Taking Stock
The Stock Market Crash of 2008 Caused the Great Recession: Theory and Evidence
Roger Farmer
NBER Working Paper, October 2011
Abstract:
This paper argues that the stock market crash of 2008, triggered by a collapse in house prices, caused the Great Recession. The paper has three parts. First, it provides evidence of a high correlation between the value of the stock market and the unemployment rate in U.S. data since 1929. Second, it compares a new model of the economy developed in recent papers and books by Farmer, with a classical model and with a textbook Keynesian approach. Third, it provides evidence that fiscal stimulus will not permanently restore full employment. In Farmer's model, as in the Keynesian model, employment is demand determined. But aggregate demand depends on wealth, not on income.
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Aviad Pe'er & Oliver Gottschalg
Strategic Management Journal, December 2011, Pages 1356-1367
Abstract:
This paper advances the debate concerning the relationship between politics and business conduct by investigating the influence of the institutional context on leveraged buyout investments. We propose that the formal and informal institution context in ‘red' states (those dominated by the U.S. Republican Party) is more aligned with the principal strategies through which leveraged buyout investors create value than such a context is in ‘blue' states (those dominated by the Democratic Party). Therefore, according to institutional theory, one would expect, ceteris paribus, a higher likelihood of buyout transactions in red states and vice versa. We analyze a sample of 10,746 U.S. buyout investments in 4,633 distinct target companies made by 2,396 different funds managed by 1,300 private equity firms from 1980 to 2003. The results indicate strong evidence of a positive association between a more aligned institutional context and both the volume of buyout activity and different measures of performance for these buyouts.
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Corporate Governance Objectives of Labor Union Shareholders: Evidence from Proxy Voting
Ashwini Agrawal
Review of Financial Studies, forthcoming
Abstract:
Labor union pension funds have become increasingly vocal in governance matters; however, their motives are subject to fierce debate. I examine the proxy votes of AFL-CIO union funds around an exogenous change in the union representation of workers across firms. AFL-CIO-affiliated shareholders become significantly less opposed to directors once the AFL-CIO labor organization no longer represents a firm's workers. Other institutional investors, including mutual funds and public pension funds, do not exhibit similar voting behavior. Union opposition is also associated with negative valuation effects. The data suggest that some investors pursue worker interests, rather than maximize shareholder value alone.
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Comparing the Investment Behavior of Public and Private Firms
John Asker, Joan Farre-Mensa & Alexander Ljungqvist
NBER Working Paper, September 2011
Abstract:
We evaluate differences in investment behavior between stock market listed and privately held firms in the U.S. using a rich new data source on private firms. Listed firms invest less and are less responsive to changes in investment opportunities compared to observably similar, matched private firms, especially in industries in which stock prices are particularly sensitive to current earnings. These differences do not appear to be due to unobserved differences between public and private firms, how we measure investment opportunities, lifecycle differences, or our matching criteria. We suggest that the patterns we document are most consistent with theoretical models emphasizing the role of managerial myopia.
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Is College a Focal Point of Investor Life?
Massimo Massa & Andrei Simonov
Review of Finance, October 2011, Pages 757-797
Abstract:
We study the link between college interaction and portfolio choice. We consider both the general imprinting of values shared by all the students attending the same school - values-based interaction - and the ensuing interaction with the classmates - bonding-based interaction. We show that even after controlling for the standard motivations of portfolio theory, college-based interaction affects the choice of styles - growth/value investing as well as stock picking. Both dimensions of interaction - values-based and bonding-based interactions - contribute to shape the investor choice. Overall, college interaction significantly affects portfolio choice. Investors invest in the same stocks in which their former classmates do. Each individual college leaves a specific and distinct trace on his students.
