Knowledge that Transforms

We estimate a dynamic investment model in which firms finance with equity, cash, or debt. Misvaluation affects equity values, and firms optimally issue and repurchase overvalued and undervalued shares. The funds flowing to and from these activities come from investment, dividends, or net cash. The model fits a broad set of data moments in large heterogeneous samples and across industries. Our parameter estimates imply that misvaluation induces larger changes in financial policies than investment. The investment responses are strongest for small firms but nonetheless modest. Managers' rational responses to misvaluation increase shareholder value by up to 4%.

We document that announcement-period abnormal returns of sovereign wealth fund (SWF) equity investments in publicly traded firms are positive but lower than those of comparable private investments. Further, SWF investment targets suffer from declining return on assets and sales growth over the following three years. Our results are robust to controls for target and deal characteristics and are not driven by SWF target selection criteria. Larger discounts are associated with SWFs taking seats on boards of directors and with SWFs under strict government control acquiring greater stakes, supporting the hypothesis that political influence negatively affects firm value and performance.

We document differences in human-capital deployment between diversified and focused firms. We find that diversified firms have higher labor productivity and that they redeploy labor to industries with better prospects in response to changing opportunities. The opportunities and incentives provided in internal labor markets in turn affect the development of workers' human capital. We find that workers more frequently transition to other industries in which their diversified firms operate and with smaller wage losses compared with workers in the open market, even when they leave their original firms. Overall, internal labor markets provide a bright side to corporate diversification.

Blockholders' incentives to intervene in corporate governance are weakened by free-rider problems and high costs of activism. Theory suggests activists may recoup expenses through informed trading of target firms' stock when stocks are liquid. We show that stock liquidity increases the probability of activism but does less so for potentially overvalued firms for which privately informed blockholders may have greater incentives to sell their stake than to intervene. We also document that activists accumulate more stocks in targets when stock is more liquid. We conclude that liquidity helps overcome the free-rider problem and induces activism via preactivism accumulation of target firms' shares.

We develop a dynamic model of investment, financing, and cash management decisions in which investment is lumpy and firms face capital supply uncertainty. We characterize optimal policies explicitly, demonstrate that smooth-pasting conditions may not guarantee optimality, and show that firms may not follow standard single barrier policies. In the model, firms with high investment costs differ in their behaviors from firms with low investment costs, financing policy does not follow a strict pecking order, and the optimal payout policy may feature several regions with both incremental and lumpy dividend payments.

Using a sample of non-U.S. firms from 43 countries, we investigate whether laws and regulations as well as votes cast by U.S. institutional investors are consistent with an effective shareholder voting process. We find that laws and regulations allow for meaningful votes to be cast, as shareholder voting is both mandatory and binding for important elections. For votes cast, we find there is greater dissent voting when investors fear expropriation. Further, greater dissent voting is associated with higher director turnover and more M&A withdrawals. Our results suggest that shareholder voting is an effective mechanism for exercising governance around the world.

Many explanations for the rapid growth of the shadow banking system in the mid-2000s focus on money demand. This paper asks whether the short-term liabilities of the shadow banking system behave like money. We first present a simple model where households demand money services, which are supplied by three types of claims: deposits, Treasury bills, and asset-backed commercial paper (ABCP). The model provides predictions for the price and quantity dynamics of these claims, as well as the behavior of the banking system (in terms of issuance) and the monetary authority (in terms of open market operations). Consistent with the model, the empirical evidence suggests that the shadow banking system does respond to money demand. An extrapolation of our estimates would suggest that heightened money demand could explain up to approximately half the growth of ABCP in the mid-2000s.

The literature posits that some CEO overconfidence benefits shareholders, though high levels may not. We argue that adequate controls and independent viewpoints provided by an independent board mitigates the costs of CEO overconfidence. We use the concurrent passage of the Sarbanes-Oxley Act and changes to the NYSE/NASDAQ listing rules (collectively, SOX) as natural experiments, to examine whether board independence improves decision making by overconfident CEOs. The results are strongly supportive: after SOX, overconfident CEOs reduce investment and risk exposure, increase dividends, improve postacquisition performance, and have better operating performance and market value. Importantly, these changes are absent for overconfident-CEO firms that were compliant prior to SOX.

This study examines stock return predictability via lagged financial variables with unknown stochastic properties. We propose a novel testing procedure that (1) robustifies inference to regressors' degree of persistence, (2) accommodates testing the joint predictive ability of financial variables in multiple regression, (3) is easy to implement as it is based on a linear estimation procedure, and (4) can be used for long-horizon predictability tests. We provide some evidence in favor of short-horizon predictability during the 1927-2012 period. Nevertheless, this evidence almost entirely disappears in the post–1952 period. Moreover, predictability becomes weaker, not stronger, as the predictive horizon increases.

Banks are subject to capital requirements because their privately optimal leverage is higher than the socially optimal one. This is in turn because banks fail to internalize all costs that their insolvency creates for agents who use their money-like liabilities to settle transactions. If banks can bypass capital regulation in an opaque shadow banking sector, it may be optimal to relax capital requirements so that liquidity dries up in the shadow banking sector. Tightening capital requirements may spur a surge in shadow banking activity that leads to an overall larger risk on the money-like liabilities of the formal and shadow banking institutions.