Research articles for the 2020-01-31

A Survey of Recent Evidence on Boards of Directors and CEO Incentives
Masulis, Ronald W.
This article surveys the recent literature on boards of directors and the interplay between director incentives and CEO incentives. The primary focus is on how the incentives and other characteristics of directors, boards and CEOs interact to affect firm performance. The article reviews the recent evidence documenting a causal relationship between board independence and measures of firm performance. It also discusses the major limitations of the current measure of director independence. Finally, the article highlights how board independence provides strong incentives for CEOs to create firm value and examines the recent evidence on what other director characteristics improve board effectiveness.

Advertising Exposure and Investor Attention: Estimates from Super Bowl Commercials
Branikas, Ioannis,Buchbinder, Gabriel
Product advertising captures the attention not only of consumers but also of investors. Constructing a new measure of local investment interest on stocks from Google searches and using the Super Bowl as an experiment, we study the effects of advertising expenses on investor attention. We find that the post-game Monday attention of investors in areas with high viewership increases significantly for both local and non-local companies that air commercials. Non-local firms with high advertising exposure in a region attract more interest than local firms with low exposure, suggesting that advertising has a stronger impact on investor attention than local bias.

Challenges of Retirement Policy, Social Security Reform, and Retirement Income: A Discussion with Alicia H. Munnell, PhD
Munnell, Alicia H.,Powell, Robert,Fichtner, Jason J.,Ghilarducci, Teresa
Director of the Center for Retirement Research at Boston College, Alicia H. Munnell talked with with members of the Retirement Management Journal Editorial Advisory Board in February 2019 about the challenges of addressing retirement policy at the national level and the practical steps advisors can take to help support their clients in retirement.

Chaos and Retirement Income
Sandidge, James
When the media, academics, and politicians tout investment strategies such as indexing as universal truths without distinguishing between wealth accumulation and distribution, they promote strategies that are dangerous to retirees’ life savings. Accumulating wealth is a linear process, but taking withdrawals from a portfolio injects nonlinearity. Chaos theory, which focuses on nonlinear processes such as retirement income, is key to understanding why and how the rules of portfolio management change from pre- to post-retirement. This understanding is the basis for creating safer portfolios for retirees. Chaos theory is also the basis for making retirement income simpler and more personalized because it allows us to see what to pay attention to and what to ignore.

Disagreement About Fundamentals: Measurement and Consequences
Fischer, Paul E.,Kim, Chongho,Zhou, Frank
We propose a measure of disagreement among investors (i.e., differences of opinion as opposed to information asymmetry) based on analyst earnings forecasts. Our measure relies on the notion that when analysts agree, the law of iterated expectations applies and a regression of an analyst's forecast on the previous forecast issued by another analyst should produce a slope coefficient of one. Using existing metrics reflecting belief dispersion, we provide evidence that generally validates our measure. Finally, we employ our measure to test for associations between disagreement and expected returns predicted by antecedent theoretical studies, which suggest that disagreement can influence expected returns by altering investor perceptions of uncertainty. Consistent with disagreement increasing perceptions of priced uncertainty on average, we document a positive association between disagreement and expected returns.

Do Controlling Shareholders Matter for the Conditions of Bank Loans? Evidence From Spain
Alvarez-Botas, Celia,Fernandez, Carlos,González, Víctor M.
This paper analyses the influence of large controlling shareholders on the terms of bank loans for a sample of 984 loans to 261 nonfinancial Spanish public and private firms over the period 2001-2017. The results show that the presence of large controlling shareholders increases interest rate spread and reduces loan maturity. A less evenly balanced distribution of ownership among large shareholders is associated with higher loan spreads. During the crisis, non-financial Spanish firms obtained worse conditions on bank loans, as loan spread increased and maturity decreased. Furthermore, the maturity of bank loans was found to be positively related to the presence of families as large controlling shareholders during the financial crisis, reflecting that these shareholders reduced the agency costs of debt.

Do Tax Incentives Reduce Investment Quality?
Eichfelder, Sebastian,Jacob, Martin,Schneider, Kerstin
This paper examines the effect of tax incentives in the form of bonus depreciation on the quality of investment. Using the expiration of tax incentives via bonus depreciation in East Germany and a representative panel of West German establishments, we show that bonus depreciation significantly lowers the quality of investment. The average quality of investments, measured by the responsiveness of future sales to current investment, reduces by 22.6â€"34.6%. This adverse effect of tax subsidies is greater for jurisdictions with higher tax rates as well as for large or high-productivity firms. Overall, while increasing investment quantity, as shown by prior literature, tax incentives such as bonus depreciation substantially reduce the quality of investments.

