Charles A. Dice Center

Working Papers

A First Look at the Historical Performance of the New NAV REITs
Spencer J. Couts and Andrei S. Gonçalves 
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Private Commercial Real Estate (CRE) funds provide institutional investors an opportunity to access the CRE market, but most of them are inaccessible to typical individual (retail) investors. In this paper, we study the early performance (2016 to 2023) of a special and emerging class of non-listed CRE funds that are accessible to individual investors. These funds, referred to as Net Asset Value (NAV) Real Estate Investment Trusts (REITs), have grown in importance over the last decade. They now represent a major alternative to publicly traded REITs in providing individual investors a way to access CRE investments without direct ownership. We find that the observed returns from these NAV REITs suffer from smoothness due to lagged pricing updates, and thus unsmoothing returns is important for studying their risk-adjusted performance. We then show that NAV REITs have delivered large alphas relative to public indices over our sample period. Finally, we highlight that traditional alpha analysis may not be adequate for a short sample like ours and provide an alternative alpha analysis that indicates the alphas of NAV REITs over our sample period were economically meaningful, albeit substantially lower than traditional alpha analysis suggests.

Unsmoothing Returns of Illiquid Funds
Spencer J. Couts, Andrei S. Gonçalves, and Andrea Rossi
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Funds that invest in illiquid assets report returns with spurious autocorrelation. Consequently, investors need to unsmooth these funds’ returns when evaluating their risk exposures. We show that funds with similar investments have a common source of spurious autocorrelation not fully resolved by traditional unsmoothing methods, leading to underestimation of systematic risk. As such, we propose a generalized unsmoothing technique and apply it to hedge funds and private commercial real estate funds. Our method significantly improves the measurement of funds’ risk exposures and risk-adjusted performance, especially for highly illiquid funds. Overall, the average illiquid fund alpha is lower than previously thought.

Beyond Carry: The Prospective Interest Rate Differential and Currency Excess Returns
Mengmeng Dong, Shingo Goto, Kewei Hou, Yan Xu, and Yuzhao Zhang
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We use a Beveridge-Nelson decomposition to link expected foreign-currency excess returns to the “prospective interest rate differential” – the infinite sum of expected future interest rate differentials. Empirically, we find our prospective interest rate differential is a stronger predictor of currency excess returns than carry, in both portfolio sorts and Fama-MacBeth regressions. A factor based on the prospective interest rate differential is also useful in explaining the returns of a broad set of currency test portfolios.

Is There Information in Corporate Acquisition Plans?
Sinan Gokkaya, Xi Liu, and René M. Stulz
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For many firms, the acquisition process begins with the development of an acquisition plan that is communicated to investors. We construct a comprehensive sample of acquisition plans to provide novel perspectives on the acquisition process and find that acquisition plans are informative to investors and incrementally predict subsequent acquisition activity. These results are more pronounced for firms announcing their commitment to acquisitions from an internal pipeline. Acquisition plans improve acquisition performance due to learning from market feedback and alleviate acquisition-related market uncertainty. Communication of acquisition plans does not increase takeover premiums but is less common in more competitive industries.

Understanding Factor Value
Shaojun Zhang
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The value spread of factors fluctuates over time because of changes in market equity or book value but predicts factor returns only through the component driven by market equity changes (the dme spread). Exploiting cross-sectional mispricing, the dme spread captures 90 years of sentiment and subsumes the predictability in existing sentiment measure. Factor predictability concentrates on factors most predictable by sentiment and factors more subject to asymmetric limits of arbitrage. A factor value strategy exploiting the predictability outperforms and explains cross-sectional value factors. The value premium is not an independent factor but summarizes time-varying factor returns conditional on sentiment.

Risk-Adjusting the Returns to Private Debt Funds
Isil Erel, Thomas Flanagan, Michael Weisbach
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Private debt funds are the fastest growing segment of the private capital market. We evaluate their risk-adjusted returns, applying a cash-flow based method to form a replicating portfolio that mimics their risk profiles. Using both equity and debt benchmarks to measure risk, a typical private debt fund produces an insignificant abnormal return to its investors. However, gross-of-fee abnormal returns are positive, and using only debt benchmarks also leads to positive abnormal returns as funds contain equity risks. The rates at which private debt funds lend appear to be high enough to offset the funds’ fees and risks, but not high enough to exceed both their fees and investors’ risk-adjusted rates of return.

When Protectionism Kills Talent
Mehmet Canayaz, Isil Erel, and Umit G. Gurun
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We examine the repercussions of protectionist policies implemented in the United States since 2018 on the composition of workforce and career choices within the semiconductor industry. Using a unique dataset of 1.6 million active engineers and scientists working in the chip manufacturing industry worldwide, we find that the shift towards protectionism, aimed at reviving domestic manufacturing and employment, paradoxically resulted in a significant drop in hiring domestic talent. The effect is stronger for entry-level and junior positions, indicating a disproportionate impact on newcomers to the workforce. Additionally, we trace the trajectories of undergraduate and graduate cohorts possessing chip-related skills over time, and document significant shifts away from the chip industry. Our findings highlight the challenges in achieving the goals of initiatives like the 2022 CHIPS and Science Act, emphasizing the need to address talent shortages to sustain the semiconductor industry’s intended growth.

Is the Decline in the Number of Community Banks Detrimental to Community Economic Development?
Bernadette A. Minton, Alvaro G. Taboada, and Rohan Williamson
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Our research examines the impact of dwindling community bank numbers on community investment and economic development. Initially, we confirm the vital role of community banks’ small business lending in local development. Contrary to popular belief, we find that a decrease in community banks positively affects community investment, through small business loan (SBL) originations. Key factors include the local presence of other community banks and the continuity of the consolidating bank's presence. Interestingly, the effect remains neutral in underserved or distressed counties and diminishes when a large bank acquires a community bank without maintaining a local presence. Post-consolidation, community banks emerge larger and more robust, capable of issuing larger SBLs, while larger banks and Fintech firms contribute by providing smaller SBLs. Overall, our findings reinforce the critical contribution of community banks to local development, suggesting that a reduction in their numbers leads to a stronger, more stable banking infrastructure in the small business lending landscape.

Does greater public scrutiny hurt a firm’s performance?
Benjamin Bennett, René M. Stulz, and Zexi Wang
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Public attention to a firm may provide valuable monitoring, but it may also have a dark side by constraining management’s decisions and distracting it. We use inclusion in the S&P 500 index as a positive shock to public attention. Media coverage, Google searches, SEC downloads, SEC comment letters, shareholder proposals, analyst coverage, and lawsuits increase following inclusion. Post-inclusion performance falls and is negatively related to the increase in attention. Included firms’ investment and payout policies become more similar to those of index peers and the increase in similarity is positively related to the size of the attention increase.

Finding Anomalies in China
Kewei Hou, Fang Qiao, and Xiaoyan Zhang
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To study the cross-section of returns in the Chinese stock market, we follow the anomaly literature and construct 454 strategies between 2000 and 2020, based on 208 firm-level trading and accounting signals. With the conventional single-testing t-statistic cutoff of 1.96, 101 strategies have significant value-weighted raw returns, and 20 remain significant after risk adjustments. To avoid false discoveries, we recalibrate the t-statistic cutoff to 2.85 to accommodate multiple testing. 36 strategies survive the higher hurdle rate in value-weighted raw returns, while none remains significant after risk adjustments. When we use machine learning techniques to combine information from multiple signals, the resulting composite strategies mostly have significant returns after risk adjustments, even with the higher t-statistic cutoff. We relate Chinese anomaly returns to aggregate economic conditions and find that they comove with financial market development, accounting quality, market liquidity, and government regulations.

Debt Maturity Structure and Corporate Investment
Claire Y. Hong, Kewei Hou, and Thien T. Nguyen
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We show that firms’ debt maturity structure has an important impact on investment above and beyond that of leverage. Firms with a longer debt maturity structure tend to invest more. This result is stronger for firms with higher profitability and growth potential. We rationalize our results in a model in which debt maturity structure is determined by the trade-off between liquidity cost and the repayment flexibility of long-term debt. In our model, highly productive firms invest more and prefer to use
long-term debt to free up funds for future investment. This mechanism is supported by the data. Our findings highlight the importance of debt maturity structure in understanding corporate investment decisions.

Stereotypes about Successful Entrepreneurs
Victor Lyonnet and Léa H. Stern
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What comes to mind when thinking about a successful entrepreneur? Belief formation models suggest that what comes to mind is an oversimplified picture of the characteristics of successful entrepreneurs, i.e, stereotypes about successful entrepreneurs. Using French administrative data on 48,767 new firms, we show that some characteristics are stereotypical of success and have distributions that can generate miscalibrated beliefs. To illustrate how stereotypical thinking can lead to biased assessments, we report the discrepancies between the implied fraction of successful entrepreneurs under Bayesian vs. stereotypical thinking for several stereotypes. We discuss the consequences of stereotyping for venture capital allocation.

How Do Managers’ Expectations Affect Share Repurchases?
Minsu Ko
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It is widely believed that undervaluation is an important determinant of share repurchases. However, empirical evidence on undervaluation remains mixed. This paper considers a novel measure of undervaluation that relies on the difference between management earnings forecasts and the corresponding consensus analyst forecasts. It finds that firms repurchase significantly more shares when they expect higher future earnings relative to market expectations, which is consistent with the undervaluation hypothesis. This finding holds regardless of the level of underlying valuations. The results do not appear to be driven by managerial misvaluation or bias. Rather, my findings suggest that firms utilize insider information to time the market with respect to share repurchase decisions.

Modeling Managers As EPS Maximizers
Itzhak Ben-David and Alex Chinco
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Textbook theory assumes that firm managers maximize the net present value of future cash flows. But when you ask them, the people running large public corporations say that they are maximizing something else entirely: earnings per share (EPS). Perhaps this is a mistake. No matter. We take managers at their word and show that EPS maximization provides a single unified explanation for a wide range of corporate policies involving leverage, share repurchases, cash holdings, and capital budgeting.

Salient Attributes and Household Demand for Security Designs
Petra Vokata
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Using a large database of complex securities, I study how salient attributes of security design distort household investment decisions. I show banks add non-standard (fine-print) conditions to artificially increase advertised rates of headline return and downside protection-a phenomenon I term "enhancement." Enhancement increases headline returns by 11 percentage points, on average, but does not increase realized returns. Flexibly controlling for all other product attributes and using high-frequency shocks to structuring costs of enhancement for identification, I find demand is highly elastic to enhancement. Enhancement is costly to investors: a one standard deviation decrease implies savings of more than $1 billion in fees.

FinTech Lending with LowTech Pricing
Mark J. Johnson, Itzhak Ben-David, Jason Lee, and Vincent Yao
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FinTech lending—known for using big data and advanced technologies—promised to break away from the traditional credit scoring and pricing models. Using a comprehensive dataset of FinTech personal loans, our study shows that loan rates continue to rely heavily on conventional credit scores, including 45% higher rates for nonprime borrowers. Other known default predictors are often neglected. Within each segment(prime/nonprime) loan rates are not very responsive to default risk, resulting in realized loan-level returns decreasing with risk. The pricing distortions result in substantial transfers from nonprime to prime borrowers and from low- to high-risk borrowers within segment.

Why are bank holdings of liquid assets so high?
René M. Stulz, Alvaro G. Taboada, and Mathijs A. van Dijk
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Banks hold large amounts of liquid assets compared to non-financial firms and to before the global financial crisis (GFC). The transaction and precautionary motives for holding liquid assets cannot explain the size and evolution of bank liquid asset holdings. We introduce a portfolio motive that leads banks to invest in liquid assets when they have exhausted their ability to make profitable loans. With this motive, loans and liquid assets are substitutes. Post-GFC capital requirement increases lowered the profitability of loans relative to liquid assets and help explain why liquid asset holdings are larger and more so for large banks.

Crisis Risk and Risk Management
René M. Stulz
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This paper assesses the current state of knowledge about crisis risk and its implications for risk management. Better data that became available since the Global Financial Crisis (GFC) has improved our understanding of crisis risk. These data have been used to show that some types of crises become predictable when one accounts for interactions between risks. Specifically, a financial crisis is much more likely in the years following both high credit growth and high asset valuations. However, some other types of crises do not seem predictable. There is no evidence that the frequency of economic and financial crises is increasing. The existing data show that political crises make economic crises more likely, so that, as suggested by the concept of polycrisis, feedback between non-economic crises and economic crises can be important, but there is no comparable evidence for climate events. Strategies that increase firm operational and financial flexibility appear successful at reducing the adverse impact of crises on firms.

The Real Effects of Sentiment and Uncertainty
Justin Birru and Trevor Young
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The effects of sentiment should be strongest during times of heightened valuation uncertainty. As such, we document a significant amplifying role for market uncertainty in the relation between sentiment and aggregate investment. A one-standard-deviation increase in uncertainty more than doubles the effect of sentiment on investment. Moreover, allowing uncertainty-dependent sentiment effects substantially increases explanatory power (i.e., R²). Our results are robust to many sentiment, uncertainty, and investment measures. We also document similar effects for aggregate equity issuance. Consistent with theory, we find even stronger results in the cross-section of valuation uncertainty. The evidence suggests that the importance of sentiment for corporate decisions varies over time and depends crucially on the underlying level of market uncertainty.

The Politics of Academic Research
Matthew C. Ringgenberg, Chong Shu, and Ingrid M. Werner
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We develop a novel measure of political slant in research to examine whether political ideology influences the content and use of academic research. Our measure examines the frequency of citations from think tanks with different political ideologies and allows us to examine both the supply and demand for research. We find that research in Economics and Political Science displays a liberal slant, while Finance and Accounting research exhibits a conservative slant, and these differences cannot be accounted for by variations in research topics. We also find that the ideological slant of researchers is positively correlated with that of their Ph.D. institution and research conducted outside universities appears to cater more to the political party of the current President. Finally, political donations data confirms that the ideological slant we measure based on think tank citations aligns with the political values of researchers. Our findings have important implications for the structure of research funding.

*No author has received financial support for this research. Ringgenberg and Shu have nothing further to disclose. Werner is an independent director for Dimensional U.S. Mutual Funds and ETF Trust, is a director for the Fourth Swedish Pension Fund (AP4), and serves on the Prize Committee for Riksbanken's Prize in Economic Sciences in Memory of Alfred Nobel.

Systematic Default and Return Predictability in the Stock and Bond Markets
Jack Bao, Kewei Hou, and Shaojun Zhang
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We construct a measure of systematic default defined as the probability that many firms default at the same time. We account for correlations in defaults between firms through exposures to common shocks. Systematic default spikes during recessions, is correlated with macroeconomic indicators, and predicts future realized defaults. More importantly, it predicts future equity and corporate bond index returns both in- and out-of-sample. Finally, we find that the cross-section of average stock returns is related to firm-level exposures to systematic default risk.

The Subjective Risk and Return Expectations of Institutional Investors
Spencer J. Couts, Andrei S. Gonçalves and Johnathan A. Loudis
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We use the long-term Capital Market Assumptions of major asset managers and institutional investor consultants from 1987 to 2022 to provide three stylized facts about their subjective risk and return expectations on 19 asset classes. First, there is a strong and positive subjective risk-return tradeoff, with most of the variability in subjective expected returns due to variability in subjective risk premia (compensation for market beta) as opposed to subjective alphas. Second, belief variation and the positive risk-return tradeoff are both stronger across asset classes than across institutions. And third, the subjective expected returns of these institutions predict subsequent realized returns across asset classes and over time. Taken together, our findings imply that models with subjective beliefs should reflect a risk-return tradeoff. Additionally, accounting for this subjective risk-return tradeoff when modeling multiple asset classes is even more important than incorporating average belief distortions or belief heterogeneity in our setting.