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Less Pay and More Sensitivity? Institutional Investor Heterogeneity and CEO Pay
Jae Yong Shin & Jeongil Seo
Journal of Management, November 2011, Pages 1719-1746
Abstract:
In this article, the authors develop and test a theory on the effect of institutional investor heterogeneity on CEO pay. Their theory predicts that institutional investors' incentives and capabilities to monitor CEO pay are determined by the fiduciary responsibilities, conflicts of interest, and information asymmetry that institutional investors face. Their theory suggests, in contrast to previous literature, that public pension funds and mutual funds exert different effects on CEO pay at their portfolio firms because they do not have the same monitoring incentives and capabilities. Using a longitudinal sample of S&P 1500 firms for the years 1998 to 2002, the authors find that public pension fund ownership is more negatively - indeed, oppositely - associated with both the level of CEO pay and CEO pay-for-performance sensitivity than mutual fund ownership. Their findings suggest that (a) researchers' use of institutional investor classifications that do not distinguish public pension fund ownership and mutual fund ownership can be misleading and (b) while CEO pay critics have called for pay plans that are in line with the "less pay and more sensitivity"
principle, this may be an ineffective goal to pursue.
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Corporate Governance, Debt, and Investment Policy during the Great Depression
John Graham, Sonali Hazarika & Krishnamoorthy Narasimhan
NBER Working Paper, September 2011
Abstract:
We study a period of severe disequilibrium to investigate whether board characteristics are related to corporate investment, debt usage, and firm value. During the 1930-1938 Depression era, when the corporate sector was shocked by an unprecedented downturn, we document a relation between board characteristics and firm performance that varies in economically sensible ways: Complex firms (that would benefit more from board advice) exhibit a positive relation between board size and firm value, and simple firms exhibit a negative relation between board size and firm value. Moreover, simple firms with large boards do not downsize adequately in response to the severe economic contraction: they invest more (or shrink less) and use more debt during the 1930s. We document similar effects for the number of outside directors on the board. Finally, we also find that companies with properly aligned governance structures are more likely to replace the company president following poor performance.
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Remuneration Committees, Pay Consultants and the Determination of Executive Directors' Pay
Stuart Ogden & Robert Watson
British Journal of Management, forthcoming
Abstract:
This paper explores how Board Remuneration Committee (Remco) decisions about executive pay are influenced by pay consultants. Drawing on resource dependency theory and case study evidence from five companies, the paper illuminates the complexities of the pressures and processes confronting both Remcos and pay consultants in the determination of executive pay awards. In contrast to ‘managerial power' arguments, it demonstrates that the Remcos are proactive in managing pay policy, conscientious in seeking to ensure that pay is appropriate and not over-generous, and that pay consultants are independent and take their instructions entirely from the Remco. Nevertheless, Remcos' understandings of the wider pay environment, informed by the comparative data supplied by pay consultants, constructs a climate in which the Remcos come to perceive a need for periodic upward pay adjustments to ensure that executive remuneration is consistent with external benchmarks if they are to avoid recruitment and retention problems.
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Political Uncertainty and Risk Premia
Lubos Pastor & Pietro Veronesi
NBER Working Paper, September 2011
Abstract:
We study the pricing of political uncertainty in a general equilibrium model of government policy choice. We find that political uncertainty commands a risk premium whose magnitude is larger in poorer economic conditions. Political uncertainty reduces the value of the implicit put protection that the government provides to the market. It also makes stocks more volatile and more correlated when the economy is weak. In addition, we find that government policies cannot be judged by the stock market response to their announcement. Announcements of deeper reforms tend to elicit less favorable stock market reactions.
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Geographical Proximity and Mutual Funds' Proxy Voting Behavior
Praveen Das
Managerial and Decision Economics, October 2011, Pages 425-437
Abstract:
This paper examines the influence of geographical proximity on mutual fund proxy voting decisions. Using mutual fund proxy voting data for the sample period July 1, 2003 to June 30, 2004, we find that fund managers vote more in favor of management of locally headquartered firms. The results are strong for proposals related to executive compensation, anti-takeover provisions, social and political issues. We provide evidence to show that bias in proxy voting is not being driven by informational advantage; voting bias is prevalent in small as well as large size companies. Additionally, the voting pattern suggests that geographical proximity does not facilitate in better corporate monitoring as revealed in their voting decisions. We find that local fund managers vote more favorably in those proposals which do not increase shareholders' wealth and rights. Our results suggest that familiarity and social interaction between fund managers and firm executives located in the same geographic area might explain the local bias in mutual fund proxy voting behavior.
