Knowledge that Transforms

We examine the determinants of vertical acquisitions using product text linked to product vocabulary from input-output tables. We find that the innovation stage is important in understanding vertical integration. R&D-intensive firms are less likely to become targets of vertical acquisitions. In contrast, firms with patented innovation are more likely to sell to vertically related buyers. Firms’ R&D intensity is a more important deterrent to their vertical acquisitions when the provision of innovation incentives by potential acquirers is more difficult. The role of patents in fostering vertical acquisitions is more prevalent when potential buyers face a higher risk of holdup.

This paper finds that banks and nonbanks respond differently to increased competition in consumer credit markets. Increased competition and a greater threat of failure induces banks to specialize in relationship business lending, and surviving banks are more profitable. However, nonbanks change their credit policy when faced with more competition and expand credit to riskier borrowers at the extensive margin, resulting in higher default rates. These results show how the effects of competition depend on the form of intermediation. They also suggest that increased competition can cause credit risk to migrate outside the traditional supervisory umbrella.

Using trading data from a sports wagering market, we estimate individuals’ dynamic risk preferences within a prospect theory paradigm. This market’s experimental-like features facilitate preference estimation, and our long panel enables us to study whether preferences vary across individuals and depend on earlier outcomes. Our estimates extend support for experimental findings—mild utility curvature, moderate loss aversion, and probability overweighting of extreme outcomes—to a market setting and reveal that preferences are heterogeneous and history dependent. Applying our estimates to a portfolio choice problem, we show prospect theory can better explain the prevalence of the disposition effect than previously thought.

We model the strategic interaction between fundamental investors and “back-runners,” whose only information is about the past order flow of fundamental investors. Back-runners partly infer fundamental investors’ information from their order flow and exploit it in subsequent trading. Fundamental investors counteract back-runners by randomizing their orders, unless back-runners’ signals are too imprecise. Surprisingly, a higher accuracy of back-runners’ order flow information can harm back-runners and benefit fundamental investors. As an application of the model, the common practice of payment for (retail) order flow reveals information about institutional order flow and enables back-runners to earn large profits.

Interbanking rates were, until recently, based on judgmental estimates of borrowing costs. We interpret this as a cheap-talk game that allowed banks to communicate nonverifiable information about their opportunity cost to potential counterparties. Under normal market conditions there is a welfare maximizing equilibrium where banks truthfully disclose their borrowing cost, but, in times of financial stress, only “coarse” equilibria survive. We take this prediction to the data and show that banks round more frequently if the risk of the bank increases. Rounding is also more frequent for the more liquid short-term rates and certain benchmark maturities.

Research in finance and macroeconomics has routinely employed multiple horizons to test asset return predictability. In a simple predictive regression model, we find the popular scaled test can have zero power when the predictor is not sufficiently persistent. A new test based on implication of the short-run model is suggested and is shown to be uniformly more powerful than the scaled test. The new test can accommodate multiple predictors. Compared with various other widely used tests, simulation experiments demonstrate remarkable finite-sample performance. We reexamine the predictive ability of various popular predictors for aggregate equity premium.

According to our survey about climate risk perceptions, institutional investors believe climate risks have financial implications for their portfolio firms and that these risks, particularly regulatory risks, already have begun to materialize. Many of the investors, especially the long-term, larger, and ESG-oriented ones, consider risk management and engagement, rather than divestment, to be the better approach for addressing climate risks. Although surveyed investors believe that some equity valuations do not fully reflect climate risks, their perceived overvaluations are not large.

We study the effects of policies proposed to address “short-termism” in financial markets. We examine a noisy rational expectations model in which investors’ exposures and information about fundamentals endogenously vary across horizons. In this environment, taxing or outlawing short-term investment doesn’t negatively affect the information in prices about long-term fundamentals. However, such a policy reduces short- and long-term investors’ profits and utility. Changing policies about the release of short-term information can help long-term investors—an objective of some policy makers—at the expense of short-term investors. Doing so also makes prices less informative and increases costs of speculation. Received June 24, 2018; editorial decision February 19, 2019 by Editor Stijn Van Nieuwerburgh.

We investigate how communication within banks affects small business lending. Using travel times between a bank’s headquarters and its branches to proxy for the costs of communicating soft information, we exploit shocks to these travel times—the introduction of new airline routes—to evaluate the impact of within-bank communication costs on small business loans. We find that reducing headquarters-branch travel time boosts small business lending in the branch’s county. Several extensions suggest that new airline routes facilitate in-person communications that boost small-firm lending.

The value a director provides to a firm is empirically difficult to establish. We estimate that value by exploiting the commonality in idiosyncratic returns of firms linked by a director and show that, on average, a director’s influence causes variation in firm value of almost 1% per year. The return commonality is not due to industry or other observable economic links. Variation in the availability of information on shared directors and a placebo test exploiting the timing of shared directors provide further identification. The results also imply that the directorial labor market does not fully assess directors in real time.