Archive for the ‘Academic Research’ Category

The Informational Role of Internet-Based Short Sellers

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday April 23, 2014 at 9:32 am
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Editor’s Note: The following post comes to us from Lei Chen of the Department of Accounting at the London School of Economics and Political Science.

Despite serious concerns about the quality of auditing and financial reporting of U.S.-listed Chinese firms, the SEC and the PCAOB have been unable to provide sufficient or timely information to U.S. investors due to resource constraints, the confidentiality rules underlying the PCAOB disciplinary proceedings, and no access to relevant work papers of Chinese auditors. In the paper, The Informational Role of Internet-Based Short Sellers, which was recently made publicly available on SSRN, I focus on a new breed of information intermediary, i.e. Internet-based short sellers that have emerged in response to such regulatory loopholes and severe information asymmetry. Based on hand-collected Internet reports released during the 2009-2012 period by short sellers that target U.S.-listed Chinese firms, I find that these short sellers provide substantial information both directly and indirectly to investors.

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The New Financial Industry

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday April 22, 2014 at 9:15 am
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Editor’s Note: The following post comes to us from Tom C.W. Lin of Temple Law School.

The recent discussions surrounding Michael Lewis’s new book, Flash Boys, revealed a profound and uncomfortable truth about modern finance to the public and policymakers: Machines are taking over Wall Street. Artificial intelligence, mathematical models, and supercomputers have replaced human intelligence, human deliberation, and human execution in many aspects of finance. The modern financial industry is becoming faster, larger, more complex, more global, more interconnected, and less human. An industry once dominated by humans has evolved into one where humans and machines share dominion.

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Has Persistence Persisted in Private Equity?

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday April 21, 2014 at 9:34 am
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Editor’s Note: The following post comes to us from Robert Harris, Professor of Finance at the University of Virginia; Tim Jenkinson, Professor of Finance at the University of Oxford; Steven N. Kaplan, Professor of Finance at the University of Chicago; and Rüdiger Stucke of Saïd Business School at the University of Oxford.

In our paper, Has Persistence Persisted in Private Equity? Evidence from Buyout and Venture Capital Funds, which was recently made publicly available on SSRN, we use detailed cash-flow data to study the persistence of buyout and VC fund performance over successive funds. We confirm the previous findings that there was significant persistence in performance, using various measures, for pre-2000 funds—particularly for VC funds. Post-2000, we find that persistence of buyout fund performance has fallen considerably. When funds are sorted by the quartile of performance of their previous funds, performance of the current fund is statistically indistinguishable regardless of quartile. At the same time, however, the returns to buyout funds in all previous performance quartiles, including the bottom, have exceeded those of public markets as measured by the S&P 500.

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Equity Overvaluation and Short Selling

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Friday April 18, 2014 at 9:02 am
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Editor’s Note: The following post comes to us from Messod Daniel Beneish, Professor of Accounting at Indiana University, Bloomington; Charles M. Lee, Professor of Accounting at Stanford University; and Craig Nichols, Assistant Professor of Accounting at Syracuse University.

In our paper, In Short Supply: Equity Overvaluation and Short Selling, which was recently made publicly available on SSRN, we use detailed equity lending data to examine the role of constraints on equity prices. We find that constrained stocks underperform, the short interest ratio (SIR) has a nonlinear association with constraints, constrained stocks have negative returns regardless of short interest ratio, high short interest yet unconstrained stocks do not underperform, yet low short interest unconstrained stocks outperform. Moreover, we show that limited supply is a key feature distinguishing constrained and unconstrained stocks, and that among constrained stocks, those with the lowest supply have the strongest negative returns. Our findings confirm that supply varies across firms (in contrast to SIR, which assumes supply is 100 percent of outstanding shares for all stocks) and short supply in the equity lending market has implications for the informational efficiency of equity prices.

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Corporate Governance According to Charles T. Munger

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Thursday April 17, 2014 at 9:07 am
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Editor’s Note: The following post comes to us from David Larcker, Professor of Accounting at Stanford University, and Brian Tayan of the Corporate Governance Research Initiative at the Stanford Graduate School of Business.

Berkshire Hathaway Vice Chairman Charlie Munger is well known as the partner of CEO Warren Buffett and also for his advocacy of “multi-disciplinary thinking”—the application of fundamental concepts from across various academic disciplines to solve complex real-world problems. One problem that Munger has addressed over the years is the optimal system of corporate governance. How should an organization be structured to encourage ethical behavior among organizational participants and motivate decision-making in the best interest of shareholders? His solution is unconventional by the standards of governance today and somewhat at odds with regulatory guidelines. However, the insights that Munger provides represent a contrast to current “best practices” and suggest the potential for alternative solutions to improve corporate performance and executive behavior. In our paper, Corporate Governance According to Charles T. Munger, which was recently made publicly available on SSRN, we examine this solution in greater detail.

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Shareholder Voting in an Age of Intermediary Capitalism

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday April 16, 2014 at 9:00 am
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Editor’s Note: The following post comes to us from Paul H. Edelman and Randall S. Thomas, Professor of Law and Mathematics and Professor of Law and Business, respectively, at Vanderbilt University, and Robert Thompson, Professor of Business Law at the Georgetown University Law Center.

