Associate Professor of Finance
Rifkin Family Faculty Fellow
Kelley School of Business
Finance Department, Room HH6109
1309 East 10th Street
Bloomington, IN 47405
Tel: +1 812 856 0749
Papers available from SSRN, Vita
We show that the performance of actively managed equity mutual funds increases when portfolios are concentrated in the top one or two stocks within each industry sector. Funds managed by a single manager have much more concentrated portfolios, tend to perform better, and have higher expense ratios than funds managed by multiple managers. We observe that when a fund's management design is changed from single manager to multiple managers, the portfolio's within- and cross-sector concentration, performance, and expense ratios decrease.
We examine whether the stock market considers corporate lobbying to be value enhancing, using an event that potentially limited the ability of firms to lobby but was exogenous to their characteristics and prior lobbying decisions. The results show that this exogenous shock negatively affects the value of firms that lobby. In particular, we estimate that a firm that spends $100,000 more on lobbying in the 3 years before the shock (where sample average lobbying expenses are about $4 million), experiences a loss of about $1.2 million in shareholder value on average. We also examine the channels through which lobbying may create value for firms.
Using hand-collected data, we document the actual separation pay given to CEOs upon departing their company and show that, on average, actual separation pay levels are $3 million higher than the amount specified in the CEO's severance contract. We investigate several potential explanations for this phenomenon and find evidence that in voluntary departures, excess separation pay represents a governance problem. In contrast, we find evidence that in forced departures, excess separation pay represents a need to facilitate a quick and smooth transition from the failed ex-CEO to a new CEO. These results help to shed light on the dual role played by severance compensation and on the bargaining game played between the board and the departing executive.
Complex assets are assets that are difficult to value in the short term. In this paper, we analyze the incentives of a manager who is compensated based on short-term stock prices to invest in complex assets and explore how the manager's investment decision is affected by the presence of a large shareholder. The short-term stock price reflects information about the profitability of the investment to the extent that a large shareholder collects private information and trades on it. We model the large shareholder as a mutual fund or a hedge fund manager and show that large ownership stakes by these agents motivates the firm's manager to invest in more complex projects. This, in turn, lowers the large shareholder's incentive to collect information. The key to our model is the observation that the horizon of the fund manager, who is in effect the large shareholder, may be shorter than the time needed for the project's true value to become known to the public. This leads to an equilibrium in which the trades of the fund manager bias the short term price upwards and managers increase the complexity of their investment projects in order to strengthen this upward bias.
This paper analyzes whether political connections of public corporations in the United States affect the allocation of government procurement contracts. The paper classifies the political affiliation of S&P 500 companies using hand collected data that detail the past political position of each of their board members. Using this classification, the study focuses on the change in control of both House and Senate following the 1994 midterm election and on the change in the Presidency following the 2000 election. An analysis of the change in the value of the procurement contracts awarded to these companies before and after 1994 and 2000, respectively, indicates that companies that are connected to the winning (losing) party are significantly more likely to experience an increase (decrease) in procurement contracts. The results remain significant after controlling for industry classifications as well as for several firm characteristics. In total, these findings suggest that the allocation of procurement contracts is influenced, at least in part, by political connections. Thus, our study provides one of the first pieces of evidence showing a direct avenue through which political connections add value to U.S. companies.
Previous work on fraudulent earnings manipulation has focused on the fraud firm. This paper broadens the scope of analysis and studies how fraud impacts the rivals of the fraud firm. Our starting point is the observation that a rival firm may either suffer or benefit from the revelation that one of its competitors has committed fraud. On the one hand a rival firm may benefit due to the expectation that the fraud firm will be less able to compete in the product market. On the other hand the rival firm may suffer to the extent that the revelation of inflated earnings by the fraud firm results in shareholders revising downward their assessment of future rival firm or industry-wide profits. Based on this observation we develop several predictions about the impact of the announcement of fraud and find that while rival firms, on average, suffer a loss in value upon the revelation of fraud this negative effect is not uniform across all rivals. Consistent with our predictions, we find, for example, that announcement returns are higher for rival firms in more concentrated industries, for rivals of larger fraud firms, and for rivals with lower valuation uncertainty.
This paper explores whether political connections are important in the United States. The paper uses an original hand-collected data set on the political connections of board members of S&P500 companies to sort companies into those connected to the Republican Party and those connected to the Democratic Party. The analysis shows a positive abnormal stock return following the announcement of the nomination of a politically connected individual to the board. The paper also analyzes the stock price response to the Republican win of the 2000 Presidential Election and finds that companies connected to the Republican Party increase in value while companies connected to the Democratic Party decrease in value.
This paper develops an agency model in which stock-based compensation is a double-edged sword, inducing managers to exert productive effort but also to divert valuable firm resources to misrepresent performance. We examine how the potential for manipulation affects the equilibrium level of pay-for-performance sensitivity and derive several new cross-sectional implications that are consistent with recent empirical studies. In addition, we analyze the impact of recent regulatory changes contained in the Sarbanes-Oxley Act of 2002 and show how policies intended to increase firm value by reducing misrepresentation can actually reduce firm value or increase the upward bias in manipulated disclosures.
