Finance Theses and Dissertations

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INTERNATIONAL CORPORATE GOVERNANCE: A STUDY OF COMPLEMENTARITIES AND CONVERGENCE
(2004-08-31) Ayyagari, Meghana; MAKSIMOVIC, VOJISLAV; Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This thesis contributes to contemporary research in international corporate governance by investigating two related questions: (1) Is there a convergence in corporate governance towards the US model as suggested by theories of functional convergence and (2) How do differing regulatory environments influence the choice of corporate governance instruments? In Part I, I examine if firms from poor investor protection regimes bond themselves to better corporate governance by listing on exchanges in more protective regimes, such as the US, thereby achieving functional convergence. I study the effect of cross-listing on ownership and control structures in a sample of 425 firms from 42 countries that cross-list on a major exchange in the US. I find the following features post cross-listing: (1) Very few firms (11 out of 262) migrate to a dispersed ownership structure, contrary to the theory that firms change their corporate governance structure by bonding to US laws (2) A significant fraction of firms experience control changes where the original controlling shareholder sells his control block to a new owner (3) 45% of the control changes result in a foreign owner and individual firm characteristics like small size and low leverage are strong predictors of a foreign control change (4) Firms that undergo a control change significantly increase their debt capacity. The findings of this section show that foreign firms use cross-listing as a means to sell control blocks and increase debt capacity rather than as legal bonding mechanisms. In Part II, I provide a theoretical motivation for the empirical finding in Part I, by deriving the features of an optimal governance system as a function of the level of investor protection in the economy. The model predicts that in an environment of poor investor protection, ownership, leverage and monitoring are complementary instruments of corporate governance where the use of one instrument increases the marginal benefit of the other. The model suggests that one cannot expect to see convergence in governance systems by changing only one aspect of the complementary cluster. Empirical evidence of the complementarities suggested by the model is provided using a sample of transition economy firms from the Amadeus Database. The two parts of the thesis together show that selection of corporate governance mechanisms involves complementarities between the mechanisms and the regulatory environment and we are not likely to see a convergence in governance structures unless there is a significant convergence in legal rules shaping the governance structures.
Empirical Essays in Corporate Finance
(2005-04-20) Minnick, Kristina Leigh; Senbet, Lemma; Prabhala, Nagpurnanand; Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
Over the past twenty years, write-offs have grown in popularity. With the increased usage of write-offs, it is becoming more important to understand the mechanisms behind why companies take write-offs and how write-offs affect company performance. In this paper, I examine the cross-sectional determinants of the decision to take write-offs. I use a hand-collected dataset on write-offs that is much more comprehensive than existing write-off datasets. Contrary to much hype and scandals surrounding a few write-offs, I find that quality of governance is positively related to write-off decisions in the cross-section. My results also suggest that poor governance companies wait to take write-offs until it becomes inevitable, while well-monitored companies take write-offs sooner. As a result, the charge is substantially larger than the average write-off charge. When these poor governance companies announce write-offs, the announcement generates negative abnormal returns. However, when good corporate governance companies announce write-offs, the charge is substantially smaller than the average charge. These well-monitored companies take write-offs immediately following a problem. Following the write-off announcements of these types of companies, average announcement day effects exceed a positive six percent. These results suggest that companies with quality monitoring mechanisms use write-offs in a manner that is consistent with enhancing shareholder value. In my second essay I examine the effect of write-off announcements on the stock market liquidity of firms taking write-offs from 1980 to 2000. I find that there are substantial improvements in stock market liquidity following corporate write-offs. Spreads decrease and turnover volume increases after write-off announcements, which indicates an improvement in liquidity. The liquidity improvement is greater for better governed companies. I decompose bid-ask spreads and show that adverse selection costs decrease substantially as market participants respond to the write-off announcement. The evidence suggests a liquidity benefit of write-offs that must be weighed against any other perceived cost of write-offs. Such a liquidity benefit may validate that write-offs convey favorable information about the firm.
Securities Fraud: An Economic Analysis
(2005-04-20) Wang, Yue; Senbet, Lemma W.; Prabhala, Nagpurnanand; Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This thesis develops an economic analysis of securities fraud. The thesis consists of a theory essay and an empirical essay. In the theory essay, I analyze a firm's propensity to commit securities fraud and the real consequences of fraud. I show that fraud can lead to investment distortions. I characterize the nature of the distortions, and show that it results from fraud-induced market mispricing and management's ability to influence the firm's litigation risk through investment. The theory also characterizes the equilibrium supply of fraud. I demonstrate the linkages between a firm's fraud propensity and the structure of its assets in place and growth options, and analyze the effect of corporate governance on fraud. The theory provides testable implications on cross-sectional determinants of firms' fraud propensities and the relation between fraud and investment. In the empirical essay, I test my main model predictions, using a new hand-compiled fraud data set. I use econometric methods to account for the unobservability of undetected frauds, and disentangle the effects of cross-sectional variables into their effect on the probability of committing fraud and the effect on the probability of detecting fraud. I find that the level, type, and financing of investment all matter in determining the probability of fraud and the likelihood of detection. I also examine the monitoring roles of large shareholders, institutional owners, independent auditors, and corporate boards. I find that large block or institutional holdings tend to discourage fraud by increasing the detection likelihood. The roles of independent auditors and corporate board are weaker. Finally, insider equity incentives, growth potential, external financing needs and profitability all influence a firm's propensity to commit fraud. The paper also demonstrates the importance of separating fraud commitment and fraud detection, because cross-sectional variables can have opposing effects on these two components, and therefore can be masked in their overall effect on the incidence of detected fraud.
