December 2022
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Agency Costs of Debt in Conglomerate Firms
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
The Informational Role of Ownership Networks in Bank Lending
– Haoyu Gao, Hong Ru, Xiaoguang Yang
This article documents novel large-sample evidence on the informational role of interfirm ownership networks in bank lending. Using comprehensive loan-level data in China, we find that banks internal loan ratings at issuance predict subsequent delinquent events more accurately when borrowers are connected to banks existing customers via ownership networks. In post-issuance monitoring for delinquent loans, banks with access to ownership networks manage to downgrade their initial ratings before late payments. These findings suggest that ownership networks facilitate the transmission of private information for bank lending. Moreover, ownership networks are more important for transmitting information related to small and medium enterprises.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Using Patent Capital to Estimate Tobins Q
– Michael Woeppel
I construct a new proxy for Tobins Q that incorporates the replacement cost of patent capital. This proxy, which I call patent Q, explains up to 62% more variation in investment than other proxies for Q. Furthermore, investment is more sensitive to patent Q than to other proxies for Q. Although investment is predicted more accurately by, and is more sensitive to, patent Q, controlling for patent Q leads to relatively larger, not smaller, cash flow coefficients. All results are stronger in sub-samples with more patent capital. Overall, patent Q strengthens the historically weak investment Q relation.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Capital Inflows and Property Prices: Ethnicity, Education, and Spillovers
– Yuk-Ying Chang, Sudipto Dasgupta
China has experienced significant capital flight over the past two decades. Despite anecdotal evidence that some of this capital has been invested in foreign residential markets, not much is known about its destination and impact. We examine the effects of capital inflows from China on residential property prices and the real economy in the USA and global metropolitan areas. We show that inflows had significant effects on residential property markets and employment in regions that i) have strong ethnic ties to China and ii) are destinations of Chinese students. We document spill overs to geographically adjacent regions without strong Chinese links.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
De Facto Bank Bailouts
– Phong T. H. Ngo, Diego L. Puente-Moncayo
The U.S. government uses its voting power to direct IMF loans to countries where U.S. banks are exposed to sovereign default (a de facto bailout). This effect is stronger in years when the costs of direct bailouts are higher and is also found among major European IMF members. We find that de facto bailouts reduce government incentives to default and that U.S. Congressional voting on IMF funding is consistent with a private interest view of government. Overall, we identify an alternative mechanism through which governments can backstop the losses of large multinational banks.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Political Uncertainty and Household Stock Market Participation
– Vikas Agarwal, Hadiye Aslan, Lixin Huang, Honglin Ren
Using micro-level panel data and a difference-in-differences identification strategy, we study the effect of political uncertainty on household stock market participation. We find that households significantly reduce their participation and reallocate funds to safer assets during periods of increased political uncertainty prior to gubernatorial elections. The decline in participation is related to households response to elevated asset risk and their incentive to hedge increased labor income risk. In situations where uncertainty remains high after elections, pre-election reduction in participation is only partially reversed.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Consolidating Product Lines via Mergers and Acquisitions: Evidence From the USPTO Trademark Data
– Po-Hsuan Hsu, Kai Li, Xing Liu, Hong Wu
Using a new trademark-based product market competition measure and a novel trademark-merger data set over the period 1983-2016, we show that companies facing greater product market competition are more likely to be acquirers. We further show that post merger, compared to their non acquiring peers, acquirers consolidate their product offerings by discontinuing more existing product lines and developing fewer new product lines. Using a quasi-experiment based on bids withdrawn due to exogenous reasons helps us establish the causal effect of deal completion on product-market consolidation. We conclude that acquisitions create product market synergies by cutting overlapping product offerings to achieve cost efficiency.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Language Skills and Stock Market Participation: Evidence From Immigrants
– Xu Gan, Frank M. Song, Yang Zhou
Do language skills affect investment decisions? This article addresses this question by identifying the effect of English proficiency on the stock market participation of immigrants in the United States and Australia. To establish causality, we construct an instrumental variable for English proficiency by exploiting the phenomenon that younger children acquire languages more easily than older children. We find that English proficiency has a significant positive effect on stock ownership among immigrants in both countries. Moreover, we provide evidence that a reduction in information costs and an increase in trust may serve as the mechanisms underlying the language ability effect.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Private Funds for Ordinary People: Fees, Flows, and Performance
– Timothy J. Riddiough, Jonathan A. Wiley
We study private funds available to retail investors of modest wealth. Our sample covers unlisted real estate investment trusts (REITs) for superior cash flow and fee data. Fee structures are skewed toward performance-insensitive components of the compensation contract, particularly front-end loads. The average unlisted REIT underperforms the listed benchmark by 6.5% per year, 5% of which is attributable to fees. Unlisted REITs underperform institutional-grade private equity real estate funds. Fees paid to investment advisors also explain fundraising success, while past performance does not. The underperformance is consistent with the consequences of managerial conflicts of interest, inadequate governance mechanisms, opaque disclosure, and poor investment advice.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
The China Syndrome Affects Banks: The Credit Supply Channel of Foreign Import Competition
– Sergio Mayordomo, Omar Rachedi
Did the rise of Chinese import competition in the early 2000s affect banks credit supply policies? Using bank-firm-level data on the universe of Spanish corporate loans, we find that banks rebalanced their loan portfolios away from firms facing Chinese import competition and toward profitable firms in non exposed sectors. Banks supplied more credit also to the construction sector, albeit independently of firms profitability. This was not due to banks exposure to the housing boom. Rather, the geographical concentration of the manufacturing industries competing with China left local banks with few alternatives other than local construction firms to rebalance their loan portfolios.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Business Cycle Variation in Short Selling Strategies: Picking During Expansions and Timing During Recessions
– Peter N. Dixon, Eric K. Kelley
We present evidence that short sellers alternate between stock picking during expansions and market timing during recessions. First, firm-level short interest is a much stronger negative predictor of the cross-section of stock returns during expansions than it is during recessions. High short interest also only predicts negative future earnings announcement returns during expansions. We attribute these findings to short sellers emphasis on collecting firm-specific signals. Second, short sellers appear to make factor bets more so during recessions than during expansions. These bets tend to pay off as we observe a strong negative relation between the betas of highly shorted stocks and future stock market returns, a result that disappears during expansions. Together, these findings are consistent with theories of information acquisition under attention constraints, endogenous information production, as well as theories of time variation in aggregate overconfidence amongst traders.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Financial Globalization and Bank Lending: The Limits of Domestic Monetary Policy
– Jin Cao, Valeriya Dinger
Exploring bank-level data from a small open economy, we present evidence that global funding conditions limit the effectiveness of domestic monetary policy in terms of shaping both the volume and the riskiness of bank lending. We show that more favorable global funding conditions associated with a local currency appreciation encourage banks to increase lending, leverage up, take more risks, and thus insulate themselves from lean-against-the-wind domestic monetary policy. These results support the existence of a risk-taking channel of currency appreciation at the bank level.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Exporting Uncertainty: The Impact of Brexit on Corporate America
– Murillo Campello, Gustavo S. Cortes, Fabricio dAlmeida, Gaurav Kankanhalli
We show that the 2016 Brexit Referendum had multifaceted consequences for corporate America, shaping employment, investment, divestitures, R&D, and savings. The unexpected vote outcome led U.S. firms to cut jobs and investment within U.S. borders. Using establishment-level data, we document that these effects were modulated by the reversibility of capital and labor. American-based job destruction was particularly pronounced in industries with less skilled and more unionized workers. U.K.-exposed firms with less redeployable capital and high input-offshoring dependence cut investment the most. Data on the near universe of U.S. establishments also point to measurable, negative effects on establishment turnover (openings and closings). Our results demonstrate how foreign-born political uncertainty is transmitted across international borders, shaping domestic capital formation and labor allocation.
