Knowledge that Transforms

Does trading away from public exchanges affect the way top executives are paid? Yes, our study finds that companies with a higher proportion of shares traded in “dark” (i.e., off-exchange) venues tend to offer more stock-based compensation to their CEOs. This relationship is primarily driven by enhanced price informativeness in lit (i.e., on-exchange/public) markets resulting from dark trading activities, making stock-based compensation a more attractive and effective tool for aligning executive incentives with shareholder returns. Consistent with this explanation, we show that the effect is most pronounced in firms where the impact of dark trading is likely greatest on price informativeness (firms with opaque information environments) and where compensation committees are more likely to extract information from stock prices (committees possessing greater financial expertise, higher equity ownership, and fewer external commitments). To address endogeneity concerns, we employ a treatment effects model and a difference-in-differences framework using the SEC's Tick Size Pilot Program as an exogenous shock to dark trading.

We show that political polarization among directors negatively affects corporate board effectiveness by reducing forced CEO turnover-performance sensitivity. Our results are more pronounced in presidential election years and for firms with more monitoring and advising needs. Polarization also increases the departure likelihood for directors who are ideologically distant from the rest of the board, making boards more politically homogeneous over time. Finally, we show that polarization in the boardroom lowers firms' investment- Q sensitivity and Environmental, Social and Governance (ESG) performance. Our findings highlight the real economic cost of political polarization.

We investigate how international trade shocks affect corporate investment efficiency. Utilizing a novel pairwise firm-product level dataset in China, we find that the investment efficiency of target firms significantly improves following the implementation of trade defense instruments (TDIs), including antidumping, countervailing, and safeguard measures. The reduction in free cash flow and heightened competition triggered by TDIs discourage overinvestment, particularly in firms more prone to overinvestment and those operating in industries with lower ex-ante competition. Moreover, the efficiency-enhancing effect is more pronounced in firms subject to stricter penalties and higher-value targeted products. Taken together, these findings suggest that Chinese target firms respond to international trade shocks by altering their investment strategies and improving efficiency.

We examine how sovereign rating downgrades affect firms' environmental, social, and governance (ESG) policies, leveraging the sovereign “ceiling” rule as a quasi-natural experiment that generates exogenous variation in corporate credit ratings. Under this rule, firms originally rated at or above the sovereign rating (bound firms) face a higher likelihood of downgrade following a sovereign downgrade. Using a difference-in-differences (DiD) setting, we find that bound firms experience a decline in ESG performance following a sovereign downgrade. This decline occurs only after the downgrade, not before, validating the parallel trends assumption. Our analysis further indicates that this effect is not driven by financing frictions and is concentrated in countries with a shareholder-centric orientation, and among firms with low institutional ownership from countries with strong social norms. Additional evidence suggests that affected firms experience an increase in ESG-related incidents, damaging their reputation post-downgrade. Overall, our findings underscore the crucial role of sovereign risk in shaping corporate sustainability practices.

We investigate the impact of product market competition (PMC) on workplace health and safety violations. Our findings reveal that firms facing intense PMC have higher incidences of workplace safety standards violations and pay higher penalties for such offenses. By leveraging reductions in import tariffs as quasi-exogenous shocks, we demonstrate that competitive pressures significantly worsen these violations. The strategic orientations of firms, whether towards cost-cutting or product differentiation, markedly shape these outcomes. Furthermore, pressure from analysts amplifies the negative impact, while labor unionization helps mitigate these detrimental effects, highlighting the nuanced interplay between governance and market forces.

We find no evidence of stock price manipulation by hedge funds from 2011 to 2019, despite confirming the portfolio-pumping pattern documented between 2000 and 2010. In the more recent period, the magnitude, frequency, and persistence of manipulation by hedge funds appear to have declined. This decrease is linked to reduced rewards, as fund flows no longer react positively to the end-of-quarter returns of hedge fund portfolios. Proactive regulatory actions, measured by SEC litigation cases involving hedge funds, and increased press attention to hedge fund fraud also contribute to reduced manipulation during both periods.

Over the recent decade or so, the Chinese government implemented a commercial reform that features governmental application of digital technologies to acquire and process firm information. The core objective of commercial reform is to improve information transparency and monitoring on corporate commercial activities. To explore the economic effectiveness of the reform, we examine how it impacts firms' stock price crash risk. We find robust evidence that the commercial reform that digitalizes government regulatory activities mitigates stock price crash risk and achieves so via enhancing information environment and monitoring for firms. This finding is more prominent for firms with higher levels of digitalization and innovation and those with weaker internal governance. Overall, our findings highlight a potential benefit of applying digital technologies to regulatory reform, encouraging governments to adopt digital tools to improve information environments and monitoring for firms, and thereby promoting a more stable and efficient capital market.

Does the recent proliferation of technology in lending process have an impact on business loan market competition? Using a theoretical model that assumes heterogeneity in lenders’ screening abilities and borrowers’ investment horizons, we show that FinTech (Traditional) lenders primarily supply unsecured (asset-backed) loans to borrowers with short-term (long-term) projects. The model builds on the interplay between screening ability and collateral requirements to characterize the competition between two ex-ante symmetric lenders. Lenders use screening technology and collateral requirements to mitigate competition and restrict the supply of credit through an endogenous segmentation of the loan market. As information technology improves, the effect on credit supply and equilibrium interest rates becomes more nuanced and depends on the market segment. The results offer a supply-side explanation for the growth of unsecured lending.

Conventional linear benchmarked contracts tend to cause excessive pegging to the benchmark and thus price distortion of stocks in the benchmark. This paper studies the optimal delegation contract when there is principal-agent friction. Specifically, it explores the impacts of incorporating the risk of invested portfolio in the contract on optimal strategies of the principal and the agent as well as on equilibrium asset prices. When agency friction is severe, the optimal contract provides rewards for portfolio risk to improve risk sharing and grants compensation for index return to propel the agent to deviate from pegging to index. In equilibrium, the principal conducts index investment while the agent invests only in individual risky assets, and price distortion caused by agency friction is mitigated.

Using a unique proprietary dataset of daily mutual fund trading records and the COVID-19 pandemic-triggered lockdown in Wuhan (China) as a natural experiment, we find that individual mutual fund investors in Wuhan significantly reduced their daily trading frequency, total investment of their portfolios, and risk level of their invested funds during the lockdown period as compared to investors in other cities. The results suggest that the elimination of face-to-face interaction among individual investors during the lockdown reduced their information sharing, which led to more conservatism in their financial trading. We rule out alternative explanations of salience bias due to limited investor attention and temporary changes in personal circumstances such as depression and/or income reduction, during the lockdown period. Finally, consistent with the theory of naïve investor trading, we also find that investors received higher trading returns during the lockdown as they reduced trading aggressively in the absence of face-to-face interactions.