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Abstract:
Assets managed by hedge funds have grown faster over the last ten years than assets managed by mutual funds. Hedge funds and mutual funds perform the same economic function, but hedge funds are largely unregulated while mutual funds are tightly regulated. This paper compares the organization, performance, and risks of hedge funds and mutual funds. It then examines whether one can expect increasing convergence between these two investment vehicles and concludes that the performance gap between hedge funds and mutual funds will narrow, that regulatory developments will limit the flexibility of hedge funds, and that hedge funds will become more institutionalized.

Abstract:
This paper develops and tests a model of how country characteristics, such as legal protections for minority investors, and the level of economic and financial development, influence firms' costs and benefits in implementing measures to improve their own governance and transparency. The model focuses on an entrepreneur who needs to raise funds to finance the firm's investment opportunities and who decides whether or not to invest in better firm-level governance mechanisms to reduce agency costs. We show that, for a given level of country investor protection, the incentives to adopt better governance mechanisms at the firm level increase with a country's financial and economic development. When economic and financial development is poor, the incentives to improve firm-level governance are low because outside finance is expensive and the adoption of better governance mechanisms is expensive. Using firm-level data on international corporate governance and transparency ratings for a large sample of firms from around the world, we find evidence consistent with this prediction. Specifically, we show that (1) almost all of the variation in governance ratings across firms in less developed countries is attributable to country characteristics rather than firm characteristics typically used to explain governance choices, (2) firm characteristics explain more of the variation in governance ratings in more developed countries, and (3) access to global capital markets sharpens firm incentives for better governance, but decreases the importance of home-country legal protections of minority investors.

Abstract:
This paper develops and tests a model of how country characteristics, such as legal protections for minority investors and the level of economic and financial development, influence firms' costs and benefits in implementing measures to improve their own governance and transparency. We show that the incentives to adopt better governance mechanisms at the firm level increase with a country's financial and economic development. Further, these incentives increase or decrease with a country's investor protection depending on whether firm-level governance mechanisms and country-level investor protection are substitutes or complements. When economic and financial development is poor, the incentives to improve firm-level governance are low because outside finance is expensive and the adoption of better governance mechanisms is expensive. Using international corporate governance and transparency ratings for a large sample of firms from around the world, we find evidence consistent with this prediction. Our main empirical result is that country characteristics explain much more of the variance in governance ratings ranging from 39% to 73%) than observable firm characteristics (ranging from 4% to 22%). Further, we show that firm characteristics explain almost none of the variation in governance ratings in less-developed countries and that access to global capital markets sharpens firms'incentives for better governance.

corporate governance, financial globalization, investor protection

Abstract:
But if risk management has been mistakenly identified as the culprit in many cases, current risk management practice can be improved by taking into account the lessons from financial crises past and present. In particular, such crises have occurred with enough frequency that crisis conditions can be modeled, at least to some extent. And when models reach their limits of usefulness, companies should consider using scenario planning that aims to reveal the implications of crises for their financial health and survival. Instead of relying on past data, scenario planning must use forward-looking economic analysis to evaluate the expected impact of sudden illiquidity and the associated feedback effects that are common in financial crises. In making this distinction, the paper also identifies a number of different ways that risk management can fail. In addition to choosing the wrong risk metrics and misidentifying or mismeasuring risks, risk managers can fail to communicate their risk assessments and provide effective guidance to top management and boards. And once top management has used that information to help determine the firm's risk appetite and strategy, the risk management function can also fail to monitor risks appropriately and maintain the firm's targeted risk positions. The difficulties of the past year have convinced many observers that current risk management practices are deeply flawed, and that such flaws have contributed greatly to the current financial crisis. In this paper, the author challenges this view by showing the need to distinguish between flawed assessments by risk managers and corporate risk-taking decisions that, although resulting in losses, were reasonable at the time they were made. In making this distinction, the paper also identifies a number of different ways that risk management can fail. In addition to choosing the wrong risk metrics and misidentifying or mismeasuring risks, risk managers can fail to communicate their risk assessments and provide effective guidance to top management and boards. And once top management has used that information to help determine the firm's risk appetite and strategy, the risk management function can also fail to monitor risks appropriately and maintain the firm's targeted risk positions. But if risk management has been mistakenly identified as the culprit in many cases, current risk management practice can be improved by taking into account the lessons from financial crises past and present. In particular, such crises have occurred with enough frequency that crisis conditions can be modeled, at least to some extent. And when models reach their limits of usefulness, companies should consider using scenario planning that aims to reveal the implications of crises for their financial health and survival. Instead of relying on past data, scenario planning must use forward-looking economic analysis to evaluate the expected impact of sudden illiquidity and the associated feedback effects that are common in financial crises.

Abstract:
A large loss is not evidence of a risk management failure because a large loss can happen even if risk management is flawless. I provide a typology of risk management failures and show how various types of risk management failures occur. Because of the limitations of past data in assessing the probability and the implications of a financial crisis, I conclude that financial institutions should use scenarios for credible financial crisis threats even if they perceive the probability of such events to be extremely small.

Abstract:
I argue that the mainstream approach to capital budgeting focuses excessively on the special case where diversifiable risks do not affect the contribution of a project to the value of the firm. This approach ignores the impact of a new project on a firm's total risk and therefore often leads to an inappropriate assessment of the value of the project. I present arguments for why total risk is often costly and discuss how taking total risk into account in capital budgeting is necessary to make capital budgeting and capital structure decisions consistent.

Abstract:
We study the determinants and consequences of cross-listings on the New York and London stock exchanges from 1990 to 2005. This investigation enables us to evaluate the relative benefits of New York and London exchange listings and to assess whether these relative benefits have changed over time, perhaps as a result of the passage of the Sarbanes-Oxley Act of Congress (SOX) in 2002. We find that cross-listings have been falling on U.S. exchanges as well as on the Main Market in London. This decline in cross-listings is explained by changes in firm characteristics rather than by changes in the benefits of cross-listing. We show that, after controlling for firm characteristics, there is no deficit in cross-listing counts on U.S. exchanges related to SOX. Investigating the valuation differential between listed and nonlisted firms (the "cross-listing premium") from 1990 to 2005, we find that there is a significant premium for U.S. exchange listings every year, that the premium has not fallen significantly in recent years, that it persists when allowing for unobservable firm characteristics, and that there is a permanent premium in event time. In contrast, there is no premium for listings on London's Main Market for any year. Crosslisting in the U.S. leads firms to increase their capital-raising activity at home and abroad while a London listing has no such impact. Our evidence is consistent with the theory that an exchange listing in New York has unique governance benefits for foreign firms. These benefits have not been seriously eroded by SOX and cannot be replicated through a London listing.

Abstract:
This paper examines the impact of globalization on the cost of equity capital. We argue that the cost of equity capital decreases because of globalization for two important reasons. First, the expected return that investors require to invest in equity to compensate them for the risk they bear generally falls. Second, the agency costs which make it harder and more expensive for firms to raise funds become less important. The existing empirical evidence is consistent with the theoretical prediction that globalization decreases the cost of capital, but the documented effects are lower than theory leads us to expect. We discuss various reasons for why this is the case.

Abstract:
In this paper, we explain how enterprise risk management creates value for shareholders. In contrast to the existing finance literature, we emphasize the organizational benefits of risk management. We show how a firm should choose its risk appetite and measure risk when implementing enterprise risk management. We also provide an extensive guide to the implementation issues faced by firms that implement enterprise risk management.