Foreign Portfolio Investment and the Financial Constraints of Small Firms
(2005-05-27) Knill, April Thompson; Maksimovic, Vojislav; Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This essay examines the impact of foreign portfolio investment on the financial constraints of small firms. Utilizing a dataset of over 195,000 firm-year observations across 53 countries, I examine the impact of foreign portfolio investment on capital issuance and firm growth across countries and firm characteristics, in particular size. After controlling for firm-, industry- and country-level characteristics such as change in foreign exchange rate, share of market capitalization, relative interest rates and investment climate, I find that foreign portfolio investment helps to bridge the gap between the amounts of financing small firms require and that which they can access through the capital markets. Specifically, I find that foreign portfolio investment is associated with an increased ability to issue publicly traded securities for small firms in all nations, regardless of property rights development. For those small firms that do issue, the form of capital appears to be debt. Since small firms often rely heavily on bank lending, I also test for potential increases in credit for small firms utilizing the bank lending theory of monetary transmission. Results show significantly decreased short-term debt and increased long-term debt, supporting the contention that bank debt maturity to these firms has increased. This transition to longer-term debt could also be as a result of the increased public debt securities these firms are more able to access. The overall increased access to capital only leads to value-enhancing growth at the firm level in nations with more developed property rights. I find that the volatility of foreign portfolio investment is significantly negatively associated with the probability of small firms issuing publicly-traded securities as well as their firm growth, in periods when their domicile nations are deemed less 'creditworthy.' Results underscore the significance of a good financial system that minimizes information asymmetry and enhances liquidity, as well as property rights and country creditworthiness, to instill confidence in foreign investors.
Three Essays on Volatility Issues in Financial Markets
(2005-05-31) Panayotov, George; Madan, Dilip B.; Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
Studies of asset returns time-series provide strong evidence that at least two stochastic factors drive volatility. The first essay investigates whether two volatility risks are priced in the stock option market and estimates volatility risk prices in a cross-section of stock option returns. The essay finds that the risk of changes in short-term volatility is significantly negatively priced, which agrees with previous studies of the pricing of a single volatility risk. The essay finds also that a second volatility risk, embedded in longer-term volatility is significantly positively priced. The difference in the pricing of short- and long-term volatility risks is economically significant - option combinations allowing investors to sell short-term volatility and buy long-term volatility offer average profits up to 20% per month. Value-at-Risk measures only the risk of loss at the end of an investment horizon. An alternative measure (MaxVaR) has been proposed recently, which quantifies the risk of loss at or before the end of an investment horizon. The second essay studies such a risk measure for several jump processes (diffusions with one- and two-sided jumps and two-sided pure-jump processes with different structures of jump arrivals). The main tool of analysis is the first passage probability. MaxVaR for jump processes is compared to standard VaR using returns to five major stock indexes over investment horizons up to one month. Typically MaxVaR is 1.5 - 2 times higher than standard VaR, whereby the excess tends to be higher for longer investment horizons and for lower quantiles of the returns distributions. The results of the essay provide one possible justification for the multipliers applied by the Basle Committee to standard VaR for regulatory purposes. Several continuous-time versions of the GARCH model have been proposed in the literature, which typically involve two distinct driving stochastic processes. An interesting alternative is the COGARCH model of Kluppelberg, Lindner and Maller (2004), which is driven by a single Levy process. The third essay derives a backward PIDE for the COGARCH model, in the case when the driving process is Variance-Gamma. The PIDE is applied for the calculation of option prices under the COGARCH model.
