The Future of Securities Regulation

The U.S. system of security law was designed more than 70 years ago to regain investors’ trust after a major financial crisis. Today we face a similar problem. But while in the 1930s the prevailing perception was that investors had been defrauded by offerings of dubious quality securities, in the new millennium, investors’ perception is that they have been defrauded by managers who are not … [ Read more ]

Modigliani and Miller Meet Chandler: Organizational Complexity and Capital Structure

We study how the degree of organizational complexity of a firm relates to its corporate financial policies. We measure complexity as the number of layers in the firm’s subsidiary structure, and focus on a sample of US firms over the period 1996-2006. We argue that organizational complexity makes the firm opaque and increases the asymmetry of information between it and the market. We show that … [ Read more ]

Economic Characteristics, Corporate Governance, and the Influence of Compensation Consultants on Executive Pay Levels

This study investigates the relation between the use of compensation consultants and CEO pay levels. Using new proxy statement disclosures from 2,116 companies, we examine claims that pay is higher in clients of compensation consultants, and test whether any pay differences in users and non-users of consultants are due to differences in economic or corporate governance characteristics. We find that CEO pay is generally higher … [ Read more ]

A Survey of Behavioral Finance

Behavioral finance argues that some financial phenomena can plausibly be understood using models in which some agents are not fully rational. The field has two building blocks: limits to arbitrage, which argues that it can be difficult for rational traders to undo the dislocations caused by less rational traders; and psychology, which catalogues the kinds of deviations from full rationality we might expect to … [ Read more ]

A Unified Theory of Ten Financial Puzzles has a post (with link) about an important finance paper which potentially explains “a host of puzzles.”

Towards an Integrated Theory of Intellectual Property

Abstract: This Article addresses a curious gap in the theory of intellectual property. One of the central dogmas in both the legal and economic literatures is that patents, copyrights and trademarks constitute separate forms of protection, each serving different purposes and designed to operate independently of the others. By challenging this dogma, however, this Article shows that certain combinations of intellectual property protection give … [ Read more ]

The Differential Roles of Respect and Trust on Negotiation

This paper examines the effect trust and respect has on the strategies used to negotiate, as well as the outcomes of that negotiation. The authors define trust as “the willingness to be vulnerable to another person in the absence of monitoring or the belief that a person does not intend to deceive or harm the trusting person.” Respect is “the value one is shown in … [ Read more ]

Core Finance Trends in the Top MBA Programs in 2005

This paper presents and analyzes a survey taken of core (required) finance courses in the curricula of the highest-reputation MBA programs in the school year 2004-2005. Five of the nineteen schools responding have increased hours spent in the finance core substantially, compared to results of our earlier survey in 2001. We received mixed signals on the trends or tendencies that we were able to … [ Read more ]

What’s Really Wrong With U.S. Business Schools?

A research paper entitled “What’s Really Wrong with U.S. Business Schools” shines a light on what has become a growing dilemma for business school deans-the yearly scorecard that assigns numerical rankings to selected business programs. The paper describes a “dysfunctional competition for media rankings that leads schools to divert resources from investment in knowledge creation and other important areas to short-term strategy aimed at improving … [ Read more ]

Reconciling Efficient Markets with Behavioral Finance: The Adaptive Markets Hypothesis

The battle between proponents of the Efficient Markets Hypothesis and champions of behavioral finance has never been more pitched, and there is little consensus as to which side is winning or what the implications are for investment management and consulting. In this article, I review the case for and against the Efficient Markets Hypothesis, and describe a new framework – the Adaptive Markets Hypothesis … [ Read more ]

The Rational-Behavioral Debate in Financial Economics

The debate as to the merit of behavioral finance is a hot one. Brav, Heaton, and Rosenberg discuss the debate over behavioral finance and conclude that neither side is totally correct. [ Annotation]

How the Inflation Illusion Killed the CAPM

What killed the CAPM? While there may not be enough evidence to pronounce a court sentence, a leading candidate is the inflation illusion. Cohen, Polk, and Vuolteenaho “show that an implication of this joint hypothesis is that the security market line (the relation between an asset’s average return and its CAPM beta) is steeper [i.e there is a larger risk premium] than predicted … [ Read more ]

Irrational Optimism

No doubt many of you (myself included) will dutifully report to our students that the historical average return for large stocks is about 12% which corresponds to a risk premium of around 8%. (keeping math simple 😉 (see virtually any investment text for these numbers)) However, Dimson, Marsh, and Staunton report that this is probably an overly optimistic number. Not because the expected … [ Read more ]

When Labor Has a Voice in Corporate Governance

Employees may not make good owners after all! Faleye,Mehrotra,and Morck study firms where there are large blocks of employee owned shares that ARE VOTED. Their findings may surprise some people: “Relative to otherwise similar firms, labor-controlled publicly traded firms invest less, take fewer risks, grow more slowly, create fewer new jobs, have worse free cash flow problems, and exhibit lower labor and total factor … [ Read more ]

Remuneration: Where We’ve Been, How We Got to Here, What are the Problems, and How to Fix Them

In many ways, Murphy and Jensen’s 1990 paper on CEO pay may have been one of the most influential finance papers written in the past 15 years. It showed not only how CEOs were being paid, but also stressed the importance of incentive based (pay for performance) pay. As I wrote in the summary of that paper for my classes: This is a classic work … [ Read more ]

Agency Costs of Overvalued Equity

Jensen’s 1986 Free Cash flow paper showed that too much cash is bad. Now he shows that a stock price can be too high. Why? “A stock price that is overvalued is caused when investors have overly optimistic expectations. Thus, if the investors were to learn the truth, the stock price would fall. This creates an incentive to hide information from investors. … [ Read more ]

Transaction Structures in the Developing World: Evidence from Private Equity

Lerner and Schoar make available an interesting look at private equity financing. For instance, did you know that “in developing nations, the bulk of financings are private ones?” After examining 210 private equity transactions in developing countries, L&S report that in developing nations there is a much greater heterogeneity in private issuances. “The choice of security appears to be driven by the … [ Read more ]

Socially Responsible Investing: The Eco-Efficiency Premium Puzzle

Does socially responsible investing (SRI) hurt (or help) returns on a risk adjusted basis? Of course theoretically it seemingly should lower pecuniary returns, but empirically it seems that every researcher has a different answer. Now Derwall, Guenster, Bauer, and Koedijk present their views on the argument. The authors form portfolios based on Innovest eco-efficiency scores. The finding? “After controlling for … [ Read more ]

Interpersonal Effects in Consumption: Evidence from the Automobile Purchases of Neighbors

Much research has been devoted to what is often called herding behavior. This is the idea that investors trade just because others are trading. This is often cited as evidence of irrationality by finance behavorialists. (Is that a word? It should be!) Grinblatt, Keloharju, and Ikaheimo examine this type of behavior by looking at car purchases. No, really. … [ Read more ]

Stock Options and Long Term IPO Performance

A paper by Pukthuanthong and Walker that was presented at the European FMA Meetings examines the use of options in pay packages of IPO firms. It finds that “new public companies that have high use of stock options outperform those that have low use of stock options from the lock-up period until three years after the issue.” The authors find similar results when looking … [ Read more ]