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Ran Duchin Assistant Professor of Finance Stephen M. Ross School of Business University of Michigan Phone: (734) 764-9181 Email: duchin@umich.edu |
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(Please Note: Links take you to the SSRN page for the paper) Main
Publications/Forthcoming Papers
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Using hand-collected data on segment
executives at the S&P 500 firms, we provide some of the first evidence on
the role of divisional managers in internal capital markets. Managers with
social ties to the CEO receive more capital. The effect of informal ties
outweighs measures of formal influence, such as board membership and
seniority, and persists after controlling for endogeneity. The impact of
connections on investment efficiency depends on the tradeoff between agency
and information asymmetry. When governance is weak, connections reduce
investment efficiency and erode firm value by fostering favoritism. When information
asymmetry is high, managerial ties increase investment efficiency and firm
value, arguably by facilitating information transfer. Overall, we offer novel
evidence on formal and informal managerial influence inside the firm. Riding the Merger Wave: Uncertainty, Reduced Monitoring, and Bad Acquisitions (with Breno Schmidt), 2012 We show that
acquisitions initiated during periods of high merger activity (“merger
waves”) are accompanied by poorer quality of analysts’ forecasts and greater
uncertainty. Furthermore, CEO turnover-performance sensitivity is weaker for
mergers initiated during waves. These conditions imply reduced monitoring and
lower penalties for initiating inefficient mergers. We posit that therefore
merger waves foster agency-driven behavior, which, along with managerial
herding, may lead to worse mergers. Consistent with this hypothesis, we find
that the average long-term performance of acquisitions initiated during
merger waves is significantly worse. We also find that corporate governance
of in-wave acquirers is poorer, suggesting that agency problems contribute to
the performance gap between in-wave and out-wave acquisitions. The Politics of Government Investment (with
Denis Sosyura), 2011 Journal of
Financial Economics, forthcoming This paper investigates whether
political influence of firms affects government investment decisions. We
study the efficacy of the various forms of political influence, ranging from
the relatively passive connections between firms and politicians, such as
those based on politicians’ voting districts to the more active forms of
influence, such as lobbying, campaign contributions, and connections to
regulators via directorships. Using hand-collected data on firm applications
for government investment funds in the United States, we find that firms with
political connections are significantly more likely to be funded, controlling
for other firm characteristics. Investments in politically-connected firms
underperform those in unconnected firms. Overall, we demonstrate one mechanism through which
political influence affects investment and show that connections between
firms and regulators appear to distort rather than improve investment
efficiency. Cash Holdings and Corporate Diversification,
2010 Journal of Finance 65, 955-992 This paper studies the relation
between corporate liquidity and diversification. A key finding is that
multi-division firms hold significantly less cash than standalone firms
because they are diversified in their investment opportunities. Lower
cross-divisional correlations in investment opportunity and smaller gaps
between investment opportunity and cash flow correspond to lower cash
holdings, even after controlling for cash-flow volatility. The effects are
strongest in financially constrained firms and in well-governed firms, and
correspond to efficient fund transfers from low- to high-productivity
divisions. Taken together, these results bring forth an efficient link
between diversification in investment opportunity and corporate liquidity. |
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When Are Outside Directors Effective? (with
John G. Matsusaka and Oguzhan Ozbas), 2010 Journal of Financial Economics
96, 195-214 This paper uses recent regulations that have required
some companies to increase the number of outside directors on their boards to
generate estimates of the effect of board independence on performance that
are largely free from endogeneity problems. Our main finding is that the
effectiveness of outside directors depends on the cost of acquiring
information about the firm: when the cost of acquiring information is low,
performance increases when outsiders are added to the board, and when the
cost of information is high, performance worsens when outsiders are added to
the board. The estimates provide some of the cleanest estimates to date that
board independence matters, and the finding that board effectiveness depends
on information cost supports a nascent theoretical literature emphasizing
information asymmetry. We also find that firms compose their boards as if
they understand that outsider effectiveness varies with information costs. |
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Costly External Finance, Corporate Investment, and the
Subprime Mortgage Credit Crisis (with Oguzhan Ozbas and Berk Sensoy),
2010 Journal of Financial Economics 97,
418-435 We study the effect of the financial crisis that began in
August 2007 on corporate investment. The crisis represents an unexplored
negative shock to the supply of external finance for non-financial firms. We
find that corporate investment declines significantly following the onset of
the crisis, controlling for firm fixed effects and time-varying measures of
investment opportunities. Consistent with a causal effect of a supply shock,
the decline is greatest for firms that have low cash reserves or high net
short-term debt, are financially constrained, or operate in industries
dependent on external finance. To address concerns about the endogeneity of
firms’ finances to changes in investment opportunities, we measure these
financial positions as much as four years prior to the crisis and confirm
that we do not find similar results following placebo crises in the summers
of 2003-2006. We also do not find similar results following the negative
demand shock caused by the events of September 11. These effects weaken
considerably beginning in the third quarter of 2008, when the demand-side
effects of the crisis became apparent, suggesting that supply constraints may
no longer have been binding. Additional analysis suggests an important
precautionary savings motive for seemingly excess cash that has not been
emphasized in the literature. |
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Disagreement, Portfolio Optimization and Excess
Volatility (with Moshe Levy), 2010 Journal of Financial and Quantitative Analysis 45, 623-640 A central task facing investors who
believe in market efficiency is that of portfolio optimization. As it is far
from obvious how to best estimate the ex-ante expected returns and
covariances, it is quite plausible that investors would hold different
beliefs regarding these parameters, and that the degree of disagreement about
the parameters may change over time. Levy, Levy and Benita (2006) have shown
that in the portfolio context disagreement regarding the expected returns
does not affect asset prices. In this paper we study the pricing effects of
disagreement regarding return variances. We show that disagreement about
variances has systematic and significant pricing effects. Even if the average
belief about the variance is constant, tiny fluctuations in the disagreement
about the variance lead to substantial price fluctuations. This result may
offer an explanation for the excess volatility puzzle: small changes in the
degree of disagreement are very likely to occur, and they induce relatively
large price changes. Yet, the changes in disagreement may be hard to directly
detect empirically, leading to apparent “excess volatility”. |
Selected Working Papers
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Using unique, hand-collected data,
this paper investigates how corporations combine the use of derivative
hedging, cash holdings, and bank lines of credit to manage cash flow risks.
