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TopRalph M. Kurtz Chair in Finance
Department of Finance
The Ohio State University
740A Fisher Hall
2100 Neil Avenue
Columbus, Ohio 43210
Secretary: Kathy
Zwanziger (614)292-8202
Phone: (614) 292-5174
Fax: (614) 292-2418
E-mail: hirshleifer_2@cob.osu.edu
Home Page | Working Paper List on SSRN | Department of Finance | Fisher Business School | The Ohio State University
Takeovers and Corporate Control | Risk Management and Futures Markets |Psychology and Markets |
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Expository Writing | Evolution of Cooperation | Industrial Organization |
Takeovers and Corporate Control
Do Takeovers Create Value? New Methods and Evidence
Journal of Financial Economics, forthcoming
Sanjai Bhagat Ming Dong David Hirshleifer Robert Noah
We develop the Probability Scaling Method, which rescales short-window announcement period returns; and the Intervention Method, which uses returns associated with intervening events, to estimate value improvements from tender offers. These methods address biases in conventional techniques, which measure only a fraction of the total tender offer gain; and which include revelation about bidder stand-alone value. Perceived value improvements are much larger than traditional methods indicate, so that we cannot reject the hypothesis that bidders on average pay fair prices for targets. Furthermore, our new methods affect inferences about economic forces in the takeover market. We identify several effects (higher combined bidder-target stock returns for hostile offers, lower for equity offers, and lower for diversifying offers) that reflect differences in revelation about stand-alone value, not gains from combination.
Does Investor Misvaluation Drive the Takeover Market?
September 2003
Journal of Finance, forthcoming
Ming Dong David Hirshleifer Scott Richardson Siew Hong Teoh
This
paper tests the hypothesis that irrational market misvaluation affects firms'
takeover behavior. We employ two contemporaneous proxies for market misvaluation,
pre-takeover book/price ratios and pre-takeover ratios of residual income model
value to price. Misvaluation of bidders and targets influences the means of
payment chosen, the mode of acquisition, the premia paid, target hostility to
the offer, the likelihood of offer success, and bidder and target announcement
period stock returns. The evidence is broadly supportive of the misvaluation
hypothesis.
A
Theory of Costly Sequential Bidding
July 1998
University of Michigan Business School Working Paper No. 98028
Kent Daniel David Hirshleifer
We propose a model of sequential bidding for a valuable object, such as a takeover target, when it is costly submit or revise a bid. An implication of the model is that bidding occurs in repeated jumps, a pattern that is consistent with certain types of natural auctions such as takeover contests. The jumps in bid communicate bidders' information rapidly, leading to contests that are completed with a small number of bids. The model provides several new results concerning revenue and efficiency relationships between different auctions, and provides an information-based interpretation of delays in bidding.
Corporate Control through Board Dismissals and Takeovers
Journal of Economics and Management Strategy Volume: 7, Issue: 4, Winter 1998: 489-520.
David Hirshleifer Anjan Thakor
This paper examines some policy issues related to the interaction between internal and external corporate control mechanisms--board dismissals and takeovers--by focusing on the information aggregation and other effects related to this interaction. We model the functioning of corporate control mechanisms as an example of a multilayered principal-agent relationship in which shareholders delegate the task of monitoring management quality to the board and rely on the external takeover market to provide additional disciplining of the manager as well as of the board. This gives rise to two effects: (1) a substitution effect, whereby the takeover market partially substitutes for board dismissal of the manager, leading to greater lenience toward the manager by a board acting in the shareholders' best interest, and (2) a kick-in-the-pants effect, whereby the board is stricter with the manager because it may be dismissed by a successful acquirer who views it as lax. The interaction of these two effects leads to various implications about the behavior of boards and potential acquirers. In particular, a well-functioning internal control mechanism (the board) does not obviate the need for external control (takeovers). Moreover, somewhat counterintuitively, there may be a greater incidence of takeovers when the internal control mechanism is working well than when it is not.
Mergers and Acquisitions: Strategic and Informational Issue
Finance, Volume 9, North Holland Handbooks in Operations Research and Management Science, 1995, ch. 26, pp. 839-887.
David Hirshleifer
This essay describes the relationships between different models of the takeover process, and where possible provides analytical syntheses to integrate major trends in the literature. I focus mainly on three types of models: (1) models of tender offers, which examine the decisions of individual shareholders whether to tender (sell) their shares to a bidder, (2) models of competition among multiple bidders, and (3) models that examine the voting power of target managers who own shares.
Managerial Performance, Boards of Directors and Takeover Bidding
Journal of Corporate Finance Volume: 1, Issue: 1, March 1994. pp. 63-90.
David Hirshleifer Anjan V. Thakor
This paper models the maintenance of management quality through
the simultaneous functioning of internal and external corporate control mechanisms--board
dismissals and takeovers. We examine how the information sets of the board and
the acquiror are noisily aggregated, and how this affects the behavior of the
board and the acquiror. The board of directors, acting in shareholders' interests,
will sometimes oppose a takeover, and this opposition can be good news for the
firm. An unsuccessful takeover attempt may be followed by a high rate of management
turnover, because a takeover attempt conveys adverse information possessed by
the bidder about the manager. If there is a probability that the board is ineffective,
then a forced resignation of the manager can be either good or bad news for
the firm. A positive effect is predicted to dominate when there is more adverse
public information available about the manager's performance and when there
is a higher ex ante probability that the board is ineffective, for example,
if the board is management-dominated rather than outsider-dominated.
