Creating Value by Changing the Old Guard: The Impact of Controlling Shareholder Heterogeneity on Firm Performance and Corporate Policies

Journal of Financial and Quantitative Analysis / Volume 48 / Issue 06 / December 2013, pp 1781-1811

Creating Value by Changing the Old Guard: The Impact of Controlling Shareholder Heterogeneity on Firm Performance and Corporate Policies

Hua Deng^a1, Fariborz Moshirian^a2, Peter Kien Pham^a3 and Jason Zein^a4

Abstract

Theory suggests that controlling shareholders can influence firm value through both shared benefits creation and private benefits consumption. Using negotiated control-block transfers from 31 countries, we look beyond ownership concentration and investigate how controlling shareholder heterogeneity influences the relative importance of these two effects. We document that a control transfer precipitates positive firm outcomes particularly when the vendor has maintained control over an extended period and the acquirer displays a strong incentive to engage in restructuring. In such cases, we observe a sustained positive price reaction, more focused corporate investments, lower leverage, higher operating efficiency, and superior long-term performance.

Wisdom of Crowds: The Value of Stock Opinions Transmitted Through Social Media

Wisdom of Crowds: The Value of Stock Opinions Transmitted Through Social Media

Hailiang Chen

Prabuddha De

Yu (Jeffrey) Hu

Byoung-Hyoun Hwang

Social media has become a popular venue for individuals to share the results of their own

analysis on financial securities. This paper investigates the extent to which investor opinions

transmitted through social media predict future stock returns and earnings surprises. We

conduct textual analysis of articles published on one of the most popular social media

platforms for investors in the United States. We also consider the readers’ perspective as

inferred via commentaries written in response to these articles. We find that the views

expressed in both articles and commentaries predict future stock returns and earnings

Investor Networks in the Stock Market

Investor Networks in the Stock Market

Han N. Ozsoylev

Johan Walden

M. Deniz Yavuz

Recep Bildik

We study the trading behavior of investors in an entire stock market. Using an account

level dataset of all trades on the Istanbul Stock Exchange in 2005, we identify investors

with similar trading behavior as linked in an empirical investor network (EIN). Consistent

with the theory of information networks, we find that central investors earn higher returns

and trade earlier than peripheral investors with respect to information events. Overall, our

results support the view that information diffusion among the investor population influences

trading behavior and returns.

Do Security Analysts Speak in Two Tongues?

Do Security Analysts Speak in Two Tongues?

Ulrike Malmendier

University of California, Berkeley

Devin Shanthikumar

University of California, Irvine

Why do security analysts issue overly positive recommendations? We propose a novel

approach to distinguish strategic motives (e.g., generating small-investor purchases and

pleasing management) from nonstrategic motives (genuine overoptimism). We argue that

nonstrategic distorters tend to issue both positive recommendations and optimistic forecasts,

while strategic distorters “speak in two tongues,” issuing overly positive recommendations

but less optimistic forecasts. We show that the incidence of strategic distortion is large and

systematically related to proxies for incentive misalignment. Our “two-tongues metric”

reveals strategic distortion beyond those indicators and provides a new tool for detecting

incentives to distort that are hard to identify otherwise.

Connected Stocks

THE JOURNAL OF FINANCE • VOL. LXIX, NO. 3 • JUNE 2014

Connected Stocks

MIGUEL ANTON and CHRISTOPHER POLK ´ ∗

ABSTRACT

We connect stocks through their common active mutual fund owners. We show that the

degree of shared ownership forecasts cross-sectional variation in return correlation,

controlling for exposure to systematic return factors, style and sector similarity, and

many other pair characteristics. We argue that shared ownership causes this excess

comovement based on evidence from a natural experiment—the 2003 mutual fund

trading scandal. These results motivate a novel cross-stock-reversal trading strategy

exploiting information contained in ownership connections. We show that long-short

hedge fund index returns covary negatively with this strategy, suggesting these funds

may exacerbate this excess comovement.

Broad-based Employee Stock Ownership: Motives and Outcomes

Broad-based Employee Stock Ownership: Motives and Outcomes

E. Han Kim 

University of Michigan, Stephen M. Ross School of Business

Paige Parker Ouimet 

University of North Carolina at Chapel Hill
June 10, 2013
Journal of Finance, Forthcoming

Abstract: 
Firms initiating broad-based employee share ownership plans often claim ESOPs increase productivity by improving employee incentives. Do they? The answer depends. Small ESOPs comprising less than 5% of shares, granted by firms with moderate employee size, increase the economic pie, benefitting both employees and shareholders. The effects are much weaker when there are too many employees to mitigate free-riding. Although some large ESOPs increase productivity and employee compensation, the average impacts are small, because they are often implemented for non-incentive purposes, such as conserving cash by substituting wages with employee shares or forming a worker-management alliance to thwart takeover bids.

