Knowledge that Transforms

We examine capital structures of 2,572 project-financed investments in 124 countries for the period 1997–2006. In contrast to the general prediction of the trade-off theory, we find that project companies use more leverage when project risk is high, but they use less leverage in the presence of risk-reducing features including offtake agreements. Project companies use less leverage and instead rely more on offtake agreements when the control benefits of cash flow from the project are high, suggesting that leverage and contract structures in the project company are important hedging mechanisms.

We identify large discontinuous changes, known as jumps, in daily stock prices and explore the role of jumps in cross-sectional stock return predictability. Our results show that small and illiquid stocks have higher jump returns to the extent that cross-sectional differences in jumps fully account for the size and illiquidity effects. Based on value-weighted portfolios, jumps also account for the value premium. On the other hand, jumps are not the cause of momentum or net share issue effects. The findings of our study shed new light on stock return dynamics and present challenges to conventional explanations of stock return predictability.

We examine capital structures of 2,572 project-financed investments in 124 countries for the period 1997–2006. In contrast to the general prediction of the trade-off theory, we find that project companies use more leverage when project risk is high, but they use less leverage in the presence of risk-reducing features including offtake agreements. Project companies use less leverage and instead rely more on offtake agreements when the control benefits of cash flow from the project are high, suggesting that leverage and contract structures in the project company are important hedging mechanisms.

We study a sample of Form 13F filings where fund advisors seek confidential treatment for some or all of their 13(f)-reportable positions. Consistent with the hypothesis that managers seek confidentiality to protect proprietary information, we find that confidential positions earn positive and significant abnormal returns over the post-filing confidential period. We also find that managers are more likely to seek confidential treatment of illiquid positions that are more susceptible to front-running. Overall, our analysis highlights important benefits of reduced disclosure that are relevant to the current policy debate on hedge fund transparency.

Executive pay disparity, as measured by chief executive officer (CEO) pay slice (CPS), is positively associated with the implied cost of equity, even after controlling for other determinants of the cost of equity. The difference in the cost of equity can explain 43% of the difference in the valuation effect attributable to CPS reported by Bebchuk, Cremers, and Peyer (2011). Further analysis shows that the positive association is stronger when agency problems of free cash flow are more severe and when CEO succession planning is more important. Our evidence suggests that a large CPS is associated with CEO entrenchment and high succession risk.

We investigate whether there are predictable patterns in the dynamics of higher-order risk-neutral moments (RNMs) extracted from the market prices of Standard & Poor’s (S&P) 500 index options. To this end, we conduct a horse race among alternative forecasting models within an out-of-sample context over various forecasting horizons. We consider both a statistical and an economic setting. We find that higher RNMs can be statistically forecasted. However, only the 1-day-ahead skewness forecasts can be economically exploited. This economic significance vanishes once we incorporate transaction costs. The results have implications for the dynamics of implied volatility surfaces.

In acquisitions, target chief executive officers (CEOs) face a moral hazard: Any personal gain from the deal could be offset by the loss of the future compensation stream associated with their jobs. Larger, more important parachutes provide greater relief for these losses. To explicitly measure the moral hazard target CEOs face, we standardize the parachute payment by the expected value of their acquisition-induced lost compensation. We examine 851 acquisitions from 1999–2007, finding that more important parachutes benefit target shareholders through higher completion probabilities. Conversely, as parachute importance increases, target shareholders receive lower takeover premia, while acquirer shareholders capture additional rents from target shareholders.

We examine how the Sarbanes-Oxley Act (SOX) affects pre-repurchase earnings management and its association with post-repurchase firm performance. Unlike prior pre-SOX studies, our post-SOX results indicate that open-market repurchasers do not engage in pre-buyback downward accrual-based earnings management. Audit committee independence, reforms in corporate governance structures, and changes in executives’ equity holdings prompted by SOX may explain the findings. Post-SOX, the significant negative association between pre-repurchase abnormal accruals and post-repurchase performance disappears, the market reaction to repurchase announcements becomes significantly less favorable, and there is no evidence of any shift away from accrual-based to real earnings management.

Any firm choosing a chief executive officer (CEO) faces a double problem: candidate selection and choice of a compensation scheme. We derive sufficient conditions where the unique optimal compensation scheme is a capped-bonus contract in a pure moral-hazard environment, while equity is used when the firm also faces adverse selection. Then, we provide a rationale for the simultaneous increases in CEO pay, use of equity in compensation, and external hiring of CEOs. Our results are consistent with empirical evidence that shows externally hired CEOs earn more than those internally hired and that externally hired CEOs get a higher fraction of their compensation equity based.

We examine the impact of influenza on stock markets. For the United States, a higher incidence of flu is associated with decreased trading, decreased volatility, decreased returns, and higher bid-ask spreads. Consistent with the flu affecting institutional investors and market makers, the decrease in trading activity and volatility is primarily driven by the incidence of influenza in the greater New York City area. However, the effect of the flu on bid-ask spreads and returns is related to the incidence of flu nationally. International data confirm our findings of a decrease in trading activity and returns when flu incidence is high.