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                 Short Reviews of Academic Articles
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Short Reviews of Corporate Finance articles.  These are largely from past FinanceProfessor.com newsletters.  Note, while these are still useful as abstracts, the links are often been removed once the article is published.


A must read! Philippon examines firms' capital structure empirically and
theoretically. He finds that firm value does not exactly fit the static
trade-off model. Specifically he finds that low levels of debt are not
accompanied by as low of firm values as would be expected. However, in
other areas, what we have been teaching seems exactly right: more growth
options means less debt, highly profitable firms do have higher target
debt ratios (even though they may not all be at the targets), and
expected future financing deficits makes financial slack more valuable.
Interestingly, he also finds some evidence that managerial power (as
proxied by CEO tenure) is associated with lower levels of debt. READ
IT!!! :)
http://papers.ssrn.com/paper.taf?abstract_id=503863

Another cannot miss article!!! Jensen talks about what led to the
governance crisis we saw at Tyco, Enron, etc. A big part of the answer
may be overpriced equity. Why? A stock price that is overvalued is
caused when investors have overly optimistic expectations. Thus, if the
investors were to learn the truth, the stock price would fall. This
creates an incentive to hide information from investors. Moreover, to
keep the stock price high, management may be willing to take more
chances and further hide the bad results. Typical control mechanisms
fail to work on this problem. For instance, stock based pay makes the
problem worse and the takeover market fails miserably since no one would
want to take over an overpriced stock. Jensen suggests one solution: the
board providing more information (including to short sellers).
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=480421

A paper by Pukthuanthong and Walker that was presented at the European
FMA Meetings examines the use of options in pay packages of IPO firms.
It finds that "new public companies that have high use of stock options
outperform those that have low use of stock options from the lock-up
period until three years after the issue." The authors find similar
results when looking at operating performance. The authors also document
that firms with higher use of options (even after controlling for better
performance) experience lower managerial turnover. Now there is
somewhat of a problem with endogenity (i.e. Management has the ability
to select the use of options and will not if the future looks bleak),
but that said, this is an important paper as it reminds us all that
options are useful and can lead to higher shareholder returns. That is
something we may be tempted to downplay (especially in class) after the
problems at Enron, Worldcom etc.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=497286

The opposite side of the option debate is shown by Gibson and Chesney.
They point ou that call options are a staple in Executive pay packages,
but the use of the options has come under attack for giving managers the
incentive to take advantage of their informational advantages to the
detriment of shareholders and other stakeholders. In fact the authors
go even further and find that use of options can worsen what they call
an “incentive to cheat.”   Interestingly one suggestion they have for
solving this problem? Make the pay package include put options! This
might lessen the incentive to “cheat” but would likely open a whole
other set of problems by creating an incentive to lower stock prices.
http://papers.ssrn.com/paper.taf?abstract_id=488565

For a more “real world” look at options, CFO.com provides a survey that
documents that at least some of the problems Gibson and Chesney suggest
do in fact happen. READ IT!
http://www.cfo.com/Article?article=14397

Yet more evidence that better corporate governance leads to happier
investors. Bauer, Guenster, and Otten look at the governance practices
of European firms. By grouping the firms into portfolios, the authors
find that valuation and governance are “positively related.”
Interestingly, they do not find the same relationship when various
“earning based performance measures” were examined. (my guess as to why
the latter finding exists: fewer accounting games are played where there
is good governance. This game playing would skew any ratio comparison
based on accounting numbers.)
http://papers.ssrn.com/paper.taf?abstract_id=444543

In a paper that was recently presented at the European FMA meetings,
Jones and Danbolt investigate what happens to stock prices around 158
joint venture announcements of UK listed firms. They find “significant
positive market-adjusted abnormal returns of 0.5% on the announcement
date.”   Not surprisingly, they also find that larger deals are more
positive.
http://papers.ssrn.com/paper.taf?abstract_id=485668

