Showing papers in "Journal of Financial and Quantitative Analysis in 2011"
TL;DR: In this article, the authors investigate the firm characteristics associated with innovation in over 19,000 firms across 47 developing economies and find that access to external financing is associated with greater firm innovation.
Abstract: 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 United States, our database includes public and private firms, and small and medium-sized 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.
596 citations
TL;DR: In this paper, the authors examined the relation between corporate governance and institutional ownership and found that the fraction of a company's shares that are held by institutional investors increases with the quality of its governance structure.
Abstract: In this study we examine the relation between corporate governance and institutional ownership. Our empirical results show that the fraction of a company’s shares that are held by institutional investors increases with the quality of its governance structure. In a similar vein, we show that the proportion of institutions that hold a firm’s shares increases with its governance quality. Our results are robust to different estimation methods and alternative model specifications. These results are consistent with the conjecture that institutional investors gravitate to stocks of companies with good governance structure to meet fiduciary responsibility as well as to minimize monitoring and exit costs.
355 citations
TL;DR: This paper examined the association of a VC firm's reputation with the post-initial public offering (IPO) long-run performance of its portfolio firms and found that more reputable VCs exhibit more active post-IPO involvement in the corporate governance of their portfolio firms.
Abstract: We examine the association of a venture capital (VC) firm’s reputation with the post-initial public offering (IPO) long-run performance of its portfolio firms. We find that VC reputation, measured by the past market share of VC-backed IPOs, has significant positive associations with long-run firm performance measures. While more reputable VCs initially select better-quality firms, more reputable VCs continue to be associated with superior long-run performance, even after controlling for VC selectivity. We find that more reputable VCs exhibit more active post-IPO involvement in the corporate governance of their portfolio firms, and this continued VC involvement positively influences post-IPO firm performance.
333 citations
TL;DR: The authors found that positive emotional states such as excitement induce people to take risks and to be confident in their ability to evaluate investment options, while negative emotions such as anxiety have the opposite effects.
Abstract: Neuroeconomics research shows that brain areas that generate emotional states also process information about risk, rewards, and punishments, suggesting that emotions influence financial decisions in a predictable and parsimonious way. We find that positive emotional states such as excitement induce people to take risks and to be confident in their ability to evaluate investment options, while negative emotions such as anxiety have the opposite effects. Beliefs are updated so as to maintain a positive emotional state by ignoring information that contradicts individuals’ prior choices. Marketplace features or outcomes of past choices may change emotions and thus influence future financial decisions.
307 citations
TL;DR: The authors examined the relation between corporate lobbying and fraud detection and found that firms' lobbying activities make a significant difference in fraud detection: compared to non-lobbying firms, on average, firms that lobby 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.
Abstract: 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 nonlobbying firms, on average, firms that lobby 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 nonfraudulent firms, and they spend 29% more on lobbying during their fraudulent periods than during nonfraudulent 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.
291 citations
TL;DR: In this paper, the authors study whether the constraints on firms' operations imposed by labor unions affect firms' costs of equity and find that the cost of equity is significantly higher for firms in more unionized industries.
Abstract: We study whether the constraints on firms’ operations imposed by labor unions affect firms’ costs of equity. The cost of equity is significantly higher for firms in more unionized industries. This effect holds after controlling for several industry and firm characteristics, is robust to endogeneity concerns, and is not driven by omitted variables. Moreover, the unionization premium is stronger when unions face a more favorable bargaining environment and is highly countercyclical. Unionization is also positively related to various measures of operating leverage. Our findings suggest that labor unions increase firms’ costs of equity by decreasing firms’ operating flexibility.
245 citations
TL;DR: This article examined the effect of derivative use on firm risk and value using a large sample of non-financial firms from 47 countries, and found strong evidence that the use of financial derivatives reduces both total risk and systematic risk.
