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European Financial Management 2019 Archive

January 2019, VOL 25:1 March 2019, VOL 25:2

European Financial Management, VOL 25:1, January 2019

An International Analysis of CEO Social Capital and Corporate Risk-Taking


This study examines the effects of CEO social capital on corporate risk-taking around the world. We document a significant positive relation between CEO social capital and aggregate corporate risk-taking. Further, we find that CEOs with large social capital prefer riskier investment and financial policies. We also determine that the effect of CEO social capital on corporate risk-taking is moderated by the extent of legal protections provided to shareholders, the financial development, and the culture of the country in which a firm is incorporated. Our results are robust to alternative proxies of risk-taking, alternative model specifications, and tests for endogeneity.

Keywords: Social capital, social networks, corporate risk-taking

JEL Classification: G30, Z13

Target Information Asymmetry and Takeover Strategy: Insights from a New Perspective


We examine the relation between information asymmetry and firm value around an M&A. Due to the due diligence and intense scrutiny around M&A announcements, acquisitions are significant shocks to a target’s information asymmetry. We find that M&A announcement-period wealth gains are significantly related to a target’s information asymmetry and the relationship is concentrated in same-state or same-industry mergers. Our difference-in-difference analysis shows that the wealth effects become weaker when overall information environment improves. Furthermore, we document that information asymmetry is an important factor in target selection and the likelihood of diversifying deals, deal size, and deal closure time.

Keywords: Information asymmetry, acquisitions, Firm valuation.

JEL Classification: G14, G34

Do Investment Banks Create Value for their Clients? Empirical Evidence from European Acquisitions


Europe provides an interesting setting to explore the role that investment banks play in acquisitions because it is composed of countries with different legal regimes—the shareholder-oriented common law regime in the UK/Ireland and the stakeholder oriented civil law regime in Continental Europe. Since investment banks are hired to act in the interests of shareholders, and due to differences in disclosure requirements, market transparency, accounting standards and ownership between the UK and Continental Europe, I argue that investment banks are relatively more important in UK-only acquisitions. My findings support this conjecture.

Keywords: Hedge funds, private equity, alternative assets, portfolio choice, asset allocation

JEL Classification: G11, G14, G23

Sentiment, Order Imbalance and Co-movement. An Examination of Shocks to Retail and Institutional Trading Activity


Using order flow imbalance as a measure of sentiment we show that positive and negative shocks to sentiment lead to lower co-movement between portfolio and market returns in the post-shock period. Furthermore, an asymmetry is present as positive shocks to sentiment have less impact on co-movement changes than negative shocks. Moreover, shocks to retail sentiment and the sentiment of two types of institutional investors leads to a reduction in co-movement. Positive shocks to institutional order flow imbalance lead to smaller reductions in co-movement than associated with retail shocks. These effects exist even after controlling for firm specific and market-wide news.

Keywords: Order flow shock and sentiment, co-movement, smooth transition model

JEL Classification: G12, G14

The Payback of Mutual Fund Selectivity in European Markets


Is European fund management selectivity skill (1-R2) profitable (alpha)? To examine this question, we use a sample of 2,947 actively-managed domestic equity mutual funds from 11 European countries. We find that high fund selectivity generates significant investor gains. The results are robust to investor sentiment and stock-market dispersion conditions. Moreover, we investigate the moderating effect of country characteristics on the profitability of fund selectivity and find that managers’ selectivity ability is more valuable in countries with high economic development, strong legal system, small but highly liquid equity markets, and young mutual fund industries.

Keywords: European fund selectivity skill, fund manager skill, fund performance.

JEL Classification: G11, G14, G20, G23

Stock Market Integration, Cost of Equity Capital and Corporate Investment: Evidence from Brazil


We study the effect of stock market integration on the cost of capital and investment, using Brazil as a case study. We show that integration, as proxied by foreign ownership, has a positive impact on the financing side by reducing cost of capital. On the output side, we find that integration increases corporate investment, but only for well-governed firms. We contribute to the debate on the pros and cons of financial globalisation, particularly by providing evidence of important linkages between financial integration and real economic activity.

