Corporate culture and analyst catering

This study examines the relation between financial institutions’ corporate culture and the quality of analysts’ research services. Using data collected from the Financial Industry Regulatory Authority, I measure the weakness of financial institutions’ corporate culture based on violations observed in securities activities unrelated to equity research. I find evidence demonstrating an association between weak corporate culture and analysts’ providing research products catered to institutional clients at the expense of individual investors. Specifically, FINRA violations are associated with both (i) less accurate forecasts and less informative reports, and (ii) higher institutional commission revenues and more broker-hosted conferences for select institutional clients.     

Value relevance of analyst earnings forecasts in emerging markets

Even though research in accounting and finance has extensively examined the role of financial analysts in developed economies, this issue has not been thoroughly examined in an emerging market setting. In this paper, I examine whether, following a market opening, analyst forecast accuracy and the market's reliance on analyst forecasts increase with time. Accuracy is expected to increase over time as analysts exert more effort and gain valuable forecasting experience. Results indicate that time is positively related to analyst forecast accuracy after controlling for a number of other firm and country characteristics. Second, I posit that time should also be related to the market's propensity to use analyst forecasts to form earnings expectations. As markets open and investors become more sophisticated, the reliance on analyst forecasts should also increase. Results are consistent with this expectation. In particular, I find that in the first sub-period earnings expectations based on random walk exhibit greater relative information content than earnings expectations based on analyst forecasts. This pattern is reversed in the third sub-period where analyst forecast errors better explain returns. Incremental information content tests produce similar results. Future research should further investigate the relation between financial analysts and other important market characteristics in emerging economies.     

Hedge funds and their prime broker analysts

Are sell-side analysts reluctant to go against the investment views of their hedge funds when these hedge funds are their prime brokerage clients? We show that prime broker analysts tend to upgrade stocks recently bought by their clients. For stocks with upgraded recommendations, post-announcement cumulative abnormal returns are significantly lower for those purchased by the prime brokerage clients. Our results are stronger with high-dollar-turnover clients who generate more trading commissions. We also find that a hedge fund with a large bet on a stock has a stronger incentive to pressure the fund’s prime brokers to issue a favorable recommendation on the stock. Results are not driven by stocks of firms with low analyst coverage or small size.     

The value of combining the information content of analyst recommendations and target prices

In assessing the usefulness of the analysts’ stock picking advice, the extant literature has largely focused on the profitability of either their stock recommendations or target prices in isolation. In this paper, we examine the profitability of investment strategies that exploit the information analysts convey through revisions in both their stock recommendations and target prices. We find that these strategies significantly outperform the comparable strategies that make use of only one analyst output.     

The consequences to analyst involvement in the IPO process: Evidence surrounding the JOBS Act

The JOBS Act allows certain analysts to be more involved in the IPO process, but does not relax restrictions on analyst compensation structure. We find that these analysts initiate coverage that is more optimistically biased, less accurate, and generates smaller stock market reactions. Investors purchasing shares following these initiations lose over 3% of their investment by the firm's subsequent earnings release. By contrast, issuers, analysts, and investment banks appear to benefit from this increased bias, as optimism is more positively associated with proxies for firm visibility and investment banking revenues when analysts are involved in the IPO process.     

New evidence on price impact of analyst forecast revisions

Previous research shows a positive relationship between consensus forecast revisions and stock returns in developed markets. We obtain new evidence from four major Asia-Pacific markets that suggest that abnormal returns are related to latest forecast revisions. The price impact of negative revisions is consistently stronger than that of the positive revisions. We also found considerable differences in price impact between developed and emerging markets for positive revisions, while no such difference is detected for negative revisions. The latest forecast revisions and category of analysts (those working in international broking firms) appear to be two key determinants of abnormal stock returns.     

Analyst versus model-based earnings forecasts: implied cost of capital applications

We find that a composite implied cost of capital (ICC) estimate – based on the earnings forecasts generated by cross-sectional models – is highly correlated with future realised returns in both portfolio- and regression-based tests. By contrast, we find very little evidence for an association with future realised returns for an ICC estimate based on analyst earnings forecasts. We also document the time-varying nature of expected returns and risk premia, and provide up-to-date estimates of an implied Australian market risk premium.     

Problem bank loans, conflicts of interest, and institutions

I consider problem bank loans as the outcome of decisions made by banks in the dual role they serve as financial intermediaries. This dual role necessarily introduces conflicts of interest that can lead to bank mismanagement and consequently problem bank loans. Because bank activities take place within the tangible and intangible structure of institutions, institutions may affect the quality of bank loans. I consider legal, political, sociological, economic, and banking institutions and explore their contribution to problem bank loans. I find support that a variety of institutions impact the share of bank assets that are non-performing.     

Rating the raters: Are reputation concerns powerful enough to discipline rating agencies?

Credit rating agencies (CRAs) are accused of bearing a strong responsibility for contributing to the subprime crisis by having been deliberately too lax in the ratings of some structured products. In response to this accusation, CRAs argue that such an attitude would be too dangerous for them, since their reputation is at stake. The objective of this article is to examine the validity of this argument within a formal model: Are reputation concerns sufficient to discipline rating agencies?We show that the reputation argument only works when a sufficiency large fraction of the CRA income comes from other sources than rating complex products. By contrast when rating complex products becomes a major source of income for the CRA, we show that it is always too lax with a positive probability and inflates ratings with probability one when its reputation is good enough.We provide some empirical support for this prediction, by showing that ceteris paribus, the proportion of subprime residential mortgage-backed securities (RMBS) that were rated AAA by the three main CRAs indeed increased over the last eight years.We analyze the policy implications of our findings and advocate for a new business model of CRAs that we call the platform-pays model.     