Monetary Policy Transmission Through Online Banks
Isil Erel, Jack Liebersohn, Constantine Yannelis and Samuel Earnest
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Financial technology has reshaped commercial banking. It has the potential to radically alter the transmission of monetary policy by lowering search costs and expanding banking markets. This paper studies the reaction of online banks to changes in the federal funds rate. We find that these banks increase rates that they offer on deposits significantly more than traditional banks do. A 100 basis points increase in the federal funds rate leads to a 30 basis points larger increase in the rates of online banks relative to traditional banks. Consistent with the rate movements, online bank deposits experience inflows, while traditional banks experience outflows during monetary tightening in 2022. Results are similar across banking markets of different competitiveness and demographics, but they vary with the stickiness of banking relationships. Our findings shed new light on the role of online banks in interest rate passthrough and the deposit channel of monetary policy.

The Role of Domestic and Foreign Sentiment for Cross-Border Portfolio Flows
Justin Birru and Matthew M. Wynter
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We show that sentiment influences the demand for foreign stocks, as identified by international portfolio flows between investors in the United States and investors in 44 other countries. We document two channels through which sentiment affects flows. First, inflows are higher to countries with higher sentiment. Second, higher sentiment in a given country is associated with lower outflows from that country to bilateral trade partners, suggesting that sentiment in one country can have spillover effects on demand for assets in other countries. The combined sentiment effects are associated with economically meaningful implications for net flows. Finally, we consider country closed-end funds and find evidence of pricing effects of sentiment.

The Value of Bank Lending
Thomas Flanagan
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Using a novel dataset of realized syndicated loan cash-flows and a risk-adjustment methodology adapted from the private equity literature, I provide a measure of risk-adjusted returns for bank loan cash-flows. Banks, on average, generate 190 bps in gross risk-adjusted returns and earn higher returns when they lend to financially constrained borrowers. However, shareholders earn nearly zero net risk-adjusted returns once bank staff are compensated for their effort in lending. Overall, these findings offer evidence that banks provide valuable services to mitigate borrowers’ financing frictions, and the present value of loan cash-flows pays for the costs of the bank providing these services.

Consumption Disconnect Redux
Alessandro Melone
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Several papers show that the apparent disconnect between stock returns and consumption growth is due to mismeasurement in standard consumption data, and propose to use new consumption measures instead. This paper finds that standard consumption is valuable for asset pricing if one focuses on consumption levels rather than growth. I analytically show that, when consumption levels contain a permanent and a transitory component, the latter—dubbed the consumption gap— should predict returns if the time series consumption-based model is valid. A simulated economy demonstrates that the relationship between expected returns and the consumption gap is robust to mismeasurement of consumption. Empirically, the consumption gap forecasts stock returns in-and out-of-sample at horizons from one quarter to five years, even after controlling for alternative popular predictors. This predictability generates significant economic value from the perspective of a mean variance investor. Finally, I use the cross-section of stocks to construct a heuristic stochastic discount factor that displays properties consistent with benchmark macro-finance models.

New Technology and Business Dynamics
Hans K. Hvide and Tom Meling
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We examine business dynamics following a natural experiment: the staggered roll-out of a new technology, broadband internet, throughout Norway. The new technology led to a large, almost 25% increase in per-capita startup rates. Quality measures for these startups did not decline. In contrast, we do not find effects on the survival, employment or assets of established firms. Applications to literatures on business dynamics, entrepreneurship, and technology adoption are discussed. Overall, our findings support ideas from Schumpeter (1934) and Arrow (1962) that startups play an important role in adapting the economy to new technology.

Anomaly Predictability with the Mean-Variance Portfolio
Carlo A. Favero, Alessandro Melone, and Andrea Tamoni
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According to a no-arbitrage condition, risk-adjusted returns should be unpredictable. Using several prominent factor models and a large cross-section of anomalies, we find that past cumulative risk-adjusted returns predict future anomaly returns. Cumulative returns can be interpreted as deviations of an anomaly price from the price of the mean-variance efficient portfolio. Price deviations constitute a novel anomaly-specific predictor, endogenous to the given heuristic mean-variance portfolio, thus providing direct evidence for conditional misspecification. A zero-cost investment strategy using price deviations generates positive alphas. Our findings suggest that incorporating price information into cross-sectional models improves their ability to capture time-series return dynamics.

The US equity valuation premium, globalization, and climate change risks
Craig Doidge, G. Andrew Karolyi, and René M. Stulz
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In the 2000s, US firms have higher valuations than comparable non-US firms listed only outside the US but not non-US firms cross-listed in the US. Though one would expect this US valuation premium to fall over time because of globalization, it widens for firms in developed markets by 36% and falls for firms in emerging markets by 20% after the global financial crisis of 2007-2008. This evolution is explained in part by the decreased valuation of brown firms in other developed countries relative to the US. Other potential explanations are explored and rejected.

Payout-Based Asset Pricing
Andrei S. Gonçalves and Andreas Stathopoulos
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Firms' payout decisions respond to expected returns: everything else equal, firms invest less and pay out more when their cost of capital increases. Given investors' demand for firm payout, market clearing implies that the dynamics of productivity and payout demand fully determine equilibrium asset prices and returns. We use this logic to propose a payout-based asset pricing framework and we illustrate the analogy between our approach and consumption-based asset pricing in a simple two-period model. Then, we introduce a quantitative payout-based asset pricing model and calibrate the productivity and payout demand processes to match aggregate U.S. corporate output and payout empirical moments. We find that model-implied payout yields and firm returns go a long way in reproducing key attributes of their empirical counterparts.

Climate Change, Demand Uncertainty, and Firms’ Investments: Evidence from Planned Power Plants
Chen Lin, Thomas Schmid, and Michael S. Weisbach
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How does demand uncertainty affect firms’ investment decisions? We consider this issue from the perspective of electricity-producing firms and their planned investments in new power plants. Using plausibly exogenous variations in temperature predictions across scientific climate models to measure uncertainty about future electricity demand, we find that uncertainty increases investments in plants with flexible production technologies but depresses non-flexible investments. The net effect of uncertainty on investments is positive if firms have access to flexible investment opportunities. These results are consistent with models in which the impact of uncertainty on investments depends on the investments’ production flexibility.

Factor Value
Shaojun Zhang
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This paper finds that the value anomaly summarizes time series predictability in other factors using value and reversal spreads, representing differences in log value-weighted book-to-market ratios and minus past long-term stock returns between factor legs. Factors only yield significantly positive returns when the spreads exceed historical median. Employing value and reversal spreads, factor value strategy outperforms and explains various value-style anomalies. Value anomalies time other factors with factor loading increasing in the spreads. Factor predictability is consistent with persistent overpricing correction and asymmetric limits of arbitrage, introducing additional restrictions for models explaining cross-sectional and time-series equity returns simultaneously.

Supply Network Fragility, Inventory Investment, and Corporate Liquidity
Leandro Sanz
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This study uses a novel dataset of over 11,000 foreign suppliers to U.S. manufacturers to investigate the impact of supply network fragility on corporate policies. The scarcity of suppliers offering specialized inputs emerges as a key driver of fragility. Both theoretical and empirical evidence indicate that firms with fragile supply networks maintain more input inventories, less cash, and higher leverage. Moreover, plausible exogenous variation in fragility from technology adoption and disruptions supports a causal interpretation of the results. My findings indicate that because specialized inputs lack a spot market post-disruptions, firms with fragile supply networks favor operational over financial hedging.

Firm-level Irreversibility
Hang Bai, Erica X.N. Li, Chen Xue, and Lu Zhang
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Contradicting Cooper and Haltiwanger (2006), Clementi and Palazzo (CP, 2019) report a largely symmetric investment rate distribution in Compustat, with a large fraction of negative investment rates, 18.2%, and conclude “no sign of irreversibility (p. 289).” CP’s analysis is flawed. A data error on depreciation rates understates gross investment and shifts the whole gross investment rate distribution leftward. Nonstandard sample screens on age and acquisitions further curb its right tail, which is then truncated at 0.2. Fixing these problems restores the heavily asymmetric investment rate distribution with a fat right tail. The fraction of negative investment rates is small, only 4.9%–6.2%.

Relationship-Specific Investments and Firms’ Boundaries: Evidence from Textual Analysis of Patents
Jan Bena, Isil Erel, Daisy Wang, and Michael S. Weisbach
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The hold-up problem can impair firms’ abilities to make relationship-specific investments through contracts. Ownership changes can mitigate this problem. To evaluate changes in the specificity of human capital investments, we perform textual analyses of patents filed by lead inventors from both acquirer and target firms before and after acquisitions. Inventors whose human capital is highly complementary with the patent portfolios of their acquisition partners are more likely to stay with the combined firm post-deal and subsequently make their investments more specific to the partner’s assets. As ownership of another firm results in increasingly specific investments to that firm’s assets, contracting issues related to relationship-specific investments is likely a motive for acquisitions.

Quantifying Risk Transformation in Bank Lending
Thomas Flanagan
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How different is the cost of capital when banks finance a loan compared to the rate required by direct household investors? This paper quantifies this difference by estimating the prices both investors would be willing to pay for an identical set of loan cash flows when markets are segmented and households are subject to idiosyncratic consumption shocks. Using recently developed methods from the private equity literature, I find that banks are willing to pay 70% more than households for the same loans, which equates to a 2% pp lower cost of capital for banks. This difference in cost of capital arises because loans are more ‘diversifiable’ in the bank’s portfolio than they are in a household’s portfolio, which is subject to idiosyncratic consumption shocks. Additionally, this cost of capital advantage increases when banks lend to riskier firms and possess a larger deposit base. Overall, these findings corroborate classic theories of bank risk-sharing, in which banks invest on behalf of risk-averse households in an effectively more risk-tolerant fashion, providing a lower cost of finance.

Steering Labor Mobility through Innovation
Song Ma, Wenyu Wang, and Yufeng Wu
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This paper argues that firms proactively use innovation decisions to influence the mobility and human capital accumulation of their workers. We develop a dynamic model in which workers conduct R&D projects, accumulating both general and firm-specific human capital. Firms choose the scope of innovation, influencing the type of human capital workers accumulate during the process. Pursuing more general innovation leads to increased knowledge redeployability for the firm at the cost of more difficult employee retention. We estimate the model using granular innovation production and mobility data of three million inventors. Our model closely matches the observed mobility and innovation specificity over inventors' life cycles. Empirical estimates of the model parameters imply that 24% of observed innovation specificity among U.S. firms is driven by their labor market considerations, which enhances the firm value but lowers the inventors' surplus.

Diving Into Dark Pools
Sabrina Buti, Barbara Rindi,and Ingrid Werner
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We study 2009 and 2020 dark trading for U.S. stocks. Dark trading is lower when volume is low, volatility high, and in periods of markets stress. Dark pools are more active for large caps, while internalization is more common for small caps. Traders use dark pools to jump the queue for large caps in 2009, and to avoid crossing the spread for small caps in both years. Internalization is higher when spreads are wide and depth is high. Dark pool trading improves spreads in 2009, but worsens market quality for large caps in 2020. We discuss explanations for the change.

Venture Capital (Mis)Allocation in the Age of AI
Victor Lyonnet and Léa H. Stern
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We use machine learning to study how venture capitalists (VCs) make investment decisions. Using a large administrative data set on French entrepreneurs that contains VC-backed as well as non-VC-backed firms, we use algorithmic predictions of new ventures’ performance to identify the most promising ventures. We find that VCs invest in some firms that perform predictably poorly and pass on others that perform predictably well. Consistent with models of stereotypical thinking, we show that VCs select entrepreneurs whose characteristics are representative of the most successful entrepreneurs (i.e., characteristics that occur more frequently among the best performing entrepreneurs relative to the other ones). Although VCs rely on accurate stereotypes, they make prediction errors as they exaggerate some representative features of success in their selection of entrepreneurs (e.g., male, highly educated, Paris-based, and high-tech entrepreneurs). Overall, algorithmic decision aids show promise to broaden the scope of VCs’ investments and founder diversity.

Asymmetric Investment Rates
Hang Bai, Erica X. N. Li, Chen Xue, Lu Zhang
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Integrating national accounting with financial accounting, we provide firm-specific estimates of current-cost capital stocks for the entire Compustat universe, as well as an array of estimates of investment flows, economic depreciation rates, and capital and investment price deflators. The firm-level current-cost investment rate distribution is heavily right-skewed, with a small fraction of negative investment rates, 5.51%, but a huge fraction of positive investment rates, 91.64%. Despite a tiny fraction of inactive investment rates, 2.85%, firm-level investment also seems lumpy, featuring a fraction of 32.66% for positive spikes (investment rates higher than 20%). For a typical firm, 39% of total investment is completed within 20% of the sample years.

Evolution of Debt Financing toward Less-Regulated Financial Intermediaries in the United States
Isil Erel and Eduard Inozemtsev
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Nonbank lenders have been playing an increasing role in supplying debt, especially after the Great Recession. How important are the distortions in the greater regulation of banks that differentially limit risk-taking across alternative providers of credit? How might the growing role of nonbanks in credit markets affect financial stability? This selective review addresses these questions and discusses how banks and nonbanks helped provide liquidity to the nonfinancial sector during the COVID-19 pandemic shock. We argue that tighter bank regulation has created incentives for nonbanks to increase their participation in credit markets, a trend that creates concerns about financial stability.

The Determinants of Bank Liquid Asset Holdings
René M. Stulz, Alvaro G. Taboada, Mathijs A. van Dijk
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Bank liquid asset holdings vary significantly across banks and through time. The determinants of liquid asset holdings from the corporate finance literature are not useful to predict banks’ liquid asset holdings. Banks have an investment motive to hold liquid assets, so that when their lending opportunities are better, they hold fewer liquid assets. We find strong support for the investment motive. Large banks hold much more liquid assets after the Global Financial Crisis (GFC), and this change cannot be explained using models of liquid asset holdings estimated before the GFC. We find evidence supportive of the hypothesis that the increase in liquid assets of large banks is due at least in part to the post-GFC regulatory changes.

Carbon Returns Across the Globe
Shaojun Zhang
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The carbon return refers to the excess return associated with brown firms and is central to the debate on climate-aware investment. Emissions grow with firm sales, and the emission data are only available to investors with significant lags. The positive carbon return documented in previous studies arises from the forward-looking firm performance information contained in emissions instead of the risk premium. After accounting for the data release lag, carbon returns turn negative in the U.S. and insignificant globally. Developed markets experience lower carbon returns due to intense climate concern shocks, while countries with stringent climate policies exhibit higher carbon returns.

The Rise of Anti-Activist Poison Pills
Ofer Eldar, Tanja Kirmse, and Michael D. Wittry
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We create a novel dataset of the terms of poison pill plans to examine their prevalence over time. Consistent with the hypothesis that poison pills have responded to the increase in hedge fund activism, recent adoptions have characteristics and provisions that appear to target hedge funds, such as low trigger thresholds. Moreover, using unique data on activist hedge fund views of SEC filings as a proxy for the mere threat of an activist intervention, we show that hedge fund interest strongly predicts pill adoption. Finally, the likelihood of a 13D filing declines after firms adopt “antiactivist” pills. Our analysis has implications for understanding the modern dynamics of market discipline of managers in public corporations, and evaluating policies that regulate defensive tactics.