Takeovers
The New Palgrave Dictionary of Money and Finance, 1993
David Hirshleifer
This essay reviews a number of issues about
takeovers, including the reasons for and the consequences of takeovers, the
pitfalls in estimating takeover gains, the effects of different takeover
mechanisms, that of managerial resistance and the means of payments, and the
role of debt and managerial share ownership. It explains the average high stock
returns of the targets and low returns of the bidders during the transaction
period in the U.S. takeover market. It also analyzes the wealth distribution
between different stakeholders and the effects of the regulation during the
takeover process on the outcome of the takeover. (Abstract by Danling Jiang and
David Hirshleifer)
Control Corporativo y Posiciones Mayoritarias [Corporate Control and Takeovers]
Cuadernos Economicos de ICE, Vol. 50, No. 1, 1992:. 175-201.
David Hirshleifer
This essay addresses some salient issues associated
with corporate control. First, what determines the distribution of insider and
outsider share ownership in the firm, and how does this distribution affect
corporate performance? Second, how effective are board dismissals, proxy fights
and takeovers as alternative corporate control mechanisms? Third, how do these
alternative mechanisms interact, and what are the resulting incentives for boards
of directors, managers, and takeover bidders? Fourth, do takeovers change underlying
value, or do they merely redistribute wealth between affected parties? Finally,
what explains the changes in supervision by boards of directors and through
takeovers that occur over time?
Share Tendering Strategies and the Success of Hostile Takeover Bids
The Journal of Political Economy, Vol. 98, No. 2., Apr. 1990: 295-324.
David Hirshleifer Sheridan Titman
This paper presents a model of tender offers in which the bid perfectly reveals the bidder's private information about the size of the value improvement that can be generated by a takeover. We argue that bidders with greater improvements will offer higher premia to ensure that sufficient shares are tendered to obtain control. The model relates announcement date returns and takeover success or failure to the amount bid, the initial shareholdings of the bidder, the number of shares the bidder attempts to purchase, the dilution of minority shareholders, and managerial opposition. We show that managerial defensive measures will sometimes increase the probability of the offer's success, either by raising the incentive to bid high or by decreasing the asymmetry of information about the improvement.
Facilitation of Competing Bids and the Price of a Takeover Target
The Review of Financial Studies, Vol. 2, No. 4, 1989: 587-606.
David Hirshleifer I. P. L. Png
We present a model of corporate acquisitions in which initially uninformed bidders must incur costs to learn their (independent) valuations of a potential takeover target. The first bidder makes either a preemptive bid that will deter the second bidder from investigating or a lower bid that will induce the second bidder to investigate and possibly compete. We show that the expected price of the target may be higher when the first bidder makes a deterring bid than when there is competitive bidding. Hence, by weakening the first bidder's incentive to choose a preemptive bid, regulatory and management policies to assist competing bidders may reduce both the expected takeover price and social welfare.
Risk Management and Futures Markets
Futures Versus Share Contracting as Means of Diversifying Output Risk
The Economic Journal, Vol. 103, No. 418, May 1993: 620-638.
David Hirshleifer Avanidhar Subrahmanyam
Two means by which commodity producers can reduce their exposure to quantity risk are share contracting and futures hedging. This paper explains the coexistence of these arrangements by showing that these will normally be complementary means of transferring risk. Share contracting by a purchaser with many producers can help diversify imperfectly correlated quantity risks. Futures contracts, on the other hand, hedge the systematic but not the idiosyncratic components of output risk. Thus, futures hedging helps to ameliorate the main disadvantage of multiple share contracting, an excessive loading of systematic risk on the purchaser.
Seasonal Patterns of Futures Hedging and the Resolution of Output Uncertainty
Journal of Economic Theory, 3(2), April 1991:304-27.
David Hirshleifer
Optimal futures hedging is examined in a two-good model with stochastic output and sequential information arrival. A producer's optimal hedge depends on demand elasticity, sensitivity of his output to weather, his correlation with aggregate output, and how rapidly his output uncertainty is resolved relative to other producers during different seasonal periods. Because regional output uncertainties are resolved at different times, the optimal futures position of a grower will commonly reverse in direction during the crop year. A producer with non-stochastic output who faces price risk arising from demand shocks may remain unhedged or even maintain a long position.
Hedging Pressure and Futures Price Movements in a General Equilibrium Model
Econometrica, Vol. 58, No. 2, Mar. 1990: 411-428.
David Hirshleifer
Optimal futures hedging and equilibrium futures price bias are examined in a model characterized by two consumption goods, one of which has stochastically varying output, and where information arrives sequentially. Positive (negative) complementarity in consumer preferences promotes downward (upward) bias in the futures price viewed as a predictor of the later spot price. I demonstrate that the conclusion derived from partial equilibrium analysis--that when speculators are risk averse, risk premia are a function of hedging pressure--fails in the general equilibrium analysis, so long as there are no transaction costs. A counterexample is analyzed in which, as consumers' additive logarithmic preferences are varied, producers' hedging positions change from long to short, while the futures risk premium remains unchanged. However, hedging pressure is reinstated as a force influencing risk premia in the sense that the futures price is downward biased when hedgers take short positions and is upward biased when hedgers take long positions, provided it can be assumed (as is usually valid) that fixed setup costs of trading deter consumers more than producers from participating in the futures market.
Determinants of Hedging and Risk Premia in Commodity Futures Markets
The Journal of Financial and Quantitative Analysis, Vol. 24, No. 3., Sep. 1989: 313-331.
