Shell games: On the value of shell companies

A reverse merger allows a private company to assume the current reporting status of another company that is public. This can be done quickly, without fundraising, road show, underwriter, substantial ownership dilution, or great expense. Private firms that go public via reverse merger are often motivated by the need to quickly secure financing through privately placed stock (PIPEs) and the desire to make acquisitions using stock as payment. In each of the last eight years reverse mergers have outnumbered traditional IPOs as a mechanism for going public, and reporting shell companies are providing fuel for much of this growth. We study 585 trading shell companies over the period 2006-2008. The purpose of most of these shell firms is to find a suitor for a reverse merger agreement. These companies have no systematic risk, operations, or assets, and their share price tends to decline over time. Yet, these firms have investors. When a takeover agreement is consummated, shell company three-month abnormal returns are 48.1%. We argue that this exceptional return is compensation to investors for shell stock illiquidity and the uncertainty of finding a reverse merger suitor. We show that shell company returns are much greater at the consummation of a merger than those of a similar entity that in dollar terms is more popular among investors — Special Purpose Acquisition Companies (SPACs).     

Merger Announcements and Trading

We test whether an increase either in informed trades or in large liquidity trades leads to greater correlation of trading volume across markets. We confirm that both trading volume and positive returns of target companies are abnormally high before merger announcements. We find a statistically significant increase in the correlation between New York Stock Exchange and Nasdaq/regional trading volume before merger announcements. Furthermore, after merger announcements, we find evidence of both large liquidity trading and a statistically significant increase in the correlation of trading volume across markets.     

The industrial organization of post-trade clearing and settlement

The introduction to this special issue reviews the literature on the industrial organization of securities market clearing and settlement, covering institutional, theoretical, and empirical contributions, including both papers in this special issue and previous studies. Clearing and settlement is an important but under-researched network industry. Recent theoretical research has characterized the network externalities in clearing and settlement and explored the economic efficiency of various alternative industrial structures. Initial empirical research has identified substantial economies of both scale and scope and important interactions with trading platforms. More research is needed to elaborate these theoretical insights and improve our understanding of the economics of this major industry.     

The role of risk management in mergers and merger waves

We show that merger activity and particularly waves are significantly driven by risk management considerations. Increases in cash flow uncertainty encourage firms to vertically integrate and this contributes to the start of merger waves. These effects are incremental to previously identified causes of wave activity. Our risk management hypothesis is further supported by cross-sectional differences in the likelihood that a firm vertically integrates, and by the post-acquisition characteristics of vertically integrating firms. These results are consistent with the view (from the industrial organization literature) that vertical integration is an operational hedging mechanism that reduces the cost of increased uncertainty.     

Competition between Exchanges: Euronext versus Xetra

Exchanges in Europe are in a process of consolidation. After the failure of the proposed merger between Deutsche Börse and Euronext, these two groups are likely to become the nuclei for further mergers and co‐operation with currently independent exchanges. A decision for one of the groups entails a decision for the respective trading platform. Against that background we evaluate the attractiveness of the two dominant continental European trading systems. Though both are anonymous electronic limit order books, there are important differences in the trading protocols. We use a matched‐sample approach to compare execution costs in Euronext Paris and Xetra. We find that both quoted and effective spreads are lower in Xetra. The differences are more pronounced for less liquid stocks. When decomposing the spread we find no systematic differences in the adverse selection component. Realised spreads, on the other hand, are significantly higher in Euronext. Neither differences in the number of liquidity provision agreements nor differences in the minimum tick size or in the degree of domestic competition for order flow explain the different spread levels. We thus conclude that Xetra is the more efficient trading system.     

Riding the merger wave: Uncertainty,reduced monitoring,and bad acquisitions

We show that acquisitions initiated during periods of high merger activity (“merger waves”) are accompanied by poorer quality of analysts' forecasts, greater uncertainty, and weaker CEO turnover-performance sensitivity. These conditions imply reduced monitoring and lower penalties for initiating inefficient mergers. Therefore, merger waves may foster agency-driven behavior, which, along with managerial herding, could lead to worse mergers. Consistent with this hypothesis, we find that the average long-term performance of acquisitions initiated during merger waves is significantly worse. We also find that corporate governance of in-wave acquirers is weaker, suggesting that agency problems may be present in merger wave acquisitions.     

The market for shareholder voting rights around mergers and acquisitions: Evidence from institutional daily trading and voting

This paper explores the market for voting rights and shareholder voting around 350 mergers and acquisitions between 1999 and 2005 by examining institutional-investor trading and voting outcomes. Our results show institutions in aggregate buy shares and hence voting rights before merger record dates. This trading is not related to proxies for merger arbitrage or trading around merger announcements, and thus is not simply a continuation of the latter. Trading and buying before record dates are positively related to voting turnout and negatively related to shareholder support of merger proposals. We explore several possible interpretations of these results.     

