Knowledge that Transforms

This article tests whether stock market investors appropriately distinguish between new and old information about firms. I define the staleness of a news story as its textual similarity to the previous ten stories about the same firm. I find that firms' stock returns respond less to stale news. Even so, a firm's return on the day of stale news negatively predicts its return in the following week. Individual investors trade more aggressively on news when news is stale. The subsequent return reversal is significantly larger in stocks with above-average individual investor trading activity. These results are consistent with the idea that individual investors overreact to stale information, leading to temporary movements in firms' stock prices. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.

This article uses a unique dataset to study how firms managed liquidity during the 2008–2009 financial crisis. Our analysis provides new insights on interactions between internal liquidity, external funds, and real corporate decisions, such as investment and employment. We first describe how companies used credit lines during the crisis (access, size of facilities, and drawdown activity), the characteristics of these facilities (fees, markups, maturity, and collateral), and whether managers had difficulties in renewing or initiating lines. We also describe the dynamics of credit line violations and the outcome of subsequent renegotiations. We show how companies substitute between credit lines and internal liquidity (cash and profits) when facing a severe credit shortage. Looking at real-side decisions, we find that credit lines are associated with greater spending when companies are not cash-strapped. Firms with limited access to credit lines, in contrast, appear to choose between saving and investing during the crisis. Our evidence indicates that credit lines eased the impact of the financial crisis on corporate spending.

In a model with heterogeneous-risk-aversion agents facing margin constraints, we show how securities' required returns increase in both their betas and their margin requirements. Negative shocks to fundamentals make margin constraints bind, lowering risk-free rates and raising Sharpe ratios of risky securities, especially for high-margin securities. Such a funding-liquidity crisis gives rise to “bases,” that is, price gaps between securities with identical cash-flows but different margins. In the time series, bases depend on the shadow cost of capital, which can be captured through the interest-rate spread between collateralized and uncollateralized loans and, in the cross-section, they depend on relative margins. We test the model empirically using the credit default swap–bond bases and other deviations from the Law of One Price, and use it to evaluate central banks' lending facilities.

Uncertainty plays a key role in economics, finance, and decision sciences. Financial markets, in particular derivative markets, provide fertile ground for understanding how perceptions of economic uncertainty and cash-flow risk manifest themselves in asset prices. We demonstrate that the variance premium, defined as the difference between the squared VIX index and expected realized variance, captures attitudes toward uncertainty. We show conditions under which the variance premium displays significant time variation and return predictability. A calibrated, generalized long-run risks model generates a variance premium with time variation and return predictability that is consistent with the data, while simultaneously matching the levels and volatilities of the market return and risk-free rate. Our evidence indicates an important role for transient non-Gaussian shocks to fundamentals that affect agents' views of economic uncertainty and prices.

Using new data for the universe of firms covered in Amadeus, we reconstruct the portfolios of shareholders who hold equity stakes in private- and publicly traded European firms. We find great heterogeneity in the degree of portfolio diversification across large shareholders. Exploiting this heterogeneity, we document that firms controlled by diversified large shareholders undertake riskier investments than firms controlled by nondiversified large shareholders. The impact of large shareholder diversification on corporate risk-taking is both economically and statistically significant. Our results have important implications at the policy level because they identify one channel through which policy changes can improve economic welfare.

Using loan-level data, we analyze the quality of subprime mortgage loans by adjusting their performance for differences in borrower characteristics, loan characteristics, and macroeconomic conditions. We find that the quality of loans deteriorated for six consecutive years before the crisis and that securitizers were, to some extent, aware of it. We provide evidence that the rise and fall of the subprime mortgage market follows a classic lending boom-bust scenario, in which unsustainable growth leads to the collapse of the market. Problems could have been detected long before the crisis, but they were masked by high house price appreciation between 2003 and 2005.

We relate trade credit to product characteristics and aspects of bank-rm relationships and document three main empirical regularities. First, the use of trade credit is associated with the nature of the transacted good. In particular, suppliers of dierentiated products and services have larger accounts receivable than suppliers of standardized goods and rms buying more services receive cheaper trade credit for longer periods. Second, rms receiving trade credit secure nancing from relatively uninformed banks. Third, a majority of the rms in our sample appears to receive trade credit at low cost.

We identify a "slope" factor in exchange rates. High interest rate currencies load more on this slope factor than low interest rate currencies. This factor accounts for most of the cross-sectional variation in average excess returns between high and low interest rate currencies. A standard, no-arbitrage model of interest rates with two factors--a country-specific factor and a global factor--can replicate these findings, provided there is sufficient heterogeneity in exposure to global or common innovations. We show that our slope factor identifies these common shocks, and we provide empirical evidence that it is related to changes in global equity market volatility. By investing in high interest rate currencies and borrowing in low interest rate currencies, U.S. investors load up on global risk. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.

We find that repeated borrowing from the same lender translates into a 10–17 bps lowering of loan spreads and that relationships are especially valuable when borrower transparency is low. These results hold using multiple approaches (propensity score matching, instrumental variables, and treatment effects model) that control for the endogeneity of relationships. We also provide a demarcation line between relationship and transactional lending. Spreads charged for relationship loans and nonrelationship loans are statistically identical if the borrower is in the largest 30% by asset size; has public rated debt; or is part of the S&P 500 index. Past relationships reduce collateral requirements and are also associated with obtaining larger loans. Our results imply that, even for firms that have multiple sources of outside financing, borrowing from a prior lender obtains better loan terms.

[We examine the design of control rights of external financiers, and how these interact with the firm's security issuance and capital structure when the firm's initial owners and managers may disagree with new investors over project choice. The first main result is an ex ante managerial preference for "soft" financial claims that maximize managerial projectchoice autonomy, which is in contrast to agency theory. Second, a dynamic "pecking order" of cash, equity, and debt emerges. Additional results explain equity issuance at high prices, the drifting of leverage ratios with stock returns, cash hoarding, and debt usage without taxes, agency, or signaling.]