November 2022
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Why Are Bidder Termination Provisions Included in Takeovers?
– Zhiyao Chen, Hamed Mahmudi, Aazam Virani, Xiaofei Zhao
We present a rationale for bidder termination provisions that considers their effect on bidders and targets joint takeover gains. The provisions inclusion can create value by enabling termination when the target becomes less valuable to the bidder than on its own, but creates a trade-off because termination may also occur when the target is more valuable to the bidder than on its own. This trade-off explains why the provision is included in only some deals, and explains variation in termination fees. Inclusion of the provision is associated with larger combined announcement returns, provided that the termination fee is priced appropriately.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Blockholder Disclosure Thresholds and Hedge Fund Activism
– Guillem Ordonez-Calafi, Dan Bernhardt
Block-holder disclosure thresholds shape incentives for hedge fund activism, which are jointly determined with real investment and managerial behavior. Uninformed investors value lower thresholds (greater transparency) when the cost of trading against an informed activist outweighs the benefits of the activists disciplining of management. Conversely, activists may desire disclosure thresholds if the threat of their participation discourages managerial malfeasance, which is their source of profits. Hedge fund activism can be excessive: If market opacity sufficiently harms uninformed investors, the costs of reduced real investment outweigh the social benefits from managerial disciplining, and society benefits from lower thresholds.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Actively Keeping Secrets From Creditors: Evidence From the Uniform Trade Secrets Act
– Scott Guernsey, Kose John, Lubomir P. Litov
We find that an increase in a firms incentives to use trade secrets to protect its intellectual property results in a more actively managed capital structure. Exploiting U.S. states adoption of the Uniform Trade Secrets Act as a positive shock in the protection afforded to trade secrets, we find that firms covered by the Act reduce debt levels while increasing investments in intangibles. Additional tests suggest that firms fund these financing and investment activities by issuing more equity. Consistent with an increase in overall intangibility magnifying contracting problems with creditors, we find that covered firms experience higher costs of debt.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Speculation Sentiment
– Scott Guernsey, Kose John, Lubomir P. Litov
We find that an increase in a firms incentives to use trade secrets to protect its intellectual property results in a more actively managed capital structure. Exploiting U.S. states adoption of the Uniform Trade Secrets Act as a positive shock in the protection afforded to trade secrets, we find that firms covered by the Act reduce debt levels while increasing investments in intangibles. Additional tests suggest that firms fund these financing and investment activities by issuing more equity. Consistent with an increase in overall intangibility magnifying contracting problems with creditors, we find that covered firms experience higher costs of debt.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Speculation Sentiment
– Shaun William Davies
I exploit the leveraged exchange-traded funds (ETFs) primary market to measure aggregate, uninformed, gambling-like demand, that is, speculation sentiment. The leveraged ETFs primary market is a novel setting that provides observable arbitrage activity attributed to correcting mispricing between ETFs shares and their underlying assets. The arbitrage activity proxies for the magnitude and direction of speculative demand shocks and I use them to form the Speculation Sentiment Index. The measure negatively relates to contemporaneous market returns (e.g., it is bullish in down markets) and negatively predicts returns. The results are consistent with speculation sentiment causing market-wide price distortions that later reverse.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
CEO Marketability, Employment Opportunities, and Compensation: Evidence from Compensation Peer Citations
– Daewoung Choi, David Cicero, Shawn Mobbs
Mandatory disclosure of CEO compensation peers signals potential outside opportunities for the cited CEOs by revealing which companies view them as viable executive candidates. CEOs cited often as compensation peers (especially by larger firms, which represent attractive employment opportunities) are more likely to leave for better positions or receive compensation increases. Equity-based awards following cites by larger firms have shorter vesting periods, suggesting these CEOs gain negotiating power relative to their boards. The disclosure requirement enhanced labor market transparency and led to higher compensation for highly cited CEOs without penalizing less cited CEOs, putting upward pressure on CEO compensation.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
The Shadow Costs of Illiquidity
– Kristy A. E. Jansen, Bas J. M. Werker
We solve a flexible model that captures transactions costs and infrequencies of trading opportunities for illiquid assets to better understand the shadow costs of illiquidity for different origins of asset illiquidity and heterogeneous investor types. We show that illiquidity that results in suboptimal asset allocation carries low shadow costs, whereas these costs are high when illiquidity restricts consumption. As a result, the shadow costs are high for short-term investors, investors who face substantial liquidity shocks, and investors who desire to allocate a large fraction of their wealth to illiquid assets.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Flooded Through the Back Door: The Role of Bank Capital in Local Shock Spillovers
– Oliver Rehbein, Steven Ongena
This article demonstrates that low bank capital carries a negative externality because it amplifies local shock spill overs. We exploit a natural disaster that is transmitted to firms in non disaster areas via their banks. Firms connected to a strongly disaster- exposed bank with lowest-quartile capitalization significantly reduce their total borrowing by 6.6% and tangible assets by 6.9% compared to similar firms connected to a well-capitalized bank. These findings translate to negative regional effects on GDP and unemployment. Additionally, following a disaster event, banks reduce their exposure to currently unaffected but generally disaster-prone areas.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Relative Versus Absolute Performance Evaluation and CEO Decision-Making
– Karen H. Wruck, YiLin Wu
We provide new evidence on how performance-based compensation plans affect CEO decision-making, especially risk-taking. Our main finding is that relative performance evaluation (RPE) plans provide incentives for CEOs to make decisions that generate more idiosyncratic performance outcomes; absolute performance evaluation (APE) plans do not. After switches from APE to RPE, the correlation between firm stock return and industry index return falls and firm idiosyncratic risk increases. Further, switches to RPE are followed by larger deviations in financial, investment, and operating policies from industry norms (i.e., more idiosyncratic strategies). All results are opposite for switches to APE.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Taxing the Disposition Effect: The Impact of Tax Awareness on Investor Behavior
– William J. Bazley, Jordan Moore, Melina Murren Vosse
Standard portfolio choice models predict that investors consider the tax implications of trading. However, individuals are disposed toward realizing gains and holding losing investments, behaviors that worsen their performance. We show, in an experimental market, that increasing tax salience reduces the disposition effect between 22% and 47%, leading to higher portfolio balances without increasing total trading activity. Using field data, we find that investors disposition is sensitive to taxes around tax rate changes when taxes are likely salient. Our analysis demonstrates that increasing tax awareness can affect households portfolio choices, which suggests policy implications for improving financial decision-making.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Investor Heterogeneity and Liquidity
– Kalok Chan, Si Cheng, Allaudeen Hameed
Fund flows are more correlated among funds with similar investment horizon, consistent with correlated demand for liquidity. We find that stocks held by institutions with more heterogeneous investment horizon are more liquid and have lower volatility of liquidity. Identification tests confirm that the improvement in stock liquidity holds when the increase in investor heterogeneity arises from an exogenous shock due to the 2003 tax reform. In addition, extreme flow-induced trading by institutional funds has a bigger price impact when stocks have a less heterogeneous investor base. Moreover, the premium associated with stock illiquidity is concentrated in stocks with low investor heterogeneity.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Skin in the Game: Operating Growth, Firm Performance, and Future Stock Returns
– Sean Shun Cao, Zhe Wang, P. Eric Yeung
Prior research documents that asset growth is negatively associated with future firm performance. In contrast, we show that growth financed by product market stakeholders (i.e., operating growth) is positively associated with future firm performance. Investors and security analysts underestimate the positive effects of operating growth on future performance, resulting in return predictability and overly pessimistic earnings forecasts for firms with high operating growth. Future stock returns largely concentrate around subsequent earnings announcements with declining magnitudes, consistent with the error-in-expectation explanation. Results from cross-sectional tests further support the hypothesis that operating growth signals high future performance but investors underreact to it.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
The Digital Credit Divide: Marketplace Lending and Entrepreneurship
– Douglas Cumming, Hisham Farag, Sofia Johan, Danny McGowan
We conjecture that marketplace lending provokes an increase in the quantity of entrepreneurship, particularly in more regionally disadvantaged areas, albeit at lower average quality. Using a fuzzy regression discontinuity design that exploits exogenous variation in borrowers access to marketplace loans along U.S. state borders, we estimate a 10% increase in marketplace lending causes a 0.44% increase in business establishments per capita. The effects are more pronounced for less experienced entrepreneurs, for small and less profitable firms, firms more dependent upon external finance, in industries with lower sunk costs of entry, and for low-income regions with inferior access to financial institutions.
