Prof. Craig Lewis assumes leadership of SEC "think tank"
Lewis’ academic work includes research on convertible debt, analyst behavior, executive compensation, and market volatility
Vanderbilt finance professor Craig M. Lewis was tapped earlier this year by the U.S. Securities and Exchange Commission to serve as its new Chief Economist and Director of the Division of Risk, Strategy, and Financial Innovation (RiskFin).
In this dual role, Lewis, who has been on faculty at the Owen Graduate School of Management since 1986, will oversee economic analysis of current policy issues facing the SEC, as well as help the agency identify future industry trends. He was appointed to his new position on May 20, 2011.
When SEC Chairman Mary Schapiro announced the creation of RiskFin in 2009 – the regulator’s first new division in 37 years – she described it as a “think tank…working behind the scenes when fresh, interdisciplinary insights are vital to good decision-making.” RiskFin includes six specialized areas covering topics ranging from the buy- and sell-sides of financial markets to data analytics.
Lewis, the Madison S. Wigginton Professor of Finance at Owen, had previously served two consecutive appointments as a visiting academic fellow at the SEC, starting in July 2010.
“Professor Lewis is a distinguished economist with a clear understanding of the complexities of financial markets,” Schapiro said in announcing his appointment.
A certified public accountant, Lewis earned his master’s and doctorate degrees from the University of Wisconsin-Madison, and has since published research in several distinct areas, including convertible debt, analyst behavior, executive compensation, and market volatility.
Convertible debt serves as a kind of hybrid between corporate debt and equity, allowing holders to convert bonds into stock at an agreed-upon price. For both the issuing company and investors, convertible debt includes features of both stocks and bonds.
In one of his most recent working papers, Lewis and co-authors Stephen J. Brown, Bruce D. Grundy, and Patrick Verwijmeren, present evidence that hedge funds financed 73.4% of newly issued convertibles from 2000-2008. The study found that rather than going to hedge funds as a last resort to raise new funds, as previous research had indicated, firms turned to these investors because the transaction costs tended to be lower than a traditional seasoned equity offering. “By placing a convertible with hedge funds, a firm can receive financing today while avoiding the discounts and underwriter fees associated with a secondary equity offering,” the authors write. “Where those costs are higher than the costs associated with the private placement and the security is eventually converted, the firm will have issued equity at a lower cost.”
Similar research Lewis conducted dealt with firm performance and market reaction related to the issuance of convertible debt. A 2001 study published in the Journal of Corporate Finance, for example, found negative long-term performance among companies that issued convertible debt. The cause was not from the convertible debt itself, but from industry-specific factors, prompting the authors to conclude, “Firms issue securities other than common equity prior to periods of poor operating performance.”
ANALYST HERD BEHAVIOR
In the early 2000s, as star securities analysts working in the technology sector helped drive share prices to dizzying heights, Lewis and his colleagues examined the impact of “herd” behavior on stock performance. They devised a new method to identify “lead analysts.” An examination of the high-tech and restaurant industries indicated that their forecasts had a greater impact on stock prices than “follower analysts.”
“We find evidence that the market response to selected forecast revisions by timeliness leaders is greater than that for forecast revisions by follower analysts,” write Lewis and co-authors, Rick A. Cooper and Theodore E. Day. “This suggests that forecast revisions by timeliness leaders provide greater value to investors than forecasts by other analysts. In addition, we find that forecast revisions by lead analysts are positively correlated with recent changes in stock prices.”
The 2001 study, titled “Following the Leader: A Study of Individual Analysts’ Earnings Forecasts,” was published in the Journal of Financial Economics and received the publication’s DFA-Fama Prize for Best Paper Published in the Areas of Capital Markets and Asset Pricing, 2001.
There’s been a trend in recent years among major companies, including Coca-Cola and Eli Lilly, to adopt so-called Economic Profit Plans (EPPs) to reward executives for raising profits above agreed-upon levels. The idea is that EPPs makes up for deficiencies in stock-ownership plans, which give executives incentive only to raise share prices. They also overcome the potential for accounting manipulation that comes with rewarding executives for exceeding earnings targets.
In a 2005 paper published in the Journal of Quantitative Analysis, Lewis and co-author Chris Hogan examined how well these new forms of compensation plans actually worked. What they found is that “EPPs are no worse than but certainly no better than alternative incentive-based compensation plans.” The recently popularity of EPPs, the authors concluded, “simply reflects impressive marketing (by consulting companies), rather than a new and different way to motivate managers.”
The 1987 Wall Street Crash, in which the Dow Jones Industrial Average dropped by 22% in a single day, presented a new level of market volatility not seen since the SEC was created in 1934.
It was against this backdrop that Lewis published some of his earliest academic work, including a co-authored 1988 study in the Journal of Financial Economics examining the market volatility around the expiration dates of stock index options. Other research analyzes methods of forecasting market volatility using derivatives such as futures contracts, as well as gauging the effect of margin requirements on volatility.
Copyright 2011 Vanderbilt Owen Graduate School of Management