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Abstract:
We develop an equilibrium model to investigate whether an Exchange-Traded Fund (ETF) is a more efficient indexing vehicle than an Open-Ended Mutual Fund (OEF). We find that while flow-induced trading is costly to OEF investors, it is also beneficial to those investors who cause the flow -- it is simply a zero-sum game. Indeed, the OEF structure can be viewed as providing insurance for investors with liquidity shocks, and hence is beneficial for risk averse investors. However, this liquidity insurance is not without cost -- it can cause moral hazard %that induce excessive trading and reduce the OEF performance. Moreover, we find that investors with higher individual liquidity needs prefer to invest via the OEF since they benefit more from the liquidity insurance. Surprisingly, the OEF structure is still viable despite the concentration of higher-liquidity-need investors in the OEF. The reason is that flow-induced trading costs depend only on the aggregate liquidity need, not on individual liquidity needs, which cancel out at the fund level. As a result, OEFs and ETFs coexist in equilibrium with different liquidity clienteles. Finally, we derive empirical predictions that ETFs are better suited for narrower and less liquid underlying indexes, and for investors with longer investment horizons.

ETF, Index Mutual Fund, Transaction Costs

Abstract:
We examine whether accounting for mutual fund families can help explain the performance of their mutual funds, and if so, how they succeed to affect the performance of the funds they manage. We hypothesize that larger families not only have the incentive to selectively push some of their funds, but also the means to do so. When restricting our sample to funds that belong to larger families, a portfolio of funds that longs the portfolio of the previous year's best performing funds and shorts the previous year's worst performing funds has a positive monthly alpha of 58 basis points. We also show that there exists persistence of performance of these funds inside their respective families. This persistence is directly related to the number of funds in the family which we interpret as a measure of the latitude the family has in allocating resources unevenly between its funds. Lastly, we show that indeed the better performing funds in a family have a higher probability of getting more managers, which are one of the main resources available. This seems to imply that families do not always allocate resources proportionally according to the funds' needs but in a way that allows the family to promote certain funds.

Mutual Funds, Mutual Fund Families, Performance Persistence, Organizational Structure

Abstract:
This paper investigates the role of director networks in firms' decision-making. Using data on 25,621 unique directors who served on the boards of S&P 1,500 firms between the years 1996-2004, we map the entire network of directors and generate measures that account for each director's importance in the network. We find strong evidence that in firms whose directors are more central in the network, CEO pay is higher, CEO pay is less sensitive to firm performance, CEO turnover is less sensitive to firm performance, and forced CEO turnover is less likely to occur. Moreover, well-connected directors are more likely to be awarded more directorships in the future. These results continue to hold when we look only at the connectedness level of independent directors. Our results support what we refer to as the reputation hypothesis - when directors are not connected they build their reputation by providing superior monitoring but when they are highly connected they provide softer monitoring of the CEO as they feel that their status in the network is secure.

Executive compensation, Networks, Directors, Corporate Governance

Abstract:
This paper explores the effect of vertical integration on investment behavior in the pharmaceutical industry. I study a detailed, project-level sample of 4057 drug candidates that were sponsored by 40 large pharmaceutical firms during the period 1984-2001. Of these projects, 447 were conducted through a contractual alliance with another, smaller company that had discovered the drug candidate. The existence of these two types of governance structures allows me to compare integrated and non-integrated projects within the same firm. Controlling for project and firm characteristics, I document that pharmaceutical firms are more selective in continuing their integrated projects than in continuing projects governed by contract. I hypothesize that this difference is caused by the rigidity of the contract that governs non-integrated projects, making them less flexible in adapting to changes in the firm's situation. In line with this hypothesis, I document that although more frequently continued, non-integrated projects have a lower probability of success. Moreover, investment in non-integrated projects is less sensitive to the firm's cash flow and to the existence of other projects in the firm.