September 2022
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
The Bond-Pricing Implications of Rating-Based Capital Requirements
– Scott Murray, Stanislava Nikolova
This article demonstrates that rating-based capital requirements, through their impact on insurers investment demand, affect corporate bond prices. Consistent with insurers low demand for investment-grade bonds with a rating close to non investment-grade, these bonds outperform. Consistent with insurers high (low) demand for investment-grade bonds with high (low) systematic risk exposure, these bonds underperform (outperform). Insurer demand, measured by insurer holdings, explains most of these pricing effects. We identify rating-based capital requirements as the driver of insurer demand, and thus the pricing effects, by showing that the effects do not exist before these requirements implementation in 1993.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Global Board Reforms and the Pricing of IPOs
– Yangyang Chen, Abhinav Goyal, Leon Zolotoy
We document that global board reforms are associated with a significant reduction in the underpricing of initial public offerings (IPOs). The effect is amplified for IPOs with greater agency problems and mitigated for IPOs certified by reputable intermediaries, IPOs with greater disclosure specificity, and IPOs in countries with better shareholder protection and stringent financial reporting regulations. Furthermore, global board reforms have led to an improvement in the long-term market performance, proceeds, and subscription level of IPOs and have enhanced board independence in the issuing firms. Our findings suggest that global board reforms have strengthened board oversight in the issuing firms, leading to less underpriced IPOs.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Cultivating Self-Control in FinTech: Evidence from a Field Experiment on Online Consumer Borrowing
– Di Bu, Tobin Hanspal, Yin Liao, Yong Liu
We report the results of a longitudinal intervention with students across 5 universities in China designed to reduce online consumer debt. We allocate participants to either a financial literacy treatment group, a self-control treatment group, or a zero-touch control group. Our self-control training intervention features detailed tracking of spending and borrowing, budgeting, and introspection about consumption choices. This intervention reduces online borrowing and delinquency charges, mainly driven by a reduction in entertainment-related spending and borrowing. In contrast, financial literacy interventions improve test scores but only marginally affect borrowing. Our results suggest that cultivating self-regulation and budgeting skills can improve borrowing behavior on e-commerce platforms.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Underwriter Reputation, IssuerUnderwriter Matching, and SEO Performance
– Charles W. Calomiris, Yehuda Izhakian, Jaime F. Zender
The role of underwriters is altered in new seasoned equity offering deal types in which the offering follows quickly after its announcement. Controlling for the endogenous matching between issuing firms and underwriters, we find increased underwriter reputation mitigates the immediate price impact of announcing an accelerated book built offering, exacerbates the price impact of announcing a bought offering, and has no immediate price impact for fully marketed deals. In contrast, underwriter reputation positively affects price outcomes for fully marketed deals around the offer date. Reputation effects are not apparent in the absence of controlling for the endogenous matching.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Deleting Unreported Innovation
– Ping-Sheng Koh, David M. Reeb, Elvira Sojli, Wing Wah Tham, Wendun Wang
The absence of observable innovation data for a firm often leads us to exclude or classify these firms as non-innovators. We assess the reliability of six methods for dealing with unreported innovation using several different counterfactuals for firms without reported R&D or patents. These tests reveal that excluding firms without observable innovation or imputing them as zero innovators and including a dummy variable can lead to biased parameter estimates for observed innovation and other explanatory variables. Excluding firms without patents is especially problematic, leading to false-positive results in empirical tests. Our tests suggest using multiple imputation to handle unreported innovation.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Do Social Networks Facilitate Informed Option Trading? Evidence from Alumni Reunion Networks
– Harvey Cheong, Joon Ho Kim, Florian Munkel, Harold D. Spilker III
The absence of observable innovation data for a firm often leads us to exclude or classify these firms as non-innovators. We assess the reliability of six methods for dealing with unreported innovation using several different counterfactuals for firms without reported R&D or patents. These tests reveal that excluding firms without observable innovation or imputing them as zero innovators and including a dummy variable can lead to biased parameter estimates for observed innovation and other explanatory variables. Excluding firms without patents is especially problematic, leading to false-positive results in empirical tests. Our tests suggest using multiple imputation to handle unreported innovation.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Where Do Shareholder Gains in Hedge Fund Activism Come From? Evidence From Employee Pension Plans
– Anup Agrawal, Yuree Lim
We find that defined benefit employee pension plans of firms that are targets of hedge fund activism experience under funding and their defined contribution plans experience reductions in employer contributions. Pension under funding occurs due to reduced employer contributions to the plans, which target firms justify by increasing the assumed rates of returns on plan investments and the discount rate used to compute the present value of plan obligations. Despite tilting plan investments toward riskier assets, pension fund performance does not improve after activists target a firm. Our evidence suggests that shareholder wealth gains from activism are partly wealth transfers from employees.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Unintended Consequences of the DoddFrank Act on Credit Rating Risk and Corporate Finance
– Bina Sharma, Binay K. Adhikari, Anup Agrawal, Bruno R. Arthur, Monika K. Rabarison
Prior research finds that Dodd-Frank Acts regulations on credit rating agencies (CRAs) increase rated firms risk of rating downgrades, regardless of their credit quality. Our difference-in-difference estimates suggest that after Dodd-Frank, low-rated firms, which face steep costs from a further downgrade, significantly reduce their debt issuance and investments compared to similar unrated firms. Our results are not driven by credit supply or the financial crisis. They reveal an unintended consequence of Dodd-Frank: Greater regulatory pressure on CRAs leads to negative spillover effects on firms concerned about credit ratings, regardless of their credit quality.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
The Pricing of Volatility and Jump Risks in the Cross-Section of Index Option Returns
– Guanglian Hu, Yuguo Liu
Existing studies relate the puzzling low average returns on out-of-the-money (OTM) index call and put options to nonstandard preferences. We argue the low option returns are primarily due to the pricing of market volatility risk. When volatility risk is priced, expected option returns match the realized average option returns. Moreover, consistent with its theoretical effect on expected option returns, the volatility risk premium is positively related to future index option returns and this relationship is stronger for OTM options and at-the-money straddles. Finally, we find the jump risk premium contributes to some portion of OTM put option returns.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Does CEO Succession Planning (Disclosure) Create Shareholder Value?
