Knowledge that Transforms

I show dividend policies have peer effects. My estimates indicate that firms speed up the time taken to make a dividend change by about 1.5 quarters and increase payments by 16% in response to peer changes. The peer effects matter in increases but not decreases. In contrast to dividends, repurchases show no peer effects. In addition, announcement returns indicate that investors partially anticipate the consequences of peer effects. Overall, peer interdependencies account for 12% of total dividend payments.

The relative size and inflexibility of labor expenses lead to a form of operating leverage, which we call labor leverage. We derive a set of conditions for the existence of labor leverage even when labor markets are frictionless. Our model provides theoretical support for the use of firm-level labor share as a measure of labor leverage. Using Compustat/CRSP and confidential Census data, we provide evidence for the existence and for the economic significance of labor leverage: high labor share firms have operating profits that are more sensitive to economic shocks and have higher expected returns.

Firms consider wages, current and expected productivity, as well as firing and hiring costs when firing a worker. Financing constraints distort this intertemporal trade-off, leading firms to sub-optimally fire short-tenured workers with high future expected productivity. We provide empirical evidence of this distortion using matched employer-employee data from the Swedish population between 2000 and 2010. We propose a new empirical strategy that uses credit ratings to identify financing constraints and uses exchange rates and trade data to identify demand shocks. Our empirical results identify an important new misallocation effect of financial frictions that operates within firms across different types of workers.

We find that social capital, as captured by secular norms and social networks surrounding corporate headquarters, is negatively associated with levels of CEO compensation. This relation holds in a range of robustness tests including those that address omitted variable bias and reverse causality. Additionally, social capital reduces the likelihood that firms make opportunistic option grant awards that unduly favor CEOs, including lucky awards, backdated awards, and unscheduled awards. Social capital also lessens the accretive effect of CEO power on CEO compensation. These findings indicate that social capital mitigates agency problems by restraining managerial rent extraction in CEO compensation.

We consider a dynamic model in which receiving support from the lender of last resort (LLR) may help banks to weather investor runs. We show the need for regulatory liquidity standards when the underlying social trade-offs make the uninformed LLR inclined to support troubled banks during a run. Liquidity standards increase the time available before the LLR must decide on supporting the bank. This facilitates the arrival of information on the bank’s financial condition and improves the efficiency of the decision taken by the LLR, a role that can be modified but not replaced with the use of capital regulation.

I develop a dynamic model of optimal funding to understand why financial assets are used as collateral instead of being sold to raise funds. Firms need funds to invest in risky projects with nonobservable returns. Since holding these assets allows firms to raise these funds, investing firms value the asset more than noninvesting ones. When assets are less than perfectly liquid and investment opportunities are persistent, collateralized debt minimizes asset transfers from investing to noninvesting firms and thus is optimal. Frictions in asset markets lead to an illiquidity discount and a collateral premium, which increase with the asset’s illiquidity.

We find that firms experiencing improvements in crowdsourced employer ratings significantly outperform firms with declines. The return effect is concentrated among reviews from current employees, stronger among early firm reviews, and also stronger when the employee works in the headquarters state. Decomposing employer ratings, we find the return effect is related to changing employee assessments of Career Opportunities and views of senior management. It is unrelated to work-life balance. Employer rating changes are associated with growth in sales and profitability and help forecast one-quarter-ahead earnings announcement surprises. The evidence is consistent with employee reviews revealing fundamental information about the firm.

We study whether industry familiarity is an advantage in stock trading by exploring the trading patterns of industry insiders in their own personal portfolios. To do so, we identify accounts of industry insiders in a large data set provided by a retail discount broker. We find that insiders trade firms from their own industry more frequently. Furthermore, they earn abnormal returns exclusively when trading own-industry stocks, especially obscure stocks (small, low analyst coverage, high volatility). In a battery of tests, we find no evidence of the use of private information. The results are most consistent with the interpretation that industry familiarity is an advantage in stock trading.

We link investor heterogeneity to the persistence of the overnight and intraday components of returns. We document strong overnight and intraday firm-level return continuation along with an offsetting cross-period reversal effect, all of which lasts for years. We look for a similar tug of war in the returns of 14 trading strategies, finding in all cases that profits are either earned entirely overnight (for reversal and a variety of momentum strategies) or entirely intraday, typically with profits of opposite signs across these components. We argue that this tug of war should reduce the effectiveness of clienteles pursuing the strategy. Indeed, the smoothed spread between the overnight and intraday return components of a strategy generally forecasts time variation in that strategy’s close-to-close performance in a manner consistent with that interpretation. Finally, we link cross-sectional and time-series variation in the decomposition of momentum profits to a specific institutional tug of war.

Firms finance intangible investment through employee compensation contracts. In a dynamic model in which intangible capital is embodied in a firm’s employees, we analyze the firm’s optimal decisions on intangible capital investment, employee compensation contracts, and financial leverage. Employee financing is achieved by delaying wage payments in the form of future claims. We show that intangible capital investment is highly correlated with employee financing but not with debt issuance or regular equity refinancing. In our quantitative analysis, we show that this new channel of employee financing explains the cross-industry differences in leverage and financing patterns.