Knowledge that Transforms

We show that in countries with more societal trust shareholders cast fewer votes at shareholder meetings and are more supportive of management proposals. This result is confirmed by instrumental variable regressions. It also holds at the U.S.-county level and for voting by U.S. institutional investors. Lower monitoring via voting relates less negatively to future firm performance in high-trust countries, suggesting that managers do not exploit greater discretion when trust is high. We also find a negative relation between trust and bond spreads. Our evidence supports theory arguing that trust substitutes for monitoring and has implications for investors’ optimal monitoring effort.

I study the return predictability of firm life cycle, originally documented by Dickinson (2011). I show that a hedge portfolio strategy going long on mature firms and short on introduction firms generates a significant hedge portfolio return of 1.29% per month in return-weighted portfolios and 0.72% in value-weighted portfolios. The returns to firm life cycle are related to investors’ and analysts’ expectation errors, are driven by market-wide investor sentiment, and are more pronounced among stocks with low institutional ownership and high idiosyncratic volatility. Quantile regressions show that introduction firms have considerably greater uncertainty and skewness in future earnings growth outcomes than mature firms, such that analysts are better able to justify optimistically biased forecasts for introduction firms compared to mature firms.

We develop a new rationale for capital allocation in business groups’ internal capital markets. We show that productivity and pledgeable income jointly drive capital allocation within an internal capital market. In financially constrained business groups, an efficient internal capital market can allocate marginal funds to firms that have high pledgeability of income because of a multiplier effect: a dollar of internal funds generates a bigger increase in investment. This result has important implications for the business group affiliation strategy. Whether or not a financially constrained but highly productive firm will benefit from group affiliation depends on its borrowing capacity vis-à-vis other affiliates.

This paper extends the signaling hypothesis by investigating the signal strength adjustment behavior with respect to the announcement of an open market repurchase (OMR). Given that an OMR is a non-binding commitment for the repurchasing firm, the stock market would likely scrutinize the credibility of the undervaluation signal from the OMR announcement of the firm. This may compel the manager to engage in various mechanisms in order to strengthen the undervaluation signal of the OMR announcement. This paper investigates whether managers of repurchasing firms would modify the terms of the OMR program when the simultaneous announcements of bad news threaten the credibility of the signal from the OMR announcements. Consistent with our signal strength adjustment hypothesis, we find that managers of repurchasing firms increase (shorten) the repurchase plan size (period) with the magnitude of bad news in the simultaneous announcements. Our results also show that the stock market reacts positively to the signal strength adjustments, indicating that they are informative to the market. These results hold after using various techniques to control for sample selection bias.

I analyze 70,000 transactions by retail impact investors on a peer-to-peer lending platform that intermediates loans to firms in low-income countries. Loans pay interest to investors and publicize indicators of expected social impact. Financial returns significantly influence investors’ decisions: a one percentage point increase in the interest rate increases funding speed seven-fold, investment probability two-fold and transaction size by 122 Euro. Expected social impact influences investors’ perception but has no influence (for female empowerment, employees and beneficiaries) or limited influence (for turnover) on investors’ funding decisions. When all available loans pay the same interest rates, female borrowers - but not firms with many employees or beneficiaries - are more likely to be chosen, suggesting that variation in financial returns can crowd out salient dimensions of social impact. The study implies that peer-to-peer lending platforms should function as gatekeepers of social impact and cannot outsource the evaluation of social impact to retail impact investors.

We document a reduction in both the level and cross-sectional dispersion of systematic risk in the target-date fund (TDF) market after 2008, which resulted in better performance of TDFs during the COVID-19 selloff compared to the 2008 selloff and a reduction in TDF return dispersion. We find that the shift is more pronounced in close-to-retirement funds and driven by the TDF series investing more in equities in the early period, consistent with TDFs catering to the market demand for lower risk exposure after the 2008 crisis. In addition, TDF systematic risk shifters do not exhibit more idiosyncratic risk-taking.

This paper establishes a sizeable negative effect of poor mental health on individuals’ net worth. In a representative panel of U.S. households, we find that a one standard deviation (or four unit) increase in Kessler’s K6 psychological distress level decreases net worth by 13.2 percent and increases by 5 percent the baseline risk of being in deficit net worth, where levels of debt outstrip the value of assets. Survival analyses further show that psychological distress accelerates the entry into and prolongs the stay in deficit net worth states, as well as increasing the probability of re-entry into deficit. Using a Blinder-Oaxaca decomposition, we find that differences in level of savings, medical debt and labor income predominantly explain the lower net worth and higher likelihood of deficit net worth of individuals with high psychological distress. Our findings highlight the significant longer-term implications of mental health on the net worth of individuals.

According to the gradient allocation principle based on a positively homogeneous and subadditive risk measure, the capital allocated to a sub-portfolio is the Gâteaux derivative, assuming it exists, of the underlying risk measure at the overall portfolio in the direction of the sub-portfolio. We consider the capital allocation problem based on the higher moment risk measure, which, as a generalization of expected shortfall, involves a risk aversion parameter and a confidence level and is consistent with the stochastic dominance of corresponding orders. As the main contribution, we prove that the higher moment risk measure is Gâteaux differentiable and derive an explicit expression for the Gâteaux derivative, which is then interpreted as the capital allocated to a corresponding sub-portfolio. We further establish the almost sure convergence and a central limit theorem for the empirical estimate of the capital allocation, and address the robustness issue of this empirical estimate by computing the influence function of the capital allocation. We also explore the interplay of the risk aversion and the confidence level in the context of capital allocation. In addition, we conduct intensive numerical studies to examine the obtained results and apply this research to a hypothetical portfolio of four stocks based on real data.

Counterparty Credit Risk (CCR) represents one of the major sources of uncertainty in many financial contracts. The role of credit value adjustment (CVA) is, in fact, that of rewarding the parties for the exposure to such risk. A key driver of CVA is the recovery risk, generated by the variability of recovery rates. In this paper, we develop a framework to assess the CCR accounting for the recovery risk that arises from the introduction of stochastic recovery rates. Adopting the structural model for the time to default that exploits a time-changed Lévy process for the risk driver of the equity value, we provide a complete picture to monitor the CCR and gauge the effects of the stochastic recovery rates. The model extracts information on the creditworthiness of the parties in the OTC contract combining Fourier Cosine Expansion and Monte Carlo simulations methods to price CDS spreads, the related underlying, and to retrieve the default barrier. We apply the model proposed to a business case analyzing the CCR of two parties involved in the OTC contract with underlying energy commodities. Low average recovery rates reveal to be associated with high implied volatility and depart from the fixed value of 40%, especially during periods of market distress.

We examine how the market power of credit rating agencies (CRAs) affects their rating standards. Using a global sample across 26 countries from 1994 to 2019, we find that greater market power of global CRAs, measured by their country-level market shares, is associated with stricter corporate ratings. In addition, the increase in global CRAs' market shares contributes to the tightening trend in their credit ratings worldwide. Exploiting the NRSRO designation of local CRAs in Japan, we find that global CRAs issue more inflated ratings following a decline in their market power. Further, global CRAs' greater market power is associated with timelier ratings, fewer missed defaults, but more false warnings. Collectively, our findings suggest that global rating agencies' market power leads to stricter rating standards and timelier ratings by strengthening the agencies’ reputation concerns, but at the expense of increased false warnings.