Showing papers by "Andrei Shleifer published in 1987"

Breach of Trust in Hostile Takeovers

Abstract: The paper questions the common view that share price increases of firms involved in hostile takeovers measure efficiency gains from acquisitions. Even if such gains exist, most of the increase in the combined value of the target and the acquirer is likely to come from stakeholder wealth losses, such as declines in value of subcontractors' firm-specific capital or employees' human capital. The use of event studies to gauge wealth creation in takeovers is unjustified. The paper also suggests a theory of managerial behavior, in which hiring and entrenching trustworthy managers enables shareholders to commit to upholding implicit contracts with stakeholders. Hostile takeovers are an innovation allowing shareholders to renege on such contracts ex post, against managers' will. On this view, shareholder gains are redistributions from stakeholders, and can in the long run result in deterioration of trust necessary for the functioning of the corporation.

The Economic Consequences of Noise Traders

Abstract: The claim that financial markets are efficient is backed by an implicit argument that misinformed "noise traders" can have little influence on asset prices in equilibrium. If noise traders' beliefs are sufficiently different from those of rational agents to significantly affect prices, then noise traders will buy high and sell low. They will then lose money relative to rational investors and eventually be eliminated from the market. We present a simple overlapping-generations model of the stock market in which noise traders with erroneous and stochastic beliefs (a) significantly affect prices and (b) earn higher returns than do rational investors. Noise traders earn high returns because they bear a large amount of the market risk which the presence of noise traders creates in the assets that they hold: their presence raises expected returns because sophisticated investors dislike bearing the risk that noise traders may be irrationally pessimistic and push asset prices down in the future. The model we present has many properties that correspond to the "Keynesian" view of financial markets. (i) Stock prices are more volatile than can be justified on the basis of news about underlying fundamentals. (ii) A rational investor concerned about the short run may be better off guessing the guesses of others than choosing an appropriate P portfolio. (iii) Asset prices diverge frequently but not permanently from average values, giving rise to patterns of mean reversion in stock and bond prices similar to those found directly by Fama and French (1987) for the stock market and to the failures of the expectations hypothesis of the term structure. (iv) Since investors in assets bear not only fundamental but also noise trader risk, the average prices of assets will be below fundamental values; one striking example of substantial divergence between market and fundamental values is the persistent discount on closed-end mutual funds, and a second example is Mehra and Prescott's (1986) finding that American equities sell for much less than the consumption capital asset pricing model would predict. (v) The more the market is dominated by short-term traders as opposed to long-term investors, the poorer is its performance as a social capital allocation mechanism. (vi) Dividend policy and capital structure can matter for the value of the firm even abstracting from tax considerations. And (vii) making assets illiquid and thus no longer subject to the whims of the market -- as is done when a firm goes private -- may enhance their value.

Characteristics of Hostile and Friendly Takeover Targets

Abstract: Compared to an average Fortune 500 firm, a target of a hostile takeover is smaller, older, has a lower Tobin's Q, invests less of its income, and is growing more slowly. The low Q seems to be an industry-specific rather than a firm-specific effect. In addition, a hostile target is less likely to be run by a member of the founding family, and has lower officer ownership, than the average firm. In contrast, a target of a friendly acquisitions is smaller and younger than an average Fortune 500 firm, and has comparable Tobin's Qs and most other financial characteristics. Friendly targets are more likely to be run by a member of the founding family, and have higher officer ownership, than the average firm. The decision of a CEO with a large stake and/or with a relationship to a founder to retire often precipitates a friendly acquisition. These results suggest that the motive for a takeover often determines its mood. Thus disciplinary takeovers are more often hostile, and synergistic ones are more often friendly.

The Economic Consequences of Noise Traders

Abstract: The claim that financial markets are efficient is backed by an implicit argument that misinformed "noise traders" can have little influence on asset prices in equilibrium. If noise traders' beliefs are sufficiently different from those of rational agents to significantly affect prices, then noise traders will buy high and sell low. They will then lose money relative to rational investors and eventually be eliminated from the market. We present a simple overlapping-generations model of the stock market in which noise traders with erroneous and stochastic beliefs (a) significantly affect prices and (b) earn higher returns than do rational investors. Noise traders earn high returns because they bear a large amount of the market risk which the presence of noise traders creates in the assets that they hold: their presence raises expected returns because sophisticated investors dislike bearing the risk that noise traders may be irrationally pessimistic and push asset prices down in the future. The model we present has many properties that correspond to the "Keynesian" view of financial markets. (i) Stock prices are more volatile than can be justified on the basis of news about underlying fundamentals. (ii) A rational investor concerned about the short run may be better off guessing the guesses of others than choosing an appropriate P portfolio. (iii) Asset prices diverge frequently but not permanently from average values, giving rise to patterns of mean reversion in stock and bond prices similar to those found directly by Fama and French (1987) for the stock market and to the failures of the expectations hypothesis of the term structure. (iv) Since investors in assets bear not only fundamental but also noise trader risk, the average prices of assets will be below fundamental values; one striking example of substantial divergence between market and fundamental values is the persistent discount on closed-end mutual funds, and a second example is Mehra and Prescott's (1986) finding that American equities sell for much less than the consumption capital asset pricing model would predict. (v) The more the market is dominated by short-term traders as opposed to long-term investors, the poorer is its performance as a social capital allocation mechanism. (vi) Dividend policy and capital structure can matter for the value of the firm even abstracting from tax considerations. And (vii) making assets illiquid and thus no longer subject to the whims of the market -- as is done when a firm goes private -- may enhance their value.