Chung asks the interesting question of whether Financial Analysts
consider corporate hedging strategies when analyzing a company. By
examining the hedging strategies of two gold mining firms, he finds
evidence that suggest that analysts do incorporate financial hedging
into their estimates of future earnings. In his words: “Results of this
study confirm that derivatives can be used to reduce a firm's risk
exposure.
Specifically, the empirical results show a firm that employs intensive
hedging activities through derivatives tends to experience both
statistically and economically significant risk reductions on its future
cash-flows as well as equity returns.”
In addition, the results indicate that financial analysts incorporate
the information of a firm's hedging strategy and that it is reflected in
their earnings forecasts.”
http://papers.ssrn.com/paper.taf?abstract_id=492722

What a treat! European Financial Management has a cool paper by Jay
Ritter discussing the differences between the US and European IPO
markets. For instance: did you know that in Germany there is a "when
issued market" that allows trading in the shares prior to issuance. For
what it is worth, this is sort of like how the opening lines are set on
NFL football games in Las Vegas.   The only question on this one is
where to put it. Should it be a corporate story or an international
story. Either way, it is a real keeper!
http://www.blackwellpublishing.com/pdf/eufm_lead_nov03.pdf

Loughran and Ritter (2002, RFS) suggested that CEOs may not be concerned
about leaving money on the table in IPOs because the losses are netted
against the rises in stock price in the secondary market. Ljunqvist and
Wilhelm now test this and find that CEOs who are happy with the IPO are
less likely to switch investment bankers for the firm's SEO. Which does
fit the initial story. It should probably be noted that this line of
research (behavioral finance in a corporate setting) is really still in its
infancy. Stay tuned!
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=485302

This one makes sense. Better governance, better credit rating.
Ashaugh, Collins, and Lafond find that increased transparency, increased
board independence, and a decreased ability of shareholders to block
takeovers associated with higher credit ratings. On the other side, a
higher number of blockholders is associated with lower ratings.
Additionally the authors report that "having a majority of the board
that is made up of outside independent directors is a key provision in
corporate governance that overshadows the NYSE and NASDAQ requirements
of having 100% independent audit, nominating, and compensation
committees."
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=511902

In an upcoming JF, Grullon and Michaely give us an in depth look at
stock repurchases. They find more buybacks and that the buybacks reduce
the free cash flow problem. They also find that buybacks apparently do
not signal improved operating performance in the future. Cool factoid:
"between 1984 and 2000 corporations spent approximately 26 percent of
their annual earnings on repurchases." Additionally, the paper brings
up some interesting questions. Probably the most interesting question
is why stock repurchases lead to lower systematic risk?! My guess is
that there is a confounding variable at work. Specifically, suppose
that firms who have seen recent increases in slack (so lower leverage)
are more apt to do buy backs. These same firms would be more likely
than their peers (who have not seen their leverage drop) to have lower
systematic risk. Which is a bit of a stretch, but is consistent with
the finding.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=431762
http://www.afajof.org/Pdf/forthcoming/repurchases.pdf

On the other hand, in the Journal of Financial Intermediation, Hirtle
finds that profitability at banks who do repurchases does in fact
increase following the repurchase.
http://www.olin.wustl.edu/jfi/vol12.htm#Repurchases

Garcia has a thought provoking piece that warns against short-term
thinking. The short version of the paper is that as technology,
competition, and strategy have shrunk the business world, firms may have
an even greater incentive to think short term. Winner takes all idea
and if you do not win the first round, you may not be around to play
other rounds. While I am not in total agreement, is a very thought
provoking--be sure to read the modified prisoners dilemma and the doctor
example, both are good!
http://www.westga.edu/~bquest/2004/thinking.htm

Sometimes too much of a good thing is a bad thing. This can be the case
with money (Free Cash flow problem), with food (obesity epidemic),
insider ownership (Philippe). Huh? Never heard of Philippe? Me
neither. Here is the deal: if you figure out what firm this is really
about you get a free FinanceProfessor newsletter :) Ok, so it is not
that hard to figure out. It is a case study by Carol Fischer and myself
on a cable firm that is in the news quite a bit lately. (BTW if you
want the case using the real names, check out FinanceProfessor.com.)
http://www.westga.edu/~bquest/2004/philippe.htm
http://www.financeprofessor.com/Adelphia/adelphia_communications%202.19.04.htm

http://www.financeprofessor.com/Adelphia/Adelphianews.html

Frye confirms that firms are using equity based compensation *EBC) more
than in the past. Additionally she finds a "positive relation between
Tobin's q and the percentage of employee compensation that is equity
based." Interestingly, she finds accounting measures decrease after
firms begin paying with EBC. (which may suggest that firms without EBC
focus too much on accounting measures and not enough of cash flow
measures.
http://www.business.sc.edu/jfr/forthcoming.html

