November 2009

Beneficial or Detrimental Legislation?
Responding to reports of corrupt business behavior by Enron, Tyco, and other large corporations, the U.S. Congress passed the Sarbanes-Oxley Act in 2002. Thomas Lys suggests that the legislation has fallen short of its goal of controlling illegal business practices.

Daniel Cohen

Aiyesha Dey

Thomas Lys

November 2009

In with the “In” Crowd
Like the cool kids in high school who discourage those who “don’t belong” from encroaching on their turf, Yael Hochberg notes that venture capitalists in tightly networked geographic markets deter new entrants using some of the same behaviors exhibited in high school hallways.

Yael Hochberg

Alexander Ljungqvist

Yang Lu

September 2009

Suspiciously Short
Stock options are often seen as a way to align both executive and shareholder interests. Yet accepted accounting principles leave management with some leeway when reporting earnings, inviting the possibility of stock price manipulation. Anup Srivastava and his colleagues discovered a surprising link between executive compensation packages and firms that miss earnings targets.

Mary Lea McAnally

Anup Srivastava

Connie D Weaver

September 2009

There’s No Place Like Home
Investors strongly tilt their portfolios toward domestic assets and away from foreign instruments in a phenomenon called “home bias.” Wioletta Dziuda discusses how better information could level the imbalance between foreign and domestic mutual fund investments.

Wioletta Dziuda

Jordi Mondria

September 2009

Should I Stay or Should I Go?
Alexander Chernev has spent his career studying consumer behavior. In a recent study he found that a consumer’s personal goals, particularly their concern for safety and security, strongly influence how likely they are to switch to something new or stay with what they know.

Alexander Chernev

September 2009

Agreeing to Disagree
The standard view of how stock prices move—that investors act rationally on information and that markets are efficient—does not account for price drift. Snehal Banerjee explains that price drift may occur because investors agree to disagree about the average valuation of an asset.

Snehal Banerjee

Ron Kaniel

Ilan Kremer

August 2009

The Biochemistry of Financial Risk
Testosterone may play a surprising role in financial risk. New research by Paola Sapienza and her colleagues shows how the amount of testosterone in our veins could influence our monetary decisions.

Paola Sapienza

Luigi Zingales

Dario Maestripieri

August 2009

Mysterious Profit
The carry trade is an enigma in the financial world. When experts attempt to explain its continued profitability using traditional risk factors such as consumption growth, stock market returns, and other more complex predictors, they fail miserably. Sergio Rebelo and his colleagues discovered a tantalizing new way to minimize the risk posed by the unpredictable.

A. Craig Burnside

Martin Eichenbaum

Isaac Kleshchelski

Sergio Rebelo

August 2009

Super-Premium Ice Cream
When regulators evaluate proposed mergers and acquisitions, they use sophisticated econometric models. Current models consider price but not product variety. Michael Mazzeo and colleagues provide insights into conditions that result in merged companies providing greater product variety.

Michael J. Mazzeo

Michaela Draganska

Katja Seim

August 2009

Currency Exchange Rates
It seems that any world event can shift exchange rates, but what economic, business, political, and social events truly drive the dollar down—or up? Torben Andersen helps us understand what lies behind daily rises and falls in the value of a dollar.

Torben Andersen

Tim Bollerslev

Francis X. Diebold

Clara Vega

July 2009

Banks, Bonds, and Accounting Quality
When corporations want to borrow, they have a several options. Jayanthi and Shyam Sunder show how a borrower’s financial reporting quality affects not only the choice between private and public debt markets but also the loan agreement terms.

Sreedhar Bharath

Jayanthi Sunder

Shyam Sunder

July 2009

Walking Away
With more than 20 percent of U.S. homeowners realizing negative equity, strategic defaults are on the rise. Paola Sapienza notes that moral and social considerations play a crucial role in dissuading householders from taking that route—that is, until potential losses reach a certain threshold.

