Knowledge that Transforms

This paper examines how cash flows, investment expenditures, and stock price histories affect debt ratios. Consistent with earlier work, we find that these variables have a substantial influence on changes in capital structure. Specifically, stock price changes and financial deficits (i.e., the amount of external capital raised) have strong influences on capital structure changes, but in contrast to previous conclusions, we find that over long horizons their effects are partially reversed. These results indicate that although firms’ histories strongly influence their capital structures, over time their capital structures tend to move towards target debt ratios that are consistent with the tradeoff theories of capital structure.

Using a sample of all-star analysts who switch investment banks, we examine (1) whether analyst behavior is influenced by banking relationships and (2) whether analyst behavior affects investment banking deal flow. Although the stock coverage decision depends on the relationship with the client firms, we find no evidence that analysts change their optimism or recommendation levels when joining a new firm. Investment banking deal flow is related to analyst reputation only for equity transactions. For debt and M&A transactions, analyst reputation does not matter. There is no evidence that issuing optimistic earnings forecasts or recommendations affects investment banking deal flow.

Understanding both the dynamics of volatility and the shape of the distribution of returns conditional on the volatility state is important for many financial applications. A simple single-factor stochastic volatility model appears to be sufficient to capture most of the dynamics. It is the shape of the conditional distribution that is the problem. This paper examines the idea of modeling this distribution as a discrete mixture of normals. The flexibility of this class of distributions provides a transparent look into the tails of the returns distribution. Model diagnostics suggest that the model, SV-mix, does a good job of capturing the salient features of the data. In a direct comparison against several affine-jump models, SV-mix is strongly preferred by Akaike and Schwarz information criteria.

Municipal bonds trade in decentralized broker-dealer markets, and are underpriced when issued, but unlike equities the average price rises slowly over several days. Newly issued municipal bonds have high levels of price dispersion and the average price rises because the mix of trade sizes changes over time. While large trades occur close to the reoffering price, small trades occur between the reoffering price to as much as 5% above the reoffering price. Using a mixed-distribution model we quantify the losses uninformed traders or issuers give up to broker-dealers.

Because sell-side analysts are dependent on institutional investors for performance ratings and trading commissions, we argue that analysts are less likely to succumb to investment banking or brokerage pressure in stocks highly visible to institutional investors. Examining a comprehensive sample of analyst recommendations over the 1994–2000 period, we find that analysts’ recommendations relative to consensus are positively associated with investment banking relationships and brokerage pressure but negatively associated with the presence of institutional investor owners. The presence of institutional investors is also associated with more accurate earnings forecasts and more timely re-ratings following severe share price falls.

This paper develops three distinct methods to quantify the risk of a systemic failure in the global banking system. We examine a sample of 334 banks (representing 80% of global bank equity) in 28 countries around five global financial crises. Our results suggest statistically significant, but economically small, increases in systemic risk. Although policy responses are endogenous, the low estimated probabilities suggest that the distress of central bankers, regulators and politicians about the events we study could be overstated and that current policy responses to financial crises could be adequate to handle major macroeconomic events.

Using data on defaulted firms in the United States over the period 1982–1999, we show that creditors of defaulted firms recover significantly lower amounts in present-value terms when the industry of defaulted firms is in distress. We investigate whether this is purely an economic-downturn effect or also a fire-sales effect along the lines of Shleifer and Vishny [1992. Liquidation values and debt capacity: a market equilibrium approach. Journal of Finance 47, 1343–1366]. We find the fire-sales effect to be also at work: Creditors recover less if the industry is in distress and non-defaulted firms in the industry are illiquid, particularly if the industry is characterized by assets that are specific, that is, not easily redeployable by other industries, and if the debt is collateralized by such specific assets. The interaction effect of industry-level distress and asset-specificity is strongest for senior unsecured creditors, is economically significant, and robust to contract-specific, firm-specific, macroeconomic, and bond-market supply effects. We also document that defaulted firms in distressed industries are more likely to emerge as restructured firms than to be acquired or liquidated, and spend longer time in bankruptcy.

Insider trading in the credit derivatives market has become a significant concern for regulators and participants. This paper attempts to quantify the problem. Using news reflected in the stock market as a benchmark for public information, we find significant incremental information revelation in the credit default swap market under circumstances consistent with the use of non-public information by informed banks. The information revelation occurs only for negative credit news and for entities that subsequently experience adverse shocks, and increases with the number of a firm's relationship banks. We find no evidence, however, that the degree of asymmetric information adversely affects prices or liquidity in either the equity or credit markets.

This paper analyzes the interaction between corporate taxes and corporate governance. We show that the design of the corporate tax system affects the amount of private benefits extracted by company insiders and that the quality of the corporate governance system affects the sensitivity of tax revenues to tax changes. Analyses of a tax enforcement crackdown in Russia and cross-country data on tax changes support this two-way interaction between corporate governance and corporate taxation.

Laddering is a practice whereby the allocating underwriter requires the ladderer to buy additional shares of the issuer in the aftermarket as a condition for receiving shares at the offer price. This paper identifies factors that create incentives to engage in this type of manipulation and models the effect of laddering on initial public offering (IPO) pricing. I show that laddering has a bigger effect on the market price of IPOs with greater expected underpricing (without laddering) and greater expected momentum in the aftermarket; laddering increases the IPO offer price, the aftermarket price, and the money left on the table but does not necessarily increase the percentage underpricing; laddering contributes to long-run underperformance and creates a negative correlation between short-run and long-run returns; and profit-sharing increases the extent of laddering and the percentage underpricing.