Assaf Eisdorfer

Distress Anomaly and Shareholder Risk: International Evidence

Financially distressed stocks in the U.S. earn puzzlingly low returns giving rise to the distress risk anomaly. In this paper we provide evidence on the performance of distressed stocks in 34 different countries. We find that the distress anomaly appears to exist in developed countries but not in emerging ones. Using cross-country analyses we explore several alternative potential drivers of returns to distressed stocks. We find that the distress anomaly is stronger in countries with stronger takeover legislation, lower barriers to arbitrage, higher information transparency, and easier access to new loans. We find a weak relation between the distress anomaly and debt enforcement risk, and a measure of country-level return skewness. We find no relation between the anomaly and the legal origin of a country. These findings suggest that various aspects of shareholders’ risk play an important role in shaping distressed stocks returns.

Why is Convertible Debt Subordinated? An Investment-Based Agency Theory

This paper offers an agency-based explanation for the junior priority status of convertible bonds. Using a simple economic model, I show that when convertible and straight debt have equal priority, shareholders can prefer value-decreasing projects, which results in wealth transfers from bondholders to shareholders; and I prove that this problem is solved when convertible debt is subordinated. Empirical evidence supports the theory. I find that firms with greater potential for investment-based agency conflicts are more likely to issue subordinated convertible debt, and firms with senior convertible debt are more likely to deviate from the optimal investment policy.

Pricing assets with stochastic cash-flow growth

We model the time series behavior of dividend growth rates, as well as the profitability rate, with a variety of autoregressive moving-average processes, and use the capital asset pricing model (CAPM) to derive the appropriate discount rate. One of the most important implications of this research is that the rate of return beta changes with the time to maturity of the expected cash flow, and the degree of mean reversion displayed by the growth rate. We explore the consequences of this observation for three different strands of the literature. The first is for the value premium anomaly, the second for stock valuation and learning about long-run profitability, and the third is for the St. Petersburg paradox. One of the most surprising results is that the CAPM implies a higher rate of return beta for value stocks than growth stocks. Therefore, value stocks must have higher expected returns, and this is what is required theoretically in order to explain the well-known value premium anomaly.

Distressed Stocks in Distressed Times

Financially distressed stocks do not underperform healthy stocks when the entire economy is in distress. The asset beta and financial leverage of distressed stocks rise significantly after major market downturns, resulting in a dramatic increase in equity beta. Hence, a long/short healthyminus-distressed trading strategy leads to significant losses when the market rebounds. Managing this risk mitigates the severe losses of financial distress strategies, and significantly improves their Sharpe ratios.

Corporate Sport Sponsorship and Stock Returns: Evidence from the NFL

Most home stadiums/arenas of major-sport teams in the U.S. are sponsored by large publicly traded companies. Using NFL data we find that stock returns to the sponsoring firms are affected by the outcomes of games played in their stadiums. Wins in Monday night games generate next-day abnormal returns 50 basis points higher than losses. The effect is 80 basis points in the post-season and when the game outcome is unexpected. This does not revert over the next few days. Outcomes of NFL games could serve as a reasonably exogenous instrument for investor sentiment.

Default Option and the Cross-Section of Stock Returns

We argue that default option is important for equity valuation and construct a model that explicitly prices the option to default or abandon the firm. An investment strategy that buys stocks that are classified as undervalued by our model and shorts overvalued stocks generates an annual 4-factor alpha of about 11% for U.S. stocks. The model’s performance is stronger for stocks with higher value of default option, such as distressed or highly volatile stocks. We construct a similar strategy in a sample of nine most highly capitalized developed markets and find consistent results. Our findings suggest that investors do not properly incorporate the value of default options in stock prices.

How Do Managers Move Firm Value? Cash Flows vs. Expected Returns

Stock prices are mechanically driven by changes in either expected cash flows or discount rates (expected returns). Fundamentally firm values move with managerial decisions. We explore through which channel managers commonly affect their firms’ value. A variance decomposition analysis indicates that when managers have a greater degree of discretion – i.e., when CEO compensation and ownership are high, and in unregulated and heterogeneous industries – cash-flow news becomes significantly more important in driving stock returns, while expected - return news becomes significantly less important. This suggests that managers move firm value mainly by changing expected cash flows and not firm risk.

The Firm-Specific Nature of Debt Tax Shields and Optimal Corporate Investment Decisions

Purpose - While an operations unlevered value is objective, the value of the debt tax shield is subjective since it depends on the capital structure policy of the firm that owns the operation. The purpose of this paper is to explore the implications of this subjective nature of debt tax shield value for corporate investment decisions. Design/methodology/approach - The study develops a simple theoretical model. Findings - The paper shows that even a low probability of selling a project in the future to a firm with a different tax shield value can significantly affect a projects weighted average cost of capital (WACC) and total value. Practical implications - Managers should be aware of this issue when making corporate investment decisions. Originality/value - This is the first study to address the implication of the subjective nature of debt tax shield value.