Knowledge that Transforms

We present a new measure of liquidity known as “latent liquidity” and apply it to a unique corporate bond database. Latent liquidity is defined as the weighted average turnover of investors who hold a bond, in which the weights are the fractional investor holdings. It can be used to measure liquidity in markets with sparse transactions data. For bonds that trade frequently, our measure has predictive power for both transaction costs and the price impact of trading, over and above trading activity and bond-specific characteristics thought to be related to liquidity. Additionally, this measure exhibits relationships with bond characteristics similar to those of other trade-based measures.

Firms facing significant business risks have incentives to mitigate the costs of these risks by adjusting their capital structures. This paper investigates this link by analyzing the exposures of multinational firms to political risk. The evidence indicates that returns on investment in politically risky countries are more volatile than returns elsewhere. Multinational firms reduce their leverage in response to these political risks: a one standard deviation increase in foreign political risk is associated with 3.5% reduced leverage. The effect of foreign political risks on leverage is most pronounced for firms in industries whose returns are most susceptible to political influence.

Extant research examines the extent to which bankruptcy has intra-industry valuation consequences. This study broadens the investigation by examining the wealth effects of distress and bankruptcy filing for suppliers and customers of filing firms. On average, important wealth effects occur prior to and at bankruptcy filings and extend beyond industry competitors along the supply chain. Specifically, distress related to bankruptcy filings is associated with negative and significant stock price effects for suppliers. Supplier wealth effects are more negative when intra-industry contagion is more severe. We also investigate the importance of industry structure, specialized product nature, and leverage on supply chain effects.

By documenting the evolution of Tobin's q before, during, and after firms internationalize, this paper provides evidence on the bonding, segmentation, and market-timing theories of internationalization. We find that Tobin's q does not rise after internationalization, even relative to domestic firms. Instead, q rises significantly before and during the internationalization year, but then falls sharply in the following year, quickly relinquishing the increases of the previous years. In decomposing these dynamics, we find that market capitalization rises before internationalization and remains high, while corporate assets increase during internationalization. The evidence supports the theory that financial internationalization facilitates corporate expansion, but challenges the theory that internationalization produces an enduring effect on q by bonding firms to a better corporate governance system.

This study provides empirical evidence that firms with larger boards have lower variability of corporate performance. The results indicate that board size is negatively associated with the variability of monthly stock returns, annual accounting return on assets, Tobin's Q, accounting accruals, extraordinary items, analyst forecast inaccuracy, and R&D spending, the level of R&D expenditures, and the frequency of acquisition and restructuring activities. The results are consistent with the view that it takes more compromises for a larger board to reach consensus, and consequently, decisions of larger boards are less extreme, leading to less variable corporate performance.

This paper analyzes the interaction between financial leverage and takeover activity. We develop a dynamic model of takeovers in which the financing strategies of bidding firms and the timing and terms of takeovers are jointly determined. In the paper, capital structure plays the role of a commitment device, and determines the outcome of the acquisition contest. We demonstrate that there exists an asymmetric equilibrium in financing policies with endogenous leverage, bankruptcy, and takeover terms, in which the bidder with the lowest leverage wins the takeover contest. Based on the resulting equilibrium, the model generates a number of new predictions. In particular, the model predicts that the leverage of the winning bidder is below the industry average and that acquirers should lever up after the takeover consummation. The model also relates the dispersion in leverage ratios to various industry characteristics, such as cash flow volatility or bankruptcy costs.

We examine the link between Internal Revenue Service (IRS) monitoring and yield spreads on private firms’ 144A bond issues. After controlling for security-specific and other firm-specific determinants, we provide evidence that debt financing is cheaper when the probability of a face-to-face IRS audit is higher. Consistent with another prediction, we find that IRS oversight has a stronger impact on bond pricing for private firms with high ownership concentration, which suffer worse agency problems between controlling shareholders and outside investors. Collectively, our research implies that IRS monitoring plays a valuable corporate governance role by reducing information asymmetry evident in borrowing costs.

We estimate latent factor models of liquidity, aggregated across various liquidity measures. Shocks to assets’ liquidity have a common component across measures which accounts for most of the explained variation in individual liquidity measures. We find that across-measure systematic liquidity is a priced factor while within-measure systematic liquidity does not exhibit additional pricing information. Controlling for across-measure systematic liquidity risk, there is some evidence that liquidity, as a characteristic of assets, is priced in the cross-section. Our results are robust to the inclusion of other equity characteristics and risk factors, such as market capitalization, book-to-market, and momentum.

This paper proposes a new methodology to evaluate the economic effect of state-specific policy changes, using bank-branching deregulations in the US as an example. The new method compares economic performance of pairs of contiguous counties separated by state borders, where on one side restrictions on statewide branching were removed relatively earlier, to create a natural “regression discontinuity” setup. The study uses a total of 285 pairs of contiguous counties along 38 segments of such regulation change borders to estimate treatment effects for 23 separate deregulation events taking place between 1975 and 1990. To distinguish real treatment effects from those created by data-snooping and spatial correlations, fictitious placebo deregulations are randomized (permutated) on another 32 segments of non-event borders to establish empirically a statistical table of critical values for the estimator. The method determines that statistically significant growth accelerations can be established at a extgreater 90% confidence level in five (and none prior to 1985) out of the 23 deregulation events examined. “Hinterland counties” within the still-regulated states, but farther away from the state borders, are used as a second control group to consider and reject the possibility that cross-border spillover of deregulation effects may invalidate the empirical design.

We entertain the possibility of pervasive factors that are not common across two (or more) groups of securities. We propose and implement a general procedure to estimate the space spanned by common and group-specific pervasive factors. In our empirical analysis, we study the factor structure of excess returns on stocks traded on the NYSE and Nasdaq using our methodology. We find that there are only two common pervasive factors that govern the returns for both NYSE and Nasdaq. At the same time, the NYSE and Nasdaq each have one more group-specific factor that is not the same across the two exchanges. Our results point to the absence of complete similarity between the factors driving the returns on these exchanges.