MIT: A Tale of Two Entrepreneurs: Understanding Differences in the Types of Entrepreneurship in the Economy

A Tale of Two Entrepreneurs: Understanding Differences in the Types of Entrepreneurship in the Economy

William Aulet Massachusetts Institute of Technology (MIT)

Fiona Murray Massachusetts Institute of Technology (MIT) – Entrepreneurship Center

May 1, 2013

Abstract: 
Not all startup companies are created equal. Although both innovation-driven enterprises (IDEs) and traditional small- and medium-sized enterprises (SMEs) can provide valuable products and services and create jobs, IDEs – startups focused on addressing global markets based on technological, process or business model innovation – can potentially create hundreds or even thousands of high-skill jobs if they succeed. This paper examines the distinctive differences between these two forms of entrepreneurial ventures, their importance for governments and policymakers wanting to support long-term economic growth; their roles in local, regional and global economies; and their differing needs in terms of financial and policy support.

Compliance, Detection, and Mergers and Acquisitions

Compliance, Detection, and Mergers and Acquisitions

Vivek Ghosal Georgia Institute of Technology; Center for Economic Studies and Ifo Institute for Economic Research (CESifo)

D. Daniel Sokol University of Florida – Levin College of Law; University of Minnesota School of Law; George Washington University Law School Competition Law Center

May 1, 2013
University of Minnesota Law School, Legal Studies Research Paper Series, Paper No. 13-21

Abstract: 
Firms operate under a wide range of rules and regulations. These include, for example, environmental regulations (in which some industries have increased regulatory exposure) and finance and accounting (where all industries have reporting requirements). In other areas, such as antitrust cartels, enforcement is unregulated and antitrust leaves the market as the default tool to police against anti-competitive behavior. In all of these areas, detection of non-compliance by a firm can result in significant penalties. This issue of non-compliance has implications in the merger and acquisitions (M&A) context. In a transaction between an acquiring firm (buyer) and a target firm (seller), there is asymmetric information about the target’s quality. In our framework, we link a target’s quality directly to the strength of its regulatory compliance. In an M&A transaction, an acquirer seeks information about the target’s compliance, as a compliance failure may result in substantial penalties and sanctions, post-acquisition. In the presence of quality (compliance) uncertainty about target firms, low quality targets can masquerade as high quality. This would tend to give rise to a M&A market with Lemons-like characteristics, resulting in low transactions prices and dampening of M&A activity. We examine how M&A transactions in such regulatory areas – environmental, finance and accounting, and antitrust compliance problems – might function to alleviate quality uncertainty.

Classification Shifting Using the ‘Corporate/Other’ Segment

Classification Shifting Using the ‘Corporate/Other’ Segment

Bradley E. Lail Baylor University

Wayne B. Thomas University of Oklahoma – Michael F. Price College of Business

Glyn J. Winterbotham Winthrop University

April 26, 2013
Accounting Horizons, Forthcoming

Abstract: 
In this paper, we examine management’s use of the “corporate/other” segment to mask the true performance of operating (or core) segments. The corporate/other segment represents firm-wide expenses not allocated to core segments. We find that managers take advantage of vague cost allocation requirements to shift expenses between the corporate/other segment and core segments. Specifically, in the presence of agency problems (i.e., transfer of resources to underperforming segments), our evidence is consistent with expenses being shifted from core segments to the corporate/other segment. This shifting increases the reported performance of underperforming core segments. In addition, when proprietary concerns are high (i.e., operations in less competitive industries), we find evidence consistent with corporate/other expenses being shifted to core segments. By shifting expenses to core segments, core profits are concealed when proprietary motives are present. Our research contributes to a growing literature on earnings manipulation through expense shifting (rather than accrual manipulation or real activities management).

An Analysis of Accounting Frauds and the Timing of Analyst Coverage Decisions and Recommendation Revisions: Evidence from the US

An Analysis of Accounting Frauds and the Timing of Analyst Coverage Decisions and Recommendation Revisions: Evidence from the US

Susan M. Young Fordham University

Emma Y. Peng Fordham University – Accounting Area

April/May 2013
Journal of Business Finance & Accounting, Vol. 40, Issue 3-4, pp. 399-437, 2013

Abstract: 
This paper provides a comprehensive exploration of the types of accounting fraud committed by firms over the period 1995–2009. Using detailed data from US SEC Accounting and Auditing Enforcement Releases (AAER), we examine the likelihood and timing of analyst coverage decisions and recommendation revisions related to fraud firms versus firms without accounting fraud. We find that analysts have a higher probability of taking the more severe action of dropping coverage rather than only revising down recommendations for firms with any type of accounting fraud and also for specific egregious types of accounting fraud. Through the use of competing hazards models, we also find that accounting frauds and their egregiousness are positively (negatively) associated with the timeliness of the analysts’ action to drop coverage (revise only). Overall, we find that analysts’ actions may be useful in determining the occurrence of accounting fraud prior to the public announcement of the fraud.