Stock-Oil Comovement: Cash Flows or Discount Rates?
Alessandro Melone, Otto Randl, Leopold Sögner, and Josef Zechner
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The return correlation between U.S. stocks and oil has shifted from negative to positive since 2008. We use a return decomposition framework to show that an underlying reason for this structural change is a shift in the correlation between cash flow news for both assets. The U.S. oil production is a key driver of both the stock-oil correlation and the cash flow news correlation. Post-2008, positive oil demand shocks are good news for the cash flows of both assets. Our findings help to understand the set of potential determinants of equity-commodity correlations and the diversification benefits of investing in commodities.

Corporate Takeover Defenses
Jonathan M. Karpoff and Michael D. Wittry
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Takeover defenses, also called antitakeover provisions, reflect decades of innovation in the interplay of offensive and defensive tactics in the market for corporate control. This paper summarizes research on how firms use takeover defenses and how defenses affect firm value and operations. Recent evidence shows that defenses convey both costs and benefits that vary across firms and over an individual firm’s life – helping to explain the mixed empirical results in many earlier studies. We also review evidence on the extent to which takeover defenses work to forestall takeovers, and the costs and benefits of adding or removing takeover defenses. We conclude by identifying unresolved issues about takeover defenses and questions for future research.

All Clear for Takeoff: Evidence from Airports on the Effects of Infrastructure Privatization
Sabrina T. Howell, Yeejin Jang, Hyeik Kim, and Michael S. Weisbach
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We study how privatization and four variants of private ownership type affect infrastructure performance, focusing on global airports over 25 years. Privatization in general does not improve performance. However, private equity (PE) ownership has strong and persistent positive effects on measures of efficiency, volume, and quality. To address selection, we use close auctions in which both PE and non-PE firms bid. The disparities across ownership types are related to fees charged to airlines, physical capacity expansion, local state capacity, and the presence of a state-owned flag carrier. Overall, PE-owned airports benefit from high-powered incentives and access to capital.

Cross-Border Mergers and Acquisitions
Isil Erel, Yeejin Jang,and Michael S. Weisbach
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One of the most consequential events in any firm’s lifetime is a major acquisition. Because of their importance, mergers and acquisitions (M&As) have been an enormous area of research. However, the vast majority of this research and survey papers summarizing this research have focused on domestic deals. Cross-border ones, however, constitute about 30% of the total number and 37% of the total volume of M&As around the world since the early 1990s. We survey the literature on cross-border M&As, focusing on international factors that can lead firms to acquire a firm in another country. Such factors include differences in economic development, laws, institutions, culture, labor rights, protection of intellectual property, taxes, and corporate governance.

The Unicorn Puzzle
Daria Davydova, Rüdiger Fahlenbrach, Leandro Sanz, and René M. Stulz
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From 2010 to 2021, 639 US VC-funded firms achieved unicorn status. We investigate why there are so many unicorns and why controlling shareholders give investors privileges to obtain unicorn status. We show that unicorns rely more than other VC-funded firms on organizational capital as well as network effects and the internet. Unicorn status enables startups to access new sources of capital. With this capital, they can invest more in organizational intangible assets with less expropriation risk than if they were public. As a result, they are more likely to capture the economies of scale that make their business model valuable.

Expert Network Calls
Sean S. Cao, T. Clifton Green, Lijun Lei, Shaojun Zhang
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Expert networks provide investors with in-depth discussions with subject matter experts. Expert call demand is higher for younger, technology-oriented firms and those with greater intangible assets, consistent with demand for information on hard-to-value firms. Expert calls are more (less) likely to emphasize technology and operational (financial) topics relative to earnings calls. We find that expert call volume is associated with hedge fund position changes and greater price efficiency. The relation is asymmetric, with call volume preceding hedge fund sales, greater short interest, and negative firm performance. The evidence suggests that expert networks help investors discern complicated bad news.

The Retail Execution Quality Landscape
Anne Haubo Dyhrberg, Andriy Shkilko, and Ingrid M. Werner
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We show that off-exchange (wholesaler) executions provide significant trading cost savings to retail investors. Despite industry concentration, three findings suggest that wholesalers do not abuse market power. First, brokers closely monitor and reward wholesalers offering low liquidity costs with more order flow. Second, the largest wholesalers offer the lowest costs due to economies of scale. Finally, the entry of a new large wholesaler does not reduce liquidity costs. Drawing from these insights, we discuss the implications of two proposed alternatives to the status quo: (i) pooling retail and institutional flows on exchanges and (ii) sending retail flow to order-by-order auctions.

*Werner is an independent director for DFA US Mutual Funds and ETF Trust, is a director for the Fourth Swedish Pension Fund (AP4), and serves on the Prize Committee for the Riksbanken's Prize in Economic Sciences in Memory of Alfred Nobel.

Competition for Attention in the ETF Space
Itzhak Ben-David, Francesco Franzoni, Byungwook Kim, and Rabih Moussawi
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The interplay between investors’ demand and providers’ incentives has shaped the evolution of exchange-traded funds (ETFs). While early ETFs invested in broad-based indexes and therefore offered diversification at low cost, more recent products track niche portfolios and charge high fees. Strikingly, over their first 5 years, specialized ETFs lose about 30% (risk-adjusted). This underperformance cannot be explained by high fees or hedging demand. Rather, it is driven by the overvaluation of the underlying stocks at the time of the launch. Our results are consistent with providers catering to investors’ extrapolative beliefs by issuing specialized ETFs that track attention grabbing themes.

The Cash Flow Sensitivity of Cash: Replication, Extension, and Robustness
Heitor Almeida, Murillo Campello, and Michael S. Weisbach
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This paper reexamines the empirical evidence on the cash flow sensitivity of cash presented by Almeida, Campello, and Weisbach (2004). The original paper introduces a model in which financially constrained firms choose to save cash out of incremental cash flows but financially unconstrained do not. The authors find evidence consistent with this hypothesis on a sample of U.S. public firms between 1971 and 2000. This paper extends that analysis in a number of ways. In particular, it uses a larger sample covering the 1971–2019 window, considers a number of alternative definitions of financial constraints, and incorporates new methods and tests suggested by Welch (2020), Almeida, Campello, and Galvao (2010), and Grieser and Hadlock (2019). The original empirical findings are robust to these alternative specifications.

Discontinued Positive Feedback Trading and the Decline of Return Predictability
Itzhak Ben-David, Jiacui Li, Andrea Rossi, and Yang Song
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We show that demand effects generated by institutional frictions can influence systematic return predictability patterns in stocks and mutual funds. Identification relies on a reform to the Morningstar rating system, which we show caused a structural break in style-level positive feedback trading by mutual funds. As a result, momentum-related factors in stocks, as well as performance persistence and the "dumb money effect" in mutual funds, experienced sharp decline. Consistent with the proposed channel, return predictability declined right after the reform, was limited to the U.S. market, and was concentrated in factors and mutual funds most exposed to the mechanism.

Discount Rate Risk in Private Equity: Evidence from Secondary Market Transactions
Brian Boyer, Taylor D. Nadauld, Keith P. Vorkink, and Michael S. Weisbach
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Standard measures of PE performance based on cash flows overlook discount rate risk. An index constructed from prices paid in secondary market transactions indicates that PE discount rates vary considerably. While the standard alpha for our index is zero, measures of performance based on cash flow data for funds in our index are large and positive. To illustrate that results are not driven by idiosyncrasies of PE secondary markets, we obtain similar results using cash flows and returns of synthetic funds that invest in small cap stocks. Ignoring variation in PE discount rates can lead to a misallocation of capital.

Is Public Equity Deadly? Evidence from Workplace Safety and Productivity Tradeoffs in the Coal Industry
Erik P. Gilje and Michael D. Wittry
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We study how public listing status relates to the balance between workplace safety and labor productivity. Theory offers competing hypotheses on how listing-related frictions may affect this tradeoff. We exploit asset-level data in the U.S. coal industry and find that workplace safety deteriorates under public firm ownership, primarily in mines that experience the largest productivity increases. The tradeoff towards higher productivity and poorer workplace safety for public firms is concentrated when information asymmetry problems between managers and shareholders are likely exacerbated, and when the transition to public ownership occurs in communities where the prior private owner had stronger local ties.

Do Firms with Specialized M&A Staff Make Better Acquisitions?
Sinan Gokkaya, Xi Liu, and René M. Stulz
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We open the black box of the M&A decision process by constructing a comprehensive sample of US firms with specialized M&A staff. We investigate whether specialized M&A staff improves acquisition performance or facilitates managerial empire building instead. We find that firms with specialized M&A staff make better acquisitions when acquisition performance is measured by stock price reactions to announcements, long-run stock returns, operating performance, divestitures, and analyst earnings forecasts. This effect does not hold when the CEO is powerful, overconfident, or entrenched. Acquisitions by firms without specialized staff do not create value, on average. We provide evidence on mechanisms through which specialized M&A staff improves acquisition performance. For identification, we use the staggered recognition of inevitable disclosure doctrine as a source of exogenous variation in the employment of specialized M&A staff.

Keeping up with the Joneses and the Real Effects of S&P 500 Inclusion
Benjamin Bennett, René M. Stulz, and Zexi Wang
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Firms added to the S&P 500 index join a prestigious and exclusive club. They want to fit in the club, which creates a “keeping up with the Joneses” effect. Firms pay more attention to their index peers after inclusion and their investment, external financing, and payouts comove more with their index peers. These effects do not appear to result from the increased coordination among investors posited by the common ownership literature as inclusion does not cause a decrease in competition. Since index inclusion does not increase shareholder wealth permanently, these peer effects do not appear to benefit shareholders.

Scammed and Scarred: Effects of Investment Fraud on its Victims
Samuli Knüpfer, Ville Rantala, and Petra Vokata
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We study the effects of investment-fraud victimization using information on thousands of Ponzi scheme participants combined with register data on the Finnish population. A difference-in-differences analysis reveals the victims earn 5% less income after the scheme collapses. This persistent loss arises from a combination of unemployment, absenteeism, mobility, and labor force exit, and its long-run value exceeds the direct investment loss. Victims also experience higher indebtedness and more divorces and shy away from investments delegated to asset managers. These scars from fraud victimization add to the social cost of fraud and are relevant for optimal regulatory design.

Beyond Reverse Splits: How Do Fallen Angels Restructure?
Abed El Karim Farroukh, Jennifer L. Koski, and Ingrid M. Werner
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Firms with very low stock prices face a unique set of frictions that affect trading and liquidity. We study the restructuring actions of firms whose stock prices experience a sharp decline to a low-price level – fallen angels. We find that, relative to a matched sample, fallen angels implement more reverse stock splits. However, we find no significant relation between reverse splits and subsequent returns for our fallen angels, and reverse splits are associated with negative future returns for control stocks. Reverse splits are an ineffective way to avoid frictions associated with low stock prices. We therefore explore alternative restructuring actions and find that fallen angels cut investments in fixed assets and decrease operating expenses. Retrenching fallen angels experience higher subsequent returns but also increased delisting and financial distress risk, worse operating performance, lower growth opportunities, and higher asset volatility. Overall, our findings suggest that low-price firms must engage in actions beyond reverse splits to boost stock prices, and these actions are costly.

Leverage and Cash Dynamics
Harry DeAngelo, Andrei S. Gonçalves, and René M. Stulz
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This paper documents new and empirically important interactions between cash-balance and leverage dynamics. Cash ratios typically vary widely over extended horizons, with dynamics remarkably similar to (and complementary with) those of capital structure. Leverage and cash dynamics interact approximately as predicted by the internal-versus-external funding regimes in Myers and Majluf (1984). Leverage is quite volatile when cash ratios are stable and vice-versa, while net-debt ratios are almost always volatile. Most firms increase leverage sharply as cash balances (internal funds) become scarce. Capital structure models that extend Hennessy and Whited (2005) to include cash-balance dynamics explain some, but not all, aspects of the observed relation between cash squeezes and leverage increases.

Directors’ Incentives from Potential Regulatory Penalties: Evidence from their Voting
Wenzhi Ding, Chen Lin, Thomas Schmid, and Michael S. Weisbach
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What makes independent directors perform their monitoring duty? One possible reason is that they are concerned about being sanctioned by regulators if they do not monitor sufficiently well. Using unique features of the Chinese financial market, we estimate the extent to which independent directors’ perceptions of the likelihood of receiving a regulatory penalty affect their monitoring. Our results suggest that they are more likely to vote against management after observing how another director in their board network received a regulatory penalty related to negligence. This effect is long-lasting and stronger if the observing and penalized directors share the same professional background or gender and if the observing director is at a firm that is more likely to be penalized. These results provide direct evidence suggesting that the possibility of receiving penalties is an important factor motivating directors.

Why do bank boards have risk committees?
René M. Stulz, James Tompkins, Rohan Williamson, and Zhongxia (Shelly) Ye
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We develop a theory of bank board risk committees that explains why such committees can be valuable to shareholders even when they do not reduce bank risk. As predicted by our theory (1) many large and complex banks voluntarily chose to have a risk committee before the Dodd-Frank Act forced bank holding companies with assets in excess of $10 billion to have a board risk committee, and (2) establishing a board risk committee does not reduce a bank’s risk on average. Using unique interview data, we show that the work of risk committees is consistent with our theory.

Specialized Investments and Firms’ Boundaries: Evidence from Textual Analysis of Patents
Jan Bena, Isil Erel, Daisy Wang, and Michael S. Weisbach
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Inducing firms to make specialized investments through bilateral contracts can be challenging because of potential holdup problems. Such contracting difficulties have long been argued to be an important reason for acquisitions. To evaluate the extent to which this motivation leads to mergers, we perform a textual analysis of the patents filed by the same lead inventors of the target firms before and after the mergers. We find that patents of inventors from target firms become 28.9% to 46.8% more specific to those of acquirers’ inventors following completed mergers, benchmarked against patents filed by targets and a group of counterfactual acquirers. This pattern is stronger for vertical mergers that are likely to require specialized investments. There is no change in the specificity of patents for mergers that are announced but not consummated. Overall, we provide empirical evidence that contracting issues in motivating specialized investment can be a motive for acquisitions.

Why Did Small Business FinTech Lending Dry Up During the COVID-19 Crisis?
Itzhak Ben-David, Mark Johnson, and René M. Stulz
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FinTech small business lenders fund loans mostly through credit facilities and securitizations. This business model could make them financially constrained when a shock reduces the value of existing loans. We find evidence supporting this prediction using detailed applicant-level and lender-level data from a platform that intermediates loans between dozens of FinTech lenders and small businesses. Despite the increased demand for credit at the onset of the COVID crisis, the credit supply quickly dwindled, regardless of borrowers' credit quality. Overall, our analysis demonstrates the fragility of the FinTech lending model in the face of a crisis.

Waiting on a Friend: Strategic Learning and Corporate Investment
Paul H. Décaire and Michael D. Wittry
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Using detailed project-level data, we document a novel mechanism through which information externalities distort investment. Firms anticipate information spillover from peers’ investment decisions and delay project exercise to learn from their peers’ outcomes. To establish a causal interpretation of our results, we exploit local exogenous variation from the 1800s that shapes the number of peers that a firm can learn from today. The incentive to wait is most salient for projects with uncertain profitability, when peers’ underlying assets are similar, and in environments where peers are skilled. Finally, our results suggest that the anticipation of peer information dampens aggregate investment.