Breach of Trust in Hostile Takeovers

Abstract: The paper questions the common view that share price increases of firms involved in hostile takeovers measure efficiency gains from acquisitions. Even if such gains exist, most of the increase in the combined value of the target and the acquirer is likely to come from stakeholder wealth losses, such as declines in value of subcontractors' firm-specific capital or employees' human capital. The use of event studies to gauge wealth creation in takeovers is unjustified. The paper also suggests a theory of managerial behavior, in which hiring and entrenching trustworthy managers enables shareholders to commit to upholding implicit contracts with stakeholders. Hostile takeovers are an innovation allowing shareholders to renege on such contracts ex post, against managers' will. On this view, shareholder gains are redistributions from stakeholders, and can in the long run result in deterioration of trust necessary for the functioning of the corporation.(This abstract was borrowed from another version of this item.)

Characteristics of Hostile and Friendly Takeover Targets

Abstract: Compared to an average Fortune 500 firm, a target of a hostile takeover is smaller, older, has a lower Tobin's Q, invests less of its income, and is growing more slowly The low Q seems to be an industry-specific rather than a firm-specific effect In addition, a hostile target is less likely to be run by a member of the founding family, and has lower officer ownership, than the average firm In contrast, a target of a friendly acquisitions is smaller and younger than an average Fortune 500 firm, and has comparable Tobin's Qs and most other financial characteristics Friendly targets are more likely to be run by a member of the founding family, and have higher officer ownership, than the average firm The decision of a CEO with a large stake and/or with a relationship to a founder to retire often precipitates a friendly acquisition These results suggest that the motive for a takeover often determines its mood Thus disciplinary takeovers are more often hostile, and synergistic ones are more often friendly

The Efficiency of Investment in the Presence of Aggregate Demand Spillovers

Abstract: In the presence of aggregate demand spillovers, an imperfectly competitive firm's profit is positively related to aggregate income, which in turn rises with profits of all firms in the economy. This pecuniary externality makes a dollar of a firm's profit raise aggregate income by more than a dollar, since other firms' profits also rise, and in this way gives rise to a "multiplier." Since such "multipliers" are ignored by firms making investment decisions, privately optimal investment choices under uncertainty will not in general be socially optimal. Under reasonable conditions, private investment is too low.

The Differences between Hostile & Friendly Takeovers

Abstract: Compared to an average Fortune 500 firm, a target of a hostile takeover is smaller, older, has a lower Tobin's Q, invests less of its income, and is growing more slowly. The low Q seems to be an industry-specific rather than a firm-specific effect. In addition, a hostile target is less likely to be run by a member of the founding family, and has lower officer ownership, than the average firm. In contrast, a target of a friendly acquisitions is smaller and younger than an average Fortune 500 firm, and has comparable Tobin's Qs and most other financial characteristics. Friendly targets are more likely to be run by a member of the founding family, and have higher officer ownership, than the average firm. The decision of a CEO with a large stake and/or with a relationship to a founder to retire often precipitates a friendly acquisition. These results suggest that the motive for a takeover often determines its mood. Thus disciplinary takeovers are more often hostile, and synergistic ones are more often friendly.

The Efficiency of Investment in the Presence of Aggregate Demand Spillovers

Abstract: In the presence of aggregate demand spillovers, an imperfectly competitive firm's profit is positively related to aggregate income, which in turn rises with profits of all firms in the economy. This pecuniary externality makes a dollar of a firm's profit raise aggregate income by more than a dollar since other firms' profits also rise, and in this way gives rise to a "multiplier." Since such multipliers are ignored by firms making investment decisions, privately optimal investment decisions under uncertainty will not in general be socially optimal. Under reasonable conditions, investment is too low.

The Economic Consequences of Noise Traders

Abstract: The claim that financial markets are efficient is backed by an implicit argument that misinformed "noise traders" can have little influence on asset prices in equilibrium. If noise traders' beliefs are sufficiently different from those of rational agents to significantly affect prices, then noise traders will buy high and sell low. They will then lose money relative to rational investors and eventually be eliminated from the market. We present a simple overlapping-generations model of the stock market in which noise traders with erroneous and stochastic beliefs (a) significantly affect prices and (b) earn higher returns than do rational investors. Noise traders earn high returns because they bear a large amount of the market risk which the presence of noise traders creates in the assets that they hold: their presence raises expected returns because sophisticated investors dislike bearing the risk that noise traders may be irrationally pessimistic and push asset prices down in the future. The model we present has many properties that correspond to the "Keynesian" view of financial markets. (i) Stock prices are more volatile than can be justified on the basis of news about underlying fundamentals. (ii) A rational investor concerned about the short run may be better off guessing the guesses of others than choosing an appropriate P portfolio. (iii) Asset prices diverge frequently but not permanently from average values, giving rise to patterns of mean reversion in stock and bond prices similar to those found directly by Fama and French (1987) for the stock market and to the failures of the expectations hypothesis of the term structure. (iv) Since investors in assets bear not only fundamental but also noise trader risk, the average prices of assets will be below fundamental values; one striking example of substantial divergence between market and fundamental values is the persistent discount on closed-end mutual funds, and a second example is Mehra and Prescott's (1986) finding that American equities sell for much less than the consumption capital asset pricing model would predict. (v) The more the market is dominated by short-term traders as opposed to long-term investors, the poorer is its performance as a social capital allocation mechanism. (vi) Dividend policy and capital structure can matter for the value of the firm even abstracting from tax considerations. And (vii) making assets illiquid and thus no longer subject to the whims of the market -- as is done when a firm goes private -- may enhance their value.