David Hirshleifer
This paper examines the determinants of commodity futures hedging and of risk premia arising from covariation of the futures price with stock market returns, and with the revenues of producers. Owing to supply shocks that stochastically redistribute real wealth (surplus) between producers and consumers, and to limited participation in the futures market, the total risk premium in the model is not proportional to the contract's covariance with aggregate consumption. Stock market variability interacts with the incentive to hedge, causing the producer hedging component of the risk premium to increase (decrease) with income elasticity, for a normal (inferior) good. Production costs that depend on output raise the premium. We argue that output and demand shocks will typically be positively correlated, raising the premium. High supply elasticity reduces the absolute hedging premium by reducing the variability of spot price and revenue.
Futures Trading, Storage, and the Division of Risk: A Multiperiod Analysis
The Economic Journal, Vol. 99, No. 397, Sep. 1989: 700-719.
David Hirshleifer
This paper analyzes the interaction of storage and futures trading when producers make decisions covering many harvests. In this more general context, by examining how risks are distributed between storers and growers, results are obtained that differ dramatically from previous models in the literature. When storage is costly, storers may reduce risk by taking long hedging positions, rather than selling inventories short. Contrary to the conventional view (in a tradition beginning with J. M. Keynes and J. R. Hicks), costless storage does not imply downward bias of futures prices (" normal backwardation"). Hedging against the optimally varying planting costs promotes upward price bias (" contango"), while hedging against storage costs to be incurred promotes downward bias. When the risks faced by growers and storers are negatively correlated, futures trading can substitute for vertical integration as a means of reducing risk.
Risk, Futures Pricing, and the Organization of Production in Commodity Markets
The Journal of Political Economy, Vol. 96, No. 6, Dec. 1988: 1206-1220.
David Hirshleifer
This paper examines equilibrium in a spot and futures market with both primary producers (growers) and intermediate producers (processors). For a commodity that is subject to output shocks, processors tend to hedge long, in contrast with Hick's theory of futures hedging. Nevertheless, if transaction costs are low, the two-stage production process brings about a downward futures price bias, consistent with Hick's pricing prediction. But if costs of trading futures are high, growers tend to be differentially driven from the futures market, reversing the direction of the bias. Futures trading may also affect the organization of industry; when demand is inelastic, futures trading can serve as a substitute for vertical integration as a means of diversifying risk because the risk positions of growers are complementary with those of processors.
Residual Risk, Trading Costs, and Commodity Futures Risk Premia
The Review of Financial Studies, Vol. 1, No. 2, Summer 1988: 173-193.
David Hirshleifer
Trading costs, in the form either of explicit charges or of the costs of becoming informed, limit the participation of some classes of traders in commodity futures markets. When speculators face a fixed cost of participating in a futures market that is used by commodity producers to hedge their stochastic revenues, the futures risk premium deviated from the perfect markets prediction. The deviation rises in absolute value with the square root of the trading cost and with the standard deviation of residual returns, and it is unrelated to the covariance of the futures price with producers' nonmarketable wealths. The residual-risk premium depends not on the total magnitude of the risk that producers hedge (i.e., aggregate revenue variance), but on the variability of their revenue relative to its mean (i.e., the coefficient of variation). Hence, even a commodity that constitutes a minor fraction of aggregate consumption may have a large premium for residual risk if the revenue derived from it has a large coefficient of variation.
Do Investors Overvalue Firms with Bloated Balance Sheets?
February 2004
Dice Center Working Paper Series 2003-10
David Hirshleifer Kewei Hou Siew Hong Teoh Yinglei Zhang
This paper examines whether market prices fully reflect the information contained in the level of net operating assets about the long-term sustainability of the firm' financial performance. In our 1964-2002 sample, the ratio of net operating assets to beginning total assets (NOA) is a strong negative predictor for at least three years of future stock returns. Predictability is robust with respect to the use of a characteristic portfolio benchmark matching procedure, Fama-French 3 and 4-factor benchmarks, and Fama-MacBeth crosssectional monthly regressions using an extensive set of controls for pricing anomalies in the finance literature (market value, the book-to-market ratio, and one-month, 12-month, and 3-year past stock returns). Furthermore, the sustainability effect remains after controlling for current and past period operating accruals and the most recent change in net operating assets, and provides higher and statistically more significant hedge profits than the operating accruals anomaly. Controlling for NOA weakens but does not entirely subsume the operating accruals anomaly. A Fama-MacBeth Mishkin test suggests that investors fail to take into account the adverse information contained in NOA about future earnings.
Feedback and the Success of Irrational Investors
Journal of Financial Economics, forthcoming
David Hirshleifer Avanidhar Subrahmanyam Sheridan Titman
We provide a model in which irrational investors trade based upon considerations that are not inherently related to fundamentals. However, because trading activity affects market prices, and because of feedback from security prices to cash flows, the irrational trades influence under-lying cash flows. As a result, irrational investors can, in some situations, learn positive expected profits. These expected profits are not market compensation for bearing risk, and can exceed the expected profits of rational informed investors. The trades of irrational investors can distort real investment choices and lower ex ante firm values, even though stocks prices follow a random walk.
Deception and Self-Deception in Capital Markets
Chapter in forthcoming book, Deception in Markets, Caroline Gerschlager, Ed., Palgrave Macmillan/U.K.
Joshua Coval David Hirshleifer Siew Hong Teoh
We argue that self-deception underlies various aspects of the behavior of investors and of prices in capital markets. We examine the implications of self-deception for investor overconfidence, and how firms and financial institutions can exploit the overconfidence of investors in a predatory fashion. These ideas link self-deception to deception by others. We also examine how investor self-deception and overconfidence can affect financial reporting and disclosure policy.