Corporate Transactions in Hard-to-Value Stocks
Itzhak Ben-David, Byungwook Kim, Hala Moussawi, and Darren Roulstone
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Hard-to-value stocks provide opportunities for managers to exploit their informational advantage through trading on their firms' and their own personal accounts. In contrast to the prediction that such transactions reflect private information about future events, they are contrarian and heavily depend on past returns. Corporate transactions in hard-to-value stocks outperform those in easy-to-value stocks in the early part of our sample, but this difference disappears after 2002, coinciding with a general decline in the profitability of stock market anomalies. Our evidence is consistent with managers' perception of mispricing, rather than private information, being a key motivator of their transactions.

Payment Risk and Bank Lending
Ye Li and Yi Li
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Deposits finance bank lending and serve as means of payment for bank customers. Under uncertain payment flows, deposits are debts with random maturities. Payment outflows drain reserves, and the risk is most prominent when funding markets are under stress and banks are unable to smooth out payment shocks. We provide the first evidence on the negative impact of payment risk on bank lending, bridging the literatures on payment systems and credit supply. An interquartile increase in payment risk is associated with a decline in loan growth rate that is 10% of standard deviation. Our findings are stronger in times of funding stress and robust across banks of different sizes and loans of long and short maturities. Banks with higher payment risk raise deposit rates to expand customer base and internalize payment flows. Finally, we show that payment risk dampens the bank lending channel of monetary policy transmission.

Buyouts: A Primer
Tim Jenkinson, Hyeik Kim and Michael S. Weisbach
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This paper provides an introduction to buyouts and the academic literature about them. Buyouts are initiated by “buyout funds”, which are limited partnerships raised from mostly institutional investors. The funds earn returns for their investors by improving the operations of the firms they acquire and exiting them for a profit. Buyout funds have grown substantially and currently raise more than $400 billion annually in capital commitments. We first discuss the institutional environment that developed to foster such buyouts and to provide incentives for general partners and firm managers to earn returns for the fund’s investors. We then describe various strategies that funds use to increase the values of their portfolio companies. The paper provides up to date statistics on all aspects of the buyout industry. Finally, we present a summary of the academic literature on buyouts. This literature has paid particular attention to the extent to which buyouts earn risk-adjusted abnormal returns for their investors, as well as the sources of those returns.

The Persistent Effects of Financial Crises on the Composition of Real Investment
Shelia Jiang, Ye Li and Douglas Xu
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Our paper provides the first cross-country evidence on the distinct dynamics of tangible and intangible investments during and after the global financial crisis. The pre-crisis rise of intangible-to-tangible capital ratio was reversed due to a greater decline of intangible investment relative to tangible investment during the crisis and a much slower recovery of intangible investment after the crisis. Tangible capital can be externally financed, and its post-crisis recovery benefits from the restoration of credit supply. In contrast, Intangible investment relies on firms' liquidity holdings that were drawn down in the crisis and can only be rebuilt gradually through retained profits. We provide a unified account of the findings through a dynamic model of corporate investment and liquidity management. Consistent with our model predictions, the divergence between tangible and intangible investments is more prominent in countries with weaker intellectual property protection (less external financing options for intangibles) and riskier government bonds (less robust corporate liquidity holdings).

Cross-Border Activities as a Source of Information: Evidence from Insider Trading during the Covid-19 Crisis
Leandro Sanz
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Insider trading during the early months of the COVID-19 pandemic provides a unique opportunity to study how corporate insiders benefit from information flows in their network of business contacts. I find that insiders at firms with activities in China sell more shares of their companies than other insiders and do so earlier. Consistent with an information channel, I show that firms with supply-chain relationships and subsidiaries in China, more local assets and employees, and insiders overseeing global operations drive these effects. Insiders' private information seems to have been forward-looking, which allowed them to avoid significant losses during the period.

Do Employees Have Useful Information About Firms’ ESG Practices?
Hoa Briscoe-Tran
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This paper investigates whether employees have useful information for assessing firms’ environmental, social, and governance (ESG) practices. I analyze 10.4 million anonymous employee reviews via a word-embedding model to construct an inside view of corporate ESG practices. The inside view has useful information beyond external ratings in predicting a firm’s future misconduct, governance issues, downside risk, growth, and valuation. In addition, the inside view appears robust to greenwashing, both theoretically and empirically. In various settings including a novel exogenous shock, I show that low-cost changes in a firm’s stated ESG policies do not affect the inside view while more expensive changes do.

Bank Credit and Money Creation on Payment Networks: A Structural Analysis of Externalities and Key Players
Ye Li, Yi Li and Huijun Sun
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This paper documents a strong connection between payment system and credit supply. The dual role of deposits as financing instruments for banks and means of payment for bank customers implies spillover effects of bank lending. After a bank finances loans with new deposits, the deposit holders' payments cause reserves and deposits to flow from the lending bank to the payees' banks. The change in liquidity conditions for both banks and their customers gives rise to two opposing forces that generate respectively strategic complementarity and strategic substitution in banks' lending decisions. We model bank lending through a linear-quadratic game on a random graph of payment flows and structurally estimate the spillover effects using Fedwire data to quantify the probability distribution of payment-flow network. Payment network externalities reduce the average level of aggregate credit supply by 9% while amplify the volatility by 20%. We identify a small subset of banks that have a disproportionately large influence on credit supply due to their special positions in the payment-flow network.

The Corporate Finance of Multinational Firms
Isil Erel, Yeejin Jang, and Michael S. Weisbach
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An increasing fraction of firms worldwide operate in multiple countries. We study the costs and benefits of being multinational in firms’ corporate financial decisions and survey the related academic evidence. We document that, among U.S. publicly traded firms, the prevalence of multinationals is approximately the same as domestic firms, using classification schemes relying on both income-based and a sales-based metrics. Outside the U.S., the fraction is lower but has been growing. Multinational firms are exposed to additional risks beyond those facing domestic firms coming from political factors and exchange rates. However, they are likely to benefit from diversification of cash flows and flexibility in capital sources. We show that multinational firms, indeed, have a better access to foreign capital markets and a lower cost of debt than otherwise identical domestic firms, but the evidence on the cost of equity is mixed.

Why Does Equity Capital Flow Out of High Tobin’s q Industries?
Dong Lee, Han Shin and René M. Stulz
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High Tobin’s q industries receive more funding from capital markets than low Tobin’s q industries from 1971 to 1996. Since then, the opposite is true. The key to understanding this shift is that large firms for which q is more a proxy for rents than for investment opportunities have become more important within industries. For these firms, repurchases increase with q but capital expenditures do not, so that q explains more the variation of repurchases than of capital expenditures. Consequently, equity capital flows out of high q industries because, for these industries, stock repurchases are high and issuances are low.

Are Corporate Payouts Abnormally High in the 2000s?
Kathleen Kahle and René M. Stulz
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Adjusting for inflation, the annual amount paid out through dividends and share repurchases by public non-financial firms is three times larger in the 2000s than from 1971 to 1999. We find that an increase in aggregate corporate income explains 38% of the increase in the average of aggregate annual payouts from 1971-1999 to the 2000s, while an increase in the aggregate payout rate explains 62%. At the firm level, changes in firm characteristics explain 71% of the increase in average payout rate for the population and 49% of the increase in the average payout rate of firms with payouts. Though there is a negative relation between payouts and investment, most of the increase in payouts is unrelated to the decrease in investment. Models estimated over 1971-1999 underpredict the payout rate of firms with payouts in the 2000s. These models perform better when we forecast non-debt-financed payouts for a sample of larger firms, but not for the sample as a whole. Payouts are more responsive to firm characteristics in the 2000s than before, which is consistent with management having stronger payout incentives.

Regional Divergence and House Prices
Greg Howard and Jack Liebersohn
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This paper develops a model of the U.S. housing market that explains much of the time series of rents and house prices since World War II. House prices depend on expectations of future rents. We show that rents are tied to regional income inequality, and therefore, house prices are determined by how much faster incomes are growing in richer regions. This theory also matches many cross-sectional facts, including regional variation in rents and prices, differing house price sensitivities to national trends, patterns of inter-state migration, and surveys of income expectations. An industry shift-share instrument provides causal evidence for our channel. The model implies that while interest rates have an ambiguous effect on house price levels, low rates increase house price volatility.

Is financial globalization in reverse after the 2008 global financial crisis? Evidence from corporate valuations
Craig Doidge, G. Andrew Karolyi, and René M. Stulz
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For the last two decades, non-US firms have lower valuations than similar US firms. We study the evolution of this valuation gap to assess whether financial markets are less integrated after the 2008 global financial crisis (GFC). The valuation gap for firms from developed markets increases by 31% after the GFC – a reversal in financial globalization – while the gap for firms from emerging markets (excluding China) stays stable. There is no evidence of greater segmentation for non-US firms cross-listed on major US exchanges and the typical valuation premium of such firms relative to domestic counterparts stays unchanged. However, the number of such firms shrinks sharply, so that the importance of US cross-listings as a mechanism for market integration diminishes.

Crisis Poison Pills
Ofer Eldar and Michael D. Wittry
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We show that a large number of firms adopt poison pills during periods of market turmoil. Specifically, during the coronavirus pandemic, many firms adopted poison pills following declines in valuations, and stock prices increased upon the announcement of firms’ poison pill adoption. Stock price increases are driven by (1) firms in which activist shareholders acquire ownership stakes and (2) firms in industries that had high exposure to the crisis. Likewise, we find a positive reaction to pills with provisions directed at stalling activists’ interventions. Our results suggest that crisis pills that target potentially disruptive ownership changes may benefit current shareholders.

How valuable is financial flexibility when revenue stops? Evidence from the COVID-19 crisis
Rüdiger Fahlenbrach, Kevin Rageth, and René M. Stulz
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Firms with greater financial flexibility should be better able to fund a revenue shortfall resulting from the COVID-19 shock and benefit less from policy responses. We find that firms with high financial flexibility within an industry experience a stock price drop lower by 26% or 9.7 percentage points than those with low financial flexibility. This differential return persists as stock prices rebound. The firms more exposed to the COVID-19 shock benefit more from cash holdings. There is no evidence that recent payouts made the average firm’s stock price drop worse. Our results cannot be explained by a leverage effect.

Housing Risk and the Cross-Section of Returns Across Many Asset Classes
Sai Ma and Shaojun Zhang
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When households consume both nondurable goods and housing services, external habit preference over nondurable consumption generates procyclical demand for housing. Marginal utility falls when housing demand rises and innovations to housing demand arise as a risk factor. Motivated by theory, we use shocks to the ratio of residential-to-aggregate investment to capture the housing demand risk. The single-factor model exhibits strong explanatory power for expected returns across various equity characteristic-sorted portfolios and non-equity asset classes with positive risk price estimates that are similar in magnitude. The model is robust to controlling for other factor models based on durable consumption, financial intermediaries, household heterogeneity, and return- based multifactor models designed to price these assets.

How Important Is Moral Hazard For Distressed Banks?
Itzhak Ben-David, Ajay A. Palvia, and René M. Stulz
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The moral hazard incentives of the bank safety net predict that distressed banks take on more risk and higher leverage. Since many factors reduce these incentives, including charter value, regulation, and managerial incentives, the net economic effect of these incentives is an empirical question. We provide evidence on this question using two distinct periods that include financial crises and are subject to different regulatory regimes (1985–1994, 2005–2014). We find that distressed banks reduce their leverage and decrease observable measures of riskiness, which is inconsistent with the view that, on average, moral hazard incentives dominate distressed bank leverage and risk-taking policies.

Sentiment and Uncertainty
Justin Birru and Trevor Young
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Sentiment should exhibit its strongest effects on asset prices at times when valuations are most subjective. Accordingly, we show that a one-standard-deviation increase in aggregate uncertainty amplifies the predictive ability of sentiment for market returns by two to four times relative to when uncertainty is at its mean. For the cross-section of returns, the predictive ability of sentiment for test assets expected to be most sensitive to sentiment, including existing measures of both risk and mispricing, is substantially larger in times of higher uncertainty. The results hold for both daily and monthly proxies for sentiment and for various proxies for uncertainty.

Cryptocurrency Exchanges and Comovements of Cryptocurrency Returns
Amin Shams
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This paper documents that similarity in cryptocurrencies' investor bases proxied by their trading exchange is the main driver of cryptocurrencies' comovement structure. This comovement structure is far stronger than can be explained by similarities in cryptocurrency characteristics such as size, volume, age, consensus mechanism, and industries. I examine three potential channels for these results. First, evidence from new exchange listings and a quasi-natural experiment shows that unobservable characteristics cannot explain these results. Second, the results are driven by exchange-specific commonalities in demand that lead to global price movements across exchanges. Third, analysis of social media data shows that the demand-driven comovement is significantly larger for cryptocurrencies that rely heavily on organic adoption. Overall, these findings suggest that unique features of cryptocurrencies make demand pressures a first-order driver of cryptocurrency returns.

Bank Mergers, Acquirer Choice and Small Business Lending: Implications for Community Investment
Bernadette A. Minton, Alvaro G. Taboada, and Rohan Williamson
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We examine the effects of bank merger and local market characteristics on local small business lending. Mergers involving small, in-state acquirers are positively associated with small business loan (SBL) originations in counties where target banks are located. Conversely, mergers involving large, out-of-state acquirers are associated with fewer SBL originations. The analysis suggests that the results are driven by acquirer’s choice of target. Small and in-state acquirers target banks that focus more on SBL and targets with strong relationships while large, out-of-state acquirers pursue better performing banks with stronger balance sheets and less focus on SBL. Results are particularly strong in counties with a large number of small firms. Post-merger activity supports banks expanding on their acquisition strategy decisions. The findings suggest that acquirer strategy is important for evaluating the impact of acquisitions on local community development and that one-size-fits-all policy solutions for bank mergers may not produce common local outcomes.

Dynamic Banking and the Value of Deposits
Patrick Bolton, Ye Li, Neng Wang, and Jinqiang Yang
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We propose a dynamic theory of banking where the role of deposits is akin to that of productive capital in the classical Q-theory of investment for non-financial firms. As a key source of leverage, deposits create value for well-capitalized banks. However, unlike capital of nonfinancial firms, deposits can have a negative marginal q for undercapitalized banks. Demand deposit accounts commit banks to allow holders to withdraw or deposit funds at will, so banks cannot perfectly control leverage. When banks have insufficient equity capital to buffer risk, deposit inflows and the associated uncertainty in future leverage can destroy value. Our model predictions on bank valuation and dynamic asset-liability management are broadly consistent with the evidence. Moreover, our model lends itself to a re-evaluation of the costs and benefits of leverage regulation and offers new perspectives on the challenges that banks face in a low interest rate environment.

The Performance of Hedge Fund Performance Fees
Itzhak Ben-David, Justin Birru, Andrea Rossi
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Performance-based fees in asset management contribute to the growing cost of financial intermediation. But how well do these fees align the long-run outcomes of fund managers and investors? In a large 22-year sample of hedge funds, we find that 60% of the gains on which incentive fees are paid are eventually offset by losses. As a result, the effective incentive fee rate is 50% vis-a-vis the nominal 20% rate. Overall, hedge fund fees consume 64% of the gross returns on investors’ capital and are only weakly correlated with actual long-run performance in the cross-section of funds.

