In this paper we investigate the claim that hedge funds offer investors a superior risk-return trade-off. We do so using a continuous time version of Dybvig's (1988a, 1988b) payoff distribution pricing model. The evaluation model, which does not require any assumptions with regard to the return distribution of the funds in question, is applied to the monthly returns of 77 hedge funds and 13 hedge fund indices over the period May 1990 - April 2000. The results show that as a stand-alone investment hedge funds do not offer a superior risk-return profile. We find 12 indices and 72 individual funds to be inefficient, with the average efficiency loss amounting to 2.76% per annum for indices and 6.42% for individual funds. Part of the inefficiency cost of individual funds can be diversified away. Funds of funds, however, are not the preferred vehicle for this as their performance appears to suffer badly from their double fee structure. Looking at hedge funds in a portfolio context results in a marked improvement in the evaluation outcomes. Seven of the 12 hedge fund indices and 58 of the 72 individual funds classified as inefficient on a stand-alone basis are capable of producing an efficient payoff profile when mixed with the S&P 500. The best results are obtained when 10-20% of the portfolio value is invested in hedge funds.

This study examines the linkage among the initial hypothesis set, the information search, and decision performance in performing analytical procedures. We manipulated the quality of the initial hypothesis set and the quality of the information search to investigate the extent to which deficiencies (or benefits) in either process can be remedied (or negated) by the other phase. The hypothesis set manipulation entailed inheriting a correct hypothesis set, inheriting an incorrect hypothesis set, or generating a hypothesis set. The information search was manipulated by providing a balanced evidence set to auditors (i.e., evidence on a range of likely causes including the actual cause ‐ analogous to a standard audit program) or asking them to conduct their own search. One hundred and two auditors participated in the study. The results show that auditors who inherit a correct hypothesis set and receive balanced evidence performed better than those who inherit a correct hypothesis set and did their own search, as well as those who inherited an incorrect hypothesis set and were provided a balanced evidence set. The former performance difference arose because auditors who conducted their own search were found to do repeated testing of non‐errors and truncated their search. This suggests that having a correct hypothesis set does not ensure that a balanced testing strategy is employed, which, in turn, diminishes part of the presumed benefits of a correct hypothesis set. The latter performance difference was attributable to auditors' failure to generate new hypotheses when they received evidence about a hypothesis that was not in the current hypothesis set. This demonstrates that balanced evidence does not fully compensate for having an initial incorrect hypothesis set. These findings suggest the need for firm training and/or decision aids to facilitate both a balanced information search and an iterative hypothesis generation process.

This paper investigates whether and how individual managers affect corporate behavior and performance. We construct a manager-firm matched panel data set which enables us to track the top managers across different firms over time. We find that manager fixed effects matter for a wide range of corporate decisions. A significant extent of the heterogeneity in investment, financial, and organizational practices of firms can be explained by the presence of manager fixed effects. We identify specific patterns in managerial decision-making that appear to indicate general differences in "style" across managers. Moreover, we show that management style is significantly related to manager fixed effects in performance and that managers with higher performance fixed effects receive higher compensation and are more likely to be found in better governed firms. In a final step, we tie back these findings to observable managerial characteristics. We find that executives from earlier birth cohorts appear on average to be more conservative; on the other hand, managers who hold an MBA degree seem to follow on average more aggressive strategies.

This paper examines whether mandatory auctions promote the efficient restructuring of distressed firms relative to a reorganization-based bankruptcy system such as Chapter 11. Under a mandatory auction system, aggressive bidding by a coalition of incumbent management and pre-bankruptcy creditors may deter outside bidders, may result in the coalition paying more than its valuation to acquire the firm, and may result in assets remaining in a lower value use. In a reorganization-based bankruptcy system, management's voluntary choice to seek an auction conveys information about the coalition's valuation, which facilitates competition. Our model shows that a reorganization-based bankruptcy system that encourages, but does not mandate auctions, can actually increase the likelihood that an outside bidder enters and the assets of the bankrupt firm are redeployed.

This paper extends the literature on executive compensation by developing and testing a principal-agent model in the context of project selection. The model's focus on executive project selection decisions highlights the multidimensional nature of executive choices that affect the value of the firm. An executive not only makes an effort choice that determines the quality of information on which to base a decision but also sets the decision criteria for selecting projects. A project selection framework is also shown to introduce endogenous uncertainty into compensation that can influence the executive's effort choice. Using an extensive data set, our empirical work supports the main hypotheses of the model, including the significance of executive rank in determining the extent of use of incentive pay in general and equity-based incentive pay in particular.

Using microdata for 22 countries over the 198594 period, we find that more compressed male wage structures and lower female net supply are both associated with a lower gender pay gap, with an especially large effect for wage structures. Reduced-form specifications indicate that the extent of collective bargaining coverage is also significantly negatively related to the gender pay gap. Together, the wage compression and collective bargaining results suggest that the high wage floors that are associated with highly centralized, unionized wage setting raise women's relative pay, since women are at the bottom of the wage distribution in each country.

We analyze the use of alternative trading systems in a large sample of institutional orders and the trades that constitute these orders. Proprietary data allow us to distinguish between orders and trades filled by day and after-hours crossing systems, electronic communication networks (ECNs), and traditional brokers. Controlling for variation in order and security characteristics, as well as endogeneity in the choice of trading venue, we find that realized execution costs are generally lower on alternative trading systems. Order handling rules and tick size changes implemented in 1997 appear to have reduced the cost advantage of trading on ECNs.

Prior research on justification has typically focused on the differences in judgments between auditors required, or not required, to justify their decisions. However, justification memos can be prepared using different approaches. In this study we examine the impact of using three justification memos: supporting, balanced, and component. Using a comprehensive control environment case based on an actual client that experienced fraud, we find that the justification memo used can affect the judgments of auditors preparing the memos as well as the judgments of auditors who review their work. Specifically, the results indicate that auditors using an unrestricted component memo, who were required to write memos for components of their task by providing important positive and negative evidence, thought that the firm's control environment was more likely to prevent fraud as compared with the supporting and balanced memo groups. Additional analyses suggest that the reason for this result is that an unrestricted component memo focuses auditors’ attention on a larger percentage of positive control environment characteristics when a firm's underlying evidence set is mostly positive. This may be problematic because firms can have more positive than negative control environment characteristics, even when fraud is present.

We examine theories of leverage and debt maturity, focusing on the impact of firms' investment opportunity sets and regulatory environments in determining these policies. Using results on strategic complementarities, we identify sufficient conditions for the theory to have testable implications for reduced-form and structural-equation regression coefficients. Obtaining testable implications for structural equations requires less from the theory but more from the data than the reduced-form specification because it requires an instrumental-variables approach. We examine this trade-off between theory and statistical methods and provide tests using two decades of data for over 5000 industrial firms.