Does operating risk affect portfolio risk? Evidence from insurers' securities holding

This study empirically examines, in the setting of insurance companies, the hypothesis that investors facing more operating risk may behave as if they were more risk averse in investment decisions. Specifically, we study how operating risk from underwriting insurance policies affects insurers' risk taking behavior in their portfolio investments. We find that insurers with higher volatilities in underwriting incomes and cash flows are more conservative in their financial investment risk taking – they have lower credit risk exposure in their bond investments, as well as lower portfolio weights on risky bonds and equities. Further, insurers' portfolio risk exposure is sensitive to the risk of permanent underwriting income shocks but insensitive to the risk of transitory shocks. Transitory operating risk, however, is significantly related to portfolio risk when insurers face tight financing constraints. Our findings suggest a substitutive effect of operating risk on investment decisions by financial institutions.     

Deviation from the target capital structure and acquisition choices

This study finds that managers take deviations from their target capital structures into account when planning and structuring acquisitions. Specifically, firms that are overleveraged relative to their target debt ratios are less likely to make acquisitions and are less likely to use cash in their offers. Furthermore, they acquire smaller targets and pay lower premiums. Managers of overleveraged firms also actively rebalance their capital structures when they anticipate a high likelihood of making an acquisition. Finally, they pursue the most value-enhancing acquisitions. Collectively, these findings improve understanding of how firms choose their capital structures and shed light on the interdependence of capital structure and investment decisions in the presence of financial frictions.     

Altruism and egoism in investment decisions

We provide survey evidence that personal values have an impact on individual investment decisions, in particular preferences for socially responsible investing. Our findings show that there is a positive link between altruistic values and the relative importance of social responsibility. This effect is stronger when individuals believe that they can make a positive social or environmental impact with their investments, or when they feel morally obliged to invest responsibly. If altruistic individuals associate responsible investments with higher returns, it decreases their motivation to invest responsibly. Egoistic values are negatively associated with the decision to invest responsibly, unless individuals associate responsible investing with higher returns.     

The role of equity compensation in reducing inefficient investment in labor

We investigate whether equity compensation incentivizes executives to make efficient labor investment decisions. In doing so, we examine the extent to which stock options and restricted stock differentially influence labor investment decisions. Consistent with theoretical predictions, we find that stock options exacerbate, while restricted stock mitigates, inefficient labor investment. The effect of stock options (restricted stock) are weaker (stronger) for financially constrained firms. Our results are robust to alternative proxies for inefficient labor investment and when addressing a range of endogeneity concerns. Our research demonstrates that stock options and restricted stock matter in executives' labor investment decisions, but in different ways. Our findings have implications for future research, suggesting that stock options and restricted stock need to be separately considered when examining the impact equity compensation has on capital or investment decision making; and for executive remuneration practice.     

Product markets and corporate investment: Theory and evidence

Investment patterns often associated with agency and information problems can emerge as rational responses to product-market rivalry. We illustrate this result when industry players make simultaneous or sequential investment decisions in the face of two negative externalities. One externality arises when all competing firms invest, thus eroding the gains to investment accruing to any one firm. Another externality arises when some firms do not invest and lose out to rivals who do invest. The value of investment therefore depends on the investment’s intrinsic merits and the actions of all competitors. Our analysis can rationalize investment patterns that might appear suboptimal when such externalities are ignored. For instance, our simultaneous model can justify investment levels that might otherwise be interpreted as under- or over-investment. Our sequential model shows that value-maximizing firms might optimally herd in their investment decisions. We present evidence supporting key aspects of both the simultaneous and sequential models.     

Why Hang on to Losers? Divestitures and Takeovers

We study the divestiture decisions of managers who care about their reputations. Managers' divestiture and investment decisions are publicly observable, but managers privately observe signals with respect to the future payoff distribution of investments they have initiated. We establish that in equilibrium there is too little divestiture. These inefficiencies create the opportunity for wealth-enhancing divestiture-motivated takeovers. A key result is that only managers of targets with “middle of the road” asset specificity should consider the takeover threat credible. These findings suggest that uniqueness of assets is an important determinant of both agency costs and takeover activity. Our analysis leads to several empirical predictions.     

