven out of the market. Dealers with extensive experience are neither more nor less overconfident than their junior colleagues. We set the stage for this investigation by providing evidence that currency dealers display two forms of overconfidence: they underestimate uncertainty and they overestimate their professional success. This is notable since dealers face strong incentives to accuracy, have access to comprehensive information, and have extensive experience.
An International Comparison of Capital Structure and
Debt Maturity Choices
Joseph P.H. Fan, Sheridan Titman, and Garry Twite
This study examines the influence of institutional environment on capital structure and debt maturity choices by examining a cross-section of firms in 39 developed and developing countries. We find that a country’s legal and tax system, the level of corruption and the preferences of capital suppliers explain a significant portion of the variation in leverage and debt maturity ratios. Our evidence indicate that firms in countries that are viewed as more corrupt tend to use less equity and more debt, especially short-term debt, while firms operating within legal systems that provide better protection for financial claimants tend to have capital structures with more equity, and relatively more long-term debt. In addition, the existence of an explicit bankruptcy code and/or deposit insurance is associated with higher leverage and more long-term debt. We also find that firms tend to use more debt in countries where there is a greater tax gain from leverage, while firms in countries with larger government bond markets have lower leverage, suggesting that government bonds tend to crowd out corporate debt. Countries with more extensive defined benefit pension funds have higher debt ratios and longer debt maturities, whereas those with more extensive defined contribution fund activities have lower debt ratios. In addition, debt ratios are lower in countries that limit the bond holdings of pension funds. Finally, we do not find a significant association between financing choices and the size of the insurance industry.
Do Investors See through Mistakes in Reported Earnings?
Katsiaryna Salavei Bardos, Joseph Golec, and John P. Harding
This study investigates whether investors see through materially misstated earnings, and whether they anticipate earnings restatements. For firms that restate at least one annual report, we find that investors are misled by mistakes in reported earnings at the time of initial earnings announcements. Investors react positively to the component of the favorable earnings surprise that will subsequently be restated, and attach the same valuation to it as to the true earnings surprise. We also find that investors anticipate the subsequent downward restatements and start marking stock prices down several months before a restatement announcement, so that the full impact of a restatement is about three times as large as the restatement announcement effect. Indeed, we show that investors punish restating firms because the stock price gains that shareholders enjoy when firms initially announce overstated earnings are more than reversed by the time of the restatement announcement.
IPOs versus Acquisitions and the Valuation Premium Puzzle: A
Theory of Exit Choice by Entrepreneurs and Venture Capitalists
Onur Bayar and Thomas J. Chemmanur
We analyze a private firm’s choice of exit mechanism between IPOs and acquisitions, and provide a resolution to the “IPO valuation premium puzzle.” The private firm is run by an entrepreneur and a venture capitalist (insiders) who desire to exit partially from the firm. A crucial factor driving their exit choice is competition in the product market: while a stand-alone firm has to fend for itself after going public, an acquirer is able to provide considerable support to the firm in product market competition. A second factor is the difference in information asymmetry characterizing the two exit mechanisms. Finally, the private benefits of control accruing post-exit to the entrepreneur and the bargaining power of outside investors versus firm insiders are also different across the two mechanisms. We analyze two different situations: the first, where the entrepreneur can make the exit choice alone (independent of the venture capitalist) and the second, where the entrepreneur can make the exit choice only with the concurrence of the venture capitalist. We derive a number of testable implications regarding insiders’ exit choice between IPOs and acquisitions and about the IPO valuation premium puzzle.
New Evidence on the Relation between the Enterprise Multiple and
Average Stock Returns
Tim Loughran and Jay W. Wellman
Practitioners increasingly use the enterprise multiple as a valuation measure. The enterprise multiple is (equity value + debt + preferred stock – cash)/ (EBITDA). We document that the enterprise multiple is a strong determinant of stock returns. Following Fama and French (1993) and Chen, Novy-Marx, and Zhang (2010), we create an enterprise multiple factor that generates a return premium of 5.28% per year. We interpret the enterprise multiple as a proxy for the discount rate. Firms with low enterprise multiple values appear to have higher discount rates and higher subsequent stock returns than firms with high enterprise multiple values.
Institutions and Corporate Investment: Evidence from
Investment-Implied Return on Capital in China
Qiao Liu and Alan Siu
We assess the impact of institutions on Chinese firms’ corporate investment in an investment Euler equation framework. We allow the variables measuring institutions to affect the rate at which firm managers discount future investment payoffs. Applying generalized method of moments estimators to large samples of Chinese firms, we estimate the stochastic discount rates derived from actual investment and examine how they vary across institutional variables. We document robust evidence that ownership is the primary institutional factor affecting corporate investment in China. The derived discount rate for a non-state firm is approximately 10 percentage points higher than that of an otherwise equal state firm. State firms tend to use higher discount rates to invest after they are partially privatized. We also find that firms with higher levels of corporate governance use higher discount rates to make investment.
The Determinants of Operational Risk in U.S. Financial Institutions
Anna Chernobai, Philippe Jorion, and Fan Yu
We examine the incidence of operational losses among U.S. financial institutions using publicly reported loss data from 1980 to 2005. We show that most operational losses can be traced to a breakdown of internal control, and that firms suffering from these losses tend to be younger, more complex, and have higher credit risk, more antitakeover provisions, and CEOs with higher stock option holdings and bonuses relative to salary. These findings highlight the correlation between operational risk and credit risk, as well as the role of corporate governance and proper managerial incentives in mitigating operational risk.