The diversification discount is the finding that diversified firms sell
at less than similar firms in the same industries. (the 1+1 = 1.5 story
from class). In a forthcoming JFR piece, Best, Hodges, and Lin find
that this discount is partially (but not completely) explained by higher
information asymmetries at diversified firms which does make perfect
sense.
http://www.business.sc.edu/jfr/forthcoming.html (BTW sorry about the
link)   

Anderson, Becher, and Campbell (ABC) report that following bank mergers,
CEO pay increases. That part is not new. What is new is that they show
that these increases in pay are the result of increases in
productivity and not just because the CEO is running a larger bank or
because the CEO is more entrenched. While almost a year old I found the
link when doing class notes and since I am friends with all three
authors, figured, why not?
http://www.olin.wustl.edu/jfi/vol12.htm#Incentives

Penas and Unal examine bonds around bank mergers and find that bondholders benefit from the deals.
Why? Diversification (that lowers risk) and "achieving too-big-to-fail status" are the main reasons.
http://jfe.rochester.edu/03176.pdf

The existence of virtually any anomaly suggests multiple explanations
that are possibly correct. For example, it could be that the unexpected
returns really do exist (thus drawing market efficiency into question),
or that the model is incorrect. Another explanation that should never
be overlooked is that the poor controls were used and thus the anomaly
is only due to researcher error. As Fama pointed out in his behavioral
finance article (my favorite Fama article!), this is especially
problematic in longer term studies. For instance previous work has
found there to be a long-run underperformance for firms that issue
seasoned equity.   Li and Zhao use a more complete matching control (the
so-called propensity score matching method) and find that SEO issuers do
NOT under perform in the long run!
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=451740

Three of my favorite teachers ever have collaborated on the next two
papers!

Barclay, Holderness, and Sheehan find that private placements
(which have been long seen as a means of improving monitoring) may
actually reduce monitoring and help to entrench managers. Consistent
with previous research there is an immediate price jump on the
announcement of the private placement. Further like Hertzel, Lemmon,
Linck, and Reees (2002), they find a longer run price decline. What is
new however is that this price decline is associated with private
investors that subsequently turn out to be passive. An interesting
hypothesis: this passivity is purchased by managers in the form of
purchase discounts.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=471720

Due to the dividend exemption, corporations would logically be expected
to be prefer dividends to other forms of return. However, Barclay,
Holderness, and Sheehan provide evidence that blockholders (who may have
acquired the shares in either open market or through private placements)
do not show evidence of that they buy shares in firms that pay higher
dividends, or (and this is actually related to their other paper) do
firms with corporate blockholders increase dividends at a faster rate
than their peers.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=472201

Need another reason why liquidity is important? Butler, Grullon, and
Weston find that after controlling for other factors (size etc)
"investment banks' fees are significantly lower for firms with more
liquid stock." Moreover, the cost difference is seemingly economically
significant. They "estimate that the difference in the investment
banking fee for firms in the most liquid quintile versus the least
liquid quintile, controlling for other factors, is approximately 107
basis points, which represents about 22.3 percent of the average
investment banking fee in our sample." Which to me is a surprisingly
large impact.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=471721

Kisgen reports that managers manage capital structure in a way to
prevent downgrades and to get upgrades. For instance firms that "are
near a change in credit rating" make moves to improve their rating by
issuing less debt and retiring more debt. Importantly, he finds that
this balance sheet management takes place before firms are in what we
would generally call financial distress. (I always love it when a paper
catches me by surprise with something that should have been obvious.)
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=355680