Luigi Guiso

Paola Sapienza

Luigi Zingales

June 2009

Driven Offshore
In 2002 the U.S. Congress responded to the corporate governance crisis that followed the scandal-ridden behavior of Enron, Tyco, WorldCom, and other high-profile corporations by passing the Sarbanes-Oxley Act (SOX). The legislation set out to restore investors’ confidence in financial markets by improving corporate governance. However, in the case of at least one group of companies, the act seems to have produced unexpected results. A study co-authored by Thomas Lys (Professor of Accounting Information & Management at the Kellogg School of Management) indicates that the managements of poorly governed foreign-domiciled firms responded to the act by closing shop in the United States.

Peter Hostak

Emre Karaoglu

Thomas Lys

Yong Yang

June 2009

Picking Up Pennies for Profit
There’s more to “buy low, sell high” than just buying low and selling high. Twitchy markets spew endless, jittery streams of temporary highs and retreating lows. Which low is the “buy” low? When is the “sell” high? A sellers’ high today may be humdrum in a week. Noontime buyers’ rock-bottom low might not impress an hour later. Given these fluctuations in stock prices and the recalibration of highs and lows, traders probe the peaks and valleys in search of patterns and values. New research by Robert Korajczyk (Professor of Finance at the Kellogg School of Management), Kellogg alumnus Ronnie Sadka (Professor of Finance at Boston College), and Steven L. Heston (Professor of Finance at the University of Maryland) reveals surprising patterns that can help predict daily peaks in stock price. This work was deemed so influential in the field of quantitative investment that it was awarded the 2009 Crowell Prize by PanAgora Asset Management.

Steven L. Heston

Robert Korajczyk

Ronnie Sadka

May 2009

Liquidity Rules
On the surface, the meltdown of the U.S. subprime mortgage market should not have triggered a worldwide financial crisis. Worst-case estimates put subprime mortgage losses at $250 billion—a drop in the bucket compared to the many trillions of dollars worth of financial instruments traded around the globe.

Ricardo J. Caballero

Arvind Krishnamurthy

March 2009

Reforming Credit Reform
The federal budget deficit will nearly triple to a historically unprecedented $1.2 trillion for the 2009 budget year, grim Congressional Budget Office figures reported in January. Thanks to all of the bailouts in the financial industry and the assumption of Fannie Mae and Freddie Mac, the deficit for the first four months of fiscal 2009 exceeded all of 2008.

Deborah Lucas

Marvin Phaup

February 2009

Blame It on the Genes!
Financial institutions teeter on the brink of ruin. Banks are devouring bailout money but have yet to loosen credit enough to ease a recession that is sweeping the globe. A question on many lips is, “How in the world did so many financial titans take such huge risks with our nation’s well being?” A new study by Camelia Kuhnen (Finance) and Joan Chiao (Psychology, Northwestern University) takes provocative steps toward answering that extraordinarily complex question. Appearing in the journal PLoS ONE, the study is the first to link financial investment risk-taking to variations in certain genes that regulate chemicals in the brain.

Camelia Kuhnen

Joan Chiao

February 2009

To Sell but not to Missell
Imagine you are at a major electronics chain store, finally ready to purchase that plasma television that would be just perfect for your recreation room. But when you tell the salesperson which model you want to take home, she asks you a few questions about your television room and viewing habits.

Roman Inderst

Marco Ottaviani

February 2009

Measuring Trust
Consumer spending, home prices, 401(k) values, and employment levels are but a few of the economic vital signs that have plummeted during the upheaval of the past months. While these indicators help to describe today’s crisis, new research by Paola Sapienza (Kellogg) and Luigi Zingales (Booth) suggests that true insight into the root causes of a nation’s financial strength or weakness lies in a different measure: trust.

