Knowledge that Transforms

We examine the effect of institutional ownership on corporate disclosure policy using a regression discontinuity design. Using a novel dataset comprising every 8-K filing between 1996 and 2006, we find that positive shocks to institutional ownership around Russell index reconstitutions increase the quantity, form, and quality of disclosure. Compared with those at the bottom of the Russell 1000 index, firms at the top of the Russell 2000 index increase institutional ownership by 9.8%, and disclose 4.7% longer 8-K filings with 21.3% more embedded graphics. This incremental disclosure significantly increases the information content of 8-K filings for the market and for analysts.

From 1998 to 2011, U.S. firms held more cash on average (but not at the median) than similar foreign firms (foreign twins) did. The average difference in cash holdings does not increase after 2008, and it is driven by highly R&D-intensive U.S. firms. Because there are almost no similarly R&D-intensive foreign firms, mean comparisons involving these U.S. firms are not reliable. Without these U.S. firms, neither U.S. multinational firms nor purely domestic U.S. firms hold more cash than their foreign twins do. Country characteristics have negligible explanatory power for differences in cash holdings between U.S. firms and their foreign twins.

Recent reforms across Eastern European countries have given more flexibility and information to parties to engage in secured debt transactions. The menu of assets legally accepted as collateral was enlarged to include movable assets (e.g., machinery and equipment). Generalized difference-in-differences tests show that firms operating more movable assets borrowed more as a result. Those firms also invested more, hired more, and became more efficient and profitable following the changes in the contracting environment. The financial deepening we document triggered important reallocation effects: firms affected by the reforms increased their share of fixed assets and employment in the economy.

This paper examines apparent fraud among securitized nonagency loans using three indicators: unreported second liens, owner occupancy misreporting, and appraisal overstatements. We find that around 48% of loans exhibited at least one indicator of misrepresentation. Surprisingly, misreporting is similar in both low and full documentation loans and is associated with a 51% higher likelihood of delinquency. Two-thirds of loans with unreported second liens had the same originator issuing both the first and second lien. Misrepresentations in MBS pools can explain substantial cross-sectional differences in future losses. Losses were predictable and initiating from apparent fraud by MBS underwriters and loan originators.

We show that a global imbalance risk factor that captures the spread in countries’ external imbalances and their propensity to issue external liabilities in foreign currency explains the cross-sectional variation in currency excess returns. The economic intuition is simple: net debtor countries offer a currency risk premium to compensate investors willing to finance negative external imbalances because their currencies depreciate in bad times. This mechanism is consistent with exchange rate theory based on capital flows in imperfect financial markets. We also find that the global imbalance factor is priced in cross-sections of other major asset markets.

In standard production models, wage volatility is far too high, and equity volatility is far too low. A simple modification–sticky wages because of infrequent resetting together with a constant elasticity of substitution (CES) production function leads to both smoother wages and higher equity volatility. Further, the model produces several other hard-to-explain features of financial data: high Sharpe ratios, low and smooth interest rates, time-varying equity volatility and premium, a value premium, and a downward-sloping equity term structure. Procyclical, volatile wages are a hedge for firms in standard models; smoother wages act like operating leverage, making profits and dividends riskier.

Previous studies have argued that entrepreneurs earn less and bear more risk than salaried workers with otherwise similar characteristics. In a simple model of entrepreneurship, I show that estimates of mean and variance of returns to entrepreneurship used by these previous studies are biased, as they fail to account for the option value of experimenting with new ideas. Using longitudinal data, I find patterns that are consistent with entrepreneurship as experimentation and returns to entrepreneurship that are more attractive than established by previous research.

How do private equity firms affect their portfolio companies? We document operational changes in restaurant chain buyouts using comprehensive health inspection records. Store-level operational practices improve after private equity buyout, as restaurants become cleaner, safer, and better maintained. Supporting a causal interpretation, this effect is stronger in chain-owned stores than in franchised locations—“twin” restaurants over which private equity owners have limited control. These changes are particularly apparent when private equity partners have prior industry experience. The results suggest that by bringing in industry expertise, private equity firms improve firm operations.

We hypothesize that a source of commonality in a stock’s liquidity arises from the correlated liquidity demand of the stock’s investors. Focusing on correlated trading of mutual funds, we find that stocks with high mutual fund ownership have comovements in liquidity about twice as large as those for stocks with low mutual fund ownership. Further analysis shows that the channels for these comovements derive from both common ownership across funds and funds’ correlated liquidity shocks. We obtain inferences supporting causality from an exogenous flow shock for mutual funds in the aftermath of the 2003 mutual fund scandal.

Did regulatory reforms that lowered barriers to competition increase or decrease the quality of information that banks disclose to the public? By integrating the gravity model of investment with the state-specific process of bank deregulation that occurred in the United States from the 1980s through the 1990s, we develop a bank-specific, time-varying measure of deregulation-induced competition. We find that an intensification of competition reduced abnormal accruals of loan loss provisions and the frequency with which banks restate financial statements. The results suggest that competition reduces bank opacity, potentially enhancing the ability of markets to monitor banks.