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The European Financial Management was founded in 1994 by Dr. John Doukas to serve as a high quality refereed publication outlet that publishes significant new research as it relates to European corporations, financial institutions and capital markets. The EFM journal is published in five issues per year [January, March, June, September and November ] and its acceptance rate is about 3%. The June issue is based on the Keynote Address and a small set of articles selected from the papers presented at the Annual Meetings of the European Financial Management Association. The articles published in the EFM journal are indexed and abstracted in the Social Science Citation Index.
Newly Accepted Papers
Bank Risk Dynamics Where Assets are Risky Debt Claims
Sharon Peleg and Alon Raviv
The structural approach views firm’s equity as a call option on the value of its assets, which motivates stockholders to increase risk. However, since bank assets are risky debt claims, bank equity resembles a subordinated debt. Using this assumption, and considering the strategic interaction between a bank and its debtor, we argue that risk shifting is limited to states in which the debtor is in financial distress. Furthermore,risk shifting increases with bankruptcy costs and decreases with bank capital. Thus, increasing a bank’s capital affects stability, not only through the additional capital buffer, but also by affecting the risk shifting incentive.
Keywords: Risk taking, Asset risk, Financial institutions, Stress test, Leverage
JEL Classification: G21, G28, G32, G38
The Market Liquidity Timing Skills of Debt-Oriented Hedge Funds
Baibing Li, Ji Luo and Kai-Hong Tee
We investigate the liquidity timing skills of debt-oriented hedge funds following the 2008 credit crisis, which demonstrated the importance of understanding liquidity conditions to manage the market exposure of investments. We base the analysis on the estimated co-movements of fixed income and equity market liquidity. Our findings, which are statistically robust, show evidence of liquidity timing ability in the fixed income market for all debt-oriented hedge fund strategy categories. Joint market liquidity timing skill, however, is only found in some categories. Our findings suggest that debt-oriented hedge fund managers use a sophisticated set of timing strategies in their investment managements.
Keywords: Fixed income market; hedge funds; liquidity timing skill; market exposure
JEL Classification: G1; G11; G23
Endogenous Credit Spreads and Optimal Debt Financing Structure in the Presence of Liquidity Risk
Eva Luetkebohmert, Daniel Oeltz and Yajun Xiao
We present a structural model that allows a ﬁrm to eﬀectively manage its exposure to both insolvency and illiquidity risk inherent in its ﬁnancing structure. Besides insolvency risk, the ﬁrm is exposed to rollover risk through possible runs by short-term creditors. Moreover, asset price volatilities are subject to macro-economic shocks and inﬂuence creditors' risk attitudes and margin requirements. Credit spreads are derived endogenously depending on the ﬁrm's total default risk. Equity holders have to bear the rollover losses. An optimal debt structure that maximizes the ﬁrm's equity value is determined by trading off lower ﬁnancing costs and higher rollover risk.
Keywords: funding liquidity, optimal capital structure, rollover risk, structural credit risk models
JEL Classification: G01, G32, G33
Financial Flexibility and Investment Ability Across the Euro Area and the UK
Annalisa Ferrando, Maria-Teresa Marchica, and Roberto Mura
We use a very large sample of European private and public firms to show that financial flexibility attained through a conservative leverage policy is more important for private, small-medium-sized, and young firms and for firms in countries with less access to credit and weaker investor protection. Further, using the 2007 financial crisis as a natural experiment, we show that a higher degree of financial flexibility allows firms to reduce the negative impact of liquidity shocks on investment. Our findings support the hypothesis that financial flexibility improves companies’ ability to undertake future investment, despite market frictions hampering possible growth opportunities.
Keywords: low leverage, financial flexibility, investment, cross-country analysis
JEL Classification:G31, G32, D92
Announcement Effects of Contingent Convertible Securities: Evidence from the Global Banking Industry
Manuel Ammann, Kristian Blickle and Christian Ehmann
This paper investigates the announcement effects of CoCo bonds issued by global banks between January 2009 and June 2014. Using a sample of 34 financial institutions, we examine abnormal stock price reactions and CDS spread changes before and after the announcement dates. We find that the announcement of CoCos correlates with positive abnormal stock returns and negative CDS spread changes in the immediate post-announcement period. We explain these effects with a set of theories including the lowered probability of costly bankruptcy proceedings, a signaling framework based on pecking order theory and the cost advantage of CoCos over equity (tax shield).
Keywords: contingent convertible securities, CoCo bonds, announcement effects, event study
JEL Classification: G01, G14, G21
Risk control: Who cares?
The performance of recently introduced risk-control indices is evaluated and tested with respect to a set of competing indices. Applying a method of moments methodology to these data reveals that the performance of strategies that track risk-control indices have economic and statistical significance to investors with realistic risk aversion parameter values. How- ever, this performance varies over time and appears to be determined by macroeconomic and liquidity conditions.
