Silent Swing: Do Open-End Funds Tilt Holdings Valuations in Response to Flows?
(with Jaewon Choi and Ji Yeol Jimmy Oh)
– Selected Conferences: Delaware Weinberg Corporate Governance Symposium, NFA, MFA, Berlin Mutual Fund Conference
Mutual funds face risks of dilution from trading costs when investors place purchase or redemption orders. To deal with this risk, the SEC in 2018 started allowing U.S. mutual funds to change their net asset value (NAV) up or down by a prescribed amount in response to abnormally large flows-a practice known as swing pricing. However, no U.S. fund has thus far chosen to adopt this practice. This paper provides evidence that funds can employ an alternative way to change the value of their portfolios in response to flows, namely by changing the valuation of their underlying holdings. We refer to this phenomenon as "silent swing pricing," as these swings in valuations are not announced and lack transparency, but still effectively achieve the same goal. Focusing on active fixed-income funds from mid-2008 to 2022, we find that a fund's valuation gap of a particular bond relative to peer funds' valuations is positively related to that fund's same-day flows. The sensitivity of valuations to flows is greater when a fund experiences outflows than when it has inflows, and when it holds more illiquid securities. The extent of silent swing pricing is attenuated, however, by return smoothing incentives when funds have poor past performance and fragile investor base. We show this practice has persisted even after the 2018 SEC rule change.
The Role of Assets in Place: Loss of Market Exclusivity and Investment
(with Matt Higgins, Ji Min Park, and Joshua Pollet)
– Selected Conferences: WFA
– NBER Working Paper No. w27588
We utilize a novel identification strategy to analyze the impact of assets in place on firms' decisions for future projects. We exploit the context in the pharmaceutical industry, where the loss of market exclusivity for a branded drug can be used to separate the impact of cash flows generated by a firm's current assets in place from the characteristics of its future investment opportunities. We first show that around the exclusivity losses in our sample of large drugs, the affected firms' profitability drops significantly. The timing of this profitability decrease was predetermined many years ago, and therefore, arguably independent of current investment opportunities. Nevertheless, we find that R&D spending drops by approximately 25% over two years following the loss of exclusivity of these pre-existing drugs. We also find that stock repurchases and cash balances decline significantly. Our findings do not support the predictions of traditional capital budgeting, but are more consistent with the pecking order theory. These results further point to a lack of long-term lifecycle management that could mitigate the effect of predictable negative shocks to cash flows.
Growth-promoting Bonuses and Mergers and Acquisitions
(with Tor-Erik Bakke, Hamed Mahmudi, and Aazam Virani)
– Selected Conferences: AFA (scheduled), EFA, Drexel Corporate Governance Conference, ECGI Delaware Weinberg Corporate Governance Symposium
– ECGI Finance Working Paper No. 906/2023
One-third of U.S. top executives have bonus incentives that are explicitly tied to the firm’s size. We study how such “growth-promoting bonuses” influence firms’ mergers and acquisitions (M&A) activities. We find that firms with bonus structures that promote growth are more prone to make acquisitions—especially acquisitions of a scale that help meet the bonus size target. We use shocks to sales from plausibly exogenous exchange-rate changes for exporting firms to identify these effects. Acquisitions by firms with growth-promoting bonuses have significantly lower abnormal returns, destroying value for the acquirers on average. These lower acquirer returns can be attributed to the selection of targets with lower synergies and, to a lesser extent, higher premiums paid. The growth-promoting bonuses tend to be sufficiently large such that—despite negative acquirer returns—the net monetary effect for executives who meet their sales bonus targets with a merger remains significantly positive.
Misaligned Owners: A Dark Side of Insider Ownership
(with Hwanki Brian Kim)
Insider ownership can exacerbate agency problems when insiders’ interests as owners diverge from other shareholders. Using the 2012 fiscal cliff as a natural experiment (when dividend taxes were expected to rise and many firms paid special dividends), we find that higher insider ownership makes firms less responsive to other shareholders’ tax incentives. Firms with the most “misaligned” incentives—high insider ownership combined with high tax-insensitive ownership—experienced significantly more negative abnormal returns around special-dividend announcements. A parsimonious theoretical framework illustrates how higher ownership raises managers’ weight on their own after-tax payoff, strengthening incentives to accelerate payouts even when detrimental to firm value.
Does Equity-based Compensation Cause Firms to Manage Earnings Per Share?
(with Xing Gao)
– Awards: NFA Best Paper on Derivatives
– Selected Conferences: WFA, NFA
Equity-based compensation causes increases in firms' share count and dilutes Earnings Per Share (EPS), which provides firms with an incentive to raise EPS using either share buybacks or earnings management. We employ a regression discontinuity framework to provide evidence of a causal link between equity-based pay and EPS management. Our tests compare firms experiencing dilution from ``just-in-the-money'' option exercises with firms whose options end up narrowly out-of-the-money. We find that firms engage in real- and accruals-based earnings management, but not buybacks, to boost EPS around these plausibly exogenous dilutive events. These effects are stronger when executives' bonuses depend directly on EPS.
Does Shareholder Scrutiny Affect Executive Compensation? Evidence from Say-on-Pay Voting (2018)
(with Shastri Sandy)
– Featured on the Harvard Law School Forum on Corporate Governance
– Conferences: SFS Cavalcade, EFA, NFA, Young Scholars Finance Conference
We study whether shareholder scrutiny affects CEO pay. Our identification strategy exploits the fact that recent "say-on-pay" regulation allowed firms to hold votes every two or three years. Depending on their voting frequency, firms experience alternating years where scrutiny on compensation varies following a plausibly exogenous cyclical pattern. In vote-years, firms reduce salaries and golden parachutes, but compensate for these cuts by increasing less-scrutinized compensation such as pensions. Total pay is similar across vote and no-vote years, and pay-for-performance is not stronger in vote years. These results are most consistent with greater window-dressing of compensation in times when firms are subject to heightened shareholder scrutiny.
The Market Reaction to Stock Split Announcements: Earnings Information After All (2012)
(with Alon Kalay)