Knowledge that Transforms

This paper investigates a little studied but common mechanism that firms use to obtain state favors: business owners themselves seeking election to top office. Using Thailand as a research setting, we find that the more business owners rely on government concessions or the wealthier they are, the more likely they are to run for top office. Once in power, the market valuation of their firms increases dramatically. Surprisingly, the political power does not influence the financing strategies of their firms. Instead, business owners in top office use their policy-decision powers to implement regulations and public policies favorable to their firms. Such policies hinder not only domestic competitors but also foreign investors. As a result, these politically connected firms are able to capture more market share.

Compensation contracts have been criticized for encouraging managers to manipulate information. This includes bonus schemes that encourage earnings smoothing, and option packages that allow managers to cash out early when the firm is overvalued. We show that the intransparency induced by these contract features is critical for giving long-term incentives. Lack of transparency makes it harder for the owner to engage in ex post optimal but ex ante inefficient liquidity provision to the manager. For the same reason, it is often optimal to “pay for luck ” (i.e., tie long-term compensation to variables that the manager has no influence over, but may have private information about, such as future profitability of the whole industry). (JEL G34, J33) How can effective executive compensation be set up when managers can manipulate short-term information? Although it is a long-standing question in corporate governance, public focus on this issue reached new heights at the beginning of the millennium after governance scandals at Enron and WorldCom and many other corporations. A common thread in these scandals was that accounting manipulation was used to increase stock prices. In a number of cases,

We study holdings in M&A targets by financial conglomerates which affiliated investment banks advise the bidders. We show that advisors take positions in the targets before M&A announcements. These stakes are positively related to the probability of observing the bid and to the target premium. We argue that this can be explained in terms of advisors, privy to important information about the deal, investing in the target in the expectation of its price to increase. We document the high profits of this strategy. We also document a positive relationship between the advisory stake and the deal characteristics. The advisory stake is positively related to the likelihood of deal completion and to the termination fees. However, these deals are not wealth-creating: there is a negative relation between the advisory stake and the viability of the deal. These results provide new insights into the conflicts of interest affecting financial

One can consider the concept of market neutrality for hedge funds as having breadth and depth: "breadth" reects the number of market risks to which a fund is neutral, while "depth" reects the "completeness" of the neutrality of the fund to market risks. We focus on market neutrality depth, and propose ve different neutrality concepts. "Mean neutrality" nests the standard correlation-based denition of neutrality. "Variance neutrality", "Value-at-Risk neutrality" and "tail neutrality" all relate to the neutrality of the risk of the hedge fund to market risks. Finally, "complete neutrality" corresponds to independence of the fund to market risks. We suggest statistical tests for each neutrality concept, and apply the tests to a combined database of monthly "market neutral" hedge fund returns from the HFR and TASS hedge fund databases. We nd that around one-quarter of these funds exhibit some signicant exposure to market risk.

We model the demand-pressure effect on prices when options cannot be perfectly hedged. The model shows that demand pressure in one option contract increases its price by an amount proportional to the variance of the unhedgeable part of the option. Similarly, the demand pressure increases the price of any other option by an amount proportional to the covariance of their unhedgeable parts.

Despite the central importance of investors to all initial public offering (IPO) theories, relatively little is known about their role in practice. This article is based on a survey of how institutional investors assess IPOs, what information they provide to the investment banking syndicate, and the factors they believe influence allocations. We find that investor characteristics, in particular brokerage relationships with the bookrunner, are perceived to be the most important factors influencing allocations, which supports the view that IPO allocations are part of implicit quid pro quo deals with investment banks. The survey raises doubts as to the extent of information production or revelation.

Previous research concludes that options are mispriced based on the high average returns, CAPM alphas, and Sharpe ratios of various put selling strategies. One criticism of these conclusions is that these benchmarks are ill-suited to handle the extreme statistical nature of option returns generated by nonlinear payoffs. We propose an alternative way to evaluate the statistical significance of option returns by comparing historical statistics to those generated by option pricing models. The most puzzling finding in the existing literature, the large returns to writing out-of-the-money puts, is not inconsistent (i.e., is statistically insignificant) relative to the Black-Scholes model or the Heston stochastic volatility model due to the extreme sampling uncertainty associated with put returns. This sampling problem can largely be alleviated by analyzing market-neutral portfolios such as straddles or delta-hedged returns. The returns on these portfolios can be explained by jump risk premia and estimation risk.

By generalizing the Leland and Pyle (1977) model to the case of multiple correlated assets, this paper studies the signaling and hedging behavior of an intermediary who sells multiple assets in financial markets. Based on information asymmetry, this paper demonstrates the intrinsic interdependence of risk management and asset selling for intermediaries, and obtains several testable empirical implications. For instance, an intermediary with a more diversified underlying portfolio will face greater liquidity (a smaller price impact) when selling assets to the market. Several applications are discussed, including bank loan sales and selling mechanisms. (JEL D40, D82, G20) Financial intermediaries manage and trade large portfolios of assets. For in-stance, Fannie Mae, a leading firm in the Mortgage Backed Securities (MBS) industry, issued 32 Fannie Mae MBS pools on 1 November 2004.1 Meanwhile, active risk management is becoming increasingly important for financial inter-mediaries,2 possibly due to the longterm capital management crisis in the fall of 1998. Motivated by these facts, this paper generalizes the Leland and Pyle (1977,

The authors show that the widening of a foreign firm's U.S. investor base and the improved information environment associated with cross-listing on a U.S. exchange each have a separately identifiable effect on a firm's valuation. The increase in valuation associated with cross-listing is transitory, not permanent. Valuations of Canadian firms peak in the year of cross-listing and fall monotonically thereafter, regardless of the level of U.S. investor holdings or the ownership structure of the firm. Cross-listed firms with a 20 per cent or more blockholder attract a similar number of U.S. institutional investors as widely held firms, on average, but experience a lower increase in valuation at high levels of investor recognition. While U.S. investors are less willing to invest in firms with dual-class shares, these firms benefit more from cross-listing even when they fail to widen their U.S. investor base, suggesting that the reduction in information asymmetry between controlling and minority investors has a separate impact on valuation for firms where agency problems are greatest.

This paper considers optimal compensation for a CEO who is entrusted with administering corporate assets honestly. Optimal compensation designs maximize integrity at minimum cost. These designs are very “low powered,” i.e., while specifying a lower bound for performance and increasing pay with performance, they increase compensation at a rapidly decreasing rate. Thus, integrity considerations engender optimal compensation packages that closely resemble the very pervasive 80/120 bonus plans, exactly the sort of compensation that Jensen (2003) argues should compromise integrity. Under optimal designs, expected compensation increases linearly with firm size, and increases in the market/book ratio. Moreover, given optimal compensation, CEO asset diversion is limited to high market-to-book firms that have received negative productivity shocks.