Search

This thesis investigates the investment preferences of institutional investors in the United States (US). In the second chapter, I analyse the impact of both firm and country-level determinants of foreign institutional investment. I find that the governance quality in a foreign institutional investor's (FII) home country is a determinant of their decision to invest in the US market. My findings indicate that investors who come from countries with governance setups similar to that of the US invest more in the United States. The investment levels though, are more pronounced for countries with governance setups just below that of the US. My results are consistent with both the 'flight to quality' and 'familiarity' arguments, and help reconcile prior contradictory empirical evidence. At the firm level, I present unequivocal evidence in favour of the familiarity argument. FII domiciled in countries with high governance quality prefer to invest in US firms with high corporate governance quality. In the third chapter, I investigate the impact of the Sarbanes-Oxley Act (SOX) on foreign institutional investment in the United States. I find that, post-SOX, FII increase their equity holdings in US listed firms. This result is mainly driven by passive, non-monitoring FII, who have the most to gain from the SOX-led reduction in firm information asymmetry, and the consequent reduction in the value of private information. The enactment of SOX appears to have changed the firm-level investment preferences of FII towards firms that would not be their traditional investment targets based on prudent man rules, e.g., smaller and riskier firms. In contrast to the extant literature, which mostly documents a negative SOX effect for the US markets, my chapter provides evidence of a positive SOX effect, namely the increase in foreign investment. In the fourth chapter, I examine the effect of SOX on the relation between firm innovation and institutional ownership. I find that US firms investing in innovation attract more institutional capital post-SOX. Prior literature highlights two SOX effects that could cause this result: a decreased level of information asymmetry (direct effect) and increased market liquidity (indirect effect). My findings support the direct effect, as I find that the positive relation between innovation and institutional ownership is driven by passive and dedicated institutional investors. A reduction in firms' information asymmetry is beneficial for these investors while they gain less from increased market liquidity. Overall, my results indicate that SOX is an important policy that has strengthened the institutional investor's support for firm innovation.

This thesis empirically investigates how market mispricing affects the behaviour of investors and managers in the context of the UK stock market. The thesis provides important evidence because we need to know the consequences of the market being inefficient before we can establish how important the efficient market hypothesis is. The first empirical chapter looks at how value and glamour investors react to new financial information. Based on the predictions of the well·documented confirmation bias, the chapter hypothesizes that pessimistic value investors are more biased when processing good information since it contradicts their existing beliefs, while optimistic glamour investors are more biased -when processing bad information. In line with the hypothesis, the chapter finds that value investors under-react to good financial information but they could rationally react or over-react to bad financial information. Similarly, glamour investors are found to under-react to bad financial information and rationally react or over-react to good financial information. Being the first study that provides evidence on confirmation bias, the chapter significantly extends the behavioural finance literature. The chapter offers important insight to understand why value and glamour investors over-react to past periormance (thus cause the value premium to exist) while at the same time they may under-react to new financial information (thus makes fundamental-based trading strategies profitable). Such understanding is very important given the widespread value-glamour trading strategies and the predominance of financial information as an information channel. The second empirical chapter introduces an innovative approach to examine the effect of market mispricing on managers' investment decision. Existing evidence on the effect of market mispricing on corporate investment is subject to scepticism. In particular, Tobin's 0, the most important predictor of investment, could capture information about both iv 1 , fundamentals and non-fundamentals. It leads to vague interpretation as to which components actually drive investment. To tackle this challenge, the chapter shows that Q could be decomposed into three components capturing mispricing, investment opportunities and financial leverage. The chapter finds that after controlling for I investment opportunities, leverage and cash flows, market mispricing is indeed an important driver of corporate investment. The effect of mispricing on investment -is found . to be in line with two influential theories, namely the financing and catering channel. The innovative Q decomposition approach adds an important reinforcement to existing evidence on the effect of mispricing on real investment. Moreover, thanks to its ability to disentangle the 'noisy' information content of Q, the proposed decomposition approach could potentially pave the way for subsequent research in th is area. The third empirical chapter examines how market ove r~va l ua ti on affects managers' earnings management behaviour. Existing studies often concentrate on sho rt~t e rm accruals management (i.e. managers exe rc i s~ discretion over accounting choices and estimations) and provide evidence that over·valued firms inflate earnings to maintain high stock price. The key novelty of this chapter is the examination of long~t e rm real earnings management (i.e. managers exercise discretion over real operation decisions). The chapter finds that in the long term, highly valued firms manage earnings downwards via cutting discretionary expenses and u nde r~p roduction . Taken together with the existing evidence of short~term upward accruals management, the chapter suggests that highly valued firms pursue correcting the market in the long term but try to avoid an immediate price drop in the short term. Such explanation is a large step towards a more thorough knowledge of how highly valued firms manage earnings, a topic which is extremely important especially considering the series of collapses in the early 2000s. The chapter also offers useful insight for the boards and audit committees to better perform their duties and for investors to make more informed investment decisions.

