Knowledge that Transforms

Equity options display a strong factor structure. The first principal components of the equity volatility levels, skews, and term structures explain a substantial fraction of the cross-sectional variation. Furthermore, these principal components are highly correlated with the S&P 500 index option volatility, skew, and term structure, respectively. We develop an equity option valuation model that captures this factor structure. The model predicts that firms with higher market betas have higher implied volatilities, steeper moneyness slopes, and a term structure that covaries more with the market. The model provides a good fit, and the equity option data support the model’s cross-sectional implications. Received December 20, 2013; editorial decision April 15, 2017 by Editor Leonid Kogan.

We study the credit market impact and real effects of one of the largest borrower bailouts in history, enacted by the government of India against the backdrop of the 2007–2008 financial crisis. We find that the bailout led to a significant reallocation of credit and greater defaults, but had no offsetting positive effect on productivity, wages, or consumption. Post-program loan performance deteriorates faster in districts with greater program exposure, an effect that is not driven by greater risk-taking of banks. Loan defaults become more sensitive to the electoral cycle after debt relief, suggesting strategic default in response to the bailout. Received December 1, 2015; editorial decision April 11, 2017 by Editor Philip Strahan.

A large literature finds evidence that pricing kernels nonparametrically estimated from option prices and historical returns are not monotonically decreasing in market index returns. We argue that existing estimation methods are inconsistent and propose a new nonparametric estimator of the pricing kernel that reflects the information available to investors who set asset prices. In simulations, the estimator outperforms existing techniques. Our empirical estimates using S&P 500 index option data from 1996 to 2014 and FTSE 100 index option data from 2002 to 2014 suggest that the “pricing kernel puzzle” is due to flaws in existing estimators rather than a behavioral or economic phenomenon. Received August 2, 2015; editorial decision April 15, 2017 by Editor Andrew Karolyi.

We empirically explore a trade credit channel through which foreign direct investment (FDI) firms can propagate global liquidity shocks to the host country despite its tight controls on portfolio flows. In a large sample of Chinese manufacturing firms, we find robust evidence that FDI firms provide more trade credit than local firms during tight domestic credit periods and that a favorable global liquidity shock amplifies FDI firms’ advantage in trade credit provision. Moreover, the differential responses of FDI and local firms are stronger in financially more dependent industries or in Chinese provinces with less financial depth. Received August 12, 2016; editorial decision May 16, 2017 by Editor David Denis.

In their foreign portfolio allocations, international mutual funds overweight industries that are comparatively large in their domestic stock market. Aggregate excess foreign industry allocations are sizeable, on average amounting to over 100% for the largest domestic industries. While this foreign industry bias partly reflects familiarity-based motives, a large body of evidence on investment and performance patterns is, on the whole, remarkably consistent with a specialized learning motive contributing to the bias. This suggests that differences in industry structures across domestic stock markets proxy for international information asymmetries. Received January 14, 2015; editorial decision October 5, 2017 by Editor Andrew Karolyi. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Access to finance helps explain the link between the historical African slave trade and current gross domestic product. We first present mistrust, weakened institutions, and ethnic fractionalization as plausible historical channels linking the slave trade to modern finance and development. We then show (i) the slave trade is consistently linked to reduced access to the formal and trade credit needed by modern firms, (ii) this shortage particularly reduces capital investment in smaller firms not in business groups, and (iii) the slave trade cannot explain most other business obstacles, suggesting that long-term societal shocks are exceptionally important for finance. Received December 16, 2014; editorial decision June 29, 2017 by Editor Philip Strahan.

We assess the finite sample performance of simulation estimators that are used to estimate the parameters of dynamic corporate finance models. We formulate an external validity specification test and propose a new set of statistical benchmarks that can be used to estimate and evaluate these models. These benchmarks are based on model policy functions. Our Monte Carlo simulations show that the estimators are largely unbiased with low root mean squared errors. When computed with an optimal weight matrix, the specification tests associated with the estimators are close to correctly sized. These tests have excellent power to detect misspecification. Received August 19, 2016; editorial decision May 30, 2017 by Editor Stijn Van Nieuwerburgh.

We present evidence on the labor supply of CEOs and on whether family and professional CEOs differ on this dimension. We do so through a new survey instrument that allows us to codify CEOs’ diaries in a detailed and comparable fashion and to build a bottom-up measure of CEO labor supply. The comparison of 1,114 family and professional CEOs reveals that family CEOs work 9% fewer hours relative to professional CEOs. Hours worked are positively correlated with firm performance, and differences between family and non-family CEOs account for approximately 18% of the performance gap between family and non-family firms. We investigate the sources of the differences in CEO labor supply across governance types by exploiting firm and industry heterogeneity and quasi-exogenous meteorological and sport events. The evidence suggests that family CEOs value—or can pursue—leisure activities relatively more than professional CEOs. Layperson summary

Using a hand-collected sample of election nominations for more than 30, 000 directors over the period 2001–2010, we construct a novel measure of director proximity to elections called Years-to-election. We find that the closer directors of a board are to their next elections, the higher CEO turnover-performance sensitivity is. A series of tests, including one that exploits variation in Years-to-election that comes from other boards, supports a causal interpretation. Further analyses show that other governance mechanisms do not drive the relation between board Years-to-election and CEO turnover-performance sensitivity. We conclude that director elections have important implications for corporate governance. Received March 10, 2016; editorial decision May 19, 2017 by Editor Itay Goldstein.

We examine the effects of financial reporting regulation on firms’ banking. Exploiting discontinuous public disclosure and auditing requirements assigned to otherwise similar small and medium-sized private firms, we document that financial reporting regulation reduces firms’ reliance on concentrated and local bank relationships and increases banks’ reliance on firms’ financial reporting, consistent with a shift in firms’ banking from relationship toward transactional approaches. Our evidence suggests that financial reporting regulation substitutes for banks’ information production role by burdening firms with the disclosure and auditing of their financial statements, consistent with institutional complementarities between reporting and banking systems. Received October 21, 2016; editorial decision September 15, 2017 by Editor Philip Strahan. Authors have furnished an Internet Appendix, which is available on the Oxford University PressWeb site next to the link to the final published paper online.