Tag: Stock returns

The Product Market Effects of Hedge Fund Activism

Praveen Kumar is Professor of Finance at the University of Houston. This post is based on an article authored by Professor Kumar and Hadiye Aslan, Assistant Professor of Finance at Georgia State University, available here. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here), The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here), The Law and Economics of Blockholder Disclosure by Lucian Bebchuk and Robert J. Jackson Jr. (discussed on the Forum here), and Pre-Disclosure Accumulations by Activist Investors: Evidence and Policy by Lucian Bebchuk, Alon Brav, Robert J. Jackson Jr., and Wei Jiang.

Whether intervention by activist investors, such as hedge funds, is beneficial or detrimental to the shareholders of target firms remains controversial. Proponents marshal considerable empirical evidence that hedge fund activism (HFA) is associated with significant medium-to-long-run improvements in targets’ cost and investment efficiency, profitability, productivity, and shareholder returns. Opponents, however, insist that HFA forces management to take myopic decisions that weaken firms in the longer run. The debate rages in academia, media, and has already featured in the 2016 presidential campaign.

Despite this intense interest, however, the research on the effects HFA has typically focused only on its impact on the performance of target firms. But targets of HFA do not exist in vacuum; they have industry competitors, suppliers, and customers. It is by now well known that HFA has a broad scope that often—simultaneously or sequentially—touches on virtually every major aspect of company management, including changes in product market strategy, negotiation tactics with suppliers and customers, and knowledge-based technical advice of production organization. In particular, HFA that improves target’s cost efficiency and product differentiation, and generally redesigns its competitive strategy, should have a significant impact on the target’s competitors (or rival firms). This prediction follows from basic principles of strategic interaction among firms in oligopolistic interaction. Indeed, the received theory of industrial organization provides the effects of cost improvements and product differentiation on rivals’ equilibrium profits and market shares.


Are Institutions Informed About News?

Norman Schürhoff is Professor of Finance at the Swiss Finance Institute. This post is based on an article authored by Professor Schürhoff; Terrence Hendershott, Professor of Finance at the University of California, Berkeley; and Dmitry Livdan, Associate Professor of Finance at the University of California, Berkeley.

Who is informed on the stock market? There are plenty of reasons to believe that institutional investors possess value-relevant information. Unlike retail investors, institutions often directly communicate with publicly traded firms as well as brokerage firms through their investment banking, lending, and asset management divisions. Most mutual funds and hedge funds employ buy-side analysts and enjoy better relationships with sell-side analysts. Their economies of scale allow institutions to monitor many sources of information. Last but not least, institutions employ professionals and technologies with superior information processing skills. Yet, the academic literature has struggled to identify the information channel in institutional trading. There is some evidence that institutional investors are informed, but studies examining institutional order flow around specific events provide mixed evidence.


Active Ownership

Oğuzhan Karakaş is Assistant Professor of Finance at Boston College. This post is based on an article authored by Professor Karakaş; Elroy Dimson, Professor of Finance at London Business School; and Xi Li, Assistant Professor of Accounting at Temple University. Related research from the Program on Corporate Governance includes Socially Responsible Firms by Allen Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here).

In our paper, Active Ownership, forthcoming in the Review of Financial Studies, we analyze highly intensive engagements on environmental, social, and governance (ESG) issues by a large institutional investor with a major commitment to responsible investment (hereafter “ESG activism” or “active ownership”). Given the relative lack of research on environmentally and socially themed engagements, we emphasize the environmental and social (ES) engagements throughout the paper and use the corporate governance (CG) engagements as a basis for comparison.


Firms and Earnings Guidance

Kristian Allee is Assistant Professor of Accounting at the University of Wisconsin. This post is based on an article authored by Professor Allee; Ted Christensen, Professor of Accounting at Brigham Young University; Bryan Graden, Assistant Professor of Accounting at Illinois State University; and Ken Merkley, Assistant Professor of Accounting at Cornell University.

Understanding the formation of firms’ disclosure practices is of significant interest to regulators, managers, and investors. Anecdotal evidence and prior disclosure research generally conclude that firms’ current disclosure practices are often tightly connected to prior disclosure practices. However, prior disclosure practices must have a beginning in their own right, begging the questions of when and why disclosure practices begin. In our paper, When Do Firms Initiate Earnings Guidance? The Timing, Consequences, and Characteristics of Firms’ First Earnings Guidance, we examine when firms initiate earnings guidance (i.e., establish an earnings guidance policy) after an Initial Public Offering (IPO) and what factors are associated with the initiation decision.


Timing Stock Trades for Personal Gain: Private Information and Sales of Shares by CEOs

Robert Parrino is Professor of Finance at the University of Texas at Austin. This post is based on an article by Professor Parrino; Eliezer Fich, Associate Professor of Finance at Drexel University; and Anh Tran, Senior Lecturer in Finance at City University London. Related research from the Program on Corporate Governance includes Insider Trading via the Corporation by Jesse Fried (discussed on the Forum here), Paying for Long-Term Performance (discussed on the Forum here) and the book Pay without Performance: The Unfulfilled Promise of Executive Compensation, both by Lucian Bebchuk and Jesse Fried.

