Limited Managerial Attention and Corporate Aging

Limited Managerial Attention and Corporate Aging

Claudio Loderer, René Stulz, Urs Waelchli

NBER Working Paper No. 19428
Issued in September 2013
As firms have more assets in place, more of management’s limited attention is focused on managing assets in place rather than developing new growth options. Consequently, as firms grow older, they have fewer growth options and a lower ability to generate new growth options. This simple theory predicts that Tobin’s q falls with age. Further, competition in the product market is expected to slow down the decrease in Tobin’s q because it forces firms to look for alternative sources of rents. Similarly, greater competition in the labor market reduces the decrease in Tobin’s q with age because old firms are in a better position to hire employees that can help with innovation. In contrast, competition in the market for corporate control should accelerate the decline because it forces management to focus more on managing assets in place whose performance is more directly observable than on developing growth options where results may not be observable for some time. We find strong support for these predictions in tests using exogenous variation in competition.

What Makes the Bonding Stick? A Natural Experiment Involving the U.S. Supreme Court and Cross-Listed Firms

What Makes the Bonding Stick? A Natural Experiment Involving the U.S. Supreme Court and Cross-Listed Firms

Amir N. Licht Interdisciplinary Center (IDC) Herzliyah – Radzyner School of Law; European Corporate Governance Institute (ECGI)

Christopher Poliquin Harvard Business School

Jordan I. Siegel Harvard Business School

Xi Li Hong Kong University of Science & Technology

August 27, 2013
Harvard Business School Strategy Unit Working Paper No. 11-072 

Abstract:      
On March 29, 2010, the U.S. Supreme Court signaled its intention to geographically limit the reach of the U.S. securities antifraud regime and thus differentially exclude U.S.-listed foreign firms from the ambit of formal U.S. antifraud enforcement. We use this legal surprise as a natural experiment to test the legal bonding hypothesis. This event nonetheless was met with positive or indifferent market reactions based on matched samples, Brown-Warner, and portfolio analyses. These results challenge the value of at least the U.S. civil liability regime, as currently designed, as a legal bonding mechanism in such firms.

More than Just Contrarians: Insider Trading in Glamour and Value Firms

More than Just Contrarians: Insider Trading in Glamour and Value Firms

Alan Gregory University of Exeter – Xfi Centre; University of Exeter Business School

Rajesh Tharyan University of Exeter Business School

Ian Tonks University of Bath School of Management

September 2013
European Financial Management, Vol. 19, Issue 4, pp. 747-774, 2013

Abstract: 
This study examines the patterns of, and long‐run returns to, directors’ (insiders’) trades along the value‐glamour continuum in all stocks listed on the main London Stock Exchange and analyses what these directors’ trades add to a naïve value‐glamour strategy. We consider alternative definitions of value in defining trades and in the construction of our benchmark portfolios so that directors’ trades are evaluated net of any value‐glamour effect, variously defined. We find that directors consistently trade in a contrarian fashion, buying more value stocks and selling more glamour stocks, with purchases following price falls and sales following price rises. Directors’ buy signals in value stocks generate significant positive abnormal returns while the sell signals in glamour stocks generate smaller and generally insignificant negative returns. In contrast to the results from US studies, we find that the positive abnormal returns in value stocks persist for up to two‐years after the initial directors’ trading signal. Abnormal returns are particularly concentrated in smaller value stocks, and are robust to alternative definitions of value.

Equity Vesting and Managerial Myopia

Equity Vesting and Managerial Myopia

Alex Edmans London Business School – Institute of Finance and Accounting; University of Pennsylvania – The Wharton School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Vivian W. Fang University of Minnesota – Twin Cities – Department of Accounting

Katharina Lewellen Dartmouth College – Tuck School of Business

September 2013
NBER Working Paper No. w19407

Abstract: 
This paper links the impending vesting of CEO equity to reductions in real investment. Existing studies measure the manager’s short-term concerns using the sensitivity of his equity to the stock price. However, in myopia theories, the driver of short-termism is not the magnitude of incentives but their horizon. We use recent changes in compensation disclosure to introduce a new empirical measure that is tightly linked to theory – the sensitivity of equity vesting over the upcoming year. This sensitivity is determined by equity grants made several years prior, and thus unlikely to be driven by current investment opportunities. An interquartile increase is associated with a decline of 0.11% in the growth of R&D (scaled by total assets), 37% of the average R&D growth rate. Similar results hold when including advertising and capital expenditure. Newly-vesting equity increases the likelihood of meeting or beating analyst earnings forecasts by a narrow margin. However, the market’s reaction to doing so is lower, suggesting that it recognizes CEOs’ myopic incentives.

