The Journal of Finance

Corporate Fraud and Business Conditions: Evidence from IPOs

Published: 11/09/2010   |   DOI: 10.1111/j.1540-6261.2010.01615.x

TRACY YUE WANG, ANDREW WINTON, XIAOYUN YU

We examine how a firm's incentive to commit fraud when going public varies with investor beliefs about industry business conditions. Fraud propensity increases with the level of investor beliefs about industry prospects but decreases when beliefs are extremely high. We find that two mechanisms are at work: monitoring by investors and short‐term executive compensation, both of which vary with investor beliefs about industry prospects. We also find that monitoring incentives of investors and underwriters differ. Our results are consistent with models of investor beliefs and corporate fraud, and suggest that regulators and auditors should be vigilant for fraud during booms.

Complex Asset Markets

Published: 07/20/2023   |   DOI: 10.1111/jofi.13264

ANDREA L. EISFELDT, HANNO LUSTIG, LEI ZHANG

Investors' individual arbitrage models introduce idiosyncratic risk into complex asset strategies, driving up average returns and Sharpe ratios. However, despite the attractive risk‐return trade‐off, participation is limited. This is because effective Sharpe ratios in complex asset markets vary with investors' expertise. Investors with higher expertise, better models, and lower resulting idiosyncratic risk exposures realize higher Sharpe ratios. Their demand deters entry by less sophisticated investors. As predicted by our model, market dislocations are characterized by an increase in idiosyncratic risk, investor exit, and persistently elevated alphas and Sharpe ratios. The selection effect from higher expertise agents' more favorable Sharpe ratios is unique to our model and key to our main results.

On the High‐Frequency Dynamics of Hedge Fund Risk Exposures

Published: 11/26/2012   |   DOI: 10.1111/jofi.12008

ANDREW J. PATTON, TARUN RAMADORAI

We propose a new method to model hedge fund risk exposures using relatively high‐frequency conditioning variables. In a large sample of funds, we find substantial evidence that hedge fund risk exposures vary across and within months, and that capturing within‐month variation is more important for hedge funds than for mutual funds. We consider different within‐month functional forms, and uncover patterns such as day‐of‐the‐month variation in risk exposures. We also find that changes in portfolio allocations, rather than in the risk exposures of the underlying assets, are the main drivers of hedge funds' risk exposure variation.

Auctions with Endogenous Initiation

Published: 11/02/2023   |   DOI: 10.1111/jofi.13288

ALEXANDER S. GORBENKO, ANDREY MALENKO

We study initiation of takeover auctions by potential buyers and the seller. A bidder's indication of interest reveals that she is optimistic about the target. If bidders' values have a substantial common component, as in takeover battles between financial bidders, this effect disincentivizes bidders from indicating interest, and auctions are seller‐initiated. Conversely, in private‐value auctions, such as battles between strategic bidders, equilibria can feature both seller‐ and bidder‐initiated auctions, with the likelihood of the latter decreasing in commonality of values and the probability of a forced sale by the seller. We also relate initiation to bids and auction outcomes.

Ownership Structure, Speculation, and Shareholder Intervention

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.45483

Charles Kahn, Andrew Winton

An institution holding shares in a firm can use information about the firm both for trading (“speculation”) and for deciding whether to intervene to improve firm performance. Intervention increases the value of the institution's existing shareholdings, but intervention only increases the institution's trading profits if it enhances the precision of the institution's information relative to that of uninformed traders. Thus, the ability to speculate can increase or decrease institutional intervention. We examine key factors that affect the intervention decision, the usefulness of “short‐swing” provisions and restricted shares in encouraging institutional intervention, and implications for ownership structure across different firms.

Index Options: The Early Evidence

Published: 07/01/1985   |   DOI: 10.1111/j.1540-6261.1985.tb04998.x

JEREMY EVNINE, ANDREW RUDD

Index options became the most important traded contracts during their first year of existence. Two contracts, namely those on the S&P100 and the Major Markets Index, have a trading volume which typically surpasses the trading volume in all individual stock option contracts. In this paper, we examine the pricing of the options on the S&P100 and the Major Markets Index. Using intra‐day prices, we find the options frequently violate the arbitrage boundary, put/call parity, and are substantially mispriced relative to theoretical values. Our results suggest that tests of option pricing models may be more difficult than previously realized due to nonsynchronous prices, even using “real‐time” data from the exchanges.

