2006

PROJECTS FUNDED IN 2006

Hedge Funds Activism, Corporate Governance, and Firm Performance

Alon Brav, Duke
Wei Jiang, Columbia

With over a trillion dollars of capital at the disposal of U.S.-based hedge funds, and a quarter trillion dollars in European funds, hedge fund managers have been aggressively looking for attractive investment opportunities and, in particular, have changed the role that they play in the corporate governance of publicly traded companies. Indeed, over the last few years we have witnessed a surge in hedge fund activism, ranging from proposals or proxy contests aimed at changing companies’ payout policies, acquisition decisions, or executive compensation, to full-scale take-over bids. This new form of activism has led to a heated debate as to whether it helps or harms the economic and financial health of target companies. Some argue that activism results in higher firm productivity and growth and thus higher shareholder value. Others are concerned that hedge funds’ actions generate short run profits at the expense of long-term shareholder value. To date, there has not been an empirical study with a focus on the determinants and consequences of hedge fund activism. With this project we intend to fill this gap. We plan to hand-collect a comprehensive event-based sample from various SEC and media sources, and perform an empirical study on the causes, nature and consequences of hedge fund activism. We believe that the evidence and conclusions from this project will provide a useful benchmark for law and policy makers, institutional investors, corporate boards and managers, as well as to researchers.

This study investigates hedge fund activism. What types of companies do hedge funds target and does their activism increase or decrease corporate productivity? Since hedge funds often hold larger, more concentrated positions in securities than do mutual funds, their activism may be of greater importance than the activism of other investors.

A Tale of Two Anomalies: The Implication of Investor Attention for Price and Earnings Momentum

Kewei Hou, Ohio State
Lin Peng, Baruch College
Wei Xiong, Princeton

In this project, we examine the profitability of price and earnings momentum strategies. We find that price momentum profits are higher among high volume stocks and in up markets, while earnings momentum profits are higher among low volume stocks and in down markets. In the long run, price momentum profits are reversed, while earnings momentum profits are not. The dichotomy between price and earnings momentum is more pronounced when we orthogonalize one with respect to the other. To the extent that trading volume increases with investor attention and that investors tend to pay more attention to stocks in up markets, our results suggest a dual role for investor attention: while price underreaction to earnings news declines with investor attention, price continuation caused by investors’ overreaction rises with attention.

Price and earnings momentum strategies are among the most common quantitative strategies pursued by active managers. The inter-relationship between these two forms of momentum, and their separate dependencies on trading volume therefore should be of interest to our members.

The Effect of Short Sales Constraints on Shorting Volume and Price Formation

Paul Asquith, MIT
Parag Pathak, Harvard

This project investigates the role of short sales constraints on shorting volume and price formation. Using newly released data from the SEC’s Regulation SHO of every short trade from 2005, combined with proprietary data rebate rate data from two large lenders, who make a market in over 90% of the our universe and account for over 17% of all short sale transactions, we provide a detailed empirical description of the costs of short trades. We focus on four costs: 1) locating shares to borrow, 2) price charged by lenders, 3) uptick rule and 4) recall risk. For each cost we document its empirical magnitude and investigate its effect on stock mispricing.

This study investigates the costs of shorting and the effect of those costs on stock prices. With the growth of 130/30 funds and other long/short funds, more and more managers are shorting stocks. Knowing what the costs of shorting have been and their effect on stock prices may help to gauge the future impact of increased short-selling.

The True Cost of Asset Management: Beta-Adjusted Fees

Jacob (Kobi) Boudoukh, NYU
Matthew P. Richardson, NYY
Richard H. Stanton, Berkeley
Robert F. Whitelaw, NYU

The majority of research on hedge funds, private equity funds and venture capital funds focuses on the risk/return profile of these funds, ignoring the crucial role of ex ante fees. In this paper we focus on the interaction between ex ante fees and the investment’s risk characteristics. We consider the different sources of fund risk and ask how much investors pay ex ante for alpha. The main idea is quite simple: while beta risk is nearly free and investors should only be willing to pay high fees for alpha, funds charge a high fee which is at least partly a function of total volatility (market risk plus fund specific alpha-related risk). We show, both empirically as well as theoretically, that, depending on the beta, effective fees could in some cases be huge.

Investment management fees matter to plan sponsors and participants, investment manager, investment consultants and others. Although a single fee often purchases exposure to multiple types of risk, little work has been done to characterize the relation between fees and risk components. This project should provide a deeper understanding of the economics of investment management fees, in particular how much different types of managers charge for alpha and for beta.

Stock Price Jumps and Return Predictability

George Jiang, Arizona

Tong Yao Arizona

In this study, we propose a new methodology to empirically investigate the predictability of cross-sectional stock returns. Our focus is about one particular type of stock price changes, i.e., those large and discontinuous price movements known as jumps. We use recently developed statistical techniques to identify jumps in stock prices, and examine the relation with various well-known return predictive variables. Our research can shed new lights on cross-sectional stock return predictability, and improve our understanding of competing explanations to asset return anomalies. Our research also offers practical value to investment professionals through improving the timing aspect of investment strategies.

Extreme volatility affects many investment strategies, and most particularly quantitative strategies using options. For many of our members, discrete price jumps represent either their greatest risks or their greatest opportunities. Thus, any methods that can help us better identify which securities are most subject to these jumps should be of interest.


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