Ronen Israel

The Design of Bankruptcy Law: A Case for Management Bias in Bankruptcy Reorganizations

In an incomplete contracting environment, bankruptcy is considered to be a renegotiation of the firms financial contracts. An optimal bankruptcy law is derived as optimal restrictions on the environment within which the claimants to a distressed firm bargain. The law is used as a commitment device to ensure actions that are ex ante optimal but not subgame perfect. We show that the bankruptcy court can use two types of mechanisms to implement the optimal bankruptcy outcome: direct restrictions on the bargaining game between the claimants, and the use of a “restricted auction.” In both cases, the restrictions prevent the strategic use of bankruptcy by firms not in financial distress, provide for truthful revelation of information so that distress results in an ex post efficient allocation of resources, and establish a bias toward the manager in reorganizations that provides correct ex ante decision making incentives.

The Role of Shorting, Firm Size, and Time on Market Anomalies

We examine the role of shorting, firm size, and time on the profitability of size, value, and momentum strategies. We find that long positions make up almost all of size, 60% of value, and half of momentum profits. Shorting becomes less important for momentum and more important for value as firm size decreases. The value premium decreases with firm size and is weak among the largest stocks. Momentum profits, however, exhibit no reliable relation with size. These effects are robust over 86 years of US equity data and almost 40 years of data across four international equity markets and five asset classes. Variation over time and across markets of these effects is consistent with random chance. We find little evidence that size, value, and momentum returns are significantly affected by changes in trading costs or institutional and hedge fund ownership over time.

Trading Costs of Asset Pricing Anomalies

Using nearly a trillion dollars of live trading data from a large institutional money manager across 19 developed equity markets over the period 1998 to 2011, we measure the real-world transactions costs and price impact function facing an arbitrageur and apply them to size, value, momentum, and shortterm reversal strategies. We find that actual trading costs are less than a tenth as large as, and therefore the potential scale of these strategies is more than an order of magnitude larger than, previous studies suggest. Furthermore, strategies designed to reduce transactions costs can increase net returns and capacity substantially, without incurring significant style drift. Results vary across styles, with value and momentum being more scalable than size, and short-term reversals being the most constrained by trading costs. We conclude that the main anomalies to standard asset pricing models are robust, implementable, and sizeable.

Managerial Compensation and Capital Structure

We investigate the interaction between financial structure and managerial compensation and show that risky debt affects both the probability of managerial replacement and the managers wage if he is retained by the firm. Our model yields a rich set of predictions, including the following: (i) The market values of equity and debt decrease if the manager is replaced; moreover, the expected cash flow affirms that retain their managers exceeds that affirms that replace their managers, (ii) Managers affirms with risky debt outstanding are promised lower severance payments (golden parachutes) than managers affirms that do not have risky debt. (Hi) Controlling for firms size, the leverage, managerial compensation, and cash flow of firms that retain their managers are positively correlated, (iv) Controlling for the firms size, the probability of managerial turnover and firm value are negatively correlated, (v) Managerial pay‐performance sensitivity is positively correlated with leverage, expected compensation, and expected cash flows.

Optimal bankruptcy law and firm-specific investments

In this paper we characterize an optimal bankruptcy law that takes into consideration the incentives of managers to invest in firm-specific human capital. We show that the optimal bankruptcy law is biased towards the management team, and may be implemented by the use of a ‘restricted auction’ mechanism, in which creditors have the right to refuse bankruptcy, but are not allowed to bid for the firm. The bankruptcy law is needed as a commitment device to implement the optimal outcome.

Fact, Fiction and Momentum Investing

It’s been more than 20 years since the academic discovery of momentum investing, yet much confusion and debate remains regarding its efficacy and its use as a practical investment tool. In some cases “confusion and debate” is our attempting to be polite, because it is nearly impossible for informed practitioners and academics to still believe some of the myths uttered about momentum—but that impossibility is often belied by real-world statements. In this article, the authors aim to clear up much of the confusion by documenting what we know about momentum and disproving many of the often-repeated myths. They highlight 10 myths about momentum and refute them, using results from widely circulated academic papers and analysis from simple publicly available data.

The information content of equity-for-debt swaps : An investigation of analyst forecasts of firm cash flows

Abstract We demonstrate that analysts revise their forecasts of net operating income downward following the announcement of an equity-for-debt swap. Their revisions are positively correlated with the size of the stock-price reaction to the swap announcement. This evidence supports the hypothesis that announcements of equity-for-debt swaps convey information about the expected level of cash flows of the firm. We also provide evidence that this information is about transitory changes in the expected cash flows.

Fact, Fiction, and Value Investing

Value investing has been a part of the investment lexicon for at least the better part of a century. In particular the diversified systematic “value factor” or “value effect” has been studied extensively since at least the 1980s. Yet, there are still many areas of confusion about value investing. In this article we aim to clarify many of these matters, focusing in particular on the diversified systematic value strategy, but also exploring how this strategy relates to its more concentrated implementation. We highlight many points about value investing and attempt to prove or disprove each of them, referencing an extensive academic literature and performing simple tests based on easily accessible, industry-standard public data.

How Tax Efficient are Equity Styles

We examine the after-tax returns and tax efficiency of Size, Value, Growth, and Momentum equity styles. Examining portfolios commonly used in the literature and practice we find that Value and Momentum have the highest tax exposures, but continue to outperform the market on an after-tax basis. Momentum and Value face similar tax rates, despite Momentum having five times the turnover of Value, because Value is exposed to high dividend income, while Momentum’s exposure is primarily capital gains. We then construct tax optimized portfolios to assess how taxes can be improved within each style. We find that managing capital gains incurs less tracking error than avoiding dividend income. Hence, optimal tax trading improves capital gain-heavy styles such as Momentum without incurring significant style drift, while income-heavy styles such as Value are more difficult to improve. Tax optimization, therefore, further increases the after-tax outperformance of Momentum relative to Value and Growth.

Managerial incentives and financial signaling in product market competition

This paper demonstrates how management compensation schemes can serve as an inexpensive and sometimes even free signaling mechanism. In the particular example studied here it is shown how a contract offered to the manager of a monopolistic tirm may induce him to take some actions that will credibly signal the Crm’s marginal cost and will deter entry if the firm is ‘suficiently’ ellicient. This signaling mechanism is not costly to the monopolist and therefore, it may prefer this mechanism to the costlier ‘limit pricing’ one.