Knowledge that Transforms

The economics of partnerships have been of enduring interest to economists, yet it is not clear what profit sharing within a private partnership should look like. We examine over 700 private equity partnerships and show that the allocation of fund economics to individual partners varies drastically, even among the most senior partners, and appears divorced from past success as an investor, being instead related to status as a founder. A smaller share of carried interest and ownership—and inequality in fund economics more generally—is associated with departures of senior partners which, in turn is negatively related to the funds’ ability to raise additional capital.

This paper determines the optimal ownership share held by a unit into a second unit when both face a tax-bankruptcy trade-off. Full ownership is optimal when the first unit has positive debt, because dividends help avoid its default. Positive debt is, in turn, optimal when its corporate tax rate exceeds a threshold, and/or thin capitalization rules place an upper limit on the debt level in the second unit, and/or the Volcker Rule bans bailout transfers to the second unit. Full ownership is no longer optimal only if there is a tax on intercorporate dividend. This theory rationalizes observations on multinationals, financial conglomerates, and family groups.

Historically black colleges and universities (HBCUs) pay higher underwriting fees to issue tax-exempt bonds, compared with similar non-HBCUs, apparently reflecting higher costs of finding willing buyers. The effect is three times larger in the Deep South, where racial animus remains the most severe. Credit quality plays little role. For example, identical differences are observed between HBCU and non-HBCUs with AAA ratings or when insured by the same company, even before the 2007–2009 financial crisis. HBCU-issued bonds are also more expensive to trade in secondary markets and, when they do, sit in dealer inventory longer.

Private equity funds hold assets that are hard to value. Managers have incentives to distort reported valuations if these reports are used by investors to decide on commitments to subsequent funds. Using a large dataset of buyout and venture funds, we test for the presence of return manipulations. We find that some underperforming managers inflate reported returns during fundraising. However, those managers are less likely to raise a next fund, suggesting that investors can see through the manipulation. In contrast, top-performing funds appear to understate valuations. A simple theoretical framework rationalizes our empirical results as well as those of related papers.

We study whether personal experiences are so powerful that they make individuals actively shy away from risk. Our research design relies on portfolio decisions relating to inheritances, which alter the active decision from one of choosing to take risk to one of choosing to reduce risk. Experience derives from investments in banks that defaulted following the 2007–2009 financial crisis. We classify experiences into first-hand experiences, resulting from personal losses; second-hand experiences, from losses of family members; and third-hand experiences, from locations where banks defaulted. Our results demonstrate that experiences gained personally, not common shocks, make individuals shy away from risk.

Suppliers are subject to the credit risk of their customers when they sell products on credit. However, rights to the collateral value of the products they sell may mitigate some of this risk. This paper demonstrates the important role of laws that support suppliers’ rights to reclaim and liquidate collateral. Using a change in the US bankruptcy code that altered the rights of a subset of suppliers, I use a difference-in-differences setting to show that an improvement in suppliers’ rights to the liquidation value of collateral results in an increase in the amount and duration of trade credit offered. The increase in collateral protection also reduced suppliers’ lending standards, resulting in more dispersed trade credit lending and riskier customer portfolios. Finally, I find that the increase in collateral rights decreased suppliers’ incentives to monitor their customers, consistent with collateral and monitoring being substitutes. Overall, the paper shows that with strong legal protections in place, trade credit has an important collateral component.

Psychological evidence indicates that decision quality declines after an extensive session of decision-making, a phenomenon known as decision fatigue. We study whether decision fatigue affects analysts’ judgments. Analysts cover multiple firms and often issue several forecasts in a single day. We find that forecast accuracy declines over the course of a day as the number of forecasts the analyst has already issued increases. Also consistent with decision fatigue, we find that the more forecasts an analyst issues, the higher the likelihood the analyst resorts to more heuristic decisions by herding more closely with the consensus forecast, self-herding (i.e., reissuing their own previous outstanding forecasts), and issuing a rounded forecast. Finally, we find that the stock market understands these effects and discounts for analyst decision fatigue.

In a comprehensive sample of mergers and acquisitions, we find a reference price effect: acquirers earn higher (lower) announcement-period returns when their pre-announcement stock prices are well below (near) their 52-week highs. This reference price effect is stronger in acquisitions of private targets, deals involving greater uncertainty, and acquirers with greater individual investor ownership, and it is reversed in the subsequent year. Further, acquirer reference prices affect bid premia and target announcement-period returns in deals with greater uncertainty in acquirer valuation. The overall evidence is consistent with investors irrationally using 52-week high prices as a measure of acquirer valuation.

To attenuate an inherent errors-in-variables bias, portfolios are widely employed to test asset pricing models; but portfolios might mask relevant risk- or return-related features of individual stocks. We propose an instrumental variables approach that allows the use of individual stocks as test assets, yet delivers consistent estimates of ex post risk premiums. This estimator also yields well-specified tests in small samples. The market risk premium under the capital asset pricing model (CAPM) and the liquidity-adjusted CAPM, premiums on risk factors under the Fama–French three- and five-factor models, and the Hou et al. (2015) four-factor model are all insignificant after controlling for asset characteristics.

This paper studies the role of activist investors in the market for corporate control. Our theory proposes that activist investors have an inherent advantage relative to bidders in pressuring entrenched incumbents to sell. As counterparties to the acquisition, bidders have a fundamental conflict of interests with target shareholders from which activist investors are immune. Therefore, unlike activists, the ability of bidders to win proxy fights is very limited. This result is consistent with the large number of activist campaigns that have resulted with the target’s sale to a third party and the evidence that most proxy fights are launched by activists, not by bidders.