Do labor characteristics matter to corporate decisions? We answer this question by examining whether firms consider the risk attitude of rank-and-file employees in investing the pension assets of defined benefit plans. We construct a direct measure of employees' risk attitude from their defined contribution pension portfolio allocations. We find that firms with more risk-averse employees exhibit higher sensitivity to their own default risk in their defined benefit pension investment. The reduction in pension risk taking induced by sponsor risk is more pronounced for low R&D firms, and in the period with stringent pension regulation. We further show that sponsors consider employees' risk aversion in making pension investment decisions regardless of the power of labor union. Overall, our findings suggest that firms incorporate employees' risk attitude into corporate policies.

The suitability of complex financial products for household investors is an important issue in light of consumer financial protection. The U.S. Dodd–Frank Act, for instance, mandates that distributors check suitability when selling structured products to retail investors. However, little empirical evidence exists on such transactions. Using data from Hong Kong, we find that investors purchase 8% more structured products, on average, when the suitability is not checked. The effect of suitability checks is more pronounced for less financially literate investors. Moreover, investors tend to buy products with lower risk-adjusted returns when product suitability is not checked.

We show that firms grow faster than their industry rivals if there are credit default swaps (CDS) referencing their debt. Using multiple approaches to addressing endogeneity concerns including synthetic difference-in-differences and novel instrumental variables, we find the product market effects of CDS likely to be causal. We provide evidence for two mechanisms driving the CDS effects: the reduction of creditor monitoring and the elevation of shareholder risk-taking. A detailed analysis of product market dynamics reveals that CDS firms achieve faster growth by reducing markups, developing new products, and encroaching on rivals' product space. Over the long run, these strategies increase industry concentration and help profitability growth. Consistent with the classic predation theories, our findings suggest that financial innovations that change incentive problems in financial contracting can have real effects on product market outcomes.

The rise of credit default swaps (CDS) provides creditors with a market-based approach to obtaining protection, but it can also affect lenders' monitoring of the borrowers. We find that after CDS begin trading on a given firm, new loans to that firm are less likely to require collateral and have less strict financial covenants, even controlling for endogeneity. The effects are stronger when lenders have easier access to CDS, for safer firms, credit lines, and performance-based covenants. Our evidence is consistent with the theory that the introduction of CDS trading makes loan contracting more effective for better quality borrowers.

We compare key CDO assumptions from two departments within the same rating agency but with different financial incentives. Assumptions made by the ratings division are more favorable than those by the surveillance department. The differences are not explained by collateral switching during the ramp-up period, a long time gap between reports, nor the collapse of the CDO market in 2007 Additionally, CDOs rated with more favorable assumptions by the ratings group were more likely to be subsequently downgraded. As the useful signals from the surveillance group were seemingly ignored, these findings suggest rating agencies bias towards high ratings.

Analyzing 916 collateralized debt obligations (CDOs), we find that a top credit rating agency frequently made positive adjustments beyond its main model that amounted to increasingly larger AAA tranche sizes. These adjustments are difficult to explain by likely determinants, but exhibit a clear pattern: CDOs with smaller model-implied AAA sizes receive larger adjustments. CDOs with larger adjustments experience more severe subsequent downgrading. Additionally, prior to April 2007, 91.2% of AAA-rated CDOs only comply with the credit rating agency's own AA default rate standard. Accounting for adjustments and the criterion deviation indicates that on average AAA tranches were structured to BBB support levels.

We examine whether “rating shopping” or “rating catering” is a more accurate characterization of rating agency interactions regarding collateralized debt obligations (CDOs). Although investors paid a premium for dual ratings, AAA CDO tranches rated by both Moody's and S&P defaulted more frequently than tranches rated by only one of them, which is inconsistent with pure rating shopping. Rating agencies made upward adjustments beyond their model when their competitor had more lenient assumptions. Finally, consistent with rating catering, S&P's and Moody's adjustments and disagreements at security issuance were reflected in subsequent rating downgrades, suggesting that adjustments were harmful.

We provide direct evidence that governments selectively default on debt when they can identify creditors. Analyzing a comprehensive data set of subnational debt, we show that Chinese local governments choose to default on banks with weaker political power. A reduction in a bank's political power relative to other banks increases the likelihood of selective default by local governments. Such default selections are driven by banks’ influence over politician promotion. When local politicians are highly ranked or connected to national leaders, they engage less in selective default as their promotion is less affected by bank loan defaults. Our findings suggest a politics-finance nexus through which government defaults are restrained.

We investigate the liquidity management of firms following the inception of credit default swaps (CDS) markets on their debt, which allow hedging and speculative trading on credit risk to be carried out by creditors and other parties. We find that reference firms hold more cash after CDS trading commences on their debt. The increase in cash holdings is more pronounced for CDS firms that do not pay dividends and have a higher marginal value of liquidity. For CDS firms with higher cash flow volatility, these increased cash holdings do not entail higher leverage. Overall, our findings are consistent with the view that CDS-referenced firms adopt more conservative liquidity policies to avoid negotiations with more exacting creditors.