Knowledge that Transforms

Supervision of multinational banks (MNBs) by national supervisors suffers from coordination failures. We show that supranational supervision solves this problem and decreases the public costs of an MNB’s failure, taking its organizational structure as given. However, the MNB strategically adjusts its structure to supranational supervision. It converts its subsidiary into a branch (or vice versa) to reduce supervisory monitoring. We identify the cases in which this endogenous reaction leads to unintended consequences, such as higher public costs and lower welfare. Current reforms should consider that MNBs adapt their organizational structures to changes in supervision. Received January 9, 2017; editorial decision September 15, 2018 by Editor Philip Strahan.

Data from U.S. public firms show that in booms large firms finance with debt and payout equity, whereas small firms issue both equity and debt. Therefore, large firms generally substitute between debt and equity financing over the business cycle, whereas small firms adhere to a procyclical financing policy for debt and equity. We explain these cyclical financing patterns quantitatively using a heterogeneous firm model with endogenous firm dynamics. We find that cross-sectional differences in investment returns and, therefore, funding needs and exposures to financial frictions are essential to understanding how firms’ financing policies respond to macroeconomic shocks.Received December 24, 2016; editorial decision April 24, 2018 by Editor Stijn Van Nieuwerburgh.

[We show that negative policy rates affect the supply of bank credit in a novel way. Banks are reluctant to pass on negative rates to depositors, which increases the funding cost of highdeposit banks, and reduces their net worth, relative to low-deposit banks. As a consequence, the introduction of negative policy rates by the European Central Bank in mid-2014 leads to more risk-taking and less lending by euro-area banks with a greater reliance on deposit funding. Our results suggest that negative rates are less accommodative and could pose a risk to financial stability, if lending is done by high-deposit banks.]

[We study a widespread yet under-explored corporate governance phenomenon: the pledging of company stock by insiders as collateral for personal bank loans. Utilizing a regulatory change that exogenously decreases pledging, we document a negative causal impact of pledging on shareholder wealth. We study two channels that could explain this effect. First, we find that margin calls triggered by severe price falls exacerbate the crash risk of pledging firms. Second, since margin calls may cause insiders to suffer personal liquidity shocks or to forgo private benefits of control, we hypothesize and find that pledging is associated with reduced firm risk-taking.]

The stock market participation rate among homeowners is twice as high as among renters. This paper builds a life-cycle portfolio choice model with endogenous housing tenure choice. A stylized form of preference heterogeneity generates a substantial difference in participation rates. A majority of households have a large savings motive and choose to be homeowners and participate. A minority of households have a small savings motive and find it less worthwhile to participate. Fewer of these households become homeowners. Difference-in-difference regressions on panel data do not find evidence of a crowding-out effect of homeownership on participation, supporting the message that preference heterogeneity matters. Received January 25, 2017; editorial decision March 21, 2018 by Editor Wei Jiang. Authors have furnished an Online Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

We propose that fitted values from market-wide regressions of firm returns on lagged firm characteristics provide useful benchmarks for assessing whether average returns to certain stocks are abnormal. To illustrate, we study eight documented events with abnormal returns, including credit rating and analyst recommendation downgrades, initial and seasoned public equity offerings, mergers and acquisitions, dividend initiations, share repurchases, and stock splits. We show that the apparently abnormal returns in the months after these events are substantially reduced or eliminated when compared to characteristic-based benchmarks. Characteristic-based benchmarks perform better in explaining post-event returns than do recent four- and five-factor models. Received September 19, 2016; editorial decision February 16, 2018 by Editor Andrew Karolyi.

Failing to refinance a mortgage can cost a borrower thousands of dollars. Based on administrative data from a large financial institution, we show that around 50% of borrowers leave thousands of dollars on the table by not refinancing. Survey data indicate that, among all the behavioral factors examined, only suspicion of banks’ motives is consistently related to the probability of accepting a refinancing offer. Finally, we report the results of three field experiments showing that enticing offers made by banks fail to increase participation and may even deepen suspicion. Our findings highlight the important role of trust in financial decisions. Received July 12, 2017; editorial decision April 3, 2018 by Editor Andrew Karolyi.

Does private equity (PE) contribute to financial fragility during economic crises? The proliferation of poorly structured transactions during booms may increase the vulnerability of the economy to downturns. During the 2008 crisis, PE-backed companies decreased investments less than did their peers and experienced greater equity and debt inflows, higher asset growth, and increased market share. These effects are especially strong among financially constrained companies and those whose PE investors had more resources at the crisis onset. In a survey, PE firms report being active investors during the crisis and spending more time working with their portfolio companies. Received July 19, 2017; editorial decision March 7, 2018 by Editor Wei Jiang.

Marketplace lending relies on screening and information production by investors, a major deviation from the traditional banking paradigm. Theoretically, the participation of sophisticated investors improves screening outcomes and also creates adverse selection among investors. In maximizing loan volume, the platform trades off these two forces. As the platform develops, it optimally increases platform prescreening intensity but decreases information provision to investors. Using novel investor-level data, we find that sophisticated investors systematically outperform, and this outperformance shrinks when the platform reduces information provision to investors. Our findings shed light on the optimal distribution of information production in this new lending model.Received August 29, 2018; editorial decision July 1, 2018 by Editor Itay Goldstein.

We propose a theory of security design in financing entrepreneurial production, positing that the investor can acquire costly information on the entrepreneur’s project before making the financing decision. When the entrepreneur has enough bargaining power in security design, the optimal security helps incentivize both efficient information acquisition and efficient financing. Debt is optimal when information is not very valuable for production, whereas the combination of debt and equity is optimal when information is valuable. If, instead, the investor has sufficiently strong bargaining power in security design or can acquire information only after financing, equity is optimal