Is the Decline in the Information Content of Earnings Following Restatements Short-Lived?

Is the Decline in the Information Content of Earnings Following Restatements Short-Lived?

Xia Chen Singapore Management University

Qiang Cheng Singapore Management University

Alvis K. Lo Boston College

May 1, 2013
Singapore Management University School of Accountancy Research Paper No. 1

Abstract: 
Prior research finds that the decline in the information content of earnings after restatement announcements is short-lived and that the earnings response coefficient (ERC), the proxy for the information content of earnings, bounces back after three quarters. We re-examine the persistence of the drop in the ERC after restatement announcements using a more comprehensive and recent sample of restatements. We find that material restatement firms experience a significant decrease in the ERC over a prolonged period – close to three years after restatement announcements. In contrast, other restatement firms experience a decline in the ERC only for one quarter after restatement announcements. In cross-sectional analyses, we find that among material restatement firms, those that are subject to more credibility concerns and those that do not take prompt actions to improve reporting credibility are associated with a longer drop in the ERC than others. Lastly, we reconcile our findings with prior studies. Our analyses indicate that using a potentially more powerful proxy for material restatements and imposing less restrictive sampling requirement help increase the power of the tests to detect the long-run drop in the ERC.

Using MD&A to Improve Earnings Forecasts

Using MD&A to Improve Earnings Forecasts

Khrystyna Bochkay Rutgers, The State University of New Jersey – Rutgers Business School at Newark & New Brunswick

Carolyn B. Levine Rutgers, The State University of New Jersey – Rutgers Business School at Newark & New Brunswick

April 17, 2013

Abstract: 
We estimate and compare quantitative and text-enhanced earnings forecasting models to evaluate the extent to which MD&A disclosures improve earnings forecasts. Incorporating MD&A disclosures into forecasting models significantly improves forecasting accuracy. The gains in accuracy are much greater following regulatory reforms, providing some of the first large-sample empirical evidence on the success of recent MD&A regulatory actions. The MD&A section is less informative between 2007-2009, particularly for those firms hardest hit by the financial crisis (i.e., firms with low cash and large changes in performance). Further, we find that text improves forecast accuracy most for firms in the consumer staples sector, firms with low profit margins, large changes in performance, high political and/or legal costs and high complexity. Last, we find that models enhanced by MD&A disclosures are generally less accurate than analysts’ consensus forecasts for large and medium sized firms, but equally accurate for small firms.

Hybrid Innovation in Meiji, Japan

Hybrid Innovation in Meiji, Japan

Tom Nicholas Harvard University – Entrepreneurial Management Unit

May 2013
International Economic Review, Vol. 54, Issue 2, pp. 575-600, 2013

Abstract: 
Japan’s hybrid innovation system during the Meiji era provides a useful laboratory for examining the effectiveness of complementary incentives to patents. Patents were introduced in 1885, and by 1911 1.2 million mostly nonpecuniary prizes were awarded at 8,503 competitions. Prizes provided a strong boost to patents, especially in less developed prefectures, and they also induced large spillovers of technical knowledge in prefectures adjacent to those with prizes, relative to distant control prefectures without prizes. Linking competition expenditures with the expected market value of patents induced by the prizes permits a cost–benefit assessment of the prize competitions to be made.

NBER: Informed Trading and Expected Returns

Informed Trading and Expected Returns

Stocks with the greatest information asymmetry have annualized returns that are 10.8 percentage points higher than stocks with the least information asymmetry.

In Informed Trading and Expected Returns (NBER Working Paper No. 18680), co-authors James Choi, Li Jin, andHongjun Yan use daily institutional ownership data from the Shanghai Stock Exchange to examine whether information asymmetry affects expected stock returns. They argue that focusing on China is useful because there is likely to be significant variation across companies in how much private information is shared with select investors, largely as a result of the state of Chinese legal institutions and regulations. The authors first show that stocks bought heavily by institutions subsequently outperform stocks sold heavily by institutions. Thus, institutions appear to have a strong information advantage over individual investors, and that is true for stocks of all sizes. Moreover, the authors confirm that the institutional sector’s future information advantage is larger in stocks that it previously traded more aggressively. Therefore, the aggressiveness of institutional trading in a stock, as measured by prior institutional ownership volatility, can be used as an ex ante predictor of future information asymmetry in this stock. Sorting stocks based on this predictor of information asymmetry, the authors find that the 20 percent of stocks with the greatest information asymmetry have future annualized returns that are 10.8 percentage points higher than the 20 percent of stocks with the least information asymmetry. This difference remains significant for ten months after the initial sorting month—the same amount of time that the difference in institutional information advantage between the two portfolios lasts. There is no evidence of subsequent return reversals. They conclude that information asymmetry increases the cost of capital. –Claire Brunel

