Knowledge that Transforms

This study explores how Chinese mutual fund managers’ degrees of disagreement (DOD) on stock market returns affect investor capital allocation decisions using a novel text-based measure of expectations in fund disclosures. In the time series, the DOD negatively predicts market returns. Cross-sectional results show that investors correctly perceive the DOD as an overpricing signal and discount fund performance accordingly. Flow-performance sensitivity (FPS) is diminished during high dispersion periods. The effect is stronger for outperforming funds and funds with substantial investments in bubble and high-beta stocks, but weaker for skilled funds. We also discuss the financial sophistication of investors and provide evidence that our results are not contingent upon such sophistication.

This paper examines the ramifications of government capital injections into financially distressed banks during the 1997 Japanese banking crisis. Using a dataset merging firm-level financial statements and bank balance sheets, we explore whether the capital injections primarily benefited high-productivity firms or were misallocated to struggling “zombie” firms. The results suggest that post-injection banks increased lending to high-productivity non-zombie and low-productivity zombie firms. The former aligns with conventional theories prioritizing high-productivity firms for investment and productivity enhancement; the latter suggests credit misallocation toward struggling firms mainly for debt servicing. There is no evidence that these injections promoted investments among firms. The results indicate that zombie firms reduced investments, particularly in infrastructure. High-productivity non-zombie firms did not exhibit a significant investment boost despite receiving more loans but displayed positive labor and total factor productivity growth, potentially driven by sales growth and increased advertisement expenses rather than employment and wage adjustments.

We investigate daily flows to Israeli government bonds mutual funds, which are held primarily by retail investors. We divide the bonds into six categories: nominal/CPI-linked - short-term, intermediate-term, and long-term maturity. We find that unexpected daily net flows are contemporaneously correlated with price changes in all categories, with correlations ranging from 0.094 to 0.221 depending on the bond category. These price changes are significant, and they subsequently reverse fully or mostly within 10 trading days. The price reversal indicates that the initial price changes are due to “price pressure.” We find that these price distortions affect break-even inflation—a measure of inflation expectations. Our findings indicate that even government bonds are affected by retail price pressure.

This study establishes a relation between corporate culture and debt maturity choice. Specifically, superior corporate culture is associated with the choice of shorter-term debt, supporting the notion that superior culture reduces managerial agency problems resulting in managers being more receptive to external monitoring through the choice of shorter-term debt. The culture subcomponents of integrity, teamwork, and innovation are found to have a meaningful influence on the debt maturity structure choice. The relation between culture and debt maturity is more pronounced in firms with higher managerial stock ownership and those that are financially constrained, but is weakened in firms with a greater CEO sensitivity to stock prices. Additionally, firms with superior culture are shown to have higher long-term credit ratings. These findings contribute at the confluence of corporate culture and debt financing literatures. A battery of robustness tests, including addressing endogeneity concerns, validate the findings.

Many Japanese bond issuers believe that global credit rating agencies (CRAs)—Moody's and S&P—do not consider the unique corporate governance structure in Japan and assign lower credit ratings even though the “main bank” relationship in Japan can significantly reduce the default risk of these companies. Using 5,814 rated corporate bonds issued by 558 non-financial firms in Japan from 2003 to 2021, we find that local CRAs (R&I and JCR) weigh unique Japanese corporate governance features more heavily and assign higher ratings to Japanese corporate bonds relative to global CRAs. Our results further suggest that the degree of rating differences between local and global CRAs for individual issuers results from systematically different assessments of company-specific risk by these CRAs. Our data also reveal that the importance of main bank ties in Japanese corporate governance remains intact in more recent years, contrary to previous findings.

We develop the concept of auditor industry range as the extent to which an auditor has experiences in auditing clients from different industries, and we link this construct to auditor performance, drawing on prior research in psychology and cognitive science. We find that auditors with a wide range of industry experiences are more likely to require audit adjustments than auditors with a narrow range. We conduct an extensive set of analyses to mitigate the concern that our results are driven by endogenous matching between auditors and clients. The positive relation between auditor industry range and audit adjustments exists regardless of whether the industries covered by an auditor's portfolio exhibit strong or weak economic co-movement, and the relation is stronger for more complex clients, in more uncertain environments, and for auditors with more years of audit experience. Overall, our findings suggest that an auditor's diverse experiences in different industries can enhance audit quality.

This paper explores the effects of public information such as accounting earnings in a competitive lending setting with risk shifting. Debt financing creates incentives for borrowers to take on excessive risks, in particular in bad states of the world. If a privately informed inside creditor bids against outside creditors to extend a loan, public information levels the playing field, which affects the bidding and risk shifting. Nonetheless, a perfect public signal would yield the least efficient outcome: introducing some measurement noise alleviates risk shifting by subjecting outside creditors to the winner’s curse, allowing borrowers in bad states cheaper access to loans. However, for pessimistic priors about the borrower, greater public signal precision can alleviate risk shifting, at the margin. We discuss implications for financial reporting regulations along the business cycle and for creditor turnover.

We study the role of litigation risk in M&A valuations. Specifically, we hypothesize that litigation risk leads to strategic valuations in fairness opinions (FOs) obtained in M&A transactions. Employing a regulatory shock to merger litigation risk and focusing on the most common valuation techniques – peer firm comparables and DCF analysis – we find that target-sought FOs exhibit lower valuations when litigation risk is high. The effect is concentrated in deals with greater agency conflicts between target management and outside shareholders. Furthermore, downward-biased valuations reduce appraisal litigation but are also associated with lower premiums. In contrast to prior work suggesting that target-sought FOs are used to negotiate a higher takeover price, our findings imply that they are used, at least in part, to mitigate litigation risk and facilitate successful deal completion. Our findings are relevant to academics, practitioners, and regulators interested in M&A price formation, and highlight the role litigation plays therein.

We provide the first evidence of systematic bias among an emerging type of credit rating agency that relies on subscriptions from institutional clients as its primary source of revenue. Using data from Egan-Jones Ratings Company (EJR), a representative subscriber-paid rating agency, we show that EJR issues more optimistically biased credit ratings, less timely downgrades, and less accurate ratings for firms held by more EJR clients. Our evidence is consistent with EJR optimistically biasing its ratings to bolster subscriber revenue, which allows institutional clients to invest in riskier bonds with higher expected returns. Taken together, our findings suggest that the emergence of subscriber-paid rating agencies as an alternative to more traditional issuer-paid agencies is unlikely to resolve problems arising from conflicts of interest but rather alter the nature of these conflicts in the ratings process.

Economists have long observed that stock price bubbles are associated with corporate overinvestment. We study the ex-ante identification of bubbles (i.e. stock price booms followed by busts) by examining industry-level investments in net operating asset (NOA) accruals and stock returns for 49 countries around the world. Consistent with overinvestment in operating assets being key to bubble formation, we document five findings: (1) NOA accruals positively forecast the eventual crash of an industry price run-up; (2) NOA accruals negatively forecast stock returns following a run-up; (3) NOA accruals are positively associated with investor sentiment; (4) higher NOA accruals forecast more disappointing earnings relative to analysts’ expectations for run-up industries; and (5) NOA accruals are sharply stronger predictors of crashes, returns and analyst forecast errors following run-ups compared to other periods. Our results provide the first evidence that accounting information identifies stock price bubbles and suggest that financial statements are important for detecting and anticipating industry- and market-level inefficiencies.