Beyond Q: Investment Without Asset Prices

Beyond Q: Investment Without Asset Prices

Joao F. Gomes The Wharton School

Vito Gala London Business School

July 22, 2013
The Wharton School Research Paper No. 41

Abstract: 
Empirical corporate finance studies often rely on measures of Tobin’s Q to control for “fundamental” determinants of investment. However, Tobin’s Q is a good summary of investment behavior only under very stringent conditions and it is far better to instead use the underlying state variables directly. In this paper we show that under very general assumptions about the nature of technology and markets, these state variables are easily measurable and greatly improve the empirical fit of investment models. Moreover even a general first or second order polynomial that does not rely on additional details about the nature of the investment problem provides a better overall fit and accounts for a larger fraction of the total variation in corporate investment than standard Q measures.

Corporate Divestitures and Family Control

Corporate Divestitures and Family Control

Emilie R. Feldman University of Pennsylvania – The Wharton School

Raphael H. Amit University of Pennsylvania – Management Department

Belen Villalonga New York University (NYU) – Leonard N. Stern School of Business

August 5, 2013

Abstract: 
This paper investigates the propensity of family firms to undertake divestitures and the performance consequences of these transactions, drawing on behavioral and agency theory. Using hand-collected data on a sample of over 30,000 firm-year observations, we find that family firms are less likely than their non-family counterparts to undertake divestitures, especially when these companies are managed by family rather than non-family CEOs. We also show that family firms are less likely than non-family firms to divest unrelated businesses, though there is no difference in the relative propensities of these two types of companies to undertake related divestitures. However, the divestitures undertaken by family firms, particularly those run by family-CEOs, are associated with significantly higher post-divestiture performance than those undertaken by non-family firms. Taken together, these findings contribute to research on corporate strategy and family firms by showing that owners’ and managers’ identities help explain why divestitures are underutilized despite the value they create.

Ball and Brown (1968): A Retrospective

Ball and Brown (1968): A Retrospective

Ray Ball University of Chicago

Philip R. Brown University of Western Australia – Department of Accounting and Finance; University of New South Wales – Australian School of Business; Lancaster University – Department of Accounting and Finance; Financial Research Network (FIRN)

July 31, 2013
FIRN Research Paper

Abstract: 
This essay provides a retrospective view on our co-authored paper, Ball and Brown (1968). The retrospective was commissioned by Gregory Waymire, then President of the American Accounting Association. It describes how we both came to be PhD students at the University of Chicago and set about researching the relation between earnings and share prices. It outlines the background against which we conducted the research, including the largely a priori accounting research literature at the time and the electric atmosphere and radical new ideas then in full bloom at Chicago. We describe some of the principal research choices we made, and their strengths and weaknesses. We also describe the reception our research received and how the related literature subsequently unfolded.

How Do CEOs See Their Role? Management Philosophy and Styles in Family and Non-Family Firms

How Do CEOs See Their Role? Management Philosophy and Styles in Family and Non-Family Firms

William Mullins Massachusetts Institute of Technology (MIT) – Sloan School of Management

Antoinette Schoar Massachusetts Institute of Technology (MIT) – Sloan School of Management; National Bureau of Economic Research (NBER)

September 2013
NBER Working Paper No. w19395

Abstract: 
Using a survey of 800 CEOs in 22 emerging economies we show that CEOs’ management styles and philosophy vary with the control rights and involvement of the owning family and founder: CEOs of firms with greater family involvement have more hierarchical management, and feel more accountable to stakeholders such as employees and banks than they do to shareholders. They also see their role as maintaining the status quo rather than bringing about change. In contrast, professional CEOs of non-family firms display a more textbook approach of shareholder-value-maximization. Finally, we find a continuum of leadership arrangements in how intensively family members are involved in management.

