Costa Neto, Nelson
(2012)
Essays on information asymmetry and financial institutions.
PhD thesis, London School of Economics and Political Science.
Abstract
The thesis consists of three chapters that investigate informational asymmetry mechanisms surrounding financial institutions. In the first chapter, my co-authors and I develop a theoretical model to analyse the effect of competition on the conflict of interest arising from the issuer pay compensation model of the credit rating industry. We find that relative to monopoly, rating agencies are more likely to inflate ratings under competition, resulting in lower expected welfare. These results do not depend on the presence of ratings shopping, but instead focus on the trade-off between maintaining reputation (to increase profits
in the future) and inflating ratings today (to increase current profits).
In the second chapter, I document a direct link between stock mispricing, as proxied by mutual fund flow-driven price pressure, and corporate investment. One standard deviation increase in stock price pressure leads to an increase of 1.3 percent
in investment. High price pressure firms with high investments have lower future stock returns and lower future operational performance than high price pressure firms with
low investments. Investment sensitivity to price pressure is stronger for firms that are less financially constrained, firms with high churn rates (shorter horizon) and firms with high R&D intensity (with more opaque assets). Finally, investment sensitivity to price pressure remains positive and significant for firms that do not engage in seasoned equity offerings around the investment period, suggesting there is a channel between stock price pressure and corporate investment that is independent of external financing.
The third chapter documents a pronounced market timing ability of institutional investors when it comes to selling individual stocks. Based on more than 8 million institutional trades over the period 1999 to 2009, my co-authors and I document that (i) large (block) sales of institutional investors correlate with future negative excess returns, while stock purchases do not predict positive excess returns at the stock level,(ii) the one-sided successful market timing of block liquidations is more pronounced if the block represents a larger share of the investor portfolio or/and the stock capitalization, (iii) international investors have a weaker one-sided timing ability for block liquidations. The evidence strongly supports the hypothesis that proximity of block holding investors to management provides important inside information advantages.
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