Economic Value Added and Traditional Accounting Measures for Shareholder's Wealth Creation
Panigrahi, Shrikant
This paper investigated performance measurement tools and shareholder’s wealth relationships in the context of Malaysian public listed construction companies. Conventional measures are still utilized by many Malaysian listed companies even though it has been criticized by many researchers. Both traditional accounting measures and economic measures fail to reflect a company’s true value due to the lack of long-term sustainability of a business. The study used panel data analysis techniques, particularly Error Correction Models (ECM) to test the relationship of error terms and panel Ordinary Least Square (OLS) regression to test the hypothesis. Panel data comprised of 280 observations over the period of 2003-2012 indicates that shareholder value is a function of performance measures. The results conclusively support the claims made by previous studies on the role of earnings per share, economic value added (EVA) and dividend payout ratio; and further support the potential usefulness of the performance metric for internal and external performance. Furthermore, market value added (MVA) is found to have a negative relationship with created shareholder value (CSV) contradicting with the theory that confirmed, the increase in shareholder value when there is an increase in stock market value and efficiency.

Financial Inclusion Research Around the World: A Review
Ozili, Peterson K
This paper provides a comprehensive review of the recent evidence on financial inclusion from all regions of the World. It identifies the emerging themes in the financial inclusion literature as well as some controversy in policy circles regarding financial inclusion. In particular, I draw attention to some issues such as optimal financial inclusion, extreme financial inclusion, how financial inclusion can transmit systemic risk to the formal financial sector, and whether financial inclusion and exclusion are pro-cyclical with changes in the economic cycle. The key findings in this review indicate that financial inclusion affects, and is influenced by, the level of financial innovation, poverty levels, the stability of the financial sector, the state of the economy, financial literacy, and regulatory frameworks which differ across countries. Finally, the issues discussed in this paper opens up several avenues for future research.

Flirting With Disasters: Do Firms Financially Plan Ahead for Disasters?
Gill, Balbinder Singh
There are two types of disasters: natural (Acts of God) and technological (human-caused) disasters. I investigate whether and under which conditions firms are hoarding precautionary cash holdings to address natural disaster risk, technological disaster risk or both. The empirical analysis requires me to introduce a novel multidimensional risk measure for each type of disaster as early warning sign for possible future disaster strikes. Using these measures, I provide evidence that firms do not trade-off between these two types of disasters in determining their cash policy. Firms prioritize the preparedness of possible natural disaster strikes above possible technological accidents. The natural disaster related precautionary cash holdings hoarding policy is a long-term policy option that is funded by using external financing and focused on a few disaster types such as wildfires and landslides. Firms address only technological disaster risk by precautionary hoarding cash holdings when they are less internal financially constrained or in smaller countries by surface area.

Frequency-Domain Information for Active Portfolio Management
Faria, Gonçalo,Verona, Fabio
We assess the benefits of using frequency-domain information for active portfolio management. To do so, we forecast the bond risk premium and equity risk premium using a methodology that isolates frequencies (of the predictors) with the highest predictive power. The resulting forecasts are more accurate than those of traditional forecasting methods for both asset classes. When used in the context of active portfolio management, the forecasts based on frequency-domain information lead to better portfolio performances than when using the original time series of the predictors. It produces higher information ratio (0.57 vs 0.45), higher CER gains (1.12% vs 0.81%), and lower maximum drawdown (19.1% vs 19.6%).

Hedging Against Inflation Risk with Real Annuities
Cotton, Dirk,Bodie, Zvi
The only retirement contract that both insures against longevity risk and hedges against inflation is a life annuity that is linked to the consumer price index (CPI). It is denominated in the same units of account as Social Security benefits and, unlike nominal annuities, its payments can be directly added to those benefits. The comparison of CPI-adjusted and nominal annuities often is incorrectly framed, using the nominal annuity as the baseline and interpreting the difference in initial payments as the “cost of insuring against inflation.” We show that the correct framing of the analysis is to consider the CPI-adjusted annuity as the baseline and then to consider the additional income that might be generated by exposing the annuitant to inflation risk. We explain the flaws in comparing initial payments of the two types of annuities, note that CPI-adjusted annuities can hedge inflation rather than insure against it, and show that purchasing a nominal annuity is a speculative bet on future inflation rates.