In October 2000, the SEC enacted Rule 10b5-1 which enables managers to reduce their exposure to allegations of trading on material non-public information by announcing pre-planned stock sales up to two years in advance. In our paper, Timing Stock Trades for Personal Gain: Private Information and Sales of Shares by CEOs, which was recently made publicly available on SSRN, we examine the impact of Rule 10b5-1 on the gains that CEOs earn when they sell large blocks of stock.


Financial Distress, Stock Returns, and the 1978 Bankruptcy Reform Act

Dirk Hackbarth is Associate Professor of Finance at Boston University. This post is based on an article authored by Professor Hackbarth; Rainer Haselmann, Professor of Finance, Accounting, and Taxation at Goethe University, Frankfurt; and David Schoenherr of the Department of Finance at London Business School.

In our article, Financial Distress, Stock Returns, and the 1978 Bankruptcy Reform Act, forthcoming in The Review of Financial Studies, we examine how bargaining power in distress affects the pricing of corporate securities. The nature of Chapter 11 makes bargaining an important factor in distressed reorganizations. Reorganization outcomes depend on the relative bargaining power of the parties involved. A number of papers document that shareholders receive concessions in distressed reorganization even when creditors are not paid in full despite of their contractual (junior) status as residual claimants (Franks and Torous 1989; Eberhart, Moore and Roenfeldt 1990; Weiss 1990). To this end, our research exploits an exogenous variation in the allocation of bargaining power between shareholders and debtholders due to the 1978 Bankruptcy Reform Act to examine how the ex post allocation of cash flows in distress affects the ex ante pricing (return and risk) of corporate securities, such as risky debt and levered equity.


Are Companies Setting Challenging Target Incentive Goals?

The following post comes to us from Pay Governance LLC and is based on a Pay Governance memorandum by Ira Kay, Steve Friedman, Brian Lane, Blaine Martin, and Soren Meischeid.

Do companies set appropriately challenging goals in their incentive plans? How does a compensation committee determine whether management is recommending challenging goals? How important are earnings guidance and analyst expectations in goal setting? Are more challenging goals achieved as frequently as less challenging goals? How much are annual incentive payouts increased by the achievement of incentive goals? How does the stock market react to challenging goals?


The Corporation as Time Machine

Lynn Stout is the Distinguished Professor of Corporate and Business Law at Cornell Law School.

My article, The Corporation as Time Machine: Intergenerational Equity, Intergenerational Efficiency, and the Corporate Form, advances an explanation for the rise of the corporate form and an alternative perspective on its economic function. The article argues that the board-controlled corporate entity is a legal innovation that can transfer wealth forward and sometimes backward through time, for the benefit of both present and future generations. The article was written for a symposium organized around the author’s prior work with Margaret Blair.

The corporate form allows natural persons to aggregate and transfer resources to a legal person with the capacity to hold assets in its own name in perpetuity. When the corporate entity is controlled by a board subject to the fiduciary duty of loyalty, corporate assets can be “locked in” and insulated from the demands of natural persons (e.g., the current generation of shareholders) who want to extract and consume them. Asset lock-in thus permits board-controlled corporate entities with perpetual life to invest in and pursue projects that may generate wealth only in later time periods, possibly even after the current cohort of human beings has ceased to exist.


Weather-Induced Mood, Institutional Investors, and Stock Returns

The following post comes to us from William Goetzmann, Professor of Finance at Yale University; Dasol Kim of the Department of Banking and Finance at Case Western Reserve University; Alok Kumar, Professor of Finance at the University of Miami; and Qin Wang of the Department of Accounting and Finance at the University of Michigan at Dearborn.

Studies showing that weather patterns in major financial centers influence stock index returns provide suggestive evidence that investor mood influences asset prices (Saunders, 1993; Hirshleifer and Shumway, 2003). Individuals may misattribute mood induced by weather as information when making assessments about objects that should be otherwise unrelated (Schwarz and Clore, 1983), leading to mood-congruent judgments. For example, sunnier days may induce good moods amongst investors, generating overly optimistic beliefs regarding their investments and congruently influencing their trading decisions. Despite strong evidence of the weather effect on stock index returns, establishing plausibility in mood-based explanations relies in part on distinguishing which group of investors drives the weather effect, and directly confirming mood effects in their judgments.


Relative Total Shareholder Return Performance Awards

The following post comes to us from Frederic W. Cook & Co., Inc., and is based on the Executive Summary of a FW Cook publication by David Cole and Jin Fu. The complete publication is available here.

Since 2010, performance-contingent awards have been the most widely used long-term incentive (LTI) grant type among the Top 250 companies [1] and are now in use by 89% of the sample. The prevalence of performance awards and investor preferences have spurred considerable interest in relative total shareholder return (TSR) as a performance metric. Relative TSR measures a company’s shareholder returns [2] against an external comparator group and eliminates the need to set multi-year goals. Use of relative TSR performance awards among the Top 250 companies has increased from 29% in 2010 to 49% in 2014, and relative TSR is now the most prevalent measure used to evaluate company performance for performance awards.


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