In 1993 and early 1994, Freeport McMoRan Copper and Gold (FCX), a mining company, issued two seri... more In 1993 and early 1994, Freeport McMoRan Copper and Gold (FCX), a mining company, issued two series of gold-denominated depositary shares to raise 430 million dollars expanding their mining capacity in Indonesia. We price the depositary shares using a term structure model for the forward rates implied by gold futures and we show that FCX successfully enhanced the credit quality of the issue. This credit enhancement is achieved because the effect of linking the payoff of the depositary shares to gold reduces default risk and is similar to conventional risk management. However, the bundling of financing and risk management allows the firm to target hedging benefits only to the newly issued securities. The design of the security also overcomes the asset substitution problem. The depositary shares issued by FCX illustrate how firms can enhance credit quality through financial engineering without changing the existing priority ordering of their capital structure.
We study the relation between fraud and CEO-director connectedness, focusing on the type of CEO-d... more We study the relation between fraud and CEO-director connectedness, focusing on the type of CEO-director connection. While nonprofessional connections due to shared non-business service or alma mater increase fraud probability, professional connections from employment overlaps lower the incidence of fraud. The benefits of professional connectedness are pronounced when individuals share service as executives rather than as directors or as director and executive. The results are robust to firm-specific controls, industry and time period controls, coopted directors, and measures of director quality and heterogeneity. While frauds have led regulators to (successfully) push for independent directors, our results suggest that independence is only necessary, not sufficient. Heterogeneity within the set of independent directors seems to be at least as important as independence per se.
An important public policy issue actively debated in the financial economics literature is whethe... more An important public policy issue actively debated in the financial economics literature is whether firms can increase their value solely by changing one or more corporate governance mechanisms. In this paper, we directly examine whether changing governance leads to changes in future firm performance. Specifically, we analyze a sample of firms that instituted governance changes and sort them based on the direction of their governance changes for thirteen different governance measures. We focus on firms that make large governance changes to enhance the power of our tests. We find no significant difference in future performance between firms that have a large increase in governance measures and firms that have a large decrease in governance measures. We also find that the governance changes are driven by movement towards mean industry governance levels, merger pressures, as well as changes in the firm’s observable characteristics. We conclude that firms choose their governance structur...
The agency paradigm is primarily concerned with compensation contracts with both short-term and l... more The agency paradigm is primarily concerned with compensation contracts with both short-term and long-term provisions that align the interests of top management with those of shareholders. But such alignment may be imperfect. In particular, if shareholders differ in their time-preferences, it will be impossible to find a contract that fully aligns manager interests with those of both long-term and short-term shareholders. In this study, we first theoretically examine the properties of optimal contracts when shareholders have heterogeneous time preferences about liquidating their holdings in the firm. We then show that the managerial compensation contract will create incentives for the manager to trade-off short term price increases with long term value creation. In empirical tests, we use measures of average shareholder horizon and managerial compensation horizon and identify firms where there is a misalignment between these measures. We show, both from our theoretical model and our ...
A Special Purpose Acquisition Company (SPAC) is a public entity set up by a founder for the speci... more A Special Purpose Acquisition Company (SPAC) is a public entity set up by a founder for the specific purpose of acquiring another firm, typically a private firm. The acquired firm is publicly traded after the acquisition, and the acquisition in effect represents a non-standard approach for the private firm to go public. In this paper, we develop a theoretical framework to explain several unique features of the SPAC design such as the prevalence of unit offerings and the use of equity and warrants in the founder's contract. The founder in our model undertakes costly effort to learn about the characteristics of the acquisition target and delivers a good quality firm to the SPAC shareholders. We show that the warrants play a unique role in limiting the level of risk of firms that the founder selects for acquisition. We also show that the equity grant given to the SPAC founder pre-commits the SPAC shareholders and firms to a pre-determined level of underpricing for the non-standard SPAC IPO process.
One strand of the literature has found different good governance measures to be positively correl... more One strand of the literature has found different good governance measures to be positively correlated with firm performance, while assuming governance measures to be exogenous. Using the results of these papers, many have suggested that changing a firm’s governance characteristics will “cause” firm performance to improve. This paper examines this causality argument by looking at changes in corporate governance and subsequent firm performance. We examine governance changes in three uniquely constructed samples that “stack the deck” in favor of the hypothesis that good governance changes “causes” better performance. In all three samples, however, we find no significant performance differences between firms with good governance changes and firms with bad governance changes, which is strong evidence against the null that better corporate governance leads to better firm performance. These results are robust to: firm performance defined as industryadjusted stock returns, industry-adjusted...