We offer an explanation for why raiders do not acquire the maximum possible toehold prior to announcing a takeover bid. By endogenously modeling the target firm's value following an unsuccessful takeover we demonstrate that a raider may optimally acquire a small toehold even if the acquisition does not drive up the pre-tender target price. This occurs because although a larger toehold increases profits if the takeover succeeds it also conveys a higher level of managerial entrenchment and hence a lower firm value if the takeover fails. We derive new predictions regarding the optimal toehold and target value following a failed takeover. We also examine the impact of a rival bidder and dilution.
We analyze the impact of organizational form on the incentive of market participants to collect value relevant information about divisions of the firm. We explore whether the market collects less information about divisions of a multi division firm relative to the case in which each division trades as a separate firm. We find that organizational form has a non-trivial impact on information collection. In particular, we find that a spinoff may lead to either an increase or a decrease in aggregate information collection. We explore how this result affects firm value and find the conditions under which a spinoff increases and decreases firm value. Our results provide a novel rationale for why firms may choose to spinoff a division or issue a tracking stock.
We analyze the resource allocation decision of a manager inside a multi-division firm whose compensation is based on the firm's stock price. We find that internal investments exhibit a positive correlation across the firms divisions. Namely, when two single-division firms merge the optimal investment level in one division becomes more positively related to the investment level in the other division. In addition, following a spinoff, divisional investments decline (increase) whenever the separated division has a project with a low (high) Sharpe ratio. Finally, multi-division firms trade at a discount which is larger the more diverse the investment sets of the divisions.
This paper examines how information becomes reflected in prices when investment decisions are delegated to fund managers whose tenure may be shorter than the time it takes for their private information to become public. We consider a sequence of managers, where each subsequent manager inherits the portfolio of their predecessor. We show that the inherited portfolio distorts the subsequent manager's incentive to trade on long-term information. This allows erroneous past information to persist, causing mispricing similar to a bubble. We investigate the magnitude of the mispricing. In addition, we examine endogenous information quality. In some cases, information quality increases when the manager's expected tenure decreases.
Do informed shareholders who can influence corporate decisions improve governance? We demonstrate this may not be generally true in a model of takeovers. The model suggests that a shareholder's ability to collect information and trade ex post may cause him, ex ante, to support value-destroying takeovers or oppose value-enhancing takeovers. Surprisingly, we find conditions under which giving the active shareholder greater influence power weakens governance and reduces firm value, even if such influence power can be used to reject bad takeovers ex post. Our model sheds light on why relying on informed, active shareholders to improve governance has its limits.
Media reporting of financial news is an important channel through which many investors become informed. However, is coverage of corporate financial news likely to be politically unbiased, as typically assumed? We examine financial news reports on the largest 100 U.S. firms published in the two most widely circulated national newspapers, the New York Times, and the Wall Street Journal, and find evidence of political polarization. We observe that the tone of coverage of financial news is more positive, the likelihood of coverage is lower, and length of the article is shorter, for firms that share the newspaper's political ideology compared to firms on the opposite end of the political spectrum. For example, a financial news article on a politically affiliated firm has 20% more positive words, and on a politically unaffiliated firm has 10% fewer positive words. The likelihood of coverage of "bad news" is higher and that of "good news" is lower for firms that are not politically aligned with the media source. Examining the impact of political polarization in financial news coverage on stock markets, we find that disagreement between news sources may affect trading volume, and these effects are driven by the most political firms. In particular, coverage in both newspapers compared to the same amount of coverage in just one newspaper increases daily trading volume for firms at the political extremes by $407,400 relative to mean volume, compared to $174,600 on average for the rest of the sample.
How should one regulate a firm when its investment may cause a negative externality? In this paper we present a model on regulating a firm run by an agent and owned by a principal. The regulator can impose a penalty on the agent, the principal, or both. Our characterization of optimal regulation in the presence of a principal-agent conflict demonstrates several key results. First, we find that regulation costs are lower when the principal and the agent are separate entities. Second, optimal regulation can take two forms. In one regulatory strategy fines are imposed on shareholders and they are lower if the shareholders fire the manager following a negative externality. In the other regulatory strategy fines are imposed only on the manager and no firing takes place. Finally, as the agency conflict becomes more severe the "no firing" strategy becomes more attractive.
We develop a simple model in which financial media plays an economic role: some investors only observe firm announcements that are covered by journalists. The introduction of journalists induces more informed trading by readers, but inadvertently incentivizes the manager to obfuscate announcements. We argue that this obfuscation arises in spite of journalists, not because of them. Although the stock becomes mispriced, readers are better off and prices are more informative. We find two endogenous biases: extreme financial news is more likely to be reported than mundane news and good news is more likely to be reported than bad news.