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Research | Recent Publications

January-March 2012

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  • When do high stock returns trigger equity issues?

    Altı, Aydoğan; Sulaeman, Johan

    Journal of Financial Economics, Jan 2012, Vol. 103 Issue 1, p61-87

    One of the most prominent stylized facts in corporate finance is that equity issues tend to follow periods of high stock returns. We document that firms exhibit such timing behavior only in response to high returns that coincide with strong institutional investor demand. When not accompanied by institutional purchases, stock price increases have little impact on the likelihood of equity issuance. The results highlight the importance of market reception for the timing of equity issues.
  • External Networking and Internal Firm Governance

    Fracassi, Cesare; Tate, Geoffrey

    Journal of Finance, Feb 2012, Vol. 67 Issue 1, p153-194

    We use panel data on S&P 1500 companies to identify external network connections between directors and CEOs. We find that firms with more powerful CEOs are more likely to appoint directors with ties to the CEO. Using changes in board composition due to director death and retirement for identification, we find that CEO-director ties reduce firm value, particularly in the absence of other governance mechanisms to substitute for board oversight. Moreover, firms with more CEO-director ties engage in more value-destroying acquisitions. Overall, our results suggest that network ties with the CEO weaken the intensity of board monitoring.
  • Enterprise Risk Management Through Strategic Allocation of Capital

    Ai, Jing; Brockett, Patrick L.; Cooper, William W.; Golden, Linda L.

    Journal of Risk & Insurance, Mar 2012, Vol. 79 Issue 1, p29-56

    This paper presents a conceptual framework for operationalizing strategic enterprise risk management (ERM) in a general firm. We employ a risk-constrained optimization approach to study the capital allocation decisions under ERM: Given the decision maker’s risk appetite, the problem of holistically managing enterprise-wide hazard, financial, operational, and real project risks is treated by maximizing the expected total return on capital, while trading off risks simultaneously in Value-at-Risk type of constraints. This approach explicitly quantifies the concepts of risk appetite and risk prioritization, in light of the firm’s default and financial distress avoidance reflected in its target credit rating. Our framework also allows the firm to consider a multi-period planning horizon so that changing business environments can be accounted for. We illustrate the implementation of the framework through a numerical example. As an initial conceptual advancement, our formulation is capable of facilitating more general ERM modeling within a consistent strategic framework, where idiosyncratic variations of firms and different modeling assumptions can be accommodated. Managerial implications are also discussed.
  • Multiechelon Procurement and Distribution Policies for Traded Commodities

    Goel, Ankur; Gutierrez, Genaro J.

    Management Science, Dec 2011, Vol. 57 Issue 12, p2228-2244

    We consider a firm that procures and distributes a commodity from spot and forward markets under randomly fluctuating prices; the commodity is distributed downstream to a set of nonhomogeneous retailers to satisfy random demand. We formulate a model that allows one to compute approximate, but near optimal, procurement and distribution policies for this system, and we explore the value of the commodity’s market in providing managers with (a) additional flexibility in procurement and (b) information on price dynamics generated through the trading of futures contracts. Our results indicate that the presence of the commodity market and the information that it conveys may lead to significant reductions in inventory-related costs; however, to obtain these benefits, both the spot procurement flexibility and the term structure of prices generated by the commodity market must be incorporated in the formulation of the operating policy. Managerial insights on the procurement strategy as a function of variability in prices and demand are also discussed.
  • How long must a firm be great to rule out chance? Benchmarking sustained superior performance without being fooled by randomness

    Henderson, Andrew D.; Raynor, Michael E.; Ahmed, Mumtaz

    Strategic Management Journal, Apr 2012, Vol. 33 Issue 4, p387-406

    Although sustained superior firm performance may arise from skillful management or other valuable, rare, and inimitable resources, it can also result from randomness. Studying U.S. companies from 1965–2008, we benchmark how long a firm must perform at a high level to be confident that it is something other than the outcome of a time-homogeneous stationary Markov chain defined on the state space of percentiles. We find (a) the number of sustained superior performers in Compustat, measured by ROA and Tobin's q, exceeds the number of false positives we would expect to be generated by such a process; yet (b) the occurrence of false positives is often enough to fool many observers, so (c) the identification of sustained superior performers requires particularly stringent benchmarks to enable valid study.
  • The role of aesthetic taste in consumer behavior

