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Volume 69: Issue 2 (April 2014)

Managerial Incentives and Stock Price Manipulation

Pages: 487-526  |  Published: 3/2014  |  DOI: 10.1111/jofi.12129  |  Cited by: 79


We present a rational expectations model of optimal executive compensation in a setting where managers are in a position to manipulate short‐term stock prices and the manipulation propensity is uncertain. We analyze the tradeoffs involved in conditioning pay on long‐ versus short‐term performance and show how manipulation, and investors' uncertainty about it, affects the equilibrium pay contract and the informativeness of prices. Firm and manager characteristics determine the optimal compensation scheme: the strength of incentives, the pay horizon, and the use of options. We consider how corporate governance and disclosure regulations can help create an environment that enables better contracting.

The Importance of Industry Links in Merger Waves

Pages: 527-576  |  Published: 3/2014  |  DOI: 10.1111/jofi.12122  |  Cited by: 319


We represent the economy as a network of industries connected through customer and supplier trade flows. Using this network topology, we find that stronger product market connections lead to a greater incidence of cross‐industry mergers. Furthermore, mergers propagate in waves across the network through customer‐supplier links. Merger activity transmits to close industries quickly and to distant industries with a delay. Finally, economy‐wide merger waves are driven by merger activity in industries that are centrally located in the product market network. Overall, we show that the network of real economic transactions helps to explain the formation and propagation of merger waves.

The Real Effects of Government‐Owned Banks: Evidence from an Emerging Market

Pages: 577-609  |  Published: 3/2014  |  DOI: 10.1111/jofi.12130  |  Cited by: 235


Using plant‐level data for Brazilian manufacturing firms, this paper provides evidence that government control over banks leads to significant political influence over the real decisions of firms. I find that firms eligible for government bank lending expand employment in politically attractive regions near elections. These expansions are associated with additional (favorable) borrowing from government banks. Further, these persistent expansions take place just before competitive elections, and are associated with lower future employment growth by firms in other regions. The analysis suggests that politicians in Brazil use bank lending to shift employment towards politically attractive regions and away from unattractive regions.

Sequential Learning, Predictability, and Optimal Portfolio Returns

Pages: 611-644  |  Published: 3/2014  |  DOI: 10.1111/jofi.12121  |  Cited by: 158


This paper finds statistically and economically significant out‐of‐sample portfolio benefits for an investor who uses models of return predictability when forming optimal portfolios. Investors must account for estimation risk, and incorporate an ensemble of important features, including time‐varying volatility, and time‐varying expected returns driven by payout yield measures that include share repurchase and issuance. Prior research documents a lack of benefits to return predictability, and our results suggest that this is largely due to omitting time‐varying volatility and estimation risk. We also document the sequential process of investors learning about parameters, state variables, and models as new data arrive.

Are Analysts’ Recommendations Informative? Intraday Evidence on the Impact of Time Stamp Delays

Pages: 645-673  |  Published: 3/2014  |  DOI: 10.1111/jofi.12107  |  Cited by: 146


We demonstrate that time stamps reported in I/B/E/S for analysts’ recommendations released during trading hours are systematically delayed. Using newswire‐reported time stamps, we find 30‐minute returns of 1.83% (−2.10%) for upgrades (downgrades), but for this subset of recommendations we find corresponding returns of −0.07% (−0.09%) using I/B/E/S‐reported time stamps. We also examine the information content of recommendations relative to management guidance and earnings announcements. Our evidence suggests that analysts’ recommendations are the most important information disclosure channel examined.

Growth Opportunities, Technology Shocks, and Asset Prices

Pages: 675-718  |  Published: 3/2014  |  DOI: 10.1111/jofi.12136  |  Cited by: 184


We explore the impact of investment‐specific technology (IST) shocks on the cross section of stock returns. Using a structural model, we show that IST shocks have a differential effect on the value of assets in place and the value of growth opportunities. This differential sensitivity to IST shocks has two main implications. First, firm risk premia depend on the contribution of growth opportunities to firm value. Second, firms with similar levels of growth opportunities comove with each other, giving rise to the value factor in stock returns and the failure of the conditional CAPM. Our empirical tests confirm the model's predictions.

