Initial coin offerings are fast becoming a new type of crowdfunding for blockchain-related startups. In this type of offerings, an entrepreneur raises capital through the creation and selling of virtual currencies or “tokens,” which themselves give rights to their holders (for example, access to a platform). As is to be expected, there are severe problems of information asymmetry associated with these instruments and capital raising mechanisms, especially due to the lack of the traditional underwriting process. These challenges could lead to failures of these crowdfunding exercises. In the paper “The Wisdom of Crowds in FinTech: Evidence from Initial Coin Offerings,” Jongsub Lee, Tao Li, and Donghwa Shin investigate whether the void created by the absence of an underwriter can be filled by the “wisdom of crowds” instead, defined as the collective opinion of a group of individuals rather than that of a single expert. The authors use the weighted average of ratings issued by analysts active on a prominent rating platform to capture the wisdom of the crowds. The paper finds that favorable ratings issued by analysts with diverse backgrounds are associated with fundraising success, aggressive initial token subscriptions, and long-run returns. Interestingly, analyst ratings predict potential fraud and token-price volatility, areas of considerable interest of regulators and market participants. Put together, these results point to an important role played by online analysts to deal with information problems in blockchain-related startups. These results have implications that go beyond the initial coin offerings, since the wisdom of crowds phenomenon is becoming more pervasive among FinTech platforms.
Spotlight by Andrew Ellul
Photos courtesy of Jongsub Lee, Tao Li, Donghwa Shin
It is not just managers that can have a short-term orientation—the forthcoming theoretical paper “Competition for Flow and Short-Termism in Activism,” by Mike Burkart and Amil Dasgupta, shows that activist funds too can focus on the short term. In the model, activists add value by preventing wastage by the manager. To signal their type to their own investors, they take a short-term action such as boosting leverage to make a high payout. However, in the long term, a debt overhang problem can arise, resulting in a positive NPV project being forgone in some states. A similar dilemma comes up with other actions that boost the firm in the short term at the expense of long-term performance, such as reducing R&D expenditure. Actions by activist funds therefore exacerbate the exposure of the firm to the business cycle, with interventions in good times leading to investor payouts, and subsequent economic downturns placing the firm under greater stress. This pattern has been observed recently with some private equity financed firms, and the model applies well to hedge funds as well. The paper highlights that while activist funds have a valuable role to play in corporate governance, they may introduce their own frictions into the process, by acting as short-term investors.
Spotlight by Uday Rajan
Photos courtesy of Mike Burkart and Amil Dasgupta
First published December 11, 2020
Alexander F. Wagner
Richard J. Zeckhauser
Recent survey evidence shows that the list of institutional investors paying close attention to environmental issues, with a consequent impact on their investment decisions, is increasing. A central factor that ought to be considered is the role of government regulation, especially the uncertainty surrounding it, and subsequent response of firms to those regulations against the background of a worsening environmental scenario. This is the dimension that Stefano Ramelli, Alexander F. Wagner, Alexandre Ziegler, and Richard J. Zeckhauser, investigate in their paper “Investor Rewards to Climate Responsibility: Stock-Price Responses to the Opposite Shocks of the 2016 and 2020 U.S. Elections.” The authors argue that analysis of firms’ climate-related performance so far ignore the fact that firms differ with respect to both current environmental footprint and to climate responsibility. The latter, which includes firms’ future-oriented strategies and voluntary initiatives on the road to transitioning to a low-carbon economy, is the dimension mostly overlooked so far and the paper’s major contribution. The authors treat these two dimensions of the challenge separately and do so by exploiting stock price reactions to the shock to climate policy following the 2016 U.S. election, and the opposite shock from the 2020 election. These two political shocks provide a good laboratory to analyze the interconnections between climate regulation, firms’ climate-related performance, and firm value. The authors find that, while investors reacted to the 2016 election by rewarding carbon-intensive firms, investors also rewarded companies that showed stronger commitment to the environmental transition and climate strategies. How should one interpret these findings? The authors provide what they call the “boomerang hypothesis” as an explanation, where long-term investors expected the roll-back of climate regulation over the Trump administration to be transitory in nature and a blip against a backdrop of tightening environmental regulations as the corporate world grapples with how to achieve more ambitious greenhouse gas emissions. The evidence is consistent with the view that the Trump Administration’s expected environmental hostility may have led to higher, not lower, demand for climate-responsible firms by long-term investors.
