- 27 Oct 2009
- Working Paper Summaries
Stock Price Fragility
Does the composition of ownership of a financial asset influence future returns and risk? Previous economic research has documented significant price effects of investor demand in numerous settings, including retail demand for options, investor demand for bonds, and mutual funds' flow-driven demand for stocks. This paper provides a methodology to identify assets that are vulnerable to such investor demand shocks. The central idea is that assets are risky if the current owners of the asset face correlated liquidity shocks—i.e., they buy and sell at the same time. We call assets with a high concentration of owners who trade in the same direction "fragile." A related concept is "co-fragility." Two assets are "co-fragile" if their owners have correlated trading needs, even if the holdings of these owners do not directly overlap. The authors build measures of fragility for U.S. stocks between 1990 and 2007. Consistent with their predictions, more fragile stocks are more volatile, and two co-fragile stocks exhibit high correlations among their stock returns. Key concepts include: The link between ownership structure and non-fundamental risk. The link between common ownership structure and commonality in returns. Relating the liquidity needs of an asset's owners to the risks of the asset. The concept of fragility expresses the three reasons why a stock may be volatile: ownership concentration, volatility of liquidity needs, and correlation of liquidity needs across owners. Closed for comment; 0 Comments.
- 20 Mar 2009
- Working Paper Summaries
Catering to Characteristics
Can patterns of corporate net stock issuance help identify times when particular characteristics, such as industry, size, or book-to-market ratio, are mispriced? The authors of this study argue that differences between the characteristics of issuers and repurchasers can shed light on characteristic related stock returns. Consider the case in which analysts were interested in forecasting the returns of Google. The standard approach would be to collect Google's characteristics (e.g., large, technology, non-dividend paying, etc) and associate these characteristics with an average return in the cross-section. The authors argue that if other stocks with these characteristics are issuing stock, this bodes poorly for Google's future returns, even if Google is itself not issuing. This research by HBS professor Robin Greenwood and Harvard doctoral student Samuel Hanson has implications for studying the stock market performance of seasoned equity offerings (SEOs), initial public offerings (IPOs), and recent acquirers. Key concepts include: The approach in this paper helps forecast returns to portfolios based on book-to-market, size, share price, distress, payout policy, profitability, and industry. The issuer-repurchaser spreads are informative for future returns, even controlling for firms' own issuance and repurchase decisions. Closed for comment; 0 Comments.
- 22 Aug 2007
- Research & Ideas
The Hedge Fund as Activist
Do hedge funds improve management of the companies they invest in? A new study by Harvard Business School professor Robin Greenwood and coauthor Michael Schor argues that, in fact, hedge funds create shareholder value through anticipation of change, not necessarily delivering it. Key concepts include: Hedge funds have entered the activist arena. Between 1994 and 2006, the number of public firms targeted for poor performance by hedge funds grew more than 10-fold. Hedge funds generate returns of over 5 percent on announcement of their involvement with a targeted firm. Rather than effecting significant operational change, hedge funds create value by putting firms "in play." A question for future study: Do hedge fund activist-initiated acquisitions create value for the acquirers of these firms? Closed for comment; 0 Comments.
- 20 Aug 2007
- Working Paper Summaries
Hedge Fund Investor Activism and Takeovers
Are hedge funds better than large institutional investors at identifying undervalued companies, locating potential acquirers for them, and removing opposition to a takeover? Are they best equipped to monitor management? While blockholding by large institutional investors—pension funds and mutual fund investment companies—is widespread, there is virtually no evidence that these institutional shareholders are effective monitors of management or that their presence in the capital structure increases firm value. When institutional blockholders make formal demands on management, there is no evidence of their success. This working paper outlines the advantages and limits of hedge funds to manage these tasks. Greenwood and Schor's characterization differs markedly from previous work on investor activism, which tends to attribute high announcement returns to improvements in operational performance. Key concepts include: While recent popular accounts suggest that we are in an era of the "imperial shareholder," the results in this working paper indicate that activism tends to be most successful when there is a high probability of a takeover. Where improvements may take several quarters or even years to realize, the investment horizon of hedge funds makes them unsuitable overseers of management. Firms that would benefit from modest changes in operating policy or governance, or for which a reduction in CEO pay is to be desired, are not likely to hit the radar screen of hedge funds. While hedge funds do occasionally succeed in changing the board, initiating or increasing dividends, repurchasing shares, or cutting executive pay, it is not clear that these changes increase shareholder value relative to getting the target acquired. Closed for comment; 0 Comments.
