Knowledge that Transforms

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We investigate how chief executive officers’ (CEOs) risk incentive (VEGA) affects firm innovation. To establish causality, we exploit compensation changes instigated by the FAS 123R accounting regulation in 2005 that mandated stock option expensing at fair values. Our identification tests indicate a positive and causal effect of CEOs’ VEGA on innovation activities. Furthermore, dampened managerial risk-taking incentive after the implementation of FAS 123R leads to a significant reduction in innovation related to firms’ core business and explorative inventions. It implies that managers diversify their innovation portfolios and decrease explorative inventions to curtail business risk when their risk-taking incentive is reduced.

Between 2009 and 2014, 75% of seasoned equity offerings (SEOs) were announced and issued overnight, compared to 27% between 2000 and 2008. Overnight issuers obtain a higher SEO offer price because they experience more favorable pre-offer returns. Consistent with these favorable returns being due to the avoidance of pre-issue selling pressure, non-overnight issuers experience a 2.5% pre-issue stock-price decline that reverses within 7 days. This post-issue reversal is increasing in SEO offer size and bigger following large pre-issue price declines. In contrast, returns following overnight offerings are less positive and unrelated to SEO offer size or pre-issue returns.

Firms in industry clusters have market prices that are more efficient than firms outside clusters. To establish causality, we analyze exogenous firm relocations and find that firms that relocate into industry clusters have higher levels of industry information in their prices. We argue that geographical proximity allows for information spillovers, reducing marginal cost to information producers. Our evidence supports this view: Analysts are more likely to cover stocks inside industry clusters, and when institutional investors have a large position in one stock in the industry cluster, they are more likely to hold other stocks in the same industry cluster.

Banks are growing ever larger compared to their national economies. We show that increases in relative bank size (measured as a bank’s liabilities divided by national GDP) are linked to banks displaying higher tail risk. This effect is not entirely due to risk channels that disproportionately expose relatively large banks to systematic tail risks, sovereign risks, or banking crises. Instead, we detect a persistent component in the tail risk of relatively large banks that is bank-specific and connected to government guarantees. Furthermore, as banks grow in relative size, tail risks are shifted to debtholders without wealth gains for shareholders.

We test the hypothesis that low-visibility shocks to text-based network industry peers can explain industry momentum. We consider industry peer firms identified through 10-K product text and focus on economic peer links that do not share common Standard Industrial Classification (SIC) codes. Shocks to less visible peers generate economically large momentum profits and are stronger than own-firm momentum variables. More visible traditional SIC-based peers generate only small, short-lived momentum profits. Our findings are consistent with momentum profits arising partially from inattention to economic links of less visible industry peers.

We study the effect of antitakeover provisions (ATPs) on innovation. To establish causality, we use a regression discontinuity approach that relies on locally exogenous variation generated by shareholder proposal votes. We find a positive, causal effect of ATPs on innovation. This positive effect is more pronounced in firms that are subject to a larger degree of information asymmetry and operate in more competitive product markets. The evidence suggests that ATPs help nurture innovation by insulating managers from short-term pressures arising from equity markets. Finally, the number of ATPs contributes positively to firm value for firms involved in intensive innovation activities.

We document that a firm’s culture, specifically, its religiosity, affects its cost of debt. Firms in higher-religiosity counties have higher credit ratings and lower debt costs. The impact of religiosity is stronger for firms with greater information asymmetry and during recessions. Further, religiosity has additional explanatory power for the cost of bank loans (but not the cost of public bonds) beyond its impact through ratings. This supports the argument that banks have superior abilities in pricing soft information, such as corporate culture. Finally, the impact of religiosity is stronger when the lender is a small bank.

To price assets with a parsimonious set of factor-mimicking portfolios, one typically identifies and weights well-diversified basis portfolios. Traditional weightings lead to factor-mimicking portfolios that are unlikely to price even the basis portfolios from which they are formed. We offer a method to combine basis portfolios into a single factor-mimicking portfolio that is closely linked to the optimal portfolio. In practice, this method improves the pricing accuracy of parsimonious factor models, even for anomaly portfolios formed from characteristics that are distinct from those underlying the basis portfolios.