Knowledge that Transforms

Abstract We investigate performance effects for China's listed firms when there is a change in the controlling shareholder. These changes include ownership transfers from one state entity to another state entity and from a state entity to a private entity. We find positive performance effects when control is passed to a private entity. In contrast, when the transfer is made to another branch of the state, there is little change in performance. The stock market responds positively to a change in control, with the largest effect observed for private transfers. Our results suggest the Chinese government should continue to sell down its share ownership in listed firms as the transfer of control to private owners enhances corporate profitability and efficiency. Moreover, to help ownership reform, China should encourage an active market for corporate control.

Abstract This paper examines the cross-sectional relation between idiosyncratic volatility and expected stock returns. The results indicate that i) the data frequency used to estimate idiosyncratic volatility, ii) the weighting scheme used to compute average portfolio returns, iii) the breakpoints utilized to sort stocks into quintile portfolios, and iv) using a screen for size, price, and liquidity play critical roles in determining the existence and significance of a relation between idiosyncratic risk and the cross section of expected returns. Portfoliolevel analyses based on two different measures of idiosyncratic volatility (estimated using daily and monthly data), three weighting schemes (value-weighted, equal-weighted, inverse volatility-weighted), three breakpoints (CRSP, NYSE, equal market share), and two different samples (NYSE/AMEX/NASDAQ and NYSE) indicate that no robustly significant relation exists between idiosyncratic volatility and expected returns.

Abstract Standard tests of portfolio efficiency neglect the existence of illiquid wealth. The most important illiquid asset in household portfolios is housing: if housing stock adjustments are infrequent, optimal portfolios in periods of no adjustment are affected by housing price risk through a hedge term and tests for portfolio efficiency of financial assets must be run conditionally upon housing wealth. We use Italian household portfolio data and time series on financial assets and housing stock returns to assess whether actual portfolios are efficient. We find that housing wealth plays a key role in determining whether portfolios chosen by homeowners are efficient.

Abstract This article incorporates well-documented managerial traits into a tradeoff model of capital structure to study their impact on corporate financial policy and firm value. Optimistic and/or overconfident managers choose higher debt levels and issue new debt more often but need not follow a pecking order. The model also surprisingly uncovers that these managerial traits can play a positive role. Biased managers' higher debt levels restrain them from diverting funds, which increases firm value by reducing this manager-shareholder conflict. Although higher debt levels delay investment, mildly biased managers' investment decisions can increase firm value by reducing this bondholder-shareholder conflict.

Abstract In textbook models of exchange rate determination, the news contained in public information announcements is directly impounded into prices with there being no role for trading in this process of information assimilation. This paper directly tests this theoretical result using transaction level exchange rate return and trading data and a sample of scheduled macroeconomic announcements. The main result of the paper is that even information that is publicly and simultaneously released to all market participants is partially impounded into prices via the key micro level price determinant—order flow. We quantify the role that order flow plays and find that approximately one third of price-relevant information is incorporated via the trading process.

Abstract The paper investigates how firms operating in capital market-oriented economies (the U.K. and the U.S.) and bank-oriented economies (France, Germany, and Japan) determine their capital structure. Using panel data and a two-step system-GMM procedure, the paper finds that the leverage ratio is positively affected by the tangibility of assets and the size of the firm, but declines with an increase in firm profitability, growth opportunities, and share price performance in both types of economies. The leverage ratio is also affected by the market conditions in which the firm operates. The degree and effectiveness of these determinants are dependent on the country's legal and financial traditions. The results also confirm that firms have target leverage ratioswith French firms being the fastest in adjusting their capital structure toward their target level and Japanese firms the slowest. Overall, the capital structure of a firm is heavily influenced by the economic environment and its institutions, corporate governance practices, tax systems, the borrower-lender relation, exposure to capital markets, and the level of investor protection in the country in which the firm operates.

Abstract Fund managers' bias toward geographically proximate securities is a well-researched phenomenon, yet the origins of managers' location choices have received little empirical scrutiny. This paper traces the employment and geographic heritage of 358 entrepreneurial fund managers and analyzes the determinants of where they locate their firms and stock selections. The evidence suggests that start-ups tend to be based close to the origins of their founders and in regions with more investment management firms, banking establishments, and large institutional money managers. New money managers show a strong local bias in their equity holdings, three times the levels previously documented for mutual funds. The propensity to invest closer to home correlates strongly with the presence of sub-advisory opportunities from institutional investors in the vicinity. While home bias levels between managers who relocate with their start-ups and the rest of the entrepreneurs are similar, preferences for stocks that were formally local persist.

Abstract We find that local analyst recommendations are systematically more optimistic than foreign analyst recommendations in emerging markets. The effects of this novel “home bias” among local analysts overwhelm any information asymmetry between foreign and local analysts. Consequently, local analyst upgrades underperform foreign analyst upgrades, while local analyst downgrades outperform foreign analyst downgrades. Neither foreign investors, local institutions, nor retail investors appear to be fully cognizant of this bias. Trade reactions suggest that foreign investors overestimate the bias in foreign analyst recommendations while local institutions underestimate the bias in local analyst recommendations. These results are pervasive across countries, time periods, and stock groupings, and can be traced to investment banking pressure.

Abstract This paper examines how industry structure affects corporate investment patterns. Real options theory shows that deferring irreversible investment in the face of uncertainty is valuable. Theory also shows that the value of waiting to invest falls if investment opportunities are contestable. Consistent with these theories, we find that firms in monopolistic industries exhibit lower investment-q; sensitivity and are slower to invest than firms in competitive industries. However, we find that investment-q; sensitivity and investment speed are highest in oligopolistic industries, suggesting that the value of investing strategically can outweigh the value of waiting. Indeed, oligopolistic industries experience less entry and more exit than other industries.

Abstract This paper tests whether information advantages help explain why some individual investors concentrate their stock portfolios in a few stocks. Stock investments made by households that choose to concentrate their brokerage accounts in a few stocks outperform those made by households with more diversified accounts (especially among those with large portfolios). Excess returns of concentrated relative to diversified portfolios are stronger for stocks not included in the S&P 500 index and local stocks, potentially reflecting concentracted investors' successful exploitation of information asymmetries. Controlling for households' average investment abilities, their trades and holdings perform better when their portfolios include fewer stocks.