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Abstract:
To test recent theories that suggest valuation errors affect merger activity, we develop a decomposition that breaks M/B into three components: the firm-specific pricing deviation from short-run industry pricing; sector-wide, short-run deviations from firms' long-run pricing; and long-run pricing to book. We find strong support for recent theories by Rhodes-Kropf and Viswanathan (2003) and Shleifer and Vishny (2003), which predict that misvaluation drives mergers. So much of the behavior of M/B is driven by firm-specific deviations from short-run industry pricing, that long-run components of M/B run counter to the conventional wisdom: Low long-run value to book firms buy high long-run value to book firms. Misvaluation affects who buys whom, as well as method of payment, and combines with neoclassical explanations to explain aggregate merger activity.

Abstract:
To test recent theories that suggest valuation errors affect merger activity, we develop a decomposition that breaks M/B into three components: the firm-specific pricing deviation from short-run industry pricing; sector-wide, short-run deviations from firms' long-run pricing; and long-run pricing to book. We find strong support for recent theories by Rhodes-Kropf and Viswanathan (2003) and Shleifer and Vishny (2003), which predict that misvaluation drives mergers. So much of the behavior of M/B is driven by firm-specific deviations from short-run industry pricing, that long-run components of M/B run counter to the conventional wisdom: Low long-run value to book firms buy high long-run value to book firms. Misvaluation affects who buys whom, as well as method of payment, and combines with neoclassical explanations to explain aggregate merger activity.

Abstract:
Strategic alliances are long-term contracts between legally distinct organizations that provide for sharing the costs and benefits of a mutually beneficial activity. In this paper, I develop and test a model that helps explain why firms sometimes prefer alliances over internally organized projects. I introduce managerial effort into a model of internal capital markets and show how strategic alliances help overcome incentive problems that arise when headquarters cannot pre-commit to particular capital allocations. The model generates a number of implications, which I test using a large sample of alliance transactions in conjunction with Compustat data.

G32, D21, D23

Abstract:
Strategic alliances are long-term contracts between legally distinct organizations that provide for sharing the costs and benefits of a mutually beneficial activity. In this paper, I develop and test a model that helps explain why firms sometimes prefer alliances over internally organized projects. I introduce managerial effort into a model of internal capital markets and show how strategic alliances help overcome incentive problems that arise when headquarters cannot pre-commit to particular capital allocations. The model generates a number of implications, which I test using a large sample of alliance transactions in conjunction with Compustat data. Supporting the model, I find that alliances cluster in risky, high-growth, high-tech industries, and that they typically occur between industries with different risk characteristics. Likewise, among multi-division firms with alliances, the alliance activity tends to occur in an industry that is riskier, on average, than the other industries in which the firm operates. Alliances are used to pursue related diversification, and facilitate projects that are riskier than a firm's mainstream activities.

Abstract:
We present a framework for determining the information that can be extracted from stock prices around takeover contests. In only two types of cases is it theoretically possible to use stock price movements to infer bidder overpayment and relative synergies. Even in these two cases, we argue that it is practically difficult to extract this information. We illustrate one of these generic cases using the takeover contest for Paramount in 1994 in which Viacom overpaid by more than $2 billion. Our findings are consistent with managerial overconfidence and/or large private benefits, but not with the traditional agency-based incentive problem.

Abstract:
We present a framework for determining the information that can be extracted from stock prices around takeover contests. In only two types of cases is it theoretically possible to use stock price movements to infer bidder overpayment and relative synergies. The takeover contest for Paramount in 1994 illustrates one of these generic cases. We estimate that Viacom, the 'winning' bidder, overpaid for Paramount by more than $2 billion. This occurred despite the fact that Viacom's CEO owned roughly 3/4 of Viacom. These results are consistent with managerial overconfidence and/or large private benefits, but not with the traditional agency-based incentive problem.

Abstract:
This paper analyzes the amount of information that can be extracted from stock prices around takeover contests. The first part of the paper shows that it is not generally possible to use target and bidder stock price movements to infer the market's estimates of synergies, bidder overpayment, and changes in bidder and target values. In two generic cases, however, we show that it is possible to use bidder and target stock prices to obtain market estimates of overpayment. In the second part of the paper, we illustrate one of these two generic cases through a clinical study of the takeover contest for Paramount. We find that the market estimated that Viacom, the eventual "winner" of the takeover battle, overpaid by over $1.5 billion when it agreed to purchase Paramount in a $9.2 billion acquisition in February 1994. We also find that the market believed that QVC, the eventual "loser" of the battle, had substantially larger synergies (on the order of $1 billion more) with Paramount than Viacom did. Viacom prevailed due to its willingness to over-pay. That this overpayment occurred despite the fact that Sumner Redstone, the CEO of Viacom, owned roughly 2/3 of Viacom supports Roll's Hubris hypothesis (1986) as well as the results in Morck, Shleifer, and Vishny (1990) and Lang, Stulz, and Walkling (1989).