Ex-post settlement. That is the fancy name for it. The idea that after
the fact, if you do a good job, the contract is renegotiated and you get
more money. One form of this renegotiation is in the form of a bonus.
One occasion that is often the trigger for such a bonus is a successful
(defined as completed, not one where the shareholders necessarily win!).
In a forthcoming JFE article, Grinstein and Hribar find that 39% of
their sample paid such a bonus and that this bonus was highly tied to
managerial power. As an aside they also report that the two day event
window return for firms where the CEO has the most power is a negative
and significant –3.8%. 
http://jfe.rochester.edu/03284.pdf
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=417763

This one is pretty interesting! If a single person is in charge, then
it makes sense that the decisions (and consequences) would be more
volatile than if a more formal system of checks and balances were in
place. Sure enough, a paper by Adams, Almeida, and Ferreira finds that
“stock returns are significantly more variable for firms run by powerful
CEOs.”
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=312184



From January 13th, 2004 FinanceProfessor.com Newsletter

Haley and Palepu have done it again! Another smash hit. This one looks
at the Fall of Enron. His is the paper that I had wanted to do but
never had the time. GREAT! Almost reads as a novel but is encompassing
to look at not just what happened, but how it was allowed to happen, and
how to prevent it in the future. Look for it coming to a publication
near you!
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=417840

Have you ever wondered what happens to CEOs who make "value-reducing
acquisitions"? Previous work, including Mitchell and Lehn 1990, find
that when managers make bad acquisitions, their firms are more likely to
be acquired and the managers replaced. This is often cited as evidence
that the external market disciplines mangers for bad deals. Now Zhao
and Lehn examine what happens to those managers whose firms are not
taken over. The authors report a "strong inverse relation between the
returns to acquiring firms and the likelihood that their CEOs are
subsequently fired." Interestingly, but not surprisingly, there seems to
be no relationship between getting fired and "various corporate
governance characteristics." Why not surprising? Since the firms can
choose their structure, one would hope they would pick one that
effectively.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=444360

While it is not "Heads I win, tails you lose", the executive pay does
not seem to be symmetric. Garvey and Milbourne found that managerial
pay is much more sensitive to market or industry performance when the
market or industry is going up than when it is going down. This leads
to situation where "average executive loses 25% less pay from bad luck
than she gains from good luck." Don't tell me that you are surprised!
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=392701>

Dittmann and Maug have a fascinating article that models the
shareholder-agent problem and executive risk aversion. After the
initial modeling of the problems, the paper then takes an empirical tack
and looks at CEO pay. The finding? Current pay packages seem to be
sub-optimal. Based on their assumptions (which are generally not
problematic), the authors claim that they design a pay package based on
more ownership, less use of options, and lower levels of pay, that do
not impact the executives' utility bust costs investors 14% less without
impacting the executive's incentives. (of course, I will add a caveat:
if high CEO pay and the press that it generates, motivates other
executives to work hard, then this 14% overpayment may be optimal)
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=472401

In a related article, Ferri, Markarian, Sandino examine proxies of 67
firms to determine whether shareholders want their firms to expense
employee stock options. Shareholders would prefer this expensing if the
added transparency makes up for the reduced earnings. The findings,
while somewhat ambiguous do support the view that institutional owners
want options expensed, whereas insider owners do not.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=450260

OK we’ve heard all about shareholder-manager conflicts over the past few
years (see Enron, Adelphia, Tyco etc.). And as a result we’ve heard all
about corporate governance. But how does it tie back to the classroom in
a concrete manner? One of the most frequent ways is to focus on the
problems of managerial risk aversion. (For instance: due to risk
aversion managers have incentives to use less debt than is optimal
through shareholder eyes (Fama 1980)).   Kayhan gives us evidence that
this conflict exists. She investigates about 1200 firms per year from
1990-2002 and finds that “entrenched managers” have lower leverage than
their industry peers (consistent with Mehran 1992). Interestingly she
finds the lower leverage is achieved by both more equity issuances as
well as lower dividend payouts.
http://www.aylakayhan.com/documents/kayhan_dec03.pdf

