We examine the effect of financial advisor reputation on wealth gains in corporate takeovers. In view of the adversarial nature of a takeover, we construct a measure of the relative reputation of the advisor. We document that the absolute wealth gain as well as the share of the total takeover wealth gain accruing to the bidder (target) increases (decreases) as the reputation of the bidder's advisor increases relative to that of the target. We also find that the total wealth created in the takeover is positively related to the reputation of bidder and target advisors. While bidder advisor reputation is positively related to the probability of bid success in our sample, we also present some evidence to suggest that bidders with better advisors are more likely to withdraw from potentially value-destroying takeovers.

This paper estimates the agency costs of controlling minority shareholders (CMSs), who have control of a firm's votes, while owning only a minority of the cash flow rights. Analyzing a panel of 309 listed Swedish firms during 1991–1997, for which we have complete and detailed data on ownership and corporate control instruments, we provide these results; families employ CMS structures, via dual-class shares and other corporate control instruments, about 1.5–2 times more often than other categories of owners (corporations, financial institutions). Estimated agency costs of controlling shareholders are 6%–25% of firm value (Tobin's q) for the median firm among the different categories of controlling owners, ceteris paribus. Family CMSs are associated with the largest discount on firm value. The source of the discount seems to be partly what such owners/firms do: return on assets is significantly lower for firms with concentrated vote control. It also seems as if the discount is related to what such owners/firms do not do. Family CMSs seem to hang on to the control too long from the non-controlling shareholders' perspective; e.g., firms with family CMSs are about 50% less likely to be taken over compared to other firms.

We survey two generations of research on corporate governance systems around the world, concentrating on countries other than the U.S. The first generation of international corporate governance research is patterned after the U.S. research that precedes it. These studies examine individual governance mechanisms—particularly board composition and equity ownership—in individual countries. The second generation of international corporate governance research considers the possible impact of differing legal systems on the structure and effectiveness of corporate governance and compares systems across countries.

We investigate the claim that hedge funds offer investors a superior risk-return tradeoff. We do so using a continuous-time version of Dybvig's (1988a), (1988b) payoff distribution pricing model. The evaluation model, which does not require any assumptions with regard to the return distribution of the funds to be evaluated, is applied to the monthly returns of 77 hedge funds and 13 hedge fund indices from May 1990–April 2000. The results show that, as a stand-alone investment, hedge funds do not offer a superior risk-return profile. We find 12 indices and 72 individual funds to be inefficient, with the average efficiency loss amounting to 2.76% per annum for indices and 6.42% for individual funds. Part of the inefficiency cost of individual funds can be diversified away. Funds of funds, however, are not the preferred vehicle for this as their performance appears to suffer badly from their double fee structure. Looking at hedge funds in a portfolio context results in a marked improvement in the evaluation outcomes. Seven of the 12 hedge fund indices and 58 of the 72 individual funds classified as inefficient on a stand-alone basis are capable of producing an efficient payoff profile when mixed with the S&P 500. The best results are obtained when 10%–20% of the portfolio value is invested in hedge funds.

Conservative financial policies are often criticized as serving the interests of managers rather than the interests of stockholders. We test this argument by examining the operating performance and other characteristics of firms that for a five-year period held more than one-fourth of their assets in cash and cash equivalents. Following the five-year period, operating performance of high cash firms is comparable to or greater than the performance of firms matched by size and industry or by a measure of proclivity to hold substantial cash. In addition, proxies for managerial incentive problems, such as ownership and board characteristics, are not unusual and do not explain differences in operating performance among high cash firms. We find that high cash holdings are accompanied by greater investment, particularly R&D expenditures, and by greater growth in assets. For firms that persistently hold large cash reserves, we conclude that such policies support investment without hindering corporate performance.

Using a sample of 495 project finance loan tranches (worth $151 billion) to borrowers in 61 different countries, we examine the relation between legal risk and debt ownership structure. The tranches exhibit high absolute levels of debt ownership concentration: the largest single bank holds 20.3% while the top five banks collectively hold 61.2% of a typical tranche. In countries with strong creditor rights and reliable legal enforcement, lenders create smaller and more concentrated syndicates to facilitate monitoring and low cost contracting. When lenders cannot rely on legal enforcement mechanisms to protect their claims, they create larger and more diffuse syndicates as a way to deter strategic default.

