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Abstract:
We construct optimal portfolios of mutual funds whose objectives include socially responsible investment (SRI). Comparing portfolios of these funds to those constructed from the broader fund universe reveals the cost of imposing the SRI constraint on investors seeking the highest Sharpe ratio. This SRI cost depends crucially on the investor's views about asset pricing models and stock-picking skill by fund managers. To an investor who believes strongly in the CAPM and rules out managerial skill, i.e. a market-index investor, the cost of the SRI constraint is typically just a few basis points per month, measured in certainly-equivalent loss. To an investor who still disallows skill but instead believes to some degree in pricing models that associate higher returns with exposures to size, value, and momentum factors, the SRI constraint is much costlier, typically by at least 30 basis points per month. The SRI constraint imposes large costs on investors whose beliefs allow a substantial amount of fund-manager skill, i.e., investors who rely heavily on individual funds' track records to predict future performance.

socially responsible investing, mutual funds, portfolio selection

Abstract:
This paper examines the substitutability and complementarity of a variety of risk management strategies that firms can use to reduce price risk exposure. Time-series analysis over a period of significant regulatory changes indicates that natural gas companies increased diversification and started using derivatives as price risk increased following price deregulation and the regulated unbundling of sale and transmission activities. The use of derivatives is a substitute both for holding internal cash and for storing gas underground. The latter two activities are complements. In choosing between derivatives and storage or cash holdings, less profitable and more financially distressed firms are more likely to manage risk using derivatives. Accounting earnings management strategies, however, are not complements to activities that have a "real" effect on cash flow volatilityand diversification is not related to financial hedging activities. Market-based estimates of wellhead gas price sensitivities are negative prior to deregulation and become significantly positive following price deregulation. The change in exposure is consistent with the changing role of pipelines from buyers of gas for transport to only transporters of gas resulting from deregulation. Cross-sectional variation in price sensitivities is related to firms' use of combinations of operational (non-accounting) and financial hedging activities. Firms that pursue these activities have smaller and less variable risk-adjusted wellhead gas return exposures than firms that do not, especially post-deregulation.

Abstract:
We examine firms' use of currency derivatives in order to differentiate among existing theories of hedging behavior. Firms with greater growth opportunities and tighter financial constraints are more likely to use currency derivatives. This result suggests that firms might use derivatives to reduce cash flow variation that might otherwise preclude firms from investing in valuable growth opportunities. Firms with extensive foreign exchange-rate exposure and economies of scale in hedging activities are also more likely to use currency derivatives. Finally, the source of foreign exchange-rate exposure is an important factor in the choice among types of currency derivatives.

Abstract:
We examine firms' use of currency derivatives in order to differentiate among existing theories of hedging behavior. Firms with greater growth opportunities and tighter financial constraints are more likely to use currency derivatives. This result suggests that firms might use derivatives to reduce cash flow variation that might otherwise preclude firms from investing in valuable growth opportunities. Firms with extensive foreign exchange-rate exposure and economies of scale in hedging activities are also more likely to use currency derivatives. Finally, the source of foreign exchange-rate exposure is an important factor in the choice among types of currency derivatives.

Abstract:
The standard analysis of corporate governance is that shareholders vote in the ratios that firms choose, such as one-share-one-vote. But if the cost of unbundling and trading votes is sufficiently low, then shareholders choose the ratios. We document an active market for votes within the equity-loan market, where the average vote sells for zero. We hypothesize that asymmetric information motivates this trade, and find support in the cross section of votes: there is more trade for higher-spread firms and more for poor performers, especially when the vote is close. Vote trading corresponds to support for shareholder proposals and opposition to management proposals. Similar results obtain in the U.K.

information aggregation, voting rights, equity lending, vote trading

Abstract:
Using a unique dataset from a well-known survey on derivatives use, this paper examines several questions about the use of derivatives to take a view on interest-rate and currency movements. Tests of what motivates firms to take a view suggest that they view speculation as a profitable activity. Firms specialize in taking a view on either interest rates or exchange rates, and specialization in FX contracts is positively related to the extent of the firm's foreign operations. However, the data do not support other theories of rational speculation such as the Campbell and Kracaw (1999) model. We also examine the association between speculation and governance mechanisms including compensation-based incentives, bonding contracts, and internal controls. Compensation-related incentives of the CFO, but not the CEO, are associated with the likelihood that a firm actively takes derivatives positions based on a market view. Moreover, firms with governance structures that allow for greater managerial power and indicate fewer shareholder rights, in general, are more likely to take a view, but these firms also have more extensive and sophisticated internal controls and monitoring mechanisms specifically related to derivatives activities. Finally, we examine whether investors using publicly available information in corporate disclosures could identify firms that openly admit to speculation in the confidential survey. The answer is that they cannot.

