Vijay Yerramilli

Stronger Risk Controls, Lower Risk: Evidence from U.S. Bank Holding Companies

We construct a Risk Management Index (RMI) to measure the strength and independence of the risk management function at bank holding companies (BHCs). U.S. BHCs with higher RMI before the onset of the financial crisis have lower tail risk, lower non-performing loans, and better operating and stock return performance during the financial crisis years. Over the period 1995 to 2010, BHCs with a higher lagged RMI have lower tail risk and higher return on assets, all else equal. Overall, these results suggest that a strong and independent risk management function can curtail tail risk exposures at banks. JEL Classification: G21; G32

Why Do Firms Form New Banking Relationships

Using a large loan sample from 1990 to 2006, we examine why firms form new banking relationships. Small public firms that do not have existing relationships with large banks are more likely to form new banking relationships. On average, firms obtain higher loan amounts when they form new banking relationships, while small firms also experience an increase in sales growth, capital expenditure, leverage, analyst coverage, and public debt issuance subsequently. Our findings suggest that firms form new banking relationships to expand their access to credit and capital market services, and highlight an important cost of exclusive banking relationships.

The Effect of Decimalization on the Components of the Bid-Ask Spread

Previous empirical studies that decompose the bid-ask spread were done when securities traded in discrete price points equal to one-sixteenth or one-eighth of a dollar. These studies concluded that inventory and adverse-selection costs were economically insignificant compared to order-processing costs. Natural questions arise as to: (i) whether price discreteness allowed market makers to enjoy excess rents, thus reducing the significance of the inventory and adverse selection costs; (ii) whether discreteness decreased the traders’ incentives to gather information; or (iii) whether methodologies previously employed mis-estimated the inventory and the adverse-selection costs. We show that the recent conversion to decimal pricing results in significantly tighter spreads. However, the dollar value of spreads attributed to adverse selection and inventory costs do not change significantly. Almost all of the reduction occurs in the order-processing component. As a result, inventory and adverseselection costs now account for a significantly larger proportion of the traded spreads. A plausible explanation is that the minimum tick size constraint previously in place under fractional pricing allowed market makers to enjoy spreads that were larger than their actual costs.

Relative Values, Announcement Timing, and Shareholder Returns in Mergers and Acquisitions

We examine the endogenous timing of M&A announcements in terms of the bidders relative value (ratio of bidders equity value to targets equity value) at which the deal is announced, and how it compares with the range of relative value during a 52-week reference window preceding the announcement. Accordingly, we create a normalized relative value (NRV) measure, which takes a higher (lower) value if the bidders relative value at announcement is closer to its 52-week high (low). Even after controlling for the valuations of the bidder and target firms at announcement, we find that deals announced at high NRV are more likely to feature stock payment, have higher offer premium, are more likely to fail, and are associated with lower (higher) announcement returns for the bidding (target) firm. However, bidding firms that announce deals at high NRV earn large positive abnormal returns in the period from one year before announcement to one year after announcement. Overall, our results are consistent with the market-timing hypothesis that, at the margin, bidders strategically choose the timing of M&A announcements to exploit relative misvaluation.

Insider Ownership and Shareholder Value: Evidence from New Project Announcements

How does insider ownership affect shareholder value? We answer this question by examining how the marginal valuation of new investment projects announced by Indian firms varies with the level of insider holding in the firm, and other firm and project characteristics. We find that among projects announced by firms affiliated with business groups, announcement returns are significantly lower, and usually negative, for projects announced by firms with low insider holding. This effect is mainly driven by projects that result in either the firm or the business group diversifying into a new industry. On average, diversification projects announced by firms with low insider holding have negative announcement returns. The negative effect of low insider holding is larger in firms with high level of free cash flows. Overall, our results are consistent with insiders expropriating outside shareholders by selectively housing more (less) valuable projects in firms with high (low) insider holding.