José Correia Guedes

On the Diversification, Observability, and Measurement of Estimation Risk

This paper reexamines how risk return relationships are affected by investor uncertainty about the exact parameters of the joint rate of return distribution. We attempt to clarify results relating to three central issues. First, we address the issue of diversification, focusing on an APT, factor model framework. Second, we discuss the observability of estimation risk and describe research experimental designs that should encompass the existence of estimation risk and reveal it in the data. Finally, we suggest exploiting contemporaneous return observations on high and low information securities to aid in the measurement of return parameters for low information securities.

Managerial reputation and divisional sell-offs: A model and empirical test

Abstract This paper presents a reputation model of divestiture activity that yields a sharp cross-sectional implication for event studies of sell-off announcements: A decision to divest a division that is known to be successful conveys good news about the division; in contrast, a decision to divest a division that is known for underperformance conveys no news about the division. We test these hypotheses on a sample of sell-off announcements for which we find stories in the Wall Street Journal unambiguously characterizing the division being sold as either a “winner” or a “loser”. The stock price reaction to the sell-off of losers is indistinguishable from zero while the stock price reaction to the sell-off of winners is a statistically significant 2.5%. These results are strengthened when we expand the sample to include divisions whose profitability was announced in the companys annual report. For this expanded sample, the average stock price reaction to the announcements of sell-offs of losers remains indistinguishable from zero, while returns from the sell-offs of winners average a highly significant 3.4%.

Estimating the expropriation of minority shareholders: Results from a new empirical approach

Abstract A novel methodological approach is proposed to estimate the effect of separation of ownership and control by dominant shareholders on firm value. The approach offers two major innovations. First, it frees the researcher from the necessity of having to make an ad hoc judgment call regarding which firms feature entrenched owners and which don’t. Under this approach, the main shareholder becomes entrenched when the Shapley Value (SV) of his voting rights crosses an unknown threshold that is estimated jointly with the other model parameters. This approach allows one to perform a test on the joint hypotheses that the incentive to expropriate held by the dominant shareholder impacts negatively the market performance of the firm if the main shareholder is entrenched but produces no impact otherwise. Secondly, it generates a market-based estimate of the critical level of power at which the main shareholder becomes entrenched. The method is applied to a sample of European firms and a threshold equal to 0.34 is estimated. Most firms from the UK have a main shareholder with a SV below the estimated threshold; in contrast, about half of the continental firms in the sample feature main shareholders whose power index is above the estimated threshold. A negative relationship is found between the incentive to expropriate and corporate valuation above the threshold, that is both statistically and economically significant; below the threshold, we find no evidence of a relationship.

Relative Performance, Banker Compensation, and Systemic Risk

We show that, in the presence of correlated investment opportunities across firms, risk sharing between firm shareholders and firm managers leads to compensation contracts that include relative performance evaluation. These contracts bias investment choices toward correlated investment opportunities, and thus create systemic risk. Furthermore, we show that leverage amplifies all such effects. In the context of the banking industry, we analyze recent policy recommendations for firm managerial pay and show how shareholders optimally undo the policies’ intended effects. (JEL G18, G21, G32, J33, M52)