Knowledge that Transforms

Numerous hedge funds stop reporting each year to commercial databases, wreaking havoc with analyzing investment strategies that incur the unobserved delisting return. We use estimated portfolio holdings for funds-of-funds to back out estimated hedge-fund delisting returns. For all exiting funds, the estimated mean delisting return is insignificantly different from the average monthly return for live hedge funds. However, funds with poor prior performance and no clearly stated delisting reason had a significantly negative estimated mean delisting return of -5.97%, suggesting that a shock to their returns “tips them over the edge” and leads to delisting.

We demonstrate that personal political preferences of corporate managers influence corporate policies. Specifically, Republican managers who are likely to have conservative personal ideologies adopt and maintain more conservative corporate policies. Those firms have lower levels of corporate debt, lower capital and research and development (R&D) expenditures, less risky investments, but higher profitability. Using the 9/11 terrorist attacks and Sept. 2008 Lehman Brothers bankruptcy as natural experiments, we demonstrate that investment policies of Republican managers became more conservative following these exogenous uncertainty-increasing events. Furthermore, around chief executive officer (CEO) turnovers, including CEO deaths, firm leverage policy becomes more conservative when managerial conservatism increases.

We derive a macroeconomic asset pricing model in which the key factor is the opportunity cost of money. The model explains well the cross section of stock returns in addition to the excess market return. The interest rate factor is priced and seems to drive most of the explanatory power of the model. In this model, both value stocks and past long-term losers enjoy higher average (excess) returns because they have higher interest rate risk than growth/past winner stocks. The model significantly outperforms the nested models (capital asset pricing model (CAPM) and consumption CAPM (CCAPM)) and compares favorably with alternative macroeconomic models.

Investment managers are subject to personal and institutional norms that can constrain their investment choices. We conjecture that norm-constrained investors deviate from such norms only when they have compelling information, and we predict that deviating investments earn relatively high abnormal returns ex post. Consistent with our conjecture, we find that institutions averse to holding lottery-like stocks or sin stocks earn relatively high abnormal returns when they choose to hold such stocks. We find similar but weaker results for deviations from broader style categories. Overall, our evidence indicates that deviations from established institutional or social norms signal informed investing.

We study the informativeness of trades via discount and full-service retail brokers. We find that trades via full-service retail brokers are statistically and economically more informative than are trades via discount retail brokers. This finding holds in every year over the 12-year sample period and in various subsamples. We also find that past returns, volatility, and news announcements positively relate to the net volume of discount retail brokers, but these variables are unrelated to the net volume of full-service retail brokers. Our results suggest that broker type selection bias is an important consideration in studying individual investors’ trades.

We demonstrate improvements in predictive power when introducing spline functions to take account of highly nonlinear relationships between firm failure and leverage, earnings, and liquidity in a logistic bankruptcy model. Our results show that modeling excessive nonlinearities yields substantially improved bankruptcy predictions, on the order of 70%–90%, compared with a standard logistic model. The spline model provides several important and surprising insights into nonmonotonic bankruptcy relationships. We find that low-leveraged as well as highly profitable firms are riskier than those given by a standard model, possibly a manifestation of credit rationing and excess cash-flow volatility.

We extend the Fama-French (1992) model by considering growth option (as well as distress/leverage) variables in explaining the cross section of stock returns. We find that growth option variables, namely growth in capital investment and yet-unexercised growth options (GO), are significantly and negatively related to stock returns. Investors may be willing to accept lower average returns from growth stocks in exchange for a more favorable (positively skewed) risk-return profile. Book-to-market (BM) ratio seems to proxy for omitted distress/leverage variables. When these are explicitly accounted for, BM is not that significant. Our growth options variables have added explanatory power.

We show that firms with more illiquid real assets have a higher cost of capital. This effect is stronger when real illiquidity arises from lower within-industry acquisition activity. Real asset illiquidity increases the cost of capital more for firms that face more competition, have less access to external capital, or are closer to default, and for those facing negative demand shocks. The effect of real asset illiquidity is distinct from that of firms’ stock illiquidity or systematic liquidity risk. These results suggest that real asset illiquidity reduces firms’ operating flexibility and through this channel their cost of capital.

We survey theoretical and empirical research on antitakeover provisions, focusing on the relation between antitakeover provisions and shareholder value. We divide the empirical studies based upon the evidence that they provide: short-term event studies, studies on performance and policy changes around adopting antitakeover provisions or passing state antitakeover laws, studies on the impact of antitakeover provisions on takeovers, studies on the relation between antitakeover provisions and firm characteristics, and long-term studies on the relation between antitakeover provisions and firm performance or policies. We also discuss the place of antitakeover provisions in the current debate about “good governance” practices.