Consistent with a precautionary saving motive, we find that (i) cash flow
hedging derivatives and/or lines of credit serve as substitutes for cash, and
(ii) the sensitivity of cash to cash flow volatility is significantly lower
for firms that use either derivative hedging, lines of credit, or both. We highlight
an important and largely unexplored interaction between cash flow hedging and
the use of credit lines: Hedging pushes firms to substitute cash for lines of
credit, since it reduces the risk of violating financial covenants. We also
investigate the determinants of cash flow hedging. The use of cash flow
hedging is highly related to industry, and is concentrated in industries
exposed to foreign currency and commodity price risks. We also show that the
relation between hedging, cash, and lines of credit is mainly concentrated in
financially constrained firms. Overall, our findings shed new light on the
joint determination of corporate policies to manage cash flow risks.
The Dynamics of Cash (with Amy Dittmar), 2011 Little is known about how firms manage
cash policy over time. This paper fills this gap by examining if and how
firms manage cash toward a target cash ratio. Estimating partial adjustment
models of cash, we find that firms actively adjust their cash toward a
target; however, the speed of adjustment is slow and there is large
dispersion in the speed of adjustment across firms. We investigate the causes
for this and find evidence consistent with the presence of adjustment costs.
We also examine the implications of these results for previous
interpretations of cross-sectional results. To do this, we simulate firms’
cash paths allowing for costly adjustment and find that the emerging patterns
question the interpretation of some of the standard results in the empirical
cash literature. Safer Ratios, Riskier Portfolios: Banks’ Response to Government Aid (with Denis Sosyura), 2011 We study the effect of government assistance on bank risk
taking. Using hand-collected data on bank applications for government
capital, we control for the selection of fund recipients and investigate the
effect of both application approvals and denials. To distinguish banks’
risk-taking behavior from changes in economic conditions, we also control for
the volume and quality of credit demand based on micro-level data on home
mortgages and corporate loans. Our difference-in-difference analysis
indicates that after the bailout, bailed banks approve riskier loans and
shift investment portfolios toward riskier securities. However, this
shift in risk occurs mostly within the same asset class and, therefore, has
little effect on the closely-monitored capitalization levels. Consequently,
bailed banks appear safer according to the capitalization requirements, but
show a significant increase in market-based measures of risk. Overall, our
evidence suggests that banks’ response to capital requirements may erode
their efficacy in risk regulation. |
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Portfolio Optimization and the Distribution of Firm Size (with Moshe Levy), 2010 In the context of portfolio
optimization, a firm’s market capitalization reflects the optimal portfolio
weight of the firm, and is determined by the return parameters. The empirical
distribution of firms’ market capitalizations is in excellent agreement with
the lognormal distribution. This distribution is very skewed: the largest
firms are about 1000 times larger than the median firm. The empirical
distribution of average returns is not nearly as skewed: the maximal average
return is only about 6 times larger than the median average return. Can the
empirical firm size distribution be consistent with mean-variance portfolio
optimization with realistic return parameters? We show that the expected
returns implied by the empirical firm size distribution and portfolio
optimization are actually in very good agreement with the empirical average
returns. Moreover, the portfolio optimization framework can provide a
constructive explanation for the exact lognormal functional form empirically
observed. Thus, portfolio optimization is not only consistent with the
empirical lognormal size distribution, it can actually explain it. |
Media Coverage
"Banks with political ties got
bailouts, study shows", Reuters
"Did the Banks’ Political Connections Drive TARP?", Wall Street Journal
“Banks With Political Ties Got Bailouts, Study Shows”, New York Times
"US Business Summary", Washington Post
"Missed Payments Vexing to Frank", Boston Globe
"TARP distribution shows political favoritism", San Francisco Examiner
"UM researchers say politics guided bank bailout allocations", Detroit Free Press
“Study: Politically-Connected Banks Were More Likely To Get Bailed Out”, Huffington Post
"Welcome to the Back-Scratching Economy", Smartmoney.com
"US banks with political ties got more bailouts", Press TV
"Banks with political ties got bailouts, study shows", Moneycontrol.com
"Politics Played Major Role in Bailout Choices", Newser.com
"Bailout Banks Make Riskier Loans: Study", Yahoo Finance
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