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Volume 60: Issue 4 (August 2005)

The Limits of Financial Globalization

Pages: 1595-1638  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00775.x  |  Cited by: 685


Despite the dramatic reduction in explicit barriers to international investment activity over the last 60 years, the impact of financial globalization has been surprisingly limited. I argue that country attributes are still critical to financial decision‐making because of “twin agency problems” that arise because rulers of sovereign states and corporate insiders pursue their own interests at the expense of outside investors. When these twin agency problems are significant, diffuse ownership is inefficient and corporate insiders must co‐invest with other investors, retaining substantial equity. The resulting ownership concentration limits economic growth, financial development, and the ability of a country to take advantage of financial globalization.

Consumption, Dividends, and the Cross Section of Equity Returns

Pages: 1639-1672  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00776.x  |  Cited by: 394


We show that aggregate consumption risks embodied in cash flows can account for the puzzling differences in risk premia across book‐to‐market, momentum, and size‐sorted portfolios. The dynamics of aggregate consumption and cash flow growth rates, modeled as a vector autoregression, are used to measure the consumption beta of discounted cash flows. Differences in these cash flow betas account for more than 60% of the cross‐sectional variation in risk premia. The market price for risk in cash flows is highly significant. We argue that cash flow risk is important for interpreting differences in risk compensation across assets.

Time Variation in the Covariance between Stock Returns and Consumption Growth

Pages: 1673-1712  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00777.x  |  Cited by: 67


The conditional covariance between aggregate stock returns and aggregate consumption growth varies substantially over time. When stock market wealth is high relative to consumption, both the conditional covariance and correlation are high. This pattern is consistent with the “composition effect,” where agents' consumption growth is more closely tied to stock returns when stock wealth is a larger share of total wealth. This variation can be used to test asset‐pricing models in which the price of consumption risk varies. After accounting for variations in this price, the relation between expected excess stock returns and the conditional covariance is negative.

Rational IPO Waves

Pages: 1713-1757  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00778.x  |  Cited by: 308


We argue that the number of firms going public changes over time in response to time variation in market conditions. We develop a model of optimal initial public offering (IPO) timing in which IPO waves are caused by declines in expected market return, increases in expected aggregate profitability, or increases in prior uncertainty about the average future profitability of IPOs. We test and find support for the model's empirical predictions. For example, we find that IPO waves tend to be preceded by high market returns and followed by low market returns.

Does Prospect Theory Explain IPO Market Behavior?

Pages: 1759-1790  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00779.x  |  Cited by: 115


We derive a behavioral measure of the IPO decision‐maker's satisfaction with the underwriter's performance based on Loughran and Ritter (2002) and assess its ability to explain the decision‐maker's choice among underwriters in subsequent securities offerings. Controlling for other known factors, IPO firms are less likely to switch underwriters when our behavioral measure indicates they were satisfied with the IPO underwriter's performance. Underwriters also extract higher fees for subsequent transactions involving satisfied decision‐makers. Although our tests suggest that the behavioral model has explanatory power, they do not speak directly to whether deviations from expected utility maximization determine patterns in IPO initial returns.

Private Equity Performance: Returns, Persistence, and Capital Flows

Pages: 1791-1823  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00780.x  |  Cited by: 1123


This paper investigates the performance and capital inflows of private equity partnerships. Average fund returns (net of fees) approximately equal the S&P 500 although substantial heterogeneity across funds exists. Returns persist strongly across subsequent funds of a partnership. Better performing partnerships are more likely to raise follow‐on funds and larger funds. This relationship is concave, so top performing partnerships grow proportionally less than average performers. At the industry level, market entry and fund performance are procyclical; however, established funds are less sensitive to cycles than new entrants. Several of these results differ markedly from those for mutual funds.

Predatory Trading

Pages: 1825-1863  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00781.x  |  Cited by: 505


This paper studies predatory trading, trading that induces and/or exploits the need of other investors to reduce their positions. We show that if one trader needs to sell, others also sell and subsequently buy back the asset. This leads to price overshooting and a reduced liquidation value for the distressed trader. Hence, the market is illiquid when liquidity is most needed. Further, a trader profits from triggering another trader's crisis, and the crisis can spill over across traders and across markets.

Strategic Behavior and Underpricing in Uniform Price Auctions: Evidence from Finnish Treasury Auctions

Pages: 1865-1902  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00782.x  |  Cited by: 49


We contribute to the debate on the optimal design of multiunit auctions by developing and testing robust implications of the leading theory of uniform price auctions on the bid distributions submitted by individual bidders. The theory, which emphasizes market power, has little support in a data set of Finnish Treasury auctions. A reason may be that the Treasury acts strategically by determining supply after observing bids, apparently treating the auctions as a repeated game between itself and primary dealers. Bidder behavior and underpricing react to the volatility of bond returns in a way that suggests bidders adjust for the winner's curse.

