Research Paper Series

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Departments: Finance, GREGHEC (CNRS)

There is a discrepancy between CAPM-implied and realized returns. As a result, using the CAPM in capital budgeting decisions -- as is recommended in finance textbooks -- should have valuation effects. For instance, low beta projects are expected to be valued more by CAPM-using managers than by the market. This paper empirically tests this hypothesis using publicly announced M&A decisions. We show that takeovers of lower beta targets are accompanied by lower CARs for the bidder. Consistent with our hypothesis, the effect is more pronounced for larger acquisitions, higher growth targets, and private targets. Furthermore, low beta bidders are more likely to use their own stock to finance the deal. More generally, low beta firms are less likely to issue equity, and more likely to repurchase shares. These effects are not reversed in the long-run, suggesting that CAPM-using managers may be irrational, though this last test lacks power.

Keywords: Capital Budgeting, Valuation, Mergers and Acquisitions, Capital Asset Pricing Model

Departments: Strategy & Business Policy, GREGHEC (CNRS)

We develop a conceptual understanding of when and how organizations respond to normative pressures. More precisely, we examine two main factors underlying the willingness and ability of organizations to respond to an issue: (1) issue salience, and (2) the cost-benefit analysis of resource mobilization. We suggest that decision-makers’ interpretation of issue salience in conjunction with their perception of the costs and benefits of taking action to address the issue generates five potential responses: symbolic compliance and symbolic conformity, substantive compliance and substantive conformity, and inaction. We extend the baseline model by examining a number of boundary conditions. By focusing on the willingness and ability of organizations to respond to normative pressures, and by adopting the issue as the unit of analysis, our model helps explain intra- as well as inter-organizational response heterogeneity to institutional complexity. We contribute to the institutional research tradition and offer useful implications for managerial practice, from strategic management to policy making.

Keywords: institutional theory, normative pressures, symbolic, substantive, conformity, compliance, issue salience

Departments: Tax & Law, GREGHEC (CNRS)

Young people entering the job market are in a precarious economic position. Across Europe, and in Belgium in particular, those who wish to enter into the professional world are faced with the de facto mandate that in order to gain experience and build the connections that will enable them to find paid professional work in the future, they must complete several internships. Yet many of these internships are unpaid or underpaid, forcing some young people to rely on their savings or their parents and shutting others out of the process entirely.The European Committee of Social Rights (the “Committee”) accepts collective complaints lodged by non-governmental organisations alleging violations of the European Social Charter (the “Charter”). The EU Public Interest Clinic prepared this draft Complaint for the non-profit organization European Youth Forum, alleging that unpaid internships in Belgium violate the Charter. Specifically, the provisions in Belgian law that enable unpaid internships, and the lack of enforcement of provisions that aim to curtail them, violate Articles 4, 7, and 10 of the Charter, which provide for fair remuneration, the protection of young people, and financial assistance for vocational training, respectively.

Keywords: Council of Europe, human rights, social rights, monitoring mechanism

Departments: Finance, GREGHEC (CNRS)

We study the quoting activity of market makers in relation with trading, liquidity, and expected returns. Empirically, we find larger quote-to-trade (QT) ratios in small, illiquid or neglected firms, yet large QT ratios are associated with low expected returns. The last result is driven by quotes, not by trades. We propose a model of quoting activity consistent with these facts. In equilibrium, market makers monitor the market faster (and thus increase the QT ratio) in neglected, difficult-to-understand stocks. They also monitor faster when their clients are less risk averse, which reduces mispricing and lowers expected returns.

Keywords: Liquidity, price discovery, volatility, trading volume, monitoring, neglected stocks, risk aversion, inventory, high frequency trading

Departments: GREGHEC (CNRS)

Research has suggested that firms may benefit from price uncertainty - about input commodities - because it creates an "option value". We use a stylized mathematical model to explore and generalize this claim and to specify its implications for firms' investment decisions under various setups. In particular, we study firms' motivation for investing in such risk management measures as financial hedging (FH) and technology improvement (TI): technology changes that result in less consumption of an input commodity, fewer waste products and emissions, and lower production costs. We derive a simple expression that explicitly quantities firm's attitude toward input-price risk by considering the firm's (positive or negative) risk premium (i.e., what it would pay to "lock in" the unit input price at its mean) and linking that premium to various firm and industry-level characteristics. Also, we examine the comparative risk management advantages of TI and FH and characterize conditions under which these strategies are complements or substitutes. We find that although input-price uncertainty may be beneficial even for risk-averse firms, they can benefit from investing in risk reduction measures (e.g., TI, FH) because they could increase the option value of that uncertainty. A firm's ability to adjust its price in response to both market competition and input-price variation mediates the benefit of risk-reducing measures and also affects the two strategies' complementarity.