Keywords: Stock Market Integration; Cost of Capital; International Asset Pricing; Investment

JEL Classification: F65, F61, F36, G15, G12

Intangible Assets and the Book-to-Market Effect


The book-to-market effect is well known, but prior research does not analyze the impact of goodwill and related transformations in accounting rules that may bring significant changes to the effect. This paper analyzes the impact of SFAS 142, Goodwill and Other Intangible Assets, issued in 2001. I find that the book-to-market effect is weaker in the post-SFAS 142 period especially in the firms that have goodwill, impairment loss or risk. The book-to-market effect is stronger for subsamples of firms that do not have goodwill. These findings are robust to size groups, different factor models, and test methods.

Keywords: fair-value accounting, valuation of R&D, goodwill impairment, value premium

JEL Classification: G12, M41, O3

European Financial Management, VOL 25:2, March 2019

The Face of Risk: CEO’s Facial Masculinity and Firm Risk

Shinichi Kamiya, Y. Han (Andy) Kim, and Soohyun Park

We examine whether a male CEO’s facial masculinity, measured by facial width-to-height ratio (fWHR), predicts the riskiness of his firm. Using the face pictures of 1,162 CEOs in the Execucomp database, we find supporting evidence. Firms with more masculine-faced CEOs have higher stock return volatility and higher financial leverage and are more acquisitive. Their frequency of acquisitions, the dollar amount spent on acquisitions, and the takeover premium are all higher. We find that more masculine-faced CEOs’ compensation is more sensitive to the risk of the firm. The result is robust when we use AI (artificial intelligence)-measured fWHR of the CEOs.

Keywords:Masculinity, Testosterone, Risk, CEO, Leverage, M&A, fWHR, Vega

JEL Classification: G02, G32, G34, M1, Z1

Does Size Matter in Predicting Hedge Funds Liquidation?



Keywords: TBA

JEL Classification: TBA

Discounting Methods and Personal Taxes

Michael Dempsey

We advance models of valuation that incorporate personal taxes. The models are general in allowing for uneven cash flows, changes in debt levels, and changes in the costs of equity and debt. The models are mutually consistent and are consistent with the CAPM and Modigliani and Miller propositions allowing personal taxes.

Keywords: Valuation, Taxes, Tax system, CAPM, WACC.p

JEL Classification: G12, G31, G38

Is Bank Capital Sensitive to a Tax Allowance on Marginal Equity?

Jose Martin Flores and Christophe Moussu

This paper studies how bank capital changes following the implementation and removal of a tax incentive on equity. We examine the impact of the introduction of a tax allowance in Italy granted to banks (and other firms) that increase their equity from a base year. Using a difference-in-differences setting, we observe an 8.83% increase in bank capital ratios following the implementation of this reform. When this tax mechanism is phased out, we observe an opposite effect on the equity ratio, showing the absence of a hysteresis effect in bank capital. We document a heterogeneous effect for large and small banks.

Keywords: Tax, bank capital, debt-equity tax bias.

JEL Classification: G21, G28, G32.

Contingent Capital with Repeated Interconversion Between Debt- and Equity-like Instruments

Yanping Cai, Zhaojun Yang, and Zhiming Zhao

This paper introduces a new form of contingent capital, contingent convertible securities (CCSs), which might repeatedly convert between debt- and equity-like instruments depending on financial conditions. We derive explicit prices of corporate securities, assuming the cash flow is modeled as a geometric Brownian motion. We present an explicit value of the increased tax shields due to CCSs. We provide an explicit optimal capital structure when CCSs are issued and interestingly, the ratio of the optimal straight bond coupon to CCS coupon is constant and independent of the firm’s financial conditions. All the conclusions hold true also for contingent convertibless.

Keywords: contingent capital, repeated interconversion, capital structure

JEL Classification: G12, G32

The Information Content of the Implied Volatility Term Structure on Future Returns

Yaw-Huei Wang and Kuang-Chieh Yen

We derive the theoretical relation between the term structure of implied variance and the expected excess returns of the underlying asset. Adopting three alternative approaches to compile the variables representing the information on the implied volatility index level and term structure, we show the important role of the term structure in determining future excess returns of the S&P 500 index. Both the in-sample and out-of-sample analyses suggest that the information content of the term structure variable is significant and a strong complement to that of the level variable, especially for shorter-term excess returns.

Keywords: VIX term structure, Predictability, S&P 500 index returns

JEL Classification: G13, G14

Securitization and Credit Quality in the European Market




JEL Classification: TBA