Does it pay to invest in art? A selection-corrected returns perspective : [draft october 15, 2013]

This paper shows the importance of correcting for sample selection when investing in illiquid assets with endogenous trading. Using a large sample of 20,538 paintings that were sold repeatedly at auction between 1972 and 2010, we find that paintings with higher price appreciation are more likely to trade. This strongly biases estimates of returns. The selection-corrected average annual index return is 6.5 percent, down from 10 percent for traditional uncorrected repeat sales regressions, and Sharpe Ratios drop from 0.24 to 0.04. From a pure financial perspective, passive index investing in paintings is not a viable investment strategy once selection bias is accounted for. Our results have important implications for other illiquid asset classes that trade endogenously

The elimination of broker voting in director elections

In 2009, the Securities and Exchange Commission (SEC) reformed shareholder voting by eliminating uninstructed broker voting in director elections. We use this reform as a quasi-natural experiment to assess the value of shareholder empowerment. Using different control groups and various cross-sectional tests, we find that the reform did not increase average equity values

Hole in the wall: informed short selling ahead of private placements

Companies planning a private placement typically gauge the interest of potential buyers before the offering is publicly announced. Regulators are concerned with this practice, called wall-crossing, as it might invite insider trading, especially when the potential investors are hedge funds. We examine privately placed common stock and convertible offerings and find evidence of widespread pre-announcement short selling. We show that pre-announcement short sellers are able to predict announcement day returns. The effects are especially strong when hedge funds are involved and when the number of buyers is high. We also observe pre-announcement trading in the options market

Why do convertible issuers simultaneously repurchase stock? An arbitrage-based explanation

We examine why firms combine convertible debt offerings with stock repurchases. In 2006, 33% of the convertible issuers in the US simultaneously repurchased stock. These combined transactions are inconsistent with traditional motivations for convertible issuance. We document that convertible arbitrage drives these stock repurchases. Convertible debt arbitrageurs simultaneously buy convertibles and short sell the issuer's common stock, resulting in downward pressure on the stock price. To prevent such short-selling activity, firms repurchase their stock directly from arbitrageurs. We show that combined transactions exhibit lower short-selling activity and that convertible arbitrage explains both the size and speed of the stock repurchases

Convertible bond announcement effects: why is Japan different?

U.S. and Japanese firms dominate global convertible bond issuance. Previous research documents more favorable convertible bond announcement effects in Japan than in the U.S. and other developed countries. Using a global sample of convertible bonds issued from 1982 to 2012, we find that the more favorable announcement effects of Japanese convertibles are driven by their stated uses of proceeds. Japanese convertibles more often include capital expenditure as an intended use, while U.S. firms tend to mention general purposes to motivate their offering. Our findings illustrate the value to firms of being more explicit when disclosing the intended use of proceeds of security offerings

The buyers’ perspective on security design: Hedge funds and convertible bond call provisions

We provide evidence that security design reflects the interplay of capital supplier and security issuer preferences. While call provisions have historically been the default option in convertible security design, only a minority of post-2005 issues are callable. Because hedge funds dominate the market for new convertibles today and because convertible arbitrage is less risky without callability, the recent diminution in the frequency of call provisions in new convertible bond issues illustrates the importance of the preferences of the suppliers of capital in security design

Empirical Essays on Debt, Equity, and Convertible Securities

This dissertation consists of four empirical studies on firms’ financing decisions. In the first two studies, we investigate the debt-equity choice for a large number of U.S. firms. We find that firms prefer debt financing over equity financing in case a debt issue allows the firm to keep its investment grade rating. When the financing requirement becomes sufficiently large, firms are more likely to choose equity financing. We find that most firms repurchase debt instead of equity in case they have excess funds. The last two studies of this dissertation deal with convertible security design. Since convertible securities combine debt and equity characteristics, the specific structure of these instruments can provide further insight into the relevant costs and benefits of debt and equity. We find that taxes, the costs of refinancing, and the costs of managerial discretion are important drivers of convertible security design. We further find that the desire to manage earnings has been responsible for recent innovations in the convertible market. Convertible arbitrage drives the innovation of combining a convertible issue with a stock repurchase: the stock repurchase serves to mitigate the negative price impact that results from the short sales of arbitrageurs

The earnings expectations game and the dispersion anomaly

This study examines the role of differences in firms’ propensity to meet earnings expectations in explaining why firms with high analyst forecast dispersion experience relatively low future stock returns. We first demonstrate that the negative relation between dispersion and returns is concentrated around earnings announcements. Next, we show that this relation disappears when we control for ex ante measures of firms’ propensity to meet earnings expectations and that the component of dispersion explained by these measures drives the return predictability of dispersion. We further demonstrate that firms with low analyst dispersion are substantially more likely to achieve positive earnings surprises and provide new evidence consistent with both expectations management and strategic forecast pessimism explaining this result. Overall, we conclude that investor mispricing of firms’ participation in the earnings-expectations game provides a viable explanation for the dispersion anomaly

The external financing of investment

This paper investigates the impact of investment characteristics on the financing choice. We investigate instances of seasoned equity, bank debt, straight non-bank debt, and convertible issues by U.S. firms where the stated use of proceeds is capital expenditure and where we are able to hand-collect and classify the characteristics of the investment. Controlling for a firm’s existing assets, capital structure and valuation, we document a strong empirical link between an investment’s characteristics and the choice between debt and equity financing. Factor analysis indicates that the principal determinant of the financing choice is whether an investment’s payoffs can be described as a hit or miss

Hole in the Wall: Informed Short Selling ahead of Private Placements

__Abstract__ Companies planning a private placement typically gauge the interest of potential buyers before the offering is publicly announced. Regulators are concerned with this practice, called wall-crossing, as it might invite insider trading, especially when the potential investors are hedge funds. We examine privately placed common stock and convertible offerings and find widespread evidence of pre-announcement short selling. We show that pre-announcement short sellers are able to predict announcement day returns. The effects are especially strong when hedge funds are involved and when the number of buyers is high