The accuracy of dynamic stress-test capital models remains undocumented. Three methodologies: a CLASS-style approach, Bayesian model averaging, and a Lasso specification are used to forecast the performance of 14 large US banks during the financial crisis. Individual bank models are calibrated using bank historical data while regulatory models are calibrated using representative bank data. Representative bank model forecasts differ dramatically from the forecasts from bank-specific models and from actual outcomes. The Lasso methodology is most accurate, but its superiority may be sample-specific and is only apparent ex post. The results highlight the policy uncertainty inherent in regulatory stress tests.

Ownership structure plays a critical role in the incentives and behaviors of business organizations. The literature has focused on the effects of firm ownership dispersion across managers and investors. We extend the literature by examining the roles of ownership structure within a controlling family. Specifically, we focus on the family trust structure, which is a popular vehicle for holding family ownership around the world. The trust structure typically locks controlling ownership within a family for a very long period. Although it ensures family control, the share transfer restriction may induce family shirking problems, make family conflicts difficult to resolve, and distort firm decisions. Based on a sample of publicly traded family firms in Hong Kong, we report that trust-controlled firms that are more susceptible to these problems tend to pay higher dividends, invest less in the long term, and experience worse performance. The costs of using a trust structure are more significant when the family stakes have been locked inside the trust for a longer period and when a larger amount of family ownership is held by the trust.

We examine the causal impact of public-sector spending on corporate investment. Making use of population count revisions in census years as exogenous shocks to the cross-sectional allocation of federal funds, we find that increases in federal spending reduce firms’ investment, R&D spending, employment growth, sales growth, and firm-level equity volatility. The effect is stronger for firms that are labor-intensive, smaller, geographically concentrated, financially constrained, or in regions with higher employment or more generous unemployment insurance benefits. We find that exogenous increases in government hiring reduce corporate hiring, and positive federal spending shocks reduce the flow of workers from the public-sector to the private sector. Overall, our results show that positive government spending reduces corporate investment by hurting firms’ investment opportunity sets and highlight the significant role of the labor market as an underlying mechanism.

This paper examines the relationship between investors' ambiguity in the financial options market and systemic banks' risk. Eliciting ambiguity information from option pricing data on the twelve major U.S. banks between 2003 and 2010, we show that higher behavioral deviations from risk-neutral and Bayesian valuation (i.e., investor ambiguity) are associated with higher systemic banks' downside, market and credit risks. Consistent with behavioral explanations, we confirm the detrimental effect of ambiguity on financial market outcomes and find strong evidence of ambiguity among call and put option holders. Variance decomposition indicates that such a pattern of behavior explains a significant proportion of U.S. banking risk variance. This effect is more pronounced during periods of economic turbulence and bank stress (i.e., the 2007–2009 crisis), and holds after controlling for size, tail risk, implied volatility, and volatility of volatility dynamics. We also document that ambiguity from the financial market has a depressing impact on real economic activity, including capacity utilization, non-farm payrolls and overall economic performance. Our findings are robust to alternative specifications of ambiguity such as multiple priors and expected utilities with uncertain probabilities.

We examine the role of concurrent information in the striking increase in investor response to earnings announcements from 2001 to 2016, as measured by return variability and volume following Beaver (1968). We find management guidance, analyst forecasts, and disaggregated financial statement line items are more frequently bundled with earnings announcements, and each of these items explains part of the increase in market response. Furthermore, collectively, these concurrent information releases explain a substantial fraction of the increase in market response to earnings announcements since 2001. This is in contrast to the decline in market response to management guidance issued separately from earnings and the much smaller increase in market response to analyst forecasts issued separately from earnings over this time. The findings indicate that information arrival at earnings announcement dates has increased significantly over the past two decades, and that key components of this are increased disclosures by management of guidance and financial statement line items and forecasts by analysts.

ABSTRACT We study whether the effectiveness of corporate governance mechanisms varies depending on the characteristics of the executives subject to these mechanisms, namely their “psychological type,” as proxied by their history of legal infractions. In particular, we examine insider trading, where we can compare the trading behavior of different types of executives in the same firm. We find that “recordholder” executives, that is, those with prior legal infractions, earn significantly higher profits from purchases and sales than nonrecordholder executives. Furthermore, the profitability of both purchases and sales is significantly increasing in the severity of the infraction. Governance mechanisms, such as blackout policies, lower profits of executives with only traffic infractions; however, profits for executives with serious infractions appear insensitive to blackout policies. Insiders with serious infractions are also more likely to trade during blackout periods and before large information events and are more likely to report their trades to the SEC after the filing deadline. Collectively, our evidence suggests that while governance mechanisms can discipline executives with minor offenses, they appear largely ineffective for those with more serious infractions.

ABSTRACT We examine how shareholders' trust in managers is affected by (i) the outcome of earnings management (inconsistent vs. consistent with shareholders' interests) and (ii) the method of earnings management (accruals vs. real methods). Using a controlled experiment, we predict and find that trust is impaired when the outcome of earnings management suggests that managers have put their interests above shareholders' interests and/or when the method of earnings management suggests that managers misreported the firm's economic performance. We argue that shareholders assess managers putting their interests above shareholders' interests as a signal of untrustworthiness because it involves a transfer of the firm's resources away from shareholders to managers. We argue that shareholders also assess managers' use of accruals to manage earnings as a signal of untrustworthiness because, in this instance, managers misreport the firm's economic performance. Finally, we show that trust mediates the combined effects of the outcome of earnings management and the method of earnings management on investment decisions. Our study incrementally contributes to the literature by highlighting the adverse implications of managers' use of accruals to manage earnings even when its outcome serves shareholders' interests.

This research examines the relation between political corruption and mergers and acquisitions (M&As). We find that local corruption increases firm acquisitiveness but decreases firm targetiveness. The levels of corruption in acquirer areas relate positively to the bid premiums and negatively to the likelihood of deal completion. Corruption motivates acquiring firms to use excess cash for payment, which mitigates the negative effect of corruption on acquirer shareholder value. The evidence indicates that acquisitions help acquiring firms convert cash into hard-to-extract assets and relocate assets from the high to low corruption areas, thereby shielding their liquid assets from expropriation by local officials.

We exploit the staggered adoption of the universal demand (UD) laws across U.S. states, which impedes shareholder rights to initiate derivative lawsuits, as a quasi-natural experiment to examine the relation between shareholder litigation rights and firm capital structures. We find that weaker shareholder litigation rights due to the UD laws adoption lead to higher financial leverage, which enhances firm value. Furthermore, the positive relation between the UD laws adoption and financial leverage is more pronounced for firms exposed to higher shareholder litigation risk ex ante or financially constrained firms. Our evidence is consistent with lower shareholder litigation threats motivating firms to increase financial leverage.