My chairman Jeff Peterson complained recently that academic publications
travel at "glacial speed". The paper is by Simkins, Carter, and Rogers
and looks at hedging in the US Airline industry is one such paper. It
really is one of my favorites. I saw it presented a few years ago and I
thought it was close to publication then, but I guess the glacier has
not yet completed its journey as the paper was presented at this year's
AFAs.   Their findings? Hedging does create value. Using regression
analysis, they report that hedging increases firm value by over 10%!
How? One hypothesis is that hedgers can better afford to maintain
capital spending when jet fuel prices climb. This view is supported by
their finding that there is a "positive relation between hedging
and…increases in capital investment."
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=325402

It has long been a source of consternation in some circles as to why a
stock should go up upon inclusion into the S&P 500. Traditional theory
suggests that with added analyst coverage, investors have a lower
information asymmetry and hence a lower required return. An inadequacy
of this explanation is that while stock prices equal discounted cash
flows, this traditional explanation only examines the denominator (the
discount rate). The numerator, that is the cash flows, have been
ignored. Paul and Becker-Blease have decided to investigate this in
their paper that was presented at the Southern Finance Association
meetings. They point out that, holding other things constant, lower
discount rates means more positive NPV projects and hence more cash
flow. To test this they examine capital expenditures (assuming only
positive NPV projects get done) and find, sure enough, that capital
expenditures increase in the year following inclusion in the S&P 500.
http://donnapaul.babson.edu/Documents/Liquidity%20&%20Investments%2010-21-03.doc

Text books often say that venture capitalists add management expertise
to firms but generally leave how or what this expertise is out. In a
paper that is to be presented at the AFA meetings in San Diego, Hochberg
adds to our understanding. He finds that one thing that venture
capitalists bring is improved governance. He supports this in several
ways: 1. he finds less evidence of earnings management (as measured
through accounting accruals); 2. he reports that when poison pills are
adopted at VC-backed firms there is a positive stock price jump (which
also suggests that investors realize the governance is better); 3. VC
backed firms have more independent board members and 4. VC firms are
more apt to have separate CEO and Chairperson decisions.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=474542

From November 20, 2003 FinanceProfessor.com Newsletter

How closely do the boards actually monitor management? This has been a difficult question to answer. Some authors have found there to be
little relation between firm performance and CEO turnover. However, Goldman, Hazarika, and Shivdasani now give us an explanation to this
troubling finding: the sensitivity is not the same at all times. In particular the relationship is significantly stronger in years the stock
is down. Thus, even when the firm lags its peers, if the stock price is up, there is less risk of a manager being forced out. Why? One reason
that the authors suggest is that a stock price decline triggers further investigation of performance, whereas if the stock price is up, the
board feels things are OK. The importance? In the words of the authors, the results suggest that “even though the overall sensitivity
of turnover to performance may be low in a broad sample of firms, this sensitivity can be high for firms that don’t meet a performance
threshold. In this regard, the prospect of CEO turnover can be a powerful incentive device for certain firms.”
http://207.36.165.114/Denver/Papers/CEOturnover.pdf

In an interesting paper that may surprise some who have grown accustomed to hearing that Boards of Directors fail to look out for shareholders,
Scholten finds that boards of directors are the main party that forces out CEOs following a poor acquisition. More importantly, Scholten
reports that Boards do this regardless of whether there is an active takeover market or not. (This is important because earlier papers, for
example Mikkelson and Partch (1997) and Hadlock and Lumer (1997), had found that Boards need to be pressured into action by an active takeover market).
http://207.36.165.114/Denver/Papers/InvestmentDecisionsandManagerialTurnover.pdf

In a forthcoming Journal of Finance article, Yermack investigates how board members are compensated for their actions. Specifically he asks
how sensitive their wealth is to changes in firm value (much like the famous Jensen and Murphy 1990 paper that looked at CEO pay). He finds
that for a change of $1000 in firm value, there is a corresponding change of 11 cents to board members. Thus, for a one standard deviation
change in firm value, the average board member would see his/her wealth increase by $285,000. This is from not only options and stock
ownership, but also a greater likelihood of being selected to serve on other boards.
http://www.afajof.org/Pdf/forthcoming/JF%202343%20Final%20Revision.pdf