Insider Trading With Different Risk Attitudes
Daher, Wassim,Aydilek, Harun,Saleeby, Elias G.
This paper examines the impact of different risk attitudes on the financial decisions of two insiders trading in the stock market. We consider a static version of the Kyle (1985) model with two insiders. Insider 1 is risk neutral while insider 2 is risk averse with negative exponential utility. First, we analytically prove the existence of a unique linear equilibrium. Second, we carry out a comparative static analysis with respect to the duopoly case of risk-neutral insiders (Tighe (1989)) and with respect to the duopoly case of risk-averse insiders (Holden and Subrahmanyam (1994)) models. Our findings reveal that the market depth and the information revelation are higher in Tighe (1989) than in our model. However, compared to Holden and Subrahmanyam (1994), we find that the market depth depends crucially on the degree of risk aversion. Finally, we show that regardless of the degree of risk aversion, the stock price reveals more information in our model than the stock price in Holden and Subrahmanyam (1994).

Internet Appendix to: 'Industrial Policy and Asset Prices: Stock Market Reactions to Made In China 2025 Policy Announcements'
Liu, Xia (Summer),Megginson, William L.,Xia, Junjie
This appendix provides the complete list of sample firms and the robustness checks results discussed in the paper, Industrial Policy and Asset Prices: Stock Market Reactions to Made In China 2025 Policy Announcements, found here:

Introducere în analiza anomaliilor calendaristice, Partea a doua (An Introduction to the Analysis of the Calendar Anomalies, Part 2)
Stefanescu, Razvan,Dumitriu, Ramona
Romanian Abstract: Această lucrare abordează câteva metode simple de identificare a anomaliilor calendaristice. Luând ca exemplu Efectul TOY, vom arăta cum pot fi aplicate testele t sau regresiile OLS pentru a detecta o componentă sezonieră a evoluţiei randamentelor activelor financiare.English Abstract: This paper approaches some simple methods for the calendar anomalies identification. Taking the TOY Effect as an example, we show how the t tests or the OLS regressions could be used to detect a seasonal component of the financial assets’ returns.

La eficiencia bancaria durante la crisis financiera en la Unión Europea (Bank Efficiency during the Financial Crisis in the European Union)
Ferreras, Adrián,Tascón, Maria T.,Castro, Paula
Spanish Abstract: Durante los últimos años, los bancos europeos se han enfrentado a una crisis financiera y a importantes cambios regulatorios que, en muchos casos, han puesto en peligro su viabilidad. En dicho contexto, resulta de interés evaluar el desempeño de estos bancos a través de su eficiencia. Este trabajo analiza la evolución de la eficiencia técnica de las entidades financieras de los 28 países de la Unión Europea entre 2005 y 2013, así como sus factores determinantes y la existencia de convergencia en las puntuaciones de eficiencia estimadas. Para ello, se emplea el Análisis Envolvente de Datos (DEA) y se estiman una serie de regresiones por Mínimos Cuadrados Ordinarios (MCO). Los resultados indican que la crisis redujo en gran medida la eficiencia de la banca europea, aunque esta se recuperó con relativa rapidez. Así mismo, los resultados sugieren que durante la crisis las entidades habrían sacrificado parte de su eficiencia para mantener sus niveles de capitalización, aunque estos resultados varían entre los países de Europa Occidental y Oriental. Por último, se constata la existencia de convergencia en la eficiencia de las entidades europeas.English Abstract: During the last years, European banks have faced a financial crisis and subsequent relevant regulatory changes that, in many cases, have challenged their viability. In that setting, it is worth assessing the banks’ performance through their efficiency. This work analyzes the evolution of the technical efficiency of financial firms in the 28 countries of the European Union between 2005 and 2013, as well as some efficiency drivers and the convergence pattern of the efficiency scores obtained in the period. Using Data Envelopment Analysis (DEA) and Ordinary Least Squares (OLS), the results indicate that the crisis negatively affected the European bank efficiency to a great extent, although its efficiency recovered relatively quickly. In addition, the results suggest that during the crisis some efficiency seems to be sacrificed and traded off to maintain previous capitalization levels, with different incidence on Eastern and Western European countries. Finally, we evidence a convergence pattern in the European banking efficiency.

Le Pont de Londres: Interactions Between Monetary and Prudential Policies in Cross-Border Lending
Bussière, Matthieu,Hills, Robert,Lloyd, Simon,Meunier, Baptiste,Pedrono, Justine,Reinhardt, Dennis,Sowerbutts, Rhiannon
We examine how euro area (EA) monetary policy and recipient-country prudential policy interact to influence cross-border lending of French banks. We find that monetary spillovers via cross-border lending can be partially offset by prudential measures in receiving countries. We then explore heterogeneities, specifically by bank size and location of the affiliate (French HQ vs. affiliates based in the UK). We find that the response of lending from French HQ to EA monetary policy is less sensitive to recipient-country prudential policy for systemic banks (GSIBs) than for non-GSIBs’. In contrast, the response of lending from GSIBs’ affiliates in the UK is sensitive to recipient-country prudential policy. French GSIBs’ cross-border lending from French HQ responds differently than lending from international financial centres. We also find evidence that French GSIBs channel funds towards the UK in response to EA monetary policy, in a manner dampened by global prudential policy setting. These findings suggest the existence of a ‘London Bridge’: conditional on EA monetary policy, French GSIBs adjust their funds in the UK depending on global prudential policies and, from there, lend to third-party countries according to local prudential policies. Finally, we have similar findings for all EA-owned banks UK affiliates, suggesting a broader relevance for the London Bridge.

