Knowledge that Transforms

Using the Chinese stock market data, we test the hypothesis that cognitive dissonance influences the stock market response to earnings news. Supporting this notion, we find that investors disregard earnings news that contradicts their sentiment due to cognitive dissonance, thereby causing a muted announcement date price reaction to such news. Further analysis shows that higher retail concentration and greater valuation uncertainty of the underlying firm exacerbate this cognitive dissonance and hence amplify its impact, but less credible financial report does not. Finally, we find that cognitive dissonance is temporary for bad news under optimism, but is quite persistent for good news under pessimism. Overall, our findings offer a behavioral bias explanation to understand why investors underuse accounting information.

We provide novel evidence of the role of investor sentiment in determining firms' capital structure decisions from three perspectives: leverage ratio, debt maturity and leverage target adjustment. We find that when investor sentiment is high, firms increase their leverage ratios, supporting our contention that high investor sentiment increases firms' debt capacity and facilitates the use of an aggressive leverage policy. Debt maturity is shorter in high sentiment periods, implying that firms are confident about future earnings and use shorter debt maturity to signal their financial solvency. Leverage target adjustment is slower in low sentiment periods, indicating higher costs of external finance. Furthermore, the sentiment-leverage relationship sensitivity is greater for financially constrained firms. Our extended analysis determines that leverage-increasing firms generate lower stock returns subsequent to a period of high sentiment, offering practical insights into the economic consequences of increasing leverage in high sentiment periods on corporate value for investors. Our research advances the understanding of the impact of investor sentiment on firms' financing decisions and stock returns.

Financing constraints are important to triggering controlling shareholders' share pledges. However, the related literature faces two major challenges: the endogeneity problem and the lack of direct evidence of why and how individual share pledges can ease corporate financing constraints. Based on China's Share Pledge Reform (SPR) in Q4 2012 and the phenomenon that private firms face discrimination when obtaining bank loans, this paper studies the impact of financing constraints on share pledging behavior and its mechanisms by building a difference-in-differences (DID) model. The SPR makes it more convenient for shareholders to raise money through share pledges, and shareholders of private firms facing stronger financing constraints are more vulnerable to this reform than are state-owned enterprises (SOEs). After the SPR, the probability of share pledging by controlling shareholders of private firms is approximately 23.04% higher than that of controlling shareholders of SOEs, and the pledge ratio is approximately 16.53% higher. Further tests reveal that, after the SPR, controlling shareholders of private firms are more inclined than those of SOEs to provide loans to the company to alleviate its financing constraints. Heterogeneity tests further corroborate the finding that this effect is more significant in private firms that are smaller and do not have shareholders of banking and institutional firms among their top ten shareholders.

We propose a simple and intuitive measure of the annualized excess return of investments in private equity (PE) funds, as well as in similar vehicles that hold hard-to-values assets. Our ‘Direct Alpha’ method is well-founded in theory and dominates the existing approaches to convert fund lifetime returns into inputs amenable for portfolio-wide optimization. Existing Public Market Equivalent (PME) approaches are either heuristic or involve significant approximation errors. Using real-world PE fund cash flow data, we juxtapose Direct Alpha against nearly all PME methods that have been in broad use.

A court case that reduced securities class action litigation risk led to less frequent voluntary disclosure but did not significantly alter information asymmetry among market participants. Conversely, state laws that reduced derivative litigation risk led to more frequent voluntary disclosure but resulted in significantly higher information asymmetry. To reconcile these differences, we highlight that 10b-5 securities class actions address disclosure, while derivative suits can address broader corporate wrongdoing, leading to differential effects on firm operations. Our results suggest that the observed effect of derivative litigation risk on the information environment is primarily driven by concomitant changes in firm operations.