Abstract:
Strategic alliances are commonplace in the biotechnology sector. We posit that the stock of prior alliances between participants in the biotech industry produces a network---a communications infrastructure established by past transactions---through which information is transmitted. We argue that this network serves as a governance mechanism that substitutes for other forms of control in inter-firm transactions. To test our hypothesis, we examine how equity participation and the amount of funding pledged in strategic alliances vary with two features of the way alliance participants are positioned in the network of past deals: (i) centrality, a measure of how deeply embedded a firm is in the alliance network; and (ii) proximity, a measure of how close two counterparties are to one another in the network. The results establish that the alliance network mitigates holdup problems in interfirm transactions.

Abstract:
Firms in more concentrated industries earn lower returns, even after controlling for size, book-to-market, momentum, and other return determinants. Explanations based on chance, measurement error, capital structure, and persistent, in-sample, cash flow shocks do not explain this finding. Drawing on work in industrial organization, we posit that either barriers to entry in highly concentrated industries insulate firms from undiversifiable distress risk, or that firms in highly concentrated industries are less risky because they engage in less innovation, thus commanding lower expected returns. Additional tests support these risk-based interpretations.

Abstract:
We conduct a detailed analysis of 125 strategic alliance contracts, all of which concern early-stage, genomics-based research at small, biotechnology R&D companies. Staged investment is ubiquitous, but solutions to agency problems vary. The cycle of equity participation in alliances resembles what we observe in venture capital contracts: they involve convertible equity and sometimes contain anti-dilution provisions, warrants, and board seats. Contracts contain explicit provisions linking equity participation to subsequent IPOs and contain clauses designed to insulate both parties from multi-tasking problems. Contrary to the standard assumptions of static contract theory, contracts often specify provisions that are unobservable or difficult to verify.

Strategic Alliances, Venture Capital, Incomplete Contracts

Abstract:
Mergers are the mechanisms that redraw the boundaries of the firm. In this paper, we relate incomplete contracts, upon which much of our understanding of firm boundaries is based, to empirical regularities in the market for mergers and acquisitions. We begin by empirically challenging conventional wisdom about mergers and acquisitions: high M/B acquirers typically do not purchase low M/B targets. Instead, mergers typically pair together firms with similar M/B ratios. To show why this occurs, we build a continuous time model of investment and merger activity that combines search, relative scarcity, and asset complementarity. Our model shows that the 'like buys like' empirical finding is a natural consequence of a prediction from the property rights theory of the firm; namely, that complementary assets should be placed under common control. A number of new empirical predictions emerge from our analysis. First, if asset complementarity is important, then we should see small differences in the M/B of targets and acquirers. It also predicts that the difference in M/B ratios should increase when discount rates are high and valuations are low. In additional tests, we show that both of these predictions are borne out by the data. Our findings suggest that the incomplete contracts theory of the firm is central to understanding the empirical regularities of the market for mergers and acquisitions.

Firm Boundaries, Mergers, Search

Abstract:
We study how a firm's optimal integration decision depends on the interaction between the product markets and capital markets in which it operates. An integrated firm operates an internal capital market, which provides allocative flexibility but does not allow the firm to commit to specific capital allocations in advance. A stand-alone firm, in contrast, raises capital ex ante in traditional markets and cannot change its capital level ex post, so it lacks ex post flexibility but has greater ex ante commitment ability. We show that the integrator's resource flexibility can deter entry from stand-alone firms when product markets are uncertain. This is most salient for a downstream integrator, who does not wish to foreclose a potential future supply option. On the other hand, the integrator's capital commitment problems can invite predatory capital raising from a stand alone when product market uncertainty is low. This is most salient for horizontal integrators. We also illustrate how hybrid organizational forms like strategic alliances can dominate either vertical or horizontal integration by offering some of the benefits of integration without imposing these strategic costs.

