Management Insights

Beyond the Glass Ceiling: Does Gender Matter? (p. 219)

Renée B. Adams, Patricia Funk

Does gender matter in the boardroom? Researchers have long studied gender differences in the workplace, but little is known about these differences in the boardroom. If women must be like men to break the glass ceiling, we might expect gender differences to disappear among directors. Using a large survey of directors, the authors show that female and male directors differ systematically in their core values and risk attitudes, but in ways that differ from gender differences in the general population. Consistent with findings for the population, female directors are more benevolent and universally concerned but less power oriented than male directors. However, in contrast to findings for the population, they are less traditional and security oriented than their male counterparts. They are also more risk loving than male directors. The insight for management: Having a woman on the board need not lead to more risk-averse decision making.

Does the Rolodex Matter? Corporate Elite's Small World and the Effectiveness of Boards of Directors (p. 236)

Bang Dang Nguyen

Does the Rolodex matter? The author investigates the impact of social ties on the effectiveness of boards of directors. When the chief executive officer (CEO) and a number of directors belong to the same social networks, the CEO is less likely to be dismissed for poor performance. Although being ousted is costly for all CEOs—who must then devote time to finding new employment and succeed in only 62% of cases—socially connected CEOs are more likely to find new and better employment after a forced departure. The insight for management: Close social ties between board members and CEOs can propagate the “old-boys network” in corporate boardrooms, reducing downside risk for CEOs and allowing lower performance to persist.

Keynes Meets Markowitz: The Trade-Off Between Familiarity and Diversification (p. 253)

Phelim Boyle, Lorenzo Garlappi, Raman Uppal, Tan Wang

The famed economist John Maynard Keynes advocated concentration in a few familiar assets. Warren Buffett has quoted Keynes and espouses this approach to investing. On the other hand, Harry Markowitz has won the Nobel Prize in Economics for developing portfolio diversification methods and models to reduce risk for a given desired return. Which approach should be followed? The authors show that for any given level of expected returns, the optimal portfolio depends on two quantities: relative ambiguity across assets and the standard deviation of the expected return estimate for each asset. If both quantities are low, then the optimal portfolio consists of a mix of familiar and unfamiliar assets; moreover, an increase in correlation between assets causes an investor to increase concentration in familiar assets (flight to familiarity). Alternatively, if both quantities are high, then the optimal portfolio contains only the familiar asset(s), as Keynes would have advocated. In the extreme case in which both quantities are very high, no risky asset is held (nonparticipation). The insight for management: Portfolio diversification strategies and investing in few familiar assets are competing philosophies that can be reconciled based on risk, correlation of assets, and relative ambiguity of the investment options.

A Global Equilibrium Asset Pricing Model with Home Preference (p. 273)

Bruno Solnik, Luo Zuo

Are investors biased toward domestic investments? The authors test the assumption that investors suffer from foreign aversion, a preference for home assets based on familiarity. They find that, if the degree of foreign aversion is high in a given country, investors place a high valuation on domestic equity, which results in a low expected return. Using International Monetary Fund portfolio data, the authors test the model's prediction that a country's degree of home bias and the expected return of its domestic assets are inversely related. The insight for management: Expected returns for a country's assets are negatively related to home bias.

Investor Sentiment and Analysts' Earnings Forecast Errors (p. 293)

Paul Hribar, John McInnis

Are stock analysts sentimental? The authors examine the correlation of analysts' forecast errors with investor sentiment. They find that when sentiment is high, analysts' forecasts of one-year-ahead earnings and long-term earnings growth are relatively more optimistic for “uncertain” or “difficult-to-value” firms. They find that these errors contain information; regression analysis of the errors has sizable predictive ability on future returns. The insight for management: Evaluate both what analysts say and what they may feel; investor sentiment may affect the earnings expectations of hard-to-value firms.

The Party's Over: The Role of Earnings Guidance in Resolving Sentiment-Driven Overvaluation (p. 308)

Nicholas Seybert, Holly I. Yang

“Irrational exuberance” is a famous term coined by Alan Greenspan to steer enthusiastic investors riding a bull market back to reality. It worked; a major stock market correction ensued. Can senior management provide earning guidance that helps prevent investors' sentiment-driven overvaluation? The authors find that most of the negative returns to uncertain firms in months after high-sentiment periods fall within the three-day window around the issuance of management earnings guidance. But there is also some evidence of negative returns around earnings announcements for firms that previously issued guidance, suggesting that guidance does not entirely correct optimistic earnings expectations. The authors suggest that transient or short-term focused management are more likely to fail to provide effective earnings guidance. The insight for management: Regular and clear earnings guidance can help avoid irrational expectations of investors and subsequent abrupt and negative corrections.

The Accrual Anomaly: Risk or Mispricing? (p. 320)

David Hirshleifer, Kewei Hou, Siew Hong Teoh

When investors value a firm, they should distinguish between the two components of earnings: cash flows from operations and accounting adjustments (operating accruals). Because cash flows from operations predict future profitability more strongly than do accruals, investors should discount accruals and focus on cash flows. However, past research has found that firms with high accruals underperform compared with firms with low accruals in the United States and in other countries. This pattern has come to be known as the accrual anomaly. The authors confirm that accrual characteristics cause investors to overvalue stocks. The insight for management: Investors misvalue the accrual characteristic and cast doubt on the rational risk explanation.

