Publications

Bank CEO Incentives and the Credit Crisis, 2010, forthcoming Journal of Financial Economics (joint with Rene Stulz).

Abstract: We investigate whether bank performance during the credit crisis of 2008 is related to CEO incentives and share ownership before the crisis and whether CEOs reduced their equity stakes in their banks in anticipation of the crisis. There is no evidence that banks with CEOs whose incentives were better aligned with the interests of their shareholders performed better during the crisis and some evidence that these banks actually performed worse both in terms of stock returns and in terms of accounting return on equity. Further, option compensation did not have an adverse impact on bank performance during the crisis. Bank CEOs did not reduce their holdings of shares in anticipation of the crisis or during the crisis; further, there is no evidence that they hedged their equity exposure. Consequently, they suffered extremely large wealth losses as a result of the crisis.





Estimating the Effects of Large Shareholders Using a Geographic Instrument, 2010, forthcoming Journal of Financial and Quantitative Analysis (joint with Bo Becker and Henrik Cronqvist).

Abstract: Large shareholders may play an important role for firm performance and policies, but identifying this empirically presents a challenge due to the endogeneity of ownership structures. We develop and test an empirical framework which allows us to separate selection from treatment effects of large shareholders. Individual blockholders tend to hold blocks in public firms located close to where they reside. Using this empirical observation, we develop an instrument - the density of wealthy individuals near a firm's headquarters - for the presence of a large, non-managerial individual shareholders in a firm. These shareholders have a large impact on firms, controlling for selection effects. Consistent with theories of large shareholders as monitors, we find that they increase total payouts to shareholders, reduce corporate cash holdings, reduce executive compensation and may increase firm profitability. In addition, large sharholders reduce the liquidity of the firm's stock. On average, they do not appear to affect capital structure.

 

 

Fahlenbrach, Ruediger, Angie Low, and Rene M. Stulz, 2009, Why Do Firms Appoint CEOs as Outside Directors?, forthcoming Journal of Financial Economics

Companies actively seek to appoint outside CEOs to their boards. Consistent with our matching theory of outside CEO board appointments, such appointments have a certification benefit for the appointing firm and CEOs are more likely to join boards of large established firms that are geographically close, pursue similar financial and investment policies, and have comparable governance to their own firms. The first outside CEO director appointment has a higher stock-price reaction than the appointment of another outside director. Except for interlocked directors that have an adverse impact on operating performance, CEO directors do not affect the appointing firm's operating performance, decision-making, CEO compensation, and board monitoring of management.

 

 

Cronqvist, Henrik, and Ruediger Fahlenbrach, 2009, Large Shareholders and Corporate Policies, Review of Financial Studies 22, 3941-3976.

We develop an empirical framework that allows us to analyze the effects of heterogeneity across large shareholders, and we construct a new blockholder-firm panel data set in which we can track all unique blockholders among large U.S. public firms.  We find statistically significant and economically important blockholder fixed effects in investment, financial, and executive compensation policies.  This evidence suggests that blockholders vary in their beliefs, skills, or preferences.  Different large shareholders have distinct investment and governance styles: they differ in their approaches to corporate investment and growth, their appetites for financial leverage, and their attitudes towards CEO pay.  We also find blockholder fixed effects in firm performance measures, and differences in style are systematically related to firm performance differences.  Our results are consistent with influence for activist, pension fund, corporate, individual, and private equity blockholders, but consistent with systematic selection for mutual funds.  Finally, we analyze sources of the heterogeneity, and find that blockholders with a larger block size, board membership, direct management involvement as officers, or with a single decision maker are associated with larger effects on corporate policies and firm performance.

 

 

Fahlenbrach, Ruediger, and Rene M. Stulz, 2009, Managerial Ownership Dynamics and Firm Value, Journal of Financial Economics 92, 342-361.