Paola Sapienza

Luigi Zingales

December 2008

Discounted Diapers and Stockpiles of Soup
What did Enron, WorldCom, and Tyco all have in common? Accounting abuses on a grand scale and massive financial deception from the very highest levels of management. As investors lost billions of dollars, the earnings management game with its fuzzy math and earnings magic came under fire, and stronger, sweeping legislation was enacted to reform American business practices.

Craig J. Chapman

Thomas J. Steenburgh

December 2008

Don't Look Now
Many investors at least occasionally worry that they are not spending enough time monitoring their investments and trading to optimize the returns on their portfolio. But according to finance professor Janice Eberly of the Kellogg School of Management, investors could actually be worse off if they pay too much attention to their portfolios. Her research suggests that the costs of monitoring may at times outweigh the benefits.

Andrew B. Abel

Janice C. Eberly

Stavros Panageas

November 2008

Does Function Follow Organizational Form?
“Form ever follows function. This is the law.” This hallowed tenet of modern design was first put forth in the late nineteenth century by Louis Sullivan, Chicago architect and father of the skyscraper.

Allen N. Berger

Nathan H. Miller

Mitchell Petersen

Raghuram G. Rajan

Jeremy C. Stein

September 2008

The VIX, CIV, and MFIV
Beyond growth and leverage, a key factor in the value of a given stock, and the broader market, is volatility, or the magnitude of variation in prices over time. Especially in today’s uncertainty-ridden market including a major credit crisis and declining dollar, investors pay sizeable premiums to be hedged against increases in volatility, which typically represent bad market conditions.

Torben Andersen

Oleg Bondarenko

August 2008

The Impact of the 2008 Tax Rebates on Consumer Spending
Between May and July of this year, the U.S. Federal Government has distributed more than 90 billion dollars worth of economic stimulus payments, or tax rebates, to American households. Despite much recent concern that households would save the money, we find that households are doing a significant amount of extra spending because of the stimulus payments. The typical family increased their spending on food, mass-merchandise and drug products by 3.5 percent when their rebate arrived, relative to a family yet to receive its rebate. Based on these estimates and on results from previous analysis, we forecast that demand for overall non durable consumption in the second quarter of 2008 has been boosted by 2.4 percent as a direct result of the stimulus payments, and will be held up by around 4.1 percent in the third quarter of 2008. We also study who spent their rebates and on what. We find that low income and low asset households increased their spending at nearly double the rate of the average household. We also find that shoppers are spending a higher share of their rebate in supercenters –like Walmart and Target– relative to their usual behavior. Most people report that they are not spending much of their rebates to increase or maintain their purchases of apparel or groceries, but are instead spending more of their rebates on durable goods and personal services. Finally, the rebates are having different effects in different parts of the country, with people in the Greater Los Angeles and South East regions spending more than people in major metropolitan areas in the rest of the country. Our findings underscore the potency of the economic stimulus payments in stabilizing consumer spending during recessions.

Christian Broda

Jonathan A. Parker

August 2008

Does Malpractice Liability Keep the Doctor Away?
It seems self-evident: states that pass laws protecting doctors from large malpractice awards will attract more doctors than states without malpractice liability limitations. Accordingly, the U.S. Department of Health and Human Services favors limiting the monetary damages available to patients affected by medical malpractice, arguing that the supply of doctors will shrink in states without damage caps and increase in states that enact damage caps. Furthermore, President George W. Bush has proposed a nationwide cap on noneconomic damages available in malpractice lawsuits.

David A. Matsa

July 2008

Professional Forecasters
Imagine you are the chief operating officer for a Fortune 500 technology company and you have to sign off on a major pricing increase for your firm's best-selling product line in two days. All the internal data you have—labor costs, product sales/growth trends, competitors' and vendors' anticipated pricing—support the price increase. But you are still hesitant.

