- 05 Nov 2012
- Research & Ideas
What Wall Street Doesn’t Understand About International Trade
Firms that correlate their international trading activity with the local ethnic community significantly outperform those that don't, according to new research by Lauren H. Cohen, Christopher J. Malloy, and Umit G. Gurun. Closed for comment; 0 Comments.
- 28 Aug 2012
- Working Paper Summaries
Channels of Influence
How do firms differentially navigate the global marketplace to buy and sell goods? The answer is critical to identifying which firms will ultimately succeed, and how investors should allocate capital amongst these firms. This paper analyzes the strategic entry choices of firms seeking to expand their businesses to overseas markets. Using customs and port authority data detailing the international shipments of all U.S. publicly-traded firms, the authors show that firms import and export significantly more with countries that have a strong resident population near the firm headquarters. In addition, by analyzing the formation of World War II Japanese internment camps in order to study external shocks to local ethnic populations, the authors also identify a causal link between local networks and firm trade. However, capital markets and sell-side analysts have difficulty deciphering even these observable channels, so make significant mistakes in assessing the positive impact of these links. Findings overall show a surprisingly large impact of immigrants' economic role as conduits of information for firms in their new countries. This research provides new evidence on the economic impact of immigration and ethnic diversity in the United States. Key concepts include: Firms are significantly more likely to trade with countries that have a strong resident population near their firm headquarters. Firms that exploit local networks in their international trade decisions experience significant increases in future sales growth and profitability. Strategic importers and exporters outperform other importers and exporters by 5%-7% per year in risk-adjusted returns. Although it is possible to predict which trade links, on average, are valuable for firms (using simple measures of connected population that are publicly available), the market seems to ignore this information. The increased value of strategic traders is also missed by analysts. Analysts are significantly less accurate in their earnings forecasts on these firms, with these firms having significantly more positive earnings surprises. One channel of the information network is through board members. A connected local population predicts more board members from that same country, and significantly higher returns for those firms that exploit connected board members in their trade decisions. Closed for comment; 0 Comments.
- 15 Aug 2012
- Working Paper Summaries
Legislating Stock Prices
This paper examines the importance of firms' relationships with their legal and political environment, and the actors who form this environment. Governments pass laws that affect firms' competitive landscape, products, labor force, and capital, both directly and indirectly. And yet, it remains difficult to determine which firms any given piece of legislation will affect, and how it will affect them. By observing the actions of legislators whose constituents are the affected firms, the authors gather insights into the likely impact of government legislation on firms. Specifically, the authors demonstrate that legislation has a simple yet previously undetected impact on firm prices. Key concepts include: The measurement of which firms are materially impacted by a given bill is the crux of this paper. Focusing attention on the legislators who have the largest vested interests in firms affected by a given piece of legislation gives a powerful lens into the impact of that legislation on the firms in question. Legislators who have a direct interest in firms often vote quite differently than other, uninterested legislators on legislation that impacts the firms in question. A long-short portfolio based on these legislators' views earns abnormal returns of over 90 basis points per month following the passage of legislation. These returns show no run-up prior to bill passage and no announcement effect directly at bill passage. The returns continue to accrue past the month following passage. The more complex the legislation, the more difficulty the market has in assessing the impact of these bills. The effect the authors document has been becoming stronger over time. Closed for comment; 0 Comments.
- 29 Aug 2011
- Research & Ideas
Decoding Insider Information and Other Secrets of Old School Chums
Associate Professors Lauren H. Cohen and Christopher J. Malloy study how social connections affect important decisions and, ultimately, how those connections help shape the economy. Their research shows that it's possible to make better stock picks simply by knowing whether two industry players went to the same college or university. What's more, knowing whether two congressional members share an alma mater can help predict the outcome of pending legislation on the Senate floor. Open for comment; 0 Comments.
- 09 Dec 2010
- Working Paper Summaries
Friends in High Places
Research supports the old adage that says it's not what you know; it's whom you know--especially when it comes to the voting behavior of US politicians. In a National Bureau of Economic Research working paper, Harvard Business School professors Lauren Cohen and Christopher Malloy study the congressional voting record from 1989 to 2008. They show that personal connections among Congress members reliably affect how they will vote on pending legislation. Key concepts include: US senators are more likely to vote in favor of bills when other senators who graduated from the same university also vote in favor of these bills. Social ties between Congress members and executives of firms in their home states have a direct impact on legislator behavior. Senate voting behavior also is affected by who sits near whom on the Senate chamber floor. Closed for comment; 0 Comments.
- 08 Dec 2010
- Working Paper Summaries
Decoding Inside Information
Price setters and regulators face a difficult challenge in trying to understand the stock trading activity of corporate insiders, especially when it comes to figuring out whether the activity is a good indicator of the firm's financial future. This National Bureau of Economic Research paper discusses how to distinguish "routine" trades (which predict virtually no information about a firm's financial future) from "opportunistic" trades (which contain a great deal of predictive power). Research was conducted by Harvard Business School professors Lauren Cohen and Christopher Malloy and Lukasz Pomorski of the University of Toronto. Key concepts include: Routine traders, whose trades make up some 55 percent of insider trades (over half of the universe), are those with a pattern of placing a trade in the same calendar month for at least a few years in a row. Opportunistic traders are those insiders for whom there is no discernible pattern in the past timing of their trades. Focusing solely on opportunistic trading activity allows analysts to weed out useless signals and identify those trades that will likely predict future firm returns and events. More than half of the improvement in this predictive power comes from the superior performance of opportunistic sells relative to routine sells. Closed for comment; 0 Comments.
- 24 May 2010
- Research & Ideas
Stimulus Surprise: Companies Retrench When Government Spends
Research from Harvard Business School suggests that federal spending in states appears to cause local businesses to cut back rather than grow. A conversation with Joshua Coval. Closed for comment; 0 Comments.
