Knowledge that Transforms

ABSTRACT We develop a dynamic agency model in which payout, investment, and financing decisions are made by managers who attempt to maximize the rents they take from the firm, subject to a capital market constraint. Managers smooth payout to smooth their flow of rents. Total payout (dividends plus net repurchases) follows Lintner's (1956) target adjustment model. Payout smooths out transitory shocks to current income and adjusts gradually to changes in permanent income. Smoothing is accomplished by borrowing or lending. Payout is not cut back to finance capital investment. Risk aversion causes managers to underinvest, but habit formation mitigates the degree of underinvestment.

ABSTRACT This paper uses novel data to examine the fleets of corporate jets operated by both publicly traded and privately held firms. In the cross‐section, firms owned by private equity funds average 40% smaller fleets than observably similar public firms. Similar fleet reductions are observed within firms that undergo leveraged buyouts. Quantile regressions indicate that these results are driven by firms in the upper 30% of the conditional jet distribution. The results thus suggest that executives in a substantial minority of public firms enjoy excessive perquisite and compensation packages.

ABSTRACT Investor protection is associated with greater investment sensitivity to q and lower investment sensitivity to cash flow. Finance plays a role in causing these effects; in countries with strong investor protection, external finance increases more strongly with q , and declines more strongly with cash flow. We further find that q and cash flow sensitivities are associated with ex post investment efficiency; investment predicts growth and profits more strongly in countries with greater q sensitivities and lower cash flow sensitivities. The paper's findings are broadly consistent with investor protection promoting accurate share prices, reducing financial constraints, and encouraging efficient investment.

ABSTRACT Private equity has traditionally been thought to provide diversification benefits. However, these benefits may be lower than anticipated as we find that private equity suffers from significant exposure to the same liquidity risk factor as public equity and other alternative asset classes. The unconditional liquidity risk premium is about 3% annually and, in a four‐factor model, the inclusion of this liquidity risk premium reduces alpha to zero. In addition, we provide evidence that the link between private equity returns and overall market liquidity occurs via a funding liquidity channel.

ABSTRACT Threshold events are discrete events triggered when an observable continuous variable passes a known threshold. We demonstrate how to use threshold events as identification strategies by revisiting the evidence in Rauh (2006, Investment and financing constraints: Evidence from the funding of corporate pension plans, Journal of Finance 61, 33–71) that mandatory pension contributions cause investment declines. Rauh's result stems from heavily underfunded firms that constitute a small fraction of the sample and that differ sharply from the rest of the sample. To alleviate this issue, we use observations near funding thresholds and find causal effects of mandatory contributions on receivables, R&D, and hiring, but not on investment. We also provide useful suggestions and diagnostics for analyzing threshold events.

ABSTRACT When local media report news about local companies, they use fewer negative words compared to the same media reporting about nonlocal companies. We document that one reason for this positive slant is the firms' local media advertising expenditures. Abnormal positive local media slant strongly relates to firm equity values. The effect is stronger for small firms; firms held predominantly by individual investors; and firms with illiquid or highly volatile stock, low analyst following, or high dispersion of analyst forecasts. These findings show that news content varies systematically with the characteristics and conflicts of interest of the source.

ABSTRACT We investigate the relation between organization structure and the information content of short sales, focusing on founder‐ and heir‐controlled firms. Our analysis indicates that family‐controlled firms experience substantially higher abnormal short sales prior to negative earnings shocks than nonfamily firms. Supplementary testing indicates that family control characteristics intensify informed short selling. Further analysis suggests that daily short‐sale interest in family firms contains useful information in forecasting stock returns; however, we find no discernable effect for nonfamily firms. This analysis provides compelling evidence that informed trading via short sales occurs more readily in family firms than in nonfamily firms.

ABSTRACT This paper studies the default risk of banks generated by investment and remuneration pressures. Competing banks prefer to pay their banking staff in bonuses and not in fixed wages as risk sharing on the remuneration bill is valuable. Competition for bankers generates a negative externality, driving up market levels of banker remuneration and hence rival banks’ default risk. Optimal financial regulation involves an appropriately structured limit on the proportion of the balance sheet used for bonuses. However, stringent bonus caps are value destroying, default risk enhancing, and suboptimal for regulators who control only a small number of banks.

ABSTRACT According to conventional wisdom, annualized volatility of stock returns is lower over long horizons than over short horizons, due to mean reversion induced by return predictability. In contrast, we find that stocks are substantially more volatile over long horizons from an investor's perspective. This perspective recognizes that parameters are uncertain, even with two centuries of data, and that observable predictors imperfectly deliver the conditional expected return. Mean reversion contributes strongly to reducing long‐horizon variance but is more than offset by various uncertainties faced by the investor. The same uncertainties reduce desired stock allocations of long‐horizon investors contemplating target‐date funds.

ABSTRACT Because of non‐traded human capital, real‐world financial markets are massively incomplete, while the modeling of imperfect, dynamic financial markets remains a wide‐open and difficult field. Some 30 years after Cox, Ross, and Rubinstein (1979) taught us how to calculate the prices of derivative securities on an event tree by simple backward induction, we show how a similar formulation can be used in computing heterogeneous‐agents incomplete‐market equilibrium prices of primitive securities. Extant methods work forward and backward, requiring a guess of the way investors forecast the future. In our method, the future is part of the current solution of each backward time step.