Knowledge that Transforms

[We study the relations between management contract terms and performance in private equity using new data for 837 funds from 1984–2010. We find no evidence that higher fees or lower managerial ownership are associated with lower net-of-fee performance. Nevertheless, compensation rises and shifts to performance-insensitive components during fundraising booms. Further, the behavior of distributions around contractual fee triggers is consistent with an underlying agency conflict between investors and fund managers. Our evidence suggests that managers with higher fees deliver higher gross performance, and highlights that agency costs are an inevitable consequence of the information frictions endemic to agency relationships.]

[We find that the empirical volatilities of corporate bond and CDS returns are higher than implied by equity return volatilities and the Merton model. This excess volatility may arise because structural models inadequately capture either fundamentals or illiquidity. Our evidence supports the latter explanation. We find little relation between excess volatility and measures of firm fundamentals and the volatility of firm fundamentals but some relation with variables proxying for time-varying illiquidity. Consistent with an illiquidity explanation, firm-level bond portfolio returns, which average out bond-specific effects, significantly decrease excess volatility.]

[Institutional investors exhibit substantial home-state bias in private equity. This effect is particularly pronounced for public pension funds, where overweighting amounts to 9.8% of aggregate private-equity investments and 16.5% for the average limited partner. Public pension funds' in-state investments achieve performance that is lower by two to four percentage points than both their own similar out-of-state investments and similar investments in their state by out-of-state investors. Overweighting in home-state investments by public pension funds is greater in venture capital and real estate than in buyout funds. States with political climates characterized by more self-dealing invest a larger share of their portfolio in local investments, although a given local investment performs only as poorly in these states as in other states. Relative to the performance of the rest of the private equity universe, overweighting and underperformance in local investments reduce public pension fund resources by $1.2 billion per year.]

[We develop a parsimonious model in which frictions in the labor market may turn small, continuous labor productivity declines into large drops in employment, endogenously causing disasters. Assuming one state variable and CRRA agents, we solve for prices in closed form, calibrate the model using labor market data, and show that this simple setting captures the high, countercyclical volatility and equity premium observed in the United States. Moreover, returns in our model are conditionally predicted by dividend yields. Finally, as in the data, in our setting the disasters are larger when the capital's share of income is higher.]

[We show that stock prices are more accurate when short sellers are more active. First, in a large panel of NYSE-listed stocks, intraday informational efficiency of prices improves with greater shorting flow. Second, at monthly and annual horizons, more shorting flow accelerates the incorporation of public information into prices. Third, greater shorting flow reduces post-earnings-announcement drift for negative earnings surprises. Fourth, short sellers change their trading around extreme return events in a way that aids price discovery and reduces divergence from fundamental values. These results are robust to various econometric specifications, and their magnitude is economically meaningful.]