A Theory of Debt Maturity: The Long and Short of Debt Overhang

Pages: 719-762  |  Published: 3/2014  |  DOI: 10.1111/jofi.12118  |  Cited by: 204


Debt maturity influences debt overhang, the reduced incentive for highly levered borrowers to make real investments because some value accrues to debt. Reducing maturity can increase or decrease overhang even when shorter term debt's value depends less on firm value. Future overhang is more volatile for shorter term debt, making future investment incentives volatile and influencing immediate investment incentives. With immediate investment, shorter term debt typically imposes lower overhang; longer term debt can impose less if asset volatility is higher in bad times. For future investments, reduced correlation between assets‐in‐place and investment opportunities increases the shorter term debt overhang.

Why Do Firms Evade Taxes? The Role of Information Sharing and Financial Sector Outreach

Pages: 763-817  |  Published: 3/2014  |  DOI: 10.1111/jofi.12123  |  Cited by: 128


Tax evasion is a widespread phenomenon across the globe and even an important factor in the ongoing sovereign debt crisis. We show that firms in countries with better credit information–sharing systems and higher branch penetration evade taxes to a lesser degree. This effect is stronger for smaller firms, firms in smaller cities and towns, firms in industries relying more on external financing, and firms in industries and countries with greater growth potential. This effect is robust to instrumental variable analysis, controlling for firm fixed effects in a smaller panel data set of countries, and many other robustness tests.

Sovereign Default, Domestic Banks, and Financial Institutions

Pages: 819-866  |  Published: 3/2014  |  DOI: 10.1111/jofi.12124  |  Cited by: 373


We present a model of sovereign debt in which, contrary to conventional wisdom, government defaults are costly because they destroy the balance sheets of domestic banks. In our model, better financial institutions allow banks to be more leveraged, thereby making them more vulnerable to sovereign defaults. Our predictions: government defaults should lead to declines in private credit, and these declines should be larger in countries where financial institutions are more developed and banks hold more government bonds. In these same countries, government defaults should be less likely. Using a large panel of countries, we find evidence consistent with these predictions.

Twin Picks: Disentangling the Determinants of Risk‐Taking in Household Portfolios

Pages: 867-906  |  Published: 3/2014  |  DOI: 10.1111/jofi.12125  |  Cited by: 195


This paper investigates risk‐taking in the liquid portfolios held by a large panel of Swedish twins. We document that the portfolio share invested in risky assets is an increasing and concave function of financial wealth, leading to different risk sensitivities across investors. Human capital, which we estimate directly from individual labor income, also affects risk‐taking positively, while internal habit and expenditure commitments tend to reduce it. Our microfindings lend strong support to decreasing relative risk aversion and habit formation preferences. Furthermore, heterogeneous risk sensitivities across investors help reconcile individual preferences with representative‐agent models.

Using Neural Data to Test a Theory of Investor Behavior: An Application to Realization Utility

Pages: 907-946  |  Published: 3/2014  |  DOI: 10.1111/jofi.12126  |  Cited by: 143


We conduct a study in which subjects trade stocks in an experimental market while we measure their brain activity using functional magnetic resonance imaging. All of the subjects trade in a suboptimal way. We use the neural data to test a “realization utility” explanation for their behavior. We find that activity in two areas of the brain that are important for economic decision‐making exhibit activity consistent with the predictions of realization utility. These results provide support for the realization utility model. More generally, they demonstrate that neural data can be helpful in testing models of investor behavior.

Self‐Fulfilling Liquidity Dry‐Ups

Pages: 947-970  |  Published: 3/2014  |  DOI: 10.1111/jofi.12063  |  Cited by: 104


I analyze a model in which holding cash imposes a negative externality: it worsens future adverse selection in markets for long‐term assets, which impairs their role for liquidity provision. Adverse selection worsens when potential sellers of long‐term assets hold more cash because then fewer sales reflect cash needs, and proportionally more sales reflect private information. Moreover, future market illiquidity makes current cash holding more appealing. This feedback effect may result in hoarding behavior and a market breakdown, which I interpret as a self‐fulfilling liquidity dry‐up. This mechanism suggests that imposing liquidity requirements on financial institutions may backfire.


Pages: 971-972  |  Published: 3/2014  |  DOI: 10.1111/jofi.12147  |  Cited by: 0


Pages: 973-973  |  Published: 3/2014  |  DOI: 10.1111/jofi.12160  |  Cited by: 0