Predicting Financial Markets with Google Trends and Not so Random Keywords

Predicting Financial Markets with Google Trends and Not so Random Keywords

Damien Challet Ecole Centrale Paris – Laboratory of Mathematics Applied to Systems

Ahmed Bel Hadj Ayed Ecole Centrale Paris – Laboratory of Mathematics Applied to Systems

August 14, 2013

Abstract: 
We check the claims that data from Google Trends contain enough data to predict future financial index returns. We first discuss the many subtle (and less subtle) biases that may affect the back-test of a trading strategy, particularly when based on such data. Expectedly, the choice of keywords is crucial: by using an industry-grade back-testing system, we verify that random finance-related keywords do not to contain more exploitable predictive information than random keywords related to illnesses, classic cars and arcade games. We however show that other keywords applied on suitable assets yield robustly profitable strategies, thereby confirming the intuition of Preis et al. (2013)

Acquisitions, Entry, and Innovation in Network Industries

Acquisitions, Entry, and Innovation in Network Industries

Pehr-Johan Norbäck Research Institute of Industrial Economics (IFN)

Lars Persson Research Institute of Industrial Economics (IFN); Centre for Economic Policy Research (CEPR)

Joacim Tag Research Institute of Industrial Economics (IFN)

August 2013
CEPR Discussion Paper No. DP9585

Abstract: 
In industries with network effects, incumbents’ installed bases create barriers to entry that discourage entrepreneurs from developing new innovations. Yet, entry is not the only commercialization route for entrepreneurs. We show that the option of selling to an incumbent increases innovation incentives for entrepreneurs when network effects are strong and incumbents compete to preemptively acquire innovations. We thus establish that network effects and installed bases do not necessarily restrict innovation incentives. We also show that network effects promote acquisitions over entry and that the entrepreneur has strong incentives to invest in the initial user base of the innovation.

Innovation as Determining Factor of Post-M&A Performance: The Case of Vietnam

Innovation as Determining Factor of Post-M&A Performance: The Case of Vietnam

Vietnamica THURSDAY, AUGUST 22, 2013 – 12:36

August 21, 2013 (Vietnamica) –In the 2005-2012 period, M&A transactions value in Vietnam was estimated around US$10 billion. Employing a categorical data sample of 212 M&A cases, Vuong, Napier and Samson (2013) investigate the relationship between determination of controlling an acquired firm’s capital, assets, and brand versus its capability of innovation and ex post performance. Empirical evidence suggests negative performance of post M&A operations is likely rooted in an overwhelming “resource acquiring” strategy and negligence on innovation factor – for instance, a human resource, especially corporate leaders, willing and able to make creativity. Indeed, many sellers consider M&A an exit or even an end of their entrepreneurial endeavors (Vuong and Tran, 2009; Vuong, Tran, and Nguyen, 2010). In a post M&A period, some enjoy comfortable lives of wealthy retired businesspeople while others start new venture of being capitalist.  Read more of this post

CEO Investment Cycles

CEO Investment Cycles

Yihui Pan University of Utah – Department of Finance

Tracy Yue Wang University of Minnesota – Twin Cities – Carlson School of Management

Michael S. Weisbach Ohio State University (OSU) – Department of Finance; National Bureau of Economic Research (NBER)

August 2013
NBER Working Paper No. w19330

Abstract: 
This paper documents the existence of a CEO Investment Cycle, in which firms disinvest early in a CEO’s tenure and increase investment subsequently, leading to “cyclical” firm growth in assets as well as in employment over CEO tenure. The CEO investment cycle occurs for both firings and non-performance related CEO turnovers, and for CEOs with different relationships with the firm prior to becoming CEO. The magnitude of the CEO cycle is substantial: The estimated difference in investment rate between the first three years of a CEO’s tenure and subsequent years is approximately 6 to 8 percentage points, which is of the same order of magnitude as the differences caused by other factors known to affect investment, such as business cycles or financial constraints. We present a variety of tests suggesting that this investment cycle is best explained by a combination of agency-based theories: Early in his tenure the CEO disinvests poorly performing assets that his predecessor established and was unwilling to give up on. Subsequently, the CEO overinvests when he gains more control over his board. There is no evidence that the investment cycles occur because of shifting CEO skill or productivity shocks. Overall, the results imply that public corporations’ investments deviate substantially from the first-best, and that governance-related factors internal to the firm are as important as economy-wide factors in explaining firms’ investments.

Quality Minus Junk

Quality Minus Junk

Clifford S. Asness AQR Capital Management, LLC

Andrea Frazzini AQR Capital Management, LLC

Lasse Heje Pedersen New York University (NYU); Copenhagen Business School; AQR Capital Management, LLC; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

August 21, 2013

Abstract: 
We define a quality security as one that has characteristics that, all-else-equal, an investor should be willing to pay a higher price for: stocks that are safe, profitable, growing, and well managed. High-quality stocks do have higher prices on average, but not by a very large margin. Perhaps because of this puzzlingly modest impact of quality on price, high-quality stocks have high risk-adjusted returns. Indeed, a quality-minus-junk (QMJ) factor that goes long high-quality stocks and shorts low-quality stocks earns significant risk-adjusted returns in the U.S. and globally across 24 countries. The price of quality – i.e., how much investors pay extra for higher quality stocks – varies over time, reaching a low during the internet bubble. Further, a low price of quality predicts a high future return of QMJ.

