Local Gambling Preferences and

Corporate Innovative Success

This paper is about….St. Peter’s Basilica

Steve Jobs Apple Inc.

Factors Affecting Innovations (I) Underlying

Factor Impact on Innovation Authors

CEO Overconfidence Positive Hirshleifer, Low, and

Teoh (2012) Galasso and Simcoe

(2013) Institutional Ownership Positive Aghion, Van Reenan,

and Zingales (2013)

Product Market Competition

Positive (Competitive Firms)

Negative (Laggard Firms

Aghion, Bloom, Blundell, Griffith, and

Howitt (2005)

No. of Financial Analysts Negative He and Tian (2013)

Non-Executive

Employee Stock Options

Positive

Chang, Fu, Low, and Zhang (2013)

Accounting Conservatism Negative Chang, Hilary, Kang,

and Zhang (2013)

Stock Liquidity

Negative Fang, Tian, and Tice (2013)

Banking Deregulation

Negative (Intrastate Deregulation)

Positive (Interstate Deregulation)

Chava, Oettl,

Subramanian, and Subramanian (2013)

Factors Affecting Innovations (II) Underlying

Factor Impact on Innovation Authors

Individualism Positive Gorodnichenko and Roland (2011)

Religion (CP Ratio) Positive Adhikari and Agrawal (2013)

Corporate Income Taxes

Tax Decrease: Positive

Tax Increase: Negative

Atanassove and Liu (2014)

Economic Policy Uncertainty

High Uncertainty: Negative

Bhattacharya, Hsu, Tian, and Xu (2014); Mukherjee, Singh,

and Zaldokas (2013)

Corporate Governance Positive Becker-Blease

(2011)

CEO Connections Positive Faleye, Kovacs, and

Venkateswaran (2012)

Board Friendliness

Positive

Kang, Liu, Low, and

Zhang (2012)

Hostile Take-Overs Negative Antanassove (2013); Sapra, Subramanian,

and Subramanian (2013)

Corporate Diversification

Not Necessarily Negative

Cardinal and Opler (1995)

Corporate Ownership

Concentrated Ownership: Positive Diffuse Ownership:

Negative

Francis and Smith (1995)

Characteristics of Corporate Innovations

–Large Payoff–High Probability of Failure

Geographical Variation of Corporate R&D

Top and Bottom Five States

for R&D ExpenditureTop Five

New MexicoMassachusetts

MarylandWashingtonConnecticut

Bottom Five WyomingLouisianaNevada

ArkansasOklahoma

R&D Spending and State Lotteries

NM MA MD WA CT WY OK NV LA AK0

200

400

600

Lotte

ry S

ales

per

Cap

ita

Most R&D Intensive States Least R&D Intensive States

Characteristics of Gambling Attitude

– Overstating Small Probability of Success

– Understating High Probability of Failure

In Contrast,Characteristics of Corporate Innovation

–Large Payoff–High Probability of Failure

Our Intuition is….Corporations • Not detached from local

environment• Take risk on innovation if

local residents are prone to gambling

Are Catholics more risk-taking than Protestants?

“The Higher the Catholics-to-Protestants (CP) Ratio, the Higher Gambling Attitude”

1. Kumar, Page, and Spalt (2011, JFE)• Stocks with lottery features• IPO underpricing • Employee stock option plans

2. Shu, Sulaeman, and Yeung (2012, MS)• MFs: Higher return volatilities & Higher Turnover

CP Ratio Across the United States

Source: Kumar, Page, and Spalt (JFE, 2011)

Religion and R&D

0

0.05

0.1

0.15

0.2

0.25

0.3

Catholic ratio Protestant ratio CP ratio

Religion and Patents

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

Catholic ratio Protestant ratio CP ratio

Religion and Citations

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

Catholic ratio Protestant ratio CP ratio

Major Findings Firms in high CP ratio region spend more on innovation and attain higher innovative output

Social gambling and/or Religion: More important drivers of innovative activities than CEO overconfidence

Hirshleifer, Low, and Teoh (JOF, 2012)

Overconfident CEOs achieve greater innovative success•What will happen if we

admit religion?

How to Frame Your Research Ideas

Stock Liquidity and the Value of Cash Holdings

US Corporate Cash Holdings(excl. Financials and Utilities)

Source: Sanchez and Yurdagal (2013)

US Firms with Largest Cash Holdings

1. Apple Inc.2. Microsoft Corp3. Google4. Cisco Systems Inc.5. Pfizer Inc.

Top 5 companies hold more than ¼ of corporate cash holdings. Mostly IT (1/3) and Phamaceutical (1/10) industries

US Industries with Largest (Smallest) Cash

HoldingsLargest1. Pharmaceutical Products 0.672. Electronic Equipment 0.513. Computers 0.494. Precious Metals 0.465. Business Services 0.42Smallest1. Candy and Soda 0.012. Printing and Publishing 0.026. Business Supplies 0.024. Shipping Containers 0.025. Restaurants, Hotels, Motels 0.03

Source: Dittmar and Mahrt-Smith (JFE, 2008)

Relation between Stock Liquidity and Value of

Cash Holdings

Stock Liquidity

Value of Cash

Holding

Governance Hypothesis: Positive Relation (I)

+ +

+

Stock Liquidity

Corporate Governance

Value of Cash

Holdings

Governance Hypothesis: Positive Relation (II)

1st Strand: Stock Liquidity supports Corporate Governance through Blockholders’ activities