Abstract:
We examine whether hedge funds experience contagion. First, we consider whether extreme movements in equity, fixed income, and currency markets are contagious to hedge funds. Second, we investigate whether extreme adverse returns in one hedge fund style are contagious to other hedge fund styles. To conduct this examination, we estimate binomial and multinomial logit models of contagion using daily returns on hedge fund style indices as well as monthly returns on indices with a longer history. Our main finding is that there is no evidence of contagion from equity, fixed income, and foreign exchange markets to hedge funds, except for weak evidence of contagion for one single daily hedge fund style index. By contrast, we find strong evidence of contagion across hedge fund styles, so that hedge fund styles tend to have poor coincident returns.

Abstract:
We examine whether hedge funds are more likely to experience extremely poor returns when equity, fixed income, and currency markets or other hedge funds have extremely poor performance than would be predicted by correlations of hedge fund returns with returns on these markets or with returns of other hedge funds (contagion). First, we consider whether extreme movements in these markets are contagious to Arbitrage, Directional, and Event Driven hedge fund indices. Second, we investigate whether extreme adverse returns in one hedge fund index are contagious to other hedge fund indices. To conduct these examinations, we estimate Poisson regressions using both monthly and daily returns on hedge fund style indices. We find no systematic evidence of contagion from equity, fixed income, and currency markets to hedge fund indices, although the Arbitrage index exhibits evidence of contagion from the equity and currency markets for monthly data. In contrast, we find systematic evidence of contagion across hedge fund styles for both monthly and daily data. Our results provide a new perspective on the systemic risks of hedge funds and suggest that diversification across hedge funds may not help as much as correlations would imply in reducing the probability of very poor returns.

Hedge funds, Extreme returns, Contagion, Systemic risk

Abstract:
Why do firms pay dividends? If they didn't their asset and capital structures would eventually become untenable as the earnings of successful firms outstrip their investment opportunities. Had they not paid dividends, the 25 largest long-standing 2002 dividend payers would have cash holdings of $1.8 trillion (51% of total assets), up from $160 billion (6% of assets), and $1.2 trillion in excess of their collective $600 billion in long-term debt. Their dividend payments prevented significant agency problems since the retention of earnings would have given managers command over an additional $1.6 trillion without access to better investment opportunities and with no additional monitoring. This logic suggests that firms with relatively high amounts of earned equity (retained earnings) are especially likely to pay dividends. Consistent with this view, the fraction of publicly traded industrial firms that pays dividends is high when the ratio of earned equity to total equity (total assets) is high, and falls with declines in this ratio, becoming near zero when a firm has little or no earned equity. We observe a highly significant relation between the decision to pay dividends and the ratio of earned equity to total equity or total assets,controlling for firm size, profitability, growth, leverage, cash balances, and dividend history. In our regressions, earned equity has an economically more important impact than does profitability or growth. Our evidence is consistent with the hypothesis that firms pay dividends to mitigate agency problems.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
Why do firms pay dividends? If they didn't their asset and capital structures would eventually become untenable as the earnings of successful firms outstrip their investment opportunities. Had they not paid dividends, the 25 largest long-standing 2002 dividend payers would have cash holdings of $1.8 trillion (51% of total assets), up from $160 billion (6% of assets), and $1.2 trillion in excess of their collective $600 billion in long-term debt. Their dividend payments prevented significant agency problems since the retention of earnings would have given managers command over an additional $1.6 trillion without access to better investment opportunities and with no additional monitoring. This logic suggests that firms with relatively high amounts of earned equity (retained earnings) are especially likely to pay dividends. Consistent with this view, the fraction of publicly traded industrial firms that pays dividends is high when the ratio of earned equity to total equity (total assets) is high, and falls with declines in this ratio, becoming near zero when a firm has little or no earned equity. We observe a highly significant relation between the decision to pay dividends and the ratio of earned equity to total equity or total assets, controlling for firm size, profitability, growth, leverage, cash balances, and dividend history. In our regressions, earned equity has an economically more important impact than does profitability or growth. Our evidence is consistent with the hypothesis that firms pay dividends to mitigate agency problems.

Dividends, payout policy, agency costs, earned equity, earnings, retained earnings

Abstract:
Acquiring-firm shareholders lost 12 cents around acquisition announcements per dollar spent on acquisitions for a total loss of $240 billion from 1998 through 2001, whereas they lost $7 billion in all of the 1980s, or 1.6 cents per dollar spent. The 1998 to 2001 aggregate dollar loss of acquiring-firm shareholders is so large because of a small number of acquisitions with negative synergy gains by firms with extremely high valuations. Without these acquisitions, the wealth of acquiring-firm shareholders would have increased. Firms that make these acquisitions with large dollar losses perform poorly afterwards.

Abstract:
Acquiring-firm shareholders lost 12 cents at the announcement of acquisitions for every dollar spent on acquisitions for a total loss of $240 billion from 1998 through 2001, whereas they lost $7 billion in all of the 1980s, or 1.6 cents per dollar spent. Though the announcement losses to acquiring-firm shareholders in the 1980s are more than offset by gains to acquired-firm shareholders, the losses of bidders exceed the gains of targets from 1998 through 2001 by $134 billion. The 1998-2001 aggregate dollar loss of acquiring-firm shareholders is so large because of a small number of acquisition announcements by firms with extremely high valuations. Without these announcements, the wealth of acquiring-firm shareholders would have increased. The large losses are consistent with the existence of negative synergies from the acquisitions, but the size of the losses in relation to the consideration paid for the acquisitions is large enough that part of the losses most likely results from investors reassessing the standalone value of the bidders. Firms that announce acquisitions with large dollar losses perform poorly afterwards.

Abstract:

Abstract:
Despite the dramatic reduction in explicit barriers to international investment activity over the last 60 years, the impact of financial globalization has been remarkably limited. I argue that country attributes are still critical to financial decision-making because of what I call the twin agency problems. These twin agency problems arise because rulers of sovereign states and corporate insiders pursue their own interests at the expense of outside investors. When these twin agency problems are significant, diffuse ownership is inefficient and corporate insiders must co-invest with other investors, retaining substantial equity. The resulting ownership concentration limits economic growth, financial development, and the ability of a country to take advantage of financial globalization. The twin agency problems help explain why the impact of financial globalization has been limited and why financial globalization can lead to capital flight and financial crises. The impact of financial globalization will remain limited as long as these agency problems are significant.

Abstract:
Despite the dramatic reduction in explicit barriers to international investment activity over the last 60 years, the impact of financial globalization has been surprisingly limited. I argue that country attributes are still critical to financial decision-making because of "twin agency problems" that arise because rulers of sovereign states and corporate insiders pursue their own interests at the expense of outside investors. When these twin agency problems are significant, diffuse ownership is inefficient and corporate insiders must co-invest with other investors, retaining substantial equity. The resulting ownership concentration limits economic growth, financial development, and the ability of a country to take advantage of financial globalization.

Abstract:
We compare the governance of foreign firms to the governance of similar U.S. firms. Using an index of firm governance attributes, we find that, on average, foreign firms have worse governance than matching U.S. firms. Roughly 8% of foreign firms have better governance than comparable U.S. firms. The majority of these firms are either in the U.K. or in Canada. When we define a firm's governance gap as the difference between the quality of its governance and the governance of a comparable U.S. firm, we find that the value of foreign firms increases with the governance gap. This result suggests that firms are rewarded by the markets for having better governance than their U.S. peers. It is therefore not the case that foreign firms are better off simply mimicking the governance of comparable U.S. firms. Among the individual governance attributes considered, we find that firms with board and audit committee independence are valued more. In contrast, other attributes, such as the separation of the chairman of the board and of the CEO functions, do not appear to be associated with higher shareholder wealth.