Internal Capital Markets, Theory of the Firm, Product Market Competition

Abstract:
This paper investigates the capital structure choices that firms make in their initial year of operations, using restricted-access data from the Kauffman Firm Survey. Contrary to many accounts of startup activity, the firms in our data rely heavily on external debt sources such as bank financing, and less heavily on friends and family-based funding sources. This striking fact holds even when we purge each firm's credit score of variation due to demand-side credit characteristics. The heavy reliance on external debt underscores the importance of well functioning credit markets for the success of nascent business activity.

capital structure, start-up, startup, funding, Kauffman Firm Survey, debt, sources

Abstract:
This paper investigates the capital structure choices that firms make in their initial year of operation, using restricted-access data from the Kauffman Firm Survey. Contrary to many accounts of startup activity, the firms in our data rely heavily on external debt sources such as bank financing, and less extensively on friends and family-based funding sources. This fact is robust to numerous controls for credit quality, industry, and business owner characteristics. The heavy reliance on external debt underscores the importance of well functioning credit markets for the success of nascent business activity.

entrepreneurial finance, pecking order, start ups

Abstract:
Whether judgment and decision making biases improve with experience remains an important and contentious question. Positive illusions, for example, have been documented extensively, but virtually always in single-shot settings. To what extent do these illusions persist over time? And what factors influence their persistence? We suggest that dispositional optimism plays an important but surprising role. Building on the link between optimism and positive coping, we suggest that, given experience, dispositional optimists have fewer positive illusions than pessimists. We test this hypothesis in a longitudinal study of graduate students. Initially we find that optimists' expectations about their grades are more positively biased than pessimists'. However, the impact of experience is quite different for optimists than pessimists-optimists' positive illusions decline over time while pessimists' increase. Consequently, by year's end the pattern is fully reversed: optimists have fewer positive illusions than do pessimists.

Abstract:
We create a novel measure of optimism using the Survey of Consumer Finance by comparing self-reported life expectancy to that implied by statistical tables. This measure of optimism correlates with positive beliefs about future economic conditions and with psychometric tests of optimism. Optimism is related to numerous work/life choices: more optimistic people work harder, expect to retire later, are more likely to remarry, invest more in individual stocks, and save more. Interestingly, however, moderate optimists display reasonable financial behavior, whereas extreme optimists display financial habits and behavior that are generally not considered prudent

Dispositional optimism, Psychology and economics, Household finance, Savings behavior, Self control

Abstract:
This paper presents some of the first large-scale survey evidence linking optimism to major economic choices. We create a novel measure of optimism using the Survey of Consumer Finance by comparing a person's self-reported life expectancy to that implied by statistical tables. Optimists are more likely to believe that future economic conditions will improve. Self-employed respondents are more optimistic than regular wage earners. In general, more optimistic people work harder and anticipate longer age-adjusted work careers. They are more likely to remarry, conditional on divorce. In addition, they tilt their investment portfolios more toward individual stocks.

Abstract:
The paper studies how the attitudes of entrepreneurs, in general, and family business owners, in particular, differ from others in the economy. Family business owners are entrepreneurs who operate a business with their spouse or adult children. We use data from the Survey of Consumer Finance to measure and isolate the enjoyment of private benefits, attitudes towards risk, and optimism for these groups. Entrepreneurs are more optimistic, and enjoy the nonpecuniary benefits of work more than wage earners. They are somewhat more risk loving, but perhaps less so than commonly believed. Family business owners share optimism and non-pecuniary benefits with other entrepreneurs; their tolerance for risk is not different than wage earners. These attitudes translate into actions: optimism and non-pecuniary benefits increase hours spent at work, and in some cases increase measured labor productivity. Family business owners are primarily responsible for the observed labor productivity associated with entrepreneurship.

Abstract:
Psychologists study regret primarily by measuring subjects' attitudes in laboratory experiments. This does not shed light on how expected regret affects economic actions in market settings. To address this, we use proprietary data from a blackjack table in Las Vegas to analyze how expected regret affects peoples' decisions during gambles. Even among a group of people who choose to participate in a risk-taking activity, we find strong evidence of an economically significant omission bias: players incur substantial losses by playing too conservatively. This behavior is prevalent even among large stakes gamblers, and becomes more severe following previous aggressive play, suggesting a rebound effect after aggressive play.

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 short report examines racial differences in access to financial capital. We focus on the role of capital injections - that is, injections of financial capital in the early, formative years after the business is started. Our results indicate that stark racial differences in capital injections after a business is formed are an important and under-studied component of the racial gap in new business formation. Although nearly three-quarters of all new firms inject capital in either their second or third year of existence, we know relatively little about racial differences in financial capital use in the early years of operation. The lack of empirical evidence on this issue largely reflects the lack of panel data with information on financial capital inputs in years after start up as well as the demographic background of the business owners. In this paper, we make use of detailed information on capital injections through the Kauffman Firm Survey (KFS), a longitudinal study of businesses that began operation in 2004. The KFS tracks a panel of almost 5,000 firms from their inception in 2004 through 2006, detailing capital injections, sales, employment, and owner characteristics. The richness of these data allows us to study capital injections in great detail.