    Hoyer, Wayne; Stokburger-Sauer, Nicola

    Journal of the Academy of Marketing Science, Jan 2012, Vol. 40 Issue 1, p167-180

    In light of the increasing interest in hedonic aspects of consumer behavior, it is clear that consumer taste plays a critical role in judgment and decision making, particularly for hedonic products and services. At the present time, however, our understanding of consumer aesthetic taste and its specific role for consumer behavior is limited. In this article, we review the literature from a variety of fields such as sociology, psychology, philosophy, and consumer behavior in order to develop a conceptual definition of consumer aesthetic taste. We then explore various issues related to taste and develop a conceptual framework for the relevance of expertise vs. taste in consumer decision-making. Finally, we present an agenda for future research on this important topic.
  • Understanding Money-Back Guarantees: Cognitive, Affective, and Behavioral Outcomes

    Suwelack, Thomas; Hogreve, Jens; Hoyer, Wayne D.

    Journal of Retailing, Dec 2011, Vol. 87 Issue 4, p462-478

    Although money-back guarantees (MBGs) have a long tradition in marketing and retailing practice, a deeper understanding of how consumers value this instrument is still lacking. The results of two experimental studies show that in addition to cognitive effects, MBGs evoke a positive emotional response, thereby increasing consumers’ purchase intentions and willingness to pay a price premium. Moreover, MBGs positively affect consumers’ responses for search and experience goods, although for experience goods, MBGs should be designed with stricter return conditions as compared to MBGs for search goods. The results should help retail managers understand the consumer impact of MBGs, as well as assist them in pricing guaranteed items and designing effective MBGs according to the type of product.
  • Managing capacity flexibility in make-to-order production environments

    Tanrisever, Fehmi; Morrice, Douglas; Morton, David

    European Journal of Operational Research, Jan 2012, Vol. 216 Issue 2, p334-345

    This paper addresses the problem of managing flexible production capacity in a make-to-order (MTO) manufacturing environment. We present a multi-period capacity management model where we distinguish between process flexibility (the ability to produce multiple products on multiple production lines) and operational flexibility (the ability to dynamically change capacity allocations among different product families over time). For operational flexibility, we consider two polices: a fixed allocation policy where the capacity allocations are fixed throughout the planning horizon and a dynamic allocation policy where the capacity allocations change from period to period. The former approach is modeled as a single-stage stochastic program and solved using a cutting-plane method. The latter approach is modeled as a multi-stage stochastic program and a sampling-based decomposition method is presented to identify a feasible policy and assess the quality of that policy. A computational experiment quantifies the benefits of operational flexibility and demonstrates that it is most beneficial when the demand and capacity are well-balanced and the demand variability is high. Additionally, our results reveal that myopic operating policies may lead a firm to adopt more process flexibility and form denser flexibility configuration chains. That is, process flexibility may be over-valued in the literature since it is assumed that a firm will operate optimally after the process flexibility decision. We also show that the value of process flexibility increases with the number of periods in the planning horizon if an optimal operating policy is employed. This result is reversed if a myopic allocation policy is adopted instead.
  • Diversification of fuel costs accounting for load variation

    Ruangpattana, Suriya; Preckel, Paul V.; Gotham, Douglas J.; Muthuraman, Kumar; Velástegui, Marco; Morin, Thomas L.; Uhan, Nelson A.

    Energy Policy, Mar 2012, Vol. 42, p400-408

    A practical mathematical programming model for the strategic fuel diversification problem is presented. The model is designed to consider the tradeoffs between the expected costs of investments in capacity, operating and maintenance costs, average fuel costs, and the variability of fuel costs. In addition, the model is designed to take the load curve into account at a high degree of resolution, while keeping the computational burden at a practical level. The model is illustrated with a case study for Indiana’s power generation system. The model reveals that an effective means of reducing the volatility of the system-level fuel costs is through the reduction of dependence on coal-fired generation with an attendant shift towards nuclear generation. Model results indicate that about a 25% reduction in the standard deviation of the generation costs can be achieved with about a 20–25% increase in average fuel costs. Scenarios that incorporate costs for carbon dioxide emissions or a moratorium on nuclear capacity additions are also presented.
  • A Balancing Act: How Organizations Pursue Consistency in Routine Functioning in the Face of Ongoing Change