Vertical Integration, Investment Decisions, Internal Capital Markets, Pharmaceutical Industry

Abstract:
This paper explores the effect of vertical integration on investment behavior in the pharmaceutical industry. I study a detailed, project-level sample of 4057 drug candidates that were sponsored by 40 large pharmaceutical firms during the period 1984-2001. Of these projects, 447 were conducted through a contractual alliance with another, smaller company that had discovered the drug candidate. The existence of these two types of governance structures allows me to compare integrated and non-integrated projects within the same firm. Controlling for project and firm characteristics, I document that pharmaceutical firms are more selective in continuing their integrated projects than in continuing projects governed by contract. I hypothesize that this difference is caused by the rigidity of the contract that governs non-integrated projects, making them less flexible in adapting to changes in the firm's situation. In line with this hypothesis, I document that although more frequently continued, non-integrated projects have a lower probability of success. Moreover, investment in non-integrated projects is less sensitive to the firm's cash flow and to the existence of other projects in the firm.

Vertical Integration, Investment Decisions, Internal Capital Markets, Pharmaceutical Industry

Abstract:
This paper compares the clinical trial strategies and performance of large, established ("mature") biopharmaceutical firms to those of smaller ("early stage") firms that have not yet successfully developed a drug. We study a sample of 235 cancer drug candidates that entered clinical trials during the period 1990-2002 and were sponsored by public firms. Early stage firms are more likely than mature firms to advance drug candidates from Phase I to Phase II clinical trials. However, early stage firms have much less promising clinical results in their Phase II trials and their Phase II drug candidates are also less likely to advance to Phase III and to receive Food and Drug Administration approval. This pattern is more pronounced for early stage firms with large cash reserves. The evidence points to an agency problem between shareholders and managers of single-product early stage firms who are reluctant to abandon development of their only viable drug candidates. By contrast, the managers of mature firms with multiple products in development are more willing to drop unpromising drug candidates. The findings appear to be consistent with the benefits of internal capital markets identified by Stein (1997).

Abstract:
This paper compares the clinical trial strategies and performance of large, established ("mature") biopharmaceutical firms to those of smaller ("early stage") firms that have not yet successfully developed a drug. We study a sample of 235 cancer drug candidates that entered clinical trials during the period 1990-2002 and were sponsored by public firms. Early stage firms are more likely than mature firms to advance drug candidates from Phase I to Phase II clinical trials. However, early stage firms have much less promising clinical results in their Phase II trials and their Phase II drug candidates are also less likely to advance to Phase III and to receive Food and Drug Administration approval. This pattern is more pronounced for early stage firms with large cash reserves. The evidence points to an agency problem between shareholders and managers of single-product early stage firms who are reluctant to abandon development of their only viable drug candidates. By contrast, the managers of mature firms with multiple products in development are more willing to drop unpromising drug candidates. The findings appear to be consistent with the benefits of internal capital markets identified by Stein (1997).

Internal capital markets, resource allocation, drug development, financial resources

Abstract:
We introduce a novel concept of the activeness of internal capital allocations across industries. We derive a measure of this activeness and use it to compare the performance of firms with different capital allocation styles. We find that firms that actively change their capital allocation across industries have a lower average industry-adjusted profitability than firms that follow passive strategies. Moreover, we find that active firms obtain lower valuation and lower excess stock returns in subsequent periods. Our findings suggest that conglomerate firms that actively allocate resources across industries do not do so efficiently, and that the stock market does not fully incorporate the information revealed through the internal capital allocation process.

internal capital allocation, firm performance, stock return

Abstract:
We introduce a novel concept of the activeness of internal capital allocations across industries. We derive a measure of this activeness and use it to compare the performance of firms with different capital allocation styles. We find that firms that actively change their capital allocation across industries have a lower average industry-adjusted profitability than firms that follow passive strategies. Moreover, we find that active firms obtain lower valuation and lower excess stock returns in subsequent periods. Our findings suggest that conglomerate firms that actively allocate resources across industries do not do so efficiently, and that the stock market does not fully incorporate the information revealed through the internal capital allocation process.

internal capital allocation, firm performance, stock return