Abstract:
This paper examines the use of credit derivatives by US bank holding companies from 1999 to 2003 with assets in excess of one billion dollars. Using the Federal Reserve Bank of Chicago Bank Holding Company Database, we find that in 2003 only 19 large banks out of 345 use credit derivatives. Though few banks use credit derivatives, the assets of these banks represent on average two thirds of the assets of bank holding companies with assets in excess of $1 billion. Few banks are net buyers of credit protection and disclose using credit derivatives to hedge loans. Banks are more likely to be net protection buyers if they engage in asset securitization, originate foreign loans, and have lower capital ratios. The likelihood of a bank being a net protection buyer is positively related to the percentage of commercial and industrial loans in a bank's loan portfolio and negatively or not related to other types of bank loans. The use of credit derivatives by banks is limited because adverse selection and moral hazard problems make the market for credit derivatives illiquid for the typical credit exposures of banks.

Abstract:
This paper examines the use of credit derivatives by US bank holding companies from 1999 to 2003 with assets in excess of one billion dollars. Using the Federal Reserve Bank of Chicago Bank Holding Company Database, we find that in 2003 only 19 large banks out of 345 use credit derivatives. Though few banks use credit derivatives, the assets of these banks represent on average two thirds of the assets of bank holding companies with assets in excess of $1 billion. Few banks are net buyers of credit protection and disclose using credit derivatives to hedge loans. Banks are more likely to be net protection buyers if they engage in asset securitization, originate foreign loans, and have lower capital ratios. The likelihood of a bank being a net protection buyer is positively related to the percentage of commercial and industrial loans in a bank's loan portfolio and negatively or not related to other types of bank loans. The use of credit derivatives by banks is limited because adverse selection and moral hazard problems make the market for credit derivatives illiquid for the typical credit exposures of banks.

Abstract:
This paper investigates how a foreign firm's decision to cross-list its shares in the U.S. is related to the concentration of the ownership of its cash flow rights and of its control rights. Theory has proposed that when private benefits are high, controlling shareholders are less likely to choose to list their firm's shares in the U.S. because the higher standards for transparency and disclosure, as well as the increased monitoring associated with such listings, limit their ability to extract private benefits. We offer evidence that confirms this hypothesis using data on more than 4,000 firms from 31 countries. Using logistic regression analysis, we show that the control rights held by controlling shareholders, as well as the difference between their control rights and their cash flow rights are significantly and negatively related to the existence of a U.S. listing. In addition, we employ duration analysis using a Cox proportional-hazard model to show that the probability of listing in a given year from 1995 to 2001, conditional on not yet having listed, is significantly lower for firms whose managers have high levels of control and for firms whose controlling shareholder owns more control rights than cash flow rights.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
This paper investigates how a foreign firm's decision to cross-list on a U.S. stock exchange is related to the consumption of private benefits of control by its controlling shareholders. Theory has proposed that when private benefits are high, controlling shareholders are less likely to choose to list their firm's shares in the U.S. because the higher standards for transparency and disclosure, as well as the increased monitoring associated with such listings, limit their ability to extract private benefits. Using ownership of control rights by the firm's controlling shareholder as a proxy for private benefits, we offer evidence that confirms this hypothesis with a sample of more than 4,000
firms from 31 countries. In particular, the probability that a firm will cross-list on a U.S. exchange is inversely related to the control rights held by the controlling shareholder and to the difference
between the control rights and the cash flow rights owned by the controlling shareholder.

Private benefits of control, corporate governance, cross-listing, corporate ownership

Abstract:
We show that Tobin's q, as proxied by the ratio of the firm's market value to its book value, increases with the firm's systematic equity risk and falls with the firm's unsystematic equity risk. Further, an increase in the firm's total equity risk is associated with a fall in q. The negative relation between the change in total risk and the change in q is robust through time for the whole sample, but it does not hold for the largest firms.

Abstract:
We show that Tobin's q, as proxied by the ratio of the firm's market value to its book value, increases with the firm's systematic equity risk and falls with the firm's unsystematic equity risk. Further, an increase in the firm's total equity risk is associated with a fall in q. The negative relation between the change in total risk and the change in q is robust through time for the whole sample, but it does not hold for the largest firms.

Abstract:
This paper provides an analysis of the impact of international portfolio flows on security returns. It concludes that opening a country to portfolio flows decreases its cost of capital without adverse effects on its securities markets. There is no convincing evidence that portfolio flows increase the volatility of equity returns, lead to excessive co-movement of a country's equity returns with world equity returns, or destabilize security markets. Though there has been much concern about contagion, existing empirical evidence does not provide conclusive evidence that contagion is economically important for security markets.

Abstract:
We examine a sample of 12,023 acquisitions by public firms from 1980 to 2001. Shareholders of these firms lost a total of $218 billion when acquisitions were announced. Though shareholders lose throughout our sample period, losses associated with acquisition announcements after 1997 are dramatic. Small firms gain from acquisitions, so that shareholders of small firms gained $8 billion when acquisitions were announced and shareholders of large firms lost $226 billion. We examine the cross-sectional variation in the announcement returns of acquisitions. Small firm shareholders earn systematically more when acquisitions are announced. This size effect is typically more important than how an acquisition is financed and than the organizational form of the assets acquired. The only acquisitions that have positive aggregate gains are acquisitions of subsidiaries.

Abstract:
We examine a sample of 12,023 acquisitions by public firms from 1980 to 2001. Shareholders of these firms lost a total of $218 billion when acquisitions were announced. Though shareholders lose throughout our sample period, losses associated with acquisition announcements after 1997 are dramatic. Small firms gain from acquisitions, so that shareholders of small firms gained $8 billion when acquisitions were announced and shareholders of large firms lost $226 billion. We examine the cross-sectional variation in the announcement returns of acquisitions. Small firm shareholders earn systematically more when acquisitions are announced. This size effect is typically more important than how an acquisition is financed and than the organizational form of the assets acquired. The only acquisitions that have positive aggregate gains are acquisitions of subsidiaries.

Acquisitions, bidder gains, size effect, organizational form

Abstract:
The average cash to assets ratio for U.S. industrial firms increases by 129% from 1980 to 2004. Because of this increase in the average cash ratio, American firms at the end of the sample period can pay back their debt obligations with their cash holdings, so that the average firm has no leverage when leverage is measured by net debt. This change in cash ratios and net debt is the result of a secular trend rather than the outcome of the recent buildup in cash holdings of some large firms. It is concentrated among firms that do not pay dividends. The average cash ratio increases over the sample period because the cash flow of American firms has become riskier, these firms hold fewer inventories and accounts receivable, and the typical firm spends more on R&D. The precautionary motive for cash holdings appears to explain the increase in the average cash ratio.

Abstract:
The average cash-to-assets ratio for U.S. industrial firms more than doubles from 1980 to 2006. A measure of the economic importance of this increase in cash holdings is that at the end of the sample period, the average firm can pay back all of its debt obligations with its cash holdings; in other words, the average firm has no leverage if leverage is measured as net debt. This change in cash ratios and net debt is the result of a secular trend rather than the outcome of the recent buildup in cash holdings of some large firms, and it is much more pronounced for firms that do not pay dividends and for firms in industries whose cash flows became riskier. The average cash ratio increases over the sample period because firms change: their cash flows become riskier, they hold fewer inventories and accounts receivable, and they are increasingly R&D intensive. The precautionary motive for cash holdings plays an important role in explaining the increase in the average cash ratio; in contrast, in our empirical tests, agency considerations are not successful in explaining the increase.