– John J. McConnell, Qianru Qi
Average cumulative abnormal returns around proxy statements containing in-depth disclosures of planning for CEO succession are significantly positive indicating that succession planning is a value-added undertaking. Exploiting a quasi-natural experiment based on a 2009 SEC ruling that induced more succession planning disclosures, we find that succession planning is not value-adding for all firms. Rather, succession planning is value-enhancing for larger, more complex, and more stable firms. Importantly, CEO succession planning appears to be value reducing for smaller, simpler, and less stable firms.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
The Geography of Information Acquisition
– Honghui Chen, Yuanyu Qu, Tao Shen, Qinghai Wang, David X. Xu
Using detailed data on company visits by Chinese mutual funds, we provide direct evidence of mutual fund information acquisition activities and the consequent informational advantages mutual funds establish in local firms. Mutual funds are more likely to visit local and nearby firms both in and outside of their portfolios, but the ease of travel between fund and firm locations can substantially alleviate geographic distance constraints. Company visits by mutual funds are strongly associated with both fund trading activities and fund trading performance. Our results show that geographic constraints and costly information acquisition amplify information asymmetry in financial markets.
August 2022
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Identifying the Effect of Stock Indexing: Impetus or Impediment to Arbitrage and Price Discovery?
– Byung Hyun Ahn, Panos N. Patatoukas
The rise of stock indexing has raised concerns that index investing impedes arbitrage and degrades price discovery. This article uses Russells reconstitution to identify the causal effect of index investing on information arbitrage and price discovery. Although index investing has no discernible effect on the ability of arbitrageurs to trade and impound news into the prices of large-and mid-cap stocks, we find that index investing increases the speed of price adjustment to news for micro-cap stocks. Our causal evidence identifies the relaxation of arbitrage constraints as a mechanism through which indexing facilitates informed trading for more arbitrage-constrained micro-cap stocks.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Finance in the New U.S. Economy: Local Finance and Service Job Growth in the Post-industrial Economy
– Elizabeth A. Berger
I examine whether local bank finance facilitated the transition to a service-based economy in the U.S. I identify a causal role for local finance in service job creation. I use county-level changes to alcohol laws as demand shocks to service employers across a sub-sample of U.S. counties. Counties with more local finance experience more service job creation. This leads to labor market transitions that reflect shifts in the broader economy. Information asymmetry and collateral constraints connect local finance to service sector employment. The findings identify a unique role for local finance in the evolution to a postindustrial service-based economy.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Competition and R&D Financing: Evidence From the Biopharmaceutical Industry
– Richard T. Thakor, Andrew W. Lo
The interaction between product market competition, R&D investment, and the financing choices of R&D-intensive firms on the development of innovative products is only partially understood. We hypothesize that as competition increases, R&D-intensive firms will: i) increase R&D investment relative to existing assets in place; ii) carry more cash; and iii) maintain less net debt. Using the HatchWaxman Act as an exogenous shock to competition, we provide causal evidence supporting these hypotheses through a differences-in-differences analysis that exploits differences between the biopharma industry and other industries, and heterogeneity within the biopharma industry. We also explore how these changes affect innovative output.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Liability Structure and Risk Taking: Evidence from the Money Market Fund Industry
– Ramin P. Baghai, Mariassunta Giannetti, Ivika Jager
How does the structure of financial intermediaries liabilities affect their asset holdings? We investigate the consequences of the 2014 money market fund (MMF) reform, which imposed redemption gates and liquidity fees on prime MMFs and forced prime funds marketed to institutional investors to switch from constant to floating net asset value. These changes made prime MMFs liabilities less money-like. As a consequence, the affected MMFs experienced an increase in flow performance sensitivity and started taking more risks. In addition, the total funding provided by MMFs to the corporate sector, and especially to safer issuers, has decreased.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Hot-Stove Effects: The Impact of CEO Past Corporate Experiences on Dividend Policy
– Matthew Faulkner, Luis Garcia-Feijoo
The personal traits of chief executive officers (CEOs) have been found to influence corporate policy decisions. We examine the impact of CEO past corporate distress experiences on payout policy. CEOs who have experienced a distress event in their career, while working in a non-CEO position at a different firm, subsequently alter corporate payout policy once in the CEO position. They are less likely to pay dividends and repurchase shares, pay out lower levels of dividends, and are less likely to increase dividends. They further exhibit preference toward repurchases. Overall, we report that experience-driven conservatism affects payout policy, a novel finding in the literature.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Do Alpha Males Deliver Alpha? Facial Width-to-Height Ratio and Hedge Funds
– Yan Lu, Melvyn Teo
An abundance of evidence relates facial width-to-height ratio (fWHR) to masculine behaviors in males. We show that hedge funds operated by high-fWHR managers underperform those operated by low-fWHR managers, bear greater downside risk, are more susceptible to fire sales, and fail more often. High-fWHR managers compensate for their underperformance by marketing their funds more aggressively, thereby garnering higher flows and fee revenues. By exploiting major personal events that shape testosterone, namely marriage and fatherhood, we trace the biological mechanism underlying the relation between fWHR and investment performance to circulating testosterone. Our findings are robust and extend to equity mutual funds.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
RQ Innovative Efficiency and Firm Value
– Michael Cooper, Anne Marie Knott, Wenhao Yang
We introduce and test a firm-level innovation-efficiency measure new to the finance literature. The measure, termed the research quotient (RQ), defined as the firm-specific output elasticity of research and development (R&D), was first developed in the management literature. RQ has a low correlation with existing innovation input, output, and efficiency measures. We test RQ in a number of innovation tests common to the finance literature and find that RQ is robust in all tests of firm value, even after controlling for previous innovation measures. The results suggest that RQ may serve as a relevant complementary measure of a company’s innovation.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Deposit-Lending Synergies: Evidence from Chinese Students at U.S. Universities
– Jun Yang
This paper exploits an influx of Chinese students to U.S. universities from 2000 through 2018 to study synergies between banks deposit-taking and lending activities. Banks that are more recognizable by Chinese students experience higher deposit inflows and increase their local credit supply. This credit supply expansion only occurs in information-sensitive credit markets: small business loans and second lien mortgages. Such increase concentrates in non-tradable sectors and is more pronounced at locations where managers have more autonomy. The results indicate that deposits from local consumers convey private information about the local credit market, which helps banks in information-sensitive lending.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Eyes on the Prize: Do Industry Tournament Incentives Shape the Structure of Executive Compensation?
