Knowledge that Transforms

Using mergers as shocks to fund size, I analyze the return-to-scale property of mutual funds. I find that acquiring funds’ performance deteriorates after experiencing a positive shock in size resulting from mergers, and liquidity plays an important role in the negative relationship between size and performance. I also find that the decline in performance is not due to higher performance prior to the merger, nor driven by higher integration costs after the event. These findings are consistent with mutual funds having decreasing returns to scale and thus provide empirical evidence that supports the theoretical model of Berk and Green (2004).

We find that the controlling family holds both the chief executive officer and chair positions in 79% of Norwegian family firms. The family holds more governance positions when it owns large stakes in small, profitable, low-risk firms. This result suggests that the family trades off expected costs and benefits by conditioning participation intensity on observable firm characteristics. We find that the positive effect of performance on participation is twice as strong as the positive effect of participation on performance. The endogeneity of participation, therefore, should be carefully accounted for when analyzing the effect of family governance on the family firm’s behavior.

This paper exploits a quasi-natural experiment to investigate the relation between the Sarbanes–Oxley Act (SOX) of 2002 and corporate innovation: firms with a public float under $75 million can delay compliance with Section 404 of the act. We find a significant decrease in the number of patents and patent citations for firms that are subject to Section 404 compliance relative to firms that are not. This relation is more pronounced when firms are financially constrained and when firms face high litigation risk. Overall, our evidence suggests that SOX imparts real costs to the economy by decreasing corporate innovativeness.

We study the transmission mechanism of monetary policy through business loans and illustrate subtle aspects of its functioning that relate to the contractual characteristics and the borrower–lender types of loans. We show that the puzzling increase in business loans in response to monetary tightening, documented before the Great Recession, is largely driven by drawdowns from existing commitments at large banks. Spot loans also rise and take a considerable amount of time to adjust. Banks, nonetheless, do curtail credit supply by shortening maturities of new loans. Following the Great Recession, the mechanism has worked differently, with loan responses to monetary tightening displaying a significant downward shift.

We present evidence of investors underreacting to the absence of events in financial markets. Routine-based insiders strategically choose to be silent when they possess private information not yet reflected in stock prices. Consistent with our hypothesis, insider silence following a routine sell (buy) predicts positive (negative) future returns, as well as fundamentals. The return predictability of insider silence is stronger among firms with a poor information environment and facing higher arbitrage costs, and a large fraction of abnormal returns concentrates on future earnings announcements. A long–short strategy that exploits insiders’ strategic silence behavior generates abnormal returns of 6% to 10% annually.

We use a new identification strategy to assess whether an intensification of competition among banks increases or decreases the provision of a key banking service: liquidity creation. Although theory offers conflicting predictions about the impact of competition on liquidity creation, we find that regulatory-induced competition reduces liquidity creation. Consistent with a subset of models emphasizing that banks pushed toward insolvency reduce risk-taking activities, we discover that regulatory-induced competition reduces liquidity creation more among banks with less risk-absorbing capacity (e.g., less profitable banks).

Stocks that hedge sustained market downturns should have low expected returns, but they do not. We use ex ante firm characteristics and covariances to construct a tradable safe minus risky (SMR) portfolio that hedges market downturns out of sample. Although downturns (peaks to troughs in market index levels at the business-cycle frequency) predict significant declines in gross domestic product growth, SMR has significant positive average returns and 4-factor alphas (both around 0.8% per month). Risk-based models do not explain SMR’s returns, but mispricing does. Risky stocks are overpriced when sentiment is high, resulting in subsequent returns of -0.9% per month.

We proxy for board members’ opinions and values using directors’ ancestral origins and show that diversity has costs and benefits, leading to high performance volatility. Consistent with the idea that diverse groups experiment more, firms with ancestrally diverse boards have more numerous and more cited patents. In addition, their strategies conform less to those of the industry peers. However, firms with greater ancestral diversity also have more board meetings and make less predictable decisions. These findings suggest that diversity may lead to inefficiencies in the decision-making process and conflicts in the boardroom.

We investigate the strict-exogeneity assumption, a necessary condition for estimator consistency in many finance panel-data applications. We outline tests for strict exogeneity in both traditional (non–instrumental variable (IV)) and IV settings. When we apply these tests in common traditional finance panel regressions, we find that the strict-exogeneity assumption is often strongly rejected, suggesting large inference errors. We test for strict exogeneity in specific finance panel-data IV settings and illustrate the potential for these tests to help confirm, or rule out, the validity of common panel-data IV estimators. We offer recommendations to address the strict-exogeneity issue in finance research.

Using within-loan estimations to remove the impact of demand-side factors, we find that the capital levels of banks participating in the same syndicated loan are positively associated with the banks’ contributions to the loan. Consistent with the argument that higher capital reduces the cost of uninsured debt, the positive effect of bank capital on lending is stronger among banks that rely more on wholesale funding. Furthermore, we find that banks increase their contributions to syndicated loans after receiving Troubled Asset Relief Program (TARP) funding. Taken together, we provide new evidence on the importance and causal effect of bank capital on lending.