The investment behavior of buyout funds: Theory and evidence

We analyze the determinants of buyout funds’ investment decisions. We argue that when there is imperfect competition for private equity funds, the timing of funds’ investment decisions, their risk-taking behavior, and their subsequent returns depend on changes in the demand for private equity, conditions in the credit market, and fund managers’ ability to influence perceptions of their talent. We investigate these hypotheses using a proprietary dataset of 207 U.S. buyout funds that invested in 1,957 buyout targets over a 30-year period. Our dataset contains precisely dated cash inflows and outflows in every portfolio company, links every buyout target to an identifiable buyout fund, and is free from reporting and survivor biases. Thus, we are able to characterize every buyout fund's precise investment choices. Our findings are as follows. First, established funds accelerate their investment flows and earn higher returns when investment opportunities improve, competition for deal flow eases, and credit market conditions loosen. Second, the investment behavior of first-time funds is less sensitive to market conditions. Third, younger funds invest in riskier buyouts, in an effort to establish a track record. Finally, following periods of good performance, funds become more conservative, and this effect is stronger for first-time funds.     

The Role of Investment,Financing and Dividend Decisions in Explaining Corporate Ownership Structure: Empirical Evidence from Spain

This paper analyses the determinants of ownership structure by focusing on the role played by investment, financing and dividend decisions. The use of the Generalised Method of Moments allows us to provide new evidence on this important corporate governance topic, since it controls for the endogeneity problem. Our most relevant findings show that: i) increases in debt lead insiders to limit the risk they bear by reducing their holdings; ii) monitoring by large outside owners substitutes for the disciplinary role of debt; and iii) both inside and outside owners are encouraged to increase their stakes in the firm in view of higher dividends. Our results hold after controlling for equity issues and share repurchases.     

Voluntary Disclosure,Manipulation, and Real Effects

We study a model in which managers’ disclosure and investment decisions are both endogenous and managers can manipulate their voluntary reports through (suboptimal) investment, financing, or operating decisions. Managers are privately informed about the value of their firm and have incentives to voluntarily disclose information and manipulate their reports in order to obtain more favorable terms when issuing equity to finance a new profitable investment opportunity. The model shows that treating managers’ disclosure and investment decisions both as endogenous and allowing managers to manipulate their voluntary reports yields qualitatively different predictions from when the disclosure and investment decisions are considered separately and managers cannot engage in manipulation. The model predicts that managers’ disclosure strategy is sometimes characterized by two distinct nondisclosure intervals (contrary to traditional threshold equilibria of voluntary disclosure models) and that managers with intermediate news sometimes forego the new profitable investment opportunity. As such, the paper highlights the importance of considering the interdependencies between firms’ disclosure and investment decisions and provides new empirical predictions.     

Attribution of investment performance: an analysis of Australian pooled superannuation funds*

This paper evaluates the market timing and security selection capabilities of Australian pooled superannuation funds over the eight‐year period from January 1991 to December 1998. Evaluation of both components of investment performance is surprisingly scarce in the Australian literature despite active investment managers engaging in both market timing and security selection. The paper also evaluates performance for the three largest asset classes within diversified superannuation funds and their contribution to overall portfolio return. The importance of an accurately specified market portfolio proxy in the measurement of investment performance is demonstrated. This paper employs performance benchmarks that account for the multi‐sector investment decisions of active investment managers in a manner that is consistent with their unique investment strategy. Consistent with U.S. literature, the empirical results indicate that Australian pooled superannuation funds do not exhibit significantly positive security selection or market timing skill.     

Attribution of investment performance: an analysis of Australian pooled superannuation funds*

This paper evaluates the market timing and security selection capabilities of Australian pooled superannuation funds over the eight‐year period from January 1991 to December 1998. Evaluation of both components of investment performance is surprisingly scarce in the Australian literature despite active investment managers engaging in both market timing and security selection. The paper also evaluates performance for the three largest asset classes within diversified superannuation funds and their contribution to overall portfolio return. The importance of an accurately specified market portfolio proxy in the measurement of investment performance is demonstrated. This paper employs performance benchmarks that account for the multi‐sector investment decisions of active investment managers in a manner that is consistent with their unique investment strategy. Consistent with U.S. literature, the empirical results indicate that Australian pooled superannuation funds do not exhibit significantly positive security selection or market timing skill.     

Corporate investment and stock market valuation

We study the driving forces behind the positive association observed between corporate investment and stock market valuation, and how they interact with managerial equity incentives and informativeness of investment. We build a dynamic model where managers use investment choices to influence investors' opinions about firms' future prospects and increase the market valuation. The incentives to manipulate the valuation processes increase with managerial equity incentives and informativeness of investment. Our empirical findings support the model's predictions that the tendency of using investment to boost market valuation is stronger when managerial stock ownership is high or when earnings quality is low (i.e., there is strong reliance on investment for information).     