– Emdad Islam, Lubna Rahman, Rik Sen, Jason Zein
We investigate whether external industry tournament incentives influence the design of executive-compensation contracts. Using staggered negative mobility shocks as exogenous disruptions to tournament incentives, we show that firms treated by these shocks act to restore their executives diminished implicit risk-taking incentives by increasing compensation vega. On average, post-shock compensation vegas increase by approximately 10%. These effects are considerably larger for treated executives with strong tournament incentives and high ex ante mobility. Mobility shocks have no impact on compensation delta or total pay. Our results shed light on how explicit risk-taking incentives are optimized with respect to executive career concerns.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Financial Development and Micro-Entrepreneurship
– Rajeev Dehejia, Nandini Gupta
Does financial development facilitate micro-entrepreneurship? Using randomized surveys of over 1 million Indian households and bank-branch location as predetermined by government policy, we find that access to finance shifts workers from informal micro-entrepreneurship into formal employment. Financial access reduces the likelihood of being self-employed but benefits micro-enterprises with employees, as well as formal firms. Using data on 400,000 firms, we find that in districts with more banks, firms have higher loans, productivity, employment, and wages than firms in less banked districts. This evidence suggests a labor-market mechanism by which financial development facilitates growth: by shifting workers from unproductive micro-entrepreneurship into productive employment.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Do Capital Requirements Make Banks Safer? Evidence From a Quasinatural Experiment
– Denefa Bostandzic, Felix Irresberger, Ragnar E. Juelsrud, Gregor Wei
We use the EBA capital exercise of 2011 as a quasi-natural experiment to investigate how capital requirements affect various measures of bank solvency risk. We show that, while regulatory measures of solvency improve, non regulatory measures indicate a deterioration in bank solvency in response to higher capital requirements. The decline in bank solvency is driven by a permanent reduction in banks market value of equity. This finding is consistent with a reduction in bank profitability, rather than a repricing of bank equity due to a reduction of implicit and explicit too-big-too-fail guarantees. We then discuss alternative policies to improve bank solvency.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Active Technological Similarity and Mutual Fund Performance
– Ping McLemore, Richard Sias, Chi Wan, H. Zafer Yuksel
We examine whether superior understanding of technological innovation is a source of mutual fund managers ability to garner positive abnormal returns. Consistent with our hypothesis, the inter-quintile annual net Carhart alpha spread for mutual funds sorted on changes in the technological similarity (TS) of their portfolio holdings is 282 basis points. Moreover, because changes in TS are largely orthogonal to other predictors of mutual fund success (e.g., industry concentration, active share, fund R2, and lag fund alpha), changes in TS can be combined with other measures to help identify the best performing funds.
July 2022
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Identifying the Effect of Stock Indexing: Impetus or Impediment to Arbitrage and Price Discovery?
– Byung Hyun Ahn, Panos N. Patatoukas
The rise of stock indexing has raised concerns that index investing impedes arbitrage and degrades price discovery. This article uses Russells reconstitution to identify the causal effect of index investing on information arbitrage and price discovery. Although index investing has no discernible effect on the ability of arbitrageurs to trade and impound news into the prices of large-and mid-cap stocks, we find that index investing increases the speed of price adjustment to news for micro-cap stocks. Our causal evidence identifies the relaxation of arbitrage constraints as a mechanism through which indexing facilitates informed trading for more arbitrage-constrained micro-cap stocks.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Finance in the New U.S. Economy: Local Finance and Service Job Growth in the Post-industrial Economy
– Elizabeth A. Berger
I examine whether local bank finance facilitated the transition to a service-based economy in the U.S. I identify a causal role for local finance in service job creation. I use county-level changes to alcohol laws as demand shocks to service employers across a sub-sample of U.S. counties. Counties with more local finance experience more service job creation. This leads to labor market transitions that reflect shifts in the broader economy. Information asymmetry and collateral constraints connect local finance to service sector employment. The findings identify a unique role for local finance in the evolution to a postindustrial service-based economy.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Competition and R&D Financing: Evidence From the Biopharmaceutical Industry
– Richard T. Thakor, Andrew W. Lo
The interaction between product market competition, R&D investment, and the financing choices of R&D-intensive firms on the development of innovative products is only partially understood. We hypothesize that as competition increases, R&D-intensive firms will: i) increase R&D investment relative to existing assets in place; ii) carry more cash; and iii) maintain less net debt. Using the HatchWaxman Act as an exogenous shock to competition, we provide causal evidence supporting these hypotheses through a differences-in-differences analysis that exploits differences between the biopharma industry and other industries, and heterogeneity within the biopharma industry. We also explore how these changes affect innovative output.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Liability Structure and Risk Taking: Evidence from the Money Market Fund Industry
– Ramin P. Baghai, Mariassunta Giannetti, Ivika Jager
How does the structure of financial intermediaries liabilities affect their asset holdings? We investigate the consequences of the 2014 money market fund (MMF) reform, which imposed redemption gates and liquidity fees on prime MMFs and forced prime funds marketed to institutional investors to switch from constant to floating net asset value. These changes made prime MMFs liabilities less money-like. As a consequence, the affected MMFs experienced an increase in flow performance sensitivity and started taking more risks. In addition, the total funding provided by MMFs to the corporate sector, and especially to safer issuers, has decreased.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Hot-Stove Effects: The Impact of CEO Past Corporate Experiences on Dividend Policy
– Matthew Faulkner, Luis Garcia-Feijoo
The personal traits of chief executive officers (CEOs) have been found to influence corporate policy decisions. We examine the impact of CEO past corporate distress experiences on payout policy. CEOs who have experienced a distress event in their career, while working in a non-CEO position at a different firm, subsequently alter corporate payout policy once in the CEO position. They are less likely to pay dividends and repurchase shares, pay out lower levels of dividends, and are less likely to increase dividends. They further exhibit preference toward repurchases. Overall, we report that experience-driven conservatism affects payout policy, a novel finding in the literature.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Do Alpha Males Deliver Alpha? Facial Width-to-Height Ratio and Hedge Funds
– Yan Lu, Melvyn Teo
An abundance of evidence relates facial width-to-height ratio (fWHR) to masculine behaviors in males. We show that hedge funds operated by high-fWHR managers underperform those operated by low-fWHR managers, bear greater downside risk, are more susceptible to fire sales, and fail more often. High-fWHR managers compensate for their underperformance by marketing their funds more aggressively, thereby garnering higher flows and fee revenues. By exploiting major personal events that shape testosterone, namely marriage and fatherhood, we trace the biological mechanism underlying the relation between fWHR and investment performance to circulating testosterone. Our findings are robust and extend to equity mutual funds.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
RQ Innovative Efficiency and Firm Value
– Michael Cooper, Anne Marie Knott, Wenhao Yang
We introduce and test a firm-level innovation-efficiency measure new to the finance literature. The measure, termed the research quotient (RQ), defined as the firm-specific output elasticity of research and development (R&D), was first developed in the management literature. RQ has a low correlation with existing innovation input, output, and efficiency measures. We test RQ in a number of innovation tests common to the finance literature and find that RQ is robust in all tests of firm value, even after controlling for previous innovation measures. The results suggest that RQ may serve as a relevant complementary measure of a company˖s innovation.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Deposit-Lending Synergies: Evidence from Chinese Students at U.S. Universities
– Jun Yang
This paper exploits an influx of Chinese students to U.S. universities from 2000 through 2018 to study synergies between banks deposit-taking and lending activities. Banks that are more recognizable by Chinese students experience higher deposit inflows and increase their local credit supply. This credit supply expansion only occurs in information-sensitive credit markets: small business loans and second lien mortgages. Such increase concentrates in non-tradable sectors and is more pronounced at locations where managers have more autonomy. The results indicate that deposits from local consumers convey private information about the local credit market, which helps banks in information-sensitive lending.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Eyes on the Prize: Do Industry Tournament Incentives Shape the Structure of Executive Compensation?
