Research articles for the 2019-11-02

Board Structure, Director Expertise, and Advisory Role of Outside Directors
Chen, Sheng‐Syan,Chen, Yan-Shing,Kang , Jun-Koo ,Peng, Shu-Cing
We investigate how a shock to corporate demand for experienced directors (i.e., U.S. Congress’ grant of Permanent Normal Trade Relations status to China in 2000) affects U.S. firms’ board structure and board advisory role. We find that firms appoint more outside directors with China-related experience after the grant. Firms with such directors realize higher returns around announcements of investments involving Chinese firms and better post-deal operating performance, particularly when these directors reside in the U.S. The appointment of directors with China experience is also greeted more positively by the stock market and they gain more board seats after the grant.

Can Active Fund Managers Be Replaced with Exchange Traded Funds?
Haber, Jeffry
There is a long-standing debate about whether active investment management can outperform a passive benchmark, usually expressed as an index. The debate is usually considered on the manager-level, comparing the active management return of a particular manager against an appropriate index. This paper looks at the topic on a portfolio level. Using the average asset allocation of a large, private foundation, this paper replaces managers with exchange traded funds that invest in a similar strategy. For 2017 the average portfolio return of the average, large private foundation (the actively managed portfolio) produced an average return of 14.3% compared to the portfolio comprised of exchange traded funds (the passively managed portfolio) produced a return of 11.9%. The active portfolio outperformed the exchange traded fund portfolio across every broad asset class.

Can Security Design Solve Household Reluctance to Take Risk?
Calvet, Laurent E.,Celerier, Claire,Sodini, Paolo,Vallee, Boris
Using a comprehensive administrative panel of Swedish households, we show how the introduction of capital protected investments and their broad adoption lead to a significant increase in exposure to stock markets for a large share of the population. This effect is significantly more pronounced for households exhibiting a high reluctance to take financial risk before innovation. To rationalize our empirical findings, we develop a lifecycle model and confront a set of utility functions to the data. We find that first order risk aversion with narrow framing (Barberis and Huang 2009) can explain both the increase in the risky share and the heterogeneity we empirically observe. Our results illustrate how security design can mitigate household reluctance to take financial risk.

Do Cash Windfalls Affect Wages? Evidence from R&D Grants to Small Firms
Howell, Sabrina,Brown, J. David
This paper examines how employee earnings among small firms respond to a cash flow shock, which takes the form of a government R&D grant. Applicant firms are linked to IRS W2 earnings and other U.S. Census Bureau datasets. In a regression discontinuity design based on private ranking data, we find that the grant increases average earnings with a rent-sharing elasticity of about 0.21. The effect is only observed for incumbent employees who were present at the firm before the award. Among incumbent employees, the effect is strongly increasing in worker tenure. The grant increases within-firm wage inequality, in part because new hires earn less than the firm average. The grant also leads to higher employment and revenue, but a growth channel cannot fully explain the effect on earnings. Various mechanisms may explain the results, but the data are especially consistent with a backloaded wage contract channel, in which employees of a financially constrained firm initially accept low wages and are paid more when cash is available.

Evidence on the Troubled Assets Relief Program, Bailout Size, Returns and Tail Risk
Ncube, Mthuli,Hausken, Kjell
The US government launched the Troubled Assets Relief Program (TARP) in mid-September 2008. This article analyzes the market response to the TARP launch. We reject the null hypothesis that the bailout size has no effect on the firm’s value. Banks receiving large bailouts endure significantly larger stock price declines than banks receiving small bailouts. The average buy-and-hold return from 2008 Q4 to 2009 Q1 is 42.68% for the 293 sampled banks. Bailout banks perform 5.8% worse than non-bailout banks. The banks’ losses increase significantly from the pre-TARP period to TARP initiation period, suggesting greater tail risk from 2008 Q4 to 2009 Q1. Bailout banks contribute much more to the overall systematic risk than nonbailout banks. TARP helped restore investors’ confidence, and closed December 19, 2014 with $15.3 billion profit. Finally some causal effects of bank bailouts are considered.

