Knowledge that Transforms

ABSTRACT The returns that institutional investors realize from private equity differ dramatically across institutions. Using detailed, hitherto unexplored records, we document large heterogeneity in the performance of investor classes: endowments' annual returns are nearly 21% greater than average. Analysis of reinvestment decisions suggests that endowments (and to a lesser extent, public pensions) are better than other investors at predicting whether follow‐on funds will have high returns. The results are not primarily due to endowments' greater access to established funds, since they also hold for young or undersubscribed funds. Our results suggest that investors vary in their sophistication and potentially their investment objectives.

ABSTRACT We develop and test a new theory of security issuance that is consistent with the puzzling stylized fact that firms issue equity when their stock prices are high. The theory also generates new predictions. Our theory predicts that managers use equity to finance projects when they believe that investors' views about project payoffs are likely to be aligned with theirs, thus maximizing the likelihood of agreement with investors. Otherwise, they use debt. We find strong empirical support for our theory and document its incremental explanatory power over other security‐issuance theories such as market timing and time‐varying adverse selection.

ABSTRACT This study presents new evidence that initial IPO returns have persistent underwriter‐specific components. These components cannot be explained by existing measures of underwriter quality, underwriter service, or controls for several known predictors of initial IPO returns. Tests that trace the roots of persistence most broadly support theories of asymmetric information among underwriters. I present such a model, and consistent with its predictions, I find that high underpricing underwriters (1) are responsible for a majority of the partial adjustment phenomenon, (2) make more informed analyst revisions, (3) experience superior market share growth, and (4) are more likely to serve an institutional clientele.

ABSTRACT We analyze the hedging decisions of firms, within an equilibrium setting that allows us to examine how a firm's hedging choice depends on the hedging choices of its competitors. Within this equilibrium some firms hedge while others do not, even though all firms are ex ante identical. The fraction of firms that hedge depends on industry characteristics, such as the number of firms in the industry, the elasticity of demand, and the convexity of production costs. Consistent with prior empirical findings, the model predicts that there is more heterogeneity in the decision to hedge in the most competitive industries.

ABSTRACT We examine the evolution of insider ownership of IPO firms from 1970 to 2001 to understand how U.S. firms become widely held. A majority of these firms has insider ownership below 20% after 10 years. Stock market performance and liquidity play an extremely important role in ownership dynamics. Firms with stocks that are highly valued, are liquid, and have performed well experience large decreases in insider ownership and become widely held. Ownership also falls for low cash flow and high capital expenditures firms. Surprisingly, variables proxying for agency costs have limited success in explaining the evolution of insider ownership.

ABSTRACT We estimate the impact of bank mergers and acquisitions (M&As) on outstanding credit, credit lines, and the sensitivity of investment to cash flow using a large sample of Italian corporate borrowers. We distinguish between firms that experienced relationship termination as a consequence of bank M&As and those that did not. Our findings are consistent with bank M&As having an adverse effect on credit, particularly when the M&A is followed by relationship termination. The effect persists 3 years and then is absorbed, suggesting that firms are able to compensate for the negative shock.

ABSTRACT We develop an equilibrium model of learning by rational traders to reconcile several empirical regularities: Cross sectionally, most individual speculators lose money; large speculators outperform small speculators; past performance positively affects subsequent trade intensity; most new traders lose money and cease speculation; and performance shows persistence. Learning from trading generates substantial endogenous liquidity, reducing bid–ask spreads and the impact of exogenous liquidity shocks on asset prices, but amplifying the effects of real shocks. Introducing slightly overconfident traders increases bid–ask spreads, hurting all traders. Finally, behavioral theories cannot reconcile all of these empirical regularities.

ABSTRACT We present a simple rational model to highlight the effect of investors' participation costs on the response of mutual fund flows to past fund performance. By incorporating participation costs into a model in which investors learn about managers' ability from past returns, we show that mutual funds with lower participation costs have a higher flow sensitivity to medium performance and a lower flow sensitivity to high performance than their higher‐cost peers. Using various fund characteristics as proxies for the reduction in participation costs, we provide empirical evidence supporting the model's implications for the asymmetric flow‐performance relationship.

ABSTRACT We propose a dynamic risk‐based model that captures the value premium. Firms are modeled as long‐lived assets distinguished by the timing of cash flows. The stochastic discount factor is specified so that shocks to aggregate dividends are priced, but shocks to the discount rate are not. The model implies that growth firms covary more with the discount rate than do value firms, which covary more with cash flows. When calibrated to explain aggregate stock market behavior, the model accounts for the observed value premium, the high Sharpe ratios on value firms, and the poor performance of the CAPM.

ABSTRACT We offer a new explanation for why academic studies typically fail to find value creation in bank mergers. Our conjectures are predicated on the idea that, until recently, large bank acquisitions were a new phenomenon, with no best practices history to inform bank managers or market investors. We hypothesize that merging banks, and investors pricing bank mergers, learn by observing information that spills over from previous bank mergers. We find evidence consistent with these conjectures for 216 M&As of large, publicly traded U.S. commercial banks between 1987 and 1999. Our findings are consistent with semistrong stock market efficiency.