– Emdad Islam, Lubna Rahman, Rik Sen, Jason Zein
We investigate whether external industry tournament incentives influence the design of executive-compensation contracts. Using staggered negative mobility shocks as exogenous disruptions to tournament incentives, we show that firms treated by these shocks act to restore their executives diminished implicit risk-taking incentives by increasing compensation vega. On average, post-shock compensation vegas increase by approximately 10%. These effects are considerably larger for treated executives with strong tournament incentives and high ex ante mobility. Mobility shocks have no impact on compensation delta or total pay. Our results shed light on how explicit risk-taking incentives are optimized with respect to executive career concerns.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Financial Development and Micro-Entrepreneurship
– Rajeev Dehejia, Nandini Gupta
Does financial development facilitate micro-entrepreneurship? Using randomized surveys of over 1 million Indian households and bank-branch location as predetermined by government policy, we find that access to finance shifts workers from informal micro-entrepreneurship into formal employment. Financial access reduces the likelihood of being self-employed but benefits micro-enterprises with employees, as well as formal firms. Using data on 400,000 firms, we find that in districts with more banks, firms have higher loans, productivity, employment, and wages than firms in less banked districts. This evidence suggests a labor-market mechanism by which financial development facilitates growth: by shifting workers from unproductive micro-entrepreneurship into productive employment.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Do Capital Requirements Make Banks Safer? Evidence From a Quasinatural Experiment
– Denefa Bostandzic, Felix Irresberger, Ragnar E. Juelsrud, Gregor Wei
We use the EBA capital exercise of 2011 as a quasi-natural experiment to investigate how capital requirements affect various measures of bank solvency risk. We show that, while regulatory measures of solvency improve, non regulatory measures indicate a deterioration in bank solvency in response to higher capital requirements. The decline in bank solvency is driven by a permanent reduction in banks market value of equity. This finding is consistent with a reduction in bank profitability, rather than a repricing of bank equity due to a reduction of implicit and explicit too-big-too-fail guarantees. We then discuss alternative policies to improve bank solvency.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Active Technological Similarity and Mutual Fund Performance
– Ping McLemore, Richard Sias, Chi Wan, H. Zafer Yuksel
We examine whether superior understanding of technological innovation is a source of mutual fund managers ability to garner positive abnormal returns. Consistent with our hypothesis, the inter-quintile annual net Carhart alpha spread for mutual funds sorted on changes in the technological similarity (TS) of their portfolio holdings is 282 basis points. Moreover, because changes in TS are largely orthogonal to other predictors of mutual fund success (e.g., industry concentration, active share, fund R2, and lag fund alpha), changes in TS can be combined with other measures to help identify the best performing funds.
June 2022
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Better Kept in the Dark? Portfolio Disclosure and Agency Problems in Mutual Funds
– Teodor Dyakov, Jarrad Harford, Buhui Qiu
We study the agency implications of increased disclosure using a regulatory change in the mutual fund industry as an experimental setting. This quasi-natural experiment mandated more frequent portfolio disclosure, which we show imposes managerial skill- reassessment risks from investors on funds with high relative performance volatility. In turn, this risk translates into greater agency costs to investors. We show that high- volatility funds, relative to low-volatility funds, responded to the increased skill- reassessment risk after regulation with an increase in management fees and a decrease in risk taking. These actions get transmitted to fund investors in the form of inferior net performance.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Corporate R&D and Stock Returns: International Evidence
– Kewei Hou, Po-Hsuan Hsu, Shiheng Wang, Akiko Watanabe, Yan Xu
Firms with higher R&D intensity subsequently experience higher stock returns in international stock markets, highlighting the role of intangible investments in international asset pricing. The R&D effect is stronger in countries where growth option risk is more likely priced, but is unrelated to country characteristics representing market sentiments and limits-of-arbitrage. Moreover, we find that R&D intensity is associated with higher future operating performance, return volatility, and default likelihood. Our evidence suggests that the cross sectional relation between R&D intensity and stock returns is more likely attributable to risk premium than to mispricing.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Do Large Gains Make Willing Sellers?
– Dong Hong, Roger K. Loh, Mitch Warachka
Using unique real estate data that allow for accurately measured capital gains, we examine whether sell propensities depend on the magnitude of a sellers capital gain. We find that short-term sell propensities are flat over losses and increasing in gains. Consistent with their higher sell propensities, selling prices are lower for properties with larger gains. Large-sized short-term stock investments also have sell propensities that are flat over losses and increasing in gains, although the sell propensities of typical- sized short-term stock investments are V-shaped. Our findings provide empirical support for theories of realization utility.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Social Capital, Trusting, and Trustworthiness: Evidence from Peer-to-Peer Lending
– Iftekhar Hasan, Qing He, Haitian Lu
How does social capital affect trust? Evidence from a Chinese peer-to-peer lending platform shows that regional social capital affects the trustees trustworthiness and the trustors trust propensity. Ceteris paribus, borrowers from regions with higher social capital receive larger bids from individual lenders and have higher funding success, larger loan sizes, and lower default rates, especially for low-quality borrowers. Lenders from regions with higher social capital take higher risks and have higher default rates, especially for inexperienced lenders. Cross-regional transactions are most (least) likely to be realized between parties from regions with high (low) social capital.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
How Does Past Experience Impact Hedge Fund Activism?
– Nicole M. Boyson, Linlin Ma, Robert M. Mooradian
Hedge fund activists transfer relevant prior work experience to their activism campaigns. Categorizing activists based on past employment at investment banks (generalists), private equity or special situations partnerships (specialists), or other firms (nonfinancial experts), we relate activists prior work experience to their choices and outcomes. Both generalists with codifiable skills and specialists with tacit skills contribute to successful outcomes, but differences in these skills lead to differences in activism processes. Activist choices, market responses, target firm responses, and procedural aspects of activism vary with activist identity. Our analysis examines activists heterogeneous skills and highlights their importance in shaping activist interventions.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Managerial Trustworthiness and Buybacks
– Sterling Huang, Kaisa Snellman, Theo Vermaelen
CEO trustworthiness is positively related to long-term excess returns after buyback announcements. When the Chief Executive Officer (CEO) is trustworthy, statements that the stock is undervalued are more credible. CEO trustworthiness is initially measured by the extent to which people in the county where the company headquarters is located trust each other. Further, the positive impact of trustworthiness on excess returns is higher when the CEO has been a long-term resident of a high-trust county, and correspondingly, trustworthy CEOs are less likely to be accused of financial misreporting. Our conclusions are confirmed when we use alternative measures of trustworthiness such as employee trust and CEO integrity.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Vertical and Horizontal Agency Problems in Private Firms: Ownership Structure and Operating Performance
– Sridhar Gogineni, Scott C. Linn, Pradeep K. Yadav
We investigate how ownership structure influences operating performance and implied agency costs. Our sample includes over 42,000 U.K. private and public firms. We document several new results of considerable economic significance relating to i) horizontal agency costs arising from unequal ownership within private firms, ii) amplification of agency costs from joint presence within the same firm of horizontal agency problems and vertical agency problems arising from separation of ownership and control, iii) mitigation in agency costs wrought by a second large shareholder, iv) impact of complex ownership structures, and v) agency cost differences between public firms and comparable private firms.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Crowding and Tail Risk in Momentum Returns
– Pedro Barroso, Roger M. Edelen, Paul Karehnke
Several theoretical studies suggest that coordination problems can cause arbitrageur crowding to push asset prices beyond fundamental value as investors feedback trade on each others demands. Using this logic, we develop a crowding model for momentum returns that predicts tail risk when arbitrageurs ignore feedback effects. However, crowding does not generate tail risk when arbitrageurs rationally condition on feedback. Consistent with rational demands, our empirical analysis generally finds a negative relation between crowding proxies constructed from institutional holdings and expected crash risk. Thus our analysis casts both theoretical and empirical doubt on crowding as a stand-alone source of tail risk.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Credit Ratings and Corporate Information Production: Evidence from Sovereign Downgrades
– Daisy (Sicong) Wang, Wensi Xie
Exploiting exogenous variations in corporate ratings due to sovereign credit downgrades and sovereign ceiling policies, we assess how firms respond to a reduction in credit ratings. We find that firms bounded by the sovereign ceiling significantly increase information production in response to a sovereign downgrade. The effects are stronger for firms relying more heavily on external finance and operating in a more opaque environment. Enhanced information production, in turn, affects firms subsequent access to bond markets. These findings suggest that firms actively manage information environments to maintain access to public debt markets.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Activist-Appointed Directors
– Jun-Koo Kang, Hyemin Kim, Jungmin Kim, Angie Low
We examine the value impact of independent directors nominated by activists (Activist IDs). Firms appointing Activist IDs experience larger value increases than firms appointing other directors, particularly when Activist IDs have private firm experience and when their nominators remain as shareholders. This value increase persists over a long period and is greater than that of activism events without director appointments. The increase is also higher among firms with greater monitoring needs and entrenched boards. Moreover, the appointments of Activist IDs are greeted more positively by the market, and Activist IDs obtain more favorable shareholder votes and additional future directorships.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Dividend Smoothing and Firm Valuation
– Paul Brockman, Jan Hanousek, Jiri Tresl, Emre Unlu
We examine the relationship between dividend smoothing and firm valuation across 21 countries using several empirical methods and smoothing measures. Our main results show that dividends are capitalized at significantly larger values for high-smoothing firms than for low-smoothing firms. We also find that dividend-smoothing premiums are higher in countries with weak shareholder protection suggesting that smoothing serves as a substitute mechanism to reduce agency costs. Overall, our findings support the view that managers use dividend smoothing predominantly as a bonding mechanism to reduce agency costs (Leary and Michaely (2011)), and not as a rent extraction mechanism (Lambrecht and Myers (2012)).