Informed Trading and Expected Returns

James J. Choi, Li Jin, Hongjun Yan

NBER Working Paper No. 18680
Issued in January 2013
Does information asymmetry affect the cross-section of expected stock returns? Using institutional ownership data from the Shanghai Stock Exchange, we show that institutions have a strong information advantage over individual investors. We then show that the aggressiveness of institutional trading in a stock—measured by the average absolute weekly change in institutional ownership during the past year—is an ex ante predictor of future information asymmetry in this stock. Sorting stocks on this information asymmetry predictor, we find that the top quintile outperforms the bottom quintile next month by 10.8% annualized, suggesting that information asymmetry raises the cost of capital.

Using MD&A to Improve Earnings Forecasts

Using MD&A to Improve Earnings Forecasts

Khrystyna Bochkay Rutgers, The State University of New Jersey – Rutgers Business School at Newark & New Brunswick

Carolyn B. Levine Rutgers, The State University of New Jersey – Rutgers Business School at Newark & New Brunswick

April 17, 2013

Abstract: 
We estimate and compare quantitative and text-enhanced earnings forecasting models to evaluate the extent to which MD&A disclosures improve earnings forecasts. Incorporating MD&A disclosures into forecasting models significantly improves forecasting accuracy. The gains in accuracy are much greater following regulatory reforms, providing some of the first large-sample empirical evidence on the success of recent MD&A regulatory actions. The MD&A section is less informative between 2007-2009, particularly for those firms hardest hit by the financial crisis (i.e., firms with low cash and large changes in performance). Further, we find that text improves forecast accuracy most for firms in the consumer staples sector, firms with low profit margins, large changes in performance, high political and/or legal costs and high complexity. Last, we find that models enhanced by MD&A disclosures are generally less accurate than analysts’ consensus forecasts for large and medium sized firms, but equally accurate for small firms.

10 Years Later: Where in the World is Equal Weight Indexing Now?

10 Years Later: Where in the World is Equal Weight Indexing Now?

Liyu Zeng Standard & Poor’s

Frank Luo Standard & Poor’s

April 20, 2013

Abstract: 
Often the most powerful investment ideas are simple. The S&P 500 EWI 10 years ago pioneered the simple concept of equal weighted indexing. It has now expanded in the U.S. into the S&P 100, a MegaCap index, S&P MidCap 400® and S&P SmallCap 600®. The equal weighting idea has also been applied to international equities, as well as in other asset classes such as fixed income indices and commodity indices. It has become one of the most popular alternatively-weighted ideas. While the headline cause of asset flows has been outperformance over market-cap indices, sophisticated investors have realized that equal weighting creates a different set of risk factor exposures than market cap weighting that seem to have worked over the long-term as noted in the paper. Furthermore, the concept randomizes factor mispricings in the market, and it can serve as a performance benchmark for alternative-weighted indices.

Effortless Perfection: Do Chinese Cities Manipulate ‘Blue Skies?’

Effortless Perfection: Do Chinese Cities Manipulate ‘Blue Skies?’

Dalia Ghanem University of California, San Diego (UCSD)

Junjie Zhang University of California, San Diego

April 16, 2013

Abstract: 
It is alleged that some Chinese cities manipulate their air pollution data to comply with the air quality standards set by the central government of China. This paper tests this hypothesis by using a unique data set. First, we employ a discontinuity test to detect the cities that reported dubious pollution data around the cutoff for “blue-sky days.” Then, we propose a panel matching approach to identify the conditions under which irregularities may occur. Over the period 2001-2010, 55% of cities reported dubious PM10 pollution levels that led to a discontinuity at the cutoff. Suspicious data reporting tends to occur on days when the potential manipulation is least detectable. Our findings indicate that the official daily air pollution data are not well behaved, which provides suggestive evidence of manipulation.