Abstract:
If investors are poorly protected, it is optimal for firms to be closely held because selling shares to minority shareholders is otherwise too expensive. Empirically, most firms in countries with poor investor protection are closely held so that investors cannot hold the market portfolio. We show that the prevalence of closely held firms in countries with poor investor protection explains part of the home bias of U.S. investors. We construct an estimate of the world portfolio of shares available to investors who are not controlling shareholders (the world float portfolio). The world float portfolio differs sharply from the world market portfolio. In regressions explaining the portfolio weights of U.S. investors, the world float portfolio has a positive significant coefficient but the world market portfolio has no additional explanatory power. This result holds when we control for country characteristics. An analysis of foreign investor holdings at the firm level for Sweden confirms the importance of the float portfolio as a determinant of these holdings.

Abstract:
We find that the announcement gain to target shareholders from acquisitions is significantly lower if a private firm instead of a public firm makes the acquisition. Non-operating firms like private equity funds make the majority of private bidder acquisitions. On average, target shareholders receive 55% more if a public firm instead of a private equity fund makes the acquisition. There is no evidence that the difference in premiums is driven by observable differences in targets. We find that target shareholder gains depend critically on the managerial ownership of the bidder. In particular, there is no difference in target shareholder gains between acquisitions made by public bidders with high managerial ownership and by private bidders. Such evidence suggests that the differences in managerial incentives between private and public firms have an important impact on target shareholder gains from acquisitions and managers of firms with diffuse ownership may pay too much for acquisitions.

Abstract:
We find that the announcement gain to target shareholders from acquisitions is significantly lower if private firm instead of a public firm makes the acquisition. Non-operating firms like private equity funds make the majority of private bidder acquisitions. On average, target shareholders receive 55% more if a public firm instead of a private equity fund makes the acquisition. There is no evidence that the difference in premiums is driven by observable differences in targets. We find that target shareholder gains depend critically on the managerial ownership of the bidder. In particular, there is no difference in target shareholder gains between acquisitions made by public bidders with high managerial ownership and by private bidders. Such evidence suggests that the differences in managerial incentives between private and public firms have an important impact on target shareholder gains and that managers of firms with diffuse ownership may pay too much for acquisitions.

Private equity acquisitions, target abnormal returns

Abstract:
Consistent with a lifecycle theory of dividends, the fraction of publicly traded industrial firms that pays dividends is high when retained earnings are a large portion of total equity (and of total assets) and falls to near zero when most equity is contributed rather than earned. We observe a highly significant relation between the decision to pay dividends and the earned/contributed capital mix, controlling for profitability, growth, firm size, leverage, cash balances, and dividend history, a relation that also holds for dividend initiations and omissions. In our regressions, the mix of earned/contributed capital has a quantitatively greater impact than measures of profitability and growth opportunities. We document a massive increase in firms with negative retained earnings (from 11.8% of industrials in 1978 to 50.2% in 2002). Controlling for the earned/contributed capital mix, firms with negative retained earnings show virtually no change in their propensity to pay dividends from the mid-1970s to 2002, while those whose earned equity makes them reasonable candidates to pay dividends have a propensity reduction that is twice the overall reduction in Fama and French (2001). All our evidence supports the lifecycle theory of dividends, in which a firm's stage in that cycle is well-proxied by its mix of internal and external capital.

Dividends, payout policy, corporate lifecycle, agency costs

Abstract:
At the end of 1997, the foreign companies listed in the U.S. have a Tobin's q ratio that exceeds by 16.5% the q ratio of firms from the same country that are not listed in the U.S. The valuation difference is statistically significant and largest for exchange-listed firms, where it reaches 37%. The difference persists even after controlling for a number of firm and country characteristics. We propose a theory that explains this valuation difference. We hypothesize that controlling shareholders of firms listed in the U.S. cannot extract as many private benefits from control compared to controlling shareholders of firms not listed in the U.S., but that their firms are better able to take advantage of growth opportunities. Consequently, the cross-listed firms should be those firms where the interests of the controlling shareholder are better aligned with the interests of other shareholders. The growth opportunities of cross-listed firms will be more highly valued than those of firms not listed in the U.S. both because cross-listed firms are better able to take advantage of these opportunities and because a smaller fraction of the cash flow of these firms is expropriated by controlling shareholders. We find that our theory explains the greater valuation of cross-listed firms. In particular, we find expected sales growth is valued more highly for firms listed in the U.S. and that this effect is greater for firms from countries with poorer investor rights.

Abstract:
At the end of 1997, the foreign companies listed in the U.S. have a Tobin's q ratio that exceeds by 16.5% the q ratio of firms from the same country that are not listed in the U.S. The valuation difference is statistically significant and largest for exchange-listed firms, where it reaches 37%. The difference persists even after controlling for a number of firm and country characteristics. We propose a theory that explains this valuation difference. We hypothesize that controlling shareholders of firms listed in the U.S. cannot extract as many private benefits from control compared to controlling shareholders of firms not listed in the U.S., but that their firms are better able to take advantage of growth opportunities. Consequently, the cross-listed firms should be those firms where the interests of the controlling shareholder are better aligned with the interests of other shareholders. The growth opportunities of cross-listed firms will be more highly valued than those of firms not listed in the U.S. both because cross-listed firms are better able to take advantage of these opportunities and because a smaller fraction of the cash flow of these firms is expropriated by controlling shareholders. We find that our theory explains the greater valuation of cross-listed firms. In particular, we find expected sales growth is valued more highly for firms listed in the U.S. and that this effect is greater for firms from countries with poorer investor rights.

Abstract:
At the end of 1997, the foreign companies listed in the U.S. have a Tobin's q ratio that exceeds by 16.5% the q ratio of firms from the same country that are not listed in the U.S. The valuation difference is statistically significant and largest for exchange-listed firms, where it reaches 37%. The difference persists even after controlling for a number of firm and country characteristics. We propose a theory that explains this valuation difference. We hypothesize that controlling shareholders of firms listed in the U.S. cannot extract as many private benefits from control compared to controlling shareholders of firms not listed in the U.S., but that their firms are better able to take advantage of growth opportunities. Consequently, the cross-listed firms should be those firms where the interests of the controlling shareholder are better aligned with the interests of other shareholders. The growth opportunities of cross-listed firms will be more highly valued than those of firms not listed in the U.S. both because cross-listed firms are better able to take advantage of these opportunities and because a smaller fraction of the cash flow of these firms is expropriated by controlling shareholders. We find that our theory explains the greater valuation of cross-listed firms. In particular, we find expected sales growth is valued more highly for firms listed in the U.S. and that this effect is greater for firms from countries with poorer investor rights.

Abstract:
Religions have little to say about shareholders but have much to say about creditors. We find that the origin of a country's legal system is more important than its religion and language in explaining shareholder rights. However, a country's principal religion helps predict the cross-sectional variation in creditor rights better than a country's openness to international trade, its language, its income per capita, or the origin of its legal system. Catholic countries protect the rights of creditors less than other countries, and long-term debt is less important in these countries. A country's openness to international trade mitigates the influence of religion on creditor rights. Religion and language are also important predictors of how countries enforce rights.

