Knowledge that Transforms

Abstract We study the political economy of loan guarantees within a credit-rationing framework. A government uses guarantees to decrease the borrowing cost, thus making more households incentive compatible. This shifts capital to productive projects (allocative effect). Backed by taxpayers, loan guarantees also shift consumption from nonborrowers to borrowers (redistributive effect). While a welfare-maximizing planner is only concerned about the allocative effect, vote-share-maximizing politicians are driven by the interaction of both effects. As a result, politicians may underprovide or overprovide guarantees compared to the welfare-maximizing solution, depending on the electoral setup, household risk aversion, income heterogeneity, and guarantees’ externalities. (JEL D72, G28)

Abstract We present a search model that incorporates two key features of security issuances in centralized markets: the search for investors and information gathering. In the model, a seller contacts investors sequentially and uses reported interest to update the security’s value, while each investor reports interest strategically. We characterize the seller’s value-maximizing strategy in which search structure, duration, security pricing, and allocations are jointly determined. We derive novel implications from the model and find empirical support using a sample of accelerated seasoned equity offers, which have become prevalent in recent years and involve both search and information gathering.

Abstract The IPO volume in the US significantly decreased after 2000, as more entrepreneurial firms exited through acquisitions rather than IPOs. Using proprietary U.S. Census data on private firms, we examine several new hypotheses to explain these phenomena. Our results support explanations based on standalone public firms’ greater sensitivity to product market competition as well as private firms’ obtaining access to more abundant PE financing in the post2000 era. In contrast, we do not find evidence consistent with an eroded private firm base after 2000 or with the economies of scope explanation that mainly focuses on firm size. (JEL G32, G34, G24)

Abstract Financial regulators considering the desirability of a new rule or regulation sometimes use pilot studies for evidence-based decision making. Although pilot studies can generate new knowledge, they also can be expensive and subject to serious selection biases, spillover problems, and the infeasibility of a blind design. Alternatively, regulators can often evaluate a proposed regulation’s impact by analyzing archival data or applying theory based on well-accepted economic principles. We discuss why pilot studies can be useful, but also why regulators and industry participants sometimes favor pilot studies with little scientific value. We illustrate these issues by discussing various SEC pilot studies. (JEL G18, G28, G38, K22, L51)

Abstract We study how much entrepreneurs value control rights in the context of VC financing. While many entrepreneurs prefer to maintain control, transferring control rights is also central to VC contract design. Through a discrete choice experiment, we show that entrepreneurs have a high willingness to pay, 37% of the equity value of the venture, to avoid giving up control to investors, which we operationalize as giving investors a voting majority. Furthermore, control rights are valued higher than VC value-adding activities. Our findings imply that control considerations in VC contracts may create substantial trade-offs that deter entrepreneurs from VC financing. (JEL G24, L26, G32)

Abstract Firms under common ownership have incentives to soften competition. I exploit unique data from Norway to document the economy-wide extent of common ownership, covering private and public firms and the universe of shareholders. Using exogenous variation in common ownership at the firm-household level due to marriages among individual shareholders, I show that firms experiencing an increase in common ownership due to a marriage increase profit margins by 7 to 16 percentage points, compared to firms affected by similar marriages that do not experience a change in common ownership. (JEL: G32, L22, L26)

Abstract Governance practices differ significantly across blockholder types. Compared with financial blockholders, nonfinancial blockholders are six times more likely to identify as activists. A textual analysis of regulatory filings shows that nonfinancial blocks govern through customized governance actions, while financial blocks follow generic performance metrics. Furthermore, blockholdings drive an important limitation in using Russell index thresholds as an identification strategy. Manipulation of index weights by Russell is strongly correlated with nonfinancial block ownership, confounding previous research on passive ownership. Using both reduced-form and structural estimates, we find that the market expects greater value creation from the entry of a nonfinancial blockholder.

Abstract This paper studies the role of scale inflexibility in explaining corporate credit spreads. We find robust evidence that firms with higher inflexibility have higher credit spreads. To mitigate the endogeneity concern, we employ a regression discontinuity design that uses the exogenous variations in labor adjustment costs resulting from close-call union elections. Furthermore, contraction inflexibility is more prominent in influencing credit spreads than expansion inflexibility is. Additionally, inflexibility increases credit spreads due to increased cash flow volatility and financial distress risk. Our findings highlight the importance of a firm’s ability to adapt to productivity shocks in fulfilling its debt obligations. (JEL G12, G30, G32)

Abstract Most non-executive-directors appointed by early-stage startups are not investors in the startup, and only a small fraction are venture capital (VC) directors. Non-investor-directors and angel directors are more likely to be appointed when they possess experiences that founders lack and leverage their professional connections to attract new investors, directors, top executives, and potential acquirers for startups. Among early-stage startups that appoint nonexecutive directors, those with investor-directors experience better later-stage funding outcomes and a higher likelihood of exit, as well as file fewer patents and are more likely to exit via acquisitions rather than IPOs compared to similar startups with non-investor-directors. (JEL G24, G34, L26, M13)

Abstract This paper uses an accounting rule change and the U.S. insurance industry to empirically show that the way in which accounting information is presented can distort equilibrium economic outcomes. When firms’ summary performance measure includes changes in unrealized gains and losses (UGL) from financial asset holdings, investor inattention causes the firms’ stock returns to overreact to changes in UGL. Inattentive investors perceive the firms’ earnings as having higher residual uncertainty and demand larger discounts on the firms’ stock prices. To maximize compensation, managers cut financial asset holdings. Managerial myopia exacerbates the response. A simple model formalizes the mechanism. (JEL: G11, G14, G22, G30, M41)