The Opportunistic Reporting of Material Events and the Apparent Misconception of Investors’ Reaction

The Opportunistic Reporting of Material Events and the Apparent Misconception of Investors’ Reaction

Benjamin Segal INSEAD – Accounting & Control Area

Dan Segal Interdisciplinary Center (IDC) Herzliyah; Singapore Management University – School of Accountancy

April 23, 2013
INSEAD Working Paper No. 2013/54/AC

Abstract: 
Using a comprehensive sample of non-earnings 8-K filings from 1996 to 2011, we examine whether firms engage in opportunistic reporting of mandatory and voluntary news. We find strong evidence of opportunistic reporting of negative news, especially among public firms. Public firms are more likely to delay disclosure of negative news, report negative news after trading hours, and report on the last day of the week. We also find evidence of opportunistic bundling of news. Our findings support the notion that managers engage in strategic disclosure by delaying or obfuscating negative news in order to mitigate the potential market reaction. Factors such as the risk of litigation, information asymmetry, and corporate governance influence reporting behavior. Further analysis of the market reaction to opportunistic disclosure uncovers no evidence of investor inattention or under-reaction.

Shared Auditors in Mergers and Acquisitions

Shared Auditors in Mergers and Acquisitions

Dan S. Dhaliwal University of Arizona – Department of Accounting

Phillip T. Lamoreaux university of arizona – Department of Accounting

Lubomir P. Litov University of Arizona – Department of Finance; University of Pennsylvania – Wharton Financial Institutions Center

Jordan Neyland The University of Melbourne; Financial Research Network (FIRN)

April 1, 2013

Abstract: 
We examine the effect of shared auditors, defined as audit firms that provide audit services to both target and acquirer prior to an acquisition, on transaction outcomes. We find that shared auditors are frequently observed — in a quarter of all public acquisitions — and are associated with significantly lower deal premiums, lower target event returns, higher acquirer event returns, and higher deal completion rates. Moreover, targets are likelier to receive a bid from a firm that has the same auditor. These results are more pronounced when targets and acquirers are audited by the same office of the audit firm and are mitigated to an extent after the adoption of the Sarbanes-Oxley Act. Overall, our results suggest that the bidder benefits from sharing the same auditor with the target, in part because of the lower costs to learn about it.

Entrepreneurs, Firms and Global Wealth Since 1850

Entrepreneurs, Firms and Global Wealth Since 1850

Geoffrey Jones Harvard University – Entrepreneurial Management Unit

March 12, 2013
Harvard Business School General Management Unit Working Paper No. 13-076

Abstract: 
This working paper integrates the role of entrepreneurship and firms into debates on why Asia, Latin America and Africa was slow to catch up with the West following the Industrial Revolution and the advent of modern economic growth. It argues that the currently dominant explanations, which focus on deficient institutions, poor human capital development, geography and culture are important, but not sufficient. This is partly because recent research in business history has shown that several of the arguments are not empirically proved, but especially because the impact of these factors on the creation and performance of innovative business enterprises is not clearly specified. Modern economic growth diffused from its origins in the North Sea region to elsewhere in western and northern Europe, across the Atlantic, and later to Japan, but struggled to get traction elsewhere. The societal and cultural embeddedness of the new technologies posed significant entrepreneurial challenges. The best equipped to overcome these challenges were often entrepreneurs based in minorities who held significant advantages in capital-raising and trust levels. By the interwar years productive modern business enterprise was emerging across the non-Western world. Often local and Western managerial practices were combined to produce hybrid forms of business enterprise. After 1945 many governmental policies designed to facilitate catch-up ended up crippling these emergent business enterprises without putting effective alternatives in place. The second global economy has provided more opportunities for catch up from the Rest, and has seen the rapid growth of globally competitive businesses in Asia, Latin America and Africa. This is explained not only by institutional reforms, but by new ways for business in the Rest to access knowledge and capital, including returning diaspora, business schools and management consultancies. Smarter state capitalism was also a greater source of international competitive advantage than the state intervention often seen in the past.

Groupthink: Collective Delusions in Organizations and Markets

Groupthink: Collective Delusions in Organizations and Markets

Roland Bénabou Princeton University – Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); Institute for the Study of Labor (IZA)

IZA Discussion Paper No. 7322

Abstract: 
This paper investigates collective denial and willful blindness in groups, organizations and markets. Agents with anticipatory preferences, linked through an interaction structure, choose how to interpret and recall public signals about future prospects. Wishful thinking (denial of bad news) is shown to be contagious when it is harmful to others, and self-limiting when it is beneficial. Similarly, with Kreps-Porteus preferences, willful blindness (information avoidance) spreads when it increases the risks borne by others. This general mechanism can generate multiple social cognitions of reality, and in hierarchies it implies that realism and delusion will trickle down from the leaders. The welfare analysis differentiates group morale from groupthink and identifies a fundamental tension in organizations’ attitudes toward dissent. Contagious exuberance can also seize asset markets, generating investment frenzies and crashes.

