Archive for August, 2012

On Derivatives Markets and Social Welfare: A Theory of Empty Voting and Hidden Ownership  (SSRN)
Authors: Jordan M. Barry, University of San Diego School of Law; John William Hatfield, Stanford Graduate School of Business; Scott Duke Kominers, University of Chicago – Becker Friedman Institute for Research in Economics
Paper Date:  August 22, 2012

Abstract:  The prevailing view among many economists is that derivatives markets simply enable financial markets to incorporate information better and faster. Under this view, increasing the size of derivatives markets only increases the efficiency of financial markets.  We present formal economic analysis that contradicts this view. Derivatives allow investors to hold economic interests in a corporation without owning voting rights, or vice versa. This leads to both empty voters — investors whose voting rights in a corporation exceed their economic interests — and hidden owners — investors whose economic interests exceed their voting rights. We show how, when financial markets are opaque, empty voting and hidden ownership can render financial markets unpredictable, unstable, and inefficient. By contrast, we show that when financial markets are transparent, empty voting and hidden ownership have dramatically different effects. They cause financial markets to follow predictable patterns, encourage stable outcomes, and can improve efficiency. Our analysis lends insight into the operation of securities markets in general and derivatives markets in particular. It provides a new justification for a robust mandatory disclosure regime and facilitates analysis of proposed substantive securities regulations.

Cash Holdings and Credit Risk  (via Social Science Electronic Publishing, Inc.)
Authors: Viral V. Acharya, New York University – Leonard N. Stern School of Business; Sergei A. Davydenko, University of Toronto – Finance Area; Ilya A. Strebulaev, Stanford University – Graduate School of Business; National Bureau of Economic Research
Date: August 1, 2012
Rock Center for Corporate Governance at Stanford University Working Paper No. 123

SSRN Abstract:  Intuition suggests that firms with higher cash holdings should be ‘safer’ and have lower credit spreads. Yet empirically, the correlation between cash and spreads is robustly positive. This puzzling finding can be explained by the precautionary motive for saving cash, which in our model causes riskier firms to accumulate higher cash reserves. In contrast, spreads are negatively related to the part of cash holdings that is not determined by credit risk factors. Similarly, although firms with higher cash reserves are less likely to default in the short term, endogenously determined liquidity may be related positively to the longer-term probability of default. Our empirical analysis confirms these predictions, suggesting that precautionary savings are central to understanding the effects of cash on credit risk.

IPOs and Innovation

Anat Admati, professor of finance and economics at Stanford’s Graduate School of Business, weighs in on the Federal Reserve’s proposed capital requirements for banks. Video by Wall Street Report found here.

Follow Anat Admati on Twitter: https://twitter.com/anatadmati  @anatadmati