Financial Tools and Business Growth: Evidence from Valle De México
García Pérez, Sara Lilia,García Pérez, Alejandra,Delgadillo Gómez, Patricia,Ruiz Reynoso, Adriana Mercedes
In México, micro, small and medium-sized enterprises (MSMEs) represenet 99.80% of economic units and employ 74% of the population. However, the percentage of gross production is just 35.90%. This implies that, despite their strong presence in the indicators of economic units and jobs generated, their assets are limited and there are insufficient financial resources or inadequate financial management. This study was performed in the Valle de México metropolitan area, which covers the two federative entities with the highest number of economic units, population and gross domestic product. We examine a sample firms of MSMEs in the metropolitan area to apply financial tools and identify the effect on growth and its economic-financial situation. The research was qualitative and includes six sample firms of different MSMEs which were analyzed through three stages: diagnosis, proposal and implementation of financial tools and evaluation. Data was obtained through in-depth interviews, six-month observations and analysis of financial information. Each case study showed a different situation. In most situations favorable results were obtained in administrative control yet, the growth was still not observed in most MSMEs.

Improving Analyst Target Price Performance Through Enhanced Valuation Techniques
Li, Yanfu
This study focuses on the target price issue, it aims to improve the reliability of target price through the enhanced valuation techniques. Firstly, this study improves the target price reliability by enhancing the discount rate estimation method. Secondly, the concept of industry-specific combined valuation approach has been introduced by this study, this new concept not only takes advantage of the benefit from the combination of absolute and relative model, but also consistent with the distinguishing features of different industries. Thirdly, this study presents an enhanced target price setting method to improve the target price reliability, this method provides effective solutions to the common but unsolved question about how to combine a range of value estimates. Finally, a reliability testing method has been introduced by this study to measure the performance of value estimate and target price.

Public Audit Oversight and Reporting Credibility: Evidence from the PCAOB Audit Inspection Regime
Gipper, Brandon,Leuz, Christian,Maffett, Mark G.
This paper studies the impact of public audit oversight on financial reporting credibility. We analyze changes in market responses to earnings news after public audit oversight is introduced, exploiting that the regime onset depends on fiscal-year ends, auditors, and the roll-out of auditor inspections. We find that investors respond more strongly to earnings news following public audit oversight. Corroborating these findings, we find an increase in volume responses to 10-K filings after the new regime. Our results show that public audit oversight can enhance reporting credibility and that this credibility is priced in capital markets.

Structural Breaks in Online Investor Sentiment: A Note on the Nonstationarity of Financial Chatter
Ballinari, Daniele,Behrendt, Simon
Given the increasing interest in investor sentiment derived from social media platforms, we address one overlooked question - are there structural breaks in online investor sentiment? We cast the problem of break-point estimation in the dynamics of the sentiment series as a model selection problem. Considering 360 stocks, we detect structural breaks in most of the respective online investor sentiment series. A return prediction exercise illustrates the economic significance of the detected structural breaks. Our results call into question the widespread practice of using online investor sentiment series without taking into account the nonstationarity induced by structural breaks.

When and Why Do Stock and Bond Markets Predict Economic Growth?
McMillan, David G.
We consider whether key financial variables predict macroeconomic series and if any predictive power for output growth is also seen in consumption or investment growth. Such information will allow the use of financial markets as a leading indicator for macroeconomic performance. Full sample results suggest that aggregate stock returns and the 10-year minus 3-month term structure exhibit a positive and significant predictive effect on subsequent output, consumption and investment growth. Additionally, the change in the 3-month Treasury bill has predictive power for output and investment growth. Sub-sample analysis reveals that while the term structure exhibits relatively constant predictive power that arising from stock returns largely only occurs during the great moderation period, whereas for the change in the short-term rate it largely arises in the period following the financial crisis. Results also reveal similarity in the predictive relations for output growth and investment growth but less so for consumption growth. We extend the analysis to include commodity, housing and the corporate bond markets. Full sample results reveal limited additional predictive ability, while the REIT returns do provide positive predictive power for output and investment growth over a one-quarter horizon, with the default return doing likewise at the four-quarter horizon. Notably, sub-sample results reveal a change in the sign of the predictive coefficient around the dotcom bubble and crash period.