Good Day Sunshine: Stock Returns and the Weather
Journal of Finance, June 2003: 1009-1032.
David Hirshleifer Tyler Shumway
Psychological evidence and casual intuition predict that sunny
weather is associated with upbeat mood. This paper examines the relation between
whether a day is sunny and stock returns that day at 26 stock exchanges internationally
from 1982-97. We find that sunshine is strongly positively correlated with daily
stock returns. After controlling for sunshine, other weather conditions such
as rain and snow are unrelated to returns. If transactions costs are assumed
to be minor, it is possible to trade profitably on the weather. Our results
are difficult to reconcile with fully rational price-setting.
Limited Attention, Information Disclosure, and Financial Reporting
Journal of Accounting and Economics, 36(1-3), December 2003: 337-386.
David Hirshleifer Siew Hong Teoh
This paper models firms' choices between alternative means of
presenting information, and the effects of different presentations on market
prices when investors have limited attention and processing power. In a market
equilibrium with partially attentive investors, we examine the effects of alternative:
levels of discretion in pro forma earnings disclosure, methods of accounting
for employee option compensation, and degrees of aggregation in reporting. We
derive empirical implications relating pro forma adjustments, option compensation,
the growth, persistence, and informativeness of earnings, short-run managerial
incentives, and other firm characteristics to stock price reactions, misvaluation,
long-run abnormal returns, and corporate decisions.
Can Individual Investors Beat the Market?
September 2005
Dice Center Working Paper Series 2003-5
Joshua Coval David Hirshleifer Tyler Shumway
We document strong persistence in
the performance of trades of individual investors. The correlation of the
risk-adjusted performance of an individual across sample periods is about 10
percent. Investors classified in the top performance decile in the first half of
our sample subsequently outperform those in the bottom decile by about 8 percent
per year. Strategies long in firms purchased by previously successful investors
and short in firms purchased by previously unsuccessful investors earn abnormal
returns of 5 basis points per day. These returns are not confined to small
stocks nor to stocks in which the investors are likely to have inside
information. Our results suggest that skillful individual investors exploit
market inefficiencies to earn abnormal profits, above and beyond any profits
available from well-known strategies based upon size, value, or momentum.
Does Investor Misvaluation Drive the Takeover Market?
September 2003
Journal of Finance, forthcoming
Ming Dong David Hirshleifer Scott Richardson Siew Hong Teoh
This
paper tests the hypothesis that irrational market misvaluation affects firms'
takeover behavior. We employ two contemporaneous proxies for market misvaluation,
pre-takeover book/price ratios and pre-takeover ratios of residual income model
value to price. Misvaluation of bidders and targets influences the means of
payment chosen, the mode of acquisition, the premia paid, target hostility to
the offer, the likelihood of offer success, and bidder and target announcement
period stock returns. The evidence is broadly supportive of the misvaluation
hypothesis.
Do Individual Investors Drive Post-Earnings Announcement Drift?
March 2003
Dice Center Working Paper Series 2002-2
David Hirshleifer James N. Myers Linda A. Myers Siew Hong Teoh
This study examines how individual investor trade in response to quarterly earnings surprises and the relation of trades to subsequent returns. Individuals are highly significant net buyers after negative earnings surprises; net buying is weaker after positive surprises. There is no indication that trading by any of our investor sub-categories explains the concentration of drift at subsequent earnings announcement dates. Post-announcement individual net buying is a significant negative predictor of stock returns over the next three quarters. However, individual investor trading fails to subsume any of the power of earnings surprises to predict future abnormal returns. Overall, the evidence does not support the hypothesis that individual investors drive post-earnings announcement drift.
An Economic Approach to the Psychology of Change: Amnesia, Inertia, and Impulsiveness
Journal of Economics and Management Strategy, 11(3), Fall 2002: 379-421.
David Hirshleifer Ivo Welch
This paper models how imperfect memory affects the optimal continuity
of policies. We examine the choices of a player (individual or firm) who observes
previous actions but cannot remember the rationale for these actions. In a stable
environment, the player optimally responds to memory loss with excess inertia,
defined as a higher probability of following old policies than would occur under
full recall. In a volatile environment, the player can exhibit excess impulsiveness
(i.e., be more prone to follow new information signals). The model provides
a memory-loss explanation for some documented psychological biases, implies
that inertia and organizational routines should be more important in stable
environments than in volatile ones, and provides other empirical implications
relating memory and environmental variables to the continuity of decisions.
Sidelined Investors, Trading-Generated News, and Security Returns
Review of Financial Studies, 15(2), 2002: 615-648.
H. Henry Cao Joshua D. Coval David Hirshleifer
This paper studies information blockages and the asymmetric release of information in a security market with fixed setup costs of trading. In this setting, 'sidelined' investors may delay trading until price movements validate their private signals. Trading thereby internally generates the arrival of further news to the market. This leads to 1) negative skewness following price runups and positive skewness following price rundowns (even though the model is ex ante symmetric), 2) a lack of correspondence between large price changes and the arrival of external information, and 3) increases in volatility following large price changes.
Disclosure to an Audience with Limited Attention
October 2004
Dice Center Working Paper Series 2002-3
David Hirshleifer Seongyeon Lim Siew Hong Teoh
In our model, informed players decide whether or not to disclose, and observers allocate attention among disclosed signals, and toward reasoning through the implications of a failure to disclose. In equilibrium disclosure is incomplete, and observers are unrealistically optimistic. Nevertheless, regulation requiring greater disclosure can reduce observers? belief accuracies and welfare. A stronger tendency to neglect disclosed signals increases disclosure, whereas a stronger tendency to neglect failures to disclose reduces disclosure. Observer beliefs are influenced by the salience of disclosed signals, and disclosure in one arena can crowd out disclosure in other fundamentally unrelated arenas.