Entrepreneurial Exits and Innovation

Entrepreneurial Exits and Innovation

Vikas A. Aggarwal INSEAD – Entrepreneurship and Family Enterprise

David H. Hsu University of Pennsylvania – Management Department

August 5, 2013
INSEAD Working Paper No. 2013/89/EFE/ACGRE

Abstract: 
We examine how IPOs and acquisitions affect entrepreneurial innovation as measured by patent counts and forward patent citations. We construct a firm-year panel dataset of all venture capital-backed biotechnology firms founded between 198’22’008 tracked yearly through 2006. We address the possibility of unobserved self-selection into exit mode by using coarsened exact matching (CEM), and in two additional ways: (1) comparing firms that filed for an IPO (or announced a merger) with those not completing the transaction for reasons unrelated to innovation, and (2) using an instrumental variables approach. We find that innovation quality is highest under private ownership and lowest under public ownership, with acquisition intermediate between the two. Together with a set of within-exit mode analyses, these results are consistent with the proposition that information confidentiality mechanisms shape innovation outcomes. The results are not explained by inventor-level turnover following exit events or by firms’ pre-exit window dressing behavior.

Buying to Sell: Private Equity Buyouts and Industrial Restructuring

Buying to Sell: Private Equity Buyouts and Industrial Restructuring

Pehr-Johan Norback Research Institute of Industrial Economics (IFN)

Lars Persson Research Institute of Industrial Economics (IFN); Centre for Economic Policy Research (CEPR)

Joacim Tag Research Institute of Industrial Economics (IFN)

July 29, 2013
CESifo Working Paper Series No. 4338

Abstract: 
We show how temporary ownership by private equity firms affects industry structure, competition and welfare. Temporary ownership leads to strong investment incentives because equilibrium resale prices are determined by buyers incentives to block rivals from obtaining assets. These incentives benefit consumers, but harm rivals in the industry. Evaluating optimal antitrust policy, we underscore that an active private equity market can aid antitrust authorities by triggering welfare-enhancing mergers and by preventing concentration in the industry. By spreading the cost of specializing in restructuring over multiple markets, private equity firms have stronger incentives than incumbents to invest in acquiring specialized restructuring skills.

The Long-Term Effects of Hedge Fund Activism

The Long-Term Effects of Hedge Fund Activism

Lucian A. Bebchuk Harvard Law School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Alon P. Brav Duke University – Fuqua School of Business

Wei Jiang Columbia Business School – Finance and Economics

July 9, 2013

Abstract: 
We test the empirical validity of a claim that has been playing a central role in debates on corporate governance – the claim that interventions by activist shareholders, and in particular activist hedge funds, have an adverse effect on the long-term interests of companies and their shareholders. While this “myopic activists” claim has been regularly invoked and has had considerable influence, its supporters have thus far failed to back it up with evidence. This paper presents a comprehensive empirical investigation of this claim and finds that it is not supported by the data.

We study the universe of about 2,000 interventions by activist hedge funds during the period 1994-2007, examining a long time window of five years following the intervention. We find no evidence that interventions are followed by declines in operating performance in the long term; to the contrary, activist interventions are followed by improved operating performance during the five-year period following these interventions. These improvements in long-term performance, we find, are present also when focusing on the two subsets of activist interventions that are most resisted and criticized – first, interventions that lower or constrain long-term investments by enhancing leverage, beefing up shareholder payouts, or reducing investments and, second, adversarial interventions employing hostile tactics.

We also find no evidence that the initial positive stock price spike accompanying activist interventions fails to appreciate their long-term costs and therefore tends to be followed by negative abnormal returns in the long term; the data is consistent with the initial spike reflecting correctly the intervention’s long-term consequences. Similarly, we find no evidence for pump-and-dump patterns in which the exit of an activist is followed by abnormal long-term negative returns. Finally, we find no evidence for concerns that activist interventions during the years preceding the financial crisis rendered companies more vulnerable and that the targeted companies therefore were more adversely affected by the crisis.