- 19 May 2008
- Research & Ideas
Connecting School Ties and Stock Recommendations
School connections are an important yet underexplored way in which private information is revealed in prices in financial markets. As HBS professor Lauren H. Cohen and colleagues discovered, school ties between equity analysts and top management of public companies led analysts to earn returns of up to 5.4 percent on their stock recommendations. Cohen explains more in our Q&A. Closed for comment; 0 Comments.
- 20 Mar 2008
- Working Paper Summaries
Sell Side School Ties
Certain agents play key roles in revealing information into securities markets. In the equities market, security analysts are among the most important. A large part of an analyst's job (perhaps the majority) is to research, produce, and disclose reports forecasting aspects of companies' future prospects, and to translate their forecasts into stock recommendations. Therefore, isolating how, or from whom, analysts obtain the information they use to produce their recommendations is important. Do analysts gain comparative information advantages through their social networks—specifically, their educational ties with senior officers and board members of firms that they cover? This paper investigates ties between sell-side analysts and management of public firms, and the subsequent performance of their stock recommendations. Key concepts include: Equity analysts outperform on their stock recommendations when they have an educational link to that company. A simple portfolio strategy of going long the buy recommendations of analysts with school ties and going short the buy recommendations of analysts without ties earns returns of 5.40% per year in the full sample. Informal information networks are an important, yet under-emphasized channel through which private information gets revealed into prices. Closed for comment; 0 Comments.
- 12 Feb 2008
- Working Paper Summaries
The Small World of Investing: Board Connections and Mutual Fund Returns
How does information flow in security markets, and how do investors receive information? In the context of information flow, social networks allow a piece of information to flow along a network often in predictable paths. HBS professors Lauren Cohen and Christopher Malloy, along with University of Chicago colleague Andrea Frazzini, studied a type of dissemination through social networks tied to educational institutions, examining the information flow between mutual fund portfolio managers and senior officers of publicly traded companies. They then tested predictions on the portfolio allocations and returns earned by mutual fund managers on securities within and outside their networks. Key concepts include: Social networks are important for information flow between firms and investors. Across the spectrum of U.S. mutual fund portfolio managers, fund managers place larger concentrated bets on stocks they are connected to through their education network, and do significantly better on these holdings relative to non-connected holdings, and relative to connected firms they choose not to hold. A portfolio of connected stocks held by managers outperforms non-connected stocks by up to 8.4 percent per year. This connection is not driven by firm, fund, school, industry, or geographic location effects, nor by a subset of the school connections (e.g., Ivy League). The bulk of this premium occurs around corporate news events such as earnings announcements. This finding suggests that the excess return earned on connected stocks is driven by information flowing through the network. As the information will eventually be revealed into stock prices, advance knowledge implies return predictability. Closed for comment; 0 Comments.
- 07 Feb 2008
- Working Paper Summaries
Attracting Flows by Attracting Big Clients: Conflicts of Interest and Mutual Fund Portfolio Choice
Retirement assets make up a large and growing percentage of the mutual fund universe. In 2004, nearly 40 percent of all mutual fund assets were held by defined contribution plans and individual retirement accounts. This percentage is steadily increasing largely because these retirement accounts represent the majority of new flows into non-money market mutual funds. With such a large and growing percentage of their assets coming from retirement accounts, mutual funds are likely to be interested in securing these big clients. This paper examines a new channel through which mutual fund families can attract assets: by becoming a 401(k) plan's trustee. HBS professor Lauren Cohen and colleague Breno Schmidt provide evidence consistent with the trustee relationship affecting families' portfolio choice decisions. These portfolio decisions, however, have the potential to be in conflict with the fiduciary responsibility mutual funds have for their investors, and can impose potentially large costs. Key concepts include: Mutual fund families systematically distort their portfolios to attract 401(k) clients, presenting a conflict of interest. Mutual fund families that become trustees significantly overweight 401(k) sponsor firms' stock in their fund families. The trustee family performs a valuable service to the sponsor company by buying or holding its stocks around times of substantial selling of the sponsor firm by all other funds. Increased buying of sponsor firm shares by its trustee can have substantial price impact by propping up the sponsor firm's price. The overweighting can in some cases result in a large cost to the mutual fund investors. One possible remedy is to require the trustee to be independent of the mutual fund providers in the plan. This could greatly reduce the overweighting behavior currently seen by ostensibly ridding the relationship of its embedded, and unneeded, conflict of interest. Closed for comment; 0 Comments.
Playing Favorites: How Firms Prevent the Revelation of Bad News
Given the current regulatory environment in the United States (and increasingly globally) of level playing-field information laws, firms can only communicate information in public exchanges. However, even in these highly regulated venues, there are subtle choices that firms make that reveal differential amounts of information to the market. In this paper the authors explore a subtle but economically important way in which firms shape their information environments, namely through their specific organization and choreographing of earnings conference calls. The analysis rests on a simple premise: firms understand they have an information advantage and the ability to be strategic in its release. The key finding is that firms that manipulate their conference calls by calling on those analysts with the most optimistic views on the firm appear to be hiding bad news, which ultimately leaks out in the future. Specifically, the authors show that "casting" firms experience higher contemporaneous returns on the (manipulated) call in question, but negative returns in the future. These negative future returns are concentrated around future calls where they stop this casting behavior, and hence allow negative information to be revealed to the market. Key concepts include: The paper shows new evidence on a channel through which firms influence information disclosure even in level-playing-field information environments. The pattern of firms appearing to choreograph information exchanges directly prior to the revelation of negative news is systematic across the universe of firms. Closed for comment; 0 Comments.