Investor Psychology in Capital Markets: Evidence and Policy Implications
Journal of Monetary Economics Volume: 49, Issue: 1, January, 2002. pp. 139-209.
Kent Daniel David Hirshleifer Siew Hong Teoh
We review extensive evidence about how psychological biases affect investor behavior and prices. Systematic mispricing probably causes substantial resource misallocation. We argue that limited attention and overconfidence cause investor credulity about the strategic incentives of informed market participants. However, individuals as political participants remain subject to the biases and self-interest they exhibit in private settings. Indeed, correcting contemporaneous market pricing errors is probably not government’s relative advantage. Government and private planners should establish rules and procedures ex ante to improve choices and efficiency, including disclosure, reporting, advertising, and default-option-setting regulations. Especially, government should avoid actions that exacerbate investor biases.
Investor Psychology and Asset Pricing
The Journal of Finance Volume: 56, Issue: 4, August 2001. pp. 1533-1597.
David Hirshleifer
The basic paradigm of asset pricing is in vibrant flux. The purely rational approach is being subsumed by a broader approach based upon the psychology of investors. In this approach, security expected returns are determined by both risk and misvaluation. This survey sketches a framework for understanding decision biases, evaluates the a priori arguments and the capital market evidence bearing on the importance of investor psychology for security prices, and reviews recent models.
Overconfidence, Arbitrage, and Equilibrium Asset Pricing
(formerly entitled, "Covariance Risk, Mispricing, and the Cross Section of Security Returns")
The Journal of Finance Volume: 56, Issue: 3, June 2001. pp. 921-965.
Kent D. Daniel David Hirshleifer Avanidhar Subrahmanyam
This paper offers a model in which asset prices reflect both covariance risk and misperceptions of firmsapos prospects, and in which arbitrageurs trade against mispricing. In equilibrium, expected returns are linearly related to both risk and mispricing measures (e.g., fundamental/price ratios). With many securities, mispricing of idiosyncratic value components diminishes but systematic mispricing does not. The theory offers untested empirical implications about volume, volatility, fundamental/price ratios, and mean returns, and is consistent with several empirical findings. These include the ability of fundamental/price ratios and market value to forecast returns, and the domination of beta by these variables in some studies.
On the Survival of Overconfident Traders in a Competitive Securities Market
Journal of Financial Markets Volume: 4, Issue: 1, January, 2001. pp. 73-84.
David Hirshleifer Guo Ying Luo
Recent research has proposed several ways in which overconfident
traders can persist in competition with rational traders. This paper offers
an additional reason: overconfident traders do better than purely rational traders
at exploiting mispricing caused by liquidity or noise traders. We examine both
the static profitability of overconfident versus rational trading strategies,
and the dynamic evolution of a population of overconfident, rational and noise
traders. Replication of overconfident and rational types is assumed to be increasing
in the recent profitability of their strategies. The main result is that the
long-run steady-state equilibrium always involves overconfident traders as a
substantial positive fraction of the population.
Using Psychology to Predict Market Moves
Optimus, January, 2001, pp. 34-35.
David Hirshleifer Siew Hong Teoh
Abstract not yet available
Investor Psychology and Security Market Under- and Overreactions
The Journal of Finance, Volume: 53, Issue: 6, December 1998:. 1839-1885.
Kent Daniel David Hirshleifer Avanidhar Subrahmanyam
We propose a theory of securities market under- and overreactions based on two well-known psychological biases: investor overconfidence about the precision of private information; and biased self-attribution, which causes asymmetric shifts in investors' confidence as a function of their investment outcomes. We show that overconfidence implies negative long-lag autocorrelations, excess volatility, and, when managerial actions are correlated with stock mispricing, public-event-based return predictability. Biased self-attribution adds positive short-lag autocorrelations ("momentum"), short-run earnings "drift," but negative correlation between future returns and long-term past stock market and accounting performance. The theory also offers several untested implications and implications for corporate financial policy.
Social Influence and Informational Cascades
Information Cascades and Observational Learning
Draft entry written for The New Palgrave Dictionary of Economics 2nd Edition
Sushil Bikhchandani David Hirshleifer Ivo Welch
An information cascade occurs when it is optimal for an individual, having observed the actions and possibly payoffs of those ahead of him, to take the same action regardless of his own information. When there are informational cascades, society may reap only a modest fraction of the potential gains from aggregating the diverse information of many individuals. As a result, information cascades can help explain some otherwise puzzling aspects of human and animal behavior. For example, why do individuals tend to converge on similar behavior? Why is mass behavior prone to error and fads? We suggest that the theory of observational learning, and particularly of information cascades, has much to offer economics and other social sciences.
Herding and Cascading in Capital Markets: A Review and Synthesis
European Financial Management, 9(1), March 2003: 25-66.
David Hirshleifer Siew Hong Teoh
We review theory and evidence relating to herd behavior, payoff and reputational interactions, social learning and informational cascades in capital markets. We offer a simple taxonomy of effects and evaluate how alternative theories may help explain evidence on the behavior of investors, firms and analysts. We consider both incentives for parties to engage in herding or cascading and the incentives for parties to protect against or take advantage of herding or cascading by others.
Taking the Road Less Traveled: Does Conversation Eradicate Pernicious Cascades?
(Formerly entitled, "Conversation, Observational Learning, and Informational Cascades ".)
