Abstract We study the fund-raising strategy of an entrepreneur when investors have private information about his project’s profitability. The entrepreneur cares about monetary profits and about the probability to obtain financing. If he contacts both venture capitalists (VCs) simultaneously, he obtains high monetary profits. If he commits to a period of exclusive negotiation with one VC, he increases the probability to obtain financing but deal terms deteriorate. The optimal negotiation strategy results from this tradeoff. We also solve for the equilibrium financial contracts and obtain implications for VCs’ portfolios and entrepreneurs’ deals.
Abstract We find weak governance is a primary reason investors react negatively to the announcement of seasoned equity offerings (SEOs). Using a difference-in-differences approach, we find investors worry about nonproductive use of SEO proceeds when external pressure for good governance lifts due to an external shock. Investors react negatively only when treated firms raise funds to increase capital investments. Market reaction is more negative when issuers have prior records of value-reducing acquisitions and weaker managerial wealth sensitivity to shareholder value. The magnitudes of these governance effects are surprisingly large, explaining most of the previously documented negative market reactions to primary SEOs.
Abstract Although foreign banks can act as catalysts for financial and economic development, their role remains controversial because they might displace local lending, thereby tightening firms’ overall access to credit. We study the economic channels through which domestic lending by foreign banks affects real economic activity in a large cross-section of developing and advanced countries. We find that foreign lending alleviates financial constraints and increases real growth net of the competitive reaction of local lenders. In addition to providing stable access to credit, foreign banks also mitigate the consequence of informational and legal obstacles to lending, especially in developing credit markets.
Abstract Examining the properties of stock returns has long been a central topic in finance. Most quantitative analyses conducted by academic researchers and practitioners focus only on the return distribution. However, the return distribution itself hardly helps to determine whether the price of a winner stock picked by using the momentum strategy reaches the level where the risk incurred from the falling of prices is imminent. Therefore, we construct an implied price risk index to quantify the downside risk of a stock and use it to manage the tail risk of the momentum strategy. The empirical results demonstrate that our modified strategy can not only achieve significant improvement on the overall performance but also substantially reduce the drastic losses suffered from the 2008 global recession. We also establish the connection between the implied price risk index and the cross-sectional return differences based on the well-known three factors, the market beta, the firm size, and the book-to-market ratio.
Abstract This article shows that publicly available data on buyout fund returns are sufficient to replicate the recent findings derived from superior but proprietary datasets. The average buyout fund outperforms the S&P 500. However, this study shows that buyout funds mainly invest in small and value companies; and the average buyout fund return is similar to that of small-cap indices and that of the oldest small-cap passive mutual fund (“DFA micro-cap”). If the benchmark is changed to small and value indices, and is levered up, the average buyout fund underperforms by 3.1% p.a.
Abstract Style-based management of the foreign exchange (FX) component of international investments with carry trade, FX momentum, and FX value strategies provides economically large and significant diversification benefits. These speculative benefits go beyond the hedging benefits of FX risk documented in the earlier literature. Our results hold after transaction costs and are confirmed in an extensive out-of-sample experiment mimicking investor decisions in real time. Adding a composite FX style portfolio to diversified allocations of global bonds and stocks leads to a 64% increase in the out-of-sample Sharpe ratio from 0.64 to 1.05, without adverse impact on other portfolio characteristics such as skewness.
Abstract This article presents an intensity-based model of euro-area sovereign spreads. To identify liquidity-pricing effects, we exploit the information contained in the spreads between bonds issued by a German agency (KfW) and their sovereign counterparts. KfW’s liabilities being guaranteed by the German government, these spreads are essentially liquidity-driven. Liquidity effects are found to account for a sizeable share of spreads’ fluctuations. After having filtered risk premiums out of the spreads, we estimate the physical default probabilities of eleven countries. Physical probabilities of default are lower than risk-neutral ones, consistently with the existence of a nondiversifiable euro-area sovereign credit risk.
Abstract We investigate patterns of abnormal stock performance around insider trades on the Dutch market. Listed firms in the Netherlands have a long tradition of limiting shareholders’ rights. Using a change in corporate governance regulations as a natural experiment, we show that governance rules have a causal effect on insider trading profits. Our results imply that insider transactions are more profitable at firms where shareholder rights are not restricted by antishareholder mechanisms. These findings are inconsistent with internal monitoring of insider trading. Rather, we explain this empirical pattern by imperfect substitution between insider trading profits and other private benefits of control.
Abstract We ask whether public financial aid reduces small businesses’ credit constraints. To answer the question, we analyze a policy of bank loans made from subsidized funds. Extensions of this large program are plausibly exogenous and help identify its effects. Using firm-level data, we find that the program substantially increases debt financing without substitution between subsidized and unsubsidized finance. Returns on subsidized debt are significantly above its market cost, with no subsequent surge in default risk. We interpret this as evidence that targeted firms are credit-constrained and underline the implied welfare differences between upfront financial aid and public guarantees.
Abstract Benchmarking, pay for luck, and the large compensation packages given to CEOs in recent years are three major controversial compensation practices. We examine the extent to which variation in the market for CEO talent explains these practices. We find that CEO compensation is benchmarked against other firms only in industries where CEO talent is not firm-specific, and that pay for luck is more prevalent there also. These findings are consistent with theories based on the market for CEO talent. However, CEO compensation levels do not depend on whether CEO talent is firm-specific, which seems inconsistent with the talent competition argument.