Knowledge that Transforms

In the period surrounding World War I, US firms sharply increased investment in fixed assets and working capital to accommodate large increases in demand associated with the war. Concurrently, the US adopted an excess profits tax, which created a tax bias in favor of equity financing. Despite this tax bias, firms in need of external funds largely issued debt, not equity, to finance investment spikes when the excess profits tax was in effect. Further, we find these firms systematically reduced debt after the war, whereas other firms did not. The results support models that link the dynamics of firms’ financing decisions with the dynamics of their investment opportunities and are inconsistent with models that emphasize taxes as a primary determinant of financing decisions.

We aim to make two contributions to the literature on the effects of transaction costs on financial price volatility. First, by augmenting a double differencing approach with a research design with three ingredients (a common set of companies simultaneously listed on two stock exchanges, binding capital controls, and different timing of changes in transaction costs), we obtain a control group that has identical corporate fundamentals as the treatment group. We apply the research design to Chinese stocks that are cross-listed in Hong Kong and Mainland China. Second, we allow transaction costs to have different effects in markets with different maturity. We find a significantly negative relationship, on average, between stamp duty increase and price volatility. However, this average effect masks some important heterogeneity. In particular, when institutional investors have become a significant part of the traders’ pool, we find an opposite effect. Overall, our results suggest that a Tobin tax could work in an immature market, but can backfire in a more developed market.

The media can impose reputational costs on firms because of its important role as an information intermediary and its ability to negatively slant coverage. We exploit a quasi-natural experiment that holds constant the information event across firms but varies the availability of a major news outlet in local markets. We find that firms subject to the threat of slanted coverage suppress the release of negative information before the event and release it subsequently. Our results are consistent with theory on the active role firms can play in managing their reputational capital through anticipatory actions to avoid negative media coverage.

Operating in individual cities, US clearinghouses were the closest thing to a central bank before 1914, but they only assisted banks that chose to join the association. Using an annual bank-level database for seven states between 1880 and 1910, this paper shows that after the entry of a clearinghouse member banks were less likely and nonmember banks in the same city were more likely to close. The results are driven by the fact that the presence of clearinghouses led all banks to become more exposed to systemic liquidity risk, yet provided liquidity only to member banks during panics.

We examine the performance of mutual funds whose managers simultaneously manage portfolios with performance-based incentive fees for three account types: mutual funds, hedge funds, and separate accounts. Importantly, our data set is free of selection bias because it is hand-collected from mandatory SEC filings. We find that only funds whose managers also manage hedge funds significantly underperform peer mutual funds. Moreover, underperformance begins only after fund managers begin to manage a hedge fund. We find that managerial incentives and opportunities for cross-subsidization explain variation in underperformance across funds, supporting the conflicts of interest hypothesis in the debate on “side-by-side management.”

The beta anomaly, negative (positive) alpha on stocks with high (low) beta, arises from beta’s positive correlation with idiosyncratic volatility (IVOL). The relation between IVOL and alpha is positive among underpriced stocks but negative and stronger among overpriced stocks (Stambaugh, Yu, and Yuan, 2015). That stronger negative relation combines with the positive IVOL-beta correlation to produce the beta anomaly. The anomaly is significant only within overpriced stocks and only in periods when the beta-IVOL correlation and the likelihood of overpricing are simultaneously high. Either controlling for IVOL or simply excluding overpriced stocks with high IVOL renders the beta anomaly insignificant.

We examine whether institutions’ monitoring effectiveness is related to the number of their blockholdings. We find that the number of blocks that a firm's large institutions hold is positively associated with forced chief executive officer (CEO) turnover-performance sensitivity, abnormal returns around forced CEO turnover announcements and 13D filings, and changes in firm value. These results are particularly evident when institutions have multiple blockholdings in the same industry, when they have activism experience, or when they have long-term blockholdings in their portfolio firms. Our results suggest that information advantages and governance experience obtained from multiple blockholdings are important channels through which institutions perform effective monitoring.

I analyze investment, q, and cash flow in a tractable stochastic model in which marginal q and average q are identically equal. I introduce classical measurement error and derive closed-form expressions for the coefficients in regressions of investment on q and cash flow. The cash-flow coefficient is positive and larger for faster growing firms, yet there are no financial frictions in the model. I develop the concepts of bivariate attenuation and weight shifting to interpret the estimated coefficients on q and cash flow in the presence of measurement error.

We examine the effects of diversity in the board of directors on corporate policies and risk. Using a multidimensional measure, we find that greater board diversity leads to lower volatility and better performance. The lower risk levels are largely due to diverse boards adopting more persistent and less risky financial policies. However, consistent with diversity fostering more efficient (real) risk-taking, firms with greater board diversity also invest persistently more in research and development (R&D) and have more efficient innovation processes. Instrumental variable tests that exploit exogenous variation in firm access to the supply of diverse nonlocal directors indicate that these relations are causal.

We analyze how direct employee voice affects financial leverage. German law mandates that firms’ supervisory boards consist of an equal number of employees’ and owners’ representatives. This requirement, however, applies only to firms with more than two thousand domestic employees. We exploit this discontinuity and the law’s introduction in 1976 for identification and find that direct employee power increases financial leverage. This is explained by a supply side effect: as banks’ interests are similar to those of employees, higher employee power reduces agency conflicts with debt providers, leading to better financing conditions. These findings reveal a novel mechanism of direct employee influence.