Shareholder voting, once given up for dead as a vestige or ritual of little practical importance, has come roaring back as a key part of American corporate governance. Where once voting was limited to uncontested annual election of directors, it is now common to see short slate proxy contests, board declassification proposals, and “Say on Pay” votes occurring at public companies. The surge in the importance of shareholder voting has caused increased conflict between shareholders and directors, a tension well-illustrated in recent high profile voting fights in takeovers (e.g. Dell) and in the growing role for Say on Pay votes. Yet, despite the obvious importance of shareholder voting, none of the existing corporate law theories coherently justify it.

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Beyond Efficiency in Securities Regulation

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday April 15, 2014 at 9:21 am
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Editor’s Note: The following post comes to us from Yesha Yadav of Vanderbilt Law School.

In my paper, Beyond Efficiency in Securities Regulation, recently made available on SSRN, I argue that the emergence of algorithmic trading calls into question the foundation underpinning today’s securities laws: the understanding that securities prices reflect all available information in the market. Securities regulation has long looked to the Efficient Capital Markets Hypothesis (ECMH) for theoretical validation to ground its most central tenets like mandatory disclosure, the Fraud-on-the-Market presumption in Rule 10b-5 litigation, as well as the architecture of today’s system of interconnected exchanges. It is easy to understand why. Laws that make markets more informative should also make them better at communicating with investors and in allocating capital across the economy. In this paper, I suggest that this connection between informational and allocative efficiencies can no longer be so readily assumed in the age of algorithmic trading. In other words, even as algorithmic trading pushes markets to achieve ever-greater levels of informational efficiency, able to process vast swathes of data in milliseconds, understanding what this information means for the purposes of capital allocation seems ever more uncertain. Recognizing that notions of informational efficiency are growing disconnected from the market’s ability to also interpret what this information signifies for capital allocation, this paper proposes a thoroughgoing rethinking about the centrality of efficiency economics in regulatory design.

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European Court of Human Rights Shakes Insider Trading Rules

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Sunday April 13, 2014 at 9:24 am
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Editor’s Note: The following post comes to us from Guido Rossi, former Chairman of the Consob (Italian SEC), and Marco Ventoruzzo of Pennsylvania State University, Dickinson School of Law, and Bocconi University.

A recent and groundbreaking decision of the European Court of Human Rights (ECHR) in Strasburg might shatter the entire structure of the Italian and European regulation of market abuse (insider trading and market manipulations). The case is “Grand Stevens and others v. Italy”, and was decided on March 4, 2014.

The facts can be briefly summarized as follows. In 2005, the corporations that controlled the car manufacturer Fiat, renegotiated a financial contract (equity swap) with Merrill Lynch. One of the goals of the agreement was to maintain control over Fiat without being required to launch a mandatory tender offer. Consob, the Italian securities and exchange commission, initiated an administrative action against the corporation and some of its managers and consultants, accusing them of not having properly disclosed the renegotiation of the contract to the market. The procedure resulted in heavy financial fines (for some individuals, up to 5 million euro), and additional measures prohibiting some of the people involved from serving as corporate directors and practicing law. At the same time, a criminal investigation was launched for the same facts. It is not necessary here to discuss the merits of the controversy, it is sufficient to mention that the sanctioned parties challenged the sanctions in Italian courts, but did not prevail.

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Shock-Based Causal Inference in Corporate Finance

Posted by Bernard Black, Northwestern University School of Law, on Friday April 11, 2014 at 9:03 am
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Editor’s Note: Bernard Black is the Nicholas D. Chabraja Professor at Northwestern University School of Law and Kellogg School of Management. The following post is based on a paper co-authored by Professor Black and Vladimir Atanasov at the Mason School of Business, College of William and Mary.

Much corporate finance research is concerned with causation—does a change in some input cause a change in some output? Does corporate governance affect firm performance? Does capital structure affect firm investments? How do corporate acquisitions affect the value of the acquirer, or the acquirer and target together? Without a causal link, we lack a strong basis for recommending that firms change their behavior or that governments adopt specific reforms. Consider, for example, corporate governance research. Decisionmakers—corporate boards, investors, and regulators—need to know whether governance causes value, before they decide to change the governance of a firm (or all firms in a country) with the goal of increasing firm value or improving other firm or market outcomes. If researchers provide evidence only on association between governance and outcomes, decisionmakers may adopt changes based on flawed data that may lead to adverse consequences for particular firms.

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Rethinking Basic: Towards a Decision in Halliburton

Posted by Lucian Bebchuk and Allen Ferrell, Harvard Law School, on Wednesday April 9, 2014 at 9:02 am
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Editor’s Note: Lucian Bebchuk is William J. Friedman and Alicia Townsend Friedman Professor of Law, Economics, and Finance and Director of the Program on Corporate Governance, Harvard Law School. Allen Ferrell is Greenfield Professor of Securities Law, Harvard Law School. They are co-authors of Rethinking Basic, a Harvard Law School Discussion Paper that is forthcoming in the May 2014 issue of The Business Lawyer and available here.

We have recently revised our paper Rethinking Basic (discussed earlier on the Forum here). Our revision, which will be published in the May issue of the Business Lawyer, takes into account, and relates our analysis to, the Justices’ questions at the Halliburton oral argument. As our revision explains, questions asked by some of the Justices at the oral argument suggest that the fraudulent distortion approach we support might appeal to the Court.

In the Halliburton case, the United States Supreme Court is expected to reconsider the Basic ruling that, twenty-five years ago, adopted the fraud-on-the-market theory, which has since facilitated securities class action litigation. Our paper seeks to contribute to this reconsideration by providing a conceptual and economic framework for a reexamination of the Basic rule.

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