Abstract:
Religions have little to say about shareholders but have much to say about creditors. We find that the origin of a country's legal system is more important than its religion and language in explaining shareholder rights. However, a country's principal religion helps predict the cross-sectional variation in creditor rights better than a country's openness to international trade, its language, its income per capita, or the origin of its legal system. Catholic countries protect the rights of creditors less than other countries, and long-term debt is less important in these countries. A country's openness to international trade mitigates the influence of religion on creditor rights. Religion and language are also important predictors of how countries enforce rights.

Abstract:
We investigate whether bank performance during the credit crisis of 2008 is related to CEO incentives and share ownership before the crisis and whether CEOs reduced their equity stakes in their banks in anticipation of the crisis. There is no evidence that banks with CEOs whose incentives were better aligned with the interests of their shareholders performed better during the crisis and some evidence that these banks actually performed worse both in terms of stock returns and in terms of accounting return on equity. Further, option compensation did not have an adverse impact on bank performance during the crisis. Bank CEOs did not reduce their holdings of shares in anticipation of the crisis or during the crisis; further, there is no evidence that they hedged their equity exposure. Consequently, they suffered extremely large wealth losses as a result of the crisis.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
We investigate whether bank performance during the credit crisis of 2008 is related to CEO incentives and share ownership before the crisis and whether CEOs reduced their equity stakes in their banks in anticipation of the crisis. There is no evidence that banks with CEOs whose incentives were better aligned with the interests of their shareholders performed better during the crisis and some evidence that these banks actually performed worse both in terms of stock returns and in terms of accounting return on equity. Further, option compensation did not have an adverse impact on bank performance during the crisis. Bank CEOs did not reduce their holdings of shares in anticipation of the crisis or during the crisis; further, there is no evidence that they hedged their equity exposure. Consequently, they suffered extremely large wealth losses as a result of the crisis.

Financial crisis, CEO compensation, insider trading

Abstract:
This paper discusses the extent to which derivatives pose threats to firms and to the economy. After reviewing the derivatives markets and putting in perspective the various measures of the size of these markets, the paper shows who uses derivatives and why. The difficulties firms face in valuing derivatives portfolios are evaluated. Although academics pay much attention to no-arbitrage pricing results, the paper points out that there can be considerable subjectivity in the pricing of derivatives that do not have highly liquid markets. It is shown that the known risks of derivatives portfolios can generally be measured and managed well at the firm level. However, derivatives can create systemic risks when a market participant becomes excessively large relative to particular derivatives markets. Overall, the benefits of derivatives outweigh the potential threats.

Abstract:
This paper discusses the extent to which derivatives pose threats to firms and to the economy. After reviewing the derivatives markets and putting in perspective the various measures of the size of these markets, the paper shows who uses derivatives and why. The difficulties firms face in valuing derivatives portfolios are evaluated. Although academics pay much attention to no-arbitrage pricing results, the paper points out that there can be considerable subjectivity in the pricing of derivatives that do not have highly liquid markets. It is shown that the known risks of derivatives portfolios can generally be measured and managed well at the firm level. However, derivatives can create systemic risks when a market participant becomes excessively large relative to particular derivatives markets. Overall, the benefits of derivatives outweigh the potential threats.

Abstract:
Though overall bank performance from July 2007 to December 2008 was the worst since at least the Great Depression, there is significant variation in the cross-section of stock returns of large banks across the world during that period. We use this variation to evaluate the importance of factors that have been discussed as having contributed to the poor performance of banks during the credit crisis. More specifically, we investigate whether bank performance is related to bank-level governance, country-level governance, country-level regulation, and bank balance sheet and profitability characteristics before the crisis. Banks that the market favored in 2006 had especially poor returns during the crisis. Using conventional indicators of good governance, banks with more shareholder-friendly boards performed worse during the crisis. Banks in countries with stricter capital requirement regulations and with more independent supervisors performed better. Though banks in countries with more powerful supervisors had worse stock returns, we provide some evidence that this may be because these supervisors required banks to raise more capital during the crisis and that doing so was costly for shareholders. Large banks with more Tier 1 capital and more deposit financing at the end of 2006 had significantly higher returns during the crisis. After accounting for country fixed effects, banks with more loans and more liquid assets performed better during the month following the Lehman bankruptcy, and so did banks from countries with stronger capital supervision and more restrictions on bank activities.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
Though overall bank performance from July 2007 to December 2008 was the worst since at least the Great Depression, there is significant variation in the cross-section of stock returns of large banks across the world during that period. We use this variation to evaluate the importance of factors that have been discussed as having contributed to the poor performance of banks during the credit crisis. More specifically, we investigate whether bank performance is related to bank-level governance, country-level governance, country-level regulation, and bank balance sheet and profitability characteristics before the crisis. Banks that the market favored in 2006 had especially poor returns during the crisis. Using conventional indicators of good governance, banks with more shareholder-friendly boards performed worse during the crisis. Banks in countries with stricter capital requirement regulations and with more independent supervisors performed better. Though banks in countries with more powerful supervisors had worse stock returns, we provide some evidence that this may be because these supervisors required banks to raise more capital during the crisis and that doing so was costly for shareholders. Large banks with more Tier 1 capital and more deposit financing at the end of 2006 had significantly higher returns during the crisis. After accounting for country fixed effects, banks with more loans and more liquid assets performed better during the month following the Lehman bankruptcy,and so did banks from countries with stronger capital supervision and more restrictions on bank activities.

Banking Financial Institutions, Corporate Finance, Capital Structure and Payout Policies, Coporate Finanace, Governance, Corporate Control and Corganization, Risk Management, International Finance, Monetary Economics, Corporate law, law and Finance, Regulation of financial institutions

Abstract:
This paper examines the impact of foreign investors on stock returns in Korea from November 30, 1996, to the end of 1997 using trade data. We find strong evidence of positive feedback trading and herding by foreign investors before the period of Korea's economic crisis during the last three months of 1997. The evidence of herding becomes weaker during the crisis period and positive feedback trading by foreign investors disappears. We find no evidence that trades by foreign investors had a destabilizing effect on Korea's stock market over our sample period. In particular, the market adjusted quickly and efficiently to large sales by foreign investors, and these sales were not followed by negative abnormal returns amplifying their impact.

Abstract:
This paper examines the impact of the Asian crisis on bank stocks across four Western countries and six Asian countries. In the second half of 1997, Western banks experienced positive returns. In contrast East Asian bank indices incurred losses in excess of 60% in each of the crisis countries. Most of this poor performance is explained by the exposure of the banks to general stock market movements in their countries. Currency exposures affected banks adversely beyond their stock market impact only in Indonesia and the Philippines. Except for the Korean program, IMF programs had little effect on bank values. The announcement of the Korean program increased shareholder wealth at the U.S. banks with the highest reported exposure in Korea by about 7% and had a favorable effect on bank shareholder wealth in all the countries in our sample but one. There is no evidence that the Korean IMF program had a positive impact on banks without exposure to Korea and hence our results do not support the argument that such programs reduce systemic risk.

Abstract:
This paper examines the impact of the Asian crisis on bank stocks across four Western countries and six Asian countries. In the second half of 1997, Western banks experienced positive returns. In contrast, East Asian bank indices incurred losses in excess of 60% in each of the crisis countries. Most of this poor performance is explained by the exposure of the banks to general stock market movements in their countries. Currency exposures affected banks adversely beyond their stock market impact only in Indonesia and the Philippines. Except for the Korean program, IMF programs had little effect on bank values. The announcement of the Korean program increased shareholder wealth at the U.S. banks with the highest reported exposure in Korea by about 7% and had a favorable effect on bank shareholder wealth in all the countries in our sample but one. There is no evidence that the Korean IMF program had a positive impact on banks without exposure to Korea and hence our results do not support the argument that such programs reduce systemic risk.