Competition For Order Flow, Market Quality, And Price Discovery In The Nasdaq 100 Index Tracking Stock

We investigate competition for order flow, market quality, and price discovery in the Nasdaq 100 Index Tracking Stock (QQQ). The QQQ, an AMEX‐listed, exchange‐traded fund, is the most actively traded security in the U.S. equities market. On July 31, 2001, the NYSE began trading the QQQ, marking the first time it traded securities of companies it does not list. The greatest volume of trading takes place on electronic communication networks (ECNs), following by trading on the AMEX and the NYSE. Most of the block trades are executed on the AMEX, where the bid‐ask spreads are narrower. We find that ECNs contribute the most to the price‐discovery process. The spreads on all trading platforms have decreased and market quality and price discovery have improved since QQQ shares have traded on the NYSE.     

Quote-based competition,market share,and execution quality in NASDAQ-listed securities

We show that competitive quotes help increase dealer market share on NASDAQ, despite the fact that a large proportion of order flow is preferenced. We find that decimal pricing and the introduction of new trading platforms such as SuperSOES and SuperMontage have significantly changed the effect of quote aggressiveness on dealer market share. In particular, decimal pricing reduces (increases) the price (size) elasticity, SuperSOES increases the size elasticity, and SuperMontage increases both the size and price elasticity of dealer market share. We also show that market centers provide greater price improvements and faster executions when they post competitive quotes.     

Global private information in international equity markets

This paper studies international equity markets when some investors have private information that is valuable for trading in many countries simultaneously. We use a dynamic model of equity trading to show that global private information helps explain US investors’ trading behavior and performance. In particular, the model predicts global return chasing (positive co-movement of US investors’ net purchases with returns in many countries) which we show to be present in the data. Return chasing in our model can be due to superior performance of US investors, not inferior knowledge or naive trend-following. We also show that trades due to private information are strongly correlated across countries. A common (global) factor accounts for about half their variation.     

Executive compensation and informed trading in acquiring firms around merger announcements

This paper analyzes informed trading in acquiring firms through (stock) merger announcements. We show that pre-announcement abnormal option volumes in acquiring firms strongly increase ahead of a stock merger (by approximately 300%). Furthermore, we show that the direction of option trades (puts or calls) prior to an announcement can predict post-announcement stock returns. Our results also indicate that higher wealth-to-performance sensitivities of top executives are related to higher abnormal put than call option trading before stock merger announcements. Overall, our results support the view that top executives have a hedging motive. They tend to purchase protection against, e.g., confounding (negative) information policies and/or empire-building mergers with negative NPVs, in order to avoid short-term salary losses (lower bonuses, lower stock options, etc.).     

Another look at trading costs and short-term reversal profits

Several studies report that abnormal returns associated with short-term reversal investment strategies diminish once trading costs are taken into account. We show that the impact of trading costs on the strategies’ profitability can largely be attributed to excessively trading in small cap stocks. Limiting the stock universe to large cap stocks significantly reduces trading costs. Applying a more sophisticated portfolio construction algorithm to lower turnover reduces trading costs even further. Our finding that reversal strategies generate 30-50 basis points per week net of trading costs poses a serious challenge to standard rational asset pricing models. Our findings also have important implications for the understanding and practical implementation of reversal strategies.     

Institutional trading and stock resiliency: Evidence from the 2007–2009 financial crisis

We examine the impact of institutional trading on stock resiliency during the financial crisis of 2007–2009. We show that buy-side institutions have different exposure to liquidity factors based on their trading style. Liquidity supplying institutions absorb the long-term order imbalances in the market and are critical to recovery patterns after a liquidity shock. We show that these liquidity suppliers withdraw from risky securities during the crisis and their participation does not recover for an extended period of time. The illiquidity of specific stocks is significantly affected by institutional trading patterns; participation by liquidity supplying institutions can ameliorate illiquidity, while participation by liquidity demanding institutions can exacerbate illiquidity. Our results provide guidance on why some stocks take longer to recover in a crisis.     