Market Timing and Managerial Portfolio Decisions

Pages: 1903-1949  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00783.x  |  Cited by: 286


This paper provides evidence that top managers have contrarian views on firm value. Managers' perceptions of fundamental value diverge systematically from market valuations, and perceived mispricing seems an important determinant of managers' decision making. Insider trading patterns shows that low valuation firms are regarded as undervalued by their own managers relative to high valuation firms. This finding is robust to controlling for noninformation motivated trading. Further evidence links managers' private portfolio decisions to changes in corporate capital structures, suggesting that managers try to actively time the market both in their private trades and in firm‐level decisions.

Do Insiders Learn from Outsiders? Evidence from Mergers and Acquisitions

Pages: 1951-1982  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00784.x  |  Cited by: 445


I find that the market reaction to a merger and acquisition (M&A) announcement predicts whether the companies later consummate the deal. The relation cannot be explained by the market's anticipation of the closing decision or its perception of the deal quality at the announcement. Merging companies appear to extract information from the market reaction and later consider it in closing the deal. Furthermore, the relation varies with deal characteristics, suggesting that companies seem to have a higher incentive to learn from the market when canceling the announced deal is easier or when the market has more information that the companies do not know.

On the Industry Concentration of Actively Managed Equity Mutual Funds

Pages: 1983-2011  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00785.x  |  Cited by: 769


Mutual fund managers may decide to deviate from a well‐diversified portfolio and concentrate their holdings in industries where they have informational advantages. In this paper, we study the relation between the industry concentration and the performance of actively managed U.S. mutual funds from 1984 to 1999. Our results indicate that, on average, more concentrated funds perform better after controlling for risk and style differences using various performance measures. This finding suggests that investment ability is more evident among managers who hold portfolios concentrated in a few industries.

Managerial Opportunism during Corporate Litigation

Pages: 2013-2041  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00786.x  |  Cited by: 49


Using a large sample of litigation events involving publicly listed defendants, we document a surprising fact. The resolution of litigation through a court's decision dominates settlement of litigation from the shareholders' point of view, even when the firm loses. We develop a model using agency costs within the firm to explain why the market views settlement as a negative outcome on average and find empirical evidence supporting the implications of the model. Specifically, firms with weak corporate governance settle litigation more quickly, and the market reacts more negatively to settlements involving firms with higher agency costs.

The Impact of Bank Consolidation on Commercial Borrower Welfare

Pages: 2043-2082  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00787.x  |  Cited by: 110


We estimate the impact of bank merger announcements on borrowers' stock prices for publicly traded Norwegian firms. Borrowers of target banks lose about 0.8% in equity value, while borrowers of acquiring banks earn positive abnormal returns, suggesting that borrower welfare is influenced by a strategic focus favoring acquiring borrowers. Bank mergers lead to higher relationship exit rates among borrowers of target banks. Larger merger‐induced increases in relationship termination rates are associated with less negative abnormal returns, suggesting that firms with low switching costs switch banks, while similar firms with high switching costs are locked into their current relationship.

Board Seat Accumulation by Executives: A Shareholder's Perspective

Pages: 2083-2123  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00788.x  |  Cited by: 213


While reformers have argued that multiple directorships for executives can destroy value, we investigate firms with executives that accept an outside directorship and find negative announcement returns only when the executive's firm has greater agency problems. When fewer agency concerns exist, additional directorships relate to increased firm value. Announcement returns are also higher when executives accept an outside directorship in a financial, high‐growth, or related‐industry firm. Our results suggest that outside directorships for executives can enhance firm value, which has important implications for firms employing executives nominated for outside boards and for policy recommendations restricting the number of directorships.

Report of the Editor of The Journal of Finance for the Year 2004

Pages: 2125-2139  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00789.x  |  Cited by: 0


Minutes of the Annual Membership Meeting January 8, 2005

Pages: 2141-2142  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00790.x  |  Cited by: 0

Report of the Executive Secretary and Treasurer for the Year Ending September 30, 2004

Pages: 2143-2144  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00791.x  |  Cited by: 0

David H. Pyle


Pages: 2145-2146  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00792.x  |  Cited by: 0

Back Matter

Pages: 2147  |  Published: 8/2005  |  DOI: 10.1111/j.1540-6261.2005.00793.x  |  Cited by: 1