Knowledge that Transforms

ABSTRACT We aim to tackle the longstanding debate on whether stock liquidity enhances or impedes firm innovation. This topic is of interest because innovation is crucial for firm‐ and national‐level competitiveness and stock liquidity can be altered by financial market regulations. Using a difference‐in‐differences approach that relies on the exogenous variation in liquidity generated by regulatory changes, we find that an increase in liquidity causes a reduction in future innovation. We identify two possible mechanisms through which liquidity impedes innovation: increased exposure to hostile takeovers and higher presence of institutional investors who do not actively gather information or monitor.

ABSTRACT Financial intermediaries trade frequently in many markets using sophisticated models. Their marginal value of wealth should therefore provide a more informative stochastic discount factor (SDF) than that of a representative consumer. Guided by theory, we use shocks to the leverage of securities broker‐dealers to construct an intermediary SDF. Intuitively, deteriorating funding conditions are associated with deleveraging and high marginal value of wealth. Our single ‐factor model prices size, book‐to‐market, momentum, and bond portfolios with an R 2 of 77% and an average annual pricing error of 1%—performing as well as standard multifactor benchmarks designed to price these assets.

We use measures of neural activity provided by functional magnetic resonance imaging (fMRI) to test the "realization utility" theory of investor behavior, which posits that people derive utility directly from the act of realizing gains and losses. Subjects traded stocks in an experimental market while we measured their brain activity. We find that all subjects exhibit a strong disposition effect in their trading, even though it is suboptimal. Consistent with the realization utility explanation for this behavior, we find that activity in the ventromedial prefrontal cortex, an area known to encode the value of options during choices, correlates with the capital gains of potential trades; that the neural measures of realization utility correlate across subjects with their individual tendency to exhibit a disposition effect; and that activity in the ventral striatum, an area known to encode information about changes in the present value of experienced utility, exhibits a positive response when subjects realize capital gains. These results provide support for the realization utility model and, more generally, demonstrate how neural data can be helpful in testing models of investor behavior.

ABSTRACT We examine large public interventions in the financial sector, such as bank nationalizations and search for “financial protectionism,” a decrease in the quantity and/or an increase in the price of loans that banks from one country make to borrowers resident in another. We use a bank‐level panel data set spanning all U.K.‐resident banks between 1997Q3 and 2010Q1. After nationalization, foreign banks reduced their fraction of British loans by about 11% and increased their effective interest rates by about 70 basis points. In contrast, nationalized British banks did not significantly change either their loan mix or effective interest rates.

ABSTRACT This paper proposes a new method using option prices to estimate the market value of the shareholder voting rights associated with a stock. The method consists of synthesizing a nonvoting share using put‐call parity, and comparing its price to that of the underlying stock. Empirically, we find this measure of the value of voting rights to be positive and increasing in the time to expiration of synthetic stocks. The measure also increases around special shareholder meetings, periods of hedge fund activism, and M&A events. The method is likely useful in studies of corporate control and also has asset pricing implications.

ABSTRACT Using a large and unique patent‐merger data set over the period 1984 to 2006, we show that companies with large patent portfolios and low R&D expenses are acquirers, while companies with high R&D expenses and slow growth in patent output are targets. Further, technological overlap between firm pairs has a positive effect on transaction incidence, and this effect is reduced for firm pairs that overlap in product markets. We also show that acquirers with prior technological linkage to their target firms produce more patents afterwards. We conclude that synergies obtained from combining innovation capabilities are important drivers of acquisitions.

ABSTRACT Which agency problems affect corporate cash policy? To answer this question, we estimate a dynamic model of finance and investment with three mechanisms that misalign managerial and shareholder incentives: limited managerial ownership of the firm, compensation based on firm size, and managerial perquisite consumption. We find that perquisite consumption critically impacts cash policy. Size‐based compensation also matters, but less. Firms with lower blockholder and institutional ownership have higher managerial perquisite consumption, low managerial ownership is a key factor in the secular upward trend in cash holdings, and agency plays little role in small firms' substantial cash holdings.

ABSTRACT Tax evasion is a widespread phenomenon across the globe and even an important factor in the ongoing sovereign debt crisis. We show that firms in countries with better credit information–sharing systems and higher branch penetration evade taxes to a lesser degree. This effect is stronger for smaller firms, firms in smaller cities and towns, firms in industries relying more on external financing, and firms in industries and countries with greater growth potential. This effect is robust to instrumental variable analysis, controlling for firm fixed effects in a smaller panel data set of countries, and many other robustness tests.

ABSTRACT To understand which short‐term debt markets experienced “runs” during the financial crisis, we analyze a novel data set of repurchase agreements (repo), that is, loans between nonbank cash lenders and dealer banks collateralized with securities. Consistent with a run, repo volume backed by private asset‐backed securities falls to near zero in the crisis. However, the reduction is only $182 billion, which is small relative to the stock of private asset‐backed securities as well as the contraction in asset‐backed commercial paper. While the repo contraction is small in aggregate, it disproportionately affected a few dealer banks.

ABSTRACT How important are volatility fluctuations for asset prices and the macroeconomy? We find that an increase in macroeconomic volatility is associated with an increase in discount rates and a decline in consumption. We develop a framework in which cash flow, discount rate, and volatility risks determine risk premia and show that volatility plays a significant role in explaining the joint dynamics of returns to human capital and equity. Volatility risk carries a sizable positive risk premium and helps account for the cross section of expected returns. Our evidence demonstrates that volatility is important for understanding expected returns and macroeconomic fluctuations.