Knowledge that Transforms

We find that managers receive more risk-taking incentives in their compensation packages once their firms are referenced by credit default swap (CDS) trading, particularly when institutional ownership is high and when firms are in financial distress. These findings provide suggestive evidence that boards offer pay packages that encourage greater risk taking to take advantage of the reduced creditor monitoring after CDS introduction. Further, we show that the onset of CDS trading attenuates the effect of vega on leverage, consistent with the threat of exacting creditors restraining managerial risk appetite.

This paper studies how high uncertainty affects corporate bank loans, addressing the important issue of identification. In times of high uncertainty, firms reduce their credit demand due to delayed investments or a deterioration in credit worthiness. Simultaneously, banks are more exposed to negative shocks to their balance sheet, reducing credit supply. To isolate the uncertainty effect from the credit supply effect, we employ matched bank-firm loan data covering all loans extended by all financial intermediaries to listed firms in Korea, a bank-centered economy. Our empirical results reveal that a failure to control for credit supply leads to overestimating the effect of uncertainty on bank loans. In terms of the transmission channel of uncertainty, we find the evidence of both the real option channel and the financial channel: the negative effect is stronger for firms with a higher degree of investment irreversibility and financially constrained firms. In addition, our findings suggest that larger firms may be predominantly affected by uncertainty shocks through the real option channel rather than the financial channel. In addition, our empirical findings on firm investments align with those on bank loans.

This study investigates the relationship between credit ratings and firm innovation activities using a cross-country sample over the 1995–2020 period. Exploiting the setting of rating agencies’ sovereign ceiling policies, our main analysis shows that a one-notch reduction in corporate credit ratings engendered by sovereign downgrades, on average, leads to a 5.90% reduction in research and development (R&D) spending. We identify the substitution of external acquisitions for internal expenditures and the increase in creditor control as the underlying mechanisms of the causal relation. Moreover, the negative impact of credit rating downgrades on R&D investment results in deterioration in patent output and firm performance. The cross-sectional analysis shows that the observed effects on innovation and firm performance are concentrated in firms with higher external finance dependence or more growth options.

Exploiting the staggered adoption of U.S. state-level labor protection laws, we find that household mortgage debt increases following the passage of these laws. Our findings are consistent with theories predicting that better employment protection reduces households’ layoff risk, making lenders less concerned about borrowers’ ability to repay their debts and more inclined to offer them mortgage loans. Supporting this channel, we find that the loan approval rate increases following the adoption of labor protection laws and that the effect of the laws’ adoption on mortgage debt is concentrated in old households.

We document that return anomalies related to management discretions are mitigated for firms followed by more experienced analysts. Nonetheless, only experience directly covering the firm matters while experience covering other firms is not associated with greater price efficiency. Focusing on the accrual anomaly, we then examine research and monitoring as possible channels through which experience mitigates mispricing. For firms followed by more experienced analysts, we find that forecast revisions and stock prices respond more positively to the accrual component of earnings. We further find that accrual quality is higher in firms followed by more experienced analysts, which holds after using both propensity score matching and exogenous events of brokerage closures and mergers to control for endogeneity. Collectively, our results are consistent with monitoring being the primary mechanism by which experienced analysts reduce accrual mispricing.

We investigate the political power of credit rating agencies by building a theoretical model that illustrates how heterogeneous voters change their political preferences after receiving credit signals which infer the quality of their governments. We empirically test this hypothesis using a rich dataset of daily sovereign ratings, outlook and watch signals assigned by S&P, Moody's and Fitch to EU countries from 2000 to 2017, along with a unique dataset measuring public support for governments. We find that negative rating signals lead to a significant decrease in government support, therefore influencing the electoral prospects of political parties. Both sociotropic and egocentric voters’ preferences are affected by sovereign ratings. Our results are confirmed across a battery of robustness tests and various modelling approaches, including fixed effects and difference in differences models and propensity score matching. Our findings offer wide-ranging implications for policy makers, political parties, governments, and the rating industry.

This paper finds that banks led by socially connected CEOs have a higher degree of systemic risk compared to banks with less socially connected CEOs. To address endogeneity concerns, we employ a difference-in-differences design and the instrumental variable method using CEO death as an exogenous shock to the social network. Our study uncovers two key mechanisms through which CEO social networks impact bank systemic risk. First, banks governed by connected CEOs are more active in interbank transactions. Second, bank pairs featuring connected CEOs display a greater asset similarity in comparison to those without connected CEOs. These findings highlight the significant impact of CEO social connections on banks' interconnectedness and their potential contribution to systemic risk in the banking sector.

Over the course of the past two decades, it has become a common experience for consumers authorizing an international transaction via credit card to be invited to choose the currency in which they wish the transaction to be executed. While this choice, made feasible by a technology known as dynamic currency conversion (DCC), seems to foster competition, we argue that the opposite is the case. In fact, the unique pure-strategy equilibrium in a natural fee-setting game, with uninformed and possibly inattentive consumers, turns out to be highly asymmetric, entailing fees for the service provider that persistently exceed the monopoly level. Although losses in welfare may be substantial, a regulatory solution is unlikely to come about due to a global free-rider problem.

By exploiting the staggered city-level establishment of specialized environmental courts in China as exogenous shocks and using a difference-in-differences research design, we find that an increase in the efficiency of environmental enforcement leads to a decrease in companies’ access to bank loans. The channel tests show that these same shocks lead to an increase in environmental litigation, operational and reputational risk. The cross-sectional analyses also reveal consistent evidence. Collectively, our findings suggest that the environmental mandate has important externalities for bank lending decisions, indicating that the costs of environmental enforcement go beyond reducing environmental pollution.