Abstract:
This study explores empirically the fundamental factors that influence intraday and overnight cross country stock return covariances. Using the Institute for Study of Securities Markets (ISSM) transactions data from 1988 to 1992, we construct overnight and intraday returns for a portfolio of Japanese stocks using their NYSE-traded American Depository Receipts and a matched-sample portfolio of U.S. stocks. A simple valuation framework is developed to examine cross-country correlations of returns and to discriminate between "competitive" and "global" information shocks to future expected and unexpected dividends and discount rates. We find that U.S. macroeconomic news announcements, shocks to the yen/dollar foreign exchange rate and Treasury bill returns and industry effects have no measurable influence on U.S. and Japanese return correlations. However, large shocks to broad-based market indexes (Nikkei Stock Average and Standard and Poor's 500 Stock Index) positively impact both the magnitude and persistence of the return correlations. The implications for international diversification strategies are discussed.

Abstract:
The evidence presented here is inconsistent with variants of corporate finance theory which hold that the option properties of growth opportunities or asset substitution incentives are first-order determinants of equity values, but it is supportive of risk management and capital structure theories that emphasize the costs of cash flow volatility. Specifically, controlling for known determinants of changes in shareholder wealth, we find that the change in shareholder wealth over one year is inversely related to the change in expected equity volatility over the same year in cross-section regressions. This relation holds consistently through time for all but the largest firms and is economically significant. It is stronger for firms with weaker financial health. When we decompose volatility into beta risk and idiosyncratic risk, we find that shareholder wealth is positively related to beta changes, so that our evidence cannot be explained by a beta effect. Nor can the evidence be explained by the impact of returns on volatility predicted by the leverage effect studied in the option pricing literature.

Abstract:
We review the international finance literature to assess the extent to which international factors affect financial asset demands and prices. International asset pricing models with mean-variance investors predict that an asset's risk premium depends on its covariance with the world market portfolio and, possibly, with exchange rate changes. The existing empirical evidence shows that a country's risk premium depends on its covariance with the world market portfolio and that there is some evidence that exchange rate risk affects expected returns. However, the theoretical asset pricing literature relying on mean-variance optimizing investors fails in explaining the portfolio holdings of investors, equity flows, and the time-varying properties of correlations across countries. The home bias has the effect of increasing local influences on asset prices, while equity flows and cross-country correlations increase global influences on asset prices.

Abstract:
We review the international finance literature to assess the extent to which international factors affect financial asset demands and prices. International asset pricing models with mean-variance investors predict that an asset's risk premium depends on its covariance with the world market portfolio and, possibly, with exchange rate changes. The existing empirical evidence shows that a country's risk premium depends on its covariance with the world market portfolio and that there is some evidence that exchange rate risk affects expected returns. However, the theoretical asset pricing literature relying on mean-variance investors fails in explaining the portfolio holdings of investors, equity flows, and the time-varying properties of correlations across countries. The home bias has the effect of increasing local influences on asset prices, while equity flows and cross-country correlations increase global influences on asset prices.

Abstract:
Firms conduct SEOs to resolve a near-term liquidity squeeze, and not primarily to exploit market timing opportunities. Without the SEO proceeds, 62.6% of issuers would have insufficient cash to implement their chosen operating and non-SEO financing decisions the year after the SEO. Although the SEO decision is positively related to a firm's market-to-book (M/B) ratio and prior excess stock return and negatively related to its future excess return, these relations are economically immaterial. For example, a 150% swing in future net of market stock returns (from a 75% gain to a 75% loss over three years) increases by only 1% the probability of an SEO in the immediately prior year. Strikingly, most firms with quintessential market timer characteristics fail to issue stock and a non-trivial number of mature firms do issue stock, with current and former dividend payers raising more than half of all issue proceeds.

Abstract:
This paper gauges the importance of market timing for the decision to conduct a seasoned equity offering by testing whether SEO decisions are better explained by timing opportunities or by a simple fundamentals-based theory in which firms sell stock primarily in the early stages of their lifecycle, when growth opportunities exceed internally generated cash flow. We measure timing opportunities using market-to-book ratios and prior and future stock returns (and other equity mispricing proxies advanced in the literature), and lifecycle stage by the number of years listed. Both timing and lifecycle proxies have a significant influence, with the lifecycle effect quantitatively stronger, but neither adequately explains SEO decisions because (i) a near-majority of issuers are not growth firms, and (ii) the vast majority of firms with high M/B ratios and high recent and poor future stock returns fail to issue stock. Since a full 62.6% of issuers would run out of cash by the year after the SEO without the offer proceeds (and 81.1% would have subnormal cash balances at that time), we conclude that a near-term cash need is the primary SEO motive, with market-timing opportunities and lifecycle stage exerting economically significant ancillary influences on the SEO decision.

market timing, SEO, equity financing, cash balances, corporate lifecycle

Abstract:
From 1988 to 2003, the average change in managerial ownership is significantly negative every year for American firms. We find that managers are more likely to significantly decrease their ownership when their firms are performing well and more likely to increase their ownership when their firms become financially constrained. When controlling for past stock returns, we find that large increases in managerial ownership increase q. This result is driven by increases in shares held by officers, while increases in shares held by directors appear unrelated to changes in firm value. There is no evidence that large decreases in ownership have an adverse impact on firm value. We rely on the dynamics of the managerial ownership/firm value relation to mitigate concerns in the literature about the endogeneity of managerial ownership.

Firm valuation, director and officer ownership, ownership dynamics

Abstract:
Over the last twenty years, the consensus view of systemic risk in the financial system that emerged in response to the banking crises of the 1930s and before has lost much of its relevance. This view held that the main systemic problem is runs on solvent banks leading to bank panics. But financial crises of the last two decades have not fit the mold. A new consensus has yet to emerge, but financial institutions and regulators have considerably broadened their assessment of the risks facing financial institutions. The dramatic rise of modern risk management has changed how the risks of financial institutions are measured and how these institutions are managed. However, modern risk management is not without weaknesses that will have to be addressed.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
Over the last twenty years, the consensus view of systemic risk in the financial system that emerged in response to the banking crises of the 1930s and before has lost much of its relevance. This view held that the main systemic problem is runs on solvent banks leading to bank panics. But financial crises of the last two decades have not fit the mold. A new consensus has yet to emerge, but financial institutions and regulators have considerably broadened their assessment of the risks facing financial institutions. The dramatic rise of modern risk management has changed how the risks of financial institutions are measured and how these institutions are managed. However, modern risk management is not without weaknesses that will have to be addressed.

Abstract:
This paper proposes a new approach to evaluate contagion in financial markets. Our measure of contagion captures the co-incidence of extreme return shocks across countries within a region and across regions that cannot be explained by linear propagation models of shocks. We characterize the extent of contagion, its economic significance, and its determinants using a multinomial logistic regression model. Applying our approach to daily returns of emerging markets during the 1990s, we find that contagion, when measured by the co-incidence within and across regions of extreme return shocks, is predictable and depends on regional interest rates, exchange rate changes, and conditional stock return volatility. Evidence that contagion is stronger for extreme negative returns than for extreme positive returns is mixed.

