Working Papers

All Working Papers from the Finance Department can be found online at the Social Science Research Network (SSRN).
 

Selected Working Papers
 

“Lost in Translation? The Effect of Cultural Values on Mergers Around the World” (2010)
Kenneth Ahern, Daniele Daminelli, and Cesare Fracassi

We find strong evidence that three key dimensions of national culture (trust, hierarchy, and individualism) affect merger volume, synergy gains, deal structure, and the division of gains between bidders and targets in cross-border mergers. First, the volume and gains of cross-border mergers are lower when countries are more culturally distant. Second, firms from countries that are more trusting and hierarchical capture a larger share of combined merger gains. Finally, the use of termination fees, tender offers, and the form of payment vary systematically by cultural differences. The results are the first large-scale evidence that cultural differences have substantial impacts on multiple aspects of cross-border mergers.

"Who Writes the News? Corporate Press Releases during Merger Negotiations" (2010)
Kenneth Ahern and Denis Sosyura

Firms have an incentive to manage media coverage to influence the outcome of important corporate events. We investigate this hypothesis by studying corporate press releases during mergers. Using comprehensive data on media coverage and novel data on merger negotiations, we find that bidders in stock mergers originate substantially more press releases after the start of merger negotiations, but before the public announcement. This strategy generates a short-lived run-up in bidders' stock prices during the period when the stock exchange ratio is determined. The run-up and reversal in media coverage and stock prices cannot be explained by merger rumors, passive media management, or opportunistic merger timing. Overall, we present the first evidence on active media management in M&A.

"The Great Surge in Mortgage Defaults 2006-2009: The Comparative Roles of Economic Conditions, Underwriting and Moral Hazard" (2011)
Dennis Capozza and Robert Van Order

In this research we exploit the power of a large and rich sample of individual loans originated from 2000-2007 to study the relative roles of underwriting, moral hazard and local economic conditions in the Great Surge in mortgage defaults. With these data we can observe the information available to investors and control for observable underwriting as well as economic conditions. We can also use the data to infer the share due to moral hazard. Estimates from these data suggest that much of the variation was due to economic conditions.

"Yesterday's Heroes: Compensation and Creative Taking" (2010)
Ing Haw Cheng, Harrison Hong, and Jose Scheinkman
NBER WP#16176, European Corporate Governance Institute WP# 285

We investigate the link between compensation and risk-taking among finance firms during the period of 1992-2008. First, there are substantial cross-firm differences in residual pay (defined as total executive compensation controlling for firm size). Second, residual pay is correlated with price-based risk-taking measures including firm beta, return volatility, the sensitivity of firm stock price to the ABX subprime index, and tail cumulative return performance. Third, these risk-taking measures are correlated with short-term pay such as bonuses and options even controlling for longer-term incentives such as insider ownership stakes. Finally, compensation and risk-taking are not related to governance variables; but they do convary with ownership by institutional investors who tend to have short-termist preferences and the power to influence firms' management policies. These findings suggest that our residual pay measure in also potentially picking up firm-wide, high-powered incentives not captured by insider ownership. They also suggest that the correlation between residual pay and firm risk-taking is due to investors with heterogeneous short-termist preferences investing in different firms and incentivizing them to take different levels of risk.

"Does capital market myopia affect plant productivity? Evidence from 'going private' transactions" (2010)
Sreedhar Bharath, Amy Dittmar, and Jagadeesh Sivadasan

One influential criticism of the stock market oriented U.S. financial system is that its excessive focus on short term quarterly earnings forces public firms to behave in a myopic manner. We hypothesize that if capital markets pressure listed firms to be myopic in a way that impacts efficiency, then going private (when myopia is eliminated) should cause the U.S. firms to improve their establishment level productivity relative to a peer control groups of firms. We find no evidence that this is the case. Our key finding is that while there is evidence for substantial within-establishment increases in productivity after going private, there is little evidence of difference-in-differences efficiency gains relative to peer groups of establishments constructed to control for industry, age, size at the time of going private, and the endogeneity of the going private decision effects. Also, we do not find evidence that myopic markets lead to under-investment at the establishment level. On the contrary, we find that after going private, firms shrink capital and employment, and close plants more quickly, relative to peer groups. Our findings cast doubt on the view that public markets cause listed firms to make sub-optimal, productivity-decreasing choices, or under-invest at the establishment level.