Moral Hazard and Optimal Subsidiary Structure for Financial Institutions

Published: 11/27/2005   |   DOI: 10.1111/j.1540-6261.2004.00708.x

CHARLES KAHN, ANDREW WINTON

Banks and related financial institutions often have two separate subsidiaries that make loans of similar type but differing risk, for example, a bank and a finance company, or a “good bank/bad bank” structure. Such “bipartite” structures may prevent risk shifting, in which banks misuse their flexibility in choosing and monitoring loans to exploit their debt holders. By “insulating” safer loans from riskier loans, a bipartite structure reduces risk‐shifting incentives in the safer subsidiary. Bipartite structures are more likely to dominate unitary structures as the downside from riskier loans is higher or as expected profits from the efficient loan mix are lower.

The Disposition Effect and Underreaction to News

Published: 08/03/2006   |   DOI: 10.1111/j.1540-6261.2006.00896.x

ANDREA FRAZZINI

This paper tests whether the “disposition effect,” that is the tendency of investors to ride losses and realize gains, induces “underreaction” to news, leading to return predictability. I use data on mutual fund holdings to construct a new measure of reference purchasing prices for individual stocks, and I show that post‐announcement price drift is most severe whenever capital gains and the news event have the same sign. The magnitude of the drift depends on the capital gains (losses) experienced by the stock holders on the event date. An event‐driven strategy based on this effect yields monthly alphas of over 200 basis points.

Family Firms

Published: 09/11/2003   |   DOI: 10.1111/1540-6261.00601

Mike Burkart, Fausto Panunzi, Andrei Shleifer

We present a model of succession in a firm owned and managed by its founder. The founder decides between hiring a professional manager or leaving management to his heir, as well as on what fraction of the company to float on the stock exchange. We assume that a professional is a better manager than the heir, and describe how the founder's decision is shaped by the legal environment. This theory of separation of ownership from management includes the Anglo‐Saxon and the Continental European patterns of corporate governance as special cases, and generates additional empirical predictions consistent with cross‐country evidence.

WEALTH ACCUMULATION OF BLACK AND WHITE FAMILIES: THE EMPIRICAL EVIDENCE

Published: 05/01/1971   |   DOI: 10.1111/j.1540-6261.1971.tb00904.x

Andrew F. Brimmer, Henry S. Terrell

An Analysis of Divestiture Effects Resulting from Deregulation

Published: 12/01/1986   |   DOI: 10.1111/j.1540-6261.1986.tb02527.x

ANDREW H. CHEN, LARRY J. MERVILLE

Capital market data were used to examine the divestiture effects pertaining to deregulation, the dropping of antitrust charges, and the reversing of the co‐insurance effect associated with the recent breakup of AT&T. The empirical results of the study indicate that significant economic events took place during the breakup process, which led to transfers of wealth from various parties to the securityholders of AT&T. The results also indicate that the buffering effect of regulation was reduced as AT&T went through the total deregulation process. This is in accordance with Peltzman's prediction.

Liquidation Values and Debt Capacity: A Market Equilibrium Approach

Published: 09/01/1992   |   DOI: 10.1111/j.1540-6261.1992.tb04661.x

ANDREI SHLEIFER, ROBERT W. VISHNY

We explore the determinants of liquidation values of assets, particularly focusing on the potential buyers of assets. When a firm in financial distress needs to sell assets, its industry peers are likely to be experiencing problems themselves, leading to asset sales at prices below value in best use. Such illiquidity makes assets cheap in bad times, and so ex ante is a significant private cost of leverage. We use this focus on asset buyers to explain variation in debt capacity across industries and over the business cycle, as well as the rise in U.S. corporate leverage in the 1980s.

Trading Volume: Implications of an Intertemporal Capital Asset Pricing Model

Published: 01/11/2007   |   DOI: 10.1111/j.1540-6261.2006.01005.x

ANDREW W. LO, JIANG WANG

We derive an intertemporal asset pricing model and explore its implications for trading volume and asset returns. We show that investors trade in only two portfolios: the market portfolio, and a hedging portfolio that is used to hedge the risk of changing market conditions. We empirically identify the hedging portfolio using weekly volume and returns data for U.S. stocks, and then test two of its properties implied by the theory: Its return should be an additional risk factor in explaining the cross section of asset returns, and should also be the best predictor of future market returns.