Keywords: Risk control, volatility, certainty equivalent return, method of moments
JEL Classification: G53, G11, G17
A Theoretical Model for the Term Structure of Corporate Credit based on Competitive Advantage
Myuran Rajaratnam, Bala Rajaratnam and Kanshukan Rajaratnam
We derive the term structure of Corporate Credit based on the Competitive Advantage of a firm and the tax deductibility of its interest payments. We consider the competitive advantage enjoyed by the firm as the central tenet of our model and capture its eventual demise in a probabilistic manner. We compensate the bond holder for expected losses and then provide an additional spread based on the tax deductibility of interest payments. Our simple intuitive model appears to overcome some of the well-known shortcomings of structural credit risk models.
Keywords: Term Structure, Corporate Credit, Competitive Advantage, Value-Investing, Credit Spread Puzzle
JEL Classification: EFM 340 Fixed Income; JEL G12 Bond Interest Rates
The Role of the Conditional Skewness and Kurtosis in VIX Index Valuation
Simon Lalancette and Jean-Guy Simonato
The CBOE VIX index is a widely recognised benchmark measure of expected stock market volatility. As shown in the literature, probability distributions other than Gaussian are key features required to describe the dynamics of the S&P 500, the variable that ultimately determines the VIX index level. As such, it is important to assess if deviations from the Gaussian distribution have important impacts on the VIX index level. We examine herein how a model articulated over a time-varying non-Gaussian distribution with conditional skewness and kurtosis can contribute to the overall explanation of the VIX dynamics.
Keywords: VIX, GARCH, skewness, kurtosis, risk-neutral valuation
JEL Classification: C58, G1
Dynamic Asset Allocation with Liabilities
Daniel Giamouridis, Athanasios Sakkas, Nikolaos Tessaromatis
We develop an analytical solution to the dynamic multi-period portfolio choice problem of an investor with risky liabilities and time varying investment opportunities. We use the model to compare the asset allocation of investors who take liabilities into account, assuming time varying returns and a multi-period setting with the asset allocation of myopic ALM investors. In the absence of regulatory constraints on asset allocation weights, there are significant gains to investors who have access to a dynamic asset allocation model with liabilities. The gains are smaller under the typical funding ratio constraints faced by pension funds.
Keywords: Strategic Asset Allocation,Dynamic Asset Allocation, Asset-Liability Management, Return Predictability, Myopic Investors
JEL Classification: G11, G12, G23
Bankers on the Board and CEO Incentives
Min Jung Kang and Young (Andy) Kim
Governance improvement measures often demand more financial experts on corporate boards. Directors from the lending bank require particular attention because the conflicts of interest between shareholders and debtholders would be severe. Hence, we examine whether commercial banker directors work in the best interests of shareholders in providing incentives to the CEO. We find that the CEO’s compensation VEGA is lower if an affiliated banker director is on the board, especially when the director is the chair of the compensation committee. Further, commercial banker directors increase debt-like compensation and make it more sensitive to performance and less sensitive to risk.
Keywords: bankers on board, financial expertise, conflicts of interest, governance, board of directors, CEO compensation
JEL Classification: G14
Due Diligence and Investee Performance
Douglas Cumming and Simona Zambelli
We estimate the economic value of due diligence (DD) in the context of private equity by investigating the relationship between DD and investee performance, while controlling for endogeneity. With the adoption of a novel dataset, we find evidence highly consistent with the view that a thorough DD is associated with improved investee performance. We also distinguish the role of different types of DD and show that the DD performed by fund managers has a more pronounced impact on performance. Instead, the DD mainly performed by external agents, i.e., consultants, lawyers and accountants, gives rise to puzzling results and imperfect matching.
Keywords: Due Diligence, Governance, Performance, Private Equity
JEL Classification: G23, G24, G28
The Contagion versus Interdependence Controversy between Hedge Funds and Equity Markets
Tae Yoon Kim and Hee Soo Lee
This study considers the ‘contagion versus interdependence’ controversy between hedge funds and equity markets. We find that contagion effects break down the established interdependence between them and conditional return smoothing could play a key role in the contagion process by increasing or decreasing the contagion likelihood during crisis and prosperity. It is noted that the return smoothing tends to produce a biased pattern of returns during crisis and a decreased amount of return during prosperity. These findings are obtained by linking single equation error correction model to factor model and carrying out quantile regression, Z-test and Wald–Wolfowitz runs test.
Keywords: hedge funds; contagion; interdependence; conditional return smoothing, single equation error correction model; factor model
JEL Classification: G01, C22, C58
Asset Pricing Puzzles in an OLG Economy with Generalized Preferences
Amadeu DaSilva and Mira Farka
We seek to explain a number of asset pricing anomalies–the equity premium puzzle, the risk-free rate puzzle, and portfolio allocation puzzle–in a parsimonious overlapping generations model (OLG) with two key features: borrowing constraint and Epstein-Zin-Weil (1989) preference. The model is able to simultaneously match asset pricing moments and individual portfolio decisions using reasonable values of parameters governing behavior. We find that the main driver of savings behavior, equity returns and asset allocation is the relative difference between the two parameters: the level of relative risk aversion and the inverse of the elasticity of substitution.
Keywords: Equity premium puzzle, Overlapping generations model, General- ized Preferences, Portfolio allocation.
JEL Classification: G0, G12, D10, E21.