Any bankers on Board? Xie finds that if you have a banker on your board of directors, CEO pay sensitivity is likely to be lower. This makes
sense if you consider bankers (who may be looking out for their bank and not just shareholders of the firm) tend to be more risk averse then
diversified shareholders. Additionally, and not surprisingly, the banker has a greater impact on smaller boards.
http://207.36.165.114/Denver/Papers/Banker%20Director%20and%20CEO%20Compensation.pdf

In a very cool article, Almeida, Campello, and Weisbach develop and test a model of cash sensitivity to cash flow. That is they test whether
firms that are subject to financial constraints hold more cash when they have positive cash flows than do firms that apparently have lower
constraints on raising new cash. The results support the theory that market frictions induce firms to hold more cash.
http://www.afajof.org/Pdf/forthcoming/campello.pdf

For numerous reasons managers have an incentive to hold more cash than is optimal from a shareholder perspective. These agency costs problems may be exasperated because cash can provide management with more flexibility in fighting hostile takeovers (example Harford 1999 and Pinkowitz 2002). However, as Faleye points out in an upcoming JF article, takeovers are only one means of disciplining management and
proxy contests rise with cash balances. Equally important, following the proxy contest cash balances fall regardless of outcome of proxy
battle.
http://www.afajof.org/Pdf/forthcoming/Faleye.pdf

Ok, so it may or may not work.  There is still a soft spot in my heart for CPAM.  Why? Because it is such an important and elegant model and I still think it should work.  But of course most research ver the last decade suggests it does not work very well (example Fama And French!). Now why it does not work is the real fun. Is it the model? The market? The researcher? Or some combination of the above? Research from Ang and Chen finds that the time period studied matters as well. For instance, from 1963 on there appears to be a Value anomaly. However, this disappears when the 1926-2001 period is examined and “the market factor alone is able to explain the spread of average returns of these portfolios.” [note the portfolios were created based on book to market values.] Further they find evidence of a time-varying beta relationship where value stocks (i.e. high book to market or equivalently and more commonly in the popular press low market to book ratios) “were risky in the early part of sample, but not in the latter part. This could be really big. (If you are going to the AFA meetings in early January, look for this to be presented there!)
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=346600

From September 25, 2003 edition

Erwan Morellec of the University of Rochester models the effect of managerial risk aversion on manager’s decision making. He shows that risk-averse mangers are more likely to invest early. In his words: “to speed up investment, leading to significant erosion of the value of the option to invest.” Why is this? Again quoting: “By investing, the manger transforms a real option into a productive asset. Because the volatility of a call option is always greater than the volatility of the underlying asset, investing reduces idiosyncratic risk and thus improves
managerial utility.” GREAT article!
http://papers.ssrn.com/abstract_id=422600

Why include a freeze-out provision in takeover contracts? Because if not, investors would not tender shares. How is that? Consider the
Grossman-Hart (1980) view that if the takeover is in fact value maximizing, then shareholders would have an incentive to not tender
their shares but to wait for the stock price to increase. Of course if shareholders knew this, then they would all wait sand the deal would not
get done. Freeze-outs force shareholders’ hands and thereby eliminate the problem of non-tendering shareholders, thus enabling takeovers to
occur. In an soon to be published JF article, Amihud, Kahan, and Sundaram look at the economic desirability of such freeze-outs. (BTW
Wall Freeze-Out does not have the same ring as Tenth Avenue Freeze Out.)
http://www.afajof.org/Pdf/forthcoming/FreezeoutLaws.pdf

Need another anomaly? Eberhart, Maxwell, and Siddique provide us one in their upcoming JF article. They examine an enormous sample of 8,313 firms that “unexpectedly” raised R&D expenditures. Not surprisingly they find (like others before them) that there is a positive stock
response. However, what is sort of surprising is that there is significant under reaction to the announcement and a subsequent long-term drift where the firms increasing R&D experience positive abnormal returns.
http://www.afajof.org/Pdf/forthcoming/MS1617-R3.pdf

From the August 27th, 2003 FinanceProfessor.com newsletter

Internal and external monitoring have a strong complementary (synergistic) effect. That is the finding of Cremers and Nair who show
that firms with both strong internal as well as external controls tend to outperform firms without the strong controls. To test this, the
authors construct various portfolios and find that those firms who measure high on both categories outperform others in the sample
http://papers.ssrn.com/abstract_id=412140

