Knowledge that Transforms

Abstract We study the impact of too-big-to-fail (TBTF) guarantees on the market for retail deposits. Exploiting information about all personal deposit accounts in Denmark and salient changes to the deposit insurance limit, we provide evidence that systemically important banks successfully retain and attract uninsured deposits in a crisis at the expense of other banks even as they differentially lower their interest rates. The funding shock suffered by nonsystemic banks causes a decrease in their lending. The results point to the distortive effects of TBTF guarantees in the market for retail deposits. Received March 15, 2018; editorial decision January 15, 2019 by Philip Strahan.

Abstract Some argue too-big-to-fail (TBTF) status increases the value of the largest banks. In contrast, we find that the value of the largest banks is negatively related to asset size in normal times, but much less so during the crisis. Further, shareholders lose when large banks cross a TBTF threshold through acquisitions. The negative relation between bank value and bank size for the largest banks cannot be explained by differences in ROA, ROE, equity volatility, tail risk, distress risk, or equity discount rates, but it can be partly explained by the market’s discounting of trading activities. Received December 20, 2017; editorial decision November 14, 2018 by Editor Itay Goldstein.

Abstract Researchers have long known about backfill bias in hedge fund databases. The most common treatments include either retaining all backfilled returns or truncating a fixed number of returns from each return series. However, we show that truncation largely preserves backfilled returns and document that either of these backfill treatments can lead to biased empirical findings, including cross-sectional results. Thus, our findings show that the best practice for empirical tests is to remove returns prior to the listing date. Because most databases do not have listing dates, we propose a novel method to infer unavailable listing dates. Received August 19, 2018; editorial decision December 4, 2018 by Editor Wei Jiang.

Abstract We examine how bank capital and borrower bargaining power affect loan spreads. Consistent with previous studies, higher bank capital has a negative impact on loan rates, but borrower cash flow has a significant effect on this impact: compared with high-capital banks, low-capital banks charge more for borrowers with low cash flow, but offer greater marginal discounts as these borrowers’ cash flow rises. These effects are largely focused on more bank-dependent borrowers. We find some evidence that low-capital banks charge a higher premium for bank-dependent borrowers’ systematic risk, but not for their total equity risk or default risk. Received January 27, 2015; editorial decision July 7, 2018 by Editor Philip Strahan. 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.

Abstract We study the relation between investment behavior and competitor financial constraints. Using interfirm patent citations and text-based product market similarities to identify intransitive competitor networks, we find that firms increase investment spending, patenting activity, and opportunistic hiring when competitor constraints become more binding. In addition, firms shift their investment composition (product market and patent portfolios) to compete more aggressively with relatively constrained competitors. To mitigate endogeneity concerns, we exploit the 2004 AJCA tax holiday and the 1989 junk bond crisis as exogenous shocks to competitor constraints, and we find similar effects. Received August 11, 2017; editorial decision November 6, 2018 by Editor David Denis. 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.

Abstract I conduct a field experiment to study the relationship between peoples’ misunderstanding of compound interest and their pension contributions in rural China. I find that explaining the concept of compound interest to subjects increased pension contributions by roughly 40%. The treatment effect is larger for those who underestimate compound interest than for those who overestimate compound interest. Moreover, financial education enables households to partially correct their misunderstanding of compound interest. I structurally estimate the level of misunderstanding of compound interest and conduct a counterfactual welfare analysis: lifetime utility increases by about 10% if subjects’ misunderstanding of compound interest is eliminated.

Abstract We use unique administrative data and a quasi-field experiment of exogenous allocation in Sweden to estimate medium- and longer-run effects of peoples’ exposure to financially literate neighbors on their financial behavior. We contribute evidence of (1) a causal impact of exposure and of a social multiplier of financial knowledge and (2) unfavorable distributional aspects of externalities. Exposure promotes saving in private retirement accounts and stockholding, especially when neighbors have economics or business education, but only for educated households and for substantial interaction possibilities. Findings point to a transfer of knowledge rather than mere imitation or effects through labor, education, or mobility channels. Received October 25, 2017; editorial decision December 24, 2018 by Editor Lauren Cohen. Authors have furnished code/data/an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Abstract To study the role of talent in finance workers’ pay, we exploit a special feature of the French higher education system. Wage returns to talent have been significantly higher and have risen faster since the 1980s in finance than in other sectors. Both wage returns to project size and the elasticity of project size to talent are also higher in this industry. Last, the share of performance pay varies more for talent in finance. These findings are supportive of finance wages reflecting the competitive assignment of talent in an industry that exhibits a high complementarity between talent and scale. Received October 11, 2017; editorial decision September 4, 2018 by Editor Stijn Van Nieuwerburgh. 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.

Abstract This paper studies the role of workplace peers in the transmission of information pertinent to an important household financial decision: the mortgage refinancing choice. Exploiting commonalities in teaching schedules of school teachers in Texas to identify peer groups, we find that refinancing activity among teachers’ peers increases their likelihood of refinancing by 20.7%. The effect of peers increases with the potential savings realized upon refinancing and is stronger among younger teachers. Peers also affect teachers’ choice of lender. Overall, our findings suggest that peer interactions greatly reduce a household’s cost of acquiring and processing financial information. Received March 6, 2017; editorial decision July 31, 2018 by Editor Itay Goldstein. 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.

Abstract This paper provides evidence of how noncognitive abilities affect financial distress. In a representative panel of households, we find that people in the bottom quintile of noncognitive abilities are 10 times more likely to experience financial distress than those in the top quintile. We provide evidence that this relation largely arises from worse financial choices and lack of financial insight by low-ability individuals and reflects differential exposure to income shocks only to a lesser degree. We mitigate endogeneity concerns using an IV approach and an extensive set of controls. Implications for policy and finance research are discussed. Received September 24, 2017; editorial decision September 26, 2018 by Editor Stijn Van Nieuwerburgh. 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.