Essays on Law, Finance, and Venture Capitalists' Asset Allocation Decisions
(2005-07-28) Obrimah, Oghenovo Adewale; Maksimovic, Vojislav; Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation consists of three essays. The first essay finds that small firms in poor quality legal environments (poor quality contract enforcement and property rights environments) are more financially constrained relative to small firms in better quality legal environments. Consequently, financial development, that is, the emergence of venture capitalists, has a greater effect on small firms' access to external financing in poor quality legal environments. The second essay finds that the quality of contract enforcement is a risk factor, while the quality of property rights protection is not. The results indicate that poor quality property rights protection hinders the development of informal capital markets; hence, there exists a greater need for financial intermediation in such environments. These results indicate that venture capital financing should be encouraged in poor quality legal environments and provide one rationale for why capital markets in poor quality legal environment countries tend to be bank-based. The third essay finds that the demand for growth financing is lower in poor quality legal environments relative to better quality legal environments. The existing literature has focused on the effect that limited supply of external financing has on firm growth rates in poor quality legal environments. This paper indicates that lower firm growth rates in poor quality legal environments may also result from lower demand for growth financing. The empirical results in all three essays indicate that poor quality legal environments primarily affect the development of informal capital markets. Hence, financial intermediation is of greater importance in poor quality legal environments during the early stages of a firm's growth cycle. This indicates that encouraging the growth of venture capital financing, which is better suited to ameliorating moral hazard problems (investments in small firms and technology intensive ventures) relative to debt or bank financing, will facilitate faster economic growth in poor quality legal environments. Evidence that venture capitalists' asset allocations are significantly and positively associated with long-run country growth rates is provided in the second essay.
Essays in Financial Economics
(2006-04-26) Ullrich, Carl; Bakshi, Gurdip; Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
Essay 1, Constrained Capacity and Equilibrium Forward Premia in Electricity Markets, develops a refinement of the equilibrium electricity pricing model in Bessembinder and Lemmon (2002). The refined model explicitly accounts for constrained capacity, an important feature in electricity markets. Explicitly including a role for capacity allows the model to reproduce the price spikes observed in wholesale electricity markets. The refined model implies that the equilibrium forward premium, defined to be the forward price minus the expected spot price, is decreasing in spot price variance when the expected spot electricity price is low, but is increasing in the spot price variance when the expected spot electricity price is high. Further, the refined model implies that, ceteris paribus, the equilibrium forward premium is increasing in the ratio of the expected spot electricity price to the fixed retail price. The implications of this model are closer to reality. How does currency return volatility evolve over time and what are the properties of volatility dynamics? Is the drift of currency return volatility non-linear? What forms of non-linearities are admitted in the drift and diffusion functions? The purpose of essay 2, Estimation of Continuous-Time Models for Foreign Exchange Volatility, is to estimate a large class of volatility processes and explore these issues using weekly data on two currency pairs: U.S. dollar-British pound and Japanese Yen-U.S. dollar. The estimation approach is based on maximum-likelihood estimation that relies on closed-form density approximations (A\"it-Sahalia 1999, 2002). Based on volatility implied by currency options, the constant elasticity of variance specification provides a reasonable characterization of the variance of variance function. Extending the diffusion function beyond the CEV specification does not improve the fit of the model, regardless of the assumed form of the drift function. Further, I find that certain types of non-linearities in the drift function improve the goodness of fit statistics, though no generalizations can be made.
Essays on Asset Purchases and Sales: Theory and Empirical Evidence
(2006-08-09) YANG, LIU; Maksimovic, Vojislav; Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation consists of a theory essay and an empirical essay that investigate a firm's decision to buy or sell corporate assets. It seeks to answer the following research questions: (1) why do firms choose to buy or sell assets? (2) what makes assets in an industry more likely to be traded than assets in other industries? and (3) within an industry, why asset sales come in waves and tend to cluster over a certain time period? In my theory essay, "The Real Determinants of Asset Sales", I develop a dynamic equilibrium model that jointly analyzes firms' decisions to buy or sell assets and the activity of asset sales in the industry. In my model, a firm maximizes its value by making two inter-related decisions: how much to invest in new assets and whether to buy or sell existing assets. These decisions are made under both firm- and industry-level productivity shocks. The model is solved through simulations and it is calibrated using the plant-level data from Longitudinal Research database. I show that most of the empirical evidence documented in the literature on asset sales is consistent with value-maximizing behavior. In my empirical essay, "What Drives Asset Sales - The Empirical Evidence", I test the model's predictions using the plant-level data from Longitudinal Research Database on manufacturing firms in the period of 1973 to 2000. The patterns of transactions (firm-level purchase/sale decisions, and the cross-industry and the time-series variation in asset sales activities) are consistent with my theoretical model.
Unmapped Holdings and the Performance Measurement of U.S. Equity Mutual Funds
(2009) Hunter, David L.; Wermers, Russell; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This paper investigates a dataset that provides information about assets held by U.S. equity mutual funds, but are not U.S. equities (`unmapped holdings'). I show the widespread presence of these assets and investigate how they are used within mutual fund portfolios. I find that their effects are statistically significant upon both portfolio risk and return. They can either hedge or complement mapped asset returns. I show that predictability of mutual fund returns are reduced when unmapped holdings returns are controlled. Since unmapped holdings returns are not observable, I define an econometric technique that in chapter two that can control for their effect. This technique uses an average return (an `endogenous benchmark') to control for common but immeasurable or unobservable characteristics in a group of funds. I find that an `endogenous benchmark' alone produces estimates nearly as good as those using common risk factor regression models. By combining an endoge- nous bechmark with other risk factors in regression models, I find that estimates are improved.
