Knowledge that Transforms

We identify a specific channel (debt covenants) and the corresponding mechanism (transfer of control rights) through which financing frictions impact corporate investment. Using a regression discontinuity design, we show that capital investment declines sharply following a financial covenant violation, when creditors use the threat of accelerating the loan to intervene in management. Further, the reduction in investment is concentrated in situations in which agency and information problems are relatively more severe, highlighting how the state‐contingent allocation of control rights can help mitigate investment distortions arising from financing frictions.

We examine whether a simple quantitative measure of language can be used to predict individual firms' accounting earnings and stock returns. Our three main findings are: (1) the fraction of negative words in firm‐specific news stories forecasts low firm earnings; (2) firms' stock prices briefly underreact to the information embedded in negative words; and (3) the earnings and return predictability from negative words is largest for the stories that focus on fundamentals. Together these findings suggest that linguistic media content captures otherwise hard‐to‐quantify aspects of firms' fundamentals, which investors quickly incorporate into stock prices.