Our analysis explains how vulture investors (vultures) can maintain and exploit their reputations for toughness. Vultures leverage their reputations to extract concessions from stockholders in debt restructurings. To profit from these concessions, vultures must first acquire debt from incumbent bondholders. Buying only the tranches most likely to render them marginal creditors maximizes vulture leverage in debt-purchase negotiations. Vulture profits are proportional to the degree of uncertainty regarding the identity of the marginal debt class.

Financial economists seem to believe that takeovers are partly motivated by the desire to improve poorly performing firms. However, prior empirical evidence in support of this inefficient management hypothesis is rather weak. We provide a detailed re-examination of this hypothesis in a large scale empirical study. We find little evidence that target firms were performing poorly before acquisition, using either operating or stock returns. This result holds both for the sample as a whole and for subsamples of takeovers that are more likely to be disciplinary. We conclude that the conventional view that targets perform poorly is not supported by the data.

Dominant investors can influence the publicly available information about firms by affecting the cost of information collection. Under strategic competition, transparency results in higher variability of profits and output. Thus, lenders prefer less transparency, since this protects firms when in a weak competitive position, while equity holders prefer more. Market interaction creates strategic complementarity in gathering information on competing firms, thus entry by transparent competitors will improve price informativeness. Moreover, as the return to information gathering increases with liquidity, increasing global trading may undermine the ability of bank control to keep firms opaque.

Recent theoretical models show that irrational expectations can generate return predictability consistent with apparent violations of weak-form market efficiency documented in the empirical literature. These behavioral models constrain rational investors' ability toexploit inter-temporal predictability by assuming that rational agents face high transactions costs, are myopic, or are non-existent. This paper presents a model in which there are two types of irrational expectations, one that causes momentum and another that creates reversals. I investigate whether these types of predictability will persist in the presence of fully rational agents who face no transactions costs, are long lived, and trade dynamically to optimally exploit any predictability due to irrational mispricings. I show that weak-form market efficiency will be violated under two very weak conditions: rational investors are risk averse and the fundamental value of the asset is risky. The paper also investigates the accumulation of wealth by trader type and shows that irrational agents will survive under a large set of parameters.

We investigate whether intertemporal variation in stock and bond risk premia can be explained by time-varying covariances with priced risk factors. We estimate and test a conditional two-factor variant of Merton's ICAPM in which excess returns on an equity index and a long-term government bond portfolio proxy for risk factors. Conditional second moments follow the asymmetric dynamic covariance (ADC) model of Kroner and Ng (1998). We find that conditional bond variance responds symmetrically to bond return shocks but is virtually unaffected by stock return shocks, while conditional stock variance responds asymmetrically to both stock and bond return shocks. Models that impose a constant correlation restriction on the covariance matrix between stock and bond returns are strongly rejected. We conclude that the conditional two-factor model fails to adequately explain intertemporal variation in stock and bond risk premia.

This study assesses trade execution costs and market quality for NYSE and Nasdaq stocks before and after the 2001 change to decimal pricing. Several theoretical predictions are confirmed. Quoted bid-ask spreads declined substantially on each market, with the largest declines for heavily traded stocks. The percentage of shares receiving price improvement increased on the NYSE, but not on Nasdaq. However, those trades completed at prices within or outside the quotes were improved or disimproved by smaller amounts after decimalization, and trades completed outside the quotes saw the largest reductions in trade execution costs, as a class. Effective bid-ask spreads as a percentage of share price, arguably the most relevant measure of execution costs for smaller trades, averaged 0.33% on a volume-weighted basis after decimalization for both NYSE and Nasdaq stocks. There is no evidence of systematic intraday reversals of quote changes on either market, as would be expected if decimalization had damaged liquidity supply.

This paper develops an expected utility model of a multinational firm facing exchange rate risk exposure to a foreign currency cash flow. Currency derivative markets do not exist between the domestic and foreign currencies. There are, however, currency futures and options markets between the domestic currency and a third currency to which the firm has access. Since a triangular parity condition holds among these three currencies, the available, yet incomplete, currency futures and options markets still provide a useful avenue for the firm to indirectly hedge against its foreign exchange risk exposure. This paper offers analytical insights into the optimal cross-hedging strategies of the firm. In particular, the results show the optimality of using options in conjunction with futures in the case of currency mismatching, even though cash flows appear to be linear.