Abstract: Using a large sample of nonfinancial firms from 47 countries, we examine the effect of derivative use on firm risk and value. We control for endogeneity by matching users and nonusers on the basis of their propensity to use derivatives. We also use a new technique to estimate the effect of omitted variable bias on our inferences. We find strong evidence that the use of financial derivatives reduces both total risk and systematic risk. The effect of derivative use on firm value is positive but more sensitive to endogeneity and omitted variable concerns. However, using derivatives is associated with significantly higher value, abnormal returns, and larger profits during the economic downturn in 2001–2002, suggesting that firms are hedging downside risk.
232 citations
TL;DR: The authors found that the market reaction was significantly positive for firms with high abnormal chief executive officer (CEO) compensation, with low pay-for-performance sensitivity, and responsive to shareholder pressure.
Abstract: Congress and activists recently proposed giving shareholders a say (vote) on executive pay. We find that when the House passed the Say-on-Pay Bill, the market reaction was significantly positive for firms with high abnormal chief executive officer (CEO) compensation, with low pay-for-performance sensitivity, and responsive to shareholder pressure. However, activist-sponsored say-on-pay proposals target large firms, not those with excessive CEO pay, poor governance, or poor performance. The market reacts negatively to labor-sponsored proposal announcements and positively when these proposals are defeated. Our findings suggest that say-on-pay creates value for companies with inefficient compensation but can destroy value for others.
203 citations
TL;DR: In this paper, the authors examined the effect of shareholder rights on reducing the cost of equity and the impact of agency problems from free cash flow (FCF) on this effect.
Abstract: In this paper, we examine the effect of shareholder rights on reducing the cost of equity and the impact of agency problems from free cash flow (FCF) on this effect We find that firms with strong shareholder rights have a significantly lower implied cost of equity after controlling for risk factors, price momentum, analysts’ forecast biases, and industry and year effects than do firms with weak shareholder rights Further analysis shows that the effect of shareholder rights on reducing the cost of equity is significantly stronger for firms with more severe agency problems from FCFs
194 citations
TL;DR: In this article, a large loan sample from 1990 to 2006 was used to examine why firms form new banking relationships, and they found that firms tend to expand their access to credit and capital market services, and highlight an important cost of exclusive banking relationships.
Abstract: Using a large loan sample from 1990 to 2006, we examine why firms form new banking relationships. Small public firms that do not have existing relationships with large banks are more likely to form new banking relationships. On average, firms obtain higher loan amounts when they form new banking relationships, while small firms also experience an increase in sales growth, capital expenditure, leverage, analyst coverage, and public debt issuance subsequently. Our findings suggest that firms form new banking relationships to expand their access to credit and capital market services, and highlight an important cost of exclusive banking relationships.
157 citations
TL;DR: The authors 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, and highlight dilemmas in a state-led financial system and the local stock market's sophistication in interpreting news.
Abstract: 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.
TL;DR: In this paper, the authors investigated the relationship between market liquidity and the price of credit risk by relating the liquidity of corporate bonds to the basis between the credit default swap (CDS) spread of the issuer and the par-equivalent bond yield spread.
Abstract: The recent credit crisis has highlighted the importance of market liquidity and its interaction with the price of credit risk. We investigate this interaction by relating the liquidity of corporate bonds to the basis between the credit default swap (CDS) spread of the issuer and the par-equivalent bond yield spread. The liquidity of a bond is measured using a recently developed measure called latent liquidity, which is defined as the weighted average turnover of funds holding the bond, where the weights are their fractional holdings of the bond. We find that bonds with higher latent liquidity are more expensive relative to their CDS contracts, after controlling for other realized measures of liquidity. Analysis of interaction eects shows that highly illiquid bonds of firms with a greater degree of uncertainty are also expensive, consistent with limits to arbitrage between CDS and bond markets, due to the higher costs of “shorting” illiquid bonds. Additionally, we document the positive eects of liquidity in the CDS market on the CDS-bond basis. We also find that several firm-level and bond-level variables related We acknowledge the generous support of State Street Corporation in providing the resources for conducting the research reported in this paper. We are grateful to an anonymous referee and the editor, Paul Malatesta, for detailed, helpful comments on a previous draft of this paper. We thank Craig Emrick, Gaurav Mallik, Jerey
TL;DR: In this article, the authors studied the time series of illiquidity for different maturities over an extended period of time and compared time-series determinants of on-the-run and off-the run illiquidities.