June 2002
Dice Center Working Paper Series 2002-8
H. Henry Cao David Hirshleifer
We offer a model in which sequences of individuals often converge upon poor decisions and are prone to fads, despite being able to communicate both past payoff outcomes and the private signals underlying past choices. This reflects direct and indirect action-based informational externalities; and conversational externalities-the failure of individuals to take into account the benefits their conversations confer upon later individuals. In contrast with previous cascades literature, cascades here are spontaneously dislodged and in general have a probability less than one of lasting forever. Furthermore, the ability of individuals to communicate can reduce average decision accuracy and welfare.
Learning from the Behavior of Others: Conformity, Fads, and Informational Cascades
The Journal of Economic Perspectives, Vol. 12, No. 3. Summer 1998:. 151-170.
Sushil Bikhchandani David Hirshleifer Ivo Welch
Learning by observing the past decisions of others
can help explain some otherwise puzzling phenomena about human behavior. For
example, why do people tend to converge on similar behavior? Why is mass behavior
prone to error and fads? The authors argue that the theory of observational
learning, and particularly of informational cascades, has much to offer economics,
business strategy, political science, and the study of criminal behavior.
Informational Cascades and Social Conventions
The New Palgrave Dictionary of Economics and the Law, May 1998, 23 pp.
David Hirshleifer
This entry reviews how the theory of informational cascades (in which an individual’s action is independent of his private information signal) explains the conformity, idiosyncrasy, and fragility of social behavior. It considers the effects on social outcomes of fashion leaders and of the public release of information. The entry further discusses the implications of informational cascades in various contexts, including fads, finance, medical practice, peer influence, politics, scientific theory, stigma, and zoology.
The Blind Leading the Blind: Social Influence, Fads and Informational Cascades
Chapter 12 in The New Economics of Human Behaviour, Ierulli, K. and Tommasi, M. eds.; Cambridge University Press,(1995:188-215).
David Hirshleifer
An informational cascade occurs when it is optimal for an individual, having observed the actions of those ahead of him, to hollow the behavior of the preceding person without regard to his own information. Among the phenomena that can be explained by informational cascades are conformism at specific times and places, error-prone behavior, and fragility of behaviors.
Security Analysis and Trading Patterns when Some Investors Receive Information Before Others
The Journal of Finance, Vol. 49, No. 5. Dec. 1994:. 1665-1698.
David Hirshleifer Avanidhar Subrahmanyam Sheridan Titman
In existing models of information acquisition, all informed investors receive their information at the same time. This article analyzes trading behavior and equilibrium information acquisition when some investors receive common private information before others. The model implies that, under some conditions, investors will focus only on a subset of securities ("herding"), while neglecting other securities with identical exogenous characteristics. In addition, the model is consistent with empirical correlations that are suggestive of oft-cited trading strategies such as profit taking (short-term position reversal) and following the leader (mimicking earlier trades).
A Theory of Fads, Fashion, Custom, and Cultural Change as Informational Cascades
The Journal of Political Economy, Vol. 100, No. 5. Oct. 1992:. 992-1026.
Sushil Bikhchandani David Hirshleifer Ivo Welch
An informational cascade occurs when it is optimal for an individual, having observed the actions of those ahead of him, to follow the behavior of the preceding individual without regard to his own information. We argue that localized conformity of behavior and the fragility of mass behaviors can be explained by informational cascades.
Firm and Managerial Incentives to Manipulate the Timing of Project Resolution
March 2001
Dice Center Working Paper Series 2001-4
David Hirshleifer Tarun Chordia Seongyeon Lim
A manager who wants to be viewed favorably has an incentive to advance or delay the arrival of information about his firm's profitability. In the model, a high ability manager tries to advance resolution of a likely-favorable outcome, while a low ability manager may defer resolution. Such manipulation of information arrival causes greater investment in execution projects (which tend to resolve early) than exploratory projects (which tend to resolve late), and affects investment in hastening or retarding project resolution. In contrast with previous literature, in some cases managers may secretly overinvest. The model offers empirical implications about innovative versus conventional investments, associated stock price reactions, and corporate control. The theory also implies a perverse sorting of high ability managers to conventional activities and low ability managers to visionary enterprises.
Managerial Performance, Boards of Directors and Takeover Bidding
Journal of Corporate Finance Volume: 1, Issue: 1, March 1994. pp. 63-90.
David Hirshleifer Anjan V. Thakor
This paper models the maintenance of management quality through
the simultaneous functioning of internal and external corporate control mechanisms--board
dismissals and takeovers. We examine how the information sets of the board and
the acquiror are noisily aggregated, and how this affects the behavior of the
board and the acquiror. The board of directors, acting in shareholders' interests,
will sometimes oppose a takeover, and this opposition can be good news for the
firm. An unsuccessful takeover attempt may be followed by a high rate of management
turnover, because a takeover attempt conveys adverse information possessed by
the bidder about the manager. If there is a probability that the board is ineffective,
then a forced resignation of the manager can be either good or bad news for
the firm. A positive effect is predicted to dominate when there is more adverse
public information available about the manager's performance and when there
is a higher ex ante probability that the board is ineffective, for example,
if the board is management-dominated rather than outsider-dominated.
Managerial Reputation and Corporate Investment Decisions
Financial Management, Vol. 22, No. 2. Summer 1993:. 145-160.
David Hirshleifer
The incentives of managers to use investment choices as a tool
for building their reputations or the reputations of their firms are examined.