Speaking of external monitors, Dyck and Zingales remind us that we should also consider the role of the media in monitoring (and changing)
corporate behavior. That said, there are definite problems with media monitors. These inefficiencies include a serious misalignment of
incentives that may not lead to shareholder wealth maximization.
http://gsbwww.uchicago.edu/fac/finance/papers/corporate%20governance.pdf

A stock split occurs when a company changes the number of shares it has outstanding. For example, suppose the firm had 1 million shares
outstanding and then announced a 2:1 split. The firm would now have 2 million shares outstanding. It is not surprising that the stock price
drops after the split, but what continues to leave researchers puzzled is why there is a stock price change on the announcement of the split.
For years practitioners have suggested that by making the stock price lower the shares are affordable to a greater number of investors and
hence there is greater liquidity and therefore a higher stock price. Other theories include that the news of the split signals better times
ahead and subsequently it signals higher future dividends. Dhar, Goetzmann, and Zhu use a cool data set to show that true to theory, more
individual investors appear to own (and trade) the stock after the split. However, this is not completely good news. They also find the
post-split shares trade more, have higher serial correlations, and move more with the market indices. All in all the results strengthen
arguments for both a clientele effect and also the view that splits may make the stock trade less efficiently.
http://papers.ssrn.com/abstract_id=410104

What influences what type of debt a firm uses? Denis and Mihov find that the largest determinant is the credit rating of the firm. In their
forthcoming JFE article, they report that high quality firms are more likely to opt for a public issuance while medium rated firms take the
bank debt route and low credit rated firms go for private debt placements. However, credit quality is by no means the only
determinant.
http://jfe.rochester.edu/02195.pdf

Want more on debt financing? Ok, but only since you are nice. There has long been evidence that firms try to time their equity issuances in
order to get the lowest cost of capital possible. Now Baker, Greenwood, and Wurgler report in a forthcoming JFE that firms also time debt
obligations. When long-term rates are low, the firms try to capture these “low” rates, by issuing longer-term debt. Which, while not
surprising, may be further evidence that market efficiency is not market perfection and that the financing waves we see may make sense (and
cents) after all.
http://jfe.rochester.edu/02219.pdf

What better way to spend the July 4th holiday than by catching (or in this case studying) some waves? Ok, so while I would rather be looking
at ocean waves fortunately for us, Pastor and Veronsi decided to study IPO waves on the 4th (see date on paper). They were even nice enough to write about their findings (but no postcard!). They explain IPO waves by creating a model of “optimal IPO timing.” Their model predicts that
firms will be more willing to issue shares when the required returns are lower, when the firm’s expected cash flows are higher (which could be
interpreted at there being more positive investment opportunities-and therefore likely a greater need for cash), and “when the uncertainty
surrounding those [cash] flows is high.” What sets this paper aside from others of the same genre is this not only models the IPO timing,
but it also empirically tests the model. And guess what? It passes! Using data from 1960-2002, the model is supported. What really makes
the paper valuable however is that the model can be used to explain some of the troubling findings that have been pointed out by others in the
field. For example, the finding that market-to-book values for IPO firms drop over time has been suggested to show that investors are
irrational in the pricing of IPOS. However, P&V’s model accurately predicts this decline and explain it not as irrationality but rather
that it is due to less uncertainty (options lose value) and mean reversion. (highly recommended article!)
http://gsbwww.uchicago.edu/fac/finance/papers/ipowave2.pdf

Michael Schill (get used to the name, you will see it about 5 times in this newsletter!) finds that firms raise less money in the primary
markets when the market is more volatile. Predictably, this is most pronounced for small firms and IPO firms. Specifically he finds that
when market volatility is above average, 13% fewer firms go public and they raise about 21% less. Mmm, this may be another partial explanation
for IPO waves.
http://papers.ssrn.com/abstract_id=412160