Understanding how African-American firms access capital markets for injections of later-stage capital is important for a number of reasons. Previous research indicates that blacks have substantially lower levels of personal wealth, home ownership, bank loans, and startup capital, but there is no evidence on access to financial capital in subsequent years among young black firms. We also know little about whether black and white firms differ in the dynamics of financial capital use - in particular, substituting between external and internal capital over time.

The median level of net worth among blacks is $6,200, eleven times lower than the white level. Low levels of black personal wealth may be detrimental to securing capital because this wealth can be invested directly in the business or used as collateral to obtain business loans. In addition to relatively low levels of personal wealth, previous research provides evidence that is consistent with black entrepreneurs facing lending discrimination. Black-owned firms experience higher loan denial probabilities and pay higher interest rates than white-owned businesses even after controlling for differences in credit worthiness and other factors. Finally, black-owned businesses have very low levels of startup capital relative to white-owned businesses and these differences persist across all major industries. If new black firms are constrained in their access to capital not just at startup, but also in subsequent years, then this could have a detrimental effect on their long-term performance. Of course, it also could be an indication that external investors expect lower long-term performance, and direct their capital accordingly. The existing literature suggests that lack of black access to capital is a potential barrier to successful entrepreneurship. Indeed, there is some evidence that racial differences in startup capital affect the relative performance of black-owned firms.

kauffman firm survey, kfs, african-american, financial capital

Abstract:
We argue that the stock of prior alliances between participants in the biotechnology sector forms a network that serves as a governance mechanism in interfirm transactions. To test how this network substitutes for other governance mechanisms, we examine how equity participation and pledged funding in strategic alliances vary with two features of the way alliance participants are positioned in the network of past deals: proximity, or how close two firms are to one another in the network; and centrality, or how deeply a firm is embedded in the network. As centrality and proximity increase, equity participation (measured by size and propensity) diminishes, whereas pledged funding increases.

Abstract:
Does takeover increase stockholder value? - Yes. We modify the calendar-time portfolio regressions (CTPRs) approach to measure the abnormal returns of a takeover portfolio composed exclusively of successful bidders and targets from 1963 to 1995. This technique balances the positive announcement-period stock price effects against the alleged post-announcement drift that is commonly thought to accompany takeovers. By regressing the takeover portfolio returns on asset-pricing factors with GARCH(1,1) error specification, our methodology overcomes a number of limitations that would otherwise confound this approach. Studying 3,467 successful takeover events, we find that value weighted portfolios earn a highly significant 72 basis points a month in abnormal returns. Equally weighted results are even more dramatic. We extend the analysis to study mergers within and across industry boundaries. Using method of payment as a proxy for pooling versus purchase accounting, we also examine the impact of accounting choice on performance.

Abstract:
This work explores the idea that governments use direct public ownership to make credible commitments to other agents in the economy. We argue that governments exercise indirect control rights over other agents' cash flows: direct ownership is a means of mitigating the holdup problems that arise when the government cannot commit to avoid abusing these rights. The empirical implication of this theory is that more credible governments take lower direct ownership of the economy, since they have fewer holdup problems to solve. With a unique panel comprising measures of ownership, credibility, and expenditure, for nearly 100 countries over a 10-year period, we find strong evidence in support of our propositions. To distinguish our story from alternatives we study the how the credibility-ownership relation varies with other measures. We find more pronounced results among industrial nations than developing ones. The tendency for high expenditure governments to own more diminishes as credibility increases. These results persist after instrumenting credibility with a country's origin of legal system and controlling for unobserved country-specific heterogeneity.

Abstract:
This paper presents some of the first large-scale survey evidence linking optimism to major economic choices. We create a novel measure of optimism using the Survey of Consumer Finance by comparing a person's self-reported life expectancy to that implied by statistical tables. Optimists are more likely to believe that future economic conditions will improve. Self-employed respondents are more optimistic than regular wage earners. In general, more optimistic people work harder and anticipate longer age-adjusted work careers. They are more likely to remarry, conditional on divorce. In addition, they tilt their investment portfolios more toward individual stocks.

Optimism