Finance Theses and Dissertations
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Item 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.Item 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.Item 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.Item 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.Item 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.Item 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.Item 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.Item 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.Item 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.Item 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.