Abstract: Previous studies of Treasury market illiquidity span short time periods and focus on particular maturities. In contrast, we study the time series of illiquidity for different maturities over an extended period of time. We also compare time-series determinants of on-the-run and off-the-run illiquidity. Illiquidity increases and the difference between spreads of long- and short-term bonds significantly widens during recessions, suggesting a “flight to liquidity,” wherein investors shift into the more liquid short-term bonds during economic contractions. Macroeconomic variables such as inflation and federal funds rates forecast off-the-run illiquidity significantly but have only modest forecasting ability for on-the-run illiquidity. Bond returns across maturities are forecastable by off-the-run but not on-the-run bond illiquidity. Thus, off-the-run illiquidity, by reflecting macro shocks first, is the primary source of the liquidity premium in the Treasury market.
TL;DR: In this article, the authors explain the currency carry trade performance using an asset pricing model in which factor loadings are regime dependent rather than constant, and show that a typical CT strategy has much higher exposure to the stock market and is mean reverting in regimes of high foreign exchange volatility.
Abstract: We explain the currency carry trade (CT) performance using an asset pricing model in which factor loadings are regime dependent rather than constant. Empirical results show that a typical CT strategy has much higher exposure to the stock market and is mean reverting in regimes of high foreign exchange volatility. The findings are robust to various extensions. Our regime-dependent pricing model provides significantly smaller pricing errors than a traditional model. Thus, the CT performance is better explained by a time-varying systematic risk that increases in volatile markets, suggesting a partial resolution of the uncovered interest parity puzzle.
TL;DR: In this article, a cross-sectional analysis of non-financial firms' use of derivatives that are usually interpreted as the result of hedging may alternatively be due to speculation, showing that hedging of interest rate risk is concentrated among high-investment firms and that firms appear to use interest rate swaps to manage earnings and to speculate when their executive compensation contracts are more performance sensitive.
Abstract: Existing cross-sectional findings on nonfinancial firms’ use of derivatives that are usually interpreted as the result of hedging may alternatively be due to speculation. Panel data examinations 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 costly external finance. Simultaneously, firms appear to use interest rate swaps to manage earnings and to speculate when their executive compensation contracts are more performance sensitive.
TL;DR: This paper examined the relative importance of macroeconomic news announcements versus variation in market liquidity in explaining the observed jumps in the U.S. Treasury market and showed that preannouncement liquidity shocks, such as changes in the bid-ask spread and market depth, have significant predictive power for jumps.
Abstract: In this paper, we identify jumps in U.S. Treasury-bond (T-bond) prices and investigate what causes such unexpected large price changes. In particular, we examine the relative importance of macroeconomic news announcements versus variation in market liquidity in explaining the observed jumps in the U.S. Treasury market. We show that while jumps occur mostly at prescheduled macroeconomic announcement times, announcement surprises have limited power in explaining bond price jumps. Our analysis further shows that preannouncement liquidity shocks, such as changes in the bid-ask spread and market depth, have significant predictive power for jumps. The predictive power is significant even after controlling for information shocks. Finally, we present evidence that post-jump order flow is less informative relative to the case where there is no jump at announcement.
TL;DR: In this article, a firm-level measure of large foreign ownership (LFO) and its impact on stock return volatility in 31 emerging markets was constructed and a negative relationship between LFO and volatility was found, even after controlling for potential endogeneity and the impact of major domestic shareholders.
Abstract: This study constructs a firm-level measure of large foreign ownership (LFO) and investigates its impact on stock return volatility in 31 emerging markets. We find a negative relationship between LFO and volatility, even after controlling for potential endogeneity and the impact of major domestic shareholders. This suggests a stabilizing role of LFO in emerging markets, which is consistent with previous suggestions in the literature on the strong commitments and potential monitoring role of large foreign shareholders. Overall, our study highlights the importance of recognizing the heterogeneity among foreign investors and the benefits of large foreign shareholders to emerging stock markets.
