Knowledge that Transforms

Managers frequently cite the desire to mitigate asymmetric information as a motivation for increasing firm focus. The information benefits of focus appear relevant for the subset of firms that actually increase their focus; however, the relevance of focus-related information benefits for the population of diversified firms is an open question. This paper examines the relation between corporate diversification and asymmetric information proxies derived from analysts’ forecasts and abnormal returns associated with earnings announcements. I find that greater diversification is not associated with increased asymmetric information. These results call into question the notion that corporate diversification strictly exacerbates information problems.

We present a model of asset valuation in which short-selling requires searching for security lenders and bargaining over the lending fee. If lendable securities are difficult to locate, then the price of the security is initially elevated, and expected to decline. This price decline is to be anticipated, for example, after an initial public offering, and is increasing in the degree of heterogeneity of beliefs about the future value of the security. The prospect of lending fees may push the initial price of a security above even the most optimistic buyer's valuation of the security's future dividends. A higher price can thus be obtained with some shorting than if shorting is disallowed.

In a sample of 398 firms from Indonesia, Korea, Malaysia, the Philippines, and Thailand, firm-level differences in variables related to corporate governance had a strong impact on firm performance during the East Asian financial crisis of 1997–1998. Significantly better stock price performance is associated with firms that had indicators of higher disclosure quality (ADRs and auditors from Big Six accounting firms), with firms that had higher outside ownership concentration, and with firms that were focused rather than diversified. The results suggest that individual firms have some power to preclude expropriation of minority shareholders if legal protection is inadequate.

This paper examines the joint time series of the S&P 500 index and near-the-money short-dated option prices with an arbitrage-free model, capturing both stochastic volatility and jumps. Jump-risk premia uncovered from the joint data respond quickly to market volatility, becoming more prominent during volatile markets. This form of jump-risk premia is important not only in reconciling the dynamics implied by the joint data, but also in explaining the volatility “smirks” of cross-sectional options data.

Using a large sample of exogenous events that negatively affected Korean banks during the 1997–98 period, we examine the value of durable bank relationships in Korea. We show that adverse shocks to banks have a negative effect not only on the value of the banks themselves but also on the value of their client firms, and that this adverse effect on firm value is a decreasing function of the financial health of both the banks and their client firms. Our results are concentrated in the second half of the sample period when Korean banks experienced severe difficulties.

We develop and estimate an econometric model of limit-order execution times using survival analysis and actual limit-order data. We estimate versions for time-to-first-fill and time-to-completion for both buy and sell limit orders, and incorporate the effects of explanatory variables such as the limit price, limit size, bid/offer spread, and market volatility. Execution times are very sensitive to the limit price, but are not sensitive to limit size. Hypothetical limit-order executions, constructed either theoretically from first-passage times or empirically from transactions data, are very poor proxies for actual limit-order executions.

Some venture capital investors seek purely financial gains while others, such as corporations, also pursue strategic objectives. The paper examines a model where a strategic investor can achieve synergies, but can also face a conflict of interest with the entrepreneur. If the start-up is a complement to the strategic partner, it is optimal to obtain funding from the strategic investor. If the start-up is a mild substitute, the entrepreneur prefers an independent venture capitalist. With a strong substitute, syndication becomes optimal, such that the independent venture capitalist is the active lead investor and the strategic partner a passive co-investor. The expected returns for the entrepreneur are nonmonotonic, lowest for a mild substitute, and higher for a strong substitute as well as for a complement. The paper also explains why a strategic investor often pays a higher valuation than an independent venture capitalist.

Estimates of standard performance measures can be improved by using returns on assets not used to define those measures. Alpha, the intercept in a regression of a fund's return on passive benchmark returns, can be estimated more precisely by using information in returns on nonbenchmark passive assets, whether or not one believes those assets are priced by the benchmarks. A fund's Sharpe ratio can be estimated more precisely by using returns on other assets as well as the fund. New estimates of these performance measures for a large universe of equity mutual funds exhibit substantial differences from the usual estimates.

Repo contracts, the most important form of collateralized lending, are widely used by financial institutions and hedge funds to create short-selling positions and manage their leverage profile. Moreover, they have become the primary tool of money management and monetary control of several central banks, including the Bundesbank and the newly born European Central Bank. This paper is an empirical study of this market. More specifically, we study the extent to which the current term structure of long term “special” repo spreads discount the future collateral value (specialness) of Treasuries. We ask whether repo spreads embed a liquidity risk premium and whether such a risk premium is time-varying. We quantify the size of the average liquidity risk premium and we provide empirical evidence of the extent of its time-variation.

A diversified portfolio of risk arbitrage positions produces an abnormal return of 0.6–0.9% per month over the period from 1981 to 1996. We trace these profits to practical limits on risk arbitrage. In our model of risk arbitrage, arbitrageurs’ risk-bearing capacity is constrained by deal completion risk and the size of the position they hold. Consistent with this model, we document that the returns to risk arbitrage increase in an ex ante measure of completion risk and target size. We also examine the influence of the general supply of arbitrage capital, measured by the total equity holdings of arbitrageurs, on arbitrage profits.