A Unified Theory of Forward- and Backward-looking M&As and Divestitures
Qing Ma and Susheng Wang
In a unified theory of forward- and backward-looking M&As and divestitures, an M&A today may be a cause for a divestiture in the future; conversely a divestiture today may be a consequence of an M&A in the past. M&As and divestitures are not only two sides of the same coin, they are also causes and consequences of each other. In this paper, in a two-period model, two firms consider integrating or separating in each period. We analyze forward- and backward- looking M&As and divestitures, and compare them with static M&As and divestitures.
Keywords: unified framework, forward looking, backward looking, M&A, divestiture
JEL Classification: G34
Income Uncertainty and the Decision to Invest in Bulk Shipping
Ioannis Kyriakou, Panos K. Pouliasis, Nikos C. Papapostolou, and Nikos K. Nomikos
We develop a coherent framework for valuing real assets and determining the optimal time to invest. To this end, we model the stochastic nature of income, present a valuation paradigm for freight-linked assets and, using real option theory, we demonstrate its usefulness in investment appraisal and optimal timing of entry in the shipping industry. We find that long-run freight rate and volatility affect the decision timing and investment value that diminishes with increasing vessel age. As time-to-build declines, the value of the option to wait increases implying a high opportunity cost embedded in the investment decision due to construction lags.
Keywords: real options, investment, uncertainty, contingent claims, shipping
JEL Classification: C13, C63, G13, G31, L92
Corporate Debt Maturity and Stock Price Crash Risk
Viet Anh Dang, Edward Lee, Yangke Liu, Cheng Zeng
We find that firms with a larger proportion of short-term debt have lower future stock price crash risk, consistent with short-term debt lenders playing an effective monitoring role in constraining managers’ bad-news-hoarding behavior. The inverse relation between short-maturity debt and future crash risk is more pronounced for firms that are harder to monitor due to weaker corporate governance, higher information asymmetry, and greater risk-taking. These findings suggest that short-term debt substitutes for other monitoring mechanisms in curbing managerial opportunism and reducing future crash risk. Our study implies that short-maturity debt not only preserves creditors’ interests, but also protects shareholders’ wealth.
Keywords: debt maturity, stock price crash risk, corporate governance, information asymmetry
JEL Classification: G3, G12, G14
Selling Winners, Buying Losers: Mental Decision Rules of Individual Investors on Their Holdings
Cristiana Cerqueira Leal, Gilberto Loureiro, and Manuel Armada
We extend the study of the disposition effect – the preference for selling (holding) current winning (losing) stocks- by adding a new element to this decision process: the investors’ preference to purchase additional units of the current losing stocks. Using a unique database, we find that individual investors prefer to sell their winning stocks and, simultaneously, hold and increase their exposure to the losing ones. The additional purchase is pervasive across investors, but stronger for less sophisticated investors. Our evidence suggests that reference prices, prior stock returns, stock visibility, and investor performance and sophistication are determinants of investors’ trading behavior.
Keywords: Disposition effect; additional purchase; portfolio choice; individual investors; mental accounting; trading decision.
JEL Classification: G02,G11,G14
Sentiment, Order Imbalance and Co-movement. An Examination of Shocks to Retail and Institutional Trading Activity
Patricia Chelley-Steeley, Neophytos Lambertides, Christos S. Savva
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
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
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
Stock Market Integration, Cost of Equity Capital and Corporate Investment: Evidence from Brazil
David Hillier and Tiago Loncan
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
An International Analysis of CEO Social Capital and Corporate Risk-Taking
Stephen P. Ferris, David Javakhadze, and Tijana Rajkovic
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
Discounting Methods and Personal Taxes
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
Does Size Matter in Predicting Hedge Funds’ Liquidation?
Adrien Becam, Andros Gregoriou, and Jairaj Gupta
In this study, we propose a set of covariates that exploit information content of hedge funds’ relative size, performance, growth, tail risk, and past liquidation rate, in predicting their liquidation. Empirical results show that our proposed covariates exhibit significant predictive power for up to two years even when we control for fund specific characteristics. Furthermore, we estimate separate liquidation prediction models for small, medium, and large funds. Our findings suggest that liquidation likelihood of hedge funds is inversely related to fund size, and statistical significance of factors affecting their liquidation vary across different size categories.
Keywords: hedge fund, liquidation, fund size, failure, default
JEL Classification: G11, G17, G33
The Payback of Mutual Fund Selectivity in European Markets
Feng Dong and John A. Doukas
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
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 convertibles.
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
When do Investment Banks use IPO Price Support?
Practitioners, regulators, and the financial media argue that underwriters tie Initial Public Offering (IPO) allocations to investor post-listing buying of the issuer shares in a process labelled price support. Arguably, this excess demand boosts post-listing returns which underwriters trade quid-pro-quo with investor stock-trading-commission payments. In this paper, I investigate unique data from the Oslo Stock Exchange (OSE) including investor stock-trading-commissions, IPO allocations, and post-listing trading. I document that investors who provide high returns to underwriters before IPOs benefit from price support through increased returns in IPOs. I conclude that price support is used when investors share boosted returns with underwriters.