Marco Ottaviani

Peter Norman Sørensen

June 2008

Women and Math, the Gender Gap Bridged
Nine years before the 19th Amendment granted American women the right to vote, a committee of Swedish scientists in 1911 awarded a second Nobel Prize to Marie Curie, a French Pole, in recognition of her discovery of the elements radium and polonium. Nine years before Title IX cracked down on gender discrimination in American education, Soviet cosmonaut Valentina Tereshkova became the first woman to rocket into space, piloting Vostok 6 in 1963. Across generations and cultures, women have reached remarkable levels of scientific and social achievement. Yet five years into the 21st century, the leader of one of the world's most elite universities, in one of the oldest democracies, opined upon "the unfortunate truth" that women probably are not as mentally equipped for work in math and science as men (Summers 2005).

Luigi Guiso

Ferdinando Monte

Paola Sapienza

Luigi Zingales

May 2008

The Promise, Perils, and Performance of Private Equity
Private equity—the class of investments that includes venture capital investments and buyouts—accounts for a relatively small and, to date, little analyzed percentage of overall investments. Studies have shown that institutional investors—such as university endowment funds, corporate and public pension funds, private advisors, banks, and insurance companies—generally outperform individual investors. However, researchers have unearthed virtually no information on the success rates of different types of institutional investors.

Josh Lerner

Antoinette Schoar

Wan Wongsunwai

May 2008

Lobbyists Speak in Numbers
Although the Sarbanes-Oxley Act has come to be known as SOX, it has nothing to do with baseball teams or fancy foot coverings. Like sports teams, however, the law spurs heated debates because it addresses a hot-button topic: corporate accountability. Since SOX was passed in 2002, people have argued whether or not it will indeed improve operations, decrease corporate mismanagement, and thus benefit shareholders. Some insist it will prove detrimental because of high compliance costs and be ineffective in preventing corporate misconduct, and that it will drive companies to list on foreign exchanges.

Yael Hochberg

Paola Sapienza

Annette Vissing-Jørgensen

March 2008

Averting a Recession
In the words of Aldous Huxley, “Experience teaches only the teachable.” As United States policymakers attempt to halt the economy’s careening express train to recession, the $168 billion question is: Will the fiscal stimulus plan enacted last month really work? Income tax rebates and business tax breaks trigger déjà vu, with the response to today’s flagging economy bearing striking resemblance to action taken in the dog days of 2001. But this time around, lawmakers are armed with more than just blind faith that putting money in the hands of millions of Americans could make a difference.

David S. Johnson

Jonathan A. Parker

Nicholas S. Souleles

March 2008

Exercising Options
Though the glamour surrounding stock options and other share-based compensation dissipated with the bursting of the tech bubble at this millennium’s outset, these employee incentives are still in place for many executives. Few of these executives, however, understand the special tax treatments associated with stock option and restricted stock grants.

Robert McDonald

February 2008

When Should a Firm Decentralize?
Ask a nanoscientist how an amazing new molecule was built and you're liable to hear, "It assembled itself." Observations of such self-organizing systems are increasingly common in the natural sciences, as complex structures and astounding properties emerge without any influence from external sources. In the corporate arena, however, a boardroom decision to let a company "assemble itself" would probably lead to panic on the trading floor. When it comes to corporate structuring, it is far more normal for the players to engage in some intelligent design, to co-opt the phrase. In this vein, Kellogg School of Management Professor Artur Raviv (Finance) and longtime collaborator Milton Harris (formerly of Kellogg, now at the University of Chicago) write in Management Science about how various features of corporations can determine the structures by which the company should be organized.

Milton Harris

Artur Raviv

January 2008

(When and How) Do Markets Learn?
Can ideology influence stock price? Research conducted by Edward Zajac (Kellogg School of Management) and James Westphal (University of Michigan) suggests that sociological influences, such as dominant ideologies regarding what constitutes good corporate practices, can determine how investors view corporate policies — and thus how the market reacts to such policies. Specifically, Zajac and Westphal's study shows that investor reaction to announcements of stock repurchase plans shifted from negative to positive during the mid-1980s, coinciding with a shift in what they describe as institutional logics, or shared beliefs. In fact, they show how strong shared beliefs can become by providing additional evidence that the generally positive reaction to stock buyback announcements persisted despite growing evidence that a substantial number of firms did not implement the repurchase plans. In light of these findings, Zajac and Westphal suggest that the traditional "market learning" view of investor decision-making should be expanded to include an analysis of these and other sociological influences.