These incentives come in 3 main forms: 1. visibility bias, which encourages
a manager to try to make short-term indicators of success look better, 2. resolution
reference, which encourages managers to try to advance the arrival of good news
and delay bad news, and 3. mimicry and avoidance, which encourages a manager
to take the actions that the best managers are seen to do, and to avoid the
actions the worst managers are seen to do. The sheer variety of possible ways
of manipulating investment choices to influence reputation may seem bewildering.
However, actions that are associated with rises in stock prices tend to enhance
the firm's reputation.
Reputation, Incentives, and Managerial Decision
The New Palgrave Dictionary of Money and Finance, 1993
David Hirshleifer
This paper reviews the biases induced by
managers' incentives to build his reputation or that of his firm and the
resulting distortions in investment and operating decisions. This essay argues
that reputation incentives can influence the initiation and termination of
projects, the degree of conservatism, the timing of resolution of uncertainty
and of cash flows, and conformist versus deviant behavior. (Abstract by Danling
Jiang and David Hirshleifer)
Managerial Conservatism, Project Choice, and Debt
The Review of Financial Studies, Vol. 5, No. 3. 1992: 437-470.
David Hirshleifer Anjan V. Thakor
We show that the incentive for managers to build their reputations
distorts firms' investment policies in favor of relatively safe projects, thereby
aligning managers' interests with those of bond-holders, even though managers
are hired and fired by shareholders. This effect opposes the familiar agency
problem of risky debt that is imperfectly covenant-protected, wherein shareholders
are tempted to favor excessively risky projects in order to expropriate bondholders.
Consequently, when managerial concern for reputation results in conservatism,
it can actually make shareholders better off ex ante by allowing the firm to
issue more debt. We examine how the optimal choice of leverage from the shareholders'
standpoint is influenced by takeover activity, and how the adoption of anti-takeover
measures affects a firm's investment policy and leverage choice.
Risk, Managerial Effort and Project Choice
Journal of Financial Intermediation, Vol. 3, 1992: 308-345.
David Hirshleifer Yoon Suh
In our model risk-neutral shareholders need to motivate a manager to select among projects with different risks, and to work hard in implementing the chosen project. Curvature of the manager's compensation contract as a function of profit affects his attitude toward project risk. The optimal curvature depends on the trade-off between controlling project risk and motivating effort. The analysis predicts greater option-based compensation when there are desirable risky growth opportunities (proxied by Tobin's q or R&D expenditures) and less option compensation when there are effective monitoring institutions (such as outside directors and bank lenders).
Herding and Cascading in Capital Markets: A Review and Synthesis
European Financial Management, 9(1), March 2003: 25-66.
David Hirshleifer Siew Hong Teoh
We review theory and evidence relating to herd behavior, payoff and reputational interactions, social learning and informational cascades in capital markets. We offer a simple taxonomy of effects and evaluate how alternative theories may help explain evidence on the behavior of investors, firms and analysts. We consider both incentives for parties to engage in herding or cascading and the incentives for parties to protect against or take advantage of herding or cascading by others.
Investor Psychology in Capital Markets: Evidence and Policy Implications
Journal of Monetary Economics Volume: 49, Issue: 1, January, 2002. pp. 139-209.
Kent Daniel David Hirshleifer Siew Hong Teoh
We review extensive evidence about how psychological biases affect investor behavior and prices. Systematic mispricing probably causes substantial resource misallocation. We argue that limited attention and overconfidence cause investor credulity about the strategic incentives of informed market participants. However, individuals as political participants remain subject to the biases and self-interest they exhibit in private settings. Indeed, correcting contemporaneous market pricing errors is probably not government’s relative advantage. Government and private planners should establish rules and procedures ex ante to improve choices and efficiency, including disclosure, reporting, advertising, and default-option-setting regulations. Especially, government should avoid actions that exacerbate investor biases.
Investor Psychology and Asset Pricing
The Journal of Finance Volume: 56, Issue: 4, August 2001. pp. 1533-1597.
David Hirshleifer
The basic paradigm of asset pricing is in vibrant flux. The purely rational approach is being subsumed by a broader approach based upon the psychology of investors. In this approach, security expected returns are determined by both risk and misvaluation. This survey sketches a framework for understanding decision biases, evaluates the a priori arguments and the capital market evidence bearing on the importance of investor psychology for security prices, and reviews recent models.
The Blurring of Boundaries between Financial Institutions and Markets
Journal of Financial Intermediation, 10(3/4), July/October (2001):272-5.
David Hirshleifer
Abstract not yet available
Mergers and Acquisitions: Strategic and Informational Issue
Finance, Volume 9, North Holland Handbooks in Operations Research and Management Science, 1995, ch. 26, pp. 839-887.
David Hirshleifer
This essay describes the relationships between different models of the takeover process, and where possible provides analytical syntheses to integrate major trends in the literature. I focus mainly on three types of models: (1) models of tender offers, which examine the decisions of individual shareholders whether to tender (sell) their shares to a bidder, (2) models of competition among multiple bidders, and (3) models that examine the voting power of target managers who own shares.
Managerial Reputation and Corporate Investment Decisions
Financial Management, Vol. 22, No. 2. Summer 1993:. 145-160.
David Hirshleifer
The incentives of managers to use investment choices as a tool
for building their reputations or the reputations of their firms are examined.
These incentives come in 3 main forms: 1. visibility bias, which encourages
a manager to try to make short-term indicators of success look better, 2. resolution
reference, which encourages managers to try to advance the arrival of good news
and delay bad news, and 3. mimicry and avoidance, which encourages a manager
to take the actions that the best managers are seen to do, and to avoid the
actions the worst managers are seen to do. The sheer variety of possible ways
of manipulating investment choices to influence reputation may seem bewildering.
