Danling Jiang

Corporate Policies of Republican Managers

We demonstrate that personal political preferences of corporate managers influence corporate policies. Specifically, Republican managers who are likely to have conservative personal ideologies adopt and maintain more conservative corporate policies. Those firms have lower levels of corporate debt, lower capital and research and development (R&D) expenditures, less risky investments, but higher profitability. Using the 9/11 terrorist attacks and Sept. 2008 Lehman Brothers bankruptcy as natural experiments, we demonstrate that investment policies of Republican managers became more conservative following these exogenous uncertainty-increasing events. Furthermore, around chief executive officer (CEO) turnovers, including CEO deaths, firm leverage policy becomes more conservative when managerial conservatism increases.

Political Values, Culture, and Corporate Litigation

Using one of the largest samples of litigation data available to date, we examine whether the political culture of a firm determines its propensity for corporate misconduct. We measure political culture using the political contributions of top managers, firm political action committees, and local residents. We show that firms with a Republican culture are more likely to be the subject of civil rights, labor, and environmental litigation than are Democratic firms, consistent with the Democratic ideology that emphasizes equal rights, labor rights, and environmental protection. However, firms with a Democratic culture are more likely to be the subject of litigation related to securities fraud and intellectual property rights violations than are Republican firms, whose party ideology stresses self-reliance, property rights, market discipline, and limited government regulation. Upon litigation filing, both types of firms experience similar announcement reaction, which suggests that the observed relationship between political culture and corporate misconduct is unlikely to reflect differences in expected litigation costs.Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2014.2106 . This paper was accepted by Brad Barber, finance .

Short-Sale Constraints and the Idiosyncratic Volatility Puzzle: An Event Study Approach

Using three natural experiments, we test the hypothesis that investor overconfidence produces overpricing of high idiosyncratic volatility stocks in the presence of binding short-sale constraints. We study three events: IPO lockup expirations, option introductions, and the 2008 short-sale ban on financial firms. Consistent with our prediction, we show that when short-sale constraints are relaxed, event stocks with high idiosyncratic volatility tend to experience greater price reductions, as well as larger increases in trading volume and short interest, than those with low idiosyncratic volatility. These results hold when we benchmark event stocks with non-event stocks with comparable idiosyncratic volatility. Overall, our findings suggest that biased investor beliefs and binding short-sale constraints contribute to idiosyncratic volatility overpricing.

Cultural New Year Holidays and Stock Returns Around the World

Using data from eleven major international markets that celebrate six cultural New Year holidays not on January 1st, we show that stock markets tend to outperform in days surrounding the cultural New Year. After controlling for firm characteristics, an average stock earns a 2.5 percent higher abnormal return across all markets in the month of the cultural New Year relative to other non-January times of the year. Further evidence suggests that a positive holiday mood in conjunction with cash infusions prior to the cultural New Year produces elevated stock prices, particularly among the stocks most preferred and traded by individual investors.

Is A Better than B? How Affect Influences the Marketing and Pricing of Financial Securities

Culture and experience associate A with superior quality. In the marketing of dual-class IPOs, issuers are mindful of this preference. For years after IPO issuance, inferior voting rights shares labeled Class A enjoy higher market valuations and smaller voting premiums than do Class B shares. A evokes a more positive feeling than B among many people. This phenomenon is the affect heuristic observed by psychologists. The affect for A is a result of both culture and experience. A is associated with superior quality—for example, Grade A eggs or honey, a grade of A in school, A rated bonds, or A journals. In our study, we asked whether participants in the financial market, such as issuers and underwriters, have exploited the affect for A over B in the marketing and pricing of financial securities. We conducted a natural experiment involving dual-class shares, which are otherwise similar shares issued by the same company but with different voting rights. A typical example is a class with 1 vote per share and another class with 10 votes per share, with both having equal cash flow rights. The former class comprises shares with inferior voting rights, whereas the shares in the latter class have superior voting rights. Companies that issue dual-class shares can choose to designate one class as Class A shares and the other as Class B shares. The issuers and their underwriters may strategically exploit investor affect for A by designating shares more frequently as A than as B, particularly when only the inferior shares are publicly issued and traded. In our study, we asked the following questions: Is there evidence that issuers of dual-voting shares and their underwriters attempt to exploit the affect for A by designating the inferior voting rights (IVR) shares A? Do A-designated IVR shares manage to mimic A-designated superior voting rights (SVR) shares such that the initial market pricing of IVR A shares is more similar to that of SVR A shares than to that of IVR B shares? Could these companies realize significantly greater economic gains from less underpricing at IPOs, smaller voting premiums, and longer-term combined company valuations? Finally, could there be a rational explanation for this affect phenomenon? We found evidence in support of affect’s marketing and pricing role in the issuance of dual-voting shares in IPOs. Our sample covered all dual-class companies with at least one share class traded on the three major exchanges from 1994 to 2008. When these dual-class shares went public, issuers and their underwriters offered more than 87 percent of IVR shares as Class A, as opposed to Class B. This finding is consistent with their perception that there is an affect for A over B. Investors, however, also confirm their affect for A by placing a higher valuation at IPOs. We found that IVR dual shares designated Class A experienced close to 70 percent (or 30 percentage points) less underpricing at issue than those designated Class B. During the first year after IPOs, A-designated shares enjoyed an economically and statistically significant price premium relative to that of B-designated shares. For a group of companies with both SVR and IVR shares, we found that when SVR shares were designated A and IVR shares were designated B or other (e.g., Common Stock), SVR shares traded at a premium of 9.82 percent relative to IVR shares. In contrast, this SVR share premium (voting premium) was only 3.78 percent when IVR shares were designated Class A. Moving from a system that designates superior shares Class A to one that designates inferior shares Class A significantly increases the market valuation (measured by market-to-book equity) of a typical dual-class company for at least five years after IPOs. Our results support the hypothesis that affect plays a role in the pricing of financial assets. Designating a share class A rather than B is a strong explanatory variable of dual-class IPO underpricing even after controlling for a host of company characteristics or time period dummies known to influence IPO underpricing or to induce a potential sample selection bias. We also showed that our results do not support the alternative rational explanation—that companies choose an A designation for IVR shares to signal quality (i.e., better future performance) such that A is less underpriced than B. We found no difference in the share return performance of companies between these two groups up to five years after issuance; instead, companies with B-designated IVR shares delivered better-than-expected operating performance in the same period. This result echoes our findings on the voting premium that investor affect for A is persistent and not limited to the period around the IPOs.