Major customers in strong bargaining position can exert pressure on dependent suppliers and adversely affect their financing conditions. Consistent with this prediction, our analysis shows that the concentration of customer bases can enhance the bargaining power of downstream customers in supplier-customer interactions, leading to the significant deterioration of financing constraints for upstream firms. We then introduce a novel machine-learning approach to analyze the heterogeneous effect of customer concentration. This allows us to identify approximately 15 % of the firms, especially those small non-SOEs, as most vulnerable to customer concentration as the bargaining effect dominates.

Although the history of China's venture capital (VC) market is relatively short, it has already become the second largest VC market in the world and produced the second largest number of “unicorns” (startups with a valuation over $1 billion) after the US. Despite the remarkable growth of both China's tech sector and venture capital market, academic research in this area remains sparse. Two broad issues hinder the efforts of researchers studying this market: choosing the right data sources and understanding evolving institutional details. To address these two issues, I first describe available data sources, accompanied with filters aimed at improving the quality of the data. I then review institutional details unique to the Chinese setting and recent regulatory changes that have direct impacts on the Chinese venture capital market. I conclude by listing some open research questions.

A central issue in evaluating the effects of firm-level corporate governance (FLCG) is how to measure it. We focus here on emerging markets (EMs). One common approach to measuring FLCG uses country-specific (CSIs), tailored to each country's laws and institutions. Several studies report that CSIs can predict firm outcomes in a panel data framework with two-way (firm and time) fixed effects (TWFE). An alternate approach uses commercial CG ratings (CCGRs) that apply the same or similar elements across many countries. We assess the three best available CCGRs covering EMs (Asset4, Thomson Reuters, and MSCI), and find that they do not predict firm outcomes with TWFE in EMs. We also provide evidence that the likely cause for CCGRs' lack of performance is their poor construction rather than the inability of FLCG measures to predict outcomes. CSI-based studies suggest that disclosure (beyond country-mandated minimums) is the FLCG aspect that most consistently predicts firm outcomes in EMs. Yet, these CCGRs have no or minimal measures of disclosure. Other important limitations of the CCGRs include the use of elements that are U.S.-centric; reflect firm outcomes rather than CG; are implausible measures of good FLCG, or are vaguely or subjectively defined. We also attempt, but fail, to use element-level information from CCGRs to construct sound measures of FLCG.

This paper investigates whether banks value the presence of prosocial CEOs when designing loan contracts. Using personal charitable donation behavior to identify prosocial CEOs, we find robust evidence that the presence of prosocial CEOs is negatively related to firms' cost of debt. We address endogeneity concerns by employing a difference-in-differences setting that exploits exogenous CEO turnover events. Moreover, we show that the presence of prosocial CEOs mitigates the conflicts of interest between shareholders and creditors, thereby reduces the agency cost of debt. In addition, we find that the effect of prosocial CEOs also extends to non-price loan contract terms. Finally, we show that the presence of prosocial CEOs has positive implications for firm value and is associated with lower default risk.

This paper examines the extent to which polluting firms covered by the world's largest multinational emission trading scheme – the European Union Emission Trading Scheme (EU ETS) – engage in corporate tax avoidance. We exploit the sudden and significant increase in carbon prices after decisions made by the EU Council on February 28th 2017, and test whether firms' tax avoidance behavior subsequently changes. We find that pollution intensive firms engage in more corporate tax avoidance after this sudden price shock. This tax avoidance response is economically sizable as the difference between the effective tax rates between the least and most polluting firms is 5.13 percentage points. Supplemental tests indicate that the tax avoidance response of the more pollution intensive firms is dependent on their operating cost structure, while we find no significant difference in the corporate tax avoidance response depending on their financing needs. Moreover, we find some evidence of reputational concerns moderating this relationship. Additional analyses also demonstrate that increased internal and external monitoring, as reflected by higher regulatory quality and board independence, mitigates the corporate tax avoidance response. Overall, our findings are consistent with the notion that firms transfer carbon costs on to governments under the form of lower societal contributions whereas more internal and external monitoring plays a vital role in preventing this transference.