Our findings that the considered claims and concerns are not supported by the data have significant implications for ongoing policy debates on corporate governance, corporate law, and capital markets regulation. Policymakers and institutional investors should not accept the validity of the frequent assertions that activist interventions are costly to firms and their long-term shareholders in the long term; they should reject the use of such claims as a basis for limiting the rights and involvement of shareholders.

Do Brokers of Insiders Tip Other Clients?

Do Brokers of Insiders Tip Other Clients?

William J. McNally, Andriy Shkilko, Brian F. Smith*

September 2012

Abstract

This paper finds evidence that brokers who execute insider trades on the Toronto Stock Exchange engage in tipping and insider trading. We find that on the day when insiders buy (sell), there is a significant increase in the proportion of non-insider client buying (selling) handled by the insider’s brokerage firm. Since there is normally a multi-day delay in the publication of these insider trades, this finding is consistent with brokers tipping their other clients. Furthermore, we find that executing brokers double their market share of principal buying (selling) on the day of insider buys (sales).

Share Repurchase Motives by Taiwanese Firms

Share Repurchase Motives by Taiwanese Firms

Shih-Chin Lee Chihlee Institute of Technology

Jen-Chang Liu Takming University of Science and Technology – Department of Banking and Finance

March 27, 2013

Abstract: 
Taiwanese firms must follow strict regulations when implementing repurchase programs. The mean (median) of completion rates is 69.2% (82.7%) for the purpose of cancelling and 68.0% (80.0%) for the purpose of transferring. We try to identify the factors determining the completion rate of a repurchaser. We find that OTC firms tend to be younger and are on the stage of expansion; hence they are less likely to write off its shares. In contrast, TSE firms are more mature and are more ready to cancel the shares when they decide to buy back shares. Besides, a repurchaser is characterized by higher ratio retained earning to total equity, lower leverage. There exist a complementary relation between dividends and repurchases. It is highly unlikely to find a firm buying back shares without history of paying dividends. Finally, we find no evidence supporting the free cash flows hypothesis; that is, the ratio of cash to total assets has no association with the repurchase decision.

Informed Trading and False Signaling with Open Market Repurchases

Informed Trading and False Signaling with Open Market Repurchases

Fried, Jesse M.

Abstract

Public companies in the United States and elsewhere increasingly use open market stock buybacks, rather than dividends, to distribute cash to shareholders. Academic commentators have emphasized the possible benefits of such repurchases for shareholders. However, little attention has been paid to their potential drawbacks. This Article explains that managers currently are able to use open market repurchases and misleading repurchase announcements to enrich themselves at public shareholders’™ expense. Managers, aware their stock is underpriced, frequently use repurchases to indirectly buy stock for themselves at a bargain price. Managers have also been able to boost stock prices by announcing repurchase programs they did not intend to execute, perhaps to unload their own shares at a high price. Such bargain repurchases and inflated-price sales systematically transfer significant amounts of value from one set of shareholders (public investors) to another (managers). Low-price buybacks are also likely to reduce aggregate shareholder value by distorting managers’ payout and investment decisions, further reducing public shareholder returns. The Article concludes by proposing a new approach to regulating open market repurchases: requiring managers to disclose specific details of the firm’s buy orders in advance. This pre-repurchase disclosure rule would undermine managers’ ability to use repurchases for informed trading and false signaling, thereby reducing the resulting distortions and costs to shareholders. Moreover, it would achieve these objectives without eroding any of the potential benefits of repurchases.

Which Institutional Investors are More Effective Monitors, Domestic or Foreign? Evidence from International Earnings Management

Which Institutional Investors are More Effective Monitors, Domestic or Foreign? Evidence from International Earnings Management

Incheol Kim University of South Florida

Steve Miller Saint Joseph’s University

Hong Wan State University of New York at Oswego

Bin Wang University of South Florida

July 27, 2013

Abstract: 
We study the impact of domestic and foreign institutional investors on earnings management in 37 non-U.S. countries from 2000 to 2009. We find that domestic institutions are more effective than foreign institutions at constraining earnings management. Further, the deterrence effect on earnings management is larger when institutions are more independent, when firms have higher levels of asymmetric information, or when the firms’ countries are characterized by greater information asymmetry and stronger investor protection. Our results are consistent with the argument that geographic proximity enhances monitoring effectiveness. Our paper shows that monitoring effectiveness is impacted by a plethora of factors and offers a nuanced view on the subject, which suggests that different institutions have comparative advantages in performing different monitoring tasks.