Dissecting Currency Momentum
Shaojun Zhang
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This paper shows that currency momentum, which cannot be explained by carry and dollar factors, summarizes the autocorrelation of these factors. A no-arbitrage model postulates that predictable global shock volatility can simultaneously generate factor and currency momentum. Empirically, carry and dollar factors are strongly autocorrelated and only earn significantly positive excess returns following positive factor returns. Future factor volatility drives out the autocorrelation. Factor momentum not only outperforms currency momentum but also explains it, whereas idiosyncratic returns do not generate momentum. Currency momentum longs the factors following positive factor returns and shorts the factors following losses.

Can FinTech Reduce Disparities in Access to Finance? Evidence from the Paycheck Protection Program
Isil Erel and Jack Liebersohn
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New technology promises to expand the supply of financial services to small businesses poorly served by banks. Does it succeed? We study the response of FinTech to financial services demand created by the introduction of the Paycheck Protection Program. Fin-Tech is disproportionately used in ZIP codes with fewer bank branches, lower incomes, and more minority households, and in industries with fewer banking relationships. It is also greater in counties where the economic effects of the COVID-19 pandemic were more severe. Substitution between FinTech and banks is economically small, implying that FinTech mostly expands, rather than redistributes, the supply of financial services.

Does Joining the S&P 500 Index Hurt Firms?
Benjamin Bennett, René M. Stulz, and Zexi Wang
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We investigate the impact on firms of joining the S&P 500 index from 1997 to 2017. We find that the positive announcement effect on the stock price of index inclusion has disappeared and the long-run impact of index inclusion has become negative. Inclusion worsens stock price informativeness and some aspects of governance. Compensation, investment, and financial policies change with index inclusion. For instance, payout policies of firms joining the index become more similar to the policies of their index peers. ROA falls following inclusion. There is no evidence of an impact of inclusion on competition.

The (Missing) Relation Between Announcement Returns and Value Creation
Itzhak Ben-David, Utpal Bhattacharya, Ruidi Huang, and Stacey Jacobsen
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Cumulative abnormal returns (CAR) computed during acquisition announcements are widely considered to be market-based assessments of expected value creation. We show that announcement returns do not correlate with commonly used and new measures of ex-post acquisition outcomes. A simple characteristics model using standard information known at announcement can predict outcomes reasonably well, and CAR fails even to capture the prediction from this model. A likely reason is that, because acquisition decisions are endogenous, CAR conveys information about the NPV of the deal as well as the event that triggered the deal announcement. We find that CAR variance is too high to be explained by NPV variance alone, suggesting that other non-NPV information related to this trigger dominates. We conclude that CAR is an unreliable measure of expected value creation.

Rise of the Machines: The Impact of Automated Underwriting
Mark Jensen, Hieu Quang Nguyen and Amin Shams
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Using a randomized experiment in auto lending, we find that algorithmic underwriting outperforms the human underwriting process, resulting in 10.2% higher loan profits and 6.8% lower default rates. The human and machine underwriters show similar performance for low-risk, less complex loans. However, the performance of human underwritten loans largely declines for riskier and more complex loans, whereas the machine performance stays relatively stable across various risk dimensions and loan characteristics. The performance difference is more pronounced at underwriting thresholds with a high potential for agency conflict. These results are consistent with algorithmic underwriting mitigating agency conflicts and humans’ limited capacity for analyzing complex problems.

Why Are Corporate Payouts So High in the 2000s?
Kathleen Kahle and René M. Stulz
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The average annual inflation-adjusted amount paid out through dividends and repurchases by public industrial firms is more than three times larger from 2000 to 2019 than from 1971 to 1999. We find that an increase in aggregate corporate income accounts for 37% of the increase in aggregate annual payouts and an increase in the payout rate accounts for 63%. Firms have higher payout rates in the 2000s not only because they are older, larger, and have more free cash flow, but also because they pay out more of their free cash flow. Though firms spend less on capital expenditures in the 2000s than before, capital expenditures decrease similarly for the firms with payouts and for firms without.

Engineering Lemons
Petra Vokata
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Recent complex financial products sold to households contradict the basic premise of canonical innovation theories: financial innovation benefits its adopters. In my 2006–2015 sample of over 28,000 yield enhancement products (YEP) the securities offer attractive yields but negative returns. The products lose money both ex ante and ex post due to their embedded fees: on average, YEPs charge 6–7% in annual fees and subsequently lose 6–7% relative to risk-adjusted benchmarks. Simple and cheap combinations of listed options often first-order dominate YEPs. Competition, disclosure, or learning do not eliminate this inferior financial innovation over my sample period.

Have exchange-listed firms become less important for the economy?
Frederik P. Schlingemann and René M. Stulz
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The firms listed on the stock market in aggregate contribute less to total non-farm employment and GDP now than in the 1970s. A major reason for this development is the decline of manufacturing and the growth of the service economy as firms providing services are less likely to be listed on exchanges. A firm’s stock market capitalization is much less instructive about its employment now than in earlier years. Listed stock market superstars account for less employment than they did in the 1970s. Market capitalizations have not become systematically less informative about firms’ contribution to GDP.

Searching for the Equity Premium
Hang Bai and Lu Zhang
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Labor market frictions are crucial for the equity premium in production economies. A dynamic stochastic general equilibrium model with recursive utility, search frictions, and capital accumulation yields a high equity premium of 4.26% per annum, a stock market volatility of 11.8%, and a low average interest rate of 1.59%, while simultaneously retaining plausible business cycle dynamics. The equity premium and stock market volatility are strongly countercyclical, while the interest rate and consumption growth are largely unpredictable. Because of wage inertia, dividends are procyclical despite consumption smoothing via capital investment. The welfare cost of business cycles is huge, 29%.

Who benefits from Analyst “Top Picks”?
Justin Birru, Sinan Gokkaya, Xi Liu, and René M. Stulz
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Following the Global Settlement, analysts extensively use a top pick designation to highlight their highest conviction best ideas. Such a designation enables analysts to provide greater granularity of information, but it can potentially be influenced by conflicts of interest. Examining a comprehensive sample of top picks, we find that they have greater investment value, attract greater media and investor attention, and lead to more trading than buy recommendations. Top picks that have poor ex-post investment performance are more likely to be influenced by strategic objectives. Institutional investors appear to be able to identify such top picks while retail investors do not.

ADHD, financial distress, and suicide in adulthood: A population study
Theodore P. Beauchaine, Itzhak Ben-David, and Marieke Bos
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Attention-deficit/hyperactivity disorder (ADHD) exerts lifelong impairment, including difficulty sustaining employment, poor credit, and suicide risk. To date, however, studies have assessed selected samples, often via self-report. Using mental health data from the entire Swedish population (N = 11.55 million) and a random sample of credit data (N = 189,267), we provide the first study of objective financial outcomes among adults with ADHD, including associations with suicide. Controlling for psychiatric comorbidities, substance use, education, and income, those with ADHD start adulthood with normal credit demand and default rates. However, in middle age, their default rates grow exponentially, yielding poor credit scores and diminished credit access despite high demand. Sympathomimetic prescriptions are unassociated with improved financial behaviors. Last, financial distress is associated with fourfold higher risk of suicide among those with ADHD. For men but not women with ADHD who suicide, outstanding debt increases in the 3 years prior. No such pattern exists for others who suicide.

Ratings-Driven Demand and Systematic Price Fluctuations
Itzhak Ben-David, Jiacui Li, Andrea Rossi, and Yang Song
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We show that mutual fund ratings generate correlated demand that creates systematic price fluctuations. Mutual fund investors chase fund performance via Morningstar ratings. Until June 2002, funds pursuing the same investment style had highly correlated ratings. Therefore, rating-chasing investors directed capital into winning styles, generating style-level price pressures, which reverted over time. In June 2002, Morningstar reformed its methodology of equalizing ratings across styles. Style-level correlated demand via mutual funds immediately became muted, significantly altering the time-series and cross-sectional variation in style returns.

Growth Forecasts and News About Monetary Policy
Nina Karnaukh and Petra Vokata
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We find that 30-minute changes in bond yields around scheduled Federal Open Market Committee (FOMC) announcements are predictable with the pre-FOMC Blue Chip professionals’ revisions in GDP growth forecasts. A positive pre-FOMC GDP growth revision predicts a contractionary policy news shock (positive change in bond yields), a negative GDP growth revision predicts an expansionary policy news shock (negative change in bond yields). Failing to account for this predictability biases the estimates of monetary policy effects on the economy. First, the Fed’s information effect dissipates as the truly unpredictable policy news shock does not affect professionals’ beliefs about the economy. Second,net policy shock has a more negative impact on actual future GDP than the raw policy shock.

Firm Quality Dynamics and the Slippery Slope of Credit Intervention
Wenhao Li and Ye Li
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In crises, low-quality firms face greater financial shortfalls and invest less than high-quality firms. Public liquidity support preserves the overall production capacity but dampens the cleansing effects of crises on firm quality. The trade-off between quantity and quality determines the optimal size of intervention. Policy distortions are self-perpetuating: A downward bias in quality necessitates interventions of greater scales in future crises. Distortions are amplified by low-quality firms’ expectations of liquidity support and overinvestment pre-crisis. Finally, the optimal intervention is larger and distortionary effects stronger in a low interest rate environment where low yields on precautionary savings discourage firms from self-insurance.

Disentangling Anomalies: Risk versus Mispricing
Justin Birru, Hannes Mohrschladt, and Trevor Young
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We examine the cross-section of returns from the perspective of a benchmark model that only includes systematic mispricing factors. In contrast to insight revealed by standard benchmark models, we recover robust positive risk-return relations for many cross-sectional risk, distress, and friction proxies. Our findings are consistent with systematic mispricing that primarily affects speculative stocks and predominantly results in overpricing, predicting lower returns. Hence, failing to control for exposure to systematic mispricing can bias tests of risk-return tradeoffs. Overall, our evidence suggests that a small shift in perspective generates a substantially different interpretation of the same data.

Money Creation in Decentralized Finance: A Dynamic Model of Stablecoin and Crypto Shadow Banking
Ye Li and Simon Mayer
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Stablecoins are at the center of debate surrounding decentralized finance. We develop a dynamic model to analyze the instability mechanism of stablecoins, the complex incentives of stablecoin issuers, and regulatory proposals. The model rationalizes a variety of stablecoin management strategies commonly observed in practice, and we characterize an instability trap: Stability can last for a long time, but once debasement happens, price volatility persists. Capital requirement improves price stability but fails to eliminate debasement. Restricting the riskiness of reserve assets can surprisingly destabilize price. Finally, data privacy regulation has an unintended benefit of reducing price volatility of stablecoins issued by data-driven platforms.

What Explains Differences in Finance Research Productivity During the Pandemic?
Brad M. Barber, Wei Jiang, Adair Morse, Manju Puri, Heather Tookes, and Ingrid M. Werner
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Based on a survey of AFA members, we analyze how demographics, time allocation, production mechanisms, and institutional factors affect research production during the pandemic. Consistent with the literature, research productivity falls more for women and faculty with young children. Independently, and novel, extra time spent teaching (much more likely for women) negatively affects research productivity. Also novel, concerns about feedback, isolation, and health have large negative research effects, which disproportionately affect junior faculty and PhD students. Finally, faculty who express greater concerns about employers’ finances report larger negative research effects and more concerns about feedback, isolation, and health.

Securities Laws, Bank Monitoring, and the Choice Between Cov-lite Loans and Bonds for Highly Levered Firms
Robert Prilmeier and René M. Stulz
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In contrast to bonds, cov-lite loans do not require SEC registration and are not subject to securities laws. We show that this distinction plays an important role in firms’ choice between funding through cov-lite loans and bonds and helps understand why the market share of cov-lite loans has been so high in recent normal times. Compared to cov-heavy loans, cov-lite loans are closer substitutes for bonds in that they have similar covenants, have tighter bid-ask spreads, have more trading, and are more likely to be used to refinance bonds than cov-heavy loans.

Persistent Government Debt and Aggregate Risk Distribution
Mariano Croce, Thien Nguyen, and Steve Raymond
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When government debt is sluggish, consumption exhibits lower expected growth, more long-run uncertainty, and more long-run downside risk. Simultaneously, the risk premium on the consumption claim (Koijen et al. (2010), Lustig et al. (2013)) increases and features more positive (adverse) skewness. We rationalize these findings in an endogenous growth model in which fiscal policy is distortionary, the value of innovation depends on fiscal risk, and the representative agent is sensitive to the resulting distribution of consumption risk. Our model suggests that committing to a rapid reduction of the debt-to-output ratio can enhance the value of innovation, aggregate wealth, and welfare.

Tick Size, Trading Strategies and Market Quality
Ingrid M. Werner, Yuanji Wen, Barbara Rindi, and Sabrina Buti
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We investigate the effects of a tick size change on market quality by modeling a multi-period public limit order book with endogenous liquidity demand and supply. We single out four channels of transmission and show that layering and mechanical change in spread prevail for liquid, tick size constrained stocks; while undercutting prevails for illiquid stocks. We examine the robustness of our results when order flows migrate to a competing venue. We find empirical support for our predictions by analysing tick size reductions respectively for a market with low (Tokyo Stock Exchange - 2014) and one with high fragmentation (U.S. Tick Size Pilot - 2018).

Real Effects of Climate Policy: Financial Constraints and Spillovers
Söhnke M. Bartram, Kewei Hou, Sehoon Kim
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We document that localized policies aimed at mitigating climate risk can have unintended consequences due to regulatory arbitrage by firms. Using a difference-in-differences framework to study the impact of the California cap-and-trade program with US plant level data, we show that financially constrained firms shift emissions and plant ownership from California to other states. In contrast, unconstrained firms do not make such adjustments. Overall, neither constrained nor unconstrained firms reduce their total emissions when only a subset of their plants are affected by the cap-and-trade rule, undermining the effectiveness of the policy.

What Do Mutual Fund Investors Really Care About?
Itzhak Ben-David, Jiacui Li, Andrea Rossi, and Yang Song
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We show that mutual fund investors rely on simple signals and likely do not engage in sophisticated learning about managers' alpha as widely believed. Simplistic performance chasing best explains aggregate flows to the mutual fund space and flows across funds. These results hold for both actively managed and passive index funds. Empirical patterns commonly interpreted as reflecting learning about managerial skill also appear in falsification tests and are mechanical. Our results are consistent with the view that, on average, households are homo sapiens with limited financial sophistication rather than hyperrational alpha-maximizing agents, as often assumed in the literature.

The Role of Financial Conditions in Portfolio Choices: The Case of Insurers
Shan Ge and Michael S. Weisbach
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Many institutional investors depend on the returns they generate to fund their operations and liabilities. How do these investors’ financial conditions affect the management of their portfolios? We address this issue using the insurance industry because insurers are large investors for which detailed portfolio data are available, and can face financial shocks from exogenous weather events that help us establish causality. Among corporate bonds, for which we can control for regulatory treatment, results suggest that when Property & Casualty (P&C) insurers become more constrained due to operating losses, they shift towards safer bonds. The effect of losses on allocations is likely to be causal since it holds when instrumenting for losses with weather shocks. The change in allocations following losses is larger for smaller or worse-rated insurers and during the financial crisis, suggesting that the shift toward safer securities is driven by concerns about financial flexibility. The results highlight the importance of financial conditions in institutional investors’ portfolio decisions.