The dark side of audit market competition

This paper examines the relation between audit market competition and audit quality. We use the staggered introduction of bullet trains in different Chinese cities as shocks to travel time between audit clients and prospective audit firms, which increases the threat of competition for incumbent audit firms. The inception of bullet train connectivity leads to a 4.5 percentage point (pp) increase in the probability of GAAP violations and a 1.7 pp decrease in the probability of modified audit opinions for clients headquartered in connected cities. Bullet train connectivity is also followed by a 1.6 pp decrease in income-decreasing audit adjustments but no change in income-increasing audit adjustments. The negative relation between bullet train connectivity and audit quality is 1) stronger when bullet trains put greater competitive pressure on incumbent auditors and 2) weaker when clients demand high audit quality. Our paper provides plausibly causal evidence that competition lowers audit quality.     

Non-compensation-related consultant service and CEO compensation

This study examines how consultants’ non-compensation-related consulting service (NCS) affects the contractual usefulness of accounting and stock information in executive compensation, as reflected in pay-performance sensitivity. The hypothesis is based on anecdotal evidence suggesting that consultants’ provision of NCS is likely to adversely affect the quality of CEO compensation plans. We investigate whether the consultants providing NCS are involved in potential conflicts of interest. The results show that CEO pay is higher in companies where consultants provide NCS and have a higher NCS fee ratio. The pay-performance sensitivity in CEO compensation decreases when consultants engage in NCS. The overall results are consistent with NCS representing a conflict of interest and compromising the quality of compensation committees.     

Do insiders time management buyouts and freezeouts to buy undervalued targets?

We provide evidence that managers and controlling shareholders time management buyouts (MBOs) and freezeout transactions to take advantage of industry-wide undervaluation. Portfolios of industry peers of MBO and freezeout targets show significant alphas of around 1% per month over the 12-month period following the transaction. These returns are not explained by a battery of risk factors or empirical methodologies, but exhibit significant heterogeneity across deals. Additional tests show that, on average, abnormal returns to industry peers are a reliable proxy for those to the target firm. Further, MBOs and freezeouts are announced during troughs of industry profitability.     

Does banks’ dual holding affect bank lending and firms’ investment decisions? Evidence from China

This study investigates the effect of banks’ dual holding on bank lending and firms’ investment decisions using a sample of listed firms in China. We find that dual holding leads to easier access to bank loans, a result that is more pronounced for non-state-owned enterprises (non-SOEs) than SOEs. We also find that dual holding distorts banks’ lending decisions and harms the investment efficiency for SOEs, while resulting in optimal lending decisions and enhanced investment efficiency for non-SOEs. For non-SOEs, further analysis suggests that optimal lending decisions and efficient investment can be achieved for firms with higher ownership concentration, and firms in which the family and foreign investors are the controlling shareholders. We argue that, in emerging markets, whether a bank plays a monitoring role by directly holding the debt and equity claims of companies relies heavily on whether the potential collusion between firm executives and bank managers can be averted, which in turn is determined by the firms’ governance framework and ownership structure.     

Blurred stars: Mutual fund ratings in the shadow of conflicts of interest

Using unique data on trading commission payments to mutual fund rating companies (MFRCs) by mutual funds in China, this paper investigates whether the conflicts of interest arising from trading commission payments bias MFRCs’ mutual fund star ratings and hence affect their informativeness. We find the rating of a mutual fund is more optimistic when the MFRC either (i) receives trading commission fees from the mutual fund or (ii) can potentially receive fees in the future. The paper further shows that the usefulness of ratings in terms of predicting a fund’s future performance is negatively impacted by conflicts of interest. There is also evidence that investors can see through the problem, responding less enthusiastically (in terms of fund flows) to the ratings of conflicted MFRCs. We further find that the introduction of a rating qualification system that aims to improve mutual fund rating quality exacerbates the rating bias.     

International house price cycles,monetary policy and credit

We evaluate three alternative predictors of house price corrections: anticipated tightenings of monetary policy, deviations of house prices from fundamentals, and rapid credit growth. A new cross-country measure of monetary policy expectations based on an international term structure model with time-varying risk premiums is constructed. House price overvaluation is estimated via an asset pricing model. The variables are incorporated into a panel logit regression model that estimates the likelihood of a large house price correction in 18 OECD countries. The results show that corrections are predicted by increases in the market’s forecast of higher policy rates. The estimated degree of house price overvaluation also contains significant information about subsequent price reversals. In contrast to the financial crisis literature, credit growth is less important. All of these variables help forecast recessions.     

Public hedge funds

Hedge funds managed by listed firms significantly under-perform funds managed by unlisted firms. The under-performance is more severe for funds with low manager deltas, poor governance, and no manager co-investment, or those managed by firms whose prices are sensitive to earnings news. Notwithstanding the under-performance, listed asset management firms raise more capital, by growing existing funds and launching new funds post listing, and harvest greater fee revenues than do comparable unlisted firms. The results are consistent with the view that, for asset management firms, going public weakens the alignment between ownership, control, and investment capital, thereby engendering conflicts of interest.     

The Traditional Hedging Model Revisited with a Nonobservable Convenience Yield

This article examines the hedging of constrained commodity positions with futures contracts. We extend the study of Adler and Detemple (1988a, 1988b) to include a partial information framework where the convenience yield is not observable. As a consequence, futures prices depend on investor's beliefs regarding the value of the convenience yield, and every component of the hedge is impacted by these beliefs. We achieve a decomposition of the demand that clarifies the impact on the optimal hedge of the beliefs, the spot price and the risk‐free rate as well as the hedging horizon.