Estimating implied volatility by inverting the Black-Scholes formula is subject to considerable error when option characteristics are observed with plausible errors. Especially for options away from the money, large changes in volatility produce small changes in option prices. Conversely, small errors in option prices and other option characteristics produce large errors in implied volatilities. In the presence of small measurement errors, unobserved truncation of option prices that violate lower bounds for absence of arbitrage can also lead to systematic volatility smiles. The paper proposes feasible GLS estimators that reduce the noise and bias in implied volatility estimates.

We investigate the impact of Focus Listing by the Council of Institutional Investors on targeting poorly performing firms. Post-listing stock returns for the targeted firms differ insignificantly from those of a suitable benchmark group. Institutional investors increase their holdings of targeted firms, but not by more than those of the benchmark firms. Similarly, though analysts revise earnings forecasts up for Focus Listed firms, they do so well after the listing event and positive revisions are no greater than the benchmark group. Moreover, there appears to be little difference between Focus List and benchmark firms in the incidence of post-listing events such as mergers and stock repurchases. Overall, we find very little evidence of the efficacy of shareholder activism.

This paper shows that there is a close relation between corporate governance and the portfolios held by investors. Most firms in countries with poor investor protection are controlled by large shareholders, so that only a fraction of the shares issued by firms in these countries can be freely traded and held by portfolio investors. We show that the prevalence of closely-held firms in most countries helps explain why these countries exhibit a home bias in share holdings and why U.S. investors underweight foreign countries in their portfolios. We construct an estimate of the world portfolio of shares available to investors who are not controlling shareholders (the world float portfolio). The world float portfolio differs sharply from the world market portfolio. In regressions explaining the portfolio weights of U.S. investors, the world float portfolio has a positive significant coefficient but the world market portfolio has no additional explanatory power. This result holds when we control for country characteristics. An analysis of foreign investor holdings at the firm level for Sweden confirms the importance of the float portfolio as a determinant of these holdings.

Agency problems are an important determinant of corporate cash holdings. For a sample of more than 11,000 firms from 45 countries, we find that corporations in countries where shareholders rights are not well protected hold up to twice as much cash as corporations in countries with good shareholder protection. In addition, when shareholder protection is poor, factors that generally drive the need for cash holdings, such as investment opportunities and asymmetric information, actually become less important. These results are stronger after controlling for capital market development. Indeed, consistent with the importance of agency costs, we find that firms hold larger cash balances when access to funds is easier. Our evidence is consistent with the conjecture that investors in countries with poor shareholder protection cannot force managers to disgorge excessive cash balances.

This paper uses an HJM model to price TIPS and related derivative securities. First, using the market prices of TIPS and ordinary U.S. Treasury securities, both the real and nominal zero-coupon bond price curves are obtained using standard coupon bond price stripping procedures. Next, a three-factor arbitrage-free term structure model is fit to the time-series evolutions of the CPI-U and the real and nominal zero-coupon bond price curves. Then, using these estimated term structure parameters, the validity of the HJM model for pricing TIPS is confirmed via its hedging performance. Lastly, the usefulness of the pricing model is illustrated by valuing call options on the inflation index.

Recent research has examined the performance of stocks held by U.S. mutual funds and found they realize abnormal returns. The result is significant as it stands in contrast to the general consensus from traditional performance studies that mutual funds do not possess superior information. Employing a unique dataset, I examine the performance of the monthly stock holdings and trades of a sample of Australian fund managers. When stock holdings are observable, performance measures can be constructed that are more precise than traditional fund manager performance measures. I find the stocks held by fund managers realize abnormal returns consistent with some stock selection ability across fund managers. Examining the performance of their individual trades, I find that the stocks they buy realize abnormal returns whereas for sell trades I find no evidence of abnormal returns. Overall, the results suggest fund managers have the ability to select stocks that realize positive abnormal returns thus providing out-of-sample support for similar recent findings for U.S. mutual funds.

We study how minimum trading unit changes on the Tel-Aviv Stock Exchange impact a stock's trading activity, price volatility, and value. The value effects are consistent with Merton's (1987) model, i.e., an increase in the investor base (trading volume) and a decrease in price noisiness affect stock value positively. Our results extend Amihud, Mendelson, and Uno's (1999) tests of Merton by demonstrating a clear relation between price noisiness changes and stock value changes, and by showing that the response to a minimum trading unit decrease becomes less favorable (and arguably even negative) in the thinnest trading stocks.