Three essays on financial economics

Gu, Lifeng

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Description

Title

Three essays on financial economics

Author(s)

Gu, Lifeng

Issue Date

2013-05-28T19:19:47Z

Director of Research (if dissertation) or Advisor (if thesis)

Dirk Hackbarth, Dirk

Doctoral Committee Chair(s)

Dirk Hackbarth, Dirk

Committee Member(s)

• Johnson, Timothy C.
• Pennacchi, George G.
• Deuskar, Prachi

Department of Study

Finance

Discipline

Finance

Degree Granting Institution

University of Illinois at Urbana-Champaign

Degree Name

Ph.D.

Degree Level

Dissertation

Keyword(s)

• Corporate governance
• Transparency
• Research and development investment
• Product market competition
• Stock returns

Abstract

My first essay, Product Market Competition, R&D Investment and Stock Returns, considers the interaction between product market competition and investment in research and development (R&D) to tackle two asset pricing puzzles: the positive R&D-return relation and the positive competition-return relation. Using a standard model of R&D return dynamics, I establish that competition and R&D investments have a strong interaction effect on stock returns. It is more likely that firms with high R&D expenditures will end up with very low returns on their ventures because rival firms win the innovation race. Because there are more potential rival firms in competitive industries, R&D intensive firms in competitive industries are riskier. Consistent with the predictions of the model, I find a robust empirical relation between R&D intensity and stock returns, but only in competitive industries. This finding suggests that the risk derived from product market competition has important asset pricing implications and potentially drives a large portion of the positive R&D-return relation. Furthermore, firms in competitive industries earn higher returns than firms in concentrated industries only among R&D-intensive firms. My second finding therefore provides a risk-based explanation for the heretofore puzzling competition premium. The second essay, Governance and Equity Prices: Does Transparency Matter?, examines how a firm's information environment and corporate governance interact. Firms with higher takeover vulnerability are associated with higher abnormal returns, but even more so if they also have higher accounting transparency. The effect is largely monotonic. It is small and insignificant cant for opaque firms and large and significant for transparent firms ,and it holds in sample splits based on firm characteristics, such as leverage or size. A portfolio that buys firms with the highest level of takeover vulnerability and shorts firms with the lowest level of takeover vulnerability--provided it includes the tercile of transparent firms as defined by the first principal component of forecast error, forecast dispersion, and revision volatility-generates a monthly abnormal return of 1.37% for value-weighted (1.28% for equal-weighted) portfolios, which is nearly twice as large as the alpha in the full sample. This result survives numerous robustness tests, and it also remains large and significant even if we extend the sample period until 2006. Hence transparency and governance (i.e., takeover vulnerability) are complements. This complementarity effect is consistent with the view that more transparent rms are more likely to be taken over, since acquirers can bid more effectively and identify synergies more precisely. The third essay, Takeover Likelihood, Firm Transparency and the Cross-Section of Returns, explores the determinants of a firm's takeover likelihood and proposes to include the firm's information environment as additional predicting variable since a transparent environment could facilitate takeovers by making it easier for bidders to value the rm and the synergy of the deal. The logit estimation including this new variable over the sample period of 1991 to 2009 produces results consistent with this view and better ts the real takeover data. The new takeover factor constructed as the return to the long-short portfolio that buys firms with top takeover probability and sells firms with bottom takeover probability better captures the variation in the cross-section of stock returns.

Graduation Semester

2013-05

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Copyright 2013 Lifeng Gu. All rights reserved.

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