Iwan Meier

The relation between excess control and cost of capital

Purpose - – The purpose of this study is to investigate the relationship between dominant shareholders, whose voting rights exceed cash flow rights (excess control), and firms’ cost of capital, including both equity capital and debt. Design/methodology/approach - – This research is conducted in Canada over a four-year period from 2002 to 2005 and uses panel data of 155 S&P/TSX firms. The weighted average cost of capital is regressed on excess control using fixed-effect regressions in a two-stage least squares framework. Findings - – The paper finds evidence that the cost of capital increases with excess control. The paper also confirms that for firms incorporated under the less protective Quebec incorporation law the excess control and, therefore, cost of capital is higher than for firms incorporated in the other provinces under the common law regime. Originality value - – Prior work examined the relationship between excess control and firm value, mostly Tobins

What Drives the Tracking Error of Hedge Fund Clones

Hedge fund clones provide a liquid, efficient, and transparent alternative to investing in hedge funds. As a group, however, their recent performance has been disappointing, despite the large variation in the replication methodologies used. The author investigates hedge fund clones’ tracking errors and finds that contrary to common belief, the reliance on historical data to “reverse engineer” hedge fund allocation is not the primary cause. Instead, the author identifies two important drivers of tracking errors of hedge fund clones. One is changes in marketwide liquidity levels as measured by the basis between derivatives and cash securities. The second is biases in measuring the returns that arise due to attrition among hedge funds that affect the performance of commonly used hedge fund indices. Together, they account for about half of the variation in hedge fund clones’ tracking errors over time.

A note on sorting bias correction in regression-based mutual fund tournament tests

The tournament hypothesis of Brown et al. (J Financ 51(1):85–110, 1996) conjectures that mutual funds with a below-average performance over the first half of the year tend to increase their risk in the second half of the year. Schwarz (Rev Financ Stud 25(3):913–936, 2012) argues that the methodologies that are used to test this hypothesis are flawed because they are affected by a bias that results from sorting on return, which likely also sorts on risk. He argues that both the contingency and regression approaches used in the literature are affected by this sorting bias. We demonstrate that simply including the return standard deviation over the first half of the year in regression-based tests corrects for most of the bias and is just as suitable a way to control for the sorting bias as the more complex Schwarz (Rev Financ Stud 25(3):913–936, 2012) correction.

Leverage, Beta Estimation, and the Size Effect

A measurement error in beta that arises from changes in leverage during the beta estimation window contributes in explaining the size effect. Simulations of asset returns show that the magnitude of the bias in equity returns is proportional to the stock market-induced changes in leverage. We propose a point-in-time beta that incorporates leverage at the end of the beta estimation window rather than the average leverage during this window. Using the point-in-time beta to compute expected stock returns for historical U.S. data, we document that the size effect is substantially reduced. In contrast to other explanations of the size effect, our approach does not introduce market frictions or additional risk factors.

Persistence Analysis of Hedge Fund Returns

We use a Markov chain model to evaluate pure persistence in hedge fund returns. We study two forms of pure persistence: absolute persistence and persistence with respect to the high water mark, accounting for the size of drawdowns. We find that hedge funds in general exhibit persistence in positive returns, but not necessarily persistence in negative returns. We develop a new approach to account for serial correlation based on the method of moments and the model of Getmansky, Lo and Makarov (2004). Our approach overcomes the issue of discontinuity in the return distribution around zero identified by Bollen and Pool (2009).

Global Cash Flow Sensitivities

We examine the role of a country’s institutional framework for investment and financing activities. A country’s financial structure, investor rights, and legal environment are important determinants of the relation between internal cash flow and firms’ investment and financing behavior. Firms from countries with a more developed institutional framework exhibit higher financing cash flow sensitivities. These firms are more likely to substitute a cash flow shortfall with equity issues. Conversely, firms’ investment-cash flow sensitivity is higher in countries with a less developed institutional framework.

Investment and Financing Decisions of Private and Public Firms

This paper analyzes the investment and financing decisions of private and public firms. We focus on their use of cash flow and find that private firms have lower investment-cash flow sensitivities and a stronger link between performance and shareholder distributions, a behavior that is consistent with private firms suffering from fewer agency conflicts. However, our results are only observable in countries with a highly developed and liquid stock market and low ownership concentration. It is the “dark side” of liquidity that reduces the incentives for shareholders to actively monitor managers and leads to inefficient cash flow allocation in public firms.