Estimating the Extent of Propping in China and How It Is Affected by the Controlling Shareholder’s Capture of Directors and Executives

Estimating the Extent of Propping in China and How It Is Affected by the Controlling Shareholder’s Capture of Directors and Executives

Maggie Williams RMIT University

Dennis William Taylor RMIT University

January 11, 2013
2013 Financial Markets & Corporate Governance Conference

Abstract: 
Research on the phenomenon of propping up a firm’s earnings or liquidity by its controlling shareholders through related-party transactions (RPTs) has suffered from arbitrary and unsettled measures of the ‘propping’ variable and a lack of theoretically underpinning. This study’s first objective is to develop a new measure of propping based on an estimation of the proportion of propping embodied in total related-party transactions. By invoking Jensen and Ruback’s (1983) theory of ‘market for ownership control’, the propping component is estimated from prevailing conditions that can trigger a market for ownership control of a firm or shield its controlling shareholders from this market. Using this theory-based estimate of the extent of propping by a firm, the second objective of this study is to investigate the extent to which controlling shareholders are able to capture directors and top executives in order for the firm’s board governance to facilitate the carrying out of propping transactions. Models are developed and empirically tested in the context of listed companies and securities regulations in China. Using the CSMAR database for the year 201’8 all companies with complete data on the Shanghai and Shenzhen Stock Exchanges are sampled. Results reveal that the key factors deemed to create a market for ownership control – namely, lower State (and State legal person) ownership, greater risk of penalty by the securities regulator and a weaker cushion of non-tradeable shares – are significant conditions affecting total RPTs. The regression coefficients of these factors provide the estimate of the propping component in total RPTs. Over the whole sample propping is found to be approximately 1.5% of total RPTs. This propping measure is then modelled as the dependent variable, and regressed against governance factors that are proxies for the extent of ‘capture’ by controlling State shareholders of directors, supervisors and top executives. The results reveal that the extent of propping is significantly positively affected by the extent of directors’ shareholdings in the firm and the top 3 executives’ emoluments. This paper establishes a new measurement approach that can be adopted in future studies on the phenomenon of propping. It also has practical implications for minority shareholders and prospective investors in terms of developing a firm-level ‘propping’ index and providing a better understanding of how controlling shareholders can ‘capture’ directors and executives to facilitate propping transactions.

Earnings Quality in Acquired and Non-Acquired Family Firms: A Socioemotional Wealth Perspective

Earnings Quality in Acquired and Non-Acquired Family Firms: A Socioemotional Wealth Perspective

Federica Pazzaglia University College Dublin

Stefano Mengoli University of Bologna – Department of Management

Elena Sapienza University of Padua – Department of Economics “M.Fanno”

April 17, 2013
Family Business Review, Forthcoming

Abstract: 
We develop a socioemotional wealth (SEW) explanation for the differences in earnings quality between family firms. We argue that the process by which families obtain ownership of firms is a key contingency affecting earnings quality. Specifically, firms acquired by families through market transactions display lower earnings quality due to lower identification of family owners relative to firms still owned by the families which created them. Acquired family firms benefit with respect to their earnings quality from having a nonfamily CEO while non-acquired family firms benefit from having a family CEO.

The Myth that Insulating Boards Serves Long-Term Value

The Myth that Insulating Boards Serves Long-Term Value

Lucian A. Bebchuk 

Harvard Law School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)
April 1, 2013
Columbia Law Review, Fall 2013, Vol. 113, Forthcoming

Abstract: 
This paper comprehensively analyzes – and debunks – the view that insulating corporate boards serves long-term value.
Advocates of board insulation claim that shareholder interventions, and the fear of such interventions, lead companies to take myopic actions that are costly in the long term – and that insulating boards from such pressure therefore serves the long-term interests of companies as well as of their shareholders. This claim is regularly invoked to support limits on the rights and involvement of shareholders and has had considerable influence. I show, however, that this claim has a shaky conceptual foundation and is not supported by the data.
In contrast to what insulation advocates commonly assume, short investment horizons and imperfect market pricing do not imply that board insulation will be value-increasing in the long term. I show that, even assuming such short horizons and imperfect pricing, shareholder activism, and the fear of shareholder intervention, will produce not only long-term costs but also some significant countervailing long-term benefits.
Furthermore, there is a good basis for concluding that, on balance, the negative long-term costs of board insulation exceeds its long-term benefits. To begin, the behavior of informed market participants reflects their beliefs that shareholder activism, and the arrangements facilitating it, are overall beneficial for the long-term interest of companies and their shareholders. Moreover, a review of the available empirical evidence provides no support for the claim that board insulation is overall beneficial in the long term; to the contrary, the body of evidence favors the view that shareholder engagement, and arrangements that facilitate it, serve the long-term interests of companies and their shareholders.
I conclude that, going forward, policy makers and institutional investors should reject arguments for board insulation in the name of long-term value.

