Knowledge that Transforms

Financial economists seem to believe that takeovers are partly motivated by the desire to improve poorly performing firms. However, prior empirical evidence in support of this inefficient management hypothesis is rather weak. We provide a detailed re-examination of this hypothesis in a large scale empirical study. We find little evidence that target firms were performing poorly before acquisition, using either operating or stock returns. This result holds both for the sample as a whole and for subsamples of takeovers that are more likely to be disciplinary. We conclude that the conventional view that targets perform poorly is not supported by the data.

Estimating implied volatility by inverting the Black-Scholes formula is subject to considerable error when option characteristics are observed with plausible errors. Especially for options away from the money, large changes in volatility produce small changes in option prices. Conversely, small errors in option prices and other option characteristics produce large errors in implied volatilities. In the presence of small measurement errors, unobserved truncation of option prices that violate lower bounds for absence of arbitrage can also lead to systematic volatility smiles. The paper proposes feasible GLS estimators that reduce the noise and bias in implied volatility estimates.

We examine the effect of financial advisor reputation on wealth gains in corporate takeovers. In view of the adversarial nature of a takeover, we construct a measure of the relative reputation of the advisor. We document that the absolute wealth gain as well as the share of the total takeover wealth gain accruing to the bidder (target) increases (decreases) as the reputation of the bidder's advisor increases relative to that of the target. We also find that the total wealth created in the takeover is positively related to the reputation of bidder and target advisors. While bidder advisor reputation is positively related to the probability of bid success in our sample, we also present some evidence to suggest that bidders with better advisors are more likely to withdraw from potentially value-destroying takeovers.

Larry Fauver, Joel Houston, Andy Naranjo, Capital Market Development, International Integration, Legal Systems, and the Value of Corporate Diversification: A Cross-Country Analysis, The Journal of Financial and Quantitative Analysis, Vol. 38, No. 1 (Mar., 2003), pp. 135-157

Benjamin C. Esty, William L. Megginson, Creditor Rights, Enforcement, and Debt Ownership Structure: Evidence from the Global Syndicated Loan Market, The Journal of Financial and Quantitative Analysis, Vol. 38, No. 1 (Mar., 2003), pp. 37-59

This paper examines the performance of momentum trading strategies in foreign exchange markets. We find the well-documented profitability of momentum strategies during the 1970s and the 1980s has continued throughout the 1990s. Our approach and findings are insensitive to the specification of the trading rule and the base currency for analysis. Finally, we show that the performance is not due to a time-varying risk premium but rather depends on the underlying autocorrelation structure of the currency returns. In sum, the results lend further support to prior momentum studies on equities. The profitability to momentum-based strategies holds for currencies as well.

I test whether corporate governance is ineffective in emerging markets by estimating the link between CEO turnover and firm performance for over 1,200 firms in eight emerging markets.I find two main results.First, CEOs of emerging market firms are more likely to lose their jobs when their firm's performance is poor, suggesting that corporate governance is not ineffective in emerging markets.Second, for the subset of firms with a large domestic shareholder, there is no link between CEO turnover and firm performance.For this subset of emerging market firms, corporate governance appears to be ineffective.

In most countries, many of the largest corporations are controlled by large shareholders.We show that, under reasonable assumptions, this stylized fact implies that portfolio holdings of U.S. investors should exhibit a home bias in equilibrium.We construct an estimate of the world portfolio of shares available to investors who are not controlling shareholders.This available world portfolio differs sharply from the world market portfolio.In regressions explaining the portfolio weights of U.S. investors, the world portfolio of available shares has a positive significant coefficient but the world market portfolio has no additional explanatory power.This result holds when we control for country characteristics.

Conservative financial policies are often criticized as serving the interests of managers rather than the interests of stockholders. We test this argument by examining the operating performance and other characteristics of firms that for a five-year period held more than one-fourth of their assets in cash and cash equivalents. Following the five-year period, operating performance of high cash firms is comparable to or greater than the performance of firms matched by size and industry or by a measure of proclivity to hold substantial cash. In addition, proxies for managerial incentive problems, such as ownership and board characteristics, are not unusual and do not explain differences in operating performance among high cash firms. We find that high cash holdings are accompanied by greater investment, particularly R&D expenditures, and by greater growth in assets. For firms that persistently hold large cash reserves, we conclude that such policies support investment without hindering corporate performance.

*The author thanks the New York Stock Exchange for the provision of financial support and data for this study, and the Nasdaq Stock Market for the provision of data. The paper was improved by the