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Estimating the Effects of Large Shareholders Using a Geographic Instrument
Bo Becker, Henrik Cronqvist & Rüdiger Fahlenbrach
NBER Working Paper, September 2011
Abstract:
Large shareholders may play an important role for firm performance and policies, but identifying this empirically presents a challenge due to the endogeneity of ownership structures. We develop and test an empirical framework which allows us to separate selection from treatment effects of large shareholders. Individual blockholders tend to hold blocks in public firms located close to where they reside. Using this empirical observation, we develop an instrument - the density of wealthy individuals near a firm's headquarters - for the presence of a large, non-managerial individual shareholder in a firm. These shareholders have a large impact on firms, controlling for selection effects.
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The Road Less Traveled: Strategy Distinctiveness and Hedge Fund Performance
Zheng Sun, Ashley Wang & Lu Zheng
Review of Financial Studies, forthcoming
Abstract:
We investigate whether skilled hedge fund managers are more likely to pursue unique investment strategies that result in superior performance. We propose a measure of the distinctiveness of a fund's investment strategy based on historical fund return data. We call the measure the "Strategy Distinctiveness Index" (SDI). We document substantial cross-sectional variations as well as strong persistence in SDI. Our main result indicates that, on average, a higher SDI is associated with better subsequent performance. After adjusting for risk, funds in the highest SDI quintile outperform funds in the lowest quintile by 3.5% in the subsequent year.
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Has the November Effect Replaced the January Effect in Stock Markets?
Ling He & Shao He
Managerial and Decision Economics, October 2011, Pages 481-486
Abstract:
Results of previous studies support the November effect of the 1986 Tax Reform Act (TRA) on certain stock portfolios. The rapid growth of mutual funds driven by the fundamental changes in the retirement benefit system in past decades may expand the seasonality from portfolios to stock markets and lead to a replacement of the January effect with the November effect in stock markets. Results of this study support the January effect in the large-cap and small-cap stock markets in the pre-TRA period, although the January effect may share a large portion of co-variation with the size effect. However, the November effect is independent of the size effect. Furthermore, a major shifting process of the January effect to the November effect occurs in both the large-cap and small-cap stock markets. The significant result of the November effect in the post-TRA period questions the claim that fund managers are capable in mitigating potential price pressures.
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The "CAPS" Prediction System and Stock Market Returns
Christopher Avery, Judith Chevalier & Richard Zeckhauser
NBER Working Paper, August 2011
Abstract:
We study the predictive power of approximately 2.5 million stock picks submitted by individual users to the "CAPS" website run by the Motley Fool company (www.caps.fool.com). These picks prove to be surprisingly informative about future stock prices. Indeed, a strategy of shorting stocks with a disproportionate number of negative picks on the site and buying stocks with a disproportionate number of positive picks produces a return of over nine percent per annum over the sample period. These results are mostly driven by the fact that negative picks on the site strongly predict future stock price declines; positive picks on the site produce returns that are statistically indistinguishable from the market. A Fama French decomposition suggests that these results are largely due to stock-picking rather than style factors or market timing.
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Do Hedge Funds Manage Their Reported Returns?
Vikas Agarwal, Naveen Daniel & Narayan Naik
Review of Financial Studies, October 2011, Pages 3281-3320
Abstract:
For funds with high incentives and more opportunities to inflate returns, we find that (i) returns during December are significantly higher than returns during the rest of the year, even after controlling for risk in both the time series and the cross-section; and (ii) this December spike is greater than for funds with lower incentives and fewer opportunities to inflate returns. These results suggest that hedge funds manage their returns upward in an opportunistic fashion in order to earn higher fees. Finally, we find strong evidence that funds inflate December returns by underreporting returns earlier in the year but only weak evidence that funds borrow from January returns in the following year.
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Trust, Sociability, and Stock Market Participation
Dimitris Georgarakos & Giacomo Pasini
Review of Finance, October 2011, Pages 693-725
Abstract:
This article investigates the importance of both trust and sociability for stock market participation and for differences in stockholding across Europe. We estimate significant effects for the two, and find that sociability can partly balance the discouragement effect on stockholding induced by low regional prevailing trust. We test for exogeneity of trust and sociability indicators using variation in history of political institutions and in frequency of contacts with grandchildren, respectively. Moreover, the effect of trust is stronger in countries with limited participation and low average trust, offering an explanation for the remarkably low stockholding rates of the wealthy living therein.