Edward J. Zajac

James D. Westphal

November 2007

Treasury Debt and Corporate Bond Rates
The authors relate the yield spread between AAA-rated corporate bonds and Treasury securities to the U.S. government debt-to-GDP ratio—that is, the ratio of the face value of publicly held U.S. government debt to U.S. gross domestic product (GDP). They find that the corporate bond spread is high when the stock of government debt is low while the spread is low when the stock of debt is high. The demand for “convenience” provided by Treasury debt depends on this yield spread, and they provide estimates of the elasticity of demand.

Arvind Krishnamurthy

Annette Vissing-Jørgensen

November 2007

Place Your Bids
The traditional belief is that a high first offer results in a high selling price. This belief is rooted in a psychological principle known as anchoring, such that the size of an opening bid is a testament to the item’s value. The numerical value of an anchor sets the tone of more or less prestige of the product up for auction. Furthermore, a high opening bid can spark the rose-colored glasses effect, leading bidders to focus on the more positive features of an item. The researchers show that low rather than high opening bids—for a variety of products from shirts to fancy rugs in online auctions—generate high selling prices, demonstrating a reversal of the anchoring effect.

Gillian Ku

Adam D. Galinsky

J. Keith Murnighan

September 2007

Pricing a Global Measure of Liquidity Risk
Most of us are not willing to bear risk without compensation. For a long time, return volatility has been almost synonymous with financial risk, but now we know that this not the only consideration. For instance, when we have an asset in our portfolio, no matter how volatile it is, we would like to be in a position to sell it at any time without incurring high penalties. We prefer assets for which we will always be able to get our money back if we suddenly need it or if the market experiences a downturn. Thus, it makes good sense to think that investors will require a relatively higher expected return if the asset they are holding is illiquid, i.e. difficult to trade.

Robert Korajczyk

Ronnie Sadka

August 2007

Trust Required Here
Buying a used car is always a difficult experience, in large part because potential buyers have trouble trusting sellers. Trust is an elusive but important component in market transactions. New work by Kent Grayson, a marketing professor at the Kellogg School of Management, and his colleagues focuses on the pension industry in the United Kingdom and Taiwan, and shows that a buyer requires two types of trust: trust in the particular seller (narrow-scope trust) and trust in the broader social context (the market) in which the transaction takes place (broad-scope trust).

Kent Grayson

Devon Johnson

Der-Fa Chen

August 2007

Mandatory or Voluntary Corporate Disclosure?
“Sunlight is said to be the best of disinfectants,” wrote Supreme Court Justice Louis Brandeis on the importance of openness and transparency in society. Such sunlight can be a pretty profitable business strategy, too: companies who are forthcoming with information about the quality of the products they sell are rewarded with superior profits from appreciative customers. But Kellogg faculty Michael Fishman, the Norman Strunk Distinguished Professor of Financial Institutions, and Kathleen Hagerty, Senior Associate Dean for Faculty and Research, argue that secrecy sometimes pays, too. Their work in The Journal of Law, Economics, & Organization analyzes firms’ disclosure decisions taking account of the fact that not all consumers will be able to make sense of the information disclosed.

Michael J. Fishman

Kathleen Hagerty

June 2007

Celebrity Analyst Influence on the Stock Market
There is no question the stock market has had its ups and downs, but have you ever wondered what drives people to pull their money out or pour money into a company? Certainly investors pay attention to analyst forecasts, but which analysts are they paying the closest attention to? Beverly Walther (Kellogg School's Department of Accounting and Information Management), Sarah E. Bonner (University of Southern California) and Artur Hugon (Georgia State University) explored whether investors react stronger to “celebrity” analysts and why.