Two Essays on Recent Innovations in Finance: Microfinancing and Floating Rate Convertibles
(2010) Padhi, Michael Stanley; Phillips, Gordon; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
The first essay provides theory concerning the risk-taking incentives of microfinance borrowers in varying cases: individual liability, group liability without social sanctions, and group liability with social sanctions. The results provide insight into how a community's social capital and a country's credit rights interact to induce recipients of microfinance programs to take risk. Consistent with recent anecdotal evidence that suggests a "dark side" to microfinance, the results show that communal ties among joint liability borrowing groups may not lead to higher repayment rates and may have worse welfare effects on the recipients by making the poorest group members unwilling to take the risks necessary to grow a business. The second essay considers floating rate convertibles (FRCs). FRCs are a category of PIPE securities that receive negative associations in both the academic and professional literature. This study sheds light on the managerial relationship to the decision to issue FRCs and to the variation in market response to these issues. One main result of the study identifies influence of the CFO relative to the CEO as significant in the decision to issue FRCs and in the market's immediate reaction to the issuance. Another main result is that FRC issuing firms with CFOs without prior public equity issuance experience have significantly negative long run abnormal returns, whereas FRC issuing firms with experienced CFOs do not.
ESSAYS IN INTERNATIONAL FINANCE
(2010) Makaew, Tanakorn; MAKSIMOVIC, VOJISLAV; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
My dissertation consists of three essays on international capital flows. In the first essay, titled "Do small firms benefit more from foreign portfolio investment? Evidence from a Natural Experiment," I test whether an increase in the supply of foreign portfolio capital benefits small firms by using the Thai government's unique restriction on capital inflows as a natural experiment. The Thai government imposed a very stringent capital control on December 19, 2006, and then quickly abandoned it one day later. Although many other studies have been plagued with the difficulty of separating the impact of foreign capital from the impact of other concurrent events, this experiment helps me solve the time-series identification problem. My results suggest that foreign portfolio investment helps large firms the most, contrary to existing evidence, which finds a benefit in foreign portfolio investment for small firms. I also investigate the importance of other firm characteristics correlated with size, which includes a firm's exchange rate exposure, foreign ownership, and political connection. The next two essays are on the dynamic patterns of international mergers and acquisitions. In the second essay, I uncover key facts about international M&As by estimating a variety of reduced form models. I find that: (1) Cross-border mergers come in waves that are highly correlated with business cycles. (2) Most mergers occur when both the acquirer and the target economies are booming. (3) Merger booms have both an industry-level component (productivity shocks) and a country-level component (financial shocks). (4) Across over one million observations, acquirers tend to be more productive and targets tend to be less productive, compared to their industry peers. These facts are consistent with the neoclassical theory of mergers in which productive firms expand overseas to seize new investment opportunities, but not with the widely held views that most cross-border mergers occur when the target economies are in a recession or face a financial crisis. In the third essay, I construct a dynamic structural model of cross-border mergers and integrate the important facts above into the model. This dynamic structural approach allows me to quantify the effects of productivity and financial shocks on M&A decisions. In addition, this approach provides a proper analytical framework for conducting policy experiments. As an example of such analyses, I investigate the impact of President Obama's proposal on multinational corporation taxation. My simulation results suggest that the foreign operation tax has economically significant effects on productive firms and can be very distortionary for cross-border mergers.
SELECTION OF STAR CEOS AND ITS IMPLICATIONS ON FIRM PERFORMANCE AND CEO COMPENSATION
(2010) Li, Minwen -; Maksimovic, Vojislav; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
My dissertation examines a board's decision to hire a star CEO and the implication of such decision on the new CEO compensation and firm performance. I develop a new methodology to identify a star CEO by analyzing the texts contained in 18,240 Wall Street Journal news articles. Unlike previous measures, my new measure accounts for the time series variations of executives' visibility as well as how favorably these executives are portrayed in the business press. In order to study the role of board composition on CEO selection, executive compensation and firm performance, I introduce board industry tenure, a new measure of board composition, to capture the average years of industry-related experience acquired by independent directors. In my first essay, I investigate a board's decision to hire a star CEO and analyze the consequences of this decision for firm performance. I show that boards with short industry tenure or busy boards are more likely to select a star CEO. Firms that hire star CEOs subsequently perform worse than firms that hire non-star CEOs. However, after I use the propensity score matching method to control for pre-hiring board composition and other determinants of star CEO selection, firms that hire star CEOs perform equally well as firms that hire non-star CEOs. My second essay compares the compensation design of a star versus a non-star CEO. I find that a star CEO is awarded 1.87 million dollars more in annual total compensation, and 2.19 million dollars more in annual option compensation, after I control for firm size, board characteristics, B/M ratio, leverage, EBIT/Assets, stock return, firm risk, industry and year effects, and other related variables. In addition, star CEOs receive higher compensation in firms where directors have short industry tenure, where directors hold multiple board seats simultaneously, where board size is large, and where board is composed of less independent directors. The above results hold true after I use a control-group approach, based on CEO matching to alleviate CEO selection issue. I also show that the equity portfolio of star CEOs exhibit higher sensitivities to change in stock price than non-star CEOs.