The Two Sides of Derivatives Usage: Hedging and
Speculating with Interest Rate Swaps
Sergey Chernenko and Michael Faulkender
Existing cross-sectional findings on non-financial firms’ use of derivatives are consistent with both hedging and speculative interpretations. An examination using panel data can distinguish between derivatives practices that endure over time, and are therefore more likely to result from hedging, and those that are more transient, thus more consistent with speculation. Our decomposition results indicate that hedging of interest rate risk is concentrated among high investment firms, consistent with the presence of costly external finance. Simultaneously, firms appear to use interest rate swaps to speculate when their executive compensation contracts are more performance sensitive and to manage earnings.
An Extended Macro-Finance Model with
Financial Factors
Hans Dewachter and Leonardo Iania
This paper extends the benchmark Macro-Finance model by introducing, next to the standard macroeconomic factors, additional liquidity-related and return forecasting factors. Liquidity factors are obtained from a decomposition of the money market spread while the return-forecasting (risk premium) factor is extracted by im- posing a single factor structure on the one-period expected excess holding returns. The model is estimated on US data using MCMC techniques. Two findings stand out. First, the model outperforms significantly most structural and non-structural Macro-Finance yield curve models in terms of cross-sectional fit of the yield curve. Second, financial shocks have a statistically and economically significant impact on the yield curve.
Manager Characteristics and Capital
Structure: Theory and Evidence
Sanjai Bhagat, Brian Bolton, and Ajay Subramanian
We investigate the effects of manager characteristics on capital structure in a structural model. We implement the manager’s optimal contracts through financial securities that leads to a dynamic capital structure, which reflects the effects of taxes, bankruptcy costs and manager-shareholder agency conflicts. Long-term debt declines with the manager’s ability, inside equity stake and the firm’s long-term risk, but increases with its short-term risk. Short-term debt declines with the manager’s ability, increases with her equity ownership, and declines with short-term risk. We show support for these implications in our empirical analysis.
Bank Loans with Chinese Characteristics:
Some Evidence on Inside Debt in a State-Controlled Banking System
Warren Bailey, Wei Huang, and Zhishu Yang
We study a transitional economy where state-controlled banks make loan decisions based on noisy inside information on prospective borrowers, and may lend to avert unemployment and social instability. In China, poor financial performance and high managerial expenses increase the likelihood of obtaining a bank loan, and bank loan approval predicts poor subsequent borrower performance. Negative event-study responses occur at bank loan announcements, particularly for borrowers measuring poorly on quality and creditworthiness, or for lenders or borrowers involved in litigation regarding loans. Our results highlight dilemmas in a state-led financial system and the local stock market’s sophistication in interpreting news.
Corporate Lobbying and Fraud Detection
Frank Yu and Xiaoyun Yu
This paper examines the relation between corporate lobbying and fraud detection. Using data on corporate lobbying expenses between 1998 and 2004, and a sample of large frauds detected during the same period, we find that firms’ lobbying activities make a significant difference in fraud detection: compared to non-lobbying firms, firms that lobby on average have a significantly lower hazard rate of being detected for fraud, evade fraud detection 117 days longer, and are 38% less likely to be detected by regulators. In addition, fraudulent firms on average spend 77% more on lobbying than non-fraudulent firms, and spend 29% more on lobbying during their fraudulent periods than during non-fraudulent periods. The delay in detection leads to a greater distortion in resource allocation during fraudulent periods. It also allows managers to sell more of their shares.
On the Scope and Drivers of the Asset Growth Effect
Marc L. Lipson, Sandra Mortal, and Michael J. Schill
Recent papers have debated whether the negative correlation between measures of firm asset growth and subsequent returns is of little importance since it applies only to small firms, justified as compensation for risk, or evidence of mispricing. We show that the asset growth effect is pervasive and evidence to the contrary arises due to specification choices; that one measure of asset growth, the change in total assets, largely subsumes the explanatory power of other measures; that the ability of asset growth to explain either the cross section of returns or the time series of factor loadings is linked to firm idiosyncratic volatility; that the return effect is concentrated around earnings announcements; and that analyst forecasts are systematically higher than realized earnings for faster growing firms. In general, there appears to be no asset growth effect in firms with low idiosyncratic volatility. Our findings are consistent with a mispricing-based explanation for the asset growth effect in which arbitrage costs allow the effect to persist.
Firm Innovation in Emerging Markets:
The Role of Finance, Governance, and Competition
Meghana Ayyagari, Asli Demirgüç-Kunt, and Vojislav Maksimovic
We investigate the firm characteristics associated with innovation in over 19,000 firms across 47 developing economies. While existing finance literature on innovation is limited to large public firms in developed markets such as the U.S., our database includes public and private firms, and small and medium enterprises. We define innovation broadly to include introduction of new products and technologies, knowledge transfers, and new production processes. We find that access to external financing is associated with greater firm innovation. Further, having highly educated managers, ownership by families, individuals or managers, and exposure to foreign competition is associated with greater firm innovation.
Last updated November 30, 2011.