The authors consider the problem of a risk-averse firm with limited liability. The firm has to se... more The authors consider the problem of a risk-averse firm with limited liability. The firm has to select the size of its investment in a risky project. We show that the optimal exposure to risk of the limited liability firm is always larger than under full liability. Moreover, there exists a positive lower bound on the value of the firm below
Proceedings of the IEEE/IAFE/INFORMS 1998 Conference on Computational Intelligence for Financial Engineering (CIFEr) (Cat. No.98TH8367), 1998
... Phone # (504) 862-8000 x 2525 Torous (1985), Akgiray and Booth (1986), French, Schwert and St... more ... Phone # (504) 862-8000 x 2525 Torous (1985), Akgiray and Booth (1986), French, Schwert and Stambaugh (1987), Akgiray (1989), Connolly (1989) and Ballie & DeGennaro (1990). ... Instead, stock returns are determined by a jump-d@vsrsion process (Merton (1 976)). ...
Review of Quantitative Finance and Accounting, 2006
ABSTRACT Discretely rebalanced options arbitrage strategies in the presence of transaction costs ... more ABSTRACT Discretely rebalanced options arbitrage strategies in the presence of transaction costs have path dependent returns that are difficult to model analytically. I instead use a quasi-analytic procedure that combines the computational efficiency of analytical solutions with the flexibility of simulations. The central feature is the estimation of the distribution of returns of the arbitrage strategy by mapping simulated returns percentiles and the input parameter set. Using the estimated density, I evaluate the tradeoff between transaction costs and risk exposure under generalized transaction costs structures that includes bid-ask spread and brokerage commission. I show that the optimal strategy depends on transaction costs, volatility, and option moneyness. Strategies such as rebalancing when the hedge ratio changes by 0.25, balances transaction costs and risk exposure, and can be optimal. Copyright Springer Science+Business Media, LLC 2007
... NK Chidambaran is Assistant Professor of Finance in the AB Freeman School of Business at Tula... more ... NK Chidambaran is Assistant Professor of Finance in the AB Freeman School of Business at Tulane University. Thomas A. Pugel is Professor of Economics and International Business in the Leonard N. Stem School of Business at New York University. ...
We propose a methodology of Genetic Programming to approximate the relationship between the optio... more We propose a methodology of Genetic Programming to approximate the relationship between the option price, its contract terms and the properties of the underlying stock price. An important advantage of the Genetic Programming approach is that we can incorporate currently known formulas, such as the Black-Scholes model, in the search for the best approximation to the true pricing formula. Using
In 1993 and early 1994, Freeport McMoRan Copper and Gold (FCX), a mining company, issued two seri... more In 1993 and early 1994, Freeport McMoRan Copper and Gold (FCX), a mining company, issued two series of gold-denominated depositary shares to raise 430 million dollars expanding their mining capacity in Indonesia. We price the depositary shares using a term structure model for the forward rates implied by gold futures and we show that FCX successfully enhanced the credit quality of the issue. This credit enhancement is achieved because the effect of linking the payoff of the depositary shares to gold reduces default risk and is similar to conventional risk management. However, the bundling of financing and risk management allows the firm to target hedging benefits only to the newly issued securities. The design of the security also overcomes the asset substitution problem. The depositary shares issued by FCX illustrate how firms can enhance credit quality through financial engineering without changing the existing priority ordering of their capital structure.
We study the relation between fraud and CEO-director connectedness, focusing on the type of CEO-d... more We study the relation between fraud and CEO-director connectedness, focusing on the type of CEO-director connection. While nonprofessional connections due to shared non-business service or alma mater increase fraud probability, professional connections from employment overlaps lower the incidence of fraud. The benefits of professional connectedness are pronounced when individuals share service as executives rather than as directors or as director and executive. The results are robust to firm-specific controls, industry and time period controls, coopted directors, and measures of director quality and heterogeneity. While frauds have led regulators to (successfully) push for independent directors, our results suggest that independence is only necessary, not sufficient. Heterogeneity within the set of independent directors seems to be at least as important as independence per se.
An important public policy issue actively debated in the financial economics literature is whethe... more An important public policy issue actively debated in the financial economics literature is whether firms can increase their value solely by changing one or more corporate governance mechanisms. In this paper, we directly examine whether changing governance leads to changes in future firm performance. Specifically, we analyze a sample of firms that instituted governance changes and sort them based on the direction of their governance changes for thirteen different governance measures. We focus on firms that make large governance changes to enhance the power of our tests. We find no significant difference in future performance between firms that have a large increase in governance measures and firms that have a large decrease in governance measures. We also find that the governance changes are driven by movement towards mean industry governance levels, merger pressures, as well as changes in the firm’s observable characteristics. We conclude that firms choose their governance structur...
