Knowledge that Transforms

[Commercial banks acquire inside information about the firms they lend to. We study the impact of this informationally privileged position on the borrowing firm using a broad panel of U.S. firms over the 1993—2004 period. We measure the strength of the bank-firm relationship by bank-firm proximity, size of the loan, and the lender's insider potential. We show that a stronger relationship, by inducing better monitoring, improves the borrower's corporate governance. Simultaneously, it makes the bank a potentially more informed agent in the equity market. This information asymmetry increases adverse selection for the other market participants and lowers the firm's stock liquidity. This trade-off between improved corporate governance and greater information asymmetry affects the firm's value. Our results have normative implications for the role of banks in the development of financial markets.]

[Using monthly returns for over 27,000 stocks from 49 countries over a three-decade period, we show that a multifactor model that includes factor-mimicking portfolios based on momentum and cash flow-to-price captures significant time-series variation in global stock returns, and has lower pricing errors and fewer model rejections than the global CAPM or a popular model that uses size and book-to-market factors. We find reliable evidence that the global cash flow-to-price factor is related to a covariance risk model. In contrast, we reject the covariance risk model in favor of a characteristic model for size and book-to-market factors.]

[We propose an asset pricing model with generalized disappointment aversion preferences and long-run volatility risk. With Markov switching fundamentals, we derive closed-form solutions for all returns moments and predictability regressions. The model produces first and second moments of price-dividend ratios and asset returns as well as return predictability patterns in line with the data. Compared to Bansal and Yaron (2004), we generate (i) more predictability of excess returns by price-dividend ratios; (ii) less predictability of consumption growth rates by price-dividend ratios. Our results do not depend on a value of the elasticity of intertemporal substitution greater than one.]

[This article studies whether the volume and composition of capital flows affect the degree of credit crunch during the 2007—2009 crisis. Using data on 3,823 firms in 24 emerging countries, we find that, on average, the decline in stock prices was more severe for firms that are intrinsically more dependent on external finance for working capital. Interestingly, while the volume of capital flows per se has no significant effect, the composition matters a lot. In particular, greater dependence on non-FDI capital inflows before the crisis worsens the credit crunch during the crisis, while exposure to FDI alleviates the liquidity constraint.]

[We explore whether government ownership affects the cost of debt using a sample of fully and partially privatized companies. On average across firms, a one-percentage-point decrease in government ownership is associated with an increase in the credit spread, used as a proxy for the cost of debt, by three-quarters of a basis point. However, fully privatized companies exhibit lower credit spreads than partially privatized firms, indicating the cost of a lengthy privatization process. Empirical evidence suggests that these findings result from decreasing government guarantees, firm performance improvements, ownership uncertainty, and bondholder-shareholder conflicts.]

[We examine how managerial incentives affect acquisition decisions in the banking industry. We find that higher pay-for-performance sensitivity (PPS) leads to value-enhancing acquisitions. Banks whose CEOs have higher PPS have significantly better abnormal stock returns around the time of the acquisition announcements. On average, acquirers in the high-PPS group outperform their counterparts in the low-PPS group by 1.4% in a three-day window around the announcement. Higher PPS helps reduce the incentives for making value-destroying acquisitions, while at the same time promotes value-enhancing acquisitions. The positive market reaction can be rationalized by post-merger performance. Following acquisitions, banks with higher PPS experience greater improvements in their operating performance. We show that the effect of PPS is mainly evident in small and medium-sized banks, but is not present in large banks.]

[We relate trade credit to product characteristics and aspects of bank—firm 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 differentiated products and services have larger accounts receivable than suppliers of standardized goods and firms buying more services receive cheaper trade credit for longer periods. Second, firms receiving trade credit secure financing from relatively uninformed banks. Third, a majority of the firms in our sample appear to receive trade credit at low cost. Additionally, firms that are more creditworthy and have some buyer market power receive larger early payment discounts.]

[We provide a simple argument that suggests that better-informed hedge funds choose to have less exposure to factor risk. Consistent with this argument, we find that hedge funds that exhibit lower tf-squareds with respect to systematic factors have higher Sharpe ratios, higher information ratios, and higher alphas. They also exhibit higher manipulation-proof performance measures and charge higher fees.]

[This article develops a model of a self-fulfilling credit market freeze and uses it to study alternative governmental responses to such a crisis. We study an economy in which operating firms are interdependent, where their success depends on the ability of other operating firms to obtain financing. In such an economy, an inefficient credit market freeze may arise in which banks abstain from lending to operating firms with good projects because of their self-fulfilling expectations that other banks will not be making such loans. Our model enables us to study the effectiveness of using alternative measures as a means of getting an economy out of an inefficient credit market freeze. In particular, we study the effectiveness of interest rate cuts, an infusion of capital into banks, direct lending by the government to operating firms, and the provision of government capital or guarantees to encourage privately managed lending. Our analysis provides a framework for analyzing and evaluating the standard and nonstandard instruments used by authorities during the 2008-2009 financial crisis. Our analysis also provides testable implications for how firms, banks, and economies can be expected to be affected by shocks to the banking system.]

[This article studies mergers between competing firms and shows that while such mergers reduce the level of product market competition, they may have an adverse effect on employee incentives to innovate. In industries where value creation depends on innovation and development of new products, mergers are likely to be inefficient even though they increase the market power of the post-merger firm. In such industries, a stand-alone structure where independent firms compete both in the product market and in the market for employee human capital leads to a greater profitability. Furthermore, our analysis shows that multidivisional firms can improve employee incentives and increase firm value by reducing firm size through a spinoff transaction, although doing so eliminates the economies of scale advantage of being a larger firm and the benefits of operating an internal capital market within the firm. Finally, our article suggests that established firms can benefit from creating their own competition in the product and labor markets by accommodating new firm entry, and the desire to do so is greater at the intermediate stages of industry/product development.]