Knowledge that Transforms

We examine the effect of say on pay regulation in the UK. Consistent with the view that shareholders regard say on pay as a value-creating mechanism, the regulation’s announcement triggered a positive stock price reaction at firms with weak penalties for poor performance. UK firms responded to negative say on pay voting outcomes by removing controversial CEO pay practices criticized as rewards for failure (e.g., generous severance contracts) and increasing the sensitivity of pay to poor realizations of performance.

We use a new data set to study the determinants of the performance of open–end actively managed equity mutual funds in 27 countries. We find that mutual funds underperform the market overall. The results show important differences in the determinants of fund performance in the USA and elsewhere in the world. The US evidence of diminishing returns to scale is not a universal truth as the performance of funds located outside the USA and funds that invest overseas is not negatively affected by scale. Our findings suggest that the adverse scale effects in the USA are related to liquidity constraints faced by funds that, by virtue of their style, have to invest in small and domestic stocks. Country characteristics also explain fund performance. Funds located in countries with liquid stock markets and strong legal institutions display better performance.

This article explores the causes and consequences of cross-country variation in mortgage market structure. It draws on insights from several fields: urban economics, asset pricing, behavioral finance, financial intermediation, and macroeconomics. It discusses lessons from the credit boom, the challenges of mortgage modification in the aftermath of the boom, consumer financial protection, and alternative mortgage forms and funding models. The article argues that the USA has much to learn from mortgage finance in other countries, and specifically from the Danish implementation of the European covered bonds system.

The pricing kernel is an important link between economics and finance. In standard models of financial economics, it is proportional to the aggregate marginal utility in the economy. We first show that none of the three standard assumptions (completeness, risk aversion, and correct beliefs) is needed for the pricing kernel to be generally decreasing. If at least one of the three assumptions is violated, the pricing kernel can have increasing parts. We explain the economic principles that lead to an increasing part in the pricing kernel and compare the resulting pricing kernels with the empirical pricing kernel estimated in Jackwerth (2000, Rev. Financ. Stud., 13, 433–451).

Using a unique data set for a commercial bank in Albania, we analyze gender differences in loan officers’ performance. Loans screened and monitored by female loan officers have a lower likelihood to turn problematic than loans handled by male loan officers. This effect cannot be explained by borrower or loan officer selection or differences in screening, work load, and experience. However, while the performance gap always exists for female borrowers, female loan officers only gain a performance advantage with male borrowers with experience and do not have an advantage with borrowers that are legal entities. We therefore interpret this as suggestive evidence for female loan officers’ better capacity to build trust relationships with borrowers.

This article focuses on the idea that cash has a real option value and it presents an explicit valuation framework of cash holdings in the context of a capacity expansion option. The model characterizes the optimal dynamic cash retention policy, the value of internal funds, and it provides a model implied regression specification based on simulated data. Results imply that high cash flow volatility decreases the value of cash and that optimal cash retention can actually delay investment relative to the case of full outside financing. Both novel implications are confirmed by subsequent empirical tests.

Using an international sample of large banks between 2000 and 2010, we evaluate the risk sensitivity of minimum capital requirements. Our results show that risk-weighted assets (the regulatory measure of portfolio risk, which determines minimum capital requirements) are ill-calibrated to a market measure of bank portfolio risk. We show that this low-risk sensitivity of capital requirements permits banks to build up capital buffers by underreporting their portfolio risk and undermines banks’ ability to withstand adverse shocks. While the risk sensitivity of capital requirements is higher for banks that have adopted Basel II, it remains low across banks and countries.

Over 300 years of UK stock returns reveal that well-known monthly seasonals are sample specific. For instance, the January effect only emerges around 1830. Most months have had their 50 years of fame, showing the importance of long time series to safeguard against sample selection bias, noise, and data snooping. The overall conclusion is that monthly seasonals might simply be in the eye of the beholder.

We analyze the interaction between financial institutions’ internal compensation policy, the quality of loans, and their securitization decision. We show when mandatory deferred bonus pay makes incentives more commensurate with the longer term risk of their transactions and hence improves the quality of loans. We also show when it has the opposite effect. We further analyze when mandatory deferred compensation can complement a policy that requires financial institutions to retain a minimum exposure to their originated loans, and we discuss the impact of a tax on short-term bonus pay. Generally, our framework allows us to study the interaction of financial institutions’ internal agency problems with the external agency problem that arises from securitization.

This article analyzes whether political connections of the board of directors of publicly traded companies in the USA affect the allocation of government procurement contracts. It focuses on the change in control of both House and Senate following the 1994 election and finds that companies with boards connected to the winning (losing) party experience a significant and large increase (decrease) in procurement contracts after the election. The results remain significant after controlling for industry classifications as well as for several other company characteristics. The findings highlight one of the main avenues through which corporate political connections add value to US companies.