Knowledge that Transforms

Abstract This paper examines the relation between information differences across investors (i.e., information asymmetry) and the cost of capital and establishes that with perfect competition information asymmetry makes no difference. Instead, a firm’s cost of capital is governed solely by the average precision of investors’ information. With imperfect competition, however, information asymmetry affects the cost of capital even after controlling for investors’ average precision. In other words, the capital market’s degree of competition plays a critical role for the relation between information asymmetry and the cost of capital. This point is important to empirical research in finance and accounting.

Abstract We examine firms’ strategic incentives to engage in horizontal mergers. In a real options framework, we show that strategic considerations may explain abnormally high takeover activity during periods of positive and negative demand shocks. Importantly, this pattern emerges solely as a result of firms’ strategic interaction in output markets. We show that the U-shaped relation between the state of demand and the propensity of firms to merge, documented in past studies, is driven by horizontal mergers in industries that are: (1) relatively more concentrated, (2) characterized by relatively strong competitive interaction among firms, and (3) characterized by relatively low merger-related operating synergies and restructuring costs. The empirical evidence, based on parametric and semi-parametric regression analyses, is consistent with these predictions.

Abstract This paper shows that managers use the information they learn from the stock market when they decide on corporate cash savings. In particular, corporate savings are much more sensitive to stock price when the price contains more information that is new to managers. Moreover, the significant effect of stock price informativeness on the savings-to-price sensitivity is not due to market mispricings and remains even after controlling for various sources of public and managerial private information. Overall, the results highlight a new channel through which the stock market affects corporate decisions, which suggests that the stock market is not a sideshow.

Abstract Recent research has focused on the estimates of the speed of adjustment to target leverage as the indicators of the importance of dynamic trade-off behavior. We show that the observed corporate financing behavior and the resulting dynamics of corporate debt ratios are such that the speed of adjustment is not an economically meaningful measure of the importance of target debt ratios. We conclude that partial adjustment regressions that rely on the existence of a well-defined target debt ratio are ill-suited for quantifying the importance of dynamic trade-off behavior vis-a-vis alternative theories.

Abstract In this paper, the authors use monthly holdings to study timing ability. These data differ from holdings data used in previous studies in that the authors’ data have a higher frequency and include a full range of securities, not just traded equities. Using a one-index model, the authors find, as do two recent studies, that management appears to have positive and statistically significant timing ability. When a multiindex model is used, the authors show that timing decisions do not result in an increase in performance, whether timing is measured using conditional or unconditional sensitivities. The authors show that sector rotation decisions with respect to high-tech stocks are a major contribution to negative timing.

Abstract This paper shows that a New Year's gambling preference of individual investors impacts prices and returns of assets with lottery features. January call options, especially the out-of-the-money calls, have higher retail demand and are the most expensive and actively traded. Lottery-type stocks outperform their counterparts in January but tend to underperform in other months. Retail sentiment is more bullish in lottery-type stocks in January than in other months. Furthermore, lottery-type Chinese stocks outperform in the Chinese New Year's Month but not in January. This New Year effect provides new insights into the broad phenomena related to the January effect.

Abstract Stock market volatility clusters in time, appears fractionally integrated, carries a risk premium, and exhibits asymmetric leverage effects. At the same time, the volatility risk premium, defined by the difference between the risk-neutral and objective expectations of the volatility, features short memory. This paper develops the first internally consistent equilibrium-based explanation for all these empirical facts. Using newly available high-frequency intraday data for the S&P 500 and the VIX volatility index, the authors show that the qualitative implications from the new theoretical continuous-time model match remarkably well with the distinct shapes and patterns in the sample autocorrelations and dynamic cross-correlations actually observed in the data.

Abstract This paper uses style analysis to investigate whether Euro-zone equity returns are driven by country or industry effects over the 1990–2008 period. We find that before the introduction of the Euro, country effects dominate, while industry effects prevail after 1999. This reversal is driven mainly by the countries that were least integrated in the Economic and Monetary Union (EMU) and world markets in the early 1990s and for which the EMU convergence process led to rapid strengthening of linkages with the core Euro-zone. For markets with stronger economic linkages, industry effects dominate both before and after the introduction of the Euro.

Abstract This paper provides evidence that venture capital (VC) syndication creates value for entrepreneurial firms in two dimensions. First, VC syndication creates product market value for their portfolio firms. Specifically, VC syndicates invest significant amounts in younger firms, in earlier financing rounds, and in early stage firms. Further, VC syndicates nurture innovation of their portfolio firms and help them achieve better post-initial public offering operating performance. Second, VC syndication creates financial market value for their portfolio firms. Specifically, VC syndicate-backed firms are more likely to have a successful exit, enjoy a lower initial public offering (IPO) underpricing, and receive a higher IPO market valuation. The findings are robust to a variety of alternative syndication measures, subsamples, econometric models, and controlling for endogeneity in VC syndication.

Abstract Prices observed in the European sovereign credit default swap (CDS) market have severely increased since the beginning of the financial crisis. We document that the state of a country’s financial system and, since the beginning of the crisis, also the state of the world financial system have strong explanatory power for the behavior of CDS spreads, and the magnitude of this impact depends on the importance of a country’s financial system pre-crisis. Furthermore, Economic and Monetary Union member countries exhibit higher sensitivities to the health of the financial system. Our results suggest the presence of a private-to-public risk transfer through which market participants incorporate their expectations about financial industry bailouts.