Capital structure and product market behavior: an examination of plant exit and investment decisions.

We examine whether sharp debt increases through leveraged buyoutsand recapitalizations interact with market structure to influenceplant closing and investment decisions of recapitalizing firmsand their rivals. We take into account the fact that recapitalizationsand investment decisions are both endogenous and may be simultaneouslyinfluenced by the same exogenous events. Following their recapitalizations,firms in industries with high concentration are more likelyto close plants and less likely to invest. Rival firms are lesslikely to close plants and more likely to invest when the marketshare of leveraged firms is higher.     

Does Earnings Management Relieve the Negative Effects of Mandatory Pension Contributions?

Mandatory pension contributions (MCs) are negative shocks to a firm's liquidity that can unfavorably impact its cost of capital, financing, and investment plans. We examine whether firms faced with MCs use both noncash (NEM) and cash‐generating earnings management (CEM) to partially offset their negative effects. Firms increase CEM, but not NEM, when they experience MCs. We also find that earnings management associated with MCs does not substantially lower the weighted cost of capital or boost external funding and investment. Our findings suggest that MC firms use CEM as it directly generates cash to fund MCs, while NEM does not.     

An experimental study on real-options strategies

We conduct a laboratory experiment to study whether people intuitively use real-option strategies in a dynamic investment setting. The participants were asked to play as an oil manager and make production decisions in response to a simulated mean-reverting oil price. Using cluster analysis, participants can be classified into four groups, which we label ‘mean-reverting’, ‘Brownian motion real-option’, ‘Brownian motion myopic real-option’, and ‘ambiguous’. We find two behavioral biases in the strategies of our participants: ignoring the mean-reverting process, and myopic behavior. Both lead to too frequent switches when compared with the theoretical benchmark. We also find that the last group behaved as if they have learned to incorporate the true underlying process into their decisions, and improved their decisions during the later stage.     

财务分析师盈利预测的投资价值:来自深沪A股市场的证据

本文研究了中国股票市场上财务分析师的盈利预测信息对投资者是否有价值。我们发现,可以利用公开的盈利预测制定可获利的套头交易策略。套头交易的回报率不仅在统计意义上显著大于零,而且在经济意义上也是显著的。这些结果不受不同的检验方法影响,也无法为我们所考虑到的风险因素所解释。本文的发现说明了中国的股票市场尚未达到Fama(1970)意义上的半强式有效,投资者在投资决策时可以利用分析师的盈利预测以提高其投资的回报。此外,本文的结果也有助于回答中国的财务分析师是否具有专业胜任能力这一颇有争议的问题。     

CEO Overconfidence and Corporate Investment

We argue that managerial overconfidence can account for corporate investment distortions. Overconfident managers overestimate the returns to their investment projects and view external funds as unduly costly. Thus, they overinvest when they have abundant internal funds, but curtail investment when they require external financing. We test the overconfidence hypothesis, using panel data on personal portfolio and corporate investment decisions of Forbes 500 CEOs. We classify CEOs as overconfident if they persistently fail to reduce their personal exposure to company‐specific risk. We find that investment of overconfident CEOs is significantly more responsive to cash flow, particularly in equity‐dependent firms.     

Investment Opportunities,Free Cash Flow and Stock Valuation Effects of Corporate Investments: The Case of Taiwanese Investments in China

This paper examines the importance of investment opportunities and free cash flow in assessing the stock market reaction to announcements of cross-border investments in China by Taiwanese firms. Our results support the investment opportunities hypothesis that Taiwanese firms with favorable investment opportunities have significantly positive response to the announcements of their investments in China whereas firms with poor investment opportunities have negative response to such announcements. In contrast, we find no support for the free cash flow hypothesis. Our findings add to the understanding of the determinants of the wealth effect of cross-border investment decisions in the Asia-Pacific region.     

Modelling optimal asset allocation when households experience health shocks

Health status is an important factor in household portfolio decision-making. We develop a theoretical framework to model how households make optimal asset allocation decisions in response to health risks. Our two- and three-asset models both suggest that the maximum utility is derived when households allocate a majority of their assets to human capital. When households experience acute illness shocks, their welfare and portfolio values reduce, and they need to increase their investment in human capital. When an expensive health catastrophe befalls member(s) of households, the optimal decision for asset-rich households is to undertake medical treatment, whereas for asset-poor households it is to forgo treatment. Asset-poor households in particular require public financial assistance to enable them to invest in human capital.