Knowledge that Transforms

We examine cash dividends and share repurchases from 1989 to 2005 in the 15 nations that were members of the European Union before May 2004. As in the United States, the fraction of European firms paying dividends declines, while total real dividends paid increase and share repurchases surge. We also show that financial reporting frequency is associated with higher payout, and that privatized companies account for almost one-quarter of total cash dividends and share repurchases. Our regression analyses indicate that increasing fractions of retained earnings to equity do not increase the likelihood of cash payouts, whereas company age does.

Using novel indicators of political connections constructed from campaign contribution data, we show that Brazilian firms that provided contributions to (elected) federal deputies experienced higher stock returns than firms that did not around the 1998 and 2002 elections. This suggests that contributions help shape policy on a firm-specific basis. Using a firm fixed effects framework to mitigate the risk that unobserved firm characteristics distort the results, we find that contributing firms substantially increased their bank financing relative to a control group after each election, indicating that access to bank finance is an important channel through which political connections operate. We estimate the economic costs of this rent seeking over the two election cycles to be at least 0.2% of gross domestic product per annum.

Models of adverse selection risk generally assume that market makers offset expected losses to informed traders with expected gains from the uninformed. We recognize that the expected loss captures a combination of two effects: (1) the probability that some traders have private information, and (2) the likely magnitude of that information. We use a maximum-likelihood approach to separately estimate the probability and magnitude of private information events for NYSE-listed stocks from 1993 through 2003. The results shed light on the price discovery process and have implications for many areas of finance.

What is good for a country may not be good for its big businesses, at least recently. More turnover in top businesses correlates with faster per capita gross domestic product, productivity, and capital growth; supporting Schumpeter's [1942. Capitalism, Socialism and Democracy, third ed., Harper & Bros., New York, NY] theory of “creative destruction”—innovative firms blooming as stagnant ones wither. These correlations are greater in more developed economies, supporting Aghion and Howitt's [1992. A model of growth through creative destruction. Econometrica 60, 323–351] thesis that creative destruction matters more to economies nearer the technological frontier. More big business turnover also correlates with smaller government, common law, less bank-dependence, stronger shareholder rights, and greater openness.

We analyze a six-factor model for Treasury bonds, corporate bonds, and swap rates and decompose swap spreads into three components: a convenience yield from holding Treasuries, a credit risk element from the underlying LIBOR rate, and a factor specific to the swap market. The convenience yield is by far the largest component of spreads. There is a discernible contribution from credit risk as well as from a swap-specific factor with higher variability which in certain periods is related to hedging activity in the mortgage-backed security market. The model also sheds light on the relation between AA hazard rates and the spread between LIBOR rates and General Collateral repo rates and on the level of the riskless rate compared to swap and Treasury rates.

This paper reexamines the validity of the expectation hypothesis (EH) of the term structure of US repo rates ranging in maturity from overnight to 3 months. We extend the work of Longstaff [2000b. The term structure of very short term rates: new evidence for the expectations hypothesis. Journal of Financial Economics 58, 397–415] in two directions: (1) we implement statistical tests designed to increase test power in this context; (2) more important, we assess the economic value of departures from the EH based on criteria of profitability and economic significance in the context of a simple trading strategy. The EH is rejected throughout the term structure examined on the basis of the statistical tests. However, the results of our economic analysis are favorable to the EH, suggesting that the statistical rejections of the EH in the repo market are economically insignificant.

We examine the effect of regime change on privatization. In the 2004 Indian election, the pro-reform BJP was unexpectedly defeated by a less reformist coalition. Stock prices of government-controlled companies that had been slated for privatization by the BJP dropped 3.5% relative to private firms. Government-controlled companies that were under study for possible privatization fell 7.5% relative to private firms. This is consistent with investor belief of a “point of no return,” where advanced reforms are more difficult to reverse. Further analysis suggests that layoffs, combined with the privatization announcement, served as a credible commitment to privatize.

It is well documented that the venture capital industry is highly volatile and that much of this volatility is associated with shifting valuations and activity in public equity markets. This paper examines how changes in public market signals affected venture capital investing between 1975 and 1998. We find that venture capitalists with the most industry experience increase their investments the most when public market signals become more favorable. Their reaction to an increase is greater than the reaction of venture capital organizations with relatively little industry experience and those with considerable experience but in other industries. The increase in investment rates does not affect the success of these transactions adversely to a significant extent. These findings are consistent with the view that venture capitalists rationally respond to attractive investment opportunities signaled by public market shifts.

We ask whether the apparent impact of governance structure and incentive-based compensation on firm performance stands up when measured performance is adjusted for the effects of earnings management. Institutional ownership of shares, institutional investor representation on the board of directors, and the presence of independent outside directors on the board all reduce the use of discretionary accruals. These factors largely offset the impact of option compensation, which strongly encourages earnings management. Adjusting for the impact of earnings management substantially increases the measured importance of governance variables and dramatically decreases the impact of incentive-based compensation on corporate performance.

Using the longest event window, we find that public target shareholders receive a 63% (14%) higher premium when the acquirer is a public firm rather than a private equity firm (private operating firm). The premium difference holds with the usual controls for deal and target characteristics, and it is highest (lowest) when acquisitions by private bidders are compared to acquisitions by public companies with low (high) managerial ownership. Further, the premium paid by public bidders (not private bidders) increases with target managerial and institutional ownership.