Keywords:IPOs, Price Support, Stock-trading commission
JEL Classification: G24
Confucianism, Cultural Interactions and Corporate Investment Efficiency
Lei Chen, Zhi Jin，Yongqiang Ma, and Hui Xu
Our study presents robust findings that Confucianism significantly improves investment efficiency of Chinese listed firms and that the improvement is achieved through decreasing overinvestment without inducing underinvestment. Financial reporting quality is found to be an important mechanism for the disciplinary effect of Confucianism to work. More importantly, we provide strong and consistent evidence that openness to the West neutralizes the role of the Confucianism in overinvestment. Against the backdrop of globalization, this paper offers valuable references to emerging markets that experience intensive interactions with developed economies.
Keywords:Confucianism, Openness to the West, Investment efficiency, Financial reporting quality
JEL Classification: G31, G32, G34, M41, Z10
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
Are the Fama French Factors treated as Risk? Evidence from CEO compensation
Jeremy Bertomeu, Edwige Cheynel, and Michelle Liu-Watts
Asset pricing theory postulates that a risk factor correlates with individuals’ marginal utility of consumption. Hence, under plausible preferences, individuals should become more risk tolerant given favorable factor returns. We show that this wealth effect predicts a positive association between performance pay and factor returns. Our results support the hypothesized relationship for the market, book-to-market and momentum factors. Factors constructed from bond prices are positively associated to incentives, incrementally to the Fama French factors, but we obtain mixed evidence for higher-order market factors, liquidity factors or factors constructed from national income accounts, including pricing kernels.
Exploring Short- and Long-Run Links from Bank Competition to Risk
E Philip Davis and Dilruba Karim
The current literature offers diverse findings on the bank competition-risk relation. We seek to advance understanding by looking at both short- and long-run relations for banks from 27 EU countries, using a six-year period before and since 2007 and employing both the H-statistic and the Lerner index as measures of competition. We thus highlight further nuances in the competition–risk relation that are absent from the current literature. Both measures have a positive short-run relation with risk, while long-run effects differ. Underlying this, the competition measures differ in their relation to the volatility of profits, with important policy implications.
Keywords: Bank competition, financial stability, EU banking markets, Lerner index, Panzar–Rosse H-statistic, Z-score
JEL Classification: G21, G28
Lottery Preferences and the Idiosyncratic Volatility Puzzle
Doina C. Chichernea, Haimanot Kassa, and Steve Slezak
We investigate the empirical implications of investors’ heterogeneous preferences for skewness with respect to the idiosyncratic volatility (IVOL) puzzle, that is, the negative correlation between IVOL and mean returns. We show that the IVOL puzzle is stronger 1) within stocks held primarily by agents with a preference for lottery-like payoffs and 2) during economic downturns, when the demand for lottery-like payoffs is high. These results support recent theories that suggest lottery preferences could be a significant source of the IVOL puzzle.
Keywords: Idiosyncratic volatility; skewness; lottery preferences; economic conditions.
JEL Classification: G11; G12
Individualistic Cultures and Crash Risk
Tung Lam Dang, Robert Faff, Hoang Luong, and Lily Nguyen
This study examines whether individualistic national culture is associated with stock price crash risk (“crash risk”) for a sample of firms from 36 countries over the period of 1990 to 2015. We find robust evidence that firms in more individualistic cultural settings exhibit higher future crash risk. Digging deeper, we find that earnings management, excessive managerial risk-taking, and investors’ difference of opinion and overconfidence are all possible explanations for the positive effect of individualism on crash risk. Overall, our findings suggest that individualism, as a key cultural dimension, has an important impact on investor welfare, manifested through crash risk.
Keywords: National culture; Individualism; Stock price crash risk; Earnings management; Excessive managerial risk-taking
JEL Classification: G12; G15
The Impact of the Morningstar Sustainability Rating on Mutual Fund Flows
Manuel Ammanna, Christopher Bauerb, Sebastian Fischerc, Philipp.
We examine the effect of the introduction of Morningstar’s Sustainability Rating in March 2016 on mutual fund flows. Exploiting this shock to the availability of sustainability information we find strong evidence that retail investors shift money away fromlow-rated and into high-rated funds. An average high-rated retail fund receives between$4.1m and $10.1m higher net flows and an average low-rated retail fund suffers from$1.0m to $5.0m lower net flows than an average-rated fund during the first year afterthe publication of the Rating. Institutional investors react much more weakly to the publication of the Rating.
Keywords: Mutual Fund, Sustainability, Investment Decisions, Information
JEL Classification: G11, G14, G23
Equity Issues When in Distress
Mark D. Walker, Qingqing Wu
We investigate the role of financial distress in the seasoned equity market. We find that distressed firms comprise about 40% of SEOs and these distressed issuers have worse abnormal announcement returns than non-distressed issuers. Stock return volatility is an important determinant for announcement returns for non-distressed SEO issuers but not for distressed SEO issuers. Signals of firm quality are associated with better announcement returns, larger issues, increased investment, improved operating performance, and lower likelihood of delisting for distressed SEO firms as compared to non-distressed firms. Our findings suggest equity finance is valuable for financially distressed firms with strong growth prospects.
Keywords: Financial Distress, SEO
JEL Classification: G31; G32
The Positive Externalities of CEO Delta
Hongrui Feng and Yuecheng Jia.