TL;DR: In this article, the authors examined the incidence of operational losses among U.S. financial institutions using publicly reported loss data from 1980 to 2005 and found that most operational losses can be traced to a breakdown of internal control, and that firms suffering from these losses tend to be younger and more complex.
Abstract: 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 and more complex, and have higher credit risk, more antitakeover provisions, and chief executive officers (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.
TL;DR: This article found that managers from higher-SAT (Scholastic Aptitude Test) undergraduate institutions tend to have higher raw and risk-adjusted returns, more inflows, and take fewer risks.
Abstract: Using a large sample of hedge fund manager characteristics, we provide one of the first comprehensive studies on the impact of manager characteristics, such as education and career concern, on hedge fund performances. We document differential ability among hedge fund managers in either generating risk-adjusted returns or running hedge funds as a business. In particular, we find that managers from higher-SAT (Scholastic Aptitude Test) undergraduate institutions tend to have higher raw and risk-adjusted returns, more inflows, and take fewer risks. Unlike mutual funds, we find a rather symmetric relation between hedge fund flows and past performance, and that hedge fund flows do not have a significant negative impact on future performance.
TL;DR: In this article, the authors develop and test an empirical framework that allows them to separate selection from treatment effects of large shareholders, and develop an instrument (the density of wealthy individuals near a firm's headquarters) for the presence of large, non-managerial individual shareholders.
Abstract: Large shareholders may play an important role for firm performance and policies, but identifying this empirically presents a challenge due to the endogeneity of ownership structures. We develop and test an empirical framework that allows us to separate selection from treatment effects of large shareholders. Individual blockholders tend to hold blocks in public firms located close to where they reside. Using this empirical observation, we develop an instrument (the density of wealthy individuals near a firm's headquarters) for the presence of large, nonmanagerial individual shareholders in firms. These shareholders have a large impact on firms, controlling for selection effects.
TL;DR: In this article, the authors analyzed a private firm's choice of exit mechanism between initial public offerings (IPOs) and acquisitions, and provided a resolution to the “IPO valuation premium puzzle.
Abstract: We analyze a private firm’s choice of exit mechanism between initial public offerings (IPOs) and acquisitions, and we provide a resolution to the “IPO valuation premium puzzle.” The private firm is run by an entrepreneur and a venture capitalist (VC) (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 to the entrepreneur post-exit and the bargaining power of outside investors versus firm insiders are also different across the two mechanisms. We analyze two situations: the first, where the entrepreneur can make the exit choice alone (independent of the VC), and the second, where the entrepreneur can make the exit choice only with the concurrence of the VC. We derive a number of testable implications regarding insiders’ exit choice between IPOs and acquisitions and about the IPO valuation premium puzzle.
TL;DR: In this article, the authors used a unique database of aggregate daily flows to equity mutual funds in Israel, and found strong support for the temporary price pressure hypothesis regarding mutual fund flows.
Abstract: Using a unique database of aggregate daily flows to equity mutual funds in Israel, we find strong support for the “temporary price pressure hypothesis” regarding mutual fund flows: Mutual fund flows create temporary price pressure that is subsequently corrected. We find that flows are positively autocorrelated, and are correlated with market returns (R2 of 20%). Our main finding is that approximately one-half of the price change is reversed within 10 trading days. This support for the “temporary price pressure hypothesis” complements microstructure research concerning price impact and price noise in stocks by indicating price noise at the aggregate market level.
TL;DR: In this article, the authors show that the negative correlation between measures of firm asset growth and subsequent returns is of little importance since it applies only to small firms, is justified as compensation for risk, or is evidence of mispricing.
Abstract: 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, is justified as compensation for risk, or is 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 (IVOL); 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 IVOL. Our findings are consistent with a mispricing-based explanation for the asset growth effect in which arbitrage costs allow the effect to persist.
TL;DR: The authors examined the use of derivatives and its relation with risk taking in the hedge fund industry and found that 71% of hedge funds trade derivatives and that derivatives users exhibit lower fund risks (e.g., market risk, downside risk, and event risk).
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.
TL;DR: The authors found that institutions increase round-trip stock trades, increase average commissions per share, and pay unusually high commissions on some trades in order to send abnormally high commissions to the lead underwriters of profitable initial public offerings (IPOs).