• Threat of Intervention: Maug (1998); Norli, Ostergaard, and Schindele (2010)•Threat of Exit: Edmans (2009); Bharath, Jayaraman, and Nagar (2013); Dou, Hope, Thomas, and Zou (2014)

2nd Strand: Good Governance has positive effect on the value of cash holdings [Pinkowitz, Stulz, and Williamson 2006; Dittmar and Mahrt-Smith 2008; Fresard and Salva (2010)]

$1 Worth How Much?: Impact of Corporate Governance

Good

Governance Group

Poor Governance

Group Remarks

Pinkowitz, Stulz, and Williamson (2006, JOF)

$0.91 $0.33

32 countries Investor Protection (La Porta, Lopez-de-Selinas, Shleifer, and Vishny Index)

Dittmar and Mahrt-Smith (2007, JFE)

$0.88 $0.42

US Market

Anti-Takeover

(Gompers Ishii, and Metrick Index)

Fresard and Salvo (2010,

JFE) $1.61 $0.58

Non-US firms listed in US from

40 countries

Financial Constraints Hypothesis: Negative Relation (I)

- +

-

Stock Liquidity

FinancialConstraint

Value of Cash

Holdings

Financial Constraints Hypothesis: Negative Relation (II)

1st Strand: Stock liquidity relaxes financial constraintsthrough IPOs, SEOs, lower COC) [Baker and Stein 2004; Butler, Grullon, and Weston 2005]

2nd Strand: Value of cash is higher for financially constrained firms than unconstrained firms[Almeida, Campello and Weisbach 2004; Faulkender and Wang 2006; and Denis and Sibilkov 2010]

Corporate Governance Hypothesis is

supported, then what?

Which corporate governance channel?

The Threat of Intervention

Larger Stake

at Lower Cost

Lower Freerider Problem in Monitoring

Higher Incentive for Intervention

Balance between Blockholders and

Managers

HigherLiquidity

The effect of stock liquidity on value of cash is stronger for firms with stronger shareholder rights

The Threat of Exit

The effect of liquidity on value of cash is stronger for managers whose compensation is more sensitive to stock price

Strategic Dumping of

Shares

Downward Pressure on Share Price

Penalizing Managers

Which Governance Channel?• The Threat of Intervention

• The Threat of Exit

Shareholder Rights

Impact of Liquidity on Cash Value

Manager Compensation’s

Sensitivity to Stock Price

Impact of Liquidity on Cash Value

Anything Wrong with Breaking a Buck?

An Empirical Evaluation of NASDAQ’s$1-Minimum-Price Maintenance Criterion

34

Minimum Price Rules in US Markets

–NYSEUS$1.00 closing price–NASDAQ

US$1.00 bid-price over a 30-day period; applicable to all its three tier markets:1. Global Select Market2. Global Market (formerly NASDAQ National Market)3. Capital Market (formerly NASDAQ Small Cap Market)

The Minimum Price Rule Elsewhere

• London No• HKEx No• SGX No• ASX No• China No• Bursa Malaysia No• IDX 100 Rupiah Minimum• KRX 20% of Face Value

No for KOSDAQ

Types of NASDAQ Delistings CRSP Delisting

Code Description Number of Delistings %

550 Insufficient number of market makers 48 2.72% 551 Insufficient number of shareholders 33 1.87% 552 Price fell below acceptable level 744 42.11% 560 Insufficient capital, surplus, and/or equity 386 21.84% 561 Insufficient float or asset 543 30.73% 587 Corporate governance violation 13 0.74%

Does the Rule Make Sense?• SEC; Financial Industry Regulatory Authority (FINRA);

NASDAQ– YES• It “serves to increase investor confidence and the

credibility of (the) market” • Law firms or lawyers, issuers, securities industry related

firms– NO• “It is a dubious measure even in the best of times”

• Academic Research:– … (silence)

Major Findings • Is the $1 Rule Necessary?

Stocks traded below $1 overwhelmingly exhibit large extreme price drops than higher-priced stocks

• Does it Work?LHS fat tails of low-priced stocks are significantly thinner after the $1 rule was introduced

• Is $1 a Good Cut-off Point?One-dollar-benchmark performs better than any other price thresholds

Return Reversals, Idiosyncratic Risk, and Expected Returns

Is Idiosyncratic Risk Priced in Asset Returns? (I)

– In CAPM Framework: It shouldn’t mattera. the market is completeb. investors are rationalc. idiosyncratic risk can be diversified away

Empirical Evidence Mixed – Positive Relation: Malkiel and Xu (2002), Goyal and Santa-

Clara (2003), Jiang and Lee (2004), Fu (2005), Spiegel and Wang (2005), Chua et al. (2005)

– Fama and MacBeth (1973): Statistical significance of idiosyncratic risk is negligible

– Bali et al.(2004): Positive relation documented by Goyal and Santa-Clara (2003) is not robust

Is Idiosyncratic Risk Priced in Asset Returns? (II)

Negative Intertemporal Relation: Ang, Hodrick, Xing, and Zhang (2006a and 2006b)i. Portfolios with high idiosyncratic volatility in the current month yield lower returns in the following month.ii. This negative relation is confirmed in international markets (Canada, France, Germany, Italy, Japan, United Kingdom, US)

Major Findings• The negative relation is driven by short term

return reversals• Hence, this negative (intertemporal) relation

does not hold if return reversals are controlled • No ex ante relation is observed between

expected idiosyncratic volatility and expected returns once short-term return reversals are controlled for

Thank You for Your Attention