Knowledge that Transforms

We examine the relationship between shareholder leverage constraints and corporate risk-taking, focusing on its impact on debtholders. Our findings show that mutual fund leverage constraints are related to more risk-taking activities of portfolio companies, inducing higher credit risk and greater risk-shifting concerns for the firms’ debtholders. In response, the debtholders raise borrowing costs and tighten lending conditions. These effects intensify for firms facing higher levels of conflict between debtholders and shareholders and when mutual funds exert greater influence over firms. Econometric analyses, including instrumental variable specifications and asset management company mergers, support a causal interpretation.

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Equity returns follow a pronounced V-shape pattern around the onset of recessions. They sharply drop into negative territory just before business cycle peaks and then strongly recover as the recession unfolds. Recessions are typically preceded by a flat yield curve. Probit models relying on the term spread as a predictor therefore time the beginning of recessions well. We show that model-implied recession probabilities based on the term spread strongly improve equity premium prediction in- and out-of-sample and outperform several benchmark predictors. Correcting for a structural break in the mean of the term spread in 1982 further strengthens the forecast performance.

We study trading among strategic traders who may incorrectly assess the degree of market crowdedness. These mistakes distort equilibrium strategies and prices. When traders underestimate market crowdedness, they target larger inventories and trade more aggressively, but their actual profits are lower than expected because they underestimate the amount of information already impounded in prices. Crowded markets are prone to abrupt crashes. The magnitude of price dislocations and the speed of recovery during fire-sale events can help infer traders’ beliefs about market crowdedness.

After medical marijuana legalization (MML) by U.S. states, firms’ cost of equity (COE) decreases, especially for those with more growth opportunities, higher productivity, or a more skilled workforce. This policy change also reduces firm risk and leads to an increase in labor supply through increased labor force participation, employment, hours worked, and net migration. Further, home prices rise after MML, reflecting increased local housing demand due to a growing supply of workers. These findings align with theoretical models that link asset prices to labor markets and suggest that MML can lower firms’ COE by mitigating labor search frictions.

Active equity mutual funds that own shares in product-market competitors have higher risk-adjusted returns, even after fees. This positive association comes from their common ownership positions, and remains robust after controlling for industry concentration, common stock selection, and the tendency to invest in firms with more common ownership. These funds charge higher fees and are active voters: more likely to vote against executive pay-for-performance and for directors with existing directorships in competitors. Our findings suggest that actively managed equity mutual funds are incentivized to soften product-market competition, and proxy voting may serve as a mechanism for influencing corporate policy.

This article proposes a theoretical explanation for the positive pre-announcement drift empirically documented ahead of scheduled announcements, using the Federal Open Market Committee (FOMC) meetings as a main example. The framework entails a general equilibrium model of disagreement (differences of opinion), where investors interpret a costly signal differently. Investors optimally decide to stop learning when an announcement is imminent, increasing the risk premium ahead of an announcement. The model jointly rationalizes puzzling empirical evidence by generating i) an upward drift in prices just before scheduled announcements, regardless of the announcement’s content, which coexists with ii) low volatility and iii) low trading volume.

I analyze the effects of bank competition on gender and racial gaps in entrepreneurship. By leveraging interstate bank deregulation from 1994 to 2021, I find that stronger bank competition increases the quantity and quality of banking services offered to minority borrowers. Developing a novel measure of discrimination using narrative information in the complaints filed with the Consumer Financial Protection Bureau, I demonstrate that bank competition reduces discrimination, alleviating the financial constraints of female and minority entrepreneurs. Stronger bank competition also reduces gender and racial gaps in firm performance and business equity accumulation, promoting wealth equality and fostering equitable economic growth.

We investigate whether judges’ political ideology affects corporate tax behaviors. We find that firms engaging in less aggressive tax planning when Circuit Court judges are more liberal. Cross-sectionally, the deterrent effect of liberal judge ideology is more pronounced for firms that engage in judiciary-sensitive tax strategies, face higher enforcement risk from the Internal Revenue Service (IRS), or have larger reputational costs from tax disputes. Our findings further suggest that liberal judge ideology reduces firms’ R&D investments and market value by constraining tax planning. Overall, our evidence highlights the importance of judge ideology for firm behavior in the context of corporate tax planning.

Practical real-world activities consume energy and emit thermal infrared radiation (TIR). Leveraging this physical fact, we develop a direct, real-time measure of firms’ operating activity using satellite data. Tracking 28,236 factories of Chinese listed firms, we find TIR declines significantly following operational shocks and strongly forecasts subsequent sales growth, costs, investment, employment, and profits. TIR also predicts future stock returns, especially among opaque firms and those with limited investor access, yet sophisticated investors largely ignore this information. Our findings highlight TIR as a distinctive, under-exploited indicator of corporate fundamentals.