ESSAYS ON FORCES UNDERLYING 2008 FINANCIAL CRISIS: CREDIT RATING AGENCIES AND INVESTOR SENTIMENT
(2010) Alp, Aysun; Prabhala, Nagpurnanand R.; Kyle, Albert S.; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
The roots of the 2008 financial crisis are often traced back to the collapse of the housing bubble. The factors that precipitated the crisis, and propagated its effects on firms and consumers to produce an economic contraction, are still the subject of ongoing debate among academics, policy makers, and practitioners. Macroeconomic factors, flawed government policies, and perverse incentives at financial institutions that lead to excessive risk taking are often cited as contributing forces to the crisis. In this dissertation, I investigate two forces that drove the 2008 financial crisis. One force is the credit rating agencies, whose excessively generous ratings lie at the root of the 2008 financial crisis. The popular claim is that the rating agencies have become too loose at their rating assignments, which led to overestimation of the creditworthiness of the companies by the public. In this dissertation, I examine the assertion that the rating companies have progressively relaxed their standards in recent decades for corporate credit ratings. Such relaxation seems to have lulled investors into a false sense of security about the safety of credit instruments whose values collapsed abruptly. Next I examine the contagion effects of rating downgrades. I ask whether rating downgrade news have spill over effects on the rest of the industry. I then investigate a different force that has received less attention in the crisis; investor confidence. The third essay focuses explicitly on the period when the financial crisis was at its peak. In Essay 1 titled, "Structural Shifts in Credit Rating Standards", I examine the time series variation in corporate credit rating standards for the period 1985-2007. I report two main findings: (i) There is a divergent pattern between investment grade and speculative grade rating standards during 1985-2002. Investment grade ratings tighten between 1985 and 2002. In contrast, the speculative grade rating standards loosen during the same period. Consistent with an agency explanation, rating companies assign more issuer friendly ratings to speculative grade credits, where there is substantial growth by the first-time entrants. The loose standards in speculative grade ratings are consistent with widespread criticism of the rating agencies during the Dot-Com crash. However, while the media focused on failure of rating agencies in high profile corporate debacles, the more serious problem was in the speculative grade rating assignments. (ii) There is a sharp structural break in both investment grade and speculative grade standards towards more stringent ratings around 2002. The change in rating levels due to the structural break is both economically and statistically significant. Holding firm characteristics constant, firms experience a drop of 1.5 notches in ratings due to tightening standards between 2002 and 2007. It appears that widespread criticism and threat of regulation led rating agencies to move towards more conservative ratings after the Dot-Com crash, Enron debacle and passage of Sarbanes-Oxley Act. In Essay 2 titled "Contagion Effects of Rating Downgrade Announcements", we examine the intra-industry spill over effects of rating downgrade announcements based on abnormal returns for stock and CDS spreads of competitor industry portfolios. We find minor contagion effects for the equity prices of the industry portfolios for the entire sample. For the competitors of investment grade firms, we find significant contagion effects in the magnitude of -15 basis points for the window (0,1). For the speculative grade sample, we do not observe contagion or competition effects although this result can be due to cancellation of contagion and competition effects for the low rated firms. These results suggest that the net effect is dependent on the event firm's original rating. We find statistically significant CDS reaction of industry portfolios to downgrade news although in moderate magnitudes. The cross sectional tests show that the industry portfolio equity response and event firm equity response are positively correlated. This finding presents further evidence of contagion effects for rating downgrades. Essay 3 discusses a different force that has received less attention in the financial crisis, investor sentiment, and focuses on data drawn from the crisis period. In Essay 3, titled "Confidence and the 2008 Financial Crisis", we examine the role of confidence in the 2007-2008 financial crisis using new high frequency data on daily closed-end fund discounts and novel measures of consumer sentiment from non-financial sources extracted at daily frequency. Empirically, there is some movement in sentiment through much of the crisis period but it is relatively moderate. However, tests detect a sharp structural break around the Lehman bankruptcy, after which there are breaks in both pricing across multiple asset classes and co-movement, especially in hard-to-arbitrage fund classes. Fund discounts also exhibit significantly increased co-movement with non-financial Gallup sentiment measures after the Lehman bankruptcy, and closed-end fund discount betas with respect to the market increase significantly during this period. While fund discounts may reflect liquidity issues in normal conditions, they seem to better reflect sentiment in stressed environments, so funds have undesirable conditional betas. The results are consistent with the view that the Lehman bankruptcy induced a negative shock to the supply of arbitrage capital, and as predicted by behavioral finance models of costly arbitrage, sentiment then matters more and is closely tied to returns. The results are also consistent with theories of financial crisis in which sentiment or confidence is an extra force that amplifies and transmits economic shocks that add to the usual credit and collateral mechanisms studied in the literature.