Sarah E. Bonner

Artur Hugon

Beverly Walther

May 2007

Whom You Know Matters
Venture capitalists often acknowledge the critical role of network relationships in the success of individual VC firms, particularly in sourcing investment opportunities, management talent, and information necessary for consistent industry success. One prominent VC, Kleiner Perkins Caufield and Byers, even goes so far as to refer to itself as a “Venture Keiretsu.” Research by Yael Hochberg (Finance Department, Kellogg School of Management) and her colleagues Alexander Ljungqvist and Yang Lu (Stern School of Business, NYU) suggests that VC networks—in particular, relationships with other VC firms—can have a significant positive impact on fund performance.

Yael Hochberg

Alexander Ljungqvist

Yang Lu

May 2007

Why Do IPO Auctions Fail?
When Google successfully launched its initial public offering (IPO) by auction in 2004, there was much media and industry fanfare. In reality, using an IPO auction to determine who gets to buy how many shares at what price is an old approach that either never took off in some countries, or has gone out of fashion in others. IPO auctions were attempted in more than twenty countries in the 1980s and early 1990s, but are rare today.

Ravi Jagannathan

Ann E. Sherman

April 2007

Brain Gain
Investors systematically deviate from rationality when making financial decisions, yet the mechanisms responsible for these deviations have not been identified. Using data from functional MRI scans, Kuhnen and Knutson examine whether anticipatory neural activity would predict optimal and suboptimal choices in a financial decision-making task. Their findings suggest that distinct neural circuits linked to anticipatory affect promote different types of financial choices, and indicate that excessive activation of these circuits may lead to investing mistakes. Thus, consideration of anticipatory neural mechanisms may add predictive power to the rational actor model of economic decision-making.

Camelia Kuhnen

Brian Knutson

April 2007

Can geography affect your bank account?
Do Koreans save more than the British? Are Eastern Europeans more reluctant to invest in stocks? Do Brazilians mistrust financial markets? While modern commerce may be global and pay little attention to national borders, people can retain a kind of economic heritage based on culture that influences their views in provincial ways.

Luigi Guiso

Paola Sapienza

Luigi Zingales

April 2007

Bucks Not a Matter of Luck
It's a perennial debate among investors and financial professionals: Should greater market returns be attributed to superior stock-picking acumen or to mere luck? Research by Kellogg School Associate Professor of Accounting Beverly Walther and two co-authors considers the question with respect to sell-side analysts — professionals employed by brokerage houses to manage accounts and create publicly available research often relied upon by investors.

Michael B. Mikhail

Beverly Walther

Richard H. Willis

April 2007

Cashed Out
Korajczyk and Sadka, a professor at the University of Washington, looked at how trading costs affect the profitability of investment strategies that rely on these patterns of momentum. They focused in particular on how large a momentum-based fund would have to be before the cost of trading drives profits to zero. Their findings were published in a June 2004 article in the Journal of Finance.

Robert Korajczyk

Ronnie Sadka

April 2007

A Dollar Short
It happened in one country after another during the 1990s: a large, contractionary currency devaluation followed by surprisingly mild rates of inflation. But when Kellogg School Finance Professor Sergio Rebelo and his co-researchers looked closely at the aftermath of the devaluations, they observed a remarkably similar set of economic reactions. Whether in Finland, Sweden, Mexico, Korea, Thailand, Malaysia, the Philippines, Indonesia or Brazil, the same patterns in pricing emerged. In each country, the prices that changed most were those of imports and exports at the dock. The prices of these goods in retail stores were more stable, Rebelo's team found.

Ariel Burstein

Craig Burnside

Martin Eichenbaum

Sergio Rebelo

João C. Neves