Knowledge that Transforms

Drawing on a novel database of the 401(k) plans of 296 firms, we examine the international equity allocations of 3.8 million individuals over the 2005–2011 period. We find enormous cross-individual variation, ranging from zero to more than 75%, and strong cohort effects, with younger cohorts investing more internationally than older ones and each cohort investing more internationally over time. Access to financial advice, lower fees, and more international fund choices are associated with higher international allocations, suggesting a role for plan design and policy. Education, financial literacy, and the fraction of foreign-born population in the ZIP code also have positive effects on international diversification, consistent with explanations based on familiarity bias and information barriers.

We investigate whether corporations and their executives react to an exogenous change in passive institutional ownership and alter their corporate governance structure. We find that exogenous increases in passive ownership lead to increases in CEO power and fewer new independent director appointments. Consistent with these changes not being beneficial for shareholders, we observe negative announcement returns to the appointments of new independent directors. We also show that firms carry out worse mergers and acquisitions after exogenous increases in passive ownership. These results suggest that the changed ownership structure causes higher agency costs.

We study the returns to investing in VIX futures, VIX Exchange Traded Notes (ETNs), and variance swaps. We document substantial negative return premia for these assets. For example, the constant maturity portfolio of 1-month VIX futures loses about 30% per year over our sample period (2006–2013). We investigate if these findings are consistent with dynamic equilibrium. We derive a model based on present value computation that endogenizes stock prices, the VIX index, and its associated derivative contracts. The model explains the negative return premia as well as several other stylized features of the VIX futures, ETNs, and variance swap data.

We characterize the dynamic fragmentation of U.S. equity markets using a unique data set that disaggregates dark transactions by venue types. The “pecking order” hypothesis of trading venues states that investors “sort” various venue types, putting low-cost-low-immediacy venues on top and high-cost-high-immediacy venues at the bottom. Hence, midpoint dark pools on top, non-midpoint dark pools in the middle, and lit markets at the bottom. As predicted, following VIX shocks, macroeconomic news, and firms’ earnings surprises, changes in venue market shares become progressively more positive (or less negative) down the pecking order. We further document heterogeneity across dark venue types and stock size groups.

We investigate systematic changes in corporate effective tax rates over the past 25 years and find that effective tax rates have decreased significantly. Contrary to conventional wisdom, the decline in effective tax rates is not concentrated in multinational firms; effective tax rates have declined at approximately the same rate for both multinational and domestic firms. Moreover, within multinational firms, both foreign and domestic effective rates have decreased. Finally, changes in firm characteristics and declining foreign statutory tax rates explain little of the overall decrease in effective rates.

We investigate the importance of ambiguity, or Knightian uncertainty, in executives’ stock option exercise decisions. We develop an empirical estimate of ambiguity and include it in regression models alongside the traditional measure of risk, equity volatility. We show that each variable has a significant effect on the timing of option exercises, with volatility causing executives to hold options longer to preserve option value, and ambiguity increasing the tendency for executives to exercise early.

High loan fees generate short-selling constraints and, therefore, reduce price efficiency. Despite the importance of loan fees, empirical evidence on their determinants is scarce. Using a market-wide deal-by-deal data set on the Brazilian equity lending market which uniquely identifies borrowers, brokers, and lenders, we are able to construct a proxy of search costs at the borrower–stock–day level. We find that—for the same stock, on the same day—borrowers with higher search costs pay significantly higher loan fees. Our results suggest that regulators should encourage the use of a centralized lending platform to reduce search costs in the lending market.

We show that opportunistic insiders can be identified through the profitability of their trades prior to quarterly earnings announcements (QEAs) and that opportunistic trading is associated with various kinds of firm or managerial misconduct. A value-weighted trading strategy based on (not necessarily pre-QEA) trades of opportunistic insiders earns monthly four-factor alphas of over 1%, which is much higher than in past insider trading literature and substantial and significant even on the short side. Firms with opportunistic insiders have higher levels of earnings management, restatements, US Securities and Exchange Commission enforcement actions, shareholder litigation, and executive compensation. These findings suggest that opportunism is a domain-general trait.

We design a novel test for changes in market discipline based on the relation between firm-specific risk, credit spreads, and equity returns. We use our method to analyze the evolution of bailout expectations during the recent financial crisis. We find that bailout expectations peaked in reaction to government interventions following the failure of Lehman Brothers, and returned to pre-crisis levels following the initiation of the Dodd-Frank Act. We do not find such changes in market discipline for nonfinancial firms. Finally, market discipline is weaker for government-sponsored enterprises (GSEs) and systemically important banks (SIBs) than for investment banks.

We model the debt maturity choice of firms in the presence of fixed issuance costs in the primary market and search frictions in the secondary market for debt. In the secondary market, short maturities improve the bargaining position of sellers, which reduces the required issuance yield. Long maturities reduce reissuance costs. The optimally chosen maturity trades off both considerations. Equilibrium exhibits inefficiently short maturity choices. An individual firm does not internalize that a longer maturity increases expected gains from trade in the secondary market, which attracts more buyers and, hence, facilitates the sale of debt issued by other firms.