Investor Inattention and the Market Impact of Summary Statistics (p. 336)

Thomas Gilbert, Shimon Kogan, Lars Lochstoer, Ataman Ozyildirim

Can a little information go a long way? The authors examine the effect of recurring stale information releases on U.S. stock and Treasury futures prices. The authors evaluate the effect of the U.S. Leading Economic Index^® (LEI), which is released monthly and is constructed as a summary statistic of previously released inputs. The researchers find a pronounced pattern at the release of this information, and these patterns are more pronounced for high beta stocks, for stocks that are more difficult to arbitrage, and during times when investors' sensitivity to firm-specific stale information is high. Other measures of information arrival, such as price volatility and volume, spike after the data release. The insight for management: Some investors are inattentive to the stale nature of the information included in the LEI releases, instead interpreting it as new information, and thereby causing temporary yet significant mispricing.

Market Madness? The Case of Mad Money (p. 351)

Joseph Engelberg, Caroline Sasseville, Jared Williams

Is there market madness for Mad Money? In the popular television show Mad Money, hosted by Jim Cramer, stock recommendations are regularly made. Does viewing the show pose an opportunity for viewers? Yes—if they act quickly. The authors find that stock recommendations lead to large overnight returns that subsequently reverse over the next few months. The spike-reversal pattern is strongest among small, illiquid stocks that are hard to arbitrage. They also find that the overnight return is strongest when high-income viewership is high. The pattern is also apparent among sell recommendations. The insight for management: Hype sells (there is a potential role of media in generating short-term mispricing), but be quick in order to beat the crowd.

Do Cultural Differences Between Contracting Parties Matter? Evidence from Syndicated Bank Loans (p. 365)

Mariassunta Giannetti, Yishay Yafeh

Do cultural differences between contracting parties matter? For example, do banking terms depend on how similar the parties are? The authors examine a large data set of international syndicated bank loans and find that more culturally distant lead banks offer borrowers smaller loans at a higher interest rate and are more likely to require third-party guarantees. The authors show that the differences are big: Minor differences in cultures, such as between Canada and the United States or between Japan and South Korea, are associated with a 6.5-basis-point-higher loan spread. The loan spread increases by approximately 23 basis points if the bank-firm match involves culturally more different countries, for example, from Japan and the United States. The authors suggest that familiarity is not enough; these effects do not disappear after repeated interaction between borrower and lender. The insight for management: Tolerance for cultural diversity can allow an organization expanded business opportunities and profits.

Bubbles and Information: An Experiment (p. 384)

Matthias Sutter, Jürgen Huber, Michael Kirchler

Ubiquitous information creates market efficiency, right? Speculative bubbles are inefficient, right? So then information should remedy bubbles, but these authors suggest that just the opposite can be true. Although uninformed traders are subject to the bubble phenomenon, so are symmetrically informed traders. The authors find that markets with asymmetrically informed traders have significantly smaller bubbles than markets with symmetrically informed or uninformed traders. Hence, fundamental values are better reflected in market prices—implying higher market efficiency—when some traders know more than others about future dividends. This suggests that bubbles are abated when traders know that a subset of them have an edge (in information) over others. The insight for management: Information is good for market efficiency, but asymmetric information is better.

A Transaction-Level Analysis of Spatial Arbitrage: The Role of Habit, Attention, and Electronic Trading (p. 394)

Eric Overby, Jonathan Clarke

Arbitrage creates market efficiency. But what creates arbitrage opportunities? There is limited evidence of the factors that create and eliminate arbitrage opportunities, how often arbitrage occurs, and how profitable it is. The authors evaluate spatial arbitrage in the wholesale automotive market by analyzing how sellers choose where to sell vehicles. They find that the attention that sellers pay to the distribution of a vehicle is negatively related to the probability that it is arbitraged. Arbitrage occurs in approximately 1% of transactions, although electronic trading is making arbitrage less prevalent by improving buyer/seller matching across locations. Arbitrage yields a 5.6% return on average, although arbitrageurs take a loss 14% of the time. The insight for management: Focusing on contributors to arbitrage opportunities can lead to increased profits.

Penny Wise, Dollar Foolish: Buy–Sell Imbalances On and Around Round Numbers (p. 413)

Utpal Bhattacharya, Craig W. Holden, Stacey Jacobsen

Can traders be penny wise because others are dollar foolish? The answer is yes: Stock traders fixate on whole numbers as trading focal points. The authors examine more than 100 million stock transactions and find excess buying price points one penny below round numbers. Similarly, they find excess selling one penny above round numbers. The effect is biggest at even dollar amounts, then 50-cent markers, and so on. Simply put, the buy and sell orders tend to be at focal points. The insight for management: Focal point buying and selling can be costly; buying (selling) by liquidity demanders below (above) round numbers yields losses approaching $1 billion per year.

Initial Public Offerings as Lotteries: Skewness Preference and First-Day Returns (p. 432)

T. Clifton Green, Byoung-Hyoun Hwang

Is getting in on a hot IPO like winning the lottery? The authors find that initial public offerings (IPOs) with high expected skewness experience significantly greater first-day returns. The skewness effect is stronger during periods of high investor sentiment and is related to differences in skewness across industries as well as to time-series variation in the level of skewness in the market. However, IPOs come back to earth; IPOs with high expected skewness earn more negative abnormal returns in the following one to five years. High expected skewness is also associated with a higher fraction of small-sized trades on the first day of trading, which is consistent with a greater shift in holdings from institutions to individuals. The insight for management: The results suggest that first-day IPO returns are related to a preference for skewness.

Prospect Theory, Liquidation, and the Disposition Effect (p. 445)

Vicky Henderson

It is a well-known behavioral tendency to evaluate outcomes of decision relative to a benchmark position; the disposition effect is the tendency of investors to sell assets that have risen in value rather than fallen. The researchers extend the literature in their development of a model in which the investor will “give up” and sell at a loss when the asset has a sufficiently low risk/reward ratio. The insight for management: New decision modeling captures the fact that people hate to sell at a loss but will do so in the case of sufficiently poor future prospects.