A major threat to the development of financial markets in emerging markets is “tunneling.” In China, this took on the form of controlling shareholders diverting assets from listed firms or coercing firms to serve as guarantors on questionable loans. A new set of rules enacted in 2005 prohibited asset diversion for “non-operational” purposes. Firms complying with these rules have experienced a reduction in related party transactions, an increase in investment, and better performance. In contrast, another set of contemporary rules, which aimed to standardize the practice of firms providing loan guarantees, has had very little impact. We attribute the contrasting design, implementation, and effectiveness of these two sets of rules to the difference in enforcement costs of the two types of tunneling activities. Relative to loan guarantees, it is much easier for a third party to determine (ex ante) whether a particular form of diversion destroys firm value, and to verify (ex post) that the losses to the firm resulted from the diversion. Our results highlight the importance of enforceability—laws and regulations that can be enforced at lower costs are more likely to succeed, especially in countries with underdeveloped formal institutions.

Corporate bond mutual funds increased their selling of credit protection in the credit default swaps (CDS) market during the 2007–2008 financial crisis. This trading activity was primarily in multi-name CDS, greater among larger and established funds, and directed toward counterparty dealers in financial distress. Funds that sold credit protection during the crisis experienced greater credit market risk and superior post-crisis performance, consistent with higher expected returns from liquidity provision. Funds using Lehman Brothers as a counterparty experienced abnormal outflows and returns of –2% immediately following Lehman's bankruptcy, suggesting that funds’ opportunistic trading in CDS exposed investors to counterparty risk.

Legal and institutional differences shape the ownership and terms of bank loans across the world. We show that under strong creditor protection, loans have more concentrated ownership, longer maturities, and lower interest rates. Moreover, the impact of creditor rights on loans depends on borrower characteristics such as the size and tangibility of assets. Foreign banks appear especially sensitive to the legal and institutional environment, with their ownership declining relative to domestic banks as creditor protection falls. Our multidimensional empirical model paints a more complete picture of how financial contracts respond to the legal and institutional environment than existing studies.

We document reversals of privatization in China—local governments re-possessing ownership stakes in a quarter of previously privatized firms during 1998–2007, a period when the privatization process was still ongoing. This type of ownership restructuring helped ease the unemployment burden in the local labor markets, and was more likely to occur in firms located in provinces led by an official without strong political status in the Chinese Communist Party. A reversal in privatization led to higher leverage, lower profitability and lower labor productivity. Our paper sheds light on how frictions in the political structure affect the implementation of economic policies in a top-down system.

We examine the role of financial analysts in forming institutional investors' investment decisions. In our model, a fund manager invests in a stock based on the optimal weighting of reports created by a biased sell-side analyst and an unbiased buy-side analyst. The manager puts a higher weight on the buy-side analyst's report when the quality of the buyside analyst's information relative to that of the sell-side analyst increases, or when the sell-side analyst's degree of bias or uncertainty about the bias increases. Utilizing a unique dataset of U.S. equity funds, we find evidence supporting our model predictions on how fund managers weigh buy-side research relative to sell-side and independent research.

We explore the relationship between bank branch expansion, financial inclusion, and profitability for Equity Bank. Unlike traditional banks, including foreign and government owned banks in Kenya, Equity Bank targets less developed territories and less privileged households. Its presence increased financial inclusion by 31% of the adult population between 2006 and 2015, especially for Kenyans who were less educated, did not own their own home, and lived in less-developed areas. The bank’s business model proves to be highly effective, with branch-level profits rising in areas with a smaller number of operating banks. Overall, the growth of Equity Bank demonstrates that financial inclusion can be achieved and sustained through profitable branching and service strategies that also serve the needs of underserved regions and populations. Thus, financial inclusion need not come at the sacrifice of bank profitability.

With extensive cross-country datasets and India firm samples, as well as our own surveys of small and medium firms, we examine the legal and business environments, financing channels, and growth patterns of different types of firms in India. Despite the English common-law origin and a British-style judicial system, Indian firms face weak investor protection in practice and poor institutions characterized by corruption and inefficiency. Alternative finance, including financing from all nonbank, nonmarket sources, and generally backed by nonlegal mechanisms, constitutes the most important form of external finance. Bank loans provide the second most important external financing source. Firms with access to bank or market finance are not associated with higher growth rates. Our results indicate that bank and market finance is not superior to alternative finance in fast-growing economies such as India.

In 2002 and 2003, many Chinese banks implemented reforms that delegated authority to individual loan officers. The change followed China's entrance into the WTO and offers a plausibly exogenous shock to loan officer incentives to produce information. We find that the bank's internal risk rating becomes a stronger predictor of loan interest rates and ex post outcomes after reform. When the loan officer and the branch president who approves the loan work together longer, the rating also becomes more strongly related to loan prices and outcomes. Our results highlight how incentives and communication costs affect information production and use.

Domestically listed Chinese (A‐share) firms have lower stock returns than externally listed Chinese, developed, and emerging country firms during 2000 to 2018. They also have lower net cash flows than matched unlisted Chinese firms. The underperformance of both stock and accounting returns is more pronounced for large A‐share firms, while small firms show no underperformance along either dimension. Investor sentiment explains low stock returns in the cross‐country and within‐A‐share samples. Institutional deficiencies in listing and delisting processes and weak corporate governance in terms of shareholder value creation are consistent with the underperformance in stock returns and net cash flows.

We compare the structure and performance of private (non-GSE) mortgage-backed securities sold by large issuers vs. those sold by small issuers over the period 2000–2006. Securities sold by large issuers have less subordination—a greater fraction of the deal receiving AAA rating—than those sold by small issuers. Prices for AAA-rated and non-AAA rated tranches sold by large issuers fell more when the market turned down than those sold by small issuers, and this difference was concentrated among tranches issued between 2004 and 2006. These results suggest that rating agencies grant favorable ratings to large issuers, especially during market booms.