M. P. Narayanan

Motives for Takeovers: An Empirical Investigation

Three major motives have been suggested for takeovers: synergy, agency, and hubris. Existing empirical evidence is unable to clearly distinguish among these motives probably due to the simultaneous existence of all three in any sample of takeovers. This paper suggests a way of distinguishing among these competing hypotheses by looking at the correlation between target and total gains. It is argued that this correlation should be positive if synergy is the motive, negative if agency is the motive, and zero if hubris is the motive. The empirical results show that synergy is the primary motive in takeovers with positive total gains even though the evidence is consistent with the simultaneous existence of hubris in this sample. It is also found that agency is the primary motive in takeovers with negative total gains.

Debt versus Equity under Asymmetric Information

In a world of asymmetric information in which only the insiders know the quality of the firm, it is claimed that debt, even if it is risky, is more advantageous than outside equity because issuance of debt is less attractive to inferior firms. The advantage to debt arises from the fact that it can keep unprofitable firms out of the market, thus improving the average quality of firms in the market. This advantage exists even if the firms cannot be perfectly sorted in the signaling equilibrium.

Observability and the Payback Criterion

Among the enigmas of corporate finance theory that have received little attention is the puzzling use of the payback method as a capital budgeting tool. Although the payback method has many drawbacks, it is widely used in industry (see Klammer 1972; Fremgren 1973; Schall, Sundem, and Geijsback 1978).1 Gordon (1955) attempted to explain this anomaly by observing that the inverse of the payback period is an approximation for the internal rate of return. But as Sarnat and Levy (1969) point out, the accuracy of the approximation depends on the life of the project and its IRR. For low values of IRR the inverse of payback is a very poor approximation. Moreover, it is difficult to believe that corporations that use complex and sophisticated technologies need a rule of thumb to approximate something as simple to compute as the IRR. In fact, empirical evidence shows that most firms compute both the IRR and the payback period (see Schall The payback criterion continues to be widely used in industry, although there is little support for it among the academicians. This paper attempts to find an economic rationale for it by using an incentive model with asymmetric information. It argues that when the managers possess private information regarding projects selected for implementation, it is in their interest to choose, ceteris paribus, projects that pay back faster. Since managers wages depend on output (because their productivity is unknown), by choosing projects that pay back fast they hope to improve their reputations. * I wish to thank Milton Harris and an anonymous referee for their helpful suggestions, while I retain the responsibility for any remaining errors. 1. It has been found that payback is rarely used as a primary capital budgeting method. It is used as a secondary criterion to a discounted cash-flow method such as NPV (net present value) or IRR (internal rate of return).

Timing of Investment and Financial Decisions in Imperfectly Competitive Financial Markets

The authors present a model in which firms can time their projects. They show that financing and investment decisions are interrelated if financial markets are not perfectly competitive, resulting in apparent timing of financing decisions. The authors obtain the result that the proportion of equity financing relative to debt is higher when economic conditions are improving. They also show that the type of financing depends both on current and past economic conditions. Finally, the authors show that there will be relatively more equity financing in industries in which obsolescence is more likely. Copyright 1993 by University of Chicago Press.

Are Women Executives Disadvantaged

We investigate gender differences in insider trading behavior of senior corporate executives in the U.S. between 1975 and 2005. We find that, on average, both female and male executives make positive profits from insider trading, but males earn about twice as much as females; males also trade more than females. All these results also hold for the sub sample of very top executives. We are able to rule out gender differences in overconfidence and risk-aversion as sole explanations for our results. The results are consistent with the view that female executives have a disadvantage relative to males in accessing inside information

Gender Differences in Executives’ Access to Information

We provide novel evidence on gender differences in insider-trading behavior and the profitability of senior corporate executives. On average, both female and male executives make positive profits from insider trading. Males, however, earn significantly more than females in equivalent positions and also trade more than females. These gender differences disappear when we limit the sample to firms in which female trading is relatively high. Collectively, these results suggest that female executives have a disadvantage relative to males in access to inside information, even if they have equal formal status, and informal networks may play an important role in attenuating this disadvantage.

Resource Allocation in Conglomerates under Moral Hazard

This paper investigates the resource allocation decision in conglomerates under moral hazard. We consider a firm where the input factors are unknown managerial ability that is common to all divisions, capital allocated to each division, and intangible resources that the manager allocates to each division. While capital allocation across divisions is fully observable, the allocation of intangible resources is only partially observable. The divisions differ in how informative of their cash flows are about managerial ability. The manager maximizes perceived ability. In this set up, we show that divisions with more informative cash flows about the managers ability receive more than the first-best allocation of both capital and intangible resources. This allocation inefficiency results in conglomerates being valued less than a portfolio of single-segment firms. The paper shows that the diversification discount increases with the variance of informativeness, and the correlation, between the divisions. The discount decreases as the observability of the intangible resource allocation improves. The model also highlights a cost of segment reporting, namely, that it creates avenues for managers to distort their perceived ability at the expense of shareholders.

How Should Retirement Plans Be Organized

Americans have a tough time saving for their retirement. To make matters worse, the move from defined benefit (DB) to defined contribution plans (DC) over the years has required greater investor sophistication, discipline, and sound investment advice. Unfortunately, the current rules regarding investment advice for defined contribution plans do not address the two critical deficiencies of the current system, namely opacity and conflicts of interest. We propose that one-master standard be instituted along with strict transparency requirements to control the conflicts of interest and improve retirement savings advice. We also recommend that only passive, well-diversified index funds for stocks and bonds should qualify as retirement vehicles.