Knowledge that Transforms

Extant literature shows that IPO first-day returns are correlated with market returns preceding the issue. We propose a rational explanation for this puzzling predictability by adding a public signal to Benveniste and Spindt (1989)’s information-based framework. A novel result of our model is that the compensation required by investors to truthfully reveal their information decreases with the public signal. This “incentive effect” receives strong empirical support in a sample of 6300 IPOs in 1983–2012. Controlling for the incentive effect, the positive relation between initial returns and pre-issue market returns disappears for top-tier underwriters, where the order book is held to be most informative, effectively resolving the predictability puzzle.

Our study of the corporate loan pricing policies of U.S. banks over the past two decades shows that loan spreads for riskier firms become relatively lower during periods of monetary policy easing compared to tightening. This effect is driven by banks with greater risk appetite, measured from individual banks’ answers to the Senior Loan Officers Opinion Survey. Our results hold with different fixed effects that account for time-varying observed and unobserved heterogeneity of credit demand and bank lending conditions that are not directly related to monetary policy. Together with our survey-based measure of bank risk appetite, we provide compelling evidence of the presence of a bank risk-taking channel of monetary policy in the U.S.

We examine how access to bank credit affects trade credit in the supplier–customer relationships of U.S. public firms. For identification, we use exogenous liquidity shocks to supplier firms in the form of staggered changes to interstate bank branching laws. Using a variety of tests, we show that supplier firms with greater access to banking liquidity offer more trade credit to their customers. We also show that when bank branching restrictions are relaxed in the supplier’s state, the supplier–customer relationship is more likely to survive.

In November of 2007 a fire sale of Chilean stocks was triggered by a change in the constraints that regulate pension fund portfolios. This regulatory shock provided a cleanly identified fire sale unrelated to fundamentals. Stocks with more selling pressure from pension funds lost approximately 4% in November compared to other stocks. Although the selling pressure was temporary, prices reverted only after four to six months. Pension funds initially mitigated the impact of the fire sale by selling large index stocks in which demanding liquidity was less costly. Coordination across pension funds increased during the fire sale. We find no significant evidence of real effects on firm investment in the quarters after the fire sale.

Regulatory changes in the over-the-counter (OTC) derivatives market seek to reduce systemic risk. The reforms require that standardized derivatives be cleared through central counterparties (CCPs), and they set higher capital and margin requirements for non-centrally cleared derivatives. We investigate whether these requirements create a cost incentive in favor of central clearing, as intended. We compare the total capital and collateral costs when banks transact fully bilaterally and when they clear all contracts through CCPs. We calibrate our model using data on the OTC market collected by the Federal Reserve. We find that the cost incentive may not favor central clearing. The main factors driving the cost comparison are netting benefits, the margin period of risk, and CCP guarantee fund requirements. Lower guarantee fund requirements lower the cost of clearing but make CCPs less resilient.

We study how lenders in blockheld firms exploit the information on the other holdings of equity blockholders to learn their attitude toward creditors. In the presence of the conflict of interest between lenders and equityholders, information on how blockholders behave in the other firms they control provides the lenders with key information about potential blockholder behavior. We test this hypothesis using data on US public firms over the 2001–2008 period. We show that the financial conditions of these co-owned firms affect how lenders value other firms in which the owner has a major stake. Bad news on credit quality in co-owned firms raise the firm's credit risk. Our identification is based on the instrumental variables estimation where we instrument the changes in credit risk of co-owned firms by the natural disaster events in the counties of co-owned firm headquarters.

We examine the hypothesis that fluctuations in the aggregate supply of bank loans influence the supply of new equity capital. Using residual lending standards as a clean measure of aggregate loan supply and a VAR framework to aid identification, we find that a one-standard-deviation shock to lending standards results in 15% fewer IPOs. Shocks elicit strong responses from IPO-firms that are highly dependent on external capital and increase the number of withdrawals, strengthening the interpretation that the above is driven by changes in the supply of equity. Our results suggest that credit conditions are important to a well-functioning IPO market.

This paper empirically characterizes relationship lending using data from more than 20,000 loans of a Spanish bank to small and medium enterprises (SMEs). The study analyzes the pricing determinants of loans to firms based on the entire previous bank–firm relationship, allowing for the identification of nonlinear pricing patterns in the bank–firm relationship. We show that firms only start capitalizing the gains of relationship lending when the relationship extends beyond two years. This reduction in the loan rate spread charged is driven by the opaque firms, for which the acquisition of “soft” information is especially relevant. Finally, we find that relationship lending significantly mitigates the increased costs of refinancing loans along two dimensions: relationship duration and having additional contracts—other than loans—with the bank.

We construct a measure of a bank's relative creditworthiness from the Eurosystem's proprietary inter-bank loan data: average overnight borrowing rate relative to an overnight rate index (AOR). We then investigate the dynamic relationship between AOR and the credit default swap price relative to the corresponding market index of 60 banks during 2008–2013. Price discovery mainly takes place in the CDS market, but AOR also contributes to it. The lagged daily changes of AOR help predict CDS. This indicates that AOR includes private information, which the CDS market does not immediately incorporate. We further show that the private information advantage is concentrated on days of market stress and on banks, which mainly borrow from relationship lender banks. Such borrower banks are typically smaller, have weaker ratings, and are likely to reside in crisis countries. Competent authorities can use AOR as a complementary indicator of banks’ concurrent health.

The high-tech sector accounts for the majority of corporate innovation in modern economies. In a sample of 38 countries, we document a strong positive relation between the initial size of the country's high-tech sector and subsequent rates of GDP and total factor productivity growth. We also find a strong positive connection between a country's equity (but not credit) market development and the size of its high-tech sector. Our main difference-in-differences estimates show that better developed stock markets support faster growth of innovative-intensive, high-tech industries. The main channels for this effect are higher rates of productivity and faster growth in the number of new high-tech firms. Credit market development fosters growth in industries that rely on external finance for physical capital accumulation but is unimportant for growth in innovation-intensive industries. These findings show that stock markets and credit markets play important but distinct roles in supporting economic growth. Stock markets are uniquely suited for financing technology-led growth, a particularly important concern for advanced economies.