Increases in Delta incentives are dramatic for a small group of firms (leader firms) but negligible for the majority. We show that leader firms have larger market capitalization and higher irreversibility, and are in industries with negative shocks. When leader firms experience substantial growth in Delta incentives, industry peers experience positive abnormal returns and abnormal improvement in fundamentals despite no significant change in Delta. Further, we provide evidence that abnormal returns are induced by peer CEOs’ extra efforts in response to the increasing competitive pressure caused by leader firms. To mitigate their competitive pressure and turnover threat, peer CEOs allocate their extra efforts to firms’ operating efficiency and product differentiation.
Keywords: : CEO Delta incentive, Positive externality, Incentive spillover.
JEL Classification: G14, G34
Overreaction to Growth Opportunities: An Explanation of the Asset Growth Anomaly
Charlie X. Cai, Peng Li and Qi Zhang
The negative relation between asset growth and subsequent stock returns is known as the asset growth anomaly. We propose that overreaction to growth opportunities is the source of the asset growth anomaly. This suggests that growth firms as opposed to mature firms, and firms with longer series of asset growth should experience a stronger asset growth anomaly. Our evidence supports these predictions.
Keywords: : Asset growth, Anomaly, Overreaction, Growth opportunities, US market.
JEL Classification: G1, M4
Board Structure and Role of Outside Directors in Private Firms
Huasheng Gao and Zhongda He
We examine the board composition and the role of outside directors in U.S. private firms. We find that compared with public firms, private firms have a higher proportion of outside directors on the boards and select their outside directors in a more responsive way to their advisory and monitoring needs. We also find that private firms’ CEO turnover-performance sensitivity, earnings quality, going-public likelihood, and IPO value increase with the proportion of outside directors. These results are consistent with the view that lack of external governance in private firms leads to a greater demand for board monitoring for private firms.
Keywords: : Private firms, Public firms, Outside director, Monitoring role, Advisory role, Earnings quality, External governance, Information environments
JEL Classification: G32, G34, L22
The Catalytic Effect of Internationalization on Innovation
Ching-Hsing Chang, Ching Hung Chang, Pi-Kun Hsu and Sheng-Yung Yang
This paper examines how internationalization spurs corporate innovation. Internationalization heightens the competitive environment of firms, while increasing financial flexibility. The increased competition reduces agency problems, and motivates innovation projects which are supported by improved financial flexibility. We obtain robust evidence with the difference-in-differences and instrumental variable approaches. The passage of antitakeover laws and the 1989 Loma Prieta earthquake are treated as exogenous variations to corporate governance; shocks on firm capital supply measured by mutual fund redemptions are also considered. A less positive finding is that internationalization motivates firms to focus on the appropriability of innovation rather than on basic research.
Keywords: : internationalization; competition; financial flexibility; innovation; technological appropriability
JEL Classification: F23, F61, G30, G34, O31
Does MAX Matter for Mutual Funds?
Bradley A. Goldie,Tyler R. Henry,Haimanot Kassa
Extreme returns (MAX) have been shown to impact future expected stock returns. We examine whether this relationship is present in mutual fund returns. We find that high MAX funds, as measured by past extreme daily returns, underperform both in portfolio sorts and cross-sectional tests. We further test possible explanations for why MAX funds underperform. First, we measure mutual fund flows to determine investor response to MAX. Second, we examine the underlying holdings of MAX funds to measure their concentration in MAX stocks. We find evidence that both fund flows and holdings contribute to the MAX effect on mutual fund returns.
Keywords: : Mutual fund flows and performance, MAX, lottery preferences, skewness
JEL Classification: G11, G23
Is finance a veil? Lead-and-lag relationship between financial and business cycles: the case of China
Chung-Hua Shen ,Jun-Guo Shi,Meng-Wen Wu
This study examines the lead-and-lag relationship between financial cycles (FCs) and business cycles (BCs) by using Chinese provincial data. We construct FCs of the financial sector on the basis of three financial variables: credit-to-GDP ratios, house prices, and equity prices. We use the panel dynamic logit model to investigate the lead-and-lag effect between two sectors. Results show that each province has its own unique FCs and BCs. Hence, financial policies should be different in dissimilar provinces. Next, we find that FCs lead BCs and not vice versa. Furthermore, the leading effect is stronger in rich provinces than in poor areas.
Keywords: : financial cycle; business cycle; panel dynamic logit model; credit-to-GDP ratio; direct financing ratio
JEL Classification: E32, E44, G21, P34
How Friends with Money Affect Corporate Cash Policies? The International Evidence
David Javakhadze, Tijana Rajkovic
We examine the association between managerial social capital and the cash flow sensitivity of cash in an international setting. We find that social capital reduces the marginal propensity to save cash out of cash flows. This association is stronger for more financially constrained firms, firms with high hedging needs, and firms with more uncertain cash flows. The effect of social capital is partially moderated by the extent of legal protection standards and financial development. We also show that social capital matters for valuation. These findings are robust to alternative model specifications, alternative variable measurement, and tests for endogeneity.