Keywords: Risk Management, Risk Exposure, Technology Improvement, Financial Hedging

Departments: Finance, GREGHEC (CNRS)

Both in the United States and in the Euro Area, bank supervision is the joint responsibility of local and central supervisors. I study a model in which local supervisors do not internalize as many externalities as a central supervisor. Local supervisors are more lenient, but banks also have weaker incentives to hide information from them. These two forces can make a joint supervisory architecture optimal, with more weight put on centralized supervision when cross-border externalities are larger. Conversely, more centralized supervision endogenously encourages banks to integrate more cross-border. Due to this complementarity, the economy can be trapped in an equilibrium with both too little central supervision and too little financial integration, when a superior equilibrium would be achievable.

Keywords: banking union, bank supervision, financial integration

Departments: Finance, GREGHEC (CNRS)

The regulatory use of banks' internal models makes capital requirements more risk-sensitive but invites regulatory arbitrage. I develop a framework to study bank regulation with strategic selection of risk models. A bank supervisor can discourage arbitrage by auditing risk models, and implements capital ratios less risk-sensitive than in the first-best to reduce auditing costs. The optimal capital ratios of a national supervisor can be different from those set by supranational authorities, in which case the supervisor optimally tolerates biased models. I discuss the empirical implications of this "hidden model" problem, and policy answers such as leverage ratios and more reliance on backtesting mechanisms.

Keywords: basel risk-weights, internal risk models, leverage ratio, supervisory audits

Departments: Economics & Decision Sciences, GREGHEC (CNRS)

Stochastic independence has a complex status in probability theory. It is not part of the definition of a probability measure, but it is nonetheless an essential property for the mathematical development of this theory. Bayesian decision theorists such as Savage can be criticized for being silent about stochastic independence. From their current preference axioms, they can derive no more than the definitional properties of a probability measure. In a new framework of twofold uncertainty, we introduce preference axioms that entail not only these definitional properties, but also the stochastic independence of the two sources of uncertainty. This goes some way towards filling a curious lacuna in Bayesian decision theory.

Keywords: Stochastic Independence, Probabilistic Independence, Bayesian Decision Theory, Savage

Departments: Accounting & Management Control, GREGHEC (CNRS)

This paper has three objectives: (1) To introduce a theoretical solution to the issue of non-additivity between assets in place, relying on an accounting-based valuation approach; (2) To explain how such an approach can be implemented empirically by measuring synergies between assets; (3) To present the properties of this non-additive valuation technique. We use Choquet capacities, i.e., non-additive aggregation operators, to measure the interactions between assets and apply our methodology to a sample of U.S. firms from the Capital Goods industry. To operationalize our approach we examine the relationships between synergies – captured by Choquet capacities – and the market-to-book ratio (proxying for growth options), and show how interactions between assets are consistently linked to a firm’s market-to-book ratio. We also measure firm-specific productive efficiency relative to the industry and firm size. For large firms, efficiency, as defined by our approach, is positively associated with higher future operating cash flows. For small firms, efficiency is positively associated with higher future sales growth. We document that the non-additive approach appears to be better to identify expected relationships between efficiency and future performance than a simpler approach based on the market-to-book ratio.

Keywords: Goodwill, Non-additive accounting-based valuation, Synergies, Choquet capacities, Growth options, Productive efficiency

Departments: Tax & Law, GREGHEC (CNRS)

The purpose of this legal memorandum is to provide advice to organisations and individuals interested in submitting a request for public access to documents under Regulation (EC) No 1049/01 (“Regulation 1049/01”) to the European Parliament for documents related to the spending of political groups covered by Budget Item 400 appropriations under Chapter 7.Requests for those documents may face rejection on grounds related to exceptions provided for in Regulation 1049/01, specifically those found in Articles 4(1)b, 4(2), and 4(3) pertaining to privacy and integrity of the individual, commercial interests, and institution’s decision-making process respectively.This legal memorandum addresses the applicability of those exceptions to the documents requested for potential use in a confirmatory request to be submitted to the European Parliament subsequent to the initial rejection in line with Article 7 of Regulation 1049/01. The memo also provides arguments for overcoming these exceptions in light of:1) recent developments in the case law of the Court of Justice of the European Union (“CJEU”) relating to the privacy exception; and2) the strict legal requirements for triggering the commercial interests and institutional decision-making exceptions.The last section of the memo is structured to provide draft responses to the denial of requests for documents and should be tailored to the specific situation in question.

Keywords: Open Government, Transparency, Participation, Civic Empowerment, Legitimacy, Accountability, Civil Society, European Union, Good Governance