Board Games: Timing of Independent Directors’ Dissent in China

Board Games: Timing of Independent Directors’ Dissent in China

Juan Ma 

Harvard Business School

Tarun Khanna 

Harvard University – Strategy Unit
April 18, 2013
Harvard Business School Strategy Unit Working Paper No. 13-089

Abstract: 
This paper examines the circumstances under which so-called “independent” directors voice their independent views on public boards in a sample of Chinese firms. Controlling for firm and board characteristics, we find that independent directors’ dissent is associated with breakdown of directors’ interpersonal ties with board chairpersons, who locate at the center of the board bureaucracy in China. In particular, independent directors tend to “time” their dissent into a restricted set of socially-appropriate circumstances, either when the board chairperson who appoints the independent director has left the board, or when the voting occurs at the end of board “games” that corresponds to a 60-day window prior to departure of the board chairperson or departure of the independent director herself. The endgame effect is particularly strong: 27% of the dissent was issued at board “endgames” which represent merely 4% of independent directors’ average tenure. While directors with foreign experience are more likely to dissent, we do not find that academics, accounting and law professionals are significantly more active. We also show that dissent is consequential, to the director and the firm. Although dissent has no significant marginal effect on the total number of board seats received subsequently by an independent director, it significantly increases the chance for a director to exit the director labor market. Firms suffer an economically and statistically significant cumulative abnormal return of -0.97% around announcement of dissent. Literature has suggested that dissent might be reflecting of diverse viewpoints, perhaps beneficial in and of itself through reducing variability of firm performance, however we do not find this offsetting beneficial effect to be strong.

Entrenchment or Incentive? CEO Employment Contracts and Acquisition Decisions

Entrenchment or Incentive? CEO Employment Contracts and Acquisition Decisions

Jing Zhao North Caroliona State University – Poole College of Management

April 15, 2013
Journal of Corporate Finance, Forthcoming

Abstract: 
A long-standing controversy is whether CEO employment contracts insulate inferior managers from discipline leading to shareholder wealth destruction, or whether contracts alleviate managerial risk aversion and encourage value-enhancing decisions. Using a unique dataset on S&P 500 CEO employment contracts during 1993-2005, I find that acquirers with a CEO contract obtain better announcement returns, pay lower premiums for their targets, garner superior long-run post-acquisition operating performance, and undertake riskier deals than acquirers without a contract. Further investigation of individual contract provisions reveals substantial heterogeneity. Specifically, the fixed term rather than at will contract, longer contract duration, long-term equity incentives, accelerated stock and option vesting provisions in severance arrangement, and more refined definitions of just cause (good reason) for CEO termination (resignation) alleviate managerial risk aversion, reduce contracting ambiguity, and motivate value-creating decisions.

Why the Going-Concern Anomaly: Gambling in the Market?

Why the Going-Concern Anomaly: Gambling in the Market?

Asad Kausar Nanyang Technological University (NTU)

Alok Kumar University of Miami – School of Business Administration

Richard Taffler University of Warwick – Finance Group

April 11, 2013

Abstract: 
This paper investigates why the market fails to incorporate the adverse information conveyed by the going-concern (GC) opinion in a timely manner. Our main conjecture is that the lottery-like features of GC stocks attract a predominantly retail clientele who use those stocks to gamble in the market. Such trading behavior leads to the underreaction to the GC event and significant downward drift in prices over the following year. Using a sample of first time GC firms from 1993 to 2007 we show that GC stocks have extreme lottery-type characteristics. We further demonstrate that retail investors have a proclivity to be net-buyers of these stocks around the GC event, and such contrarian behavior is directly related to the lottery-like nature of GC firms. Using individual investor-level trading, socioeconomic, and demographic data we confirm that retail investors who are known to have a greater propensity to gamble are more likely to trade GC stocks. We rule out several alternative explanations for our findings, and conclude that gambling-motivated trading behavior of retail investors is the most likely driver of the anomalous short-term market reaction and the associated longer-term market response following the release of going-concern audit opinion.