Keywords: : Social capital, social networks, cash management
JEL Classification: G32, Z13
Local Official Turnover, Ownership, and Firm Cash Holdings: Insights from an Emerging Market
Using a hand-collected dataset of city-level local official turnover in China, I find that average cash holdings of listed firms decrease significantly upon turnover of city heads, and this effect concentrates in privately owned enterprises. Such effects are more pronounced in firms located in cities with lower government quality. I also find that local official turnover leads to decreases in equity issuance for privately owned enterprises but not for state-owned enterprises, which largely explains our primary findings. Overall, this paper reveals that the cash policy of privately owned enterprises is sensitive to local official turnover in an emerging market.
Keywords: :local official turnover; cash holdings; ownership structure; emerging market
JEL Classification: G18, G32, G38
Employee Treatment and Its Implications for Bondholders
Tsung-Kang Chen, Yan-Shing Chen, and Hsiao-Lin Yang
We examine the various channels through which the quality of a firm’s employee relations can affect the welfare of bondholders. Our evidence suggests that better employee treatment benefits bondholders and leads to a lower bond spread by enhancing a firm’s productivity, and by reducing the likelihood of product failures, labor strife, and employee turnover. However, a higher level of satisfaction is more costly for bondholders in firms facing more severe financial constraints or agency problems.
Keywords: : Employee treatment, bond yield spreads, cost of debt
JEL Classification: G12, J53
Target Information Asymmetry and Takeover Strategy: Insights from a New Perspective
Paul Borochin, Chinmoy Ghosh and Di Huang
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: :G14, G34
JEL Classification: : Information asymmetry, acquisitions, Firm valuation
How Do Speculators in Agricultural Commodity Markets Impact Production Decisions and Commodity Prices? A Theoretical Analysis
Christian Koziol and Tilo Treuter
We analyze the impact of speculative trading in agricultural commodity markets on major economic quantities. We consider a theoretical model with production shocks, in which a farmer interacts with a retailer in both, the spot and the forward market. The contribution of the paper is twofold: First, we show that the current forward price drives agricultural production decisions. Since the forward trading ofspeculators influences the forward price, they indirectly affect production decisions. Second, we identify crucial variables determining whether speculative trading is beneficial or dangerous, such as the correlation between the speculators’ portfolio and the commodity prices, the risk premium ofthe forward, and the producer’s gains
Keywords: :speculative trading, production decisions, commodity spot prices
JEL Classification: Q02, D53
Creative Culture, Risk-taking, and Corporate Financial Decisions
I examine how creative culture affects corporate financial decisions. Firms have corporate risk-taking behavior and policies consistent with variations in local risk-taking propensity induced by creative culture. Firms located in areas with a strong creative culture have higher levels of risk exposure, investment, and growth. These firms also accumulate more cash consistent with the precautionary motive. My findings remain robust after controlling for endogeneity and a series of robustness checks. The empirical findings are consistent with the risk-taking tendency associated with creativity and creative culture. This paper introduces the role of creative culture and risk-taking in corporate financial decisions.
Keywords:Creative Culture, Corporate Risk-taking, Cash Holdings, Local Factors
JEL Classification: G30, G31, G32
Getting it Right or Getting it Cursed: Auction Prices in a Residential Real Estate Bubble
Clare Branigan, Cal Muckley, and Paul Ryan
This is the first study to test for a winner’s curse in a bubble market. Our hand-collected sample comprises the sequence of bids and the experience of the winning bidder at Irish residential real estate auctions, prior to the collapse of the bubble. Portfolios of practitioner- and hedonic pricing model-selected self-similar properties provide benchmark property price estimates. We show neither real estate investors nor owner occupiers shade auction bids to avoid the winner’s curse and both raise bids in line with competition. Winning investor bidders pay more for properties, ride the wave of a property bubble and potentially exacerbate it.
Keywords: :Bubbles, Owner occupier, Professional investor, Residential real estate, winner’s curse
JEL Classification: G00, G01, G02, G10, R31
Pin-Huang Chou & Tsung-Yu Chen
The median is a better measure to summarize a sample's central tendency in the pres- ence of extreme observations. We propose an alternative momentum strategy formed by buying (shorting) stocks with high (low) average median returns over a formation period of 3 to 12 months. The median momentum strategy outperforms the traditional price momentum strategy for all holding periods from one month to ve years, with no long-term reversal. This same return pattern is observed for all G7 countries. Further analysis indicates that median momentum protability is an underreaction-only phe- nomenon and shows behavioral patterns related to short-sale restrictions and investor sentiment.
Keywords: Momentum, Regret, Cognitive dissonance, Short-sale restrictions, Investor sentiment.
JEL Classification: G12, G14.
Ali Altanlara,Jiaqi Guob and Phil Holmesc
We investigate how cognitive dissonance arising from interactions between sentiment and culture affects momentum and post-earnings-announcement-drift (PEAD). We focus on differing views relating to change between Western and East Asian cultures. Building on Hong and Stein (1999) and recognising Westerners’ (Easterners’) belief in continuation (reversal), we propose cognitive dissonance arises in different circumstances and to differing degrees in the two cultures, resulting in it being a key driver of the anomalies. Results support our hypotheses, suggesting sentiment and culture interact to impact cognitive dissonance, explaining differences in the anomalies across countries evident in prior literature.
