Knowledge that Transforms

Abstract An influential emerging literature documents strong correlations between carbon emissions and stock returns. We re-examine those data and conclude that these associations are driven by two factors. First, stock returns are correlated only with unscaled emissions estimated by the data vendor, but not with unscaled emissions actually disclosed by firms. Vendor-estimated emissions systematically differ from firm-disclosed emissions and are highly correlated with financial fundamentals, suggesting that prior findings primarily capture the association between such fundamentals and returns. Second, unscaled emissions, the variable typically used in academic literature, is correlated with stock returns but emissions intensity (emissions scaled by firm size), an equally important measure used in practice, is not. While unscaled emissions represent an important metric for society, we argue that, for individual firms, emissions intensity is an appropriate measurement choice to assess carbon performance. The associations between emissions and returns disappear after accounting for either of the issues above.

Abstract Over fifty countries have introduced regulatory sandboxes to foster financial innovation. This article conducts the first evaluation of their ability to improve fintechs’ access to capital and attendant real effects. Exploiting the staggered introduction of the UK sandbox, we establish that firms entering the sandbox see an increase of 15% in capital raised post-entry. Their probability of raising capital increases by 50%. Sandbox entry also has a significant positive effect on survival rates and patenting. Investigating the mechanism, we present evidence consistent with lower asymmetric information and regulatory costs.

Abstract We investigate the relation between sovereign and corporate bond issuance. Sovereign bond issues that increase a country’s maximum maturity are followed by increases in the maximum maturity of corporate issues. Our results point to issuance complementarities based on the benchmarking of corporate bonds to sovereign bonds. Sovereign and corporate bond issues are also substitutes, but substitutability requires the availability of a high-quality sovereign bond benchmark. By adding to existing theories focusing on substitutability, our findings highlight the role that the maturity of sovereign debt plays in capital market development.

Abstract We present a model of credit market competition to derive key hypotheses about how information sharing between banks influences the spatial clustering of their branches. We then test these hypotheses using data on 56,555 branches owned by 614 banks across 19 countries. We find that information sharing incentivizes banks to establish branches in localities that are new to them but that are already served by other banks. The resultant branch clustering is associated with reduced spatial credit rationing, as information sharing enables firms to access credit from more distant banks. These findings underscore how information sharing makes it more important for banks to move closer to each other rather than closer to their borrowers.

Abstract We show that engagement on environmental, social, and governance issues can benefit shareholders by reducing firms’ downside risks. We find that the risk reductions (measured using value at risk [VaR] and lower partial moments) vary across engagement types and success rates. Engagement is most effective in lowering downside risk when addressing environmental topics (primarily climate change). Further, targets with large downside risk reductions exhibit a decrease in environmental incidents after the engagement. We estimate that the VaR of engagement targets decreases by 9 percent of the standard deviation after successful engagements, relative to control firms.

Abstract We extend the Fama–MacBeth regression framework for cross-sectional return prediction to incorporate big data and machine learning. Our extension involves a three-step procedure for generating return forecasts based on Fama–MacBeth regressions with regularization and predictor selection as well as forecast combination and encompassing. As a by-product, it provides estimates of characteristic payoffs. We also develop three performance measures for assessing cross-sectional return forecasts, including a generalization of the popular time-series out-of-sample R2 statistic to the cross section. Applying our extension to over 200 firm characteristics, our cross-sectional return forecasts significantly improve out-of-sample predictive accuracy and provide substantial economic value to investors. Overall, our results suggest that a relatively large number of characteristics matter for determining cross-sectional expected returns. Our new method is straightforward to implement and interpret, and it performs well in our application.

Abstract I test the hypothesis that the use of leverage by market speculators can increase the likelihood and magnitude of crashes in asset prices. Using a direct leverage measure derived from US public filings, I find that (1) stocks held by highly leveraged hedge funds subsequently have more negatively skewed returns than stocks held by less leveraged funds and (2) upon extremely negative earnings surprises or funding liquidity shocks, stocks owned by high-leverage funds exhibit abnormal price declines and subsequent reversal. Consistent with the fire sale and contagion hypothesis, high-leverage funds tend to reduce the position following negative news about a stock, and such selling can extend to other stocks in the portfolio, increasing the crash proneness of the stocks they hold.

Abstract While it is established that idiosyncratic volatility is negatively priced in the cross-section of stock returns, the relation between idiosyncratic volatility and hedge fund returns is largely unexplored. We document that hedge funds with high idiosyncratic volatility earn higher future risk-adjusted returns of 6 percent p.a. than hedge funds with low idiosyncratic volatility. The outperformance arises because hedge funds trade high idiosyncratic volatility stocks wisely. They pick high volatility stocks when they are underpriced and short-sell high volatility stocks when they are overpriced. Our results support the notion that hedge funds’ idiosyncratic volatility is a measure of managerial skill.

Abstract We analyze the impact of $40 billion of corporate subsidies given by US local governments on their borrowing costs. We find that winning counties experience a 15.2 basis points (bps) increase in bond yield spread as compared to the losing counties. The increase in yields is higher (18–26 bps) when the subsidy deal is associated with a lower jobs multiplier or when the winning county has a lower debt capacity. However, a high jobs multiplier does not seem to alleviate the debt capacity constraints of local governments. Our results highlight the potential costs of corporate subsidies for local governments.

Abstract We investigate the propagation of environmental performance among competitors and in customer–supplier relationships. We find a significant causal effect among competitors, while the propagation from customers to suppliers and vice versa appears insignificant or does not survive identification tests. The effect is stronger among firms in highly concentrated competitor networks and toward firms with less market and bargaining power than their competitors. We also find significantly stronger propagation of environmental performance among competitors engaged in joint research and development activity. These results show that the propagation stems from both competitive pressure and technological spillover. Importantly, we find that propagation is strong when the competitor improves its environmental performance and when the firm’s own environmental performance is poor initially, alleviating concerns that improvements in performance are concentrated among firms, which are already green. Overall, network effects among competing firms are a significant force shaping environmental performance, and a force mostly for good.