Laurence Ball argues that the Federal Reserve (the Fed) could—and should—have bailed out Lehman Brothers so that it did not have to declare bankruptcy. He presents compelling evidence that it could have. I argue that the view that the Fed should not bail out Lehman is reasonable under the circumstances the Fed was in at the time. The Lehman bankruptcy is a case study in bailouts and the attendant moral hazard problem that expectations of bailouts create. The lessons learned imply a clear case for appropriate regulatory intervention to solve the problems created when governments cannot commit themselves to not undertake bailouts.

We examine a simple measure of operating leverage: the ratio of fixed costs (measured by depreciation and amortization plus selling, general, and administrative expenses) to the market (or book) value of assets. We find that this measure of operating leverage positively predicts returns. This operating leverage measure is not explained by common factors and performs better than the traditional measures of operating leverage. Furthermore, an exploratory two-factor model with the operating leverage factor works at least as well as, but does not subsume, the Fama and French five-factor model.

Do accruals-based earnings provide better information about future operating cash flows than do operating cash flows themselves, as predicted by the Financial Accounting Standards Board's conceptual framework (FASB, 1978)? While this is a foundational issue in accounting, because it addresses the information added by accrual accounting methods, testing it remains unsettled. We show that when comparing the predictive ability of operating cash flows with that of an equivalent earnings measure calculated on an accrual basis, earnings outperform operating cash flows. The result becomes more pronounced when allowance is made for cross-sectional differences in the relation between firms' earnings and future cash flows. In fact, even “bottom line” earnings then have similar explanatory power as operating cash flows.

Using a comprehensive dataset from German banks, we document the usage of sovereign credit default swaps (CDS) during the European sovereign debt crisis of 2008–2013. Banks used the sovereign CDS market to extend, rather than hedge, their long exposures to sovereign risk during this period. Lower loan exposure to sovereign risk is associated with greater protection selling in CDS, the effect being weaker when sovereign risk is high. Bank and country risk variables are mostly not associated with protection selling. The findings are driven by the actions of a few non-dealer banks which sold CDS protection aggressively at the onset of the crisis, but started covering their positions at its height while simultaneously shifting their assets towards sovereign bonds and loans. Our findings underscore the importance of accounting for derivatives exposure in building a complete picture and understanding fully the economic drivers of the bank-sovereign nexus of risk.

We introduce a simple and intuitive approach of modeling and forecasting correlations for use in portfolio optimization. The model is composite in nature and consists of elements based on a bivariate realized volatility model. Importantly, our framework allows for volatility spill-overs between assets which provide an edge compared to competing models when forming portfolios. We apply the model to high-frequency data for commodity markets and demonstrate significant economic gains for an investor basing portfolio decisions on our modeling framework. This gain is significant in economic terms, even after imposing realistic constraints on short selling and portfolio turnover.

We investigate the impact of corporate diversification on stock risk. For identification, we exploit an exogenous shock on volatility expectations related to COVID-19 lockdowns resulting in a period of high volatility. We show that firms that diversify only internationally experience a lower post-shock increase in daily volatility. However, diversifying only by business segment leads to a higher increase in post-shock daily volatility. Our main results are robust to different proxies for international and business diversification and daily volatility. Overall, these findings provide a more nuanced picture of the potential impact of corporate diversification on stock risk.

This paper provides survey evidence on higher purpose for individuals and organizations and develops a theoretical model consistent with the evidence. The survey of 1,019 individuals in the U.S. sought to learn about their commitment to and perceived value from personal and organizational higher purpose. One striking finding from the survey is that when an organization has a written statement of higher purpose, its employees tend to trust their leaders to not only be socially responsible, but also to make better business decisions, i.e. corporate governance is perceived to be better by the employees. We then develop a simple theoretical model that provides an economic rationale for this finding. In the model, an investment in higher purpose credibly signals the firm owner's ability/marginal productivity and elicits higher employee effort. When put in a banking context, the model shows that optimal contracting within a bank that pursues a higher purpose leads to higher wages for employees, higher monitoring effort and a lower probability of bank failure when the bank has more equity capital, even though the bank's capital does not affect the bank's higher purpose investment. Even absent a signaling motivation for investing in higher purpose, these results are qualitatively sustained if the bank's employees care about its purpose. Additionally, in this case, banks that invest more in higher purpose pay lower wages, elicit higher employee effort and have lower failure probabilities for any given capital ratio. Banks with higher capital ratios still pay higher wages, but the effect of capital on wages becomes weaker as the bank's higher purpose investment increases. The decrease in the exposure of the deposit insurer due to higher capital goes beyond the direct impact of capital on the bank's probability of failure.

This study examines corporate integrity culture—that is, a firm's shared values and behaviors related to compliance, trustworthiness, and ethics. Different from prior research that associates culture measures with general firm‐level outcomes, we evaluate the pervasiveness of the integrity culture within an organization across two disparate business functions: operations and financial reporting. We first develop a measure of corporate integrity culture based on firms' internal control environments and show that, as predicted, weak integrity culture contributes to both operational and financial non‐compliance. We next document the predicted positive contemporaneous association between operational and financial non‐compliance, controlling for the integrity culture reflected in the internal control environment. Given the organizational and physical distances and lack of day‐to‐day interactions between the two business functions, we infer that management's “tone at the top” likely affects non‐compliance in both functions. Finally, for firms with existing operational non‐compliance, we find more negative market reactions to accounting restatements and higher CEO turnover propensities following restatements. These results indicate that top management must consistently reinforce a culture of compliance and integrity, lest it decay throughout the organization. Our results also imply that regulators evaluating compliance in specific functions could benefit from reviewing compliance in other functions within the firm.

We explore the contributions of Black economists to research on major economic and social policy problems in the United States. We focus on applications in education, poverty and economic mobility, and public finance to extract common themes and patterns. The major themes that emerge include (i) Black economists’ examination of individual versus structural explanations for economic outcomes, (ii) the role played by race and discrimination, (iii) the endogenous determination of race, and (iv) the nature of objectivity and positionality in economic research. A unifying theme is a willingness of many Black economists to engage critically on economic policy issues, using frameworks both from within as well as outside of mainstream neoclassical economics.

Trading volume is increasingly shifting to dark venues, and the causes of this move are not well understood. We examine whether a firm's reporting opacity affects its dark pool trading and provide robust evidence that (partly) explains this volume migration. Exploiting the exogenous variation in home‐country reporting opacity in a sample of American Depositary Receipts (ADRs) and using multiple metrics for reporting opacity, we find that greater opacity associates with increased dark pool trading. This relation holds after controlling for firms' information environments, country‐specific governance issues, observable differences between ADRs and other securities that trade in dark pools (matched sample analysis), volume migration to dark pools during earnings announcements, informed trading in lit versus dark venues, ADR levels, IFRS reporting requirements, and the possible endogenous determination of home‐country reporting opacity and dark pool volume. The positive relation is stronger for ADRs held by (quasi‐indexing) institutions with low turnover and diversified holdings and weaker for ADRs favored by (transient) institutions that trade frequently and (dedicated) institutions that hold concentrated portfolios. Bid‐ask spreads are greater for higher opacity ADRs that trade in dark pools, indicating that reporting opacity is associated with the negative effect of dark pool trading on market quality. Our findings help inform the current debate on off‐exchange trading by showing how reporting regimes affect the trading venue choice.