- 19 Feb 2007
- Research & Ideas
Inexperienced Investors and Market Bubbles
The evidence isn't conclusive, but new research from Harvard Business School suggests younger fund managers may have contributed to the tech stock bubble. Professor Robin Greenwood discusses the research paper, "Inexperienced Investors and Bubbles," and what mutual fund investors should keep in mind. Key concepts include: The research supports theories that inexperienced investors are prone to buy assets with inflated prices during times of bubbles. Even professionals are susceptible to trend-chasing. Fund managers under the age of thirty-five were more likely than older managers to overly invest in tech stocks in the last bubble. Closed for comment; 0 Comments.
- 05 Jul 2006
- Working Paper Summaries
Float Manipulation and Stock Prices
When a firm reduces the number of shares available to trade, so-called float manipulation, the price of the stock is often driven up. The author uses a series of 2,000 stock split events in Japan as an experiment to understand the consequences of float manipulation for stock prices. The conclusion: Stock prices are raised significantly when there are differing opinions about the value of shares, investors are unable to sell short, and the number of outstanding shares is reduced. Key concepts include: Firms may use a float reduction as an opportunity to raise equity, or managers may exploit it as an opportunity to sell overpriced shares. Closed for comment; 0 Comments.
- 05 Jul 2006
- Working Paper Summaries
A Cross-Sectional Analysis of the Excess Comovement of Stock Returns
This paper develops cross-sectional predictions from a model in which the excess comovement of stock returns comes from correlated demand shocks. The model is tested on 298 Nikkei index stocks and 1,458 non-index stocks for the years 1993 through 2003. The study finds that controlling for index membership, index overweighting is a significant determinant of the comovement of returns with index returns. Key concepts include: Correlated investor demand for securities causes periodic and widespread mispricing. Members of arbitrarily weighted stock indexes, oftentimes "liquid" securities, are subject to frequent mispricing. Closed for comment; 0 Comments.
- 06 Feb 2006
- Research & Ideas
The Trouble Behind Livedoor
When Livedoor CEO Takafumi Horie was arrested last month, it shook the economic underpinnings of Japan. Professor Robin Greenwood discusses what went wrong with one of that country's most-watched Internet companies. Closed for comment; 0 Comments.
A Quantity-Driven Theory of Term Premia and Exchange Rates
This paper provides a framework for understanding how the detailed structure of financial intermediation affects foreign exchange rates.
Agency Costs, Mispricing, and Ownership Structure
Under what circumstances do firms access capital markets when the potential for agency costs is high? The prevailing view holds that controlling shareholders sell shares to outsiders only when internal capital is inadequate to fund attractive investment opportunities. While the role of market efficiency in corporate finance has attracted considerable research attention, the interaction of stock market mispricing with agency problems is not well understood. HBS doctoral graduate Sergey Chernenko and professors C. Fritz Foley and Robin Greenwood propose a new explanation—based on stock market mispricing—for why firms with a controlling shareholder raise outside equity, even when firms cannot commit not to expropriate minority shareholders. Key concepts include: Stock mispricing offsets agency costs and induces a controlling shareholder to raise capital. Higher misvaluations are required to support the creation of ownership structures that give rise to more expropriation. To the extent that agency costs are deadweight instead of distributional transfers, mispricing facilitates the creation of inefficient ownership structures. Closed for comment; 0 Comments.