Knowledge that Transforms

Using a new variable based on a model of dividend smoothing, we find that dividend growth is highly predictable and that cash flow news contributes importantly to return variability. Cash flow betas derived from this predictability are central to explaining the size effect in the cross section of returns. However, they do not explain the value effect; this is explained by noise betas. We also find that the relative importance of cash flow news in explaining recent stock price run-ups and subsequent declines increases when cash flow news is estimated directly.

We examine the role of shareholder takeup in rights offerings on the subscription period price reaction and liquidity. Our results indicate that takeup information is reflected in price adjustments over the subscription period and that quality-related information disclosed on the rights announcement date further impacts prices in this period. Higher shareholder takeup improves liquidity. We do find some evidence of inefficiencies in the adjustment process over the subscription period that, in part, is consistent with a model where markets are characterized by overconfident investors and that also articulates with takeup information arriving in the market.

We investigate the long-term effect of the Asian financial crisis on corporate cash holdings in 8 East Asian countries. The Asian firms build up cash holdings by decreasing investment activities after the crisis. We find that the increase in cash holdings is not explained by changes in firm characteristics but by changes in the firms’ demand function for cash, which indicates that the crisis has systematically changed the firms’ cash-holding policies. Specifically, the firms’ increased sensitivity to cash flow volatility is one of the main factors explaining the higher level of their cash holdings in the postcrisis period.

We present a theory of the linkages between corporate governance, corporate finance, and the real sector of an economy. Using a structural model of industry equilibrium with endogenous entry, we show that poor corporate governance leads to low levels of competition, and to firms with high insider ownership and leverage. In contrast, good corporate governance promotes the adoption of more efficient technologies and development of sectors more exposed to moral hazard. We use our model to study equity market liberalization, and we show that liberalizations facilitate entry and adoption of more productive technologies, especially in countries with good corporate governance.

This study examines how the institutional environment influences capital structure and debt maturity choices of firms in 39 developed and developing countries. We find that a country’s legal and tax system, corruption, and the preferences of capital suppliers explain a significant portion of the variation in leverage and debt maturity ratios. Specifically, firms in more corrupt countries and those with weaker laws tend to use more debt, especially short-term debt; explicit bankruptcy codes and deposit insurance are associated with higher leverage and more long-term debt. More debt is used in countries where there is a greater tax gain from leverage.

This paper analyzes the loss allocation to first, second, and third loss positions in European collateralized debt obligation transactions. The quality of the underlying asset pool plays a predominant role for the loss allocation. A lower asset pool quality induces the originator to take a higher first loss position, but, in a synthetic transaction, a smaller third loss position. The share of expected default losses, borne by the first loss position, is largely independent of asset pool quality but lower in securitizations of corporate loans than in those of corporate bonds. Originators with a good rating and low Tobin’s Q prefer synthetic transactions.

This study uses Cremers and Petajisto’s (2009) method to separate active institutional investors from passive ones and shows that active investors can alleviate the anomalous comovement of stock returns. Focusing on 2 events linked to the excess comovement anomaly, Standard & Poor’s 500 Index additions and stock splits, I find that if an event stock has more active institutional investors trading in the post-event period, the anomalous comovement effect disappears. In contrast, if an event stock experiences a massive exit of active investors, this anomaly persists. The exit of active institutional investors also results in a strong price synchronicity effect.

When managing risk, frequently only imperfect hedging instruments are at hand. We show how to optimally cross-hedge risk when the spread between the hedging instrument and the risk is stationary . For linear risk positions we derive explicit formulas for the hedge error, and for nonlinear positions we show how to obtain numerically efficient estimates. Finally, we demonstrate that even in cases with no clear-cut decision concerning the stationarity of the spread, it is better to allow for mean reversion of the spread rather than to neglect it.

This study tests whether belief differences affect the cross-sectional variation of risk-neutral skewness using data on firm-level stock options traded on the Chicago Board Options Exchange from 2003 to 2006. We find that stocks with greater belief differences have more negative skews, even after controlling for systematic risk and other firm-level variables known to affect skewness. Factor analysis identifies latent variables linked to risk and belief differences. The belief factor explains more variation in the risk-neutral skewness than the risk-based factor. Our results suggest that belief differences may be one of the unexplained firm-specific components affecting skewness.

I study the relation between corporate diversification and labor productivity in a sample of over 500,000 firms from 46 countries. Across the entire sample, greater diversification is associated with significantly lower labor productivity. The negative relation between diversification and labor productivity is not stronger in countries with more burdensome employment regulation, but it is significantly stronger in countries with better financial development. In addition, the negative relation is stronger in industries with high capital/labor ratios. Overall, the results suggest that the lower productivity in diversified firms is due more to the misallocation of capital than to the inefficient use of labor.