Keywords: Culture, Investor Sentiment, Cognitive Dissonance, Momentum, Post-Earnings-Announcement-Drift
JEL Classification: G14, G41, G4
Bing Liang and Liping Qiu
Using a large panel data, we investigate the dynamics of hedge fund leverage from 2002 to 2017 and find considerable variations in both time series and cross-section. More than 70% of hedge funds use leverage and almost half of the leveraged funds are levered through margin borrowing. On average, hedge funds decrease leverage prior to the beginning of the financial crisis, with leverage remaining below the pre-crisis levels. We find that the level of leverage and its changes are related to fund characteristics such as age, governance, performance, risk, fees, liquidity, survival, and the birth of a new fund
Keywords: Hedgeedge funds, leverage, financial crisis, newborn funds, survival
JEL Classification: TBA
Ayman M.A. Omar, Tomasz Wisniewski, and Liafisu Sina Yekini
This paper examines whether it is possible to forecast one-year-ahead returns of individual companies based on the observed ‘psychopathic’ characteristics of their top management team. We find that language characteristic of psychopaths present in annual report narratives, questionable integrity, excessive risk-taking and failure to contribute to charitable undertakings tend to reduce future shareholder wealth. These findings imply that firms could benefit from incorporating psychological evaluation in their recruitment processes, especially when seeking to fill senior management posts. While the return predictability described in this paper supports the upper echelons perspective, it simultaneously challenges the notion of informationally efficient stock prices
Keywords: Corporate Psychopaths; Stock Market Returns; Shareholders’ Wealth; Behavioral Finance
JEL Classification: D22; G02; G12; G14; G34
Lundtofte and Caren Yinxia Nielsen
A simple portfolio choice model shows that, when a bank’s capital is constrained by regulation, regulatory cost (risk weightings) alters the risk and value calculations for the bank’s assets. In particular, we find that banks may respond to stricter regulation by increasing the share of high-risk assets. Our empirical results show that U.S. banks responded to the implementation of the stricter Basel II regulations by increasing the share of high-risk assets in the risky part of their portfolios
Keywords:Banks, asset risk, credit risk, portfolio choice, risk-based capital regulation
JEL Classification: G11,G18,G21,G28
Xuhui (Nick) Pan Kainan Wang and Blerina Bela Zykaj
Abstract:We show that institutional ownership in equity mutual funds predicts fund performance. Our measure of institutional ownership in mutual funds is directly from institutions’ quarterly 13(f) filings so it provides a broader coverage of institutional investment in mutual funds than existing studies. Most institutions holding mutual funds are independent investment advisors and bank trusts who invest in mutual funds on behalf of their clients. Our results show that funds held by institutions perform better than funds not held by institutions for at least three years. Institutions’ informational advantage is the main driver of the outperformance of institution-held funds.
Keywords:institutional investors; 13(f) filings; mutual funds; mutual-fund performance
JEL Classification: G11, G23
Yiwei Li and Xiuye Zhang
Abstract:This paper examines the effect of female directors on corporate debt maturity structures. We find that firms with a higher ratio of female directors tend to have a larger proportion of short-maturity debt. This effect is more pronounced with female independent directors and is insignificant with female inside directors. These findings remain robust under propensity score matching and instrumental variable approaches to address potential endogeneity concerns. Furthermore, we find that our results are driven primarily by firms with weak governance quality and low financial constraints. We also find that the effect does not differ between high- and low-leveraged firms, and there is a negative relation between female directors and likelihood of overinvestment. This evidence suggests that female directors view short-term debt as a monitoring device.
JEL Classification: TBA
John Bae, Wonik Choi, and Jongha Lim
JEL Classification: TBA
Fabrizio Crespi, Emanuela Giacomini, and Danilo V. Mascia
Abstract:We analyze whether the introduction of the bail-in tool in January 2016 affected the pricing of Italian bank bonds. Using a unique dataset of 1,798 fixed-rate bonds issued during the period 2013–2016, we find an increase of the spread at issuance of bail-inable bonds compared to non-bail-inable bonds. This increase also depends on the intrinsic characteristics of each bank. Large institutions, banks with lower ratings, profitability, capitalization, and higher liquidity faced a higher cost of issuing bail-inable bonds. Overall, our results seem to support the hypothesis of an improved market discipline for the bank bonds primary market
Keywords:bail-in, bank bonds, cost of funding, too-big-to-fail.
JEL Classification: G12, G2, G21, G28.
Andrei Bolshakov and Ludwig B. Chincarini
Abstract:Investment managers often manage a portfolio with respect to a benchmark. Typ-
ically, they use a mean-variance optimization framework to maximize the information
ratio of their portfolio. We develop an unconventional approach to this question. Given
a set of assumptions, we ask what optimal percentage of the benchmark stocks should
the portfolio manager select. This optimal portfolio depends on Fisher’s and Walle-
nius’s noncentral hypergeometric distribution. We find that the optimal selectivity of a
benchmark universe varies from 50% to 80%. These results are provocative, given that
many enhanced index portfolio managers select a low percentage of the benchmark
Keywords:Enhanced indexing, information ratio, portfolio management, active man- agement.
