Research
Job Market Paper
Measurement Errors of Expected Returns Proxies and the Implied Cost of Capital
Abstract: I develop a novel diagnostic procedure to estimate the associations between measurement errors of expected returns proxies and firm characteristics. Application to GLS, a popular implementation of the implied cost of capital ("ICC"), yields the first direct empirical evidence that ICC measurement errors i) are persistent, ii) can be associated with firms' risk or growth characteristics, and therefore iii) can lead to spurious inferences in regressions. I devise a novel methodology to account for the influence of ICCs measurement errors in regression settings, and show that its application i) can explain some puzzling associations between GLS and firm characteristics and ii) can improve upon GLS, by forming new ICCs that better sort realized returns. Together, the innovations of this paper allow researchers to better understand ICC measurement errors and provide a robust empirical strategy for future research.
Publications
Learning and the Disappearing Association between Governance and Returns (2011), forthcoming, Journal of Financial Economics (with Lucian Bebchuk and Alma Cohen)
Abstract: The correlation between governance indices and abnormal returns documented for 1990-1999 subsequently disappeared. The correlation and its disappearance are both due to market participants� gradually learning to appreciate the difference between good-governance and poor-governance firms. Consistent with learning, the correlation�s disappearance was associated with increases in market participants� attention to governance; market participants and security analysts were, until the beginning of the 2000s but not subsequently, more positively surprised by the earning announcements of good-governance firms; and, although governance indices no longer generated abnormal returns during the 2000s, their negative association with firm value and operating performance persisted.
Other Research Papers
Boardroom Centrality and Firm Performance, Revise and Resubmit, Journal of Accounting and Economics
(with David F Larcker and Eric C So)
Abstract: Firms with central boards of directors earn superior risk-adjusted stock returns. Initiating a long position in the most central firms and a short position in the least central firms earns an average risk-adjusted return of 4.68% per year. Firms with central boards also experience higher future growth in return-on-assets (ROA) with analysts failing to fully reflect this information in their earnings forecasts. Return prediction, growth in ROA, and analyst forecast errors are concentrated among firms with high growth opportunities or firms confronting adverse circumstances, consistent with board centrality mattering most for firms that stand to benefit most from the network’s resources. Together, our results suggest that board of director networks provide economic benefits that are not immediately reflected in stock prices.
Evaluating the Implied Cost of Capital Estimates, Under Review
(with Charles MC Lee and Eric C So)
Abstract: Characterizing a firm�s true (but unobservable) expected returns as the normative benchmark, we develop a two-dimensional framework for evaluating the relative performance of implied cost-of-capital (ICC) estimates. First, in time-series, variations in ICC estimates should reflect changes in true expected returns rather than changes in measurement errors. Second, cross-sectionally, ICC estimates should predict future realized returns. Using this framework, we compare seven alternative ICC measures and show that several perform quite well along both dimensions, and all do much better than Beta-based estimates. In addition, we provide evidence on the importance of appropriate matching between the earnings forecasting method (analyst vs. mechanical) and the valuation model. Overall, our evidence provides significant support for the broader adoption of ICCs as firm-level expected return proxies.
Staggered Boards and the Wealth of Shareholders: Evidence from Two Natural Experiments
(with Lucian Bebchuk and Alma Cohen)
Abstract: While staggered boards are known to be negatively correlated with firm valuation, such association might be due to staggered boards either bringing about lower firm value or merely being the product of the tendency of low-value firms to have staggered boards. In this paper, we use a natural experiment setting to identify how market participants view the effect of staggered boards on firm value. In particular, we focus on two recent rulings, separated by several weeks, that had opposite effects on the antitakeover force of the staggered boards of affected companies:
(i) an October 2010 ruling by the Delaware Chancery Court approving the legality of shareholder-adopted bylaws that weaken the antitakeover force of a staggered board by moving the company�s annual meeting up from later parts of the calendar year to January, and
(ii) the subsequent decision by the Delaware Supreme Court to overturn the Chancery Court ruling and invalidate such bylaws.
We find evidence consistent with the hypothesis that the Chancery Court ruling increased the value of companies significantly affected by the rulings �namely, companies with a staggered board and an annual meeting in later parts of the calendar year �and that the Supreme Court ruling produced a reduction in the value of these companies that was of similar magnitude (but opposite sign) to the value increase generated by the Chancery Court ruling. The identified positive and negative effects were most pronounced for firms for which control contests are especially relevant due to low industry-adjusted Tobin�s Q, low industry-adjusted return on assets, or relatively small firm size. Our findings are consistent with market participants� viewing staggered boards as bringing about a reduction in firm value. The findings are thus consistent with institutional investors� standard policies of voting in favor of proposals to repeal classified boards, and with the view that the ongoing process of board declassification in public firms will enhance shareholder value.
Golden Parachutes and the Wealth of Shareholders
(with Lucian Bebchuk and Alma Cohen)
Abstract: Golden parachutes have attracted much debate and substantial attention from investors and public officials for more than two decades, and the Dodd-Frank Act recently mandated a shareholder vote on any future adoption of a golden parachute by public firms. We use IRRC data for the period 1990-2006 to provide a comprehensive analysis of the relationship that golden parachutes have both with the evolution of firm value over time and with shareholder opportunities to obtain acquisition premiums. We find that golden parachutes are associated with increased likelihood of either receiving an acquisition offer or being acquired, a lower premium in the event of an acquisition, and higher (unconditional) expected acquisition premiums. Tracking the evolution of firm value over time in firms adopting GPs, we find that firms adopting a GP have a lower industry-adjusted Tobin’s Q already in the IRRC volume preceding the adoption, but that their value continues to decline during the inter-volume period of adoption and continues to erode subsequently. A similar pattern is displayed by an analysis of abnormal stock returns prior to the adoption of GPs, during the inter-volume period of adoption, and subsequently.
Can Implicit Regulation Change Financial Market Behavior? Evidence from Spitzer�s Attack on Market Timers
Abstract: This paper explores a natural experiment setup from the 2003-2004 mutual fund scandals to evaluate the effectiveness of implicit regulation on financial markets behavior. On average, buy-and-hold investors lost 218 basis points annually from 1998 to 2002 to market timers. Buy-and hold investors suffered further economic losses from higher cash holdings, portfolio turnover, fund fees, and substantially lower fund performance that resulted from market timing fund churn. Intensified threat of regulation from the 2003 � 2004 scandals resulted in the industry�s self- regulation by, among other things, voluntary adoption of fair value pricing. I find strong evidence that their self-regulation reduced the market timing motive as well as fund churn in international mutual funds in the post-2004 period, and reduced dilution by 93%.
Teaching
Lecture Notes
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