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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@bus.umich.edu |
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Cash Holdings and
Corporate Diversification, September 2009
Journal
of Finance, forthcoming 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),
September 2009
Journal of Financial Economics,
forthcoming 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),
September 2009
Journal of Financial Economics,
forthcoming 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 a
bout 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),
May 2007
Journal of Financial and Quantitative Analysis,
forthcoming 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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Riding the Merger Wave
(with Breno Schmidt), November 2007 This paper proposes that self-serving, empire building
managers strategically initiate inefficient acquisitions during periods of intense
merger activity (“merger waves”). We document that corporate acquisitions during waves
lead to worse long-term performance relative to non-wave mergers. However, managers that
acquire during waves are less likely to be fired following unsuccessful mergers. We examine
reasons for this and argue that merger waves provide a mechanism through which empire builders
can conceal their true motives. Consistent with our story, we also find evidence associating in-wave
mergers with poor governance. Overall, our results bring forth a possible link, unexplored in the literature,
between agency theory and merger waves.
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Cash Flow Hedging and Liquidity Choices
(with David Disatnik and Breno Schmidt), September 2009 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.
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TARP Investments: Financials and Politics
(with Denis Sosyura), September 2009 We investigate the determinants of capital allocation to financial institutions under the Troubled Asset Relief Program (TARP).
Our main finding is that banks’ political ties played a significant role in the distribution of TARP funds. Specifically, connections to House members on finance
committees and representation at the Federal Reserve via board members are positively related to the likelihood of receiving TARP capital. The TARP investment
amounts are positively related to banks’ size-adjusted political contributions and lobbying expenditures. The effect of political influence is the strongest for
poorly performing banks, thus shifting capital allocation towards weaker institutions. Overall, the study provides evidence about various channels through which
political activism affects government spending.
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Portfolio
Optimization and the Distribution of Firm Size (with Moshe Levy),
September 2007 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. |