Do Demand Curves for Stocks Slope Down?

Published: 07/01/1986   |   DOI: 10.1111/j.1540-6261.1986.tb04518.x

ANDREI SHLEIFER

Since September, 1976, stocks newly included into the Standard and Poor's 500 Index have earned a significant positive abnormal return at the announcement of the inclusion. This return does not disappear for at least ten days after the inclusion. The returns are positively related to measures of buying by index funds, consistent with the hypothesis that demand curves for stocks slope down. The returns are not related to S & P's bond ratings, which is inconsistent with a plausible version of the hypothesis that inclusion is a certification of the quality of the stock.

Performance Evaluation with Transactions Data: The Stock Selection of Investment Newsletters

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00165

Andrew Metrick

This paper analyzes the equity‐portfolio recommendations made by investment newsletters. Overall, there is no significant evidence of superior stock‐picking ability for this sample of 153 newsletters. Moreover, there is no evidence of abnormal short‐run performance persistence (“hot hands”). The comprehensive and bias‐free transactions database also allows for insights into the precision of performance evaluation. Using a measure of precision defined in the paper, a transactions‐based approach yields a median improvement of 10 percent over a corresponding factor model. This compares favorably with the precision gained by adding factors to the CAPM.

Limitation of Liability and the Ownership Structure of the Firm

Published: 06/01/1993   |   DOI: 10.1111/j.1540-6261.1993.tb04724.x

ANDREW WINTON

This paper models the optimal choice of shareholder liability. If investors want managers to be monitored, the monitors should be residual claimants (shareholders), and monitoring and firm value will increase as shareholders commit more of their wealth to the firm. When liquidating wealth is costly, contingent liability dominates direct investment as a wealth commitment device; however, if wealth is unobservable, under this regime only relatively poor investors will hold shares in equilibrium. This may be prevented at a cost by verifying shareholder wealth and restricting stock transfers. Comparative statics on various liability regimes are used to motivate actual contractual arrangements.

Federal Deposit Insurance, Regulatory Policy, and Optimal Bank Capital*

Published: 03/01/1981   |   DOI: 10.1111/j.1540-6261.1981.tb03534.x

STEPHEN A. BUSER, ANDREW H. CHEN, EDWARD J. KANE

This paper seeks to explain the combination of explicit and implicit pricing for deposit insurance employed by the FDIC. Essentially, the FDIC sells two products—insurance and regulation. To span the product space, it must and does set two prices. We argue that the need to establish regulatory disincentives to bank risk‐taking is the heart of the controversy over the adequacy of bank capital and that the ability to close risky banks before exhausting their charter value (i.e., the value of their right to continue in business) stands at the center of these disincentives and in front of the FDIC's insurance reserves.

When Uncertainty Blows in the Orchard: Comovement and Equilibrium Volatility Risk Premia

Published: 09/17/2013   |   DOI: 10.1111/jofi.12095

ANDREA BURASCHI, FABIO TROJANI, ANDREA VEDOLIN

We provide novel evidence for an equilibrium link between investors' disagreement, the market price of volatility and correlation, and the differential pricing of index and individual equity options. We show that belief disagreement is positively related to (i) the wedge between index and individual volatility risk premia, (ii) the different slope of the smile of index and individual options, and (iii) the correlation risk premium. Priced disagreement risk also explains returns of option volatility and correlation trading strategies in a way that is robust to the inclusion of other risk factors and different market conditions.

THE BLACK BANKS: AN ASSESSMENT OF PERFORMANCE AND PROSPECTS

Published: 05/01/1971   |   DOI: 10.1111/j.1540-6261.1971.tb00905.x

Andrew F. Brimmer

The Limits of p‐Hacking: Some Thought Experiments

Published: 04/30/2021   |   DOI: 10.1111/jofi.13036

ANDREW Y. CHEN

Suppose that the 300+ published asset pricing factors are all spurious. How much p‐hacking is required to produce these factors? If 10,000 researchers generate eight factors every day, it takes hundreds of years. This is because dozens of published t‐statistics exceed 6.0, while the corresponding p‐value is infinitesimal, implying an astronomical amount of p‐hacking in a general model. More structure implies that p‐hacking cannot address ≈100 published t‐statistics that exceed 4.0, as they require an implausibly nonlinear preference for t‐statistics or even more p‐hacking. These results imply that mispricing, risk, and/or frictions have a key role in stock returns.