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Why Do Directors Join Poorly Performing Firms?
– Ying Dou, Emma Jincheng Zhang
Prior research has suggested that sitting on the board of a poorly performing firm (PPF) can be undesirable to directors. Still, almost 60% of such firms are able to appoint new directors following director departures. Contrary to a quality matching explanation, we do not find that only poorly performing directors join these firms. Upon joining PPFs, directors are more likely to fill leadership positions without necessarily receiving higher pay. These directors subsequently receive career benefits, especially those who are relatively junior in the pool. As such, the evidence is consistent with the leadership positions providing a certification effect.
May 2022
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Systemic Banking Crises, Institutional Environment, and Corporate Leverage
– Ozde Oztekin
This study examines corporate leverage during systemic banking crises in an international setting, including 85 countries from 1987 to 2017. Using the historically determined component of institutions and exogenous variations in institution building, the analyses show that leverage cyclicality varies substantially across institutional settings. Leverage is strongly countercyclical under more binding constraints on the capital supply, suggesting important supply effects of such crises on leverage. Weak institutions are more conducive to crises and uncertainty. Leverage counter-cyclicality is more pronounced during crises that coincide with higher uncertainty, whereas leverage is procyclical with stronger legal systems and information sharing in capital markets.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Does Government Spending Crowd Out R&D Investment? Evidence from Government-Dependent Firms and Their Peers
– Phong T. H. Ngo, Jared Stanfield
We provide evidence that managerial incentives to manipulate real activities can influence the effectiveness of fiscal policy. Increases in federal spending lead government-dependent firms to expand research and development (R&D) investment whereas industry-peer firms contract. The net result is a reduction in industry-level R&D investment. We find evidence of a novel mechanism for the crowding out of peer- firm investment: peer-firm managers respond to falling relative performance by cutting R&D to manage current earnings upward. We show that these differential responses manifest in firm value. These findings are robust to endogeneity and selection concerns as well as a battery of alternative explanations.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Ex Post Bargaining, Corporate Cash Holdings, and Executive Compensation
– Yingmei Cheng, Jarrad Harford, Irena Hutton, Stephan Shipe
We show that high cash holdings can be used by executives in the ex post bargaining over their compensation. Cash holdings are positively associated with CEO compensation and is driven by non-salary components. In companies with weaker governance, this relation is more pronounced. Using exogenous shocks to the firms cash, we show that CEO compensation readily responds to increases in cash holdings, confirming that managers are able to derive personal benefits from excess cash holdings.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Foreign-Born Resident Networks and Stock Comovement: When Local Bias Meets Home (Country) Bias
– Yun Meng, Christos Pantzalis
Foreign migration flows have important stock market consequences. Foreign-born resident networks within U.S. Metropolitan Statistical Areas (MSAs) are associated with excess return co-movement between locally headquartered stocks and American Depositary Receipts (ADRs) from countries with ties to the MSA through the network of foreign-born residents. This co-movement is hardly due to correlated fundamentals and at least partially driven by correlated trading within members of a common investor base consisting of foreign-born residents. Our evidence has implications for both investors and foreign multinational corporations (MNCs) seeking to reap benefits from cross-listings and is consistent with the notion that foreign-born residents exhibit both local bias and home (country) bias.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
From Playground to Boardroom: Endowed Social Status and Managerial Performance
– Fangfang Du
Using U.S. census survey data on CEOs residence in their formative years, I document a negative relation between CEOs endowed family wealth and managerial performance. Consistent with the view that CEOs born into low-income families face higher entry barriers but may possess greater levels of ability that enable them to become CEOs, I find that CEOs born into less privileged families outperform those from higher-wealth families. The outperformance of CEOs from less wealthy families is not driven by risk taking or omitted variables. Overall, my results suggest that CEOs social endowment provides a useful signal for their managerial ability.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Do Funding Conditions Explain the Relation Between Cash Holdings and Stock Returns?
– Tyler K. Jensen
The prior literature links cash holdings and returns (Simutin (2010), Palazzo (2012)). Using two signals of aggregate-funding availability, I find that the positive association between cash and returns only exists during constrained funding environments. In unconstrained periods, there is no association between cash and returns. The relation in constrained environments does not appear to be related to capital expenditures, expected return, or distress risk but is more prevalent in firms undertaking research and development (R&D) expenditures. This suggests that the association between cash and returns is more consistent with expanding (or maintaining) future growth opportunities rather than being attributable to differences in capital expenditures or risk.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
The Fragility of Organization Capital
– Oliver Boguth, David Newton, Mikhail Simutin
Firms with high levels of organization capital (OK), a firm-specific production factor provided by key employees, are known to be risky and earn high stock returns. We argue that fragility of OK (i.e., its sensitivity to potential disruptions) is an independently important dimension of this risk. We proxy for fragility by the size of the top management team and show that firms with small teams outperform firms with big teams by 5% annually. The return spread increases in the level of OK and correlates with the outside options of top executives. Further supporting our interpretation, shocks to team composition from unexpected deaths of chief executive officers cause larger value losses in smaller teams.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Short-Selling Equity Exchange Traded Funds and Its Effect on Stock Market Liquidity
– Oliver Boguth, David Newton, Mikhail Simutin
We examine short selling of equity exchange traded funds (ETFs) using the 2008 short- sale ban. Contrasting the previously documented contractions in bearish strategies during the ban, we find a significant increase in short sales of the largest, most liquid ETF, the S&P 500 Spider. We offer evidence suggesting that this upsurge was driven primarily by investors circumventing the ban. We show that the bans detrimental effect on stock liquidity was around 30% less severe for the Spiders constituents. Our results suggest that ETF shorts can substitute for short sales of individual stocks, thereby alleviating short-sale constraints adverse effect on liquidity.