The Entrepreneurial Gap: How Managers Adjust Span of Accountability and Span of Control to Implement Business Strategy

The Entrepreneurial Gap: How Managers Adjust Span of Accountability and Span of Control to Implement Business Strategy

Robert Simons Harvard Business School

July 15, 2013
Harvard Business School Accounting & Management Unit Working Paper No. 13-100

Abstract: 
This study focuses on the relationship between business strategy, organization structure, and diagnostic control systems. The project analyzes data from 75 field studies to illustrate how managers adjust span of accountability and span of control to motivate different levels of innovation and entrepreneurial behavior. Six propositions are derived inductively about when, why, and how managers make these choices.

Trust: The Unwritten Contract In Corporate Governance

Trust: The Unwritten Contract In Corporate Governance

David F. Larcker Stanford University – Graduate School of Business

Brian Tayan Stanford University – Graduate School of Business

July 31, 2013
Rock Center for Corporate Governance at Stanford University Closer Look Series: Topics, Issues and Controversies in Corporate Governance and Leadership No. CGRP-34 

Abstract: 
Corporate governance systems exist to discourage self-interested behavior. One question that is often overlooked is how extensive these systems should be. A look at corporate governance today suggests that self-interest is high because companies are compelled – by regulators and the market – to adopt a long list of contracts, controls, and procedures to restrict employee behavior. However, the research literature suggests that companies might benefit if they enacted fewer, rather than more, controls. Companies that successfully foster high levels of trust between employees and monitors benefit from lower bureaucracy, simpler procedures, and higher productivity. We examine this issues in greater detail, and ask:
• Would shareholders be better off if companies devoted greater effort to fostering trust?
• Can trust be fostered in all settings?
• Are some industries more likely to attract individuals that put their own interests first?
• How can executives develop a culture that discourages self interest and encourages trust?
Topics, Issues and Controversies in Corporate Governance and Leadership: The Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important. Larcker and Tayan are co-authors of the book “Corporate Governance Matters”, and “A Real Look at Real World Corporate Governance.”

Strategies for Firm Growth

Strategies for Firm Growth

Alex Coad University of Sussex – Science and Technology Policy Research Unit (SPRU)

July 24, 2013
Palgrave Encyclopedia of Strategic Management, Forthcoming

Abstract: 
Strategies for firm growth vary in terms of their degrees of novelty, uncertainty, and synergy. Modes of firm growth include replication (growth by ‘more of the same’), diversification, and internationalization. Growth strategies can be implemented using organic growth or through acquisitions. Desire to grow is a necessary but insufficient condition for growth – what also counts is the availability of growth opportunities. Empirical work has shown that growth is largely random – hence, hard to predict. Sustained growth is rare. Firms cannot always translate their ambitions into growth, but should pay attention to critical ‘decision points.’

Investor Attention, Visual Price Pattern, and Momentum Investing

Investor Attention, Visual Price Pattern, and Momentum Investing

Li-Wen Chen National Chung Cheng University

Hsin-Yi Yu National University of Kaohsiung

July 12, 2013

Abstract: 
Since investor attention is limited, stocks that attract attention are more likely to be chosen, while stocks that do not attract attention are often ignored. Given that a visual mode of analysis is more conductive to human cognition than algebraic numbers, we propose that the visual pattern of past prices is a salient signal that attracts investor attention, and thereby boosts returns. The stocks in the winner and loser groups are further classified based on their visual patterns of past prices. We construct a long-short portfolio including the stocks which are more likely to grab investor attention by their discernible visual patterns of past prices. Our long-short portfolio commands a compounded annual risk-adjusted return of 23.1%, almost double the conventional momentum profit. The outperformance holds under various alternative specifications. Moreover, the sheer size of these profits poses a further, significant challenge to the asset pricing literature and the market efficiency hypothesis.

Analysts’ Cash Flow Forecasts are Not Sophisticated: a Rebuttal of Call, Chen and Tong (2013)

Analysts’ Cash Flow Forecasts are Not Sophisticated: a Rebuttal of Call, Chen and Tong (2013)

Dan Givoly Pennsylvania State University – Mary Jean and Frank P. Smeal College of Business Administration

Carla Hayn University of California at Los Angeles – Anderson School of Management

Reuven Lehavy University of Michigan – Stephen M. Ross School of Business

July 2013

Abstract: 
Call, Chen and Tong (2013) claim that the conclusion we reached in Givoly, Hayn and Lehavy (2009) that analysts’ forecasts of cash flow from operations are unsophisticated (in the sense that they can be replicated by a naïve extension of analysts’ own earnings forecasts) is wrong. They conclude that these forecasts are, in fact, sophisticated. Call et al.’s claim is based on inappropriate and contradictory tests and their interpretation of their own evidence suffers from serious logical flaws. In fact, rather than raising doubts about our conclusions, the evidence in Call et al. reinforces them.