Liquidity risk in securities settlement

This paper studies the potential impact on securities settlement systems (SSSs) of a major market disruption, caused by the default of the largest player. A multi-period, multi-security model with intraday credit is used to simulate direct and second-round settlement failures triggered by the default, as well as the dynamics of settlement failures, arising from a lag in settlement relative to the date of trades. The effects of the defaulter’s net trade position, the numbers of securities and participants in the market, and participants’ trading behavior are also analyzed.We show that in SSSs – contrary to payment systems – large and persistent settlement failures are possible even when ample liquidity is provided. Central bank liquidity support to SSSs thus cannot eliminate settlement failures due to major market disruptions. This is due to the fact that securities transactions involve a cash leg and a securities leg, and liquidity can affect only the cash side of a transaction. Whereas a broad program of securities borrowing and lending might help, it is precisely during periods of market disruption that participants will be least willing to lend securities.Settlement failures can continue to occur beyond the period corresponding to the lag in settlement. This is due to the fact that, upon observation of a default, market participants must form expectations about the impact of the default, and these expectations affect current trading behavior. If, ex post, fewer of the previous trades settle than expected, new settlement failures will occur. This result has interesting implications for financial stability. On the one hand, conservative reactions by market participants to a default – for example by limiting the volume of trades – can result in a more rapid return of the settlement system to a normal level of efficiency. On the other hand, limitation of trading by market participants can reduce market liquidity, which may have a negative impact on financial stability.     

Settlement delays in the money market

We track 38,000 money market trades from execution to delivery and return, and provide a first empirical analysis of settlement delays in financial markets. In accord with the predictions of recent models of strategic settlement of financial claims, we document a tendency by lenders to delay delivery of loaned funds until the afternoon hours. We find banks to follow a simple strategy to manage the risk of account overdrafts, by delaying settlement of large payments relative to that of small payments. More sophisticated strategies such as increasing delays when own liquid balances are low and when dealing with small trading partners play a marginal role. We find evidence of strategic delay also when returning borrowed funds, although we can explain a smaller fraction of the dispersion in delays in the return than in delivery leg of money market lending.     

Liquidity and market efficiency: A large sample study

Chordia et al. (2008, hereafter CRS) examine short horizon return predictability from past order flows of large, actively traded NYSE firms across three tick size regimes and conclude that higher liquidity facilitates arbitrage trading which enhances market efficiency. We extend CRS to a comprehensive sample of all NYSE firms and examine the dynamics between liquidity and market efficiency during informational periods. Our results indicate that although all NYSE firms experience an overall improvement in market efficiency across periods of different tick size regimes, this improvement varies significantly across the portfolios of sample companies formed on the basis of trading frequency, market capitalization, and trading volume. After controlling for these factors, we further document a positive association between a continuous measure of liquidity and market efficiency, and show that this effect is amplified during periods that contain new information, as reflected in high adverse selection component of the bid-ask spread.     

Option trading and individual investor performance

This paper examines the impact of option trading on individual investor performance. The results show that most investors incur substantial losses on their option investments, which are much larger than the losses from equity trading. We attribute the detrimental impact of option trading on investor performance to poor market timing that results from overreaction to past stock market returns. High trading costs further contribute to the poor returns on option investments. Gambling and entertainment appear to be the most important motivations for trading options while hedging motives only play a minor role. We also provide strong evidence of performance persistence among option traders.     

Bank Mergers and Insider Nontrading

Insiders with nonpublic information that their firms are acquisition targets can profit by purchasing their firms' stock or by delaying planned sales of their firms' stock. Under current securities laws, insiders who execute the former strategy expose themselves to civil and criminal liability, whereas insiders who execute the latter strategy do not. Using a sample of bank mergers, we find that target bank insiders significantly decrease both share purchases and share sales before merger announcements. These findings suggest that securities laws effectively deter some forms of illegal insider trading and that insiders exploit opportunities to profit legally from nonpublic information.     

The Competitive Dynamics of Geographic Deregulation in Banking: Implications for Productive Efficiency

Deregulation of geographic restrictions in banking over the past 20 years has intensified both potential and actual competition in the industry. The accumulating empirical evidence suggests that potential efficiency gains associated with consolidating banks are often not realized. We evaluate the impact of this increased competition on the productive efficiency of non-merging banks confronted with new entry in their local markets and find that the incumbent banks respond by improving cost efficiency. Thus, studies evaluating the impact of bank mergers on the efficiency of the combining parties alone may be overlooking the most significant welfare-enhancing aspect of merger activity.     

Volatility and dark trading: Evidence from the Covid-19 pandemic

We study the effect(s) of volatility on the share of trading in dark pools by exploiting the exogenous shock of the Covid-19 pandemic on financial markets and regulatory restrictions on dark trading. We find that high levels of volatility in lit exchanges is linked to an economically significant loss of market share by dark pools to lit exchanges. In line with the theory, the loss appears to be driven by informed traders’ migration from lit to dark markets during high volatility periods. The market quality implications of the trading dynamics are mixed: while it tempers liquidity decline in the lit market, it exacerbates the loss of informational efficiency.