Investing Process – Thirty Years of Shareholder Rights and Firm Valuation

Thirty Years of Shareholder Rights and Firm Valuation

Martijn Cremers 

University of Notre Dame

Allen Ferrell 

Harvard Law School; European Corporate Governance Institute (ECGI)
July 2013
Journal of Finance, Forthcoming

Abstract: 
This paper introduces a new hand-collected dataset tracking restrictions on shareholder rights at approximately 1,000 firms over 1978-1989. In conjunction with the 1990-2006 IRRC data, we track firms’ shareholder rights over thirty years. Most governance changes occurred during the 1980s. We find a robustly negative association between restrictions on shareholder rights (using the G-Index as a proxy) and Tobin’s Q. The negative association only appears after the judicial approval of antitakeover defenses in the 1985 landmark Delaware Supreme Court decision of Moran v. Household. This decision was an unanticipated, exogenous shock that increased the importance of shareholder rights.

Worth the Hype? The Relevance of Paid-For Analyst Research for the Buy-and-Hold Investor

Worth the Hype? The Relevance of Paid-For Analyst Research for the Buy-and-Hold Investor

Bruce K. Billings 

Florida State University – Department of Accounting

William L. Buslepp 

Texas Tech University – Area of Accounting

George Ryan Huston 

University of South Florida – School of Accountancy; Florida State University – Department of Accounting
September 4, 2013
Accounting Review, Forthcoming

Abstract: 
The SEC Advisory Committee on Smaller Public Companies recommends paid-for research to fill the void created by declining sell-side coverage. Potential conflicts of interest inherent in paid-for research challenge this recommendation. We evaluate whether paid-for research provides value to investors or merely reflects hype. Analyses of one- and two-year ahead paid-for earnings forecasts fail to identify significant bias. Using a portfolio approach, favorable (unfavorable) paid-for recommendations yield positive (negative) stock returns at release, with upward (downward) drift over the following year. Regressing future stock returns on recommendations and valuation estimates using paid-for analysts’ forecasts yields similar results. Further, results fail to indicate significant differences in paid-for and matched sell-side research. Overall, our evidence suggests that paid-for research provides relevant information for the buy-and-hold investor that is comparable to that of matched sell-side research, providing empirical support for the SEC Advisory Committee recommendation.

Tone Management

THE ACCOUNTING REVIEW American Accounting Association

Vol. 89, No. 3 DOI: 10.2308/accr-50684 2014 pp. 1083–1113

Tone Management

Xuan Huang

Siew Hong Teoh

Yinglei Zhang

ABSTRACT: We investigate whether and when firms manage the tone of words in

earnings press releases, and how investors react to tone management. We estimate

abnormal positive tone,ABTONE, as a measure of tone management from residuals of a

tone model that controls for firm quantitative fundamentals such as performance, risk,

and complexity. We find that ABTONE predicts negative future earnings and cash flows,

is positively associated with upward perception management events, such as, just

meeting/beating thresholds, future earnings restatements, SEO, and M&A, and is

negatively associated with a downward perception management event, stock option

grants. ABTONE has a positive stock return effect at the earnings announcement and a

delayed negative reaction in the one and two quarters afterward. Balance sheet

constrained firms and older firms are more likely to employ tone management over

accruals management. Overall, the evidence is consistent with managers using strategic

tone management to mislead investors about firm fundamentals.

Optimistic Reporting and Pessimistic Investing: Do Pro Forma Earnings Disclosures Attract Short Sellers?

Optimistic Reporting and Pessimistic Investing: Do Pro Forma Earnings Disclosures Attract Short Sellers?

Theodore E. Christensen 

Brigham Young University – Marriott School of Management

Michael S. Drake 

Brigham Young University – Marriott School

Jacob R. Thornock 

University of Washington – Michael G. Foster School of Business
September 24, 2012
Contemporary Accounting Research, Forthcoming

Abstract: 
We contribute to the debate regarding the informativeness of pro forma earnings disclosures by providing evidence that a group of informed traders, short sellers, trade as if firms’ voluntary non-GAAP earnings disclosures create information advantages they can exploit. While prior research indicates that short sellers identify firms that will experience declining operating performance, we investigate whether the disclosure of pro forma earnings acts as an indicator of future price declines that is distinct from poor operating performance. We find that short selling is significantly higher in quarters in which firms disclose non-GAAP earnings metrics relative to quarters in which they do not disclose adjusted earnings measures. Moreover, we find that short selling is significantly positively associated with the exclusion of recurring items and, more particularly, with the exclusion of stock-based compensation. We also find some evidence that short sellers trade more when managers exclude expense items to appear to meet analysts’ expectations on a pro forma basis when they fall short of expectations based on GAAP operating earnings. Finally, we find evidence based on abnormal returns suggesting that short sellers profit from short selling around earnings announcements containing pro forma earnings disclosures. Overall, the results are consistent with the notion that sophisticated market participants view pro forma earnings disclosures negatively and trade in order to take advantage of potential information asymmetries created by these disclosures.

