Forthcoming Articles

EPS-Sensitivity and Mergers

Sudipto Dasgupta, Jarrad Harford, and Fangyuan Ma

Announcements of mergers very often discuss the immediate impact of the deal on the acquirer’s earnings per share (EPS). We argue that the focus on EPS reflects the difficulty of evaluating and communicating deal synergy in M&A practice, and provide supporting evidence. We show that the acquirer’s EPS focus affects how deals are structured, the premium that is paid, and the types of deals that are done. EPS-driven M&A decisions are also associated with costly distortions in the acquirer’s financial and investment policies.

What Can Volatility Smiles Tell Us About the Too Big to Fail Problem?

Phong T. H. Ngo and Diego L. Puente

We exploit the information content of option prices to construct a novel measure of bank tail-risk. We document a persistent increase in tail-risk for the U.S. banking industry following the global financial crisis, except for banks designated as systemically important by the Dodd–Frank Act. We show that this post-crisis difference in tail-risk for large and small banks is consistent with the too-big-to-fail (TBTF) status of large banks being reinforced by the Dodd–Frank designation: Naming the banks whose failure could threaten the financial stability of the U.S. gave investors a list of banks the government deemed as TBTF.

Bringing Innovation to Fruition: Insights from New Trademarks

Lucile Faurel, Qin Li, Devin Shanthikumar, and Siew Hong Teoh

We build a novel comprehensive dataset of new product trademarks as an output measure of product development innovation. We show that risk-taking incentives in CEO compensation motivate this type of innovation and that this innovation improves firm performance. Using an exogenous shock to executive compensation, we find that reductions in stock option compensation cause reductions in new product development. We also find that firms undertaking new product development experience increases in future cash flow from operations and return on assets. These findings suggest the importance of product development innovation to firms and new trademarks as a novel innovation measure.

Withholding Bad News in the Face of Credit Default Swap Trading: Evidence from Stock Price Crash Risk

Jinyu Liu, Jeffrey Ng, Dragon Yongjun Tang, and Rui Zhong

Credit default swaps (CDS) are a major financial innovation related to debt contracting. Because CDS markets facilitate bad news being incorporated into equity prices via cross-market information spillover, CDS availability may curb firms’ information hoarding. We find that CDS trading on a firm’s debt reduces the future stock price crash risk. This effect is stronger in active CDS markets, when the main lenders are CDS market dealers with securities trading subsidiaries, or when managers have more motivation to hoard information. Our findings suggest that debt market financial innovations curtail the negative equity market effects of firms withholding bad news.

Capital Commitment and Performance: The Role of Mutual Fund Charges

Juan-Pedro Gomez, Melissa Prado, and Rafael Zambrana

We study how the scarcity of committed capital affects the equilibrium distribution of net alphas in the asset management industry. We propose a model of active portfolio management with different sales fee structures where committed capital is in short supply. In the model, a portfolio’s excess return is not fully appropriated by the money manager but shared with long-term investors. Empirically, we show that capital commitment allows funds to hold shares longer and take advantage of slow-moving arbitrage opportunities. Consistent with the model, funds with more committed capital generate higher value added, which, net of fees, accrues to long-term investors.

The Information in Industry-Neutral Self-Financed Trades

Yashar H. Barardehik, Zhi Da, and Mitch Warachka

We identify Industry-Neutral Self-Financed Informed Trading  (INSFIT) as stock trades financed by offsetting, equivalent dollar-denominated stock trades in the same industry. Approximately 37% of short-term mutual fund trading profits can be attributed to these trade pairs. Consistent with informed trading, INSFIT precedes unusually high media coverage for the underlying stocks. The trades underlying INSFIT are also larger as the release of stock-level news becomes more imminent. Both relative valuation and the hedging of industry exposure motivate INSFIT’s industry neutrality. While INSFIT positively impacts fund performance, active fund managers who execute INSFIT more aggressively obtain smaller trading profits per execution.

Insurance Pricing, Distortions, and Moral Hazard: Quasi-Experimental Evidence from Deposit Insurance

George F. Shoukry

Pricing is integral to insurance design, directly influencing firm behavior and moral hazard, though its effects are insufficiently understood. I study a quasi experiment in which deposit insurance premiums were changed for U.S. banks with unequal timing, generating differentials between banks in both levels and risk-based “steepness” of premiums. I find evidence that differentials in premiums resulted in distortions, including regulatory arbitrage, but also provided strong incentives to curb moral hazard. I find that firms that faced stronger pricing incentives to become (or remain) safer were more likely to subsequently do so than similar firms that faced weaker pricing incentives.

Do Classified Boards Deter Takeovers? Evidence from Merger Waves

Kose John, Dalida Kadyrzhanova, and Sangho Lee

We exploit the arrival of industry-wide synergistic merger waves to identify whether classified boards deter takeover bids. In a stylized model, we show that when target classified boards are costly to bidders, their negative effect on takeover likelihood should be more pronounced during merger waves. Using a sample of takeover bids in the United States between 1990 and 2016, we find strong evidence supporting this prediction. The results are robust to accounting for the benefits of classified boards and controlling for other antitakeover provisions. Our findings suggest that classified boards effectively reduce a firm’s exposure to the takeover market.