JEL Classification: G0, G13
Stefania Cosci , Roberto Guida and Valentina Meliciani
Abstract:The European Union introduced a directive aimed at reducing trade credit due to its supposedly negative effect on the European economy. This contrasts with the redistribution view arguing that trade credit could facilitate the financing of credit-constrained firms by more liquid suppliers. But does trade credit mainly flow from relatively unconstrained suppliers to more financially constrained buyers? To answer this question, we look at the characteristics of net borrowers with respect to net lenders and then estimate the substitutability between trade and bank debt separately for the two groups of firms. Overall, the results show that, in Italy, efficient redistribution does not tend to prevail in the trade credit market
Keywords:Trade credit; redistribution view; financial constraints; substitutability.
JEL Classification: G32; G21; D82
Yuecheng Jia, Ivilina Popova, Betty Simkins and Qin Emma Wang
Abstract:This literature review outlines the recent progress in fundamental second and higher moments research. We survey the moments’ existence, formation, and financial market andmacroeconomic implications. Research shows that time-varying volatility and non-Gaussian
shocks exist throughout all measures of fundamentals at both the micro and macro levels.Additionally, the granular network among firms helps explain the origin of fundamental second and higher moments. Empirical evidence shows that the moments have strong predictive
power on asset prices and macroeconomic variables. We also highlight several areas wheremore research is needed to better understand the moments.
Keywords:Fundamental second moments, Fundamental higher moments, time-varying volatility, non-Gaussian shocks, granular network
JEL Classification: G12
Fearghal Kearney and Han Lin Shang
Abstract:Accurately forecasting the price of oil, the world’s most actively traded commodity, is of
great importance to both academics and practitioners. We contribute by proposing a functional
time series based method to model and forecast oil futures. Our approach boasts a number
of theoretical and practical advantages including effectively exploiting underlying process
dynamics missed by classical discrete approaches. We evaluate the finite-sample performance
against established benchmarks using a model confidence set test. A realistic out-of-sample
exercise provides strong support for the adoption of our approach with it residing in the
superior set of models in all considered instances.
Keywords:Crude oil, Forecasting, Functional time series, Futures contracts, Futures markets
JEL Classification: G10, G15, C53
Luc Renneboog and Yang Zhao
Abstract:This paper analyzes the labor market (turnover and appointments) of executive and non-executive directors by means of social network methodology. We find that directors with strong networks are able to obtain labor market information that enables them to leave their firm more easily for better opportunities. Networks also mitigate information asymmetry problems of external director appointments. Furthermore, the strong impact of indirect connections is in line with the ‘strength of the weak ties’ theory. The fact that direct connections are less important signifies that the connections to people that are close and local are likely to convey redundant information, whereas connections to distant individuals are more efficient in terms of information acquisition and labor market performance improvement.
Keywords:Corporate Governance; Director Networks; Director Turnover; Director
JEL Classification: G34, J4, L14
F.Y. Eric C. Lam, Wikrom Prombutr, Li Ya, and K.C. John Wei
Abstract:This study comprehensively reexamines the debate over behavioral and rational explanations for
the investment effect in an updated sample. We closely follow the previous literature and provide
several differences. Our tests include five prominent measures of corporate investment and
corporate profitability in q-theory and recent investment-based asset pricing models. Both
classical and Bayesian inferences show that limits-to-arbitrage tend to be supported by more
evidence than investment frictions for all investment measures. When idiosyncratic volatility and
cash flow volatility are used in measuring investment frictions, the inference is more favorable
for the rational explanation.
Keywords:Limits-to-arbitrage; Investment frictions; q-theory; Investment, Stock returns
JEL Classification: G14, G31, G32, M41, M42
YUANCHEN CHANG, YI-TING HSIEH, WENCHIEN LIU, and PETER MIU
Abstract:How does bankruptcy contagion propagate among industry peers? We study the debt recovery channel of industry contagion by examining whether the cost of a company’s debt is affected by the observed recovery rates of its bankrupt industry peers. Our results show that lower industry recovery rates are associated with higher loan spreads, but only when the contracts were originated during industry bankruptcy waves. Consistent with the debt recovery channel of industry contagion, we find that the negative effects of industry recovery rates are significantly stronger under situations where the effect is expected to be more salient..
Keywords: Industry contagion, Recovery rate, Loan pricing, Debt recovery channel
JEL Classification: G30, G33.
JEPPE CHRISTOFFERSEN and SIMONE STAEHR
JEL Classification: TBA
Lara Cathcart, Nina Gotthelf, Matthias Uhl, and Yining Shi
JEL Classification: TBA
JAMES B. HEATON
Abstract:Managerial optimism theory is behavioral finance’s greatest achievement. It explains
two prominent features of corporate financial behavior - over-investment and pecking order capital structure preferences - that otherwise require two different theories
with mutually-incompatible assumptions about managerial loyalties to shareholdervalue maximization. After reviewing the development of managerial optimism as a
unifying theory, I use a simple change-of-measure to transform risk-averse optimism
to risk-neutral probabilities that can be pessimistic or optimistic depending on wealth
changes. This unexplored feature has implications for, among other things, pay for
performance when managers are excessively optimistic.
Keywords:Behavioral corporate finance, Managerial optimism, Agency cost theory, Asymmetric information theory, Pay for performance.
JEL Classification: TBA