From 1988 to 2003, the average change in managerial ownership is significantly negative every year for American firms. We find that managers are more likely to significantly decrease their ownership when their firms are performing well, but not more likely to increase their ownership when their firms have poor performance. Because investors learn about the total change in managerial ownership with a lag, changes in Tobin's q in a period can be affected by changes in managerial ownership in the previous period. In an efficient market, it is unlikely that changes in managerial ownership in one period are caused by future changes in q. When controlling for past stock returns, we find that large increases in managerial ownership increase q. This result is driven by increases in shares held by officers, while increases in shares held by directors appear unrelated to changes in firm value. There is no evidence that large decreases in ownership have an adverse impact on firm value. We argue that our evidence cannot be wholly explained by existing theories and propose a managerial discretion theory of ownership consistent with our evidence.



 

Fahlenbrach, Ruediger, 2009, Founder-CEOs, Investment Decisions, and Stock Market Performance, Journal of Financial and Quantitative Analysis 44, 439-466.

Eleven percent of the largest public U.S. firms are headed by the CEO who founded the firm. Founder-CEO firms differ systematically from successor-CEO firms. They have a higher accounting performance and a higher firm valuation. Founder-CEO firms invest more in R&D, have higher capital expenditures, and make more focused mergers and acquisitions. Moreover, an equal-weighted investment strategy that had invested in founder-CEO firms from 1993-2002 would have earned a benchmark-adjusted return of 8.3% annually. A value-weighted investment strategy would have earned an abnormal return of 10.7%. The excess return is robust; after controlling for a wide variety of firm characteristics, CEO characteristics, and industry affiliation, the abnormal return is still 4.4% annually.

 

 

Fahlenbrach, Ruediger, 2009, Shareholder Rights, Boards, and Executive Compensation, Review of Finance 13, 81-113.

I analyze the role of executive compensation in corporate governance. As proxies for corporate governance, I use board size, board independence, CEO-chair duality, institutional ownership concentration, CEO tenure, and an index of shareholder rights. The results from a broad cross-section of large U.S. public firms are inconsistent with recent claims that entrenched managers design their own compensation contracts. The interactions of the corporate governance mechanisms with total pay-for-performance and excess compensation can be explained by governance substitution. If a firm has generally weaker governance, the compensation contract helps better align the interests of shareholders and the CEO.

 

 

Fahlenbrach, Ruediger, and Patrik Sandas, 2009, Co-movements of Index Options and Futures Quotes, Journal of Empirical Finance 16, 151-163.

We report evidence that the co-movements of index options and index futures quotes differ sharply from perfect correlation in periods with option trades. In half-hour intervals with (without) option trades 25% (12%) of call option quote changes have either the opposite sign or are larger in magnitude than the corresponding index futures quote changes. We calibrate a stochastic volatility model that allows for trade and no-trade periods using real data and simulate the joint co-movements of index quotes and option quotes in this model. We show that for trade intervals the observed co-movements differ from the benchmark case established by our simulations approximately three times too often. We provide empirical evidence that market microstructure effects - specifically, stale quotes and aggressive quotes - explain the majority of the deviations from the benchmark. Our findings are relevant for techniques that use estimates of local co-movements as inputs to price or hedge options.

 

 

Dlugosz, Jennifer, Fahlenbrach, Ruediger, Gompers, Paul, and Andrew Metrick, 2006, Large Blocks of Stock: Prevalence, Size, and Measurement,  Journal of Corporate Finance 12, 594-618.

Large blocks of stock play an important role in many studies of corporate governance and finance. Despite this important role, there is no standardized data set for these blocks, and the best available data source, Compact Disclosure, has many mistakes and biases. In this paper, we document these mistakes and show how to fix them. The mistakes and biases tend to increase with the level of reported blockholdings: in firms where Compact Disclosure reports that aggregate blockholdings are greater than 50 percent, these aggregate holdings are incorrect more than half the time and average holdings for these incorrect firms are overstated by almost 30 percentage points. For researchers using uncorrected blockholder data as a dependent variable, these errors will increase the standard error of coefficient estimates but do not appear to cause bias. However, we find that if blockholders are used as an independent variable, economically significant errors-in-variables biases can occur. We demonstrate these biases using a representative analysis of the relationship between firm value and outside blockholders. An online appendix to our paper provides a "clean" data set for our sample firms and time period. For researchers who need to work outside of this sample, we also test the efficacy of alternative (cheaper) fixes to this data problem, and find that truncating or winsorizing the sample can reduce about half of the bias in our representative application.