Knowledge that Transforms

We study the role of regional cultural differences in M&A transactions in the U.S. A larger social trust distance between two companies reduces the likelihood of them combining via an M&A transaction and results in lower completion rates and longer completion times, indicating higher complexity in deal execution. However, a larger social trust distance is also associated with higher gains from mergers, as measured by acquirer and combined announcement returns and medium-term buy-and-hold abnormal returns. This suggests that for these announced deals, the synergy potential is high enough to offset the costs induced by the large cultural distance.

This paper assesses the value of multiple requirements in bank regulation using a novel empirical rule-based methodology. Exploiting two datasets, we apply simple threshold-based rules to assess how different capital and liquidity ratios individually and in combination might have identified banks that failed in the global financial crisis and European sovereign debt crisis. Our results support the case for a small portfolio of different regulatory metrics, calibrated holistically. A portfolio of a leverage ratio, a risk-weighted capital ratio and a liquidity ratio such as the NSFR correctly identifies a high proportion of failing banks with fewer false alarms than any of these metrics individually – and at less stringent calibrations. The relative usefulness of individual metrics also varies across different crises and regulatory regimes, highlighting how a portfolio approach may be more robust. Further, we show that market-based capitalisation measures and loan-to-deposit ratios can provide complementary value in monitoring banks.

This study shows how professional ties assist directors in gaining future board positions when their reputation is tainted by accounting fraud. We demonstrate that the influence of professional ties is more prominent for directors who are more heavily impacted by fraud. This effect is also stronger when directors share professional ties with key board members in the appointing firms. Additional tests show that appointments of these directors are associated with more favorable market reactions compared to appointments of other tainted directors. We also find that firms’ financial reporting quality improves after appointing professionally connected tainted directors.

To improve the stability of the banking system the Dodd-Frank Act mandates that central banks conduct periodic evaluations of banks’ financial conditions. An intensely debated aspect of these ‘stress tests’ regards how much of that information generated by stress tests should be disclosed to financial markets. This paper uses an environment constructed from a model by Goldstein and Leitner (2018) to gain some behavioral insight into the policy tradeoffs associated with disclosure. Experimental results indicate that variations in disclosure conditions are sensitive to overbidding for bank assets. Absent overbidding, however, optimal disclosure robustly improves risk sharing even when banks behave non-optimally.

We investigate the relationship between internal governance and firms' innovation. We hypothesize that internal governance stemming from the difference in expected employment horizons between a CEO and her subordinate executives improves a firm's innovation. Using the age difference between a CEO and her subordinate executives as the primary measure of internal governance, we find a strong positive relationship between internal governance and firms' innovation output, and scientific and economic values. We show that the positive relation is causal and robust based on empirical tests including exogenous variation in internal governance resulting from non-forced CEO turnovers. We further show that the relationship between internal governance and innovation is more pronounced when external governance is weaker and when subordinate executives are expected to have more influence on the board. Cross-sectional analysis shows that internal governance spurs innovation in younger firms, firms led by generalist CEOs, and when the likelihood of insider successions is higher.

This paper identifies the optimal restrictiveness of a financing covenant in a debt contract. We examine the decision of a debt-issuing company that has current operations as well as a future growth opportunity. The optimal financing covenant can substantially reduce the cost of debt financing, and generally allows the issuance of some debt for financing the expansion. Comparative static analysis indicates that the covenant is less likely to be included when growth opportunities, earnings volatility, earnings drift rate, interest rate and tax rate are higher; and when bankruptcy cost is lower. Also, the financing covenant is more likely when the leverage ratio is higher (bankruptcy risk is greater) but becomes less likely for very high leverage ratio (when the firm is in or close to financial distress). These results are generally consistent with existing empirical results in the literature.

We exploit the public enforcement of the anti-corruption campaign across China to identify a causal role of political corruption in corporate takeover flows through a difference-in-differences (DID) analysis. We find that a reduction in corruption increases cross-region takeover activities by 40% and that deal volume more than doubles. Further analyses reveal that treatment effects are more evident for non-SOEs, politically unconnected acquirers, and acquirers that are less corrupt ex ante. We also show that the impact of the anti-corruption campaign is more pronounced in segmented cities where corruption practices are more entrenched. The reduction in corruption leads to higher bidder returns, improves post-acquisition performance, and markedly strengthens local economic development. The evidence indicates that the anti-corruption campaign was effective in attracting inbound corporate investments and supporting economic growth.

We study how investors in the US municipal bond market price the state lockdowns announced during the coronavirus (COVID) pandemic. To begin with, we examine the extent to which state-level COVID developments influence yield spreads of municipal bonds. We find that macro-level factors are the primary determinants of municipal bond spreads during the pandemic, but state-level COVID developments also matter at the margin. For instance, a doubling of new COVID cases in a state is associated with a 2% (1.4 basis points) increase in yield spreads of municipal bonds issued in that state. Accordingly, lockdowns may decrease municipal bond spreads by reducing COVID cases, but lockdowns may also increase them by reducing local economic activities. Overall, we find that yield spreads in both primary and secondary municipal bond markets increase by about 15% following lockdown announcements, suggesting that lockdown announcements increase the risk premiums investors require for holding municipal bonds.

We conduct a novel experiment to compare how subjects form motivated beliefs in an investor-client setup with varying degrees of liability. Although we do not detect the formation of motivated beliefs, our results indicate that social preferences significantly influence investment decisions and belief formation when investors have no liability. Once we limit our subject pool to those who display social preferences (i.e., those that donate more than zero in a dictator game), we find evidence of motivated belief formation. Additionally, we show that such motivated beliefs result in significantly higher investments. These findings highlight the importance of social preferences in financial decision-making and align with the recent literature on motivated belief formation under limited liability (Barberis, 2013; Bénabou and Tirole, 2016).

Financial misbehavior is widespread and costly. The Dutch government legally requires every employee in the financial sector to take a Hippocratic oath, the so-called “banker’s oath.” We investigate whether nudges that (in)directly remind financial advisers of their oath affect their service. In a large-scale audit study, professional auditors confronted 201 Dutch financial advisers with a conflict of interest. We find that when auditors apply a nudge that directly refers to the banker’s oath, advisers are less likely to prioritize bank’s interests. In additional prediction tasks, we find that Dutch regulators expect stronger effects of the oath than observed.