Abstract:
This paper proposes a new approach to evaluate contagion in financial markets. Our measure of contagion captures the co-incidence of extreme return shocks across countries within a region and across regions that cannot be explained by linear propagation models of shocks. We characterize the extent of contagion, its economic significance, and its determinants using a multinomial logistic regression model. Applying our approach to daily returns of emerging markets during the 1990s, we find that contagion, when measured by the co-incidence within and across regions of extreme return shocks, is predictable and depends on regional interest rates, exchange rate changes, and conditional stock return volatility. Evidence that contagion is stronger for extreme negative returns than for extreme positive returns is mixed.

Abstract:
Using an index which increases as a firm adopts more governance attributes, we find that 12.7% of foreign firms have a higher index than matching U.S. firms. The best predictor for whether a foreign firm adopts more governance attributes than a comparable U.S. firm is whether the firm comes from a common law country. We show that the value of foreign firms is negatively related to the difference between their governance index and the index of matching U.S. firms. This relation is robust to various approaches to control for the endogeneity of corporate governance and is consistent with the hypothesis that foreign firms are valued less because country characteristics make it suboptimal for them to invest as much in governance as comparable U.S. firms. Overall, our evidence suggests that firm-level governance attributes are complementary to rather than substitutes for country-level investor protection, so that better country-level investor protection makes it optimal for firms to invest more in internal governance. Our evidence supports the view that minority shareholders of a typical foreign firm would benefit from an increase in investment in governance, but that the firm's controlling shareholder and possibly other stakeholders would not.

Abstract:
We construct a firm-level governance index that increases with minority shareholder protection. Compared to U.S. matching firms, only 12.68% of foreign firms have a higher index. The value of foreign firms falls as their index decreases relative to the index of matching U.S. firms. Our results suggest that lower country-level investor protection and other country characteristics make it suboptimal for foreign firms to invest as much in governance as U.S. firms do. Overall, we find that minority shareholders benefit from governance improvements and do so partly at the expense of controlling shareholders.

governance, investor protection, common law.

Abstract:
A conflict of interest exists when a party to a transaction could potentially make a gain from taking actions that are detrimental to the other party in the transaction. This paper examines the economics of conflicts of interest in financial institutions and reviews the growing empirical literature (mostly focused on analysts) on the economic implications of these conflicts. Economic analysis shows that, although conflicts of interest are omnipresent when contracting is costly and parties are imperfectly informed, there are important factors that mitigate their impact and, strikingly, it is possible for customers of financial institutions to benefit from the existence of such conflicts. The empirical literature reaches conclusions that differ across types of conflicts of interest, but overall these conclusions are more ambivalent and certainly more benign than the conclusions drawn by journalists and politicians from mostly anecdotal evidence. Though much has been made of conflicts of interest arising from investment banking activities, there is no consensus in the empirical literature supporting the view that conflicts resulting from these activities had a systematic adverse impact on customers of financial institutions.

Abstract:
A conflict of interest exists when a party to a transaction could potentially make a gain from taking actions that are detrimental to the other party in the transaction. This paper examines the economics of conflicts of interest in financial institutions and reviews the growing empirical literature (mostly focused on analysts) on the economic implications of these conflicts. Economic analysis shows that, although conflicts of interest are omnipresent when contracting is costly and parties are imperfectly informed, there are important factors that mitigate their impact and, strikingly, it is possible for customers of financial institutions to benefit from the existence of such conflicts. The empirical literature reaches conclusions that differ across types of conflicts of interest, but overall these conclusions are more ambivalent and certainly more benign than the conclusions drawn by journalists and politicians from mostly anecdotal evidence. Though much has been made of conflicts of interest arising from investment banking activities, there is no consensus in the empirical literature supporting the view that conflicts resulting from these activities had a systematic adverse impact on customers of financial institutions.

Abstract:
This paper investigates the impact on bank stock prices of emerging market currency crises and bailouts. The stock market distinguishes between banks with exposure to a crisis country and other banks. In general, banks with exposures to a crisis country are affected adversely by currency events and positively by bailouts. Other banks are mostly unaffected by events in countries experiencing a crisis. The paper uses the impact of the LTCM crisis on bank stock prices to put the emerging market events in perspective. The LTCM crisis had no significant contagion effects in the banking sector either, but banks that participated in the LTCM rescue experienced negative stock returns when the rescue was announced.

Abstract:
This paper investigates the impact on bank stock prices of emerging market currency crises and bailouts. The stock market distinguishes between banks with exposure to a crisis country and other banks. In general, banks with exposures to a crisis country are affected adversely by currency events and positively by bailouts. Other banks are mostly unaffected by events in countries experiencing a crisis. The paper uses the impact of the LTCM crisis on bank stock prices to put the emerging market events in perspective. The LTCM crisis had no significant contagion effects in the banking sector either, but banks that participated in the LTCM rescue experienced negative stock returns when the rescue was announced.

Abstract:
Managers make different decisions in countries with poor protection of investor rights and poor financial development. One possible explanation is that shareholder-wealth maximizing managers face different tradeoffs in such countries (the tradeoff theory). Alternatively, firms in such countries are less likely to be managed for the benefit of shareholders because the poor protection of investor rights makes it easier for management and controlling shareholders to appropriate corporate resources for their own benefit (the agency costs theory). Holdings of liquid assets by firms across countries are consistent with Keynes' transaction and precautionary demand for money theories. Firms in countries with greater GDP per capita hold more cash as predicted. Controlling for economic development, firms in countries with more risk and with poor protection of investor rights hold more cash. The tradeoff theory and the agency costs theory can both explain holdings of liquid assets across countries. However, the fact that a dollar of cash is worth less than $0.65 to the minority shareholders of firms in such countries but worth approximately $1 in countries with good protection of investor rights and high financial development is only consistent with the agency costs theory.

Abstract:
Managers make different decisions in countries with poor protection of investor rights and poor financial development. One possible explanation is that shareholder-wealth maximizing managers face different tradeoffs in such countries (the tradeoff theory). Alternatively, firms in such countries are less likely to be managed for the benefit of shareholders because the poor protection of investor rights makes it easier for management and controlling shareholders to appropriate corporate resources for their own benefit (the agency costs theory). Holdings of liquid assets by firms across countries are consistent with Keynes' transaction and precautionary demand for money theories. Firms in countries with greater GDP per capita hold more cash as predicted. Controlling for economic development, firms in countries with more risk and with poor protection of investor rights hold more cash. The tradeoff theory and the agency costs theory can both explain holdings of liquid assets across countries. However, the fact that a dollar of cash is worth less than $0.65 to the minority shareholders of firms in such countries but worth approximately $1 in countries with good protection of investor rights and high financial development is only consistent with the agency costs theory.

Abstract:
We merge portfolio theories of home bias with corporate finance theories of insider ownership to create the optimal corporate ownership theory of the home bias. The theory has two components: (i) foreign portfolio investors exhibit a large home bias against countries with poor governance because their investment is limited by high optimal ownership by insiders (the “direct effect” of poor governance) and domestic monitoring shareholders (the “indirect effect”) in response to the governance, and (ii) foreign direct investors from “good governance” countries have a comparative advantage as insider monitors in “poor governance” countries, so that the relative importance of foreign direct investment is negatively related to the quality of governance. Using both country-level data on U.S. investors' foreign investment allocations and Korean firm-level data, we find empirical evidence supporting our optimal corporate ownership theory of the home bias.

