Knowledge that Transforms

We study the implications of hedging for corporate financing and investment. We do so using an extensive, hand‐collected data set on corporate hedging activities. Hedging can lower the odds of negative realizations, thereby reducing the expected costs of financial distress. In theory, this should ease a firm's access to credit. Using a tax‐based instrumental variable approach, we show that hedgers pay lower interest spreads and are less likely to have capital expenditure restrictions in their loan agreements. These favorable financing terms, in turn, allow hedgers to invest more. Our tests characterize two exact channels—cost of borrowing and investment restrictions—through which hedging affects corporate outcomes. The analysis shows that hedging has a first‐order effect on firm financing and investment, and provides new insights into how hedging affects corporate value. More broadly, our study contributes novel evidence on the real consequences of financial contracting.

From 1997 to March 2000, as technology stocks rose more than five‐fold, institutions bought more new technology supply than individuals. Among institutions, hedge funds were the most aggressive investors, but independent investment advisors and mutual funds (net of flows) actively invested the most capital in the technology sector. The technology stock reversal in March 2000 was accompanied by a broad sell‐off from institutional investors but accelerated buying by individuals, particularly discount brokerage clients. Overall, our evidence supports the bubble model of Abreu and Brunnermeier (2003), in which rational arbitrageurs fail to trade against bubbles until a coordinated selling effort occurs.

This paper develops a novel trade‐off view of corporate governance. Using a model that integrates agency costs and bargaining benefits of management‐friendly provisions, we identify the economic determinants of the resulting trade‐offs for shareholder value. Consistent with the theory, our empirical analysis shows that provisions that allow managers to delay takeovers have significant bargaining effects and a positive relation with shareholder value in concentrated industries. By contrast, non‐delay provisions have an unambiguously negative relation with value, particularly in concentrated industries. Our analysis suggests that there are governance trade‐offs for shareholders and that industry concentration is an important determinant of their severity.

Can psychology‐guided information disclosure induce borrowers to lower their use of high‐cost debt? In a field experiment at payday stores, we find that information that makes people think less narrowly (over time) about finance costs results in less borrowing. In particular, reinforcing the adding‐up dollar fees incurred when rolling over loans reduces the take‐up of future payday loans by 11% in the subsequent 4 months. Although we remain agnostic as to the overall sufficiency of better disclosure policy to “remedy” payday borrowing, we cast the 11% reduction in borrowing in light of the relative low cost of this policy.

We explicitly consider financial leverage in a simple equity valuation model and study the cross‐sectional implications of potential shareholder recovery upon resolution of financial distress. Our model is capable of simultaneously explaining lower returns for financially distressed stocks, stronger book‐to‐market effects for firms with high default likelihood, and the concentration of momentum profits among low credit quality firms. The model further predicts (i) a hump‐shaped relationship between value premium and default probability, and (ii) stronger momentum profits for nearly distressed firms with significant prospects for shareholder recovery. Our empirical analysis strongly confirms these novel predictions.

Do bankrupt firms impose negative externalities on their nonbankrupt competitors? We propose and analyze a collateral channel in which a firm's bankruptcy reduces the collateral value of other industry participants, thereby increasing their cost of debt financing. We identify the collateral channel using novel data of secured debt tranches issued by U.S. airlines that include detailed descriptions of the underlying collateral pools. Our estimates suggest that industry bankruptcies have a sizeable impact on the cost of debt financing of other industry participants. We discuss how the collateral channel may lead to contagion effects that amplify the business cycle during industry downturns.

We propose a model of dynamic investment, financing, and risk management for financially constrained firms. The model highlights the central importance of the endogenous marginal value of liquidity (cash and credit line) for corporate decisions. Our three main results are: (1) investment depends on the ratio of marginal q to the marginal value of liquidity, and the relation between investment and marginal q changes with the marginal source of funding; (2) optimal external financing and payout are characterized by an endogenous double‐barrier policy for the firm's cash‐capital ratio; and (3) liquidity management and derivatives hedging are complementary risk management tools.

We investigate the influence of political and financial factors on the decision to privatize government‐owned firms. The results show that profitable firms and firms with a lower wage bill are likely to be privatized early. We find that the government delays privatization in regions where the governing party faces more competition from opposition parties. The results also suggest that political patronage is important as no firm located in the home state of the minister in charge is ever privatized. Using political variables as an instrument for the privatization decision, we find that privatization has a positive impact on firm performance.

This paper proposes a portfolio choice model in which investors are subject to liquidation risk and (endogenously) face higher costs in the event of joint liquidation (as was observed during the crisis of 2008 to 2009). The risk of joint liquidation creates an incentive for investors to choose heterogeneous portfolios and to rationally forgo diversification benefits. Joint liquidation risk is also reflected in asset prices, resulting in (1) assets with high idiosyncratic risk having low expected returns, and (2) assets that display high correlation with the portfolios of (liquidation‐prone) investors having high expected returns.

A long‐standing controversy is whether leveraged buyouts (LBOs) relieve managers from short‐term pressures from public shareholders, or whether LBO funds themselves sacrifice long‐term growth to boost short‐term performance. We examine one form of long‐run activity, namely, investments in innovation as measured by patenting activity. Based on 472 LBO transactions, we find no evidence that LBOs sacrifice long‐term investments. LBO firm patents are more cited (a proxy for economic importance), show no shifts in the fundamental nature of the research, and become more concentrated in important areas of companies' innovative portfolios.