The Role of Networks in the CEO and Director Labor Market
(2010) Liu, Yun; Prabhala, Nagpurnanand R.; Senbet, Lemma W.; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
The dissertation investigates the role of networks and connectedness on CEO and director labor market outcomes. I develop new measures of degree, closeness, betweenness, and eigenvector centrality using a new database of executive connections based on executive and director biographical information supplied by BoardEx. I then study the influence of networks and connectedness on CEO labor market outcomes, including new CEO appointments, CEO termination, and CEO compensation. I distinguish between the pairwise specific CEO-board connectedness and the strength and structure of the CEO's overall connectedness. I find that both types of connectedness add to traditional turnover and compensation variables in distinct and economically significant ways. Specific connectedness increases CEO entrenchment. Greater overall CEO connectedness on the employment network results in greater likelihood of CEO departure, greater turnover-performance sensitivity, and more rapid re-employment of a departed CEO. The existence of specific links between the CEO candidate and the board of directors enhances the chances of appointment in the event a company chooses to appoint an outsider as the CEO. Finally, CEOs with better overall connectedness enjoy higher total compensation. The evidence suggests that the general connectedness of a CEO in the employment network has significant and distinct economic effects beyond those of the connections between the CEO and the board in the current firm. In the paper "On the Independence of Independent Directors", I examine director appointment and replacement decisions after a new CEO assumes office. A new incoming CEO can make many changes in the size and structure of the board and influence on the types of individuals that populate it. I assess the role played by prior connections between the CEO and outside directors, including the overlaps established through common employment history, educational background, and other activities. I also test the nature of these changes in specifications that model CEO and director changes jointly. I find that with a higher proportion of professionally connected outside directors on the board, the CEO is more likely to stay. New CEOs reshape the board in the early years of their tenure rather than later years when they may have more power and influence. Conditional on CEO continuation, outside directors that are of similar age to the CEO and share common employment antecedents with the CEO are less likely to be replaced. Replacements of unconnected directors are accompanied by appointments of connected directors. I discuss the implications of the findings for research and practice.
ESSAYS ON NEWS AND ASSET PRICES
(2010) Sinha, Nitish Ranjan; Kyle, Albert S; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
The first essay examines news and the cross section of returns. Using a sentiment score provided by Thomson Reuters to measure the tone of news articles, this paper examines monthly portfolio returns constructed from information about past news articles. The sentiment score is obtained from the kind of words and phrases that are used in the news article. Positive tone in news articles in the past months predicts positive returns. Similarly, negative tone in the past months predicts negative returns. Past sentiment predicts future returns even for large stocks. The predictive ability of past sentiment dominates the predictive ability of past returns. After controlling for past sentiment, the predictive ability of past returns (in predicting future return) disappears. The findings are robust to multiple specifications. The predictive ability of past sentiment can be used profitably. When applied to the largest decile of stocks, a strategy that takes a long position in stocks with past positive sentiment score and a short position in stocks with past negative sentiment score generates a statistically significant alpha of 34 basis points per month. The resulting portfolio is also positively correlated with a long-short momentum portfolio. Within the same time period, a trading strategy using the sentiment scores from the subset of news articles citing analysts is not profitable. The news items that cite analysts have economically significant contemporaneous returns. The findings suggest that (i) the market underreacts to information contained in news articles, (ii) momentum might be related to underreaction to the sentiment information, and (iii) market participants pay attention to sentiment score information in analyst news. The findings are consistent with a model where one trader has private information and others are trading based on past returns and volume information. The paper also shows that after adjusting for firm size, stocks with abnormally high counts of news articles underperform stocks with normal counts of news. Stocks with abnormally low newscounts also underperform. The second essay examines the relationship between news and trading activity. The theory of trading game invariance of Kyle and Obizhaeva(2009) predicts that for every one percent increase in trading activity, the frequency of news articles should increase two-thirds of one percent. Using news data from 2003 to 2008, we show that the cross-sectional variation in news articles across stocks is related to the trading activity in a manner consistent with the trading game invariance. The relationship is robust to various estimation procedures including models of count data. The relationship is also robust to multiple ways of counting news and excluding various type of firm specific news.
