Knowledge that Transforms

We estimate the impact of venture capital (VC) contract terms on startup outcomes and the split of value between the entrepreneur and investor, accounting for endogenous selection via a novel dynamic search-and-matching model. The estimation uses a new, large data set of first financing rounds of startup companies. Consistent with efficient contracting theories, there is an optimal equity split between agents, which maximizes the probability of success. However, venture capitalists (VCs) use their bargaining power to receive more investor-friendly terms compared to the contract that maximizes startup values. Better VCs still benefit the startup and the entrepreneur due to their positive value creation. Counterfactuals show that reducing search frictions shifts the bargaining power to VCs and benefits them at the expense of entrepreneurs. The results show that the selection of agents into deals is a first-order factor to take into account in studies of contracting.

We investigate the role of forward-looking financial factors in propagating the Great Depression. We find that a new hand-collected bank stock index is better at predicting the onset of the Great Depression than the aggregate stock market or failed bank deposits. The bank stock index explains almost one-third of the fluctuations in industrial production after five years. Analysis disaggregated at each Federal Reserve district shows that bank stocks capture forward-looking information about debt defaults and credit. Our results suggest that future studies of the credit channel during the Great Depression should incorporate bank stocks to better identify the impact of credit crunches on economic activity.

We examine whether the local press is an effective monitor of corporate misconduct. Specifically, we study the effects of local newspaper closures on violations by local facilities of publicly listed firms. After a local newspaper closure, local facilities increase violations by 1.1% and penalties by 15.2%, indicating that the closures reduce firm monitoring by the press. This effect is not driven by the underlying economic conditions, the underlying local fraud environment, or the underlying firm conditions. Taken together, our findings indicate that local newspapers are an important monitor of firms’ misconduct.

This paper introduces a real-time, continuous measure of national sentiment that is language-free and thus comparable globally: the positivity of songs that individuals choose to listen to. This is a direct measure of mood that does not pre-specify certain mood-affecting events nor assume the extent of their impact on investors. We validate our music-based sentiment measure by correlating it with mood swings induced by seasonal factors, weather conditions, and COVID-related restrictions. We find that music sentiment is positively correlated with same-week equity market returns and negatively correlated with next-week returns, consistent with sentiment-induced temporary mispricing. Results also hold under a daily analysis and are stronger when trading restrictions limit arbitrage. Music sentiment also predicts increases in net mutual fund flows, and absolute sentiment precedes a rise in stock market volatility. It is negatively associated with government bond returns, consistent with a flight to safety.

A higher frequency of positive overnight returns followed by negative trading day reversals during a month suggests a more intense daily tug of war between opposing investor clienteles, who are likely composed of noise traders overnight and arbitrageurs during the day. We show that a more intense daily tug of war predicts higher future returns in the cross section. Additional tests support the conclusion that, in a more intense tug of war, daytime arbitrageurs are more likely to discount the possibility that positive news arrives overnight and thus overcorrect the persistent upward overnight price pressure.

Using novel credit data, we show that hedge fund borrowing is significantly overcollateralized, primarily with rehypothecable securities. An idiosyncratic liquidity shock to a major prime broker significantly decreases credit to connected hedge funds. The dominant channel behind this shock transmission is credit supply reduction rather than precautionary demand reduction. Funds posting more rehypothecable collateral are less affected because their collateral alleviates prime broker liquidity constraints. Exposed funds subsequently have lower aggregate credit with worse terms, suggesting imperfect substitutability across hedge fund credit sources. Funds subject to the decrease in balance sheet leverage subsequently increase portfolio illiquidity, embedded leverage, and derivatives exposure.

We study how the arrival of macro-news affects the stock market's ability to incorporate the information in firm-level earnings announcements. Existing theories suggest that macro and firm-level earnings news are attention substitutes; macro-news announcements crowd out firm-level attention, causing less efficient processing of firm-level earnings announcements. We find the opposite: the sensitivity of announcement returns to earnings news is 17% stronger, and post-earnings announcement drift 71% weaker, on macro-news days. This suggests a complementary relationship between macro and micro news that is consistent with either investor attention or information transmission channels.

We demonstrate theoretically that Bitcoin’s limited adoption arises as an equilibrium outcome rather than as a short-lived property. Our results are driven by negative network effects which arise due to Bitcoin’s need for consensus and the existence of network delay. As the Bitcoin network expands, network delay grows thereby prolonging the time needed for generating consensus. In turn, transaction settlement becomes prolonged, and users abandon the system, yielding limited adoption. Increasing transaction rates fails to solve this problem because increasing transaction rates increases fork probabilities which prolongs the consensus process and generates limited adoption.

Does enhanced regulatory transparency facilitate alignment of private and public enforcement? Utilizing the SEC's 2004 decision to publicly disclose its comment letters, we explore the actions of the SEC and shareholder litigants. We find the two parties converge more on enforcement targets after the public disclosure. The increased alignment is attributable to public scrutiny of SEC oversight enhancing regulator incentives and reducing regulatory capture, and to shareholder plaintiffs gaining information previously accessible only by regulators, enabling litigants to identify cases with “merit.” These findings suggest regulatory transparency enhances the complementarity of public and private enforcement, potentially improving enforcement outcomes.

We survey 2484 U.S. individuals with at least $1 million of investable assets about how well leading academic theories describe their financial beliefs and personal investment decisions. The wealthy's beliefs about financial markets and the economy are surprisingly similar to those of the average U.S. household, but the wealthy are less driven by discomfort with the market, financial constraints, and labor income considerations. Portfolio equity share is most affected by professional advice, time until retirement, personal experiences, rare disaster risk, and health risk. Concentrated equity holding is most often motivated by belief that the stock has superior risk-adjusted returns. Beliefs about how expected returns vary with stock characteristics frequently differ from historical relationships, and more risk is not always associated with higher expected returns. Active equity fund investment is most motivated by professional advice and the expectation of higher average returns. Berk and Green (2004) rationalize return chasing in the absence of fund performance persistence by positing that past returns reveal managerial skill but there are diminishing returns to scale in active management. Forty-two percent of respondents agree with the first assumption, 33% with the second, and 19% with both.