Knowledge that Transforms

We document that leased capital accounts for about 20% of total physical productive assets used by US public firms, and its proportion is more than 40% among small and financially constrained firms. The leased capital ratio exhibits a strong countercyclical pattern over business cycles and a positive correlation with cross-sectional idiosyncratic uncertainty. We argue that existing macro models with financial frictions assume that firms cannot rent capital and overlook the effects of leasing activities on business cycle dynamics. We explicitly introduce a buy-versus-lease decision into the Bernanke–Gertler–Gilchrist financial accelerator model setting to demonstrate a novel and quantitatively important economic mechanism: that the increased use of leased capital when financial constraints become tighter in bad states significantly mitigates the financial accelerator mechanism and thus also mitigates the response of macroeconomic variables to negative total factor productivity shocks and risk shocks. We provide strong empirical evidence to support our mechanism.

We examine whether bereavement affects managerial investment decisions in large organizations using the exogenous events of managers’ family deaths. We find evidence that bereaved managers take less risk in separate samples of mutual funds and publicly traded firms. Mutual funds managed by bereaved managers exhibit smaller tracking errors, lower active share measures, and higher portfolio weights on larger stocks after bereavement events. Firms managed by bereaved CEOs exhibit lower capital expenditures and fewer acquisitions after bereavement events. Further analyses support the emotion-driven explanation over other explanations. The risk shifting by bereaved managers has negative implications on the performance of funds and firms that they manage.

We estimate the indirect costs of financial distress due to lost sales by exploiting real estate (RE) shocks and cross-supplier variation in RE assets and leverage. We show that for the same client buying from different suppliers, the client’s purchases from distressed suppliers decline by an additional 13% following a drop in local RE prices. The effect is more pronounced in more competitive industries, manufacturing, durable goods, less-specific goods, and when the costs of switching suppliers are low. Our results suggest that clients reduce their exposure to suppliers in financial distress.

We examine search-based peer (SBP) groups proposed by Lee, Ma, and Wang (2015) and their relationship with commonality in liquidity. Our results confirm that SBP affiliation is a significant determinant of commonality in liquidity and, unlike market- and industry-commonality, SBP-commonality has been increasing over the past 15 years. We separate retail from institutional investor queries by tracing the IP locations of Electronic Data Gathering, Analysis, and Retrieval (EDGAR) searches. Our results show that retail investors are responsible for roughly 85% of the EDGAR searches that generate SBP groups. Overall, our study provides new evidence of a significant demand-side commonality associated with SBP affiliations.

We examine the effect of staggered changes in the state-level capital gains tax on venture capital (VC)-backed start-ups and show that an increase in the tax rate of VC firms reduces the quantity and quality of patents by the start-ups. The results are consistent with a reduction in VC firms’ incentives to provide effort: increases in the capital gains tax for VC firms lead to incrementally lower innovation exchanges between start-ups in the VC firm’s portfolio. VC firms also decrease the level of investment in start-ups and the size of their portfolio as well as increase the number of start-ups that they write off.

Mutual fund families set and report values of their private startup holdings, which affect the fund net asset value (NAV) at which investors buy/sell fund shares. We test three hypotheses related to the valuation practice: (i) information cost/access, (ii) litigation risk, and (iii) strategic NAV management. Consistent with (i), families with larger PE holdings and/or stronger information access update valuations more frequently in the absence of public information releases, their updates co-move less with other families, and their fund returns jump less at follow-on financings. We find no support for hypotheses (ii) or (iii). We also find that high-PE-exposure funds are subject to greater financial fragility.

Classic bond pricing centralizes bond valuation across all maturities by specifying the dynamics of the short-term interest rate. This article develops a decentralized theory that prices each bond based purely on the near-term behavior of the bond’s own yield. The theory levers the domain expertise of an investor on a particular bond and allows the investor to make pricing and investment analysis on the bond without the shackles of an ambitious centralizing mandate. The theory decomposes the short-term return on a bond with respect to the variation of its own yield. Imposing no dynamic arbitrage on the return decomposition leads to a simple pricing equation relating the bond yield to the market pricing and conditional mean and variance forecasts of the yield’s near-term change. The article illustrates the theory’s applications in decentralized investment of a single bond and in the construction and investment of decentralized butterfly bond portfolios.

This article develops a new approach to explain why risk factors constructed from index option returns are priced in the stock market. We decompose an option-based factor into three main components and identify the one responsible for the beta–return relationship. Applying this method to the bear risk factor proposed by Lu and Murray reveals that the negative correlation between bear betas and stock returns does not reflect systematic risk premia. Instead, it represents an anomaly closely related to the betting-against-beta puzzle. We trace the root of this anomaly to disagreement concerning the aggregate stock market. Our work reconciles the conflicting evidence concerning downside risk by showing that neither ex-post nor ex-ante downside risk is priced in the cross-section of stocks while making a methodological contribution that facilitates more accurate interpretation of option-based risk factors in future research.

An increasing number of studies depart from the rational expectations assumption to reconcile survey expectations with asset prices. While surveys are helpful to establish a link between subjective beliefs and investment decisions, precise inference about how investors depart from rational expectations can be challenging without relying on strong assumptions. In this article, we provide direct experimental evidence of how systematic distortions in investors’ expectations affect their risk-taking across market cycles. As mechanism, we identify an asymmetry in how individuals update their expectations across boom and bust markets. The documented mechanism is consistent with survey data and provides important implications for recently proposed asset pricing models.

This article studies how the three-way interaction among shareholders, creditors, and managers shapes firms’ executive compensation. Firms with a higher ownership share by “dual holders”—institutional investors that simultaneously hold equity and bond of the company—adopt a less risk-inducing compensation structure: less stock options and more inside debt. Exploiting financial institution mergers that increase or decrease dual ownership for portfolio companies, we identify a causal link between dual ownership and CEO compensation policies. Mutual fund proxy voting data suggest that shareholder voting is an important channel for dual holders to implement less convex contracts.