This thesis contains three essays on investment under uncertainty. The first essay in Chapter 2 provides a theory of debt and equity commitments based on the entrepreneur's investment incentives. In this essay, we compare two fundamental ways of financing investments. The first way is to secure financing in advance (i.e., before the investment) via an investor's debt or equity commitment. The second way is to obtain financing on spot (i.e., at the time of investment). We find that the entrepreneur's choices between debt and equity, and between commitment and spot financing depend on his bargaining power and his ability to extract private benefits. The entrepreneur considers spot financing only when he has full bargaining power. He is indifferent between spot debt and equity. Spot financing is efficient, as the entrepreneur exercises his option to invest at the first-best investment threshold. The entrepreneur strictly prefers commitment financing when he does not have full bargaining power. He prefers equity commitment if he is skilled in extracting private benefits at a small dead weight cost. In this case, he invests too early and causes a reduction in firm value. Otherwise, he prefers debt commitment and invests too late and again causes a reduction in firm value. Our findings help explain the capital structure of firms at different stages in their life cycle. The second essay in Chapter 3 focuses on timing of initial public offerings (IPO) in a hot issue market. We explain why some private firms lead a hot IPO market by going public early, while others follow by delaying their IPOs until late in the same market. In our model, g60d firms go public early. at the expense of issuing underpriced shares, in order to enjoy a first-mover advantage. We find evidence for our arguments in the U.S. IPQ market. Early IPOs of a hot market are underpriced more severely on average, but they experience higher growth in sales, assets, EBITDA, and capital expenditure. Moreover, their shares outperform the market up to nine months after their issues, while those of late IPOs underperform the market from the start. The third and final essay in Chapter 4 deals with optimal venture capital contracting when an entrepreneur and a venture capitalist can both exert value-adding effort that is privately costly for them. We derive the optimal contract when the effort provided by the parties increase the project 's probability of success. The costly effort each party exerts depends on the terms of financial contract the parties sign. We compare three financial contracts: common stock, straight preferred stock, and convertible preferred stock. We find that each of these contracts can be optimal depending on the terms. We show that there are cases in which common stock is infeasible and convertible preferred stock can facilitate financing. We also discuss the inclusion of a clause that prevents the venture capitalist from converting his preferred stock in the case of failure, and argue that this clause can increase efficiency.

We study the behaviour of banking intermediaries focusing on the joint relationships among risk management, fragility and the market structure. Theoretically, we use the industrial organisation approach to analyse the relationships between banking behaviour and risk management goals and between banking behaviour and regulation effects. We develop and calibrate models to study the monopolistic competition effects on banking stability and to study the effects of asset and liability uncertainty on banking decisions. We extend such analyses to study the effects caused by portfolio restrictions and deposit interest-rate regulations on banking behaviour. Empirically, we characterise the financial and banking stylised facts associated to stable and unstable banking systems. Furthermore, we assess among competing theories and policy views regarding the relationships between banking stability and management practices, and between fragility and banking market structure. The empirical study relies on OLS regressions and random effects logit models for panel data. The dataset includes data for a sample of 47 countries during the period 1990-1997. Theoretically, we show that the optimal risk management asset allocation for banking firms depends on the banking market structure. We also show that the maximisation of long-term profits and the minimisation of financial distress are complementary and compatible management objectives. Furthermore, our findings suggest that the achievement of banking and regulatory goals may depend on the degree of competition in the banking market. Moreover, they also suggest that interest-rate instruments may be better than asset portfolio restrictions as regulatory devices. Empirically, our findings suggest that financial development is associated with market-based financial systems and non-competitive banking systems. We also provide evidence that banking competition enhances fragility. Furthermore, the analyses reject the bank-based policy view regarding the relationship between financial system and banking stability. Hence, the use of derivatives and cross-sectional risk sharing techniques might encourage stability.