March 2022
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Does Corporate Investment Respond to the Time-Varying Cost of Capital? Empirical Evidence
– Yongjin Kim
I examine whether the time-varying cost of capital is considered in firms capital budgeting decisions. For this test, I measure the conditional cost of equity using individual equity option prices. I find that corporate investment responds negatively to fluctuations in the option-implied cost of equity and the weighted average costs of capital. Furthermore, through decomposing marginal, I reveal that the cost-of- capital elasticity of empirical investment is almost identical to its productivity elasticity, as theory predicts. These findings suggest that firms discount rates are updated accurately in practice despite the failure of conventional frameworks, such as factor- based models, in this regard.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Inferring Stock Duration Around FOMC Surprises: Estimates and Implications
– Zhanhui Chen
Discount rates affect stock prices directly via the discount-rate channel or indirectly via the cash-flow channel because expected future cash-flow growth varies with the discount rate. The traditional Macaulay duration captures the effect from the discount- rate channel. I propose a novel duration measure, the effective equity duration, to capture the effects from both channels. I estimate it around unexpected policies in the federal funds rates. I find that the equity yield curve is hump-shaped because expected future cash-flow growth increases with the discount rate. The effective equity duration captures information other than monetary policy risk.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Gender Gaps in Venture Capital Performance
– Paul A. Gompers, Vladimir Mukharlyamov, Emily Weisburst, Yuhai Xuan
We explore gender differences in performance in a comprehensive sample of venture capital investments in the United States. Investments by female venture capital investors have significantly lower success rates than investments by their male colleagues when controlling for personal characteristics, including employment and educational history, and portfolio companies characteristics. The gender differences in investment outcomes are not due to female investors being less skilled but, rather, are largely attributable to female investors receiving less benefit from the track records of their colleagues. Performance differences disappear in older, larger firms and firms with other female investors. This supports the view that formal feedback mechanisms and hierarchies are potentially useful in ameliorating the female performance gap.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Cash Holdings, Capital Structure, and Financing Risk
– Qi Sun, Junjie Xia
This article quantifies a new motive of holding cash through the channel of financing risk. We show that if access to future credit is risky, firms may issue long-term debt now and save funds in cash to secure the current credit capacity for the future. We structurally estimate the model and find that this motive explains approximately 24% to 30% of cash holdings in the data. Counterfactual experiments indicate that the value of holding cash is approximately 8% of shareholder value.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Network Centrality and Managerial Market-Timing Ability
– Theodoros Evgeniou, Joel Peress, Theo Vermaelen, Ling Yue
We document that long-run excess returns following announcements of share buyback authorizations and insider purchases are a U-shaped function of firm centrality in the input-output trade-flow network. These results conform to a model of investors endowed with a large but finite capacity for analyzing firms. Additional links weaken insiders informational advantage in peripheral firms (simple firms whose cash flows depend on few economic links), provided investors capacity is large enough, but eventually amplify that advantage in central firms (firms with many links) as a result of investors limited capacity. These findings shed light on the sources of managerial market-timing ability.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Maturity Driven Mispricing of Options
– Assaf Eisdorfer, Ronnie Sadka, Alexei Zhdanov
This paper documents that short-term options achieve significantly lower returns during months with 4 versus 5 weeks between expiration dates. The average return differential ranges from 16 to 29 basis points per week for delta-hedged portfolios, and from 101 to 187 basis points per week for straddles, over 1996 2017. Evidence based on earnings announcements and institutional holdings suggests that investor inattention to exact expiration date rather than underlying risk exposures or transaction costs can explain the mispricing. Market makers seem to adjust prices accordingly, and tend to over-trade mispriced options against less sophisticated investors.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Housing Wealth as Precautionary Saving: Evidence from Urban China
– Gary Painter, Xi Yang, Ninghua Zhong
This article provides new evidence on the housing-wealth effect on consumption using household panel data. A key advantage in studying the Chinese housing market is the absence of the collateral channel because households are prohibited from withdrawing housing equity. The results show that for every 1% increase in housing wealth, household consumption increases by 0.14%, suggesting an implied marginal propensity to consume out of housing wealth of 0.023. Further, we find that this marginal propensity to consume is the largest among employees who face greater income uncertainty, suggesting that precautionary-saving motives are driving the results.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Benchmark Discrepancies and Mutual Fund Performance Evaluation
– K. J. Martijn Cremers, Jon A. Fulkerson, Timothy B. Riley
We introduce a new holdings-based procedure to identify whether a mutual fund has a benchmark discrepancy, which we define as a benchmark other than the prospectus benchmark best matching a funds investment strategy. We find that funds with a benchmark discrepancy tend to be riskier than their prospectus benchmarks indicate. As a result, the funds on average outperform their prospectus benchmarks, before further risk adjustments, despite underperforming the benchmarks that best match their portfolios.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Expert Advice: Industry Expertise of M&A Advisors and Acquirer Shareholder Returns
– Cong Wang, Fei Xie, Kuo Zhang
We find that acquirers create higher shareholder returns when advised by investment banks with more experience in the target industry. This finding is stronger when acquirers face more difficulties understanding and evaluating the targets. Further analyses show that these banks help acquirers avoid overpaying for targets and thus capture more of the deal synergy rather than making deals generating higher synergy. Our results are robust to controlling for an exhaustive set of determinants of acquirer returns and an identification strategy that exploits exogenous shocks to the supply of investment banks with target-industry experience.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Media Partisanship and Fundamental Corporate Decisions
– April Knill, Baixiao Liu, John J. McConnell
Using the introduction of Fox News as a natural experiment, we investigate whether partisanship in television news coverage influences fundamental corporate decisions. We find that during the George W. Bush presidency, firms led by Republican-leaning managers headquartered in regions into which Fox was introduced shift upward their total investment expenditures and financial leverage. Our findings imply that in making fundamental corporate decisions, Republican-leaning managers are swayed by the Republican slant of Fox that presents an optimistic macroeconomic outlook. The results highlight the importance of heterogeneity in media slant in understanding the role of the media in corporate decision making.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
Investor Attention and Stock Returns
– Jian Chen, Guohao Tang, Jiaquan Yao, Guofu Zhou
We propose an investor attention index based on proxies in the literature and find that it predicts the stock market risk premium significantly, both in sample and out of sample, whereas every proxy individually has little predictive power. The index is extracted using partial least squares, but the results are similar by the scaled principal component analysis. Moreover, the index can deliver sizable economic gains for mean-variance investors in asset allocation. The predictive power of the investor attention index stems primarily from the reversal of temporary price pressure and from the stronger forecasting ability for high-variance stocks.
Journal of Financial and Quantitative Analysis
Journal of Financial and Quantitative Analysis | Cambridge Core
The Capital Structure Puzzle: What Are We Missing?
– Harry DeAngelo
An important piece of the capital structure puzzle has been missing, and it is not a contracting friction. It is recognition that managers do not have sufficient knowledge to optimize capital structure with any real precision. The literature critique in this paper i) identifies the conceptual sources of the main empirical failures of the leading models of capital structure and ii) shows how those failures can be repaired by taking into account imperfect managerial knowledge and several other factors. The analysis yields a compact set of principles for thinking about capital structure in an empirically supported way.