Speculation, Compensation, Governance

Abstract:
We investigate the robustness of the long-run underperformance of initial public offering (IPO) and seasoned equity offering (SEO) firms from 1975-1992. The conclusion that issuer underperformance is unique is questioned by our results. We find that underperformance is largely concentrated in the smallest issuing firms. IPO firms perform identical to nonissuing firms matched on the basis of size and book-to-market. SEO firm returns can be priced by four factor regression models indicating common covariation in SEO returns with nonissuing firms. Furthermore, SEO underperformance disappears for issuances beyond the first SEO. We find that the results are robust to purging benchmarks and factor returns of IPO and SEO firms.

Abstract:
Regulations allow market makers to short sell without borrowing stock, and the transactions of a major options market maker show that in most hard-to-borrow situations, it chooses not to borrow and instead fails to deliver stock to its buyers. Some of the value of failing passes through to option prices: when failing is cheaper than borrowing, the relation between borrowing costs and option prices is significantly weaker. The remaining value is profit to the market maker, and its ability to profit despite the usual competition between market makers appears to result from a cost advantage of larger market makers at failing.

Abstract:
We study the impact of brokerage relations with company insiders on insider-affiliated market makers' quoting behavior and the possibility of information leakage via piggybacking when insiders trade. We find that market makers affiliated with the brokers used by insiders post more aggressive ask quotes vis-à-vis their peers during periods when insiders trade. This aggressiveness is partially attributable to the pressure to complete sell orders for their company insider clients. However, we also find that this behavior is dependent on the management role of the insider and the degree of information asymmetry as measured by a) the number of analysts following the company, b) analyst forecast dispersion, c) bid-ask spread of the stock and d) post-event stock return. In addition, piggybacking diminishes when the firm of the broker-dealer making markets has had a prior investment banking business relationship with the company. The findings suggest that in addition to the volume of insider trades, the potential information content of insider trades also affects insider-affiliated market makers' abnormal quoting behavior. We find that this information leakage through insiders' brokers results in trading based on information signaled by those insiders.

insider trading, brokerage, market maker

Abstract:
We present evidence that the equity premium and the premium of value stocks over growth stocks are consistent in the 1982-96 period with a stochastic discount factor calculated as the weighted average of individual households' marginal rate of substitution with low and economically plausible values of the relative risk aversion coefficient. Since these premia are not explained with an SDF calculated as the per capita marginal rate of substitution with low value of the RRA coefficient, the evidence supports the hypothesis of incomplete consumption insurance. We also present evidence is that an SDF calculated as the per capita marginal rate of substitution is better able to explain the equity premium and does so with a lower value of the RRA coefficient, as the definition of asset holders is tightened to recognize the limited participation of households in the capital market.

Abstract:
We present evidence that the equity premium and the premium of value stocks over growth stocks are explained in the 1982 1996 period with a stochastic discount factor (SDF) calculated as the weighted average of individual households' marginal rate of substitution with low and economically plausible values of the relative risk aversion (RRA) coefficient. Household consumption of non-durables and services is reconstructed from the CEX database. Since the above premia are not explained with a SDF calculated as the per capita marginal rate of substitution with low value of the RRA coefficient, the evidence supports the hypothesis of incomplete consumption insurance. We also present evidence is that a SDF calculated as the per capita marginal rate of substitution is better able to explain the equity premium and does so with a lower value of the RRA coefficient, as the definition of asset holders is tightened to recognize the limited participation of households in the capital market.

Abstract:
The Euler equations of consumption are tested on the household consumption of non-durables and services, reconstructed from the CEX database. The estimated relative risk aversion coefficient of the representative household decreases, and the estimated unexplained mean equity premium decreases, as infra marginal asset holders are eliminated from the sample. These results provide evidence of limited capital market participation. The estimated unexplained mean equity premium decreases when the assumption of complete consumption insurance is relaxed. The estimated correlation between the equity premium and the cross-sectional variance of the households' consumption growth is negative, as required, if the relaxation of market completeness is to contribute towards the explanation of the premium. The overall evidence from asset prices in favor of relaxing the assumption of complete consumption insurance is weak. An extensive Monte Carlo investigation highlights the relationship between the economic implications of limited participation and the resulting statistical properties of commonly used test statistics. The simulation results provide direct evidence relating observation error in consumption.

