J. Spencer Martin

The Determinants of Credit Spread Changes

Using straight industrial bonds with quoted prices, we investigate the determinants of credit spread changes. The variables that should in theory determine credit spread changes in fact have limited explanatory power. Further, the residuals from this first-pass regression are highly cross-correlated, and principal components analysis strongly suggests they are driven by a single common factor. We investigate several macro-economic and financial variables as candidate proxies for this factor. We cannot, however, find any set of variables which explain this common systematic factor. Our results suggest the corporate bond market is a segmented market driven by corporate bond specific supply/demand shocks.

Investment opportunities and corporate demand for lines of credit

Abstract The behavior of a risk neutral corporation in selection of a line of credit is modeled in a new framework where demand for credit lines by a firm arises from the stochastic arrival in continuous time of short-lived opportunities to capture investment projects. The firm needs speed and secrecy to capture projects before competitors. The firm chooses a credit line that balances its up-front commitment cost against the expected extra cost of borrowing in the spot market upon exhaustion of its credit line. The firms demanded credit line depends upon both relative pricing within the contract and the nature of the firms growth opportunities. Interestingly, while credit line demand is positively related to business growth prospects, it is potentially negatively related to uncertainty in those prospects.

Global Momentum Strategies

Here are some practical perspectives on momentum investing in stocks internationally. Momentum is generally more profitable on the long side than on the short side, making it accessible to a broad range of institutional capital, and both price and earnings momentum profits are significant globally. Earnings momentum internationally is distinct from price momentum; using price and earnings momentum in conjunction produces greater economic profits. Momentum profits co–move more weakly across markets than market indexes. Interestingly, while market correlations are much higher in down markets than in up markets, momentum correlations are low under both market conditions. There is no appreciable difference in momentum strategy profitability in up and down markets, which means timing is less important to momentum traders. Finally, momentum strategies are not riskless? there are often periods of several months when they have netted low or negative returns. The findings altogether suggest that momentum is useful in international portfolio management, but it should be implemented very thoughtfully.

The Hidden Cost of Managerial Incentives: Evidence from the Bond and Stock Markets

We examine how incentives embedded in managerial compensation contracts are priced by the bond and stock markets. Specifically, the incentives we consider are the sensitivity of CEO wealth to stock price (delta) and the sensitivity of CEO wealth to stock-return volatility (vega). Controlling for other determinants, we find that higher levels of both vega and delta are associated with higher bond credit spreads and higher expected stock returns. In addition to having a direct effect on credit spreads and expected stock returns, higher incentives are also associated with lower average cash flows, higher volatility of cash flows, and higher volatility of stock returns (all of which increase credit spreads), and higher systematic risk (which increases expected stock return). Thus, higher incentives have a cascading effect on credit spreads and expected stock returns. Also, a portfolio of high-incentive firms significantly underperforms a portfolio of low-incentive firms on a risk-adjusted basis; thus, on average shareholders appear to be harmed ex post as a result of incentive provision.

Are Fat Cats Copycats? Evidence from Director and Consultant Network Dynamics

Prior literature identifies great similarity in executive compensation packages of firms and has succeeded in hypothesizing but not in substantiating the responsible channel or channels. We introduce dynamic stochastic network techniques to directly analyze the following three possible channels simultaneously for the first time: sharing directors, sharing compensation consultants, and sharing industry membership. Using the dynamic technology, we show that package similarity is achieved by sharing directors and industry membership rather than by sharing compensation consultants. Moreover, boards with fewer females are more likely to include higher proportions of options compensation, and higher fixed compensation deters tie formation.

Are Active Managers a Drag on Investor Wealth? Evidence from an Option-Based Estimation

We estimate an option-based value of a fund manager’s conditional market timing skill in bear market states. We combine this value with alpha based estimates of selection skill to give an overall valuation of active management. At the aggregate level, we estimate that the benefit arising from the option value of active fund management in bad times can be large enough to cover its unconditional overall cost. Our analysis suggests that by taking account of the option premium delivered by managers’ bear market timing skills, the longstanding mutual fund underperformance puzzle could be largely rationalized.