Spotlight by Andrew Ellul
Photos courtesy of Stefano Ramelli, Alexander F. Wagner, Alexandre Ziegler, and Richard J. Zeckhauser
The Call for Papers for the 17th Annual Meeting of the Financial Research Association is now available. The conference will feature a dual submission option with RAPS and RCFS. It will take place in person, December 11-12, 2021, in Las Vegas. The submission deadline is August 31, 2021. Please see the Call for Papers for more details.
“Private Equity and the Resolution of Financial Distress” by Edith Hotchkiss, David Carl Smith, and Per Stromberg
Are managers too myopic, relative to what shareholders would want? In “Short-termism, Managerial Talent, and Firm Value,” Richard Thakor provides a theoretical model in which the answer is “no,” with a surprising twist: In the model, managers prefer long-term projects, because it allows talented managers to earn higher rents. However, to reduce managerial rents, the firm may induce a manager to invest in a short-term project, even though the long-term project has a higher NPV. In equilibrium, therefore, the firm may have a short-term orientation despite rather than because of the manager’s preferences. An interesting empirical implication is that short-termism will be observed in well-governed firms. The paper also considers competition for managers. Here, the results depend crucially on whether managerial skill is observable to the market. When skill is unobserved, one way for talented managers to reveal their type is by succeeding in a short-term project. Thus, in the initial period, firms that incentivize short-term projects attract talented managers. These tend to be small- and medium-sized firms. Once talent has been revealed, the best managers are hired away by large firms, which also invest in long-term projects.
Spotlight by Uday Rajan
Photo courtesy of Richard Thakor
First published November 30, 2020
“Disregarding the Shoulders of the Giants: Inferences from Innovation Research” by David Reeb and Wanli Zhao
Do staggered (or classified) boards harm shareholder value through entrenchment or help through stability? In a forthcoming RCFS paper, “Staggered Boards and the Value of Voting Rights,” Oğuzhan Karakaş and Mahdi Mohseni revisit this question by using a novel methodology and provide causal evidence on the entrenchment view of staggered boards. Existence of staggered boards, where only a fraction of board members is up for election in a year, has been argued to be an effective and prevalent antitakeover measure for public corporations. Analyzing the impact of staggered boards on the value of shareholder voting rights (i.e., the voting premium), this paper shows that firms with staggered boards have higher voting premiums. Authors estimate the voting premium as the price difference between the stock (i.e., voting share) and the nonvoting share that is synthesized using options, normalized by the stock price. The study reports, for example, firms destaggering their boards have a 65% decrease in their voting premium, while firms staggering their boards experience a 169% increase in their voting premium. Moreover, exploiting plausibly exogenous court rulings, the paper finds that weakening of the staggered firms leads to lower voting premiums, providing strong corroborating evidence on a causal effect. Authors argue that these findings are consistent with the entrenchment view of staggered boards, as the voting premium reflects private benefits of control and inefficiencies in managing firms. It is interesting and important to note, however, that the documented entrenchment effect varies across firms, more pronounced on mature firms and those in noncompetitive industries. Hence, one should be cautious about “one-size-fits-all” approach toward staggered boards.
Spotlight by Isil Erel
Photos courtesy of Oğuzhan Karakaş and Mahdi Mohseni
First published April 30, 2021
The 17th Annual Meeting of the Financial Research Association will feature a dual submission option with RAPS and RCFS. The deadline for paper submissions is August 31, 2021. The conference will take place December 11-12, at the Encore Hotel in Las Vegas. Submit online here.
“The Wisdom of Crowds in FinTech: Evidence from Initial Coin Offerings” by Tao Li, Donghwa Shin, and Jongsub Lee