Abstract: We find direct evidence that institutions increase round-trip stock trades, increase average commissions per share, and pay unusually high commissions on some trades in order to send abnormally high commissions to the lead underwriters of profitable initial public offerings (IPOs). These excess commission payments are a particularly effective way for transient investors to receive lucrative IPO allocations. Our results suggest that the underwriter’s concern for their long-term client relationships limits the payment-for-IPO practice. We estimate that abnormal commission payments are large for the most profitable issues, and that an additional $1 excess commission payment to the lead underwriter results in $2.21 in investor profits from allocated shares.
TL;DR: This paper showed that the number of managing underwriters for an SEO is negatively related to the offer price discount, especially when the relative offer size is large and the stock return volatility is high.
Abstract: Using a sample of 2,281 seasoned equity offerings (SEOs) from 1995 to 2004, we show that the marketing of securities is important to issuers. The number of managing underwriters for an SEO is negatively related to the offer price discount, especially when the relative offer size is large and the stock return volatility is high. Larger investor networks of comanaging underwriters also lower offer price discounts. We argue that the evidence is supportive of the marketing hypothesis: The underwriters’ marketing efforts can lower the offer price discount by shifting up and flattening the demand curve of an SEO.
TL;DR: In this paper, the authors propose a model that links a firm's decision to go public with its subsequent takeover strategy, and calibrate the model using data on IPOs and mergers and acquisitions (M&As).
Abstract: We propose a model that links a firm’s decision to go public with its subsequent takeover strategy. A private bidder does not know a firm’s true valuation, which affects its gain from a potential takeover. Consequently, a private bidder pursues a suboptimal restructuring policy. An alternative route is to complete an initial public offering (IPO) first. An IPO reduces valuation uncertainty, leading to a more efficient acquisition strategy, therefore enhancing firm value. We calibrate the model using data on IPOs and mergers and acquisitions (M&As). The resulting comparative statics generate several novel qualitative and quantitative predictions, which complement the predictions of other theories linking IPOs and M&As. For example, the time it takes a newly public firm to attempt an acquisition of another firm is expected to increase in the degree of valuation uncertainty prior to the firm’s IPO and in the cost of going public, and it is expected to decrease in the valuation surprise realized at the time of the IPO. We find strong empirical support for the model’s predictions.
TL;DR: In this paper, a large data set of closely held corporations is used to test the effectiveness of shared ownership in settings characterized by illiquidity of ownership and find that shared ownership firms report a substantially larger return on assets and lower expense-to-sales ratios.
Abstract: A major governance problem in closely held corporations is the majority shareholders’ expropriation of minority shareholders. As a solution, legal and finance research recommends that the main shareholder surrender some control to minority shareholders via ownership rights. We test this proposition on a large data set of closely held corporations. We find that shared-ownership firms report a substantially larger return on assets and lower expense-to-sales ratios. These findings are robust to institutionally motivated corrections for endogeneity of ownership structure. We provide evidence on the presence of governance problems and the effectiveness of shared ownership as a solution in settings characterized by illiquidity of ownership.
TL;DR: This paper analyzed the effect of VC backing on profitability of private firm acquisitions and found that VC backing leads to significantly higher acquirer announcement returns, averaging 3%, even after controlling for deal characteristics and endogeneity of venture funding.
Abstract: We analyze the effects of venture capital (VC) backing on profitability of private firm acquisitions. We find that VC backing leads to significantly higher acquirer announcement returns, averaging 3%, even after controlling for deal characteristics and endogeneity of venture funding. This leads us to investigate whether some VCs have interests that conflict with those of other investors. We show that such conflicts arise from VCs having financial relationships with both acquirers and targets, corporate VCs having a dominant strategic focus, and VC funds nearing maturity experiencing pressure to liquidate. Our conclusions follow from examinations of target takeover premia and acquirer announcement returns.
TL;DR: In this article, the authors assess the impact of institutions on Chinese firms' corporate investment in an investment Euler equation framework and find that ownership is the primary institutional factor affecting corporate investment.
Abstract: 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 nonstate 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.