Knowledge that Transforms

Credit rating agencies (CRAs) are less likely and slower to downgrade firms with performance-sensitive debt (PSD) if these downgrades increase borrowing costs. This effect is stronger when CRAs rate their most profitable clients and is not driven by selection into PSD contracts, by borrowers adjusting their leverage, or by borrowers hiding information. Originating banks price the CRAs’ conflicts of interest and sell loans with more embedded conflicts more frequently. In contrast, secondary market participants do not price conflicts of interest to the same extent. The recent settlements between the major CRAs and the U.S. government do not prevent rating inflation.

This study proposes a specific channel through which labor markets facilitate firm growth: the occupational alignment between an establishment’s workforce and local skills. Using occupational employment statistics, we construct an index that compares each establishment’s occupational mix to that of its local market. Establishments with higher alignment grow faster in sales and employment. This growth comes primarily through lower adjustment costs and higher capital investment. We also show that the effects are most pronounced in establishments with a higher share of skilled workers and industries with higher idiosyncratic cash flow risk. This employee–firm matching channel helps explain how local labor markets translate into competitive advantage.

Empirically, the effect of corporate tax rates on leverage has been smaller than expected based on trade-off theory. In this article, I show that tax avoidance functions as a non-debt tax shield, reducing the benefits of the debt tax shield. I find that higher tax rates cause higher non-debt tax avoidance, which crowds out the debt tax shield. Moreover, I show that the strength of the relationship between debt and tax rates depends on the level of tax avoidance. A 1-standard-deviation higher tax rate implies 2.8% higher leverage for low tax avoidance firms, but has a negative effect for high tax avoidance firms.

We use a sharp regression discontinuity design (RDD) to show that victories by women candidates in close House, Senate, and gubernatorial elections lead to an increase in female directors in firms located in the candidates’ districts. The causal effect is higher when the media coverage of the woman candidate is higher, when voter turnout is high, and when firms have more local directors and local institutional investors. The heterogeneous regression discontinuity (RD) effects suggest that electoral wins may influence local gender norms and firms’ board diversity through multiple channels, including conveying majority views on gender-related social norms, increasing exposure to exemplar women, and facilitating learning about women’s different but effective leadership styles. The evidence suggests a potential spillover effect from women’s political leadership to the corporate world.

We model the time-varying probability of consumption disasters with international risk interactions and estimate the model using national accounts data of 42 countries back to 1833. The estimated world and country-specific disaster probabilities accord well with historical macroeconomic disasters. A match of the equity premium requires a relative risk aversion coefficient of approximately 5, which is significantly lower than previous estimates. Furthermore, the model provides notably better fits for equity volatility compared with alternative rare-disaster models. Finally, the disaster probability index estimated from the model demonstrates significant out-of-sample predictive power over long horizons, performing well not only over time but also across countries.

We develop a continuous-time model examining agency conflicts among controlling shareholders (managers), minority shareholders, and creditors in corporate investment decisions. The manager’s private benefits encourage overinvestment, while their equity stake and debt overhang lead to underinvestment. We show these offsetting incentive effects can achieve optimal investment timing under certain conditions. Agency costs exhibit U-shaped relationships with private benefits, tax rates, volatility, managerial ownership, and leverage. The model reveals how the interplay among agency conflicts, tax benefits, and bankruptcy costs shapes optimal ownership and capital structure, explaining several documented empirical patterns in corporate finance.

This article shows that when a compensation peer firm experiences a significant failure in its say-on-pay (SOP) voting, the focal firm’s stock price is adversely affected, resulting in reduced CEO pay in the subsequent period. This pay-reduction effect is amplified when the board is more powerful, when proxy advisors express concerns about CEO pay, and when the compensation consultant lacks quality. Directors who react to the price drop and cut the CEO’s pay receive higher votes in future director elections, implying a market feedback effect for directors of the focal firm triggered by their peers’ SOP voting failure.

We examine the relationship between shareholder leverage constraints and corporate risk-taking, focusing on its impact on debtholders. Our findings show that mutual fund leverage constraints are related to more risk-taking activities of portfolio companies, inducing higher credit risk and greater risk-shifting concerns for the firms’ debtholders. In response, the debtholders raise borrowing costs and tighten lending conditions. These effects intensify for firms facing higher levels of conflict between debtholders and shareholders and when mutual funds exert greater influence over firms. Econometric analyses, including instrumental variable specifications and asset management company mergers, support a causal interpretation.

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Equity returns follow a pronounced V-shape pattern around the onset of recessions. They sharply drop into negative territory just before business cycle peaks and then strongly recover as the recession unfolds. Recessions are typically preceded by a flat yield curve. Probit models relying on the term spread as a predictor therefore time the beginning of recessions well. We show that model-implied recession probabilities based on the term spread strongly improve equity premium prediction in- and out-of-sample and outperform several benchmark predictors. Correcting for a structural break in the mean of the term spread in 1982 further strengthens the forecast performance.