However, actions that are associated with rises in stock prices tend to enhance
the firm's reputation.
Takeovers
The New Palgrave Dictionary of Money and Finance, 1993
David Hirshleifer
This essay reviews a number of issues about
takeovers, including the reasons for and the consequences of takeovers, the
pitfalls in estimating takeover gains, the effects of different takeover
mechanisms, that of managerial resistance and the means of payments, and the
role of debt and managerial share ownership. It explains the average high stock
returns of the targets and low returns of the bidders during the transaction
period in the U.S. takeover market. It also analyzes the wealth distribution
between different stakeholders and the effects of the regulation during the
takeover process on the outcome of the takeover. (Abstract by Danling Jiang and
David Hirshleifer)
Reputation, Incentives, and Managerial Decision
The New Palgrave Dictionary of Money and Finance, 1993
David Hirshleifer
This paper reviews the biases induced by
managers' incentives to build his reputation or that of his firm and the
resulting distortions in investment and operating decisions. This essay argues
that reputation incentives can influence the initiation and termination of
projects, the degree of conservatism, the timing of resolution of uncertainty
and of cash flows, and conformist versus deviant behavior. (Abstract by Danling
Jiang and David Hirshleifer)
Using Psychology to Predict Market Moves
Optimus, January, 2001, pp. 34-35.
David Hirshleifer Siew Hong Teoh
Abstract not yet available
Learning from the Behavior of Others: Conformity, Fads, and Informational Cascades
The Journal of Economic Perspectives, Vol. 12, No. 3. Summer 1998:. 151-170.
Sushil Bikhchandani David Hirshleifer; Ivo Welch
Learning by observing the past decisions of others
can help explain some otherwise puzzling phenomena about human behavior. For
example, why do people tend to converge on similar behavior? Why is mass behavior
prone to error and fads? The authors argue that the theory of observational
learning, and particularly of informational cascades, has much to offer economics,
business strategy, political science, and the study of criminal behavior.
Informational Cascades and Social Conventions
The New Palgrave Dictionary of Economics and the Law, May 1998, 23 pp.
David Hirshleifer
This entry reviews how the theory of
informational cascades (in which an individual’s action is independent of his
private information signal) explains the conformity, idiosyncrasy, and fragility
of social behavior. It considers the effects on social outcomes of fashion
leaders and of the public release of information. The entry further discusses
the implications of informational cascades in various contexts, including fads,
finance, medical practice, peer influence, politics, scientific theory, stigma,
and zoology.
The Blind Leading the Blind: Social Influence, Fads and Informational Cascades
Chapter 12 in The New Economics of Human Behaviour, Ierulli, K. and Tommasi, M. eds.; Cambridge University Press,(1995:188-215).
David Hirshleifer
An informational cascade occurs when it is optimal for an individual, having observed the actions of those ahead of him, to hollow the behavior of the preceding person without regard to his own information. Among the phenomena that can be explained by informational cascades are conformism at specific times and places, error-prone behavior, and fragility of behaviors.
Managerial Reputation and Corporate Investment Decisions
Financial Management, Vol. 22, No. 2. Summer 1993:. 145-160.
David Hirshleifer
The incentives of managers to use investment choices as a tool
for building their reputations or the reputations of their firms are examined.
These incentives come in 3 main forms: 1. visibility bias, which encourages
a manager to try to make short-term indicators of success look better, 2. resolution
reference, which encourages managers to try to advance the arrival of good news
and delay bad news, and 3. mimicry and avoidance, which encourages a manager
to take the actions that the best managers are seen to do, and to avoid the
actions the worst managers are seen to do. The sheer variety of possible ways
of manipulating investment choices to influence reputation may seem bewildering.
However, actions that are associated with rises in stock prices tend to enhance
the firm's reputation.
Reputation, Incentives, and Managerial Decision
The New Palgrave Dictionary of Money and Finance, 1993
David Hirshleifer
This paper reviews the biases induced by
managers' incentives to build his reputation or that of his firm and the
resulting distortions in investment and operating decisions. This essay argues
that reputation incentives can influence the initiation and termination of
projects, the degree of conservatism, the timing of resolution of uncertainty
and of cash flows, and conformist versus deviant behavior. (Abstract by Danling
Jiang and David Hirshleifer)
Cooperation in a Repeated Prisoners' Dilemma with Ostracism
Journal of Economic Behavior and Organization, Vol. 12, No. 1, August 1989: 87-106.
David Hirshleifer Eric Rasmusen
The unique Nash equilibrium of the finitely repeated n-person Prisoners' Dilemma calls for defection in all rounds. One way to enforce cooperation in groups is ostracism: players who defect are expelled. If the group's members prefer not to diminish its size, ostracism hurts the legitimate members of the group as well as the outcast, putting the credibility of the threat in doubt. Nonetheless, we show that ostracism can be effective in promoting cooperation with either finite or infinite rounds of play. The model can be applied to games other than the Prisoners' Dilemma, and ostracism can enforce inefficient as well as efficient outcomes.
Price Discrimination through Offers to Match Price
Journal of Businesses, Vol. 60, No. 3, July 1987: 365-383.
I.P.L. Png David Hirshleifer
In this paper, a firm discriminates between two classes of customer who have different cost of information by coupling a list price with an offer to match the price of any other shop. If the list price elsewhere is lower, the firm will be successful in discrimination. The list price of each firm is increasing in the number of sellers, and the total sales are decreasing in the number of sellers. Furthermore, if sellers coordinate, they discriminate more efficaciously and increase their profits by increase their total sales.