"Divisional Managers and Internal Capital Markets" (2010)
Ran Duchin and Denis Sosyura

Using hand-collected data on divisional managers at the S&P 500 firms, we provide one of the first studies of their role in internal capital budgeting. Divisional managers with connections to the CEO receive more capital. Managers' informal connections, such as social ties to the CEO, outweigh measures of managers' formal influence, such as board membership and seniority, and affect both the appointment of managers and subsequent capital allocations to their divisions. The impact of connections on investment efficiency depends on the tradeoff between agency and information asymmetry. When governance is weak, connections reduce investment efficiency and erode firm value by fostering favoritism. When information asymmetry is high, managerial ties increase investment efficiency and firm value by facilitating information transfer. Overall, we provide novel evidence on the role of formal and informal managerial influence inside conglomerates.

"The CDS/Bond Basis and the Cross Section of Corporate Bond Returns” (2009)
Gi Hyun Kim, Haitao Li, and Weina Zhang

The CDS/Bond basis trade has played an important role in the current financial crisis. Many banks and hedge funds, such as Deutsche Bank, Merrill Lynch, and Citadel, have lost billions of dollars in this trade. The widening of the basis has also created significant disruptions in the credit market. In this paper, we provide a comprehensive empirical analysis on the CDS/bond basis and the impact of the basis on expected corporate bond returns. We construct the basis based on CDS spreads from Market and bond prices from TRACE and NAIC from 2001 to 2008. We find that on average the basis of investment grade bonds is negative during our entire sample and that bonds with lower basis tend to be older and have lower rating, longer maturity, higher duration and convexity. We also find that low basis bonds tend to have higher future returns than high basis bonds and that the basis can predict future returns of individual bonds and bond portfolios. Most important, we find that the basis factor, constructed as the return differential between low and high basis portfolios, helps explaining the cross-sectional differences in the expected returns of corporate bonds even after controlling for most known systematic risk factors.

“The Independent Board Requirement and Executive Suites” (2011)
Han Kim and Yao Lu

NYSE and NASDAQ listed firms are required to have a majority of independent directors starting in 2004. Our investigation using a difference-in-differences approach reveals that the regulation triggered greater entrenchment in executive suites, as measured by abnormal fractions of top-executives appointed (AFTA) during the current CEO's tenure. The increases in AFTA are not due to more executive turnovers or other confounding effects. Furthermore, the newly appointed executives are more connected to their CEOs through past employment. Higher AFTA is associated with lower firm valuation and less profitable acquisition bids. Moreover, the regulation's overall effect on shareholder value is negative and significant, implying that the benefits of more independent directors are overwhelmed by harmful effects of the unintended consequences. Importantly, AFTA does not increase when firms face strong product market competition, demonstrating the merits of market-based solutions for better governance.

"Monetary Policy Risk and the Cross Section of Stock Returns” (2009)
Erica Li and Francisco Palomino

The effects of monetary policy shocks on the equity premium and the cross-section of stock returns are analyzed in general equilibrium. Policy shocks affect real stock returns as a result of nominal product-price rigidities. Two opposite effects determine the impact of policy shocks on stock returns. A contractionary shock increases the marginal utility of consumption, reduces aggregate output and increases production markups. The output reduction requires a positive premium in expected returns. The markup increase acts as a consumption hedge and involves a negative premium. Low elasticities of intertemporal substitution of consumption and labor amplify the markup effect and can generate a negative net effect on the equity premium. In the cross-section, a contractionary shock reduces the relative output and expands the relative markup of a more rigid price industry with respect to a more flexible price industry. If the relative markup expansion dominates the relative output decline, the expected stock return of the more flexible price industry is higher than that of the more rigid price one. The policy-induced markup variation also generates time variation in expected returns. As the responsiveness of the policy to economic conditions increases, the effects of policy shocks on the equity premium and the cross-section decline.

“Financial Market Dislocations” (2011)
Paolo Pasquariello

Dislocations occur when financial markets, operating under stressful conditions, experience large, widespread asset mispricing. This study documents systematic financial market dislocations in world capital markets and the importance of their fluctuations for expected stock returns. Our novel, model-free measure of these dislocations is a monthly average of six hundred abnormal absolute violations of three textbook arbitrage parties in stock, foreign exchange, and money markets. We find that investors demand economically and statistically significant risk premiums to hold U.S. stocks and U.S. and international stock portfolios performing poorly during market dislocations.

“Optimal Corporate Governance in the Presence of an Activist Investor” (2010)
Jonathan Cohn and Uday Rajan

We provide a model of governance in which a board arbitrates between an activist investor and a manager. Reputational concerns make the manager reluctant to implement a change in firm strategy, creating an agency conflict. The optimal level of internal governance as supplied by the board depends on both the severity of the agency conflict and the strength of external governance. In some cases, the board commits to an interventionist policy to induce participation from the activist. In other cases, board intervention exacerbates managerial misbehavior, so it is optimal to be passive. The overall relationship between internal and external governance is non-monotone. As external governance becomes stronger, internal and external governance are first substitutes, and then complements.