Knowledge that Transforms

Abstract Variables that in theory determine credit spreads have limited explanatory power in existing empirical work on corporate bond data. We investigate the linear relationship between theoretical determinants of default risk and default swap spreads. We find that estimated coefficients for a minimal set of theoretical determinants of default risk are consistent with theory and are significant statistically and economically. Volatility and leverage have substantial explanatory power in univariate and multivariate regressions. A principal component analysis of residuals and spreads indicates limited evidence for a residual common factor, confirming that the theoretical variables explain a significant amount of the variation in the data.

Abstract We read all news items that came out between 1996 and 2000 on 458 Internet initial public offerings (IPOs) and a matching sample of 458 non-Internet IPOs (a total of 171,488 news items) and classify each news item as good news, neutral news, or bad news. We first document that the media were more positive for Internet IPOs in the period of the dramatic rise in share prices and more negative for Internet IPOs in the period of the dramatic fall in share prices. We then document that media hype is unable to explain the Internet bubble: A 1,646% difference exists in returns between Internet stocks and non-Internet stocks from January 1, 1997, through March 24, 2000 (the market peak), and the media can explain only 2.9% of that.

Abstract Firms reduce leverage following credit rating downgrades. In the year following a downgrade, downgraded firms issue approximately 1.5%–2.0% less net debt relative to net equity as a percentage of assets compared to other firms. This relationship persists within an empirical model of target leverage behavior. The effect of a downgrade is larger at downgrades to a speculative grade rating and if commercial paper access is affected. In particular, firms downgraded to speculative are about twice as likely to reduce debt as other firms. Rating upgrades do not affect subsequent capital structure activity, suggesting that firms target minimum rating levels.

Abstract In this paper, we propose a nonparametric estimator of the short rate diffusion process using observations of a panel of yields. The proposed estimator can greatly reduce the bias of the nonparametric estimator proposed in Stanton (1997) that uses a single time series of short rate observations. Simulations confirm that the new method significantly attenuates the spurious nonlinearity of the drift function as documented in Chapman and Pearson (2000). We apply the method to estimate the U.S. short rate process using a panel of six Treasury yields. With 42 years’ daily observations of the panel of yields, the proposed drift function estimator achieves the same efficiency as the Stanton (1997) estimator based on 145 years of daily short rate observations. Finally, we show that the proposed estimator also has significant economic implications on the pricing of bonds and interest rate derivatives.

Abstract We develop a measure (based on the relative slopes of the demand and supply schedules) quantifying the asymmetric presence of liquidity traders in the market: a steeper slope of the demand (supply) schedule indicates a concentration of liquidity traders on the demand (supply) side. Using the opening session of the Tel Aviv Stock Exchange, we demonstrate the predictive power of our measure. Consistent with theory, we find that the concentration of liquidity traders on the demand (supply) side is negatively (positively) correlated with future returns. We find that liquidity traders are likely to arrive at the market together (commonality).

Abstract We use a unique database on ownership stakes of equity mutual fund directors to analyze whether the directors’ incentive structure is related to fund performance. Ownership of both independent and nonindependent directors plays an economically and statistically significant role. Funds in which directors have low ownership, or “skin in the game,” significantly underperform. We posit two economic mechanisms to explain this relation. First, lack of ownership could indicate a director’s lack of alignment with fund shareholder interests. Second, directors may have superior private information on future performance. We find evidence in support of the first and against the second mechanism.

Abstract Analysis of a worldwide sample of sudden deaths of politicians reveals a market-adjusted 1.7% decline in the value of companies headquartered in the politician's hometown. The decline in value is followed by a drop in the rate of growth in sales and access to credit. Our results are particularly pronounced for family firms, firms with high growth prospects, firms in industries over which the politician has jurisdiction, and firms headquartered in highly corrupt countries.

Abstract In this paper, we examine how stock option usage affects total corporate payout. Using fixed-effects panel data estimators on various samples of ExecuComp firms from 1993 to 2005, we find the higher the executive stock options, the lower the total payout, ceteris paribus. We also find some evidence that firms increase payouts through repurchases in order to offset earnings per share dilution that occurs due to usage of executive and non-executive stock options. However, incentives from not having dividend protection for options appear to dominate those from antidilution, resulting in lower total payout for firms with higher options usage.

Abstract We examine the relationship between allegations of corporate misconduct and changes in profitability and risk of the alleged offender. Profitability is measured as reported earnings and analysts’ earnings forecasts. Risk is measured as stock return volatility and concordance among analysts’ forecasts. Decreases in earnings and increases in risk are found to accompany allegations of misconduct, and although the results are somewhat sensitive to the earnings and risk metrics used, the changes are found to be consistently greater for related-party offenses. The importance of reputational penalties is underscored by analysis of the association between allegation-related changes in firm value and changes in earnings and risk.

Abstract This study uses a stochastic frontier approach to evaluate firm efficiency. The resulting efficiency score, based on firm characteristics, is the input for performance evaluation. The portfolio composed of highly efficient firms significantly underperforms the portfolio composed of inefficient firms even after adjustment for firm characteristics and risk factors, suggesting a required premium for the inefficient firms. The difference in performance between the two portfolios remains for at least five years after the portfolio formation year. In addition, firm efficiency exhibits significant explanatory power for average equity returns in cross-sectional analysis.