The Journal of Finance

Proxy Advisory Firms: The Economics of Selling Information to Voters

Published: 04/17/2019   |   DOI: 10.1111/jofi.12779

ANDREY MALENKO, NADYA MALENKO

We analyze how proxy advisors, which sell voting recommendations to shareholders, affect corporate decision‐making. If the quality of the advisor's information is low, there is overreliance on its recommendations and insufficient private information production. In contrast, if the advisor's information is precise, it may be underused because the advisor rations its recommendations to maximize profits. Overall, the advisor's presence leads to more informative voting only if its information is sufficiently precise. We evaluate several proposals on regulating proxy advisors and show that some suggested policies, such as reducing proxy advisors' market power or decreasing litigation pressure, can have negative effects.

Where Is the Risk in Value? Evidence from a Market‐to‐Book Decomposition

Published: 08/09/2019   |   DOI: 10.1111/jofi.12836

ANDREY GOLUBOV, THEODOSIA KONSTANTINIDI

We study the value premium using the multiples‐based market‐to‐book decomposition of Rhodes‐Kropf, Robinson, and Viswanathan (2005). The market‐to‐value component drives all of the value strategy return, while the value‐to‐book component exhibits no return predictability in either portfolio sorts or firm‐level regressions. Existing results linking market‐to‐book to operating leverage, duration, exposure to investment‐specific technology shocks, and analysts’ risk ratings derive from the unpriced value‐to‐book component. In contrast, results on expectation errors, limits to arbitrage, and certain types of cash flow risk and consumption risk exposure are due to the market‐to‐value component. Overall, our evidence casts doubt on several value premium theories.

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.

Strategic and Financial Bidders in Takeover Auctions

Published: 08/06/2014   |   DOI: 10.1111/jofi.12194

ALEXANDER  S. GORBENKO, ANDREY MALENKO

Using data on auctions of companies, we estimate valuations (maximum willingness to pay) of strategic and financial bidders from their bids. We find that a typical target is valued higher by strategic bidders. However, 22.4% of targets in our sample are valued higher by financial bidders. These are mature, poorly performing companies. We also find that (i) valuations of different strategic bidders are more dispersed and (ii) valuations of financial bidders are correlated with aggregate economic conditions. Our results suggest that different targets appeal to different types of bidders, rather than that strategic bidders always value targets more because of synergies.

A Bayesian Approach to Real Options: The Case of Distinguishing between Temporary and Permanent Shocks

Published: 09/21/2010   |   DOI: 10.1111/j.1540-6261.2010.01599.x

STEVEN R. GRENADIER, ANDREY MALENKO

Traditional real options models demonstrate the importance of the “option to wait” due to uncertainty over future shocks to project cash flows. However, there is often another important source of uncertainty: uncertainty over the permanence of past shocks. Adding Bayesian uncertainty over the permanence of past shocks augments the traditional option to wait with an additional “option to learn.” The implied investment behavior differs significantly from that in standard models. For example, investment may occur at a time of stable or decreasing cash flows, respond sluggishly to cash flow shocks, and depend on the timing of project cash flows.

When It Pays to Pay Your Investment Banker: New Evidence on the Role of Financial Advisors in M&As

Published: 01/17/2012   |   DOI: 10.1111/j.1540-6261.2011.01712.x

ANDREY GOLUBOV, DIMITRIS PETMEZAS, NICKOLAOS G. TRAVLOS

We provide new evidence on the role of financial advisors in M&As. Contrary to prior studies, top‐tier advisors deliver higher bidder returns than their non‐top‐tier counterparts but in public acquisitions only, where the advisor reputational exposure and required skills set are relatively larger. This translates into a $65.83 million shareholder gain for an average bidder. The improvement comes from top‐tier advisors' ability to identify more synergistic combinations and to get a larger share of synergies to accrue to bidders. Consistent with the premium price–premium quality equilibrium, top‐tier advisors charge premium fees in these transactions.

DISCUSSION

Published: 07/01/1984   |   DOI: 10.1111/j.1540-6261.1984.tb03685.x

ANDREW H. CHEN

Trade Generation, Reputation, and Sell‐Side Analysts

Published: 03/02/2005   |   DOI: 10.1111/j.1540-6261.2005.00743.x

ANDREW R. JACKSON

This paper examines the trade‐generation and reputation‐building incentives facing sell‐side analysts. Using a unique data set I demonstrate that optimistic analysts generate more trade for their brokerage firms, as do high reputation analysts. I also find that accurate analysts generate higher reputations. The analyst therefore faces a conflict between telling the truth to build her reputation versus misleading investors via optimistic forecasts to generate short‐term increases in trading commissions. In equilibrium I show forecast optimism can exist, even when investment‐banking affiliations are removed. The conclusions may have important policy implications given recent changes in the institutional structure of the brokerage industry.

THE FIRM'S OPTIMAL FINANCIAL DECISIONS: AN INTEGRATION OF CORPORATE FINANCIAL THEORY UNDER CERTAINTY*

Published: 12/01/1974   |   DOI: 10.1111/j.1540-6261.1974.tb03148.x

Andrew J. Senchack

Risk‐Sharing and the Term Structure of Interest Rates

Published: 05/11/2022   |   DOI: 10.1111/jofi.13139

ANDRÉS SCHNEIDER

I propose a general equilibrium model with heterogeneous investors to explain the key properties of the U.S. real and nominal term structure of interest rates. I find that differences in investors' elasticities of intertemporal substitution are critical in accounting for the dynamics of nominal and real yields. The nominal term structure is driven primarily by real shocks so that it can be upward sloping regardless of the correlation between nominal and real shocks.

Theories of Corporate Debt Policy: A Synthesis

Published: 05/01/1979   |   DOI: 10.1111/j.1540-6261.1979.tb02098.x

ANDREW H. CHEN, E. HAN KIM

Institutional Trade Persistence and Long‐Term Equity Returns

Published: 03/21/2011   |   DOI: 10.1111/j.1540-6261.2010.01644.x

AMIL DASGUPTA, ANDREA PRAT, MICHELA VERARDO

Recent studies show that single‐quarter institutional herding positively predicts short‐term returns. Motivated by the theoretical herding literature, which emphasizes endogenous persistence in decisions over time, we estimate the effect of multiquarter institutional buying and selling on stock returns. Using both regression and portfolio tests, we find that persistent institutional trading negatively predicts long‐term returns: persistently sold stocks outperform persistently bought stocks at long horizons. The negative association between returns and institutional trade persistence is not subsumed by past returns or other stock characteristics, is concentrated among smaller stocks, and is stronger for stocks with higher institutional ownership.

Which Investors Fear Expropriation? Evidence from Investors' Portfolio Choices

Published: 05/16/2006   |   DOI: 10.1111/j.1540-6261.2006.00879.x

MARIASSUNTA GIANNETTI, ANDREI SIMONOV

Using a data set that provides unprecedented detail on investors' stockholdings, we analyze whether investors take the quality of corporate governance into account when selecting stocks. We find that all categories of investors (domestic and foreign, institutional and small individual) who generally enjoy only security benefits are reluctant to invest in companies with weak corporate governance. In contrast, individuals connected with company insiders are more likely to invest in weak corporate governance companies. These findings suggest that it is important to distinguish between investors who enjoy private benefits or access private information, and investors who enjoy only security benefits.

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.

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.