Managing Longevity Risk: The Case for Longevity-Indexed Variable Expiration Bonds
Muralidhar, Arun
There is an annuity puzzle in that the actual allocation by individuals to annuities is low. Longevity bonds, to hedge overall economy-wide mortality risk, have been proposed, but these bonds have challenges and the proponents have not shown how governments are hedged. This paper recommends that governments should create Longevity-Indexed Variable Expiration (LIVE) bonds instead. These cohort-specific bonds, targeted to individuals (and institutions) would pay income only, and they would start paying only after the average life expectancy of that cohort. Payments will be based on tax collections of that cohort, ensuring the government is fully hedged, and therefore a natural, low credit risk, issuer. Another innovation covers the life expectancy of those whose lives are shorter than the average, so only those individuals who live beyond the average (usually wealthier portions of the population) and with high risk of outliving their resources need to purchase LIVE bonds. LIVE bonds benefit individuals who want a low-cost and liquid longevity hedge with the ability to bequeath balances on death. This paper also briefly discusses the portfolio strategies of those living beyond average life expectancy and how governments can ensure that they have sufficient funds to bear this risk.

Pre-Merger Integration Planning - Antitrust Law in the Context of Strategic Transactions with Competitors
Obersteiner, Thomas
Thorough planning is key to a successful merger. When competitors want to merge, they often have to go through lengthy merger review proceedings, during which antitrust rules restrict their ability to engage in efficient joint planning. New guidelines by competition authorities recognize the need for early integration planning and explain how companies can launch joint planning prior to regulatory approval. With the right safeguards in place, companies can develop a ready-to-execute implementation plan while they try to convince the regulators to approve the deal.

Sequence of Returns Risk Reconsidered
Collins, Patrick J.,Stampfli, Josh
In the process of evaluating various retirement income strategies, it appears that, for investors not endowed with substantial wealth relative to consumption demands, sequence of returns risk is operative throughout retirement. We explore, in an asset-liability modeling context, the reasons why sequence risk exists throughout the planning horizon and why it can be particularly acute at the end of an investor’s life span. Given the nature of this risk, prudent asset management benefits from developing appropriate risk metrics, and from implementing credible monitoring, evaluation, and communication procedures. Two case studies focus on sequence of returns risk. They present risk metrics designed to answer the following questions: (1) is the investor’s retirement income strategy feasible; (2) if yes, is it sustainable; and (3) does it allow sufficient flexibility to provide security in the face of financial shocks? The risk metrics employ information derived from both investment simulation models and actuarial calculations.

The Performance of Diverse Teams: Evidence from U.S. Mutual Funds
Evans, Richard B.,Prado, Melissa Porras,Rizzo, Antonino Emanuele,Zambrana, Rafael
We use the U.S. mutual fund industry to study the relation between team diversity and performance. Focusing on diversity concerning political ideology, we find that diverse portfolio manager teams outperform homogeneous teams and have a higher active share, and tracking error. These results are robust to controlling for manager and family fixed effects, as well as other dimensions of diversity, manager political connections, and incentives. We also find that political polarization has a strong limiting effect of diversity on performance, consistent with a reversal of the benefits of diversified perspectives when external forces negatively affect team trust and cooperation. In assessing possible mechanisms for the observed outperformance, we find evidence consistent both with improved decision-making due to the increased variety of perspectives, as well as increased monitoring by heterogeneous team members. Lastly, in exploring why diverse teams are not more prevalent in the industry, we find that entrenched managers prefer homogeneous teams and that local labor markets are constrained in their supply of ideologically diverse managers.

The Quadratic Rough Heston Model and the Joint S&P 500/VIX Smile Calibration Problem
Gatheral, Jim,Jusselin, Paul,Rosenbaum, Mathieu
Fitting simultaneously SPX and VIX smiles is known to be one of the most challenging problems in volatility modeling. A long-standing conjecture due to Julien Guyon is that it may not be possible to calibrate jointly these two quantities with a model with continuous sample-paths. We present the quadratic rough Heston model as a counterexample to this conjecture. The key idea is the combination of rough volatility together with a price-feedback (Zumbach) effect.