The Role of Stock Price Informativeness in Compensation Complexity
Benjamin Bennett, Gerald Garvey, Todd Milbourn, and Zexi Wang
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We study the effect of stock price informativeness (SPI) on executive compensation complexity. Using textual analysis of SEC proxy statements to construct compensation complexity measures for US public firms, we find strong evidence that higher SPI reduces pay complexity. We then use mutual fund redemption as an exogenous decrease in SPI to address endogeneity concerns. When fund flow pressure is high, pay includes more performance metrics, a greater number of vesting periods, and options with longer vesting periods. When stock prices convey information more effectively, executive pay is simpler.

Inferring Expectations from Observables: Evidence from the Housing Market
Itzhak Ben-David, Pascal Towbin, and Sebastian Weber
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We propose a new method to identify shifts in price expectations in the housing market through the accumulation of excess capacity. Expectations of future price increases (due to anticipated future demand for housing services) cause the current supply to increase, creating a temporary vacancy. We implement this intuition in a structural vector autoregression with sign restrictions and explore the effects of price expectations in the U.S. housing market. We find that price expectation shocks were a prime factor explaining the 1996-2006 boom, particularly in the Sand States. Expectation shocks at the boom's peak reflected implausible growth expectations and reversed during the bust.

Costs of Natural Disasters in Public Financing
Benjamin Bennett and Zexi Wang
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We document the dynamics of primary municipal bond (muni) markets after severe natural disasters. We find that yields of muni issuance increase significantly in the first three months after disasters. Disasters have little effect on issuers’ credit risk but can temporarily reduce investors’ demand, which is consistent with the salience theory of choice (Bordalo, Gennaioli, and Shleifer, 2012). Natural disasters significantly increase the proceeds from muni issuances. Reacting to the larger financing costs, muni issuers use shorter maturity and a less complex structure to offset the larger financing costs. The higher yields after disasters provide speculation opportunities.

Do Distressed Banks Really Gamble for Resurrection?
Itzhak Ben-David, Ajay A. Palvia, and René M. Stulz
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We explore the actions of financially distressed banks in two distinct periods that include financial crises (1985-1994, 2005-2014) and differ in bank regulations, especially concerning capital requirements and enforcement. In contrast to the widespread belief that distressed banks gamble for resurrection, we document that distressed banks take actions to reduce leverage and risk, such as reducing asset and loan growth, issuing equity, decreasing dividends, and lowering deposit rates. Despite large differences in regulation between periods, the extent of deleveraging is similar, suggesting that economic forces beyond formal regulations incentivize bank managers to deleverage when their banks are in distress.

Why do Traditional and Shadow Banks Coexist?
Victor Lyonnet and Edouard Chrétien
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This paper shows that traditional and shadow banks interacted in similar ways in the 2007 and COVID-19 crises, when both assets and liabilities flew out of shadow banks and into traditional banks. We explain this finding in a model of the coexistence of traditional and shadow banks in which liabilities and assets flow from the former to the latter in good times to avoid regulation, and the other way in a crisis to alleviate fire sales. The model sheds light on the (unintended)consequences of regulations for traditional banks on the shadow banking sector.

Why Do Firms Use Equity-Based Pay? Managerial Compensation and Stock Price Informativeness
Benjamin Bennett, Gerald Garvey, Todd Milbourn, and Zexi Wang
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We study the motive of using equity-based pay in executive compensation: the risk-sharing motive versus the performance-measuring motive. The empirical design goes through the relationship between equity-based pay and stock price informativeness (SPI). We find equity-based pay decreases in SPI, which is consistent with the risk-sharing motive but inconsistent with the performance-measuring motive. The SPI effect on compensation is stronger in financially-constrained firms, more diversified firms, and firms with less product market competition. SPI increases pay efficiency through a larger proportion of option pay, fewer perquisites, and greater pay-for-skill. We address potential endogeneity concerns by investigating the changes in compensation of managers switching between firms with different SPI.

Clawback Provisions and Firm Risk
Ilona Babenko, Benjamin Bennett, John M. Bizjak, Jeffrey L. Coles, and Jason J. Sandvik
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Panel OLS and GMM-IV estimates indicate that executives respond to the adoption of a compensation clawback provision by decreasing firm risk. The mechanisms that transmit incentives to decisions and decisions to risk appear to be more conservative investment and financial policies and preemptive management of ESG, legal, and cyberattack risks. The stock market reaction to the announcement of a clawback adoption, as well as post-adoption stock and accounting performance, are significantly and positively related to the actual and predicted reduction in firm risk. The reduction in firm risk, arising from adoption of a clawback policy, appears to benefit shareholders.

Housing Cycles and Exchange Rates
Sai Ma and Shaojun Zhang
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This paper documents that the housing cycle, measured by the residential investment share, is a strong in-sample and out-of-sample predictor for the dollar up to twelve quarters. Housing construction is negatively associated with risk premia in equity and bonds, but positively with foreign currency premia. We study a model with external habit preferences over tradable nonhousing consumption only, which implies counter-cyclical SDF volatility and procyclical demand for nontradable housing consumption. The predictability for excess returns in foreign currencies and other assets arises endogenously. The currency predictability is robust to a host of additional checks and holds for other G10 currencies.

Are Analyst Short-Term Trade Ideas Valuable?
Justin Birru, Sinan Gokkaya, Xi Liu, and René M. Stulz
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Short-term trade ideas are a component of analyst research highly valued by institutional investors. Using a novel and comprehensive database, we find trade ideas have a stock-price impact at least as large as recommendation and target price changes. Trade ideas based on expectations of future events are more informative than those identifying incomplete incorporation of past information in stock prices. Analysts with better access to a firm’s management produce better trade ideas. Institutional investors trade in the direction of trade ideas. Investors following trade ideas can earn significant abnormal returns, consistent with analysts possessing valuable short-term stock picking skills.

Security Analysis: An Investment Perspective
Kewei Hou, Haitao Mo, Chen Xue, and Lu Zhang
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The investment theory, in which the expected return varies cross-sectionally with investment, expected profitability, and expected growth, is a good start to understanding Graham and Dodd’s (1934) Security Analysis. Empirically, the q5 model goes a long way toward explaining prominent equity strategies rooted in security analysis, including Frankel and Lee’s (1998) intrinsic-to-market value, Piotroski’s (2000) fundamental score, Greenblatt’s (2005) “magic formula,” Asness, Frazzini, and Pedersen’s (2019) quality-minus-junk, Buffett’s Berkshire, Bartram and Grinblatt’s (2018) agnostic analysis, as well as Penman and Zhu’s (2014, 2018) and Lewellen’s (2015) expected-return strategies.

Can Risk Be Shared Across Investor Cohorts? Evidence from a Popular Savings Product
Johan Hombert and Victor Lyonnet
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We study how retail savings products can share market risk across investor cohorts, thereby completing financial markets. Financial intermediaries smooth returns by varying reserves, which are passed on between successive investor cohorts, redistributing wealth across cohorts. Using data on euro contracts sold by life insurers in France, we estimate this redistribution to be large: 0.8% of GDP. We develop and provide evidence for a model in which low investor sophistication, while leading to individually sub-optimal decisions, improves risk sharing by allowing inter-cohort risk sharing.

*Part of this research was conducted while Victor Lyonnet was a student. At the time, his research was co-financed by the French Federation of Insurers and the Banque de France.

Build or Buy? Human Capital and Corporate Diversification
Paul Beaumont, Camille Hebert, and Victor Lyonnet
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Firms either enter new sectors by building on their resources or buying existing companies. Using French administrative data, we propose a measure of human capital distance between a firm and a sector of entry. Using a shift-share instrument, we show that firms build in close sectors and buy in distant sectors in terms of human capital distance. Firms build by hiring new workers, which becomes increasingly costly in distant sectors as it requires not only hiring more workers but also having more organizational capital to integrate these workers. Hence, firms buy in distant sectors to acquire already operational human capital.

Why is There a Secular Decline in Idiosyncratic Risk in the 2000s?
Söhnke M. Bartram, Gregory W. Brown, and René M. Stulz
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Except for relatively short but intense episodes of high market risk, average idiosyncratic risk (IR) falls steadily after 2000 until almost the end of our sample period in 2017. The decrease has been such that from 2012 to 2017 average IR was lower than any time since 1965. The secular decline can be explained by the fact that U.S. publicly listed firms have become larger, older, and their stock more liquid. The same changes that bring about historically low IR lead to increasingly high market-model R-squareds.

FinTech, BigTech, and the Future of Banks
René M. Stulz
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Banks are unique in that they combine the production of liquid claims with loans. They can replicate most of what FinTech firms can do, but FinTech firms benefit from an uneven playing field in that they are less regulated than banks. The uneven playing field enables non-bank FinTech firms to challenge banks for specific products whose success is not tied to what makes banks unique, but they cannot replace banks as such. In contrast, BigTech firms have unique advantages that banks cannot easily replicate and therefore present a much stronger challenge to established banks in consumer finance and loans to small firms. Both Fintech and BigTech are contributing to a secular trend of banks losing their comparative advantage as they have less access to unique information about parties seeking credit.

Reusing Natural Experiments
Davidson Heath, Matthew C. Ringgenberg, Mehrdad Samadi, and Ingrid M. Werner
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After a natural experiment is first used, other researchers often reuse the setting, examining different outcome variables. We use simulations based on real data to illustrate the multiple hypothesis testing problem that arises when researchers reuse natural experiments. We then provide guidance for future inference based on popular empirical settings including difference-in-differences regressions, instrumental variables regressions, and regression discontinuity designs. When we apply our guidance to two extensively studied natural experiments, business combination laws and the Regulation SHO pilot, we find that many results that were statistically significant using single hypothesis testing do not survive corrections for multiple hypothesis testing.

Attention and Biases: Evidence from Tax-Inattentive Investors
Justin Birru, Fernando Chague, Rodrigo De-Losso, and Bruno Giovannetti
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We first provide evidence of investor inattention to a very simple and well-known capital-gains tax exemption in the Brazilian stock market. We then show that tax-inattentive investors exhibit stronger behavioral biases and worse trading performance, even after controlling for several investor-level characteristics. The evidence is consistent with inattention being a common source of behavioral biases.

The Consequences to Directors of Deploying Poison Pills
William C. Johnson, Jonathan M. Karpoff, and Michael D. Wittry
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We examine the labor market consequences for directors who adopt poison pills. Directors who become associated with pill adoption experience a decrease in vote margins, an increase in termination rates across all their directorships, and a decrease in the likelihood of new board appointments. These adverse consequences accrue primarily when pill adoption is costly for the firm. Firms have positive stock price reactions when pill-associated directors die or depart from their boards, compared to zero abnormal returns for other directors. We conclude that directors who become associated with poison pills suffer a decrease in the value of their services.

An Improved Method to Predict Assignment of Stocks into Russell Indexes
Itzhak Ben-David, Francesco Franzoni, and Rabih Moussawi
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A growing literature uses the Russell 1000/2000 reconstitution event as an identification strategy to investigate corporate finance and asset pricing questions. To implement this identification strategy, researchers need to approximate the ranking variable used to assign stocks to indexes. We develop a procedure that predicts assignment to the Russell 1000/2000 with significant improvements relative to previous approaches. We apply this methodology to extend the tests in Ben-David, Franzoni, and Moussawi (2018).

Does Costly Reversibility Matter for U.S. Public Firms?
Hang Bai, Erica X. N. Li, Chen Xue, and Lu Zhang
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Yes, most likely. The firm-level evidence on costly reversibility is even stronger than the prior evidence at the plant level. The firm-level investment rate distribution is highly skewed to the right, with a small fraction of negative investments, 5.79%, a tiny fraction of inactive investments, 1.46%, and a large fraction of positive investments, 92.75%. When estimated via simulated method of moments, the standard investment model explains the average value premium, while simultaneously matching the key properties of the investment rate distribution, including the cross-sectional volatility, skewness, and the fraction of negative investments. The combined effect of costly reversibility and operating leverage is the key driving force behind the model’s quantitative performance.

Demand Volatility and Firms’ Investments in Operating Flexibility: Evidence from Planned Power Plants
Chen Lin, Thomas Schmid, and Michael S. Weisbach
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How does demand volatility affect firms’ investment decisions? We consider this issue from the perspective of electricity-producing firms. Their most important investment decisions concern their new power plants, which vary substantially in their flexibility to adjust their output to changing market conditions. Using an international sample of planned power plants, we find that more volatile demand causes firms to invest more in flexible plants and less in nonflexible plants, while the overall investment level remains unchanged. This effect, which is robust to a number of alternative specifications, including a weather-based IV for demand volatility, is consistent with models in which asset flexibility is an important attribute of investments when demand is volatile.

Public versus Private Equity
René M. Stulz
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The last twenty years or so have seen a sharp decline in public equity. I present a framework that explains the forces that cause the listing propensity of firms to change over time. This framework highlights the benefits and costs of a public listing compared to the benefits and costs of financing with private equity. With this framework, the decline in public equity is explained by the increased supply of funds for private equity and changes in the nature of firms. The increase in the importance of intangible assets makes it costlier for young firms to be public when the alternative is funding through private equity from investors who have specialized knowledge that enables them to better understand the business model of young firms and contribute to the development of that business model in contrast to passive public equity investors.

Token-based Platform Finance
Lin W. Cong, Ye Li, and Neng Wang
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We develop a dynamic model of platform economy where tokens serve as a means of payments among platform users and are issued to finance investment in platform productivity. Tokens are optimally issued to reward platform owners when the productivity-normalized token supply is low and burnt to boost the franchise value when the productivity-normalized normalized supply is high. Although token price is determined in a liquid market, the platform's financial constraint generates an endogenous token issuance cost, causing underinvestment through the conflict of interest between insiders (platform owners) and outsiders (users). Blockchain technology mitigates underinvestment by addressing the platform's time-inconsistency problem.

Paid Leave Pays Off: The Effects of Paid Family Leave on Firm Performance
Benjamin Bennett, Isil Erel, Léa Stern, and Zexi Wang
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Using the staggered adoption of US state-level Paid Family Leave (PFL) acts, we find that lowering labor market frictions for female workers leads to reduced employee turnover and profitability gains for private and publicly-traded firms. Relying on recent advances in econometric theory of staggered difference-in-differences analysis, we ensure this finding holds when correcting for the bias arising from staggered adoption. Following the introduction of state-level PFL, productivity increases by about 5% in treated establishments, relative to control establishments in adjacent counties on the other side of the state border. We document heterogeneous treatment effects consistent with our identity-based framework.

q-factors and Investment CAPM
Lu Zhang
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The q-factor model shows strong explanatory power and largely summarizes the cross section of average stock returns. In particular, the q-factor model fully subsumes the Fama-French (2018) 6-factor model in head-to-head factor spanning tests. The q-factor model is an empirical implementation of the investment CAPM. The basic philosophy is to price risky assets from the perspective of their suppliers (firms), as opposed to their buyers (investors). As a disruptive innovation, the investment CAPM has broad-ranging implications for academic finance and asset management practice.