Abstract:
Despite the disappearance of formal barriers to international investment across countries, we find that the average home bias of U.S. investors towards the 46 countries with the largest equity markets did not fall from 1994 to 2004 when countries are equally weighted but fell when countries are weighted by market capitalization. This evidence is inconsistent with portfolio theory explanations of the home bias, but is consistent with what we call the optimal insider ownership theory of the home bias. Since foreign investors can only own shares not held by insiders, there will be a large home bias towards countries in which insiders own large stakes in corporations. Consequently, for the home bias to fall substantially, insider ownership has to fall in countries where it is high. Poor governance leads to concentrated insider ownership, so that governance improvements make it possible for corporate ownership to become more dispersed and for the home bias to fall. We find that the home bias of U.S. investors decreased the most towards countries in which the ownership by corporate insiders is low and countries in which ownership by corporate insiders fell. Using firm-level data for Korea, we find that portfolio equity investment by foreign investors in Korean firms is inversely related to insider ownership and that the firms that attract the most foreign portfolio equity investment are large firms with dispersed ownership.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
Despite the disappearance of formal barriers to international investment across countries, we find that the average home bias of US investors towards the 46 countries with the largest equity markets did not fall from 1994 to 2004 when countries are equally weighted but fell when countries are weighted by market capitalisation. This evidence is inconsistent with portfolio theory explanations of the home bias, but is consistent with what we call the optimal insider ownership theory of the home bias. Since foreign investors can only own shares not held by insiders, there will be a large home bias towards countries in which insiders own large stakes in corporations. Consequently, for the home bias to fall substantially, insider ownership has to fall in countries where it is high. Poor governance leads to concentrated insider ownership, so that governance improvements make it possible for corporate ownership to become more dispersed and for the home bias to fall. We find that the home bias of US investors decreased the most towards countries in which the ownership by corporate insiders is low and countries in which ownership by corporate insiders fell. Using firm-level data for Korea, we find that portfolio equity investment by foreign investors in Korean firms is inversely related to insider ownership and that the firms that attract the most foreign portfolio equity investment are large firms with dispersed ownership.

Abstract:
This paper examines the use of credit derivatives by US bank holding companies with assets in excess of one billion dollars from 1999 to 2005. Using the Federal Reserve Bank of Chicago Bank Holding Company Database, we find that in 2005 the gross notional amount of credit derivatives held by banks exceeds the amount of loans on their books. Only 23 large banks out of 395 use credit derivatives and most of their derivatives positions are held for dealer activities rather than for hedging of loans. The net notional amount of credit derivatives used for hedging of loans in 2005 represents less than 2% of the total notional amount of credit derivatives held by banks and less than 2% of their loans. Banks hedge less risky loans more than riskier ones. The banks are more likely to be net protection buyers if they have lower capital ratios, a lower net interest rate margin, engage in asset securitization, originate foreign loans, have more commercial and industrial loans in their portfolio, and have fewer agricultural loans. We conclude that the use of credit derivatives by banks to hedge loans is limited because of adverse selection and moral hazard problems and because of the inability of banks to use hedge accounting when hedging with credit derivatives. Our evidence raises important questions about the validity of the often-held view that the use of credit derivatives makes banks sounder.

Abstract:
Several literatures predict a relation between acquirer announcement returns and uncertainty about the acquirer's growth prospects. Models with downward-sloping demand curves for stocks predict that an increase in shares outstanding leads to a lower stock price for firms with greater diversity of opinion among investors. Information asymmetry models imply that equity issues by firms with greater information asymmetries are accompanied by larger share price decreases. Valuation models predict a negative relation between uncertainty resolution and share prices. We find that, for our sample of firms with long-term analyst forecasts, acquirer abnormal returns for acquisitions of public firms paid for with equity decrease as proxies for the acquirer's diversity of opinion, information asymmetry, and/or uncertainty resolution increase. In contrast, abnormal returns for acquisitions of public firms paid for with cash and for acquisitions of private firms paid for with equity either are unaffected or increase as these proxies increase. Strikingly, while diversity of opinion can explain the abnormal returns difference between cash and equity offers for public firms, idiosyncratic volatility appears to be capable of explaining abnormal return differences between cash and equity offers for public firms as well as equity offers for private firms.

Acquisitions, bidder returns, analyst earnings forecasts, information asymmetries, divergence

Abstract:
In this keynote address to the 2000 Financial Management Association Meetings, I consider Merton Miller's contributions to the field of finance. I argue that his most important contribution is to have made arbitrage arguments the cornerstone of modern finance. The arbitrage proof of Proposition I introduced a new standard in finance, namely that any result the finance profession takes seriously must have the critical property that it cannot be undermined by clever arbitrageurs. I show how arbitrage is a constant theme in Merton Miller's career from his work in corporate finance to his analyses of financial innovation, financial crashes, and crises.

Abstract:
A sample of firms that focus by divesting at least one segment allows us to investigate the characteristics of segments divested as well as the nature of focusing firms. We find that firms are more likely to divest segments unrelated to the core activities of the firm and that the probability that a segment is divested is inversely related to its relative size within the firm. In fact, a segment's relative size is the variable that has the most explanatory power in predicting which segment a firm divests. We argue that this is consistent with the importance of asset market liquidity as a determinant of the divestiture decision. Financial constraints play an important role in determining which firms focus, which segments these firms divest, and in the market's reaction to divestiture announcements. Focusing firms perform less well and invest significantly less than heir non-focusing counterparts.

Abstract:
A sample of firms that focus by divesting at least one segment allows us to investigate the characteristics of segments divested as well as the nature of focusing firms. We find that firms are more likely to divest segments unrelated to the core activities of the firm and that the probability that a segment is divested is inversely related to its relative size within the firm. In fact, a segment's relative size is the variable that has the most explanatory power in predicting which segment a firm divests. We argue that this is consistent with the importance of asset market liquidity as a determinant of the divestiture decision. Financial constraints play an important role in determining which firms focus, which segments these firms divest, and in the market's reaction to divestiture announcements. Focusing firms perform less well and invest significantly less than their non-focusing counterparts.

Abstract:
We examine the determinants of appointments of outside CEOs to boards and how these appointments impact the appointing companies. We find that CEOs are most likely to join boards of large established firms that are geographically close, pursue similar financial and investment policies, and have comparable governance mechanisms to their own firms. It is also more likely that CEOs join firms with low insider ownership and firms with boards that already have other CEO directors. Except for the case of board interlocks, there is no evidence supporting the view that CEO directors have any impact on the appointing firm during their tenure, either positively or negatively. Appointments of CEO directors do not have a significant impact on the appointing firm's operating performance, its decision-making, the compensation of its CEO, or on the monitoring of management by the board. However, operating performance drops significantly for CEO director appointments when the CEO of the appointing firm already sits on the board of the appointee's firm.

Director independence, new director appointment, director influence, quiet life

Abstract:
We investigate a sample of firms whose number of reported segments falls by one or more for the first time in their reporting history. The firms in our sample have a significantly larger diversification discount, underperform, and underinvest relative to comparable firms. Firms are more likely to divest segments from industries with a more liquid market for corporate assets, segments unrelated to the core activities of the firm, poorly performing segments, and small segments. The liquidity of the market for corporate assets plays an important role in explaining why some firms divest assets while others stop reporting them without divesting them, and why some firms divest core segments while others divest unrelated segments.

Abstract:
We investigate a sample of firms whose number of reported segments falls by one or more for the first time in their reporting history. The firms in our sample have a significantly larger diversification discount, underperform, and underinvest relative to comparable firms. Firms are more likely to divest segments from industries with a more liquid market for corporate assets, segments unrelated to the core activities of the firm, poorly performing segments, and small segments. The liquidity of the market for corporate assets plays an important role in explaining why some firms divest assets while others stop reporting them without divesting them, and why some firms divest core segments while others divest unrelated segments.