Abstract:
A share's ownership of record can trade separately from its beneficial ownership, through equity loans. In a year of transactions by a major lender, we analyze the market for ownership of record on dates when this ownership is important: the record dates of votes, when loans transfer votes, and of distributions, when loans determine the direct recipient of the distributions. On voting record dates, the lender's loan volume is high relative to surrounding days, particularly so for proposals related to lagging firms and of those, especially the proposals with close votes. Loan volume associates with greater support for shareholder proposals, and weaker support for management proposals. We also find substantial lending on dividend record dates of firms with reinvestment discounts and loan pricing that is low but increasing with the implied profit. On the record dates of Canadian firms' dividends we find that U.S. investors subject to withholding can reclaim 95% of the marginal unit of dividend yield using equity loans. We also find that, consistent with the Canadian dividend tax credit, the stock market capitalizes this marginal unit at more than its full cash value. For the cross section of Canadian firms these findings predict, and portfolio data confirm, that dividends reduce investment by U.S., relative to Canadian, institutions.

Equity Lending, Shareholder Proposals, Dividend Arbitrage

Abstract:
The economic significance of the tax on cross-border dividends depends on the limits to dividend arbitrage. In the case of Canadian payments to the U.S. we observe these limits exactly because we see the actual pricing of the dividend-arbitrage transactions. These transactions recover only some withholding, so that Canadian and non-tax U.S. accounts perceive different expected returns from Canadian stocks, where the difference increases with dividend yield. The resulting difference in expected utility of wealth is small but the difference in efficient portfolio weights is potentially large and increasing in yield, and the actual difference between Canadian and U.S. holdings of Canadian stocks is large and increasing in yield. Governments may thus take advantage of robust financial markets to boost domestic governance of domestic firms at a low utility cost, though this may be more preferable for zero-dividend firms, whose governance moves abroad.

Abstract:
Regulations allow market makers to short sell without borrowing stock, and the transactions of a major options market maker show that in most hard-to-borrow situations, it chooses not to borrow and instead fails to deliver stock to its buyers. A part of the value of failing passes through to options prices: when failing is cheaper than borrowing, the relation between borrowing costs and options prices is significantly weaker. The remaining value is profit to the market maker, and its ability to profit despite competition between market makers appears to result from the cost advantage of larger market makers.

G12, G13, G29

Abstract:
Starting in 1978 and continuing throughout the 1980s, natural gas pipelines faced a series of regulatory changes, including price deregulation, which changed their exposures to price and quantity risk. We exploit this unique environment and examine cross-sectional and time-series patterns in the use of multiple risk management strategies by pipeline companies. Natural gas pipelines use a combination of such strategies, including gas storage, cash holdings, line-of-business and geographic diversification, and commodity derivatives to hedge their increasing risks. Gas storage shows a complementary relation to holding cash and using derivatives to mitigate these risks. However, differences in the financial characteristics of derivatives hedgers and storage hedgers suggest that firms use derivatives to manage price risk and store gas to manage volume risk. Derivatives hedgers are similar to firms that diversify. In addition, firms that engage in hedging activities have smaller and less variable sensitivities to price changes than firms that do not, especially post-deregulation.

natural gas pipelines, time-series patterns, pipline companies, gas storage, cash holdings, line-of-business, derivatives

Abstract:
We present evidence that the equity premium and the premium of value stocks over growth stocks are explained in the 1982-1996 period with a stochastic discount factor (SDF) calculated as the weighted average of individual households' marginal rate of substitution with low and economically plausible values of the relative risk aversion (RRA) coefficient. Household consumption of non-durables and services is reconstructed from the CEX database. Since the above premia are not explained with a SDF calculated as the per capita marginal rate of substitution with low value of the RRA coefficient, the evidence supports the hypothesis of incomplete consumption insurance. We also present evidence is that a SDF calculated as the per capita marginal rate of substitution is better able to explain the equity premium and does so with a lower value of the RRA coefficient, as the definition of asset holders is tightened to recognize the limited participation of households in the capital market.

Equity premium, Incomplete consumption insurance, Heterogeneous consumers, Limited capital market participation

Abstract:
We investigate the robustness of the long-term underperformance of initial public offering (IPO) and seasoned equity offering (SEO) firms from 1975-1992. The conclusion that issuer underperformance is unique is questioned by our results. We find that underperformance is largely concentrated in the smallest issuing firms. IPO firms perform similarly to nonissuing firms matched on the basis of firm size and book-to-market ratios. SEO firm returns can be priced by four factor regression models indicating common covariation in SEO returns with nonissuing firms. Furthermore, SEO underperformance disappears for issuances beyond the first SEO. We find that the results are robust to purging benchmarks and factor returns of IPO and SEO firms.