    Turner, Scott F.; Rindova, Violina

    Organization Science, Jan/Feb 2012, Vol. 23 Issue 1, p24-46

    This study examines how participants in routines view and balance pressures for consistency in the face of ongoing change. We address this question through a qualitative case-based inquiry into the ostensive aspects of the core operational routine in six waste management organizations. We find that organizational members simultaneously establish and maintain two ostensive patterns—one of targeted consistency and another of flexibility in internal coordination—by leveraging artifacts and connections. Organizations, however, could not establish similar patterns among their customers, who, lacking connections with other routine participants, expected consistency and performed their part less flexibly. These observations lead us to develop a theoretical model that identifies the processes through which simultaneous ostensive patterns of consistency and flexibility are established and sustained among organizational members, as well as the challenges that arise from multiplicity of ostensive patterns among routine participants with different roles and connections. The model advances the dynamic perspective on routines by articulating how artifacts and connections support the balancing of pressures for consistency and for change in routine functioning.
  • Securitization and Real Investment in Incomplete Markets

    Gaur, Vishal; Seshadri, Sridhar; Subrahmanyam, Marti G.

    Management Science, Dec 2011, Vol. 57 Issue 12, p2180-2196

    We study the impact of financial innovations on real investment decisions within the framework of an incomplete market economy comprised of firms, investors, and an intermediary. The firms face unique investment opportunities that arise in their business operations and can be undertaken at given reservation prices. The cash flows thus generated are not spanned by the securities traded in the financial market and cannot be valued uniquely. The intermediary purchases claims against these cash flows, pools them together, and sells tranches of primary or secondary securities to the investors. We derive necessary and sufficient conditions under which projects are undertaken due to the intermediary's actions, and firms are amenable to the pool proposed by the intermediary, compared to the no-investment option or the option of forming alternative pools. We also determine the structure of the new securities created by the intermediary and identify how it exploits the arbitrage opportunities available in the market. Our results have implications for valuation of real investments, synergies among them, and their financing mechanisms. We illustrate these implications using an example of inventory decisions under random demand.
  • Regulation, "Republican Moments," and Energy Policy Reform

    Spence, David B.

    Brigham Young University Law Review, 2011, Vol. 2011 Issue 5, p1561-1623

    During the last half decade or so, energy policy reform has made its way to the top of the American policymaking agenda, driven by a groundswell of concern over environmental issues (primarily, climate change), energy security issues, and the desire for a more efficient and reliable energy delivery system. This groundswell has produced some recent policy changes, but not enough to satisfy proponents of reform, who remain frustrated with the unwillingness of Congress to pass legislation aimed at fundamentally changing the way Americans produce and consume energy. This article examines the reasons why fundamental energy policy reform has been so difficult. Part I explores the historical context to the current reform debate, beginning with the energy policy reforms enacted in the 1970s. Part II examines more closely the current logic of reform, including the reasons why Congress is considering such fundamental energy policy change now, and the menu of policy instruments under consideration. Part III examines the political logic that governs legislative action, and the contextual and issue-based reasons why the energy policy reforms under consideration are particularly difficult for Congress to enact compared with major regulatory reforms of the past. I argue here that Congress is capable of enacting regulatory reforms over the objections of well organized interests (so-called "republican moments"), but Congress is particularly ill-equipped (or disinclined) to do so when, as here: (i) the issues are technically and politically complex, making the benefits of reform (or costs of inaction) seem unclear and remote to many voters, and (ii) the costs of reform fall upon current voters while many of the benefits accrue to others. Part IV offers some brief concluding thoughts about the kinds of developments that might change the current political dynamic so as to make reform more likely.
  • The high volume return premium: Cross-country evidence

    Kaniel, Ron; Ozoguz, Arzu; Starks, Laura

    Journal of Financial Economics, Feb 2012, Vol. 103 Issue 2, p255-279

    We examine the high volume return premium across 41 different countries and find it to be a persistent phenomenon found in both developed and emerging markets. The premium is not caused by systematic differences in risk or liquidity. Using Merton’s (1987) investor recognition hypothesis as a guide, we find the magnitude of the premium is generally associated with country and firm characteristics hypothesized to affect returns subsequent to a change in a stock’s visibility. We also characterize the time series properties of the premium and consider economic trading strategies.
  • Cross-Business Information Technology Integration and Acquirer Value Creation in Corporate Mergers and Acquisitions

