Knowledge that Transforms

We investigate competition between traditional stock exchanges and new dark trading venues using an important difference in regulatory treatment. Securities and Exchange Commission required minimum pricing increments constrain some stock spreads, causing large limit order queues. Dark pools allow some traders to bypass existing limit order queues with minimal price improvement. Using a regression discontinuity design, we find that spread constraints significantly weaken exchanges׳ competitiveness. As more orders migrate to dark pools, the probability of subsequent order execution there increases, raising liquidity. The ability to circumvent time priority of displayed limit orders is one cause of the rapid rise in US equity market fragmentation.

We use unique worker-plant matched panel data to measure differences in wage changes experienced by workers displaced from closing plants. We observe larger losses among women than men, comparing workers who move from the same closing plant to the same new firm. However, we find a significantly smaller gap in hiring firms with female leadership. The results are strongest among women who are displaced from male-led plants and from less competitive industries. Our results suggest an important externality to having women in leadership positions: They cultivate more female-friendly cultures inside their firms.

High speed market connections improve investors׳ ability to search for attractive quotes in fragmented markets, raising gains from trade. They also enable fast traders to obtain information before slow traders, generating adverse selection, and thus negative externalities. When investing in fast trading technologies, institutions do not internalize these externalities. Accordingly, they overinvest in equilibrium. Completely banning fast trading is dominated by offering two types of markets: one accepting fast traders, the other banning them. Utilitarian welfare is maximized with (i) a single market type on which fast and slow traders coexist and (ii) Pigovian taxes on investment in the fast trading technology.

Markets are different now, transformed by technology and high frequency trading. In this paper, I investigate the implications of these changes for high frequency market microstructure (HFT). I describe the new high frequency world, with a particular focus on how HFT affects the strategies of traders and markets. I discuss some of the gaps that arise when thinking about microstructure research issues in the high frequency world. I suggest that, like everything else in the markets, research must also change to reflect the new realities of the high frequency world. I propose some topics for this new research agenda in high frequency market microstructure.

Motivated by the pioneering study of Morck, Yeung, and Yu (2000), this paper investigates whether and how news commonality varies according to a country׳s institutional environments. Using a unique global news data set across 41 countries for the 2000–2009 period, we document three notable findings. First, firm-level news comoves more in countries with weaker institutional environments than in those with stronger institutional environments. Second, news commonality is positively associated with both stock return comovement and stock liquidity commonality. Third, the effect of news commonality on stock return and liquidity comovement is higher in countries with stronger institutions than in those with weaker institutions. These results suggest that a country׳s institutional environments affect firm-specific information production and, more importantly, support the information-efficiency view that lower price synchronicity is caused by greater capitalization of firm-specific information.

There is mounting evidence of the influence of personal characteristics of chief executive officers (CEOs) on corporate outcomes. In this paper we analyze the relation between military service of CEOs and managerial decisions, financial policies, and corporate outcomes. Exploiting exogenous variation in the propensity to serve in the military, we show that military service is associated with conservative corporate policies and ethical behavior. Military CEOs pursue lower corporate investment, are less likely to be involved in corporate fraudulent activity, and perform better during industry downturns. Taken together, our results show that military service has significant explanatory power for managerial decisions and firm outcomes.

This paper develops a theory of how angel and venture capital markets interact. Entrepreneurs first receive angel then venture capital funding. The two investor types are ‘friends’ in that they rely upon each other׳s investments. However, they are also ‘foes,’ because at the later stage the venture capitalists no longer need the angels. Using a costly search model we derive the equilibrium deal flows across the two markets, endogenously deriving market sizes, competitive structures, valuation levels, and exit rates. We also examine the role of legal protection for angel investments.

We present a theory of risk capital and of how tax and other costs of risk capital should be allocated in a financial firm. Risk capital is equity investment that backs obligations to creditors and other liability holders and maintains the firm׳s credit quality. Credit quality is measured by the ratio of the value of the firm׳s option to default to the default-free value of its liabilities. Marginal default values provide a full and unique allocation of risk capital. Efficient capital allocations maintain credit quality and preclude risk shifting. Our theory leads to an adjusted present value (APV) criterion for making investment and contracting decisions. We set out implications for risk management and corporate finance.

Firms from developed countries carry a culture of transparency in business transactions that is opposite to the culture of hiding and insider dealing in developing and transition economies. We employ Russian administrative data on reported earnings and market values of cars to measure wage misreporting for individual employees of domestic firms in Moscow. We show that closer ties to multinationals lead to improved transparency of wage reporting in private Russian companies. Employees located closest to movers from multinationals in the job quality space experience the largest gains in transparency. We find a robust correlation between wage misreporting and accounting fraud.

We examine the impact of banks׳ exposure to market liquidity shocks through wholesale funding on their supply of credit during the financial crisis using loan level data that best allow us to isolate supply-side effects. We find that banks that were more reliant on wholesale funding curtailed their credit significantly more than retail-funded banks. We also exploit the discrete fall in the liquidity of loans above the jumbo cutoff and show that this effect is significantly more pronounced for less liquid loans in line with a liquidity channel. We show that this result cannot be attributed to uneven shifts in demand. The negative relation between wholesale funding and the supply of credit is unique to the crisis episode.