The agency paradigm is primarily concerned with compensation contracts with both short-term and l... more The agency paradigm is primarily concerned with compensation contracts with both short-term and long-term provisions that align the interests of top management with those of shareholders. But such alignment may be imperfect. In particular, if shareholders differ in their time-preferences, it will be impossible to find a contract that fully aligns manager interests with those of both long-term and short-term shareholders. In this study, we first theoretically examine the properties of optimal contracts when shareholders have heterogeneous time preferences about liquidating their holdings in the firm. We then show that the managerial compensation contract will create incentives for the manager to trade-off short term price increases with long term value creation. In empirical tests, we use measures of average shareholder horizon and managerial compensation horizon and identify firms where there is a misalignment between these measures. We show, both from our theoretical model and our ...
A Special Purpose Acquisition Company (SPAC) is a public entity set up by a founder for the speci... more A Special Purpose Acquisition Company (SPAC) is a public entity set up by a founder for the specific purpose of acquiring another firm, typically a private firm. The acquired firm is publicly traded after the acquisition, and the acquisition in effect represents a non-standard approach for the private firm to go public. In this paper, we develop a theoretical framework to explain several unique features of the SPAC design such as the prevalence of unit offerings and the use of equity and warrants in the founder's contract. The founder in our model undertakes costly effort to learn about the characteristics of the acquisition target and delivers a good quality firm to the SPAC shareholders. We show that the warrants play a unique role in limiting the level of risk of firms that the founder selects for acquisition. We also show that the equity grant given to the SPAC founder pre-commits the SPAC shareholders and firms to a pre-determined level of underpricing for the non-standard SPAC IPO process.
One strand of the literature has found different good governance measures to be positively correl... more One strand of the literature has found different good governance measures to be positively correlated with firm performance, while assuming governance measures to be exogenous. Using the results of these papers, many have suggested that changing a firm’s governance characteristics will “cause” firm performance to improve. This paper examines this causality argument by looking at changes in corporate governance and subsequent firm performance. We examine governance changes in three uniquely constructed samples that “stack the deck” in favor of the hypothesis that good governance changes “causes” better performance. In all three samples, however, we find no significant performance differences between firms with good governance changes and firms with bad governance changes, which is strong evidence against the null that better corporate governance leads to better firm performance. These results are robust to: firm performance defined as industryadjusted stock returns, industry-adjusted...
The authors consider the problem of a risk-averse firm with limited liability. The firm has to se... more The authors consider the problem of a risk-averse firm with limited liability. The firm has to select the size of its investment in a risky project. We show that the optimal exposure to risk of the limited liability firm is always larger than under full liability. Moreover, there exists a positive lower bound on the value of the firm below
Proceedings of the IEEE/IAFE/INFORMS 1998 Conference on Computational Intelligence for Financial Engineering (CIFEr) (Cat. No.98TH8367), 1998
... Phone # (504) 862-8000 x 2525 Torous (1985), Akgiray and Booth (1986), French, Schwert and St... more ... Phone # (504) 862-8000 x 2525 Torous (1985), Akgiray and Booth (1986), French, Schwert and Stambaugh (1987), Akgiray (1989), Connolly (1989) and Ballie & DeGennaro (1990). ... Instead, stock returns are determined by a jump-d@vsrsion process (Merton (1 976)). ...
Review of Quantitative Finance and Accounting, 2006
ABSTRACT Discretely rebalanced options arbitrage strategies in the presence of transaction costs ... more ABSTRACT Discretely rebalanced options arbitrage strategies in the presence of transaction costs have path dependent returns that are difficult to model analytically. I instead use a quasi-analytic procedure that combines the computational efficiency of analytical solutions with the flexibility of simulations. The central feature is the estimation of the distribution of returns of the arbitrage strategy by mapping simulated returns percentiles and the input parameter set. Using the estimated density, I evaluate the tradeoff between transaction costs and risk exposure under generalized transaction costs structures that includes bid-ask spread and brokerage commission. I show that the optimal strategy depends on transaction costs, volatility, and option moneyness. Strategies such as rebalancing when the hedge ratio changes by 0.25, balances transaction costs and risk exposure, and can be optimal. Copyright Springer Science+Business Media, LLC 2007
... NK Chidambaran is Assistant Professor of Finance in the AB Freeman School of Business at Tula... more ... NK Chidambaran is Assistant Professor of Finance in the AB Freeman School of Business at Tulane University. Thomas A. Pugel is Professor of Economics and International Business in the Leonard N. Stem School of Business at New York University. ...
We propose a methodology of Genetic Programming to approximate the relationship between the optio... more We propose a methodology of Genetic Programming to approximate the relationship between the option price, its contract terms and the properties of the underlying stock price. An important advantage of the Genetic Programming approach is that we can incorporate currently known formulas, such as the Black-Scholes model, in the search for the best approximation to the true pricing formula. Using
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