Are Analysts’ Cash Flow Forecasts Naive Extensions of Their Own Earnings Forecasts?

Andrew C. Call Arizona State University (ASU) – School of Accountancy

Shuping Chen University of Texas at Austin – Red McCombs School of Business

Yen H. Tong Nanyang Technological University (NTU) – Nanyang Business School

March 1, 2012

Abstract: 
We examine the sophistication of analysts’ cash flow forecasts to better understand what accrual adjustments, if any, analysts make when forecasting cash flows. As a preliminary step, we first demonstrate that prior empirical tests used to evaluate the sophistication of analysts’ cash flow forecasts are not diagnostic. We then present three sets of evidence to triangulate our conclusion that analysts’ cash flow forecasts incorporate meaningful accrual adjustments. First, we review a stratified random sample of 90 analyst reports and find that the majority of these analysts include explicit adjustments for working capital and other accruals in their cash flow forecasts. Second, using a large sample of analysts’ cash flow forecasts from 1993-2008, we find that these forecasts outperform time-series cash flow forecasts in correctly predicting the sign and magnitude of accruals. Finally, we find a significant market reaction to analysts’ cash flow forecast revisions, suggesting that investors find these revisions informative. Collectively, our findings demonstrate that analysts’ cash flow forecasts are not simply naïve extensions of their own earnings forecasts, but that they reflect meaningful and useful accrual adjustments. These findings are relevant to researchers who examine analysts’ cash flow forecasts in a variety of settings, and to investors and practitioners who employ these forecasts for valuation purposes.

Overcoming Cognitive Biases: A Heuristic for Making Value Investing Decisions

Overcoming Cognitive Biases: A Heuristic for Making Value Investing Decisions

Eben Otuteye University of New Brunswick – Fredericton – Faculty of Business

Mohammad Siddiquee Faculty of Business, University of New Brunswick, Saint John

April 26, 2013
Forthcoming in the Journal of Behavioral Finance

Abstract: 
Investment decisions are subject to error due to cognitive biases of the decision makers. One method for preventing cognitive biases from influencing decisions is to specify the algorithm for the decision in advance and to apply it dispassionately. Heuristics are useful practical tools for simplifying decision making in a complex environment due to uncertainty, limited information and bounded rationality. We develop a simple heuristic for making value investing decisions based on profitability, financial stability, susceptibility to bankruptcy, and margin of safety. This achieves two goals. First, it simplifies the decision making process without compromising quality and secondly it enables the decision maker to avoid potential cognitive bias problems.

Do Fraudulent Firms Engage in Disclosure Herding?

Do Fraudulent Firms Engage in Disclosure Herding?

Gerard Hoberg University of Maryland – Department of Finance

Craig M. Lewis Vanderbilt University – Finance

July 25, 2013

Abstract: 
We present two new hypotheses regarding the strategic qualitative disclosure choices of firms involved in potentially fraudulent activity. First, these firms have incentives to herd with industry peers in order to escape detection. Second, these firms have incentives to locally anti-herd with the same peers on specific aspects of disclosure consistent with achieving fraud-driven objectives. We use text-based analysis of firm disclosures and compare disclosures across firms involved in SEC enforcement actions to benchmarks based on industry, size and age, and also to each firm’s own disclosure before and after SEC alleged violations. We find especially strong support for the conclusion that firms involved in alleged fraud anti-herd with industry peers on localized disclosure dimensions. We find moderately strong support for the conclusion that they herd with industry peers on broader disclosure dimensions. Content analysis then reveals key vocabulary terms used by firms involved in enforcement actions, and suggests that these firms use complexity to potentially conceal fraudulent activity, and these firms often discuss issues relating to uncertainty, litigation, and speculative statements.