Investing Process – How Does Earnings Management Influence Investors’ Perceptions of Firm Value? Survey Evidence from Financial Analysts

How Does Earnings Management Influence Investors’ Perceptions of Firm Value? Survey Evidence from Financial Analysts

Abe De Jong 

Erasmus University – Rotterdam School of Management

Gerard Mertens 

Erasmus University Rotterdam (EUR) – Department of Financial Management

Marieke Van der Poel 

Erasmus University – Rotterdam School of Management

Ronald Van Dijk 

ING Investment Management
February 26, 2013
Review of Accounting Studies, Forthcoming

Abstract: 
Survey evidence shows CFOs to believe that earnings management can enhance investor valuation of their firms. This evidence raises the question of correspondence between the beliefs of CFOs and investors. Surveying financial analysts to gain insight into how earnings management influences investor perception of firm value, we find analysts’ and CFOs’ beliefs to be generally consistent. We find that analysts perceive meeting earnings benchmarks and smoothing earnings to enhance investor perception of firm value, and all earnings management actions to reach a benchmark, save share repurchases, to be value destroying. CFOs, however, are reluctant to repurchase shares, preferring to use techniques viewed by analysts as value destroying (e.g., reductions in discretionary spending). Analysts’ inability to unravel such techniques perhaps explains CFOs’ preferences.

Valuation-driven profit transfer among corporate segments

Rev Account Stud (2014) 19:805–838

Valuation-driven profit transfer among corporate segments

Haifeng You

Published online: 4 February 2014

Springer Science+Business Media New York 2014

Abstract This paper investigates whether the desire to achieve higher equity

valuations induces conglomerates to manipulate their segment earnings. I extend the

Stein (Q J Econ 104:655–669, 1989) model to a multi-segment setting and show that

conglomerates have incentives to transfer profits from segments operating in

industries with lower valuation multiples to those with higher multiples, even if the

market is not fooled in equilibrium. If companies engage in such manipulation,

segments with relatively high (low) valuations should report abnormally high (low)

profits. The empirical tests confirm this prediction and further show that the relation

is stronger for firms with more dispersed segment valuations. This paper also

demonstrates that the simple sum-of-the-parts valuation with multiples tends to

overestimate the enterprise values for conglomerates and that the measurement

errors increase with segment valuation dispersion.

CEO Power and Mergers and Acquisitions

CEO Power and Mergers and Acquisitions

Ning Gong 

University of Melbourne; Financial Research Network (FIRN)

Lixiong Guo 

Australian School of Business at UNSW; Financial Research Network (FIRN)
May 12, 2014
FIRN Research Paper

Abstract: 
We find CEO power in acquiring firms can explain the occurrence of both large value creation and destruction deals in M&A. Specifically, we find firms with powerful CEOs make fewer deals and the returns on those deals are less dispersed. Firms with powerful CEOs are also less likely to do all cash deals and use a larger proportion of stocks in payments. We relate this to the incentive of powerful CEOs to avoid making big salient mistakes in major firm decisions to protect them from adverse career consequences. However, we also find that firms with powerful CEOs are more reluctant to withdraw deals given negative market reactions to the announcements of the deals, which suggests that powerful CEOs do pursue deals that increase their private benefits of control while avoiding deals with high ex ante uncertainty. Our evidence offers a new perspective on M&A deals with extreme returns and CEO objectives.

Alliances and Return Predictability

Alliances and Return Predictability

Jie Cao 

Chinese University of Hong Kong – Department of Finance

Tarun Chordia 

Emory University – Department of Finance

Chen Lin 

University of Hong Kong – Faculty of Business and Economics
May 8, 2014

Abstract: 
A trading strategy designed to exploit the information contained in the returns of alliance partners, yields economically and statistically significant returns. A long-short portfolio sorted on lagged returns of strategic alliance partners provides a return of 89 basis points per month that is robust to a number of specifications. Increased correlation in returns after the formation of alliances is driven by increased economic links and the increased probability of mergers amongst alliance partners. Investor inattention and limits to arbitrage may be the source of underreaction of a firm’s returns to that of its partners’.