M. Deniz Yavuz

Private Equity Fund Returns and Performance Persistence

Successful private equity managers have funds that are often oversubscribed and provide persistent abnormal returns. Why do not successful managers increase fund size or fees? We argue that managers want to attract high-quality entrepreneurs, while entrepreneurs want to match with high-ability managers. However, observing fund performance does not allow entrepreneurs to distinguish a manager’s ability from the quality of firms in the fund’s portfolio. As a consequence, a fund manager may devote unobserved effort to select firms, and keep fund size small to limit the cost of effort, hoping to manipulate entrepreneurs’ beliefs about his ability. JEL Classification: G24, G31

Specialization, Productivity, and Financing Constraints

We analyze financial contracting when the specificity of investments is endogenous. Specialization decreases the liquidation value of assets, but it also improves a firms long term productivity. While the first effect is known to make financing more difficult, we show that the second effect can ease financing constraints by improving an entrepreneurs incentive to pay. An entrepreneurs inability to commit to a given level of specialization introduces inefficiencies and may result in over or under specialization depending on which of the above effects dominates. The tradeoff we identify persists across various forms of specialized investments and generates new predictions. For example, we show that investment in human capital introduces a strategic incentive to specialize since entrepreneurs benefit from their investments even under liquidation.

Momentum and Reversal: Does What Goes Up Always Come Down?

The stocks in a momentum portfolio, which contribute to momentum profits, do not experience significant subsequent reversals. Conversely, stocks that do not contribute to momentum profits over the intermediate horizon exhibit subsequent reversals. Merging these separate securities into a single portfolio causes momentum and reversal patterns to appear linked. Stocks with momentum can be separated from those that exhibit reversal by sorting on size and book-to-market equity ratio. Controlling for proxies for behavioral biases, market illiquidity, and macroeconomic factors does not affect our results.

Network Prominence, Bargaining Power, and the Allocation of Value Capture Rights in Alliance Contracts

We suggest and provide empirical evidence that the bargaining power of alliance partners stemming from their prominence in alliance networks influences the ex-ante allocation of value capturing rights in high-tech alliance contracts. Network prominence can enhance the availability of alternative partners for a firm, and thereby elevates the firm’s bargaining power and enables the firm to receive i) more value capturing rights vis-a-vis its partner (i.e., more net value capturing rights) and ii) more rights to the unexpected outcomes vis-a-vis its partner. We empirically investigate the content of R&D collaboration contracts between biotech and pharmaceutical firms and show that as the prominence of the client (i.e., pharmaceutical firm) increases, it is able to attain i) more net value capturing rights to outcomes within the area of collaboration and ii) more rights to unexpected outcomes. By contrast, increased prominence of the R&D firm (i.e., biotech firm) decreases both the number of net value capturing rights the client receives as well as the rights to unexpected outcomes that the client captures in an alliance contract. The bargaining power that the R&D firm attains from its prominent position in alliance networks becomes less important during hot IPO markets, which provide the R&D firm more outside options to obtain financial resources. Hence, our paper documents that firms’ network positions can be an important source of bargaining power, contributing to the literature on strategic alliances, bargaining, and contract design.

Why Does Investor Protection Matter for the Cost of Equity

Investor protection matters for the cost of equity because it affects the redistribution of wealth from investors to other agents in the economy. This wealth redistribution shifts systematic risk to investors, which can not be eliminated by portfolio diversification or risk sharing through trade. Other country specific factors that affect output can be shared by international trade, which provides justification for the emphasis of the literature on investor protection in explaining cross-country differences in the cost of equity. The theory predicts that the effect of redistribution on the cost of equity is stronger in countries with larger GDP and higher GDP growth volatility. The empirical evidence shows that the effect of redistribution on the cost of equity is economically significant even across developed countries that are relatively well integrated to world markets. In addition, redistribution theory connects several seemingly unrelated international finance puzzles.

Outside Insiders: Does Access to Information Prior to an IPO Generate a Trading Advantage After the IPO?

We investigate whether access to information prior to an IPO generates a trading advantage after the IPO. We find that limited partners (LPs) of venture capital funds obtain high returns when they invest in newly listed stocks backed by their funds. These returns are not explained by LPs’ differing stock picking abilities, and are higher when LPs’ information advantage over the public is higher. Further, LPs’ access to information eliminates the familiarity bias that they display otherwise. Overall, access to information prior to the IPO results in a trading advantage. These findings contribute to the debate on insider trading regulations.

Keeping It in the Family: The Role of a Bank in Business Group Tunneling

We examine the role of a bank within a business group consisting of favored firms with greater owner rights, and disadvantaged firms with fewer owner rights. Our results suggest that a bank allows a family owner to tunnel wealth by offering high-yield subordinated debt to favored firms, increasing favored-firm financial revenue; while granting high-interest-rate loans to disadvantaged firms, increasing disadvantaged-firm financial expenses. Correspondingly, a sales-growth shock to the most disadvantaged group firm is met with more financial revenue for favored firms. For disadvantaged firms within family groups, there is also less investment efficiency in the presence of a bank.

Investor Protection and Asset Prices

Empirical evidence suggests that investor protection has significant effects on ownership concentration and asset prices. We develop a dynamic asset pricing model to address the empirical regularities and uncover some of the underlying mechanisms at play. Our model features a controlling shareholder who endogenously accumulates control over a firm and diverts a fraction of its output. Better investor protection decreases stock holdings of controlling shareholders, increases stock mean-returns, and increases stock return volatilities when ownership concentration is sufficiently high, consistent with the related empirical evidence. The model also predicts that better protection increases interest rates and decreases the controlling shareholders leverage.

The Effect of Inter-firm Ties on Performance in Financial Markets

The present study examines the effect of the information obtained through close inter-firm ties on the investor’s risk-adjusted returns. We suggest that there is a closely connected tie between an investor and an entrepreneurial firm if the investor is a limited partner of the entrepreneurial firm’s lead venture capital (VC) fund. We hypothesize that such closely connected ties convey credible, timely, and precise information regarding the underlying value of the entrepreneurial firm, which is especially valuable when market conditions are unfavorable and when the investor faces higher information asymmetry. Supporting our hypotheses, we show that investors with closely connected ties to entrepreneurial firms receive higher returns on their investments, and their returns are particularly high when investor sentiment is low (unfavorable market conditions) and when there is higher information asymmetry due to greater geographical distance.

State-Run Banks, Money Growth, and the Real Economy

Aggregate credit and investment growth correlate with prior money growth more strongly in economies whose banking systems are more fully state-run. Within countries, individual state-run banks’ lending correlates with prior money growth, while otherwise similar private-sector banks’ lending does not. Tests exploiting heterogeneity in likely political pressure on state-run banks associated with, e.g. central bank independence, privatizations, and election years, are consistent with a higher correlation of state-run banks’ lending with prior money growth if political pressure is stronger. These findings are consistent with a command-and-control channel of monetary stimulus transmission operating via state-run banks.Monetary policy correlates more significantly with lending by state controlled banks than by private sector banks. At the country-level, monetary policy is more significantly related to credit and fixed capital formation growth where larger fraction of the banking system is state controlled. SOE banks may thus strengthen monetary policy levers. We hypothesize that SOE bank managers are more responsive to political pressure, and thus more cooperative with monetary policy. Reverse causality scenarios and alternative explanations are rendered implausible by the bank-level results, and by tests exploiting bank privatizations, election years, economic cycles, and cross-country variation in measures of civil servants’ effectiveness and sensitivity to political pressure.