The second moment matters! Cross-sectional dispersion of firm valuations and expected returns

Behavioral theories predict that firm valuation dispersion in the cross-section (‘‘dispersion’’) measures aggregate overpricing caused by investor overconfidence and should be negatively related to expected aggregate returns. This paper develops and tests these hypotheses. Consistent with the model predictions, I find that measures of dispersion are positively related to aggregate valuations, trading volume, idiosyncratic volatility, past market returns, and current and future investor sentiment indexes. Dispersion is a strong negative predictor of subsequent shortand long-term market excess returns. Market beta is positively related to stock returns when the beginning-of-period dispersion is low and this relationship reverses when initial dispersion is high. A simple forecast model based on dispersion significantly outperforms a naive model based on historical equity premium in out-of-sample tests and the predictability is stronger in economic downturns. Published by Elsevier B.V.

Call-Put Implied Volatility Spreads and Option Returns

Prior literature shows that implied volatility spreads between call and put options are positively related to future underlying stock returns. In this paper, however, we demonstrate that the volatility spreads are negatively related to future out-of-the-money call option returns. Using unique data on option volumes, we reconcile the two pieces of evidence by showing that option demand by sophisticated, firm investors drives the positive stock return predictability based on volatility spreads, while demand by less sophisticated, customer investors drives the negative call option return predictability. Overall, our evidence suggests that volatility spreads contain information about both firm fundamentals and option mispricing.

Mood Betas and Seasonalities in Stock Returns

Existing research has found cross-sectional seasonality of stock returns—the periodic outperformance of certain stocks during the same calendar months or weekdays. We hypothesize that assets’ different sensitivities to investor mood explain these effects and imply other seasonalities. Consistent with our hypotheses, relative performance across individual stocks or portfolios during past high or low mood months and weekdays tends to recur in periods with congruent mood and reverse in periods with noncongruent mood. Furthermore, assets with higher sensitivities to aggregate mood—higher mood betas—subsequently earn higher returns during ascending mood periods and earn lower returns during descending mood periods.

The Preholiday Corporate Announcement Effect

We find that investors react more favorably to corporate announcements of share repurchases, SEOs, earnings, dividend changes, and acquisitions if the announcement is made immediately prior to or on holidays. These announcements are associated with more positive reactions for favorable events and less negative reactions for unfavorable events. This effect is robust to controls for market conditions and a selection bias, is accompanied by subsequent reversals, and is present in several international markets. Our findings suggest that predictable individual mood changes can cause biases in market reactions to firm-specific news.We report that investors react more favorably to corporate announcements of share repurchases, SEOs, acquisitions, and quarterly earnings when the announcement is made immediately prior to or on a holiday (i.e. pre-holiday trading days). Corporate events that typically trigger stock price declines are associated with abnormal reactions that are 22 to 49 basis points less negative on pre-holiday trading days, and events that usually result in stock price increases are associated with reactions that are 14 to 78 basis points more positive on these days. The results are not explained by a pre-holiday up market, monthly investor sentiment, short selling, investor limited attention, or adverse selection of firm announcements. Using Gallup survey data, we provide evidence that people are happier and less worried immediately prior to holidays, suggesting that our findings could be explained by an optimistic pre-holiday investor mood. This paper contributes to the literature on the pre-holiday effect by providing novel evidence that investor anticipation of holidays elevates announcement reactions to corporate events.

The No-Short Return Premium

Theory predicts that securities with greater limits to arbitrage are more subject to mispricing and thus should command a higher return premium. We test this prediction using the unique regulatory setting from the Hong Kong stock market, in which some stocks can be sold short and others cannot. We show that no-short stocks on average earn significantly higher returns than shortable stocks and the two groups of stocks tend to comove negatively. Moreover, stocks that comove more with the portfolio of no-short stocks on average earn higher subsequent abnormal returns while those comoving more with the shortable stocks earn lower subsequent abnormal returns. New additions to and deletions from the shorting list only partially contribute to the no-short return premium.