Predictive regressions find that the party of the US president, the weather in Manhattan, global warming, the El Niño phenomenon, sunspots, and the conjunctions of the planets all have significant power predicting the performance of popular anomalies. The interpretation of these results has important implications for the asset pricing literature.
We propose a theory of credit lines provided by banks to firms as a form of monitored liquidity insurance. Bank monitoring and resulting revocations help control illiquidity-seeking behavior of firms insured by credit lines. The cost of credit lines is thus greater for firms with high liquidity risk, which in turn are likely to use cash instead of credit lines. We test this implication for corporate liquidity management by identifying exogenous shocks to liquidity risk of firms in corporate bond and equity markets. Firms experiencing increases in liquidity risk move out of credit lines and into cash holdings.
Peers' valuation matters for firms' investment: a one standard deviation increase in peers' valuation is associated with a 5.9% increase in corporate investment. This association is stronger when a firm's stock price informativeness is lower or when its managers appear less informed. Also, the sensitivity of a firm's investment to its stock price is lower when its peers' stock price informativeness is higher or when demands for its products and its peers' products are more correlated. Furthermore, the sensitivity of firms' investment to their peers' valuation drops significantly after going public. These findings are uniquely predicted by a model in which managers learn information from their peers' valuation.
A theoretical tradition argues that more risk tolerant individuals are more likely to become entrepreneurs but perform worse. We test and confirm these predictions with several risk tolerance proxies. Using investment data for 400,000 individuals, we find that common stock investors are around 50% more likely to subsequently start up a firm. Firms started up by common stock investors have about 25% lower sales and 15% lower return on assets. The results are similar using personal leverage and other risk-tolerance proxies. We do not find support for alternative explanations such as unobserved wealth or behavioral effects.
Regulatory restrictions and market frictions can constrain the aggregate quantity of long and short positions in a security. When these constraints bind, we refer to the security as scarce, and its price becomes distorted relative to its value in a frictionless market. We show that an otherwise redundant derivative can reduce the price distortion of the underlying security by relaxing its scarcity. We also show that it is especially important to analyze the underlying and derivative markets jointly when evaluating the impact of regulation, such as short-sales bans and position limits in derivatives, that restricts trade.
This paper examines how the information quality of ratings from an issuer-paid rating agency (Standard and Poor's) responds to the entry of an investor-paid rating agency, the Egan-Jones Rating Company (EJR). By comparing S&P's ratings quality before and after EJR initiates coverage of each firm, I find a significant improvement in S&P's ratings quality following EJR's coverage initiation. S&P's ratings become more responsive to credit risk and its rating changes incorporate higher information content. These results differ from the existing literature documenting a deterioration in the incumbents' ratings quality following the entry of a third issuer-paid agency. I further show that the issuer-paid agency seems to improve the ratings quality because EJR's coverage has elevated its reputational concerns.
Some important puzzles in macro finance can be resolved in a model featuring systematically varying volatility of unpriced shocks to firms׳ earnings. In the data, the correlation between corporate debt and stock market valuations is low. The model accounts for this via the opposing effect of unpriced earnings risk on levered debt and equity prices. The model also explains the low (or nonexistent) risk-reward relation for the market portfolio of levered equity via the opposing effects of unpriced and priced uncertainty (both components of stock volatility) on the levered equity risk premium. Versions of the model calibrated to empirical measures of both types of fundamental risk can quantitatively substantiate these explanations. Variation in residual earning dispersion accounts for a significant fraction of observed disagreement between debt and equity valuations and of realized stock volatility. The implication that the two components of risk should forecast the levered equity risk premium with opposite signs is also supported in the data. The results are a notable advance for risk-based asset pricing.
We use the deaths of directors and chief executive officers as a natural experiment to generate exogenous variation in the time and resources available to independent directors at interlocked firms. The loss of such key co-employees is an attention shock because it increases the board committee workload only for some interlocked directors—the ‘treatment group’. There is a negative stock market reaction to attention shocks only for treated director-interlocked firms. Interlocking directors׳ busyness, the importance of their board roles, and their degree of independence magnify the treatment effect. Overall, directors׳ busyness is detrimental to board monitoring quality and shareholder value.
This paper shows connections between chief executive officers׳ (CEOs׳) absences from headquarters and corporate news disclosures. I identify CEO absences by merging records of corporate jet flights and CEOs׳ property ownership near leisure destinations. CEOs travel to their vacation homes just after companies report favorable news, and CEOs return to headquarters right before subsequent news releases. When CEOs are away, companies announce less news, mandatory disclosures occur later, and stock volatility falls sharply. Volatility increases when CEOs return to work. CEOs spend fewer days out of the office when ownership is high and when weather is bad at their vacation homes.
This paper shows that incentives created by the impending turnover of local politicians can accelerate the pace of initial public offering (IPO) activity in certain politicized environments. Focusing on China, we exploit a research setting where politicians are rewarded for capital market development, firms rely on political connections for access to capital, rent-seeking behavior is rampant, and the objectives of the state might not be to maximize capital market efficiency. We find that the rate of exchange eligible firms engaging in an IPO temporarily increases in advance of impending political promotion events. This effect holds for both state-owned and non-state-owned entities. For state-owned firms, the effect is strongest in those provinces where the politicians are more likely to be rewarded for market development activity. For non-state-owned firms, the temporary increase in IPO activity appears to be (rationally) opportunistic in nature, with the effect stronger around events more likely to disrupt the firms' political connections. Promotion period IPOs underperform non-promotion period IPOs in terms of both future financial performance and long-run stock returns, have controlling shareholders who retain a larger fraction of the company, and are more likely to divert proceeds away from their intended use after the offering.