The Mystery of Zero-Leverage Firms

The Mystery of Zero-Leverage Firms

Ilya A. Strebulaev Stanford University – Graduate School of Business; National Bureau of Economic Research

Baozhong Yang Georgia State University – Robinson College of Business

February 20, 2013
Journal of Financial Economics (JFE), Forthcoming

Abstract: 
We present the puzzling evidence that, from 1962 to 2009, an average 10.2% of large public nonfinancial US firms have zero debt and almost 22% have less than 5% book leverage ratio. Zero-leverage behavior is a persistent phenomenon. Dividend-paying zero-leverage firms pay substantially higher dividends, are more profitable, pay higher taxes, issue less equity, and have higher cash balances than control firms chosen by industry and size. Firms with higher Chief Executive Officer (CEO) ownership and longer CEO tenure are more likely to have zero debt, especially if boards are smaller and less independent. Family firms are also more likely to be zero-levered.

Does Auditor ‘Commentary’ in Unqualified Audit Reports Reflect Financial Misstatement Risk?

Does Auditor ‘Commentary’ in Unqualified Audit Reports Reflect Financial Misstatement Risk?

Keith Czerney University of Illinois at Urbana-Champaign

Jaime J. Schmidt University of Texas at Austin

Anne Thompson University of Illinois at Urbana-Champaign

April 1, 2013

Abstract: 
According to auditing standards, explanatory language added at the auditor’s discretion to unqualified audit reports should not indicate increased financial misstatement risk. However, in practice, an auditor is unlikely to add language that would strain the auditor-client relationship absent concerns about the client’s financial statements. Using a sample of 30,825 financial statements issued with unqualified audit opinions during 2000-2009, we find that audit reports containing non-going-concern explanatory language are 17-56% more likely to be subsequently restated than financial statements without such language. This association is limited to “emphasis of a matter” language, references to the application of accounting principles, and discussion of previous restatements. In addition, the financial statement accounts noted in explanatory language typically correspond to the accounts subsequently restated. In sum, our results suggest that some auditor commentary is associated with financial misstatement risk.

150 Years of Boom and Bust – What Drives Mineral Commodity Prices?

150 Years of Boom and Bust – What Drives Mineral Commodity Prices?

Martin Stürmer University of Bonn

February 1, 2013
German Development Institute Paper No. 5/2013

Abstract: 
This paper examines the dynamic effects of demand and supply shocks on mineral commodity prices. It provides empirical insights by using annual data for the copper, lead, tin, and zinc markets from 1840 to 2010. I identify structural shocks by using long-run restrictions and compare these shocks to narrative historical evidence about the respective markets. Long-term price fluctuations are mainly driven by persistent demand shocks. Supply shocks exhibit some importance in the tin and copper markets due to oligopolistic market structures. World output- driven demand shocks have persistent, positive effects on mineral production. Long-term linear trends are statistically insignificant or significantly negative for the examined commodity prices. My results suggest that the current price boom is temporary but not permanent. Commodity exporting countries should prepare for a downswing of prices, while commodity importing countries should not fear for the security of supply of these widely used mineral commodities.

Size is a Drag: How Hedge Fund Growth May Be Affecting Returns

Size is a Drag: How Hedge Fund Growth May Be Affecting Returns

Ian Hunt EDHEC Risk Institute

March 31, 2013

Abstract: 
The hedge fund industry has grown massively. Most of the growth appears to be from inward capital cash flows, rather than retained investment returns. But it is difficult to gauge hedge fund cash flows and returns exactly – no available data set straightforwardly represents the industry as a whole, and each data set is incomplete and possibly biased. Despite various data constraints, I reveal a salient negative relationship between the hedge fund industry’s size and its percentage returns. This relationship is economically and statistically significant. And it is not sensitive to the choice of data set.

The Fresh Start Effect: Breaking Points in Life Motivate Virtuous Behavior

The Fresh Start Effect: Breaking Points in Life Motivate Virtuous Behavior

Hengchen Dai University of Pennsylvania – The Wharton School

Katherine L. Milkman University of Pennsylvania – The Wharton School

Jason Riis Harvard Business School

January 20, 2013
The Wharton School Research Paper No. 51

Abstract: 
Many view the commencement of each New Year as an opportunity for a fresh start, which motivates them to pursue virtuous goals. We demonstrate that this well-known uptick in virtuous behavior following New Year’s is just one example of a broader phenomenon, which we refer to as the ‘fresh start effect.’ Specifically, special (and mundane) occasions in our lives and calendar events demarcate the passage of time (e.g., a promotion, a birthday, the beginning of a new week/month), creating many breaking points in each year. We show that these breaking points generate fresh start feelings, which are stronger at meaningful discontinuities and motivate subsequent virtuous behavior such as exercise and dieting. We propose and show that the fresh start feelings associated with breaking points originate from a psychological disassociation from our past self and belief that we are more like our ideal selves at the beginning of a new period.