Strategic Informed Trading by Corporate Executives and Firm Value

Strategic Informed Trading by Corporate Executives and Firm Value

Katherine Gunny University of Colorado at Boulder – Department of Accounting

Tracey Chunqi Zhang Singapore Management University – School of Accountancy

September 26, 2012
Singapore Management University School of Accountancy Research Paper No. 1

Abstract: 
Proponents of insider trading argue that informed trading benefits shareholders and could have a positive effect on firm value, however opponents counter that insider trading could be detrimental to firm value. We measure the extent of strategic informed trading by the fraction of insider trades that are V-shaped purchases (defined as insider purchases that are preceded by negative abnormal returns and followed by positive abnormal returns) and Λ-shaped sales (defined as insider sales that are preceded by positive abnormal returns and followed by negative abnormal returns). Our strategic informed trading proxy is negatively associated with future earnings performance and Tobin’s Q, even after controlling for the direction of insider trading intensity. We adopt the view that there could be frictions that prevent the board from setting the level of informed trading at the optimal level at any given time. We find that our measure of strategic informed insider trading is positively related to restatements, another possible manifestation of agency problems resulting from the same frictions. Moreover, strategic informed trading declines significantly after announcements of earnings restatements, which are usually accompanied with significant corporate governance improvement. Overall our evidence indicates that the type of informed trading we identify represents suboptimal informed trading that is detrimental to firm value – consistent with the opponent view of informed trading.

Is there an Incentive for Active Retail Mutual Funds to Closet Index in Down Markets? Fund Performance and Subsequent Annual Fund Flows; Study finds there’s no big benefit to active management in down markets

Is there an Incentive for Active Retail Mutual Funds to Closet Index in Down Markets? Fund Performance and Subsequent Annual Fund Flows between 1997 and 2011

Aron A. Gottesman Pace University – Lubin School of Business – Department of Finance and Economics

Matthew R. Morey Pace University – Lubin School of Business – Department of Finance and Economics

Menahem Rosenberg Pace University

April 26, 2013

Abstract: 
Closet indexing is the practice of staying close to the benchmark index while still maintaining to be an active mutual fund manager and probably also charging fees similar to those of truly active managers. Recent work shows active mutual fund managers were much more likely to closet index during down markets. Indeed, closet indexing became so popular that it accounted for about a third of all mutual fund assets during time surrounding 2008. In this paper we set out to answer the question of whether there actually is an incentive for mutual fund managers to closet index during down markets. To do this we examine the relationship between annual fund performance and subsequent annual fund flows in both up and down markets. Using this approach we find that the relationship between fund performance and subsequent net fund flows is significantly different in up markets years as compared to down market years. Specifically, we find that fund performance does not drive subsequent flows nearly as much in down markets as it does in up markets. Indeed, in up markets, we find a strong positive relationship between fund performance and subsequent flows. Conversely, in down years, the amount of outperformance or underperformance does not significantly influence the next year’s fund flows. Hence, based on these results, there is an incentive for active managers to closet index in down markets as investors do not reward outperformance with higher flows.

Fund managers should go into the closet when markets drop

Study finds there’s no big benefit to active management in down markets

By Michael Shagrin
July 25. 2013 3:54PM

Fund managers have every incentive to mimic their benchmark when markets are down, according to researchers at Pace University and Touro College. During up years, a strong relationship exists between fund performance and net flows. However, during down years, outperforming or underperforming a benchmark does not have a significant impact on the subsequent year’s flows. This means that “there is an incentive for active managers to closet-index in down markets, as investors do not reward outperformance with higher flows,” according to the researchers, who recently conducted a study, “Is There an Incentive for Active Retail Mutual Funds to Closet Index in Down Markets? Fund Performance and Subsequent Annual Fund Flows between 1997 and 2011.”  Read more of this post

Deal Initiation in Mergers and Acquisitions

Deal Initiation in Mergers and Acquisitions

Ronald W. Masulis University of New South Wales – Australian School of Business; European Corporate Governance Institute (ECGI); Financial Research Network (FIRN)

Serif Aziz Simsir Sabanci University

June 30, 2013
ECGI – Finance Working Paper No. #371

Abstract: 
This study investigates deal initiation in the context of mergers and acquisitions. We investigate how bidder and target initiated merger offers differ. Our analysis reveals that target financial or economic weakness, target financial constraints and economy wide shocks are important motives for target-initiated deals. We also find that average bid premiums, target cumulative abnormal returns (CAR) measured around the merger announcement dates and the deal value to EBITDA multiples of target-initiated deals is significantly lower than in bidder-initiated deals. However, this gap cannot be explained by weaker financial conditions of targets immediately prior to merger announcements. After adjusting for self-selection, we find evidence that the private information held by target firms is the main driver of the lower premiums observed in target-initiated deals. Supporting this perspective, the premium gap between bidder- and target-initiated deals widen when the information asymmetry between the merging firms gets higher.