Knowledge that Transforms

In response to corporate scandals in 2001 and 2002, major U.S. stock exchanges issued new board requirements to enhance board oversight. We find a significant decrease in CEO compensation for firms that were more affected by these requirements, compared with firms that were less affected, taking into account unobservable firm effects, time‐varying industry effects, size, and performance. The decrease in compensation is particularly pronounced in the subset of affected firms with no outside blockholder on the board and in affected firms with low concentration of institutional investors. Our results suggest that the new board requirements affected CEO compensation decisions.

I show that share repurchases increase pay‐performance sensitivity of employee compensation and lead to greater employee effort and higher stock prices. Consistent with the model, I find that after repurchases, employees and managers receive fewer stock option and equity grants, and that the market reacts favorably to repurchase announcements when employees have many unvested stock options. Managers are more likely to initiate share repurchases when employees hold a large stake in the firm. Moreover, since employees are forced to bear more risk in firms that repurchase shares, they exercise their stock options earlier and receive higher compensation.

A large number of empirical studies find that trading volume contains information about the distribution of future returns. While these studies indicate that observing volume is helpful to an outside observer of the economy it is not clear how investors within the economy can learn from trading volume. In this paper, I show how trading volume helps investors to evaluate the precision of the aggregate information in the price. I construct a model that offers a closed-form solution of a rational expectations equilibrium where all investors learn from (1) private signals, (2) the market price, and (3) aggregate trading volume.

A central measure of the efficiency of the Initial Public Offering (IPO) market is the extent to which issues are underpriced. We present new and comprehensive evidence covering British IPOs since World War I. During the period from 1917 to 1945, public offers were underpriced by an average of only 3.80%, as compared to 9.15% in the period from 1946 to 1986, and even more after the U.K. stock market was deregulated in 1986. The post-WWII rise in underpricing cannot be attributed to changes in firm composition, and occurred in spite of improvements in regulation, disclosure, and the prestige of IPO underwriters.

We study how competition in the product market affects the link between firms' real investment decisions and their asset return dynamics. In our model, assets in place and growth options have different sensitivities to market wide uncertainty. The strategic behavior of market participants influences the relative importance of these components of firm value. We show that the relationship between the degree of competition and assets' expected rates of return varies with product market demand. When demand is low, firms in more competitive industries earn higher returns, whereas when demand is high firms in more concentrated industries earn higher returns.

We examine international stock return comovements using country-industry and country-style portfolios as the base portfolios. We first establish that parsimonious risk-based factor models capture the data covariance structure better than the popular Heston–Rouwenhorst (1994) model. We then establish the following stylized facts regarding stock return comovements. First, there is no evidence for an upward trend in return correlations, except for the European stock markets. Second, the increasing importance of industry factors relative to country factors was a short-lived phenomenon. Third, large growth stocks are more correlated across countries than are small value stocks, and the difference has increased over time.

Using a comprehensive hedge fund database, we examine the role of managerial incentives and discretion in hedge fund performance. Hedge funds with greater managerial incentives, proxied by the delta of the option-like incentive fee contracts, higher levels of managerial ownership, and the inclusion of high-water mark provisions in the incentive contracts, are associated with superior performance. The incentive fee percentage rate by itself does not explain performance. We also find that funds with a higher degree of managerial discretion, proxied by longer lockup, notice, and redemption periods, deliver superior performance. These results are robust to using alternative performance measures and controlling for different data-related biases.

Based upon a large data set of public and private firms in the United Kingdom, I find that compared to their public counterparts, private firms rely almost exclusively on debt financing, have higher leverage ratios, and tend to avoid external capital markets, leading to a greater sensitivity of their capital structures to fluctuations in performance. I argue that these differences are due to private equity being more costly than public equity. I further examine the private firms subsample to show that private equity is more costly than its public counterpart due to information asymmetry and the desire to maintain control.

This study analyzes the role that two psychological attributes—sensation seeking and overconfidence—play in the tendency of investors to trade stocks. Equity trading data from Finland are combined with data from investor tax filings, driving records, and mandatory psychological profiles. We use these data, obtained from a large population, to construct measures of overconfidence and sensation seeking tendencies. Controlling for a host of variables, including wealth, income, age, number of stocks owned, marital status, and occupation, we find that overconfident investors and those investors most prone to sensation seeking trade more frequently.

The effective cost of trading is usually estimated from transaction-level data. This study proposes a Gibbs estimate that is based on daily closing prices. In a validation sample, the daily Gibbs estimate achieves a correlation of 0.965 with the transaction-level estimate. When the Gibbs estimates are incorporated into asset pricing specifications over a long historical sample (1926 to 2006), the results suggest that effective cost (as a characteristic) is positively related to stock returns. The relation is strongest in January, but it appears to be distinct from size effects.