Three chapters on hedge fund reserve capital and systemic risk
(2011) Xiao, Yue; Madan, Dilip B; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
Hedge fund industry has grown to be a key player in the financial markets. Just as large investment banks, the failure of this industry will greatly destroy the liquidity and stability of the whole system. However, contrast to regulated mutual funds, hedge funds are private and lightly regulated entities who are not obliged to disclose their activities to the general public. Hedge funds risk taking activity using ways such as short selling and excessive leverage and their increasingly correlated strategies pose substantial threats to the financial stability of the great economy. In the First Chapter, we propose a simple framework which adopts the theory of acceptable risks and calculate capital requirements using the limited available data on hedge funds. We model the risky cash flow asset less liability (or Net Asset Value) directly using either a Gaussian process or a Variance Gamma process and apply the method to demeaned NAV data on $3622$ hedge funds from January 2005 to April 2009. Funds are analyzed for their required capital and the value of the option to put losses back to the taxpayers. The previous study has considered funds individually with no correlation between them. Focusing only on individual funds ignores the critical interactions between them and can cause the regulators to overlook important changes in the overall system. Because many hedge funds employ similar investment strategies they produce correlated returns. The failure of these correlated large funds will greatly affect the markets systematically either in a direct or an indirect way. In the Second Chapter, we propose a systemic approach with correlated largest market participants and we study the $30$ largest funds as of April 2009 with total Asset Under Management over $\$620$ Bn. We demonstrate the systemic capital charges to be held by the broad economy, as well as the capital charges at the fund level accounting for the residual idiosyncratic risk component. Hedge fund investment strategies often include the use of leverage in order for them to build up large positions. Extensive use of leverage has increased funds liabilities especially during market downturns and has posted a great systemic risk to the economy in large. In the Third Chapter, we recognize that with limited and incomplete information on hedge funds balance sheet positions, the public usually does not know how much leverage there is in a particular fund or how to distinguish its assets and liabilities from the observed returns. We estimate hedge fund leverage using a regression-based exercise on the individual fund level. The estimated leverage information is then combined with publicly known return and other fund information to separate from fund cash flows its asset side and liability side. The two sides of the cash flows are then modeled as exponentials of two correlated L\'evy processes following \cite{EberleinMadan:2010}. Capital implications are then derived from the above setup.
Essays on Empirical Market Microstructure
(2011) Tuzun, Tugkan; Kyle, Albert S; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
The first essay examines the events of May 6, 2010: the ``Flash Crash". The Flash Crash, a brief period of extreme market volatility on May 6, 2010 raised questions about the current structure of the U.S. financial markets. Audit-trail data from U.S. Commodity Futures Trading Commission (CFTC) is used to describe the structure of the E-mini S\&P 500 stock index futures market on May 6. In this study, three questions are asked. How did High Frequency Traders (HFTs) trade on May 6? What may have triggered the Flash Crash? What role did HFTs play in the Flash Crash? There is evidence which supports that HFTs did not trigger the Flash Crash, but their responses to the unusually large selling pressure on that day exacerbated market volatility. The second essay examines the relationship between mutual fund trading and liquidity consumption in financial markets. Using Thompson Mutual Funds holdings data and the Trade and Quotes (TAQ) data, we relate the mutual fund trading to liquidity consumption. Mutual fund trading is positively correlated with liquidity consumption. Mutual fund sensitivity to liquidity consumption differs based on mutual fund investment style. Large trades reveal the trading activity of actively managed mutual funds whereas the trading activity of index funds can be explained by small trades. This is consistent with a plausible explanation that index funds need to use small trades to rebalance their portfolios and information motivates the large trades of active mutual funds. The third essay tests the predictions of trading game invariance using the sample of trades from TAQ dataset from 1993 to 2008. The theory of trading game invariance predicts that the distribution of trade sizes as a fraction of trading volume should vary across stocks proportionally to their trading activity in -2/3 power and that the number of trades should vary across stocks proportionally to their trading activity in 2/3 power. The data supports predictions of the invariance theory. For the number of trades, the estimated power coefficient of 0.69 (with standard errors of 0.001) is especially close to the predicted one of 2/3 on the subsample before 2001. These estimates increases to 0.79 (with standard errors of 0.004) after 2001 following a structural break related to a reduction in tick size and a consequent spread of algorithmic trading. Furthermore, the entire distribution of trade size shifts with the trading activity in a manner predicted by invariance theory. When trade sizes are adjusted for differences in trading activity, then their distribution is stable across stocks and similar to the distribution of a log-normal variable, truncated at the 100-share threshold.