(Debt) Overhang: Evidence from Resource Extraction
Michael Wittry
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I study the empirical importance of debt overhang using a unique dataset on resource extraction firms, which provides ex ante measures of investment opportunities and important variation in the terms of a firm’s obligations. In particular, unsecured reclamation liabilities create overhang that is costly to resolve and induces firms to forgo and postpone positive NPV investments. Traditional debt, in contrast, imposes few overhang-related investment distortions. These results show that: (i) the overhang problem is potentially large and applies more broadly to a firm’s non-debt liabilities; and (ii) overhang problems associated with traditional debt can be avoided through contracting and debt composition.

The Cyclicality of CEO Turnover
C. Jack Liebersohn and Heidi A. Packard
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CEO turnover is highly pro-cyclical. This paper aims to explain why. We begin by showing that the cyclicality is driven almost entirely by executives of retirement age. We further provide evidence that executives time their retirement to maximize the value of their pensions. Since CEO pay is pro-cyclical and pensions are based on pay in the final years of tenure, executives have the incentive to retire when the economy is doing well. Cyclicality is particular strong in firms with strong corporate governance, which suggests that retirement cyclicality is a tool firms use to constrain CEO behavior.

Eclipse of the Public Corporation or Eclipse of the Public Markets?
Craig Doidge, Kathleen M. Kahle, G. Andrew Karolyi, and René M. Stulz
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Since reaching a peak in 1997, the number of listed firms in the U.S. has fallen in every year but one. During this same period, public firms have been net purchasers of $3.6 trillion of equity (in 2015 dollars) rather than net issuers. The propensity to be listed is lower across all firm size groups, but more so among firms with less than 5,000 employees. Relative to other countries, the U.S. now has abnormally few listed firms. Because markets have become unattractive to small firms, existing listed firms are larger and older. We argue that the importance of intangible investment has grown but that public markets are not well-suited for young, R&D-intensive companies. Since there is abundant capital available to such firms without going public, they have little incentive to do so until they reach the point in their lifecycle where they focus more on payouts than on raising capital.

Why has Idiosyncratic Risk been Historically Low in Recent Years?
Söhnke M. Bartram, Gregory W. Brown, and René M. Stulz
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Since 1965, average idiosyncratic risk (IR) has never been lower than in recent years. In contrast to the high IR in the late 1990s that has drawn considerable attention in the literature, average market-model IR is 44% lower in 2013-2017 than in 1996-2000. Macroeconomic variables help explain why IR is lower, but using only macroeconomic variables leads to large prediction errors compared to using only firm-level variables. As a result of the dramatic change in the number and composition of listed firms since the late 1990s, listed firms are larger and older. Larger and older firms have lower idiosyncratic risk. Models that use firm characteristics to predict firm-level idiosyncratic risk estimated over 1963-2012 can largely or completely explain why IR is low over 2013-2017. The same changes that bring about historically low IR lead to unusu-ally high market-model R-squareds.

Which Factors
Kewei Hou, Haitao Mo, Chen Xue, and Lu Zhang
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Many recently proposed, seemingly different factor models are closely related. In spanning tests, the q-factor model largely subsumes the Fama-French (2015, 2018) 5-and 6-factor models, and the q5-model captures the Stambaugh-Yuan (2017) model. The Stambaugh-Yuan factors are sensitive to their construction, and once replicated via the standard approach, are close to the q-factors, with correlations of 0.8 and 0.84. Finally, it seems difficult to motivate the Fama-French 5-factor model from valuation theory, which predicts a positive relation between the expected investment and the expected return.

Risk Management, Firm Reputation, and the Impact of Successful Cyberattacks on Target Firms
Shinichi Kamiya, Jun-koo Kang, Jungmin Kim, Andreas Milidonis, and René M. Stulz
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We develop a model where a firm has an optimal exposure to cyber risk. With rational, fully informed agents and with no hysteresis, a successful cyberattack should have no impact on a financially unconstrained target’s reputation and post-attack policies. In contrast, when a successful attack involves the loss of personal financial information, there is a significant shareholder wealth loss, which is much larger than the attack’s out-of-pocket costs. This excess loss is higher when the attack decreases sales growth more and lower when the board pays more attention to risk management before the attack. Further, an attack decreases a firm’s risk appetite as it beefs up its risk management and information technology and decreases the risk-taking incentives of management. Finally, successful cyberattacks adversely affect the stock price of firms in the target’s industry. These results imply that successful attacks with personal financial information loss provide adverse information about cyber risk to target firms, their stakeholders, and their competitors.

Selecting Directors Using Machine Learning
Isil Erel, Léa H. Stern, Chenhao Tan, and Michael S. Weisbach
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Can algorithms assist firms in their decisions on nominating corporate directors? Directors predicted to do poorly by algorithms indeed do poorly compared to a realistic pool of candidates in out-of-sample tests. Predictably bad directors are more likely to be male, accumulate more directorships, and have larger networks than the directors the algorithm would recommend in their place. Companies with weaker governance structures are more likely to nominate them. Our results suggest that machine learning holds promise for understanding the process by which governance structures are chosen and has potential to help real-world firms improve their governance.

The Real Effects of Financial Markets: Do Short Sellers Cause CEOs to Be Fired?
Benjamin Bennett and Zexi Wang
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We study the short-selling effect on forced CEO turnover. Using difference-in-differences analyses based on the SEC Regulation SHO Pilot Program, we find short selling increases the likelihood of forced turnover. Theories suggest two potential mechanisms: informed short sellers reveal negative information (Revelation), while uninformed short sellers manipulate prices (Manipulation). Evidence shows these two mechanisms coexist. Consistent with Revelation, we find stronger effects when firms have more earnings management and less competitive product markets. Consistent with Manipulation, we find stronger effects when firms have more growth opportunities and fewer blockholders. Evidence on long-run stock performance suggests the Manipulation mechanism dominates.

Quants and Market Anomalies
Justin Birru, Sinan Gokkaya, Xi Liu, and Stanimir Markov
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Sell-side quantitative equity research analysts (Quants) conduct econometric analyses of stock returns to uncover market anomalies and assist equity analysts and institutional clients with stock selection. We present novel evidence that establishes their role in helping analysts and mutual fund clients discover market anomalies and capital markets evolve toward greater pricing efficiency. Specifically, we find that analysts and mutual fund clients with greater access to Quants make recommendations and trades that reveal greater knowledge of anomalous cross-sectional return predictability. More importantly, cross-sectional return predictability is weaker in stocks that have higher coverage (ownership) by analysts (mutual fund clients) with access to Quants, and strengthens when quasi-exogenous brokerage house closures reduce the availability of Quants.

Does Capital Flow More to High Tobin’s Q Industries?
Dong Lee, Hyun-Han Shin, and René M. Stulz
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We examine whether capital flows more to high Tobin’s q industries and find that it flows more to high q industries from 1971 until 1996 but not from 1997 to 2014. This change is due to a decrease in the q-sensitivity of equity funding resulting mostly from the increased q-sensitivity of repurchases after 1996. The increase in intangible assets, the aging of American firms, and the impact of the China shock explain much of the change in the q-sensitivity of equity funding and repurchases. The results are robust to how q is estimated and to a non-q measure of growth opportunities.

Financial Constraints and Industry Dynamics
Itzhak Ben-David, Zhi Li, and Zexi Wang
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It is well-established that financially constrained firms scale down their investment activity. The lost investment opportunities, however, could potentially be captured by other firms that are less financially constrained. We test this proposition using the Reg SHO pilot regulation, which relaxed short-selling constraints for about 30% of firms and thus tightened their financial constraints. Following the introduction of the regulation, pilot firms indeed reduced their investments, while their direct competitors increased their investments, expanded their market share, and became more profitable. We conclude that opportunities lost due to financial constraints could be salvaged by competing firms.

q⁵
Kewei Hou, Haitao Mo, Chen Xue, and Lu Zhang
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In a multiperiod investment framework, firms with high expected growth earn higher expected returns than firms with low expected growth, holding investment and expected profitability constant. This paper forms cross-sectional growth forecasts, and constructs an expected growth factor that yields an average premium of 0.82% per month (t = 9.81). The q5 model, which augments the Hou-Xue-Zhang (2015) q-factor model with the new factor, shows strong explanatory power in the cross section, and outperforms other recently proposed factor models such as the Fama-French (2018) 6-factor model.

Network Risk and Key Players: A Structural Analysis of Interbank Liquidity
Edward Denbee, Christian Julliard, Ye Li, and Kathy Yuan
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Using a structural model, we estimate the liquidity multiplier of an interbank network and banks’ contributions to systemic risk. To provide payment services, banks hold reserves. Their equilibrium holdings can be strategic complements or substitutes. The former arises when payment velocity is high and payments begets payments. The latter prevails when the opportunity cost of liquidity is large, incentivising banks to borrow neighbors’ reserves instead of holding their own. Consequently, the network can amplify or dampen individual shocks. Empirically, network topology explains cross-sectional heterogeneity in banks’ contribution to systemic risks while changes in the equilibrium type drive the time-series variation.

Are the Largest Banks Valued More Highly?
Bernadette A. Minton, René M. Stulz, and Alvaro G. Taboada
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Some argue too-big-to-fail (TBTF) status increases the value of the largest banks. In contrast, we find that the value of the largest banks is negatively related to asset size in normal times, but not during the financial crisis when TBTF status was most valuable. Further, shareholders lose when large banks cross a TBTF threshold through acquisitions. The negative relation between bank value and bank size for the largest banks cannot be explained by differences in ROA, ROE, equity volatility, tail risk, distress risk, or equity discount rates, but it can be partly explained by the market’s discounting of trading activities.

Why Do Firms Borrow Directly from Nonbanks?
Sergey Chernenko, Isil Erel, and Robert Prilmeier
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Analyzing hand-collected credit agreements for a sample of middle-market firms over 2010–2015, we find that one-third of all loans are directly extended by nonbank financial intermediaries. Two-thirds of such nonbank lending can be attributed to bank regulations that constrain banks’ ability to lend to unprofitable and highly levered borrowers. Firms with negative EBITDA and debt/EBITDA greater than six are 32% and 15% more likely to borrow from nonbanks. These firms pay significantly higher interest rates, especially following the 2013 leveraged loan guidance revisions. Nonbank borrowers also receive different nonprice terms compared to firms borrowing from banks.

The Dollar Ahead of FOMC Target Rate Changes
Nina Karnaukh
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I find that the U.S. dollar appreciates before contractionary monetary policy decisions at scheduled Federal Open Market Committee meetings and depreciates before expansionary decisions. The federal funds futures rate forecasts these dollar movements with a 22% R². A high federal funds futures spread three days in advance of an FOMC meeting not only predicts the target rate rise, but also predicts a rise in the dollar over the subsequent two-day period. This predictability is concentrated in times of high FX volatility, as the FX traders avoid arbitrage risk earlier than a few days prior to the announcement.

Tokenomics: Dynamic Adoption and Valuation
Lin William Cong, Ye Li and Neng Wang
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We develop a dynamic asset pricing model of cryptocurrencies/tokens that allows users to conduct peer-to-peer transactions on digital platforms. The equilibrium value of tokens is determined by aggregating heterogeneous users' transactional demand rather than discounting cash flows, as is done in standard valuation models. Endogenous platform adoption builds on user network externality and exhibits an S-curve: it starts slow, becomes volatile, and eventually tapers off. The introduction of tokens lowers users' transaction costs on the platform by allowing users to capitalize on platform growth. The intertemporal feedback between user adoption and token price accelerates adoption and dampens user-base volatility.

Rediscover Predictability: Information from the Relative Prices of Long-term and Short-term Dividends
Ye Li and Chen Wang
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The ratio of long- to short-term dividend prices, "price ratio" (pr), predicts one-year stock market return with an out-of-sample R2 of 19%. It subsumes the predictive power of price-to-dividend ratio (pd). The residual from regressing pd on pr predicts one-year dividend with an out-of-sample R2 of 30%. Our results hold outside the U.S. In an exponential-affine model, we show the key to understand these findings is the (lack of) persistence of expected dividend growth. We also characterize the risk of time-varying expected return: (1) the expected return is countercyclical; (2) the response of expected return (rather than expected dividend growth) accounts for the impact of monetary policy on stock price; (3) shocks to prt are priced in the cross-section, which serves as an ICAPM test of prt as an adequate proxy for the expected return.

Why is the Rent So Darn High?
Greg Howard and Jack Liebersohn
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Because of migration. In a spatial equilibrium framework, we show that three quarters of the CPI rent increase in the United States from 2000 to 2018 is due to increased demand to live in ex ante housing-supply-inelastic cities. Moving one person to a less elastic city raises the average rent because the positive effect on rents in the inelastic city outweighs the negative effect in the elastic one. In these years, the quantitative importance of this migration channel is greater if people are mobile in response to rent changes. Empirically, we show that people have high long-run mobility by estimating that income changes have similar effects on rents across cities regardless of housing supply elasticity. Supporting this migration channel, the cross-sectional pattern of migration demand implied by our model matches patterns of labor-market and amenity changes.

Corporate Investment Under the Cloud of Litigation
Benjamin Bennett, Todd Milbourn, and Zexi Wang
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We study the effect of legal risk on firms’ investment. Using legal risk measures based on the number of litigious words in SEC 10-K filings, we find legal risk reduces investment. Underlying mechanisms include both i) a financing channel, whereby legal risk reduces credit ratings, increases bank loan costs, and decreases borrowing, and ii) an attention channel, whereby legal risk consumes top-management’s attention. Accordingly, we find legal risk has negative effects on firms’ investment efficiency and stock performance. We address endogeneity concerns through a DiD analysis utilizing staggered adoptions of universal demand laws across states.

Fragile New Economy: Intangible Capital, Corporate Savings Glut, and Financial Instability
Ye Li
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Intangible-intensive firms in the U.S. hold an enormous amount of liquid assets that are in fact short-term debts issued by financial intermediaries. This paper builds a macro-finance model that captures this structure. A self-perpetuating savings glut emerges in equilibrium. As intangibles become increasingly important for production, firms hoard more liquidity to finance investments in intangibles with limited pledgeability. The resulting low interest rates induce intermediaries to increase leverage and bid up asset prices, which in turn encourages firms to invest more and hoard even more liquidity to fund expansion. Along these secular trends, endogenous risk accumulates in the financial system.

Exporting Pollution: Where Do Multinational Firms Emit CO2?
Itzhak Ben-David, Yeejin Jang, Stefanie Kleimeier, and Michael Viehs
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Despite widespread awareness of the detrimental impact of CO2 pollution on the world climate, countries vary widely in how they design and enforce environmental laws. Using novel microdata about multinational firms’ CO2 emissions across countries, we document that firms headquartered in countries with strict environmental policies perform their polluting activities abroad in countries with relatively weaker policies. These effects are largely driven by tightened environmental policies in home countries that incentivize firms to pollute abroad rather than lenient foreign policies that attract those firms. Although firms headquartered in countries with strict domestic environmental policies are more likely to export pollution to foreign countries, they nevertheless emit less overall CO2 globally.

Private Equity Indices Based on Secondary Market Transactions
Brian Boyer, Taylor D. Nadauld, Keith P. Vorkink, and Michael S. Weisbach
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We propose a new approach to evaluating the performance of private equity investments using actual prices paid for LP shares of funds transacted in secondary markets. Our transaction-based indices exhibit substantially higher CAPM betas and lower alphas than NAV-based indices even after adjusting for staleness in NAVs. Our indices load on an additional funding liquidity factor that is uncorrelated with NAV-based index returns. In comparison, a listed PE index exhibits similar loadings on the market and funding liquidity factor as our indices, but significantly lower average returns. Our indices are useful for quarter-to-quarter benchmarking and valuing illiquid stakes in funds.

