Knowledge that Transforms

Extensive research has revealed that alphabetical name ordering tends to provide an advantage to those positioned in the beginning of an alphabetical listing. This article is the first to explore the implications of this alphabetic bias in financial markets. We find that US stocks that appear near the top of an alphabetical listing have about 5–15% higher trading activity and liquidity than stocks that appear toward the bottom. The magnitude of these results is negatively related to firm visibility and investor sophistication. International evidence and fund flows further indicate that ordering effects can affect trading activity and liquidity.

The end result of major sporting events has been shown to affect next day stock returns through shifts in investor mood. By studying intraday data during the soccer matches that led to the elimination of France and Italy from the 2010 FIFA World Cup, we test whether mood-related pricing effects already materialize as events unfold. We use data for a cross-listed firm, which allows for a straightforward identification of underpricing. During the matches, the firm’s stock is underpriced by up to 7 basis points in the country that eventually loses. The probability of underpricing increases as elimination becomes more likely.

We analyze the reaction of stock returns and CDS spreads of banks from Europe and the United States to four major regulatory reforms in the aftermath of the subprime crisis, employing an event study analysis. In contrast to the public perception that nothing has happened, we find that financial markets indeed reacted to the structural reforms enacted at the national level. All reforms succeeded in reducing bail-out expectations, especially for systemic banks. However, banks’ profitability was also affected, showing up in lower equity returns. The strongest effects were found for the Dodd-Frank Act (especially the Volcker rule), whereas market reactions to the German restructuring law were small.

Multiple bank lending induces borrowers to take too much debt when creditor rights are poorly protected; moreover, banks wish to engage in opportunistic lending at their competitors’ expenses if borrowers’ collateral is sufficiently risky. These incentives lead to credit rationing and positive-profit interest rates, possibly exceeding the monopoly level. If banks share information about past debts and seniority via credit reporting systems, the incentive to overborrow is mitigated: interest and default rates decrease; credit access improves if the value of collateral is not very volatile, but worsens otherwise. Recent empirical studies report evidence consistent with these predictions. The article also shows that private and social incentives to share information are not necessarily aligned.

We use a dataset of individual investors containing test-based measures of financial literacy and administrative records on their assets holding and trades before and during the financial crisis of September 2008. We design three tests of the benefits of financial literacy during the Global Financial Crisis, by comparing the decisions actually taken by individuals with a dominated alternative, i.e., one giving lower utility according to simple normative models of financial decision-making. We find that high-literacy investors are better at timing the market. High-literacy investors are also more likely to trade according to the prescriptions of normative models and to detect intermediaries’ potential conflicts of interest. However, though statistically significant, these effects are economically small.

In December 2006, the Securities and Exchange Commission issued new rules that require enhanced disclosure on how firms tie CEO compensation to performance. We use this new available data to study the terms of performance-based awards in CEO compensation contracts in S&P 500 firms. We observe large variations in the choice of performance measures. Our evidence is consistent with predictions from optimal contracting theories: firms rely on performance measures that are more informative of CEO actions.

This article examines enterprises funded by government-sponsored venture capitalists (GVCs). We find that enterprises funded by both GVCs and private venture capitalists (PVCs) obtain more investment than enterprises funded purely by PVCs, and much more than those funded purely by GVCs. Also, markets with more GVC funding have more VC funding per enterprise and more VC-funded enterprises, suggesting that GVC finance largely augments rather than displaces PVC finance. There is also a positive association between mixed GVC/PVC funding and successful exits, as measured by initial public offerings (IPOs) and acquisitions, attributable largely to the additional investment.

This article studies the connection between risk taking and executive compensation in financial institutions. A model of shareholders, debtholders, depositors, and an executive demonstrates that (i) excess risk taking can be addressed by basing compensation on both stock price and the credit default swaps (CDS) spread, (ii) shareholders may not be able to commit to design such contracts, and (iii) they may not want to due to distortions from deposit insurance or unobservable tail risk. The advantage of using the CDS spread rather than deferred compensation or debt is due to the fact that it is a market price and reduces agency costs.