    Tanriverdi, Hüseyin; Uysal, Vahap Bülent

    Information Systems Research, Dec 2011, Vol. 22 Issue 4, p703-720

    This study develops and tests the idea that the cross-business information technology integration (CBITI) capability of an acquirer creates significant value for shareholders of the acquirer in mergers and acquisitions (M&A). In M&A, integrating the IT systems and IT management processes of acquirer and target could generate benefits such as (a) the consolidation of IT resources and the reduction of overall IT costs of the combined firm, (b) the development of an IT-based coordination mechanism and the realization of cross-firm business synergies, (c) the minimization of potential disruptions to business operations, and (d) greater ability to comply with relevant laws and regulations and the reduction of regulatory compliance costs. We test these ideas in a sample of 141 acquisitions conducted by 86 Fortune 1000 firms. In the short run, acquirers that have high levels of CBITI capabilities receive positive and significant cumulative abnormal returns to their M&A announcements. Announcement period returns indicate that the capital markets value CBITI similarly in same-industry and different-industry acquisitions. In the long run, acquirers with high levels of CBITI capabilities obtain significantly higher abnormal operating performance. They create significantly greater value in complementary acquisitions from different industries than in related acquisitions from the same industry. The findings have important implications for M&A research and practice.
  • Are Corporate Default Probabilities Consistent with the Static Tradeoff Theory?

    Hovakimian, Armen; Kayhan, Ayla; Titman, Sheridan

    Review of Financial Studies, Feb 2012, Vol. 25 Issue 2, p315-340

    Default probability plays a central role in the static tradeoff theory of capital structure. We directly test this theory by regressing the probability of default on proxies for costs and benefits of debt. Contrary to predictions of the theory, firms with higher bankruptcy costs, i.e., smaller firms and firms with lower asset tangibility, choose capital structures with higher bankruptcy risk. Further analysis suggests that the capital structures of smaller firms with lower asset tangibility, which tend to have less access to capital markets, are more sensitive to negative profitability and equity value shocks, making them more susceptible to bankruptcy risk.
  • Do financial analysts' long-term growth forecasts matter? Evidence from stock recommendations and career outcomes

    Jung, Boochun; Shane, Philip B.; Sunny Yang, Yanhua

    Journal of Accounting & Economics, Feb 2012, Vol. 53 Issue 1/2, p55-76

    Prior literature portrays long-term growth (LTG) forecasts as nonsensical from a valuation perspective. Instead, we hypothesize that LTG forecasts signal high effort and ability to analyze firms' long-term prospects. We document stronger market response to stock recommendation revisions of analysts who publish accompanying LTG forecasts. We also hypothesize and find that these analysts are less likely to leave the profession or move to smaller brokerage houses. Consistent with Reg. FD's intention to promote fundamental analysis of long-term earnings prospects, post-Reg. FD observations drive our results. Overall, we identify previously undocumented benefits accruing to analysts who publish LTG forecasts.
  • Do Financial Analysts Add Value by Facilitating More Effective Monitoring of Firms’ Activities?

    Jung, Boochun; Sun, Kevin Jialin; Yang, Yanhua

    Journal of Accounting, Auditing & Finance, Jan 2012, Vol. 27 Issue 1, p61-99

    Researchers argue that analysts’ information acquisition efforts increase firm value by facilitating monitoring of firms' activities and, thereby, reducing agency costs (e.g., Jensen and Meckling [1976]; Healy and Palepu [2001]). However, prior research provides limited and inconclusive empirical evidence to support this argument. This paper extends the literature by: examining the relation between analyst following and the value of firms' equity securities; and given a positive relation, whether that relation reflects effectively enhanced monitoring of firms' activities as a result of analysts' information acquisition efforts. We document a positive relation between analyst following and firms' asset values, and we find support for two hypotheses regarding the source of the increased asset values. First, the cash component drives the positive relation between analyst following and asset values. We interpret this evidence to imply a stronger monitoring effect for assets that are subject to higher agency costs or information asymmetry. Second, consistent with analyst following constraining asset mismanagement or motivating more efficient asset use, operating performance and total cash payout increase with analyst following. Overall, our results suggest that financial analysts facilitate more effective monitoring of firms' activities and, thereby, reduce agency costs and increase shareholder value.
  • Institutional ownership and conservatism

    Ramalingegowda, Santhosh; Yu, Yong

    Journal of Accounting & Economics, Feb 2012, Vol. 53 Issue 1/2, p98-114

    Recent research suggesting that shareholders demand conservative financial reporting raises the question: Which shareholders demand conservatism? We find that higher ownership by institutions that are likely to monitor managers is associated with more conservative financial reporting. This positive association is more pronounced among firms with more growth options and higher information asymmetry, where direct monitoring is more difficult and the potential governance benefits of conservatism are greater. Further, lead-lag tests of the direction of causality suggest that ownership by monitoring institutions leads to more conservative reporting, rather than the reverse. Collectively, these results are consistent with monitoring institutions demanding conservatism.

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Research-Recent-Publications-January-March-2012