Knowledge that Transforms

This is a first attempt to study how the structure of the industry affects mutual fund behavior. I show that industry structure matters; the mutual fund families employ strategies that rely on the heterogeneity of the investors in terms of investment horizon by offering the possibility to switch across different funds belonging to the same family at no cost. I argue that this option acts as an externality for all the funds belonging to the same family, affecting the target level of performance the family wants to reach and the number of funds it wants to set up. By using the universe of the U.S. mutual fund industry, I empirically confirm this intuition. I find evidence of family driven heterogeneity among funds and show that families actively exploit it. I argue that the more families are able to differentiate themselves in terms of non-performance-related characteristics, the less they need to compete in terms of performance. Product differentiation—i.e., the dispersion in the “services” (fees, performance) that the competing funds offer—affects performance and fund proliferation. In particular, I show that the degree of product differentiation negatively affects performance and positively affects fund proliferation.

This paper measures the value of corporate voting rights, specifically of the control block of votes, in a sample of 661 dual-class firms in 18 countries, in 1997. A consistent measure across countries is proposed. The measure is adjusted for takeover probability, block-holding costs, and dividend and liquidity differences between the share classes. The value of controlblock votes varies widely across countries. It is close to half of firm market value in South Korea, and close to zero in Finland. The value of control-block votes is interpreted as a lower bound for actual private benefits of the controlling shareholder. The legal environment, law enforcement, investor protection, takeover regulations, and power-concentrating corporate charter provisions explain 68% of the cross-country variation in the value of control-block votes.

Swedish bankruptcy filing automatically terminates the employment of the chief executive officer (CEO) and triggers an auction of the firm. Critics of this system warn of excessive shareholder risk-shifting incentives prior to filing. We argue that private benefits of control induce managerial conservatism that may override shareholder risk-shifting incentives. By investing conservatively, the CEO increases the joint probability that the auction results in a going-concern sale and that the CEO is rehired. This uniquely implies that the rehiring probability is increasing in private control benefits, which our empirical results support. We also find that buyers in the auction screen on CEO quality. Overall, labor market discipline is dramatic, as filing CEOs suffer large income losses relative to CEOs of matched, non-bankrupt firms. Firms emerging from auction bankruptcy appear healthy as they typically go on to perform at par with industry rivals. JEL classification: G33; G34

There is a general perception that the large trading volume in initial public offerings is mostly due to “flippers” that are allocated shares in the offering and immediately resell them. On average, however, flipping accounts for only 19% of trading volume and 15% of shares offered during the first two days of trading. Institutions do more flipping than retail customers and hot IPOs are flipped much more than cold IPOs. Institutions do not quickly flip cold IPOs to take advantage of price support activities by the underwriter. Explicit penalty bids are rarely assessed against flippers.

We examine firms that reprice their executive stock options and find little evidence that repricing reflects managerial entrenchment or ineffective governance. Repricing grants are economically significant, but there is little else unusual about compensation in repricing firms. Repricers tend to be smaller, younger, rapidly growing firms that experience a deep, sudden shock to growth and profitability. They are also more concentrated in the technology, trade, and service sectors and have smaller boards of directors. Repricers have abnormally high CEO turnover rates, which is inconsistent with the entrenchment hypothesis. Over 40% of repricers exclude the CEO's options when they reprice.

This paper investigates whether dealer firms’ trading and pricing decisions are governed by their equivalent inventories, based on Ho and Stoll (1983) or Froot and Stein (1998), or by their ordinary inventories. It finds that ordinary inventories best explain dealer firms’ quote placement strategy, which dealer firm executes trades, and the quality of execution offered to the trades. This finding is consistent with decentralized nature of market-making where individual dealers focus on the position risk of stocks managed by them and not the position risks of stocks managed by other dealers in the firm.

I use asymptotic arguments to show that the t-statistics in long-horizon regressions do not converge to well-defined distributions. In some cases, moreover, the ordinary least squares estimator is not consistent and the R2 is an inadequate measure of the goodness of fit. These findings can partially explain the tendency of long-horizon regressions to find “significant” results where previous short-term approaches find none. I propose a rescaled t-statistic, whose asymptotic distribution is easy to simulate, and revisit some of the long-horizon evidence on return predictability and of the Fisher effect.

Debtor-in-possession (DIP) financing is unique secured financing available to firms filing for Chapter 11. Opponents of DIP financing argue that it leads to overinvestment. Alternatively, DIP financing can allow funding for positive net present value projects that increase the likelihood of reorganization and reduce time in bankruptcy. Using a large sample of bankruptcy filings, we find little evidence of systematic overinvestment. DIP financed firms are more likely to emerge from Chapter 11 than non-DIP financed firms. DIP financed firms have a shorter reorganization period; they are quicker to emerge and also quicker to liquidate. The reorganization period is even shorter when prior lenders provide the DIP financing.

The state of development of the financial sector does not change monotonically over time. In particular, by most measures, countries were more financially developed in 1913 than in 1980 and only recently have they surpassed their 1913 levels. To explain these changes, we propose an interest group theory of financial development where incumbents oppose financial development because it breeds competition. The theory predicts that incumbents’ opposition will be weaker when an economy allows both cross-border trade and capital flows. This theory can go some way in accounting for the cross-country differences in, and the time-series variation of, financial development.

We study a known negative signal, the sale of insider shares in an IPO and find that insiders adopt two concealment strategies consistent with wealth-maximizing behavior. First, insiders underreport the number of personally owned shares in the prominent original prospectus and use an obscure amendment to communicate the true higher level of shares to be offered. Second, when insiders increase shares in a later amendment, they tend to either increase secondary shares disproportional to primary share increases, or to reduce primary shares to wholly or partly conceal the increase in secondary shares offered. Insiders confound the negative secondary share signal by simultaneously sending a positive lockup signal.