Knowledge that Transforms

Abstract We model the execution of a large uninformed sell order in the presence of strategic competitive market makers. We solve for the unique symmetric equilibrium of the model in closed form. Analysis of this equilibrium reveals that large orders unequivocally benefit market makers, while smaller investors stand to benefit only if the order trades with a sufficiently high intensity. The equilibrium results further provide a rationale for the empirically observed patterns of (1) shorter orders trading at higher intensities and (2) price pressures potentially subsiding before large orders stop executing.

Abstract A long-standing question in finance is why companies donate to charity, often attributing it to either managerial agency problems or strategic behavior. Based on a global sample of donation announcements by firms providing relief to disaster-affected communities, we test the relative importance of these two motives and the conditions under which each dominates. We exploit disaster-specific factors in an event study setting around corporate donation announcement dates to show that, on average, relief donations decrease returns. However, the strategic benefits of donating around salient events can mitigate these negative effects. To account for firms’ donation decisions, we rely on exogenous variation in the availability of corporate charitable funds due to the timing of disasters relative to firms’ financial years. We show that donations provide new information to the market and that negative returns are primarily driven by cash donations made via corporate foundations.

Abstract Firms may pursue non-meritocratic promotion policies at the cost of lower profitability, if they yield private benefits of control. Corporate governance standards that limit these private benefits favor meritocratic promotions and therefore encourage workers’ skill acquisition. Managerial incentive pay has ambiguous effects on workers’ skill acquisition: it fosters the supply of skilled labor, while reducing firms’ willingness to promote skilled workers to managerial positions. Social welfare increases with the share of meritocratic firms, but not necessarily with governance standards: small reforms generate losers and gainers, and may on balance lower welfare, while drastic enough reforms can generate Pareto improvements.

Abstract It is a long-standing fact that households mostly consume and rarely reinvest dividends. Among representative brokerage clients of one of Germany’s largest banks, we find the opposite: 80 percent reinvestments and 12 percent consumption. Of these reinvestments, the majority occurs with a delay after dividends are initially parked as brokerage cash. Motivated by this finding, we study payout modalities (deposits into brokerage accounts, checking accounts, or checks) as a novel mechanism that nudges investors toward reinvesting or consuming dividends. Consistent with a transition from checks to brokerage deposits, we find that the dividend consumption rate in the Consumer Expenditure Survey has decreased substantially over time.

Abstract Using survey data on secured funding arrangements provided by broker–dealers for their clients—a class of contracts that includes bilateral repo—we document that financing rates, collateral haircuts, lending maturities, and position limits move strongly together over time and across asset classes. Liquidity of the underlying securities, as opposed to their volatility or credit risk, is the main driver of this behavior, with dealer balance-sheet constraints also playing a role in the funding of less-liquid security types. A simple model of dealer–client interaction rationalizes these findings. Instrumenting with changes in market conventions, we find that funding conditions had little effect on cash securities markets between 2011 and 2019, but the tightening of terms during the market stress of early 2020 likely impaired liquidity and reduced asset returns to some degree.

Abstract Motivated by Coles, Li, and Wang (2020)’s prediction that industry tournament incentives are linked to heightened risk-seeking behavior, we examine whether these incentives contribute positively to systemic risk. Using a measure of systemic risk that captures the cross-sectional tail dependency between the US financial system and individual financial institutions, we find that the external pay gap is positively related to an institution’s contribution to systemic risk. Consistent with our expectation, industry tournament incentives are positively associated with individual financial institutions’ stock return volatility, Value at Risk, and crash risk, thus indirectly contributing to systemic risk due to financial institutions’ inherent interconnectedness. More interestingly, the external pay gap is positively related to an institution’s financial industry beta and encourages systemically risky activities, suggesting an important impact channel through institutions’ undertaking correlated activities.

Abstract Finance theory suggests that the privileged information that traditional banks obtain about borrowers through monitoring creates opportunities for banks to impose informational hold-up costs on such borrowers. Because a surge in borrower risk increases banks’ hold-up power, banks with information monopoly should be able to increase their rates beyond the level explained by borrower risk alone. We test this theory using the setting of activist short sellers’ public allegations—a setting that increases borrower risk and restricts borrower access to public financing sources—and find, on average, that, after controlling for both ex ante and ex post changes in borrower credit risk, banks increase loan pricing following activist short sellers’ allegations. Our loan pricing results not explained by changes in borrower credit risk are consistent with banks extorting borrowers during times of adversity.

Abstract We exploit quasi-exogenous variation in passive ownership around the Russell 1000/2000 cutoff to explore the causal effects of passive ownership on the securities lending market. We find that passive ownership causes an increase in lendable supply and short interest, while lending fees remain largely unchanged. The utilization ratio—that is, the ratio of short interest over lendable supply—goes up, implying that shorting demand increases more than lendable supply. We argue that this additional demand results from an increase in the quality of lendable supply as passive funds are less likely to recall stock loans. This higher supply quality attracts informed short sellers, who improve the information efficiency around negative news releases and correct overpricing.

Abstract We investigate whether managers’ intrinsic incentives affect firms’ environmental policies. Exploiting within-facility variation in facility-to-CEO-birthplace distances, we find that facilities located near CEOs’ birthplaces experience toxic emission reductions relative to those farther away. This is achieved by reducing waste generation at source rather than by downsizing operations or substituting pollution across locations. The effect is strongest for hometown facilities in high-polluting areas, and in firms with higher cash holdings and with CEOs with weaker pay incentives. Our results suggest that local representation in management could be a powerful means of encouraging corporate pollution abatement.

Abstract We provide evidence that dividend-paying stocks are less exposed to return extrapolation than non-dividend-paying stocks. In particular, social media sentiment and analyst price targets of dividend-paying stocks are significantly less sensitive to past returns. Our findings indicate that this difference stems from price changes playing a larger role in extrapolation and dividends diverting attention away from price changes for dividend-paying stocks. Consistent with models of return extrapolation, dividend-paying stocks earn lower momentum and long-term reversal returns. The value premium, however, is similar among both groups. Collectively, our findings suggest that return extrapolation is an important source of some anomaly returns.