Financial Policy and Ownership Stability
(2011) Kozora, Matthew Lee; Prabhala, Nagpurnanand; Wermers, Russell; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
I investigate the relationship between corporate financial policy and the ownership stability of a firm's institutional shareholders. In each chapter of my dissertation I empirically investigate this relationship in a different setting: the first chapter with respect to earnings management, the second chapter with respect to corporate spin-offs, and the third chapter with respect to payout policy. Unique to my research I utilize the complete ownership history of each institutional stock position to create measures of ownership stability including fund investment horizon and ownership length. Overall, I find significant relationships between each one of the three financial policies and measures of ownership stability.
ESSAYS ON CORPORATE INVESTMENT
(2012) Moon, Seoyeon Katie; Phillips, Gordon; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation is comprised of three essays on corporate investment. The first essay, titled "What If the Firm Does Not Diversify? A Self-Selection Free Bayesian Approach", takes a comprehensive look at the diversification discount. By employing a switching regression model with the Bayesian data augmentation methodology, I compare the actual post-acquisition firm value of diversifying acquirers to the counter-factual alternative which is a non-diversifying acquisition. I find that there is a considerable amount of acquirers that could improve their value by diversifying acquisitions more than what they would improve by non-diversifying acquisitions. When there are negative shocks to the acquirers' primary industries, when these industries are concentrated and the firms are not dominant players in the industries, diversifying acquisitions add values to the firms. The firm-by-firm analysis shows that on average, no diversification discount exists. The next two essays study U.S. manufacturing firms' outsourcing activity, using a unique dataset of purchase obligations from firm 10-Ks. The second essay is titled "Outsourcing and Firm Financial Structure", and the third essay is titled "Firm Risk Taking versus CEO Diversification: Evidence from Outsourcing Firms". In the second essay, I explore the outsourcing decision and its implications on firm investment and capital structure. I first examine what kinds of firms use external contracts to provide a product or service as a major input to their production. I find that relatively young or large firms with a large number of patents are more likely to use external purchase contracts. Within high-technology industries, firms with purchase contracts tend to have higher R&D investment, while in low- technology industries, firms with purchase contracts are more likely to enter new markets. Outsourcing activity has important risk and capital structure implications, as firms that outsource have significantly less leverage. These results are consistent with outsourcing being used by firms to improve their flexibility. Faced with this increased firm flexibility and fewer fixed assets to pledge as collateral, outsourcing firms finance their operations proportionally more with equity. In the third essay, I examine CEO compensation in outsourcing firms. I find that the intensity of outsourcing can significantly explain the variations in CEO compensation; the more the firms do outsourcing, the more they pay to their CEOs. Outsourcing firms promote managerial risk-taking by using proportionally more equity-based compensation. However, they also need to compensate additionally their CEOs for the higher risk exposure to the firms' increased total risks. I show that outsourcing firms determine their compensation level and structure based on this optimal trade-off.
Essays on Asset Pricing
(2012) Li, Su; Kyle, Albert; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation consists of three essays. The first essay is titled "Speculative Dynamics I: Imperfect Competition and the Implications for High Frequency Trading". In this essay, I analyze the nature of imperfect competition among informed traders who continuously generate and exploit private information about a risky asset's liquidation value which follows either a mean reverting process or random walk. I find the following results: (i) The combined trading of multiple informed traders is much more aggressive than the monopolistic trader in Chau and Vayanos (2008). (ii) The equilibrium price is even more revealing of the informed trader's private information. (iii) Market depth improves as the number of informed traders increases. (iv) In the limit of continuous trading, market is strong form efficient while aggregate profits of the informed traders remain bounded away from zero, in sharp contrast to the corresponding results in Holden and Subrahmanyam (1992), and Foster and Viswanathan (1993). (vi) Informed traders' inventories follows a Brownian motion, therefore enabling them to contribute significantly to total trading volume and price variance. These results shed light on empirical findings regarding high frequency traders by helping explain why they remain protable despite aggressive competition with each other, why their trading volume is very high, to what extent they improve efficiency, and through what mechanism they improve liquidity. The second essay is titled "Speculative Dynamics II: Asymmetric Informed Traders". In this essay, I study the strategic interaction between hierarchical duopolistic informed traders who continuously generate and exploit private information about a risky asset's liquidation value, which follows either a mean reverting process or random walk. I find the following results: (i) Both traders duopolize the private information they both observe and the more informed trader monopolizes the additional exclusive private information. (ii) The common private information is incorporated into prices more efficiently than the monopolistic private information. (iii) In the limit of continuous trading, both traders' inventories based on their shared information follow Brownian motions. (iv) The trader with less superior information has more contribution to the trading volume and price volatility when the frequency of trading is sufficiently high. (v) As trading becomes more frequent, the less informed trader's expected profits may fall but converges to a strictly positive constant in the limit. The third essay is titled "Real Options and Product Differentiation". In this essay, I develop a continuous time real investment model in an oligopoly industry where the products are heterogeneous. Although the heterogeneous products assumption can lower each firm's incentive to exercise the growth options prematurely, the preemption strategy is still profitable.

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