In a Modigliani and Miller world when corporate taxes are introduced, the optimal debt level increases. Desai, Foley, and Hines have a cool
paper that finds, among other things, that this positive relationship between tax rates and interest does hold. FWIW one of the “other
things” that influences debt financing is the interest rate: the higher the interest rate, the less debt firms use, which fits nicely with the
story above! (BTW, yes this is predominantly intended as an International Finance article, but it is cross-listed here because it is
so relevant.)
http://papers.ssrn.com/abstract_id=405023

From the June 5th, 2003 Newsletter

The newest Fama and French paper is ready! (Believe me in some circles that is more exciting than the next Harry Potter book, but F&F do not
get the widespread press coverage). In this paper they look at the survival rates of firms that are newly listed on major US stock
exchanges. They find that while more firms are listing (excluding last couple of years), the survival rate for these firms has declined. Their
explanation for this is that lower costs of equity have enables “weaker firms…to become viable candidates for public equity financing.”
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=279302

Outside (or independent) directors may not make much difference to executive pay.   That is the finding of Wan’s new paper that finds no
significant variation of pay or of performance at firms that could be tied to independent board members. (mmm, sounds like an endogenity
problem to me---firms that need the monitoring, have more, those that don’t, don’t, so it is hard to find anything cross-sectionally---see
Hartzell and Starks JFE(2003) who combat a similar problem of institutional ownership using changes in ownership. Thus a suggestion:
look at changes in board make-up).
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=392595
http://www.afajof.org/Pdf/forthcoming/hartzell_starks.pdf

It has long been a well-known fact that investment and cash flow are positively correlated. Some view this as a free cash flow problem
(example Lamont on oil firms’ investment following shocks to the industry) while others think this is a market imperfection problem
whereby costs of external financing are so great that firms pass up positive projects due to lack of funds. While both sides no doubt have
much validity, the market imperfection side won some support by a new paper by Gonzalez that finds that in countries with more legal
protections (more investor friendly) there is less sensitivity between capital investments and cash flow.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=392592

From the April 23rd, 2003 newsletter

Adrian and Franzoni have a very cool paper. It looks at the value anomaly (that is value stocks outperform their CAPM prediction). They
find that this may be explained by how we measure beta, specifically Franzoni, in his 2002 paper, finds that the beta of both value stocks
and small stocks has fallen dramatically. This may lead investors to “require an expected excess return that is proportional to the riskiness
they perceive, the econometrician observes a premium in excess of the realized riskiness of these stocks.” In English, this means that
investors use a higher than realized beta in their estimates of required return. This could be enormous! Time to rewrite my notes!
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=391562


From the March 24th, 2003 newsletter

This is exciting! Well at least to me. :-) A forthcoming article by
Hartzell and Starks finds that as institutional ownership goes up, the
firm is more likely to use pay for performance plans. Additionally, the
level of CEO pay tends to go down. These findings suggest that
institutional investors make better monitors than ordinary investors do.
Possibly more convincing however, (since it solves the endogenity
problem which is that is the institutional investors may select which
stocks that pay for performance and pay managers less) is their analysis
that finds as managerial ownership goes up, pay goes down relative to
control groups in the periods that follow. (This one gets used in
class!)
http://www.afajof.org/Pdf/forthcoming/hartzell_starks.pdf

From the January 22nd, 2003 newsletter

Feeling cynical? If you aren’t now, you will by the time you finish the
new Bebchuk and Fried paper on executive compensation. They paint a
fairly gloomy picture of managers exerting their power to “extract rents
and to camouflage the extent of their rent extraction.” Rather than
designed to solve agency cost problems, the paper makes the case that
executive pay can by an agency cost in and of itself. Let’s hope things
aren’t this bad.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=364220

From the December 3rd, 2002 newsletter

If you read only one article from this entire newsletter, make it this one: It is the summary of a paper by Graham and Campbell that looks at
how CFOs implement what we teach in class. Surprisingly, many of the things we spend a great deal of time on, are not used that much. For
example, “maintaining financial flexibility” is seen as the most important determinant in setting a firm’s capital structure. READ IT!
:-)
http://smr.mit.edu/past/2001/smr4221h.html


Appeared in November 5th, 2002 newsletter

Long run performance studies are notoriously model-dependent and
difficult to perform correctly. Thus any study that uses long-run
returns deserves t