The Role of Management Quality in the IPOs of Venture-Backed Entrepreneurial Firms

The Role of Management Quality in the IPOs of Venture-Backed Entrepreneurial Firms

Thomas J. Chemmanur Boston College – Carroll School of Management

Karen Simonyan Suffolk University – Department of Finance

Hassan Tehranian Boston College – Department of Finance

April 4, 2013

Abstract: 
We make use of hand-collected data on the quality and reputation of the management teams of a large sample of entrepreneurial firms going public to analyze the role of management quality in the IPOs of venture capital (VC)-backed firms for the first time in the literature. We hypothesize that management quality may affect a VC-backed firm’s IPO characteristics and post-IPO operating performance through two channels: a “certification” channel, where firms with higher management quality face reduced information asymmetry in the IPO market, and therefore find it easier and cheaper to go public; and an “ability” channel, where firms with higher quality managements select better projects and implement them more ably. Further, VC-backing may itself affect a firm’s IPO, indirectly by affecting a firm’s management quality and directly through the above certification and ability channels. These hypotheses imply that VC-backing will be associated with higher management quality, and both management quality and VC-backing will have a favorable effect on firms’ IPO characteristics, increase IPO participation by financial market players, allow firms to go public earlier, yield higher IPO and immediate after-market valuations, and will be positively related to changes in post-IPO operating performance. Our OLS regression, propensity-score matching, and instrumental variable analyses provide empirical support for the above hypotheses. While VC-backing and management quality act as substitutes in their effect on a firm’s IPO characteristics, they act as complements in their effect on firms’ IPO and secondary market valuations and post-IPO operating performance.

The Imprinting of Founders’ Human Capital on Entrepreneurial Venture Growth: Evidence from New Technology-Based Firms

The Imprinting of Founders’ Human Capital on Entrepreneurial Venture Growth: Evidence from New Technology-Based Firms

Luca Grilli Politecnico di Milano

Paul H. Jensen University of Melbourne – Melbourne Institute of Applied Economic and Social Research

Samuele Murtinu Politecnico di Milano – Dipartimento di Ingegneria Gestionale

April 2013
Melbourne Institute Working Paper No. 14/13

Abstract: 
This paper tests the presence of an ‘entrepreneurial imprinting effect’ of founders’ human capital on entrepreneurial ventures’ performance. More specifically, we empirically explore the impact of entrepreneurs’ human capital on a firm’s sales growth performance by disentangling the effect of the stock of human capital possessed at foundation from the potential injections and losses of human capital due to exit of founders and/or addition of new owner-managers in the entrepreneurial team over time. Our analysis is based on a panel dataset composed of 338 Italian new technology-based firms (NTBFs) observed from 1995 (or since their foundation) to 2008 (or until their exit from the dataset). We consider the effects of several dimensions of entrepreneurial human capital on firm sales growth and estimate Gibrat law-type dynamic panel data models using OLS estimator and GMM-system estimator to control for endogeneity. Overall, our results point to a positive and significant presence of an ‘entrepreneurial imprinting effect’ exerted by founders’ specific work experience on venture growth which is robust to a series of controls.

World Bank: Rethinking the State’s Role in Finance

Rethinking the State’s Role in Finance

Martin Cihák World Bank

Asli Demirgüç-Kunt World Bank – Financial and Private Sector Development

April 1, 2013
World Bank Policy Research Working Paper No. 6400

Abstract: 
The global financial crisis has given greater credence to the idea that active state involvement in the financial sector can be helpful for stability and development. There is now evidence that, for example, lending by state-owned banks has helped in mitigating the impact of the crisis on aggregate credit. But evidence also points to negative longer-term effects of direct interventions on resource allocation and quality of intermediation. This suggests a need to rebalance the state’s roles from direct to less direct involvement, as the crisis subsides. The state does have very important roles, especially in providing well-defined regulations and enforcing them, ensuring healthy competition, and strengthening financial infrastructure. One of the crisis lessons is the importance of getting the basics right first: countries with complex but poorly enforced regulations suffered more during the global crisis. Evidence also suggests that instead of restricting competition, the state needs to encourage contestability through healthy entry of well-capitalized institutions and timely exit of insolvent ones. There is also new evidence that supports the state’s key role in promoting transparency of information and reducing counterparty risk. The challenge of financial sector policies is to better align private incentives with public interest, without taxing or subsidizing private risk-taking.