Delegation Uncertainty
Yi Li and Chen Wang
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Delegation bears an intrinsic form of uncertainty. Investors hire managers for their superior models of asset markets, but delegation outcome is uncertain precisely because managers' model is unknown to investors. We model investors' delegation decision as a trade-off between asset return uncertainty and delegation uncertainty. Our theory explains several puzzles on fund performances. It also delivers asset pricing implications supported by our empirical analysis: (1) because investors partially delegate and hedge against delegation uncertainty, CAPM alpha arises; (2) the cross-section dispersion of alpha increases in uncertainty; (3) managers bet on alpha, engaging in factor timing, but factors' alpha is immune to the rise of their arbitrage capital - when investors delegate more, delegation hedging becomes stronger. Finally, we offer a novel approach to extract model uncertainty from asset returns, delegation, and survey expectations.

Public Debt, Consumption Growth, and the Slope of the Term Structure
Thien T. Nguyen
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The debt-to-GDP ratio negatively predicts cumulative nominal consumption growth up to a 10-year horizon, resulting from the ratio's ability to forecast lower inflation and real growth. Moreover, the debt-to-GDP ratio is positively associated with yield spreads. I rationalize these facts in a model in which positive shocks to government debt cause lower inflation and growth, making bonds attractive assets. Furthermore, because longer-term bonds are less exposed to current debt shock than are shorter-term bonds, they are better hedges, resulting in high yield spreads in high-debt states. The model highlights the importance of fiscal risk in understanding the Treasury bond market.

Why are Firms with More Managerial Ownership Worth Less?
Kornelia Fabisik, Rüdiger Fahlenbrach, René M. Stulz, and Jérôme P. Taillard
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Using more than 50,000 firm-years from 1988 to 2015, we show that the empirical relation between a firm’s Tobin’s q and managerial ownership is systematically negative. When we restrict our sample to larger firms as in the prior literature, our findings are consistent with the literature, showing that there is an increasing and concave relation between q and managerial ownership. We show that these seemingly contradictory results are explained by cumulative past performance and liquidity. Better performing firms have more liquid equity, which enables insiders to more easily sell shares after the IPO, and they also have a higher Tobin’s q.

Expectations Uncertainty and Household Economic Behavior
Itzhak Ben-David, Elyas Fermand, Camelia M. Kuhnen, and Geng Li
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We show that there exists significant heterogeneity across US households in how uncertain they are in their expectations regarding personal and macroeconomic outcomes, and that uncertainty in expectations predicts households' choices. Individuals with lower income or education, more precarious finances, and living in counties with higher unemployment are more uncertain in their expectations regarding own-income growth, inflation, and national home price changes. People with more uncertain expectations, even accounting for their socioeconomic characteristics, exhibit more precaution in their consumption, credit, and investment behaviors.

Assessing Managerial Ability: Implications for Corporate Governance
Benjamin E. Hermalin and Michael S. Weisbach
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A manager’s current and potential future employers are continually assessing her or his ability. Such assessment is a crucial component of corporate governance and this chapter provides an overview of the research on that aspect of governance. In particular, we review how assessment generates incentives (both good and bad), generates risks that must be faced by both managers and firms, and affects the contractual relationships between those parties in important ways. Assessment (or learning) proves a key perspective from which to study, evaluate, and possibly even regulate corporate governance. Moreover, because learning is a behavior notoriously subject to systematic biases, this perspective is a natural avenue through which to introduce behavioral and psychological insights into the study of corporate governance.

The relation between CEO equity incentives and the quality of accounting disclosures: New evidence
Karen H. Wruck and YiLin Wu
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This paper provides new evidence on the negative relation between CEO equity incentives and accounting disclosure quality. We analyze a comprehensive set of disclosure quality variables, including discretionary accruals quality, the quantity and quality of voluntary disclosures, fineness of reported financial statement information, and the narrative quality of regulatory filings, and use them to create information disclosure quality indices. We address the potential endogeneity of CEO equity incentives by conducting two-stage least squares/IV models and natural experiments created by situations in which there is an exogenous shock to the use or value of CEO stock options. Our results are robust to subsample analyses and to alternative measures of the incentives created by CEO options.

Trading Fees and Intermarket Competition
Marios Panayaides, Barbara Rindi, and Ingrid M. Werner
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We study the 2013 changes in maker-taker pricing fees implemented by BATS on its two European venues, CXE and BXE. The CXE rebate reduction deteriorates market quality and market share, whereas the BXE rebate removal and take-fee reduction improve them. We derive a model of two competing limit order books, in which large (small) stocks are characterized by investors with higher (lower) propensity to supply liquidity and by greater (lower) trading activity. Consistent with our model, we show that traders in large stocks are more reactive to rebate reductions while traders in small stocks are more reactive to take-fee reductions.

What is the Shareholder Wealth Impact of Target CEO Retention in Private Equity Deals?
Leonce Bargeron, Frederik Schlingemann, René M. Stulz, and Chad Zutter
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There is a widespread belief among observers that a lower premium is paid when the target CEO is retained by the acquirer in a private equity deal because the CEO’s potential conflicts of interest leads her to negotiate less aggressively on behalf of the target shareholders. Our empirical evidence is not consistent with this belief. We find that, when a private equity acquirer retains the target CEO, target shareholders receive an acquisition premium that is larger by as much as 18% of pre-acquisition firm value when accounting for the endogeneity of the retention decision. Our evidence is consistent with what we call the “valuable CEO hypothesis.” With this hypothesis, retention of the CEO can be valuable to private equity acquirers because, unlike public operating companies with managers in place, these acquirers have to find a CEO to run the post-acquisition company and the incumbent CEO may be the best choice to do so because she has valuable firm-specific human capital. When a private equity acquirer finds a target with a CEO who can manage the post-acquisition company better than other potential CEOs, we expect target shareholders to receive a larger premium because the post-acquisition value of the target is higher.

Cash, Financial Flexibility, and Product Prices: Evidence from a Natural Experiment in the Airline Industry
Sehoon Kim
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Corporate cash holdings impact firms’ product pricing strategies. Exploiting the Aviation Investment and Reform Act of the 21st Century as a quasi-natural experiment to identify exogenous shocks to competition in the airline industry, I find that firms with more cash than their rivals respond to intensified competition by pricing more aggressively, especially when there is less concern of rival retaliation. Financially flexible firms based on alternative measures respond similarly. Moreover, cash-rich firms experience greater market share gains and long-term profitability growth. The results highlight the importance of strategic interdependencies across firms in the effective use of flexibility provided by cash.

Impulsive Consumption and Financial Wellbeing: Evidence from an Increase in the Availability of Alcohol
Itzhak Ben-David and Marieke Bos
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Increased availability of alcohol may harm individuals if they have present-focused preferences and consume more than initially planned. Using a nationwide experiment in Sweden, we study the credit behavior of low-income households around the expansion of liquor stores' operating hours on Saturdays. Consistent with store closures serving as commitment devices, the policy led to higher credit demand, more default, increased dependence on welfare, and higher crime on Saturdays. The effects are concentrated among the young population due to higher alcohol consumption combined with tight liquidity constraints. The policy's impact on indebtedness is estimated at 4.5 times the expenditure on alcohol.

Accounting-based Compensation and Debt Contracts
Zhi Li, Lingling Wang, and Karen H. Wruck
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We examine how accounting-based compensation plans influence a firm’s contracts with its creditors. After granting long-term accounting-based compensation plans (LTAPs) to CEOs, firms pay lower spreads and have fewer restrictive covenants in new bank loans. Mechanisms leading to lower borrowing cost include improvements in debt repayment ability, reduced shareholder-debtholder conflicts, and reduced risk-taking incentives. Creditors view LTAPs as a substitute for monitoring, adjust covenant design based on LTAP features, and value plans with concave performance-payout functions and reasonable performance targets. A firm’s credit rating improves and CDS spread declines after LTAP grants, suggesting that LTAPs help reduce firms’ credit risk.

Are Larger Banks Valued More Highly?
Bernadette A. Minton, René M. Stulz, and Alvaro G. Taboada
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We investigate whether the value of large banks, defined as banks with assets in excess of the Dodd-Frank threshold for enhanced supervision, increases with the size of their assets using Tobin’s q and market-to-book as our valuation measures. Many argue that large banks receive subsidies from the regulatory safety net, so they should be worth more and their valuation should increase with size. Instead, using a variety of approaches, we find (1) no evidence that large banks are valued more highly, (2) strong cross-sectional evidence that the valuation of large banks falls with size, and (3) strong evidence of a within-bank negative relation between valuation and size for large banks from 1987 to 2006 but not when the post-Dodd-Frank period is included in the sample. The negative relation between bank value and bank size for large banks cannot be systematically explained by differences in ROA or ROE, equity volatility, tail risk, distress risk, and equity discount rates. However, we find that banks with more trading assets are worth less. A 1% increase in trading assets is associated with a Tobin’s q lower by 0.2% in regressions with year and bank fixed effects. This relation between bank value and trading assets helps explain the cross-sectional negative relation between large bank valuation and size. Our results hold when we use instrumental variables for bank size.

Is Post-Crisis Bond Liquidity Lower?
Mike Anderson and René M. Stulz
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Price-based liquidity metrics are much better for small trades after the crisis than before the crisis. For large trades, these metrics are generally worse from 2010 to 2012 and better from 2013 to 2014 than from 2004 to 2006. However, turnover falls sharply after the crisis, which is consistent with investors having more difficulty completing trades on acceptable terms. A frequent concern is that post-crisis liquidity could be low when markets are stressed. We consider three stress events: extreme VIX increases, extreme bond yield increases, and downgrades to high yield. We find evidence that liquidity is lower after the crisis for extreme VIX increases. However, we find no evidence that liquidity related to idiosyncratic stress events is worse after the crisis than before the crisis. Our results emphasize the importance of considering how liquidity reacts to shocks which can affect financial stability and of taking into account the information from non-price liquidity metrics.

Replicating Anomalies
Kewei Hou, Chen Xue, and Lu Zhang
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The anomalies literature is infested with widespread p-hacking. We replicate the entire anomalies literature in finance and accounting by compiling a largest-to-date data library that contains 447 anomaly variables. With microcaps alleviated via New York Stock Exchange breakpoints and value-weighted returns, 286 anomalies (64%) including 95 out of 102 liquidity variables (93%) are insignificant at the conventional 5% level. Imposing the cutoff t-value of three raises the number of insignificance to 380 (85%). Even for the 161 significant anomalies, their magnitudes are often much lower than originally reported. Out of the 161, the q-factor model leaves 115 alphas insignificant (150 with t < 3). In all, capital markets are more efficient than previously recognized.

The International Propagation of Economic Downturns Through Multinational Companies: The Real Economy Channel
Jan Bena, Serdar Dinc, and Isil Erel
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We study how non-financial multinational companies propagate economic declines from their subsidiaries located in countries experiencing an economic downturn to subsidiaries in countries not experiencing one. We find that investment is 18% lower in subsidiaries of these parents relative to the same-industry, same-country subsidiaries of parents that are headquartered in the same parent country but do not have a subsidiary in a country experiencing an economic downturn. The employment growth rate in the affected subsidiaries is zero or negative while it is 1.4% in the subsidiaries of unaffected parents. The aggregate industry-level sales and employment are also negatively impacted in the countries of the affected subsidiaries.

Product Price Risk and Liquidity Management: Evidence from the Electricity Industry
Chen Lin, Thomas Schmid, and Michael S. Weisbach
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Product price risk is a potentially important factor for firms’ liquidity management. A natural place to evaluate the impact of this risk on liquidity management is the electricity industry, since producing firms face substantial price volatility in wholesale markets. Empirically, higher volatility of electricity prices leads to an increase in cash holdings, and this effect is robust to instrumenting for price risk using weather volatility. Cash increases more with price risk in firms using inflexible production technologies and those that cannot easily hedge electricity prices, indicating that operating flexibility and hedging are substitutes for liquidity management.

Corporate Liquidity, Acquisitions, and Macroeconomic Conditions
Isil Erel, Yeejin Jang, Bernadette A. Minton, and Michael S. Weisbach
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This paper evaluates how the relation between firms’ cash holdings and their acquisition decisions changes over macroeconomic cycles using a sample of 47,615 acquisitions from 36 countries between 1997 and 2014. Higher cash holdings and stronger macroeconomic conditions each increase the likelihood that a firm will make an acquisition. However, larger cash holdings decrease the sensitivity of acquisitions to macroeconomic factors, suggesting that cash holdings lower financing constraints during times when the cost of external finance is high. Announcement day abnormal returns for acquirers follow a consistent pattern: they decrease with acquirer cash holdings and with better macroeconomic conditions.

Can Reinvestment Risk Explain the Dividend and Bond Term Structures?
Andrei S. Gonçalves
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Contradicting leading asset pricing models, recent evidence indicates the term structure of dividend discount rates is downward sloping despite the typical upward sloping bond yield curve. This paper empirically shows that reinvestment risk explains both the dividend and bond term structures. Intuitively, dividend claims hedge equity reinvestment risk because dividend present values rise as expected returns decline. This hedge is more effective for longer-term dividend claims because they are more sensitive to discount rate variation, resulting in a downward sloping dividend term structure. For bonds, as expected equity returns decline, nominal interest rates rise, and bond prices fall. Consequently, bonds are exposed to equity reinvestment risk, and this exposure increases with duration, giving rise to an upward sloping bond term structure.

How Important Was Contagion Through Banks During the European Sovereign Crisis?
Andrea Beltratti and René M. Stulz
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We use days with tail sovereign CDS spread changes of peripheral countries to identify the effects of shocks to the cost of borrowing of these countries on stock returns of banks from other countries. We find that tail sovereign GIIPS CDS changes have an asymmetric impact in that bank stocks benefit more from negative CDS spread shocks than they are hurt by positive shocks, which creates moral hazard and is best explained by a “too-systemic-to-fail” effect. The contagion effects are stronger for more pervasive shocks, so that idiosyncratic shocks to small countries, such as Greece, do not have an economically significant impact, but shocks involving large GIIPS countries or multiple GIIPS countries have such an impact. In our benchmark specification, holdings of peripheral country bonds by banks from other countries do not constitute a statistically or economically significant contagion channel for tail spread increases.

The Economics of Value Investing
Kewei Hou, Haitao Mo, Chen Xue, and Lu Zhang
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The investment CAPM provides an economic foundation for Graham and Dodd’s (1934) Security Analysis, without mispricing. Expected returns vary cross-sectionally, depending on firms’ investment, expected profitability, and expected investment growth. Our economic model also offers an appealing alternative to two workhorse accounting models. Empirically, many anomaly variables are associated with future investment growth, in the same direction with future returns. An expected growth factor earns on average 0.56% per month (t = 6.66), and adding it to the q-factor model improves the model’s performance substantially. In all, value investing is consistent with efficient markets.

De Facto Seniority, Credit Risk, and Corporate Bond Prices
Jack Bao and Kewei Hou
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We study the effect of a bond's place in its issuer's maturity structure on credit risk. Using a structural model as motivation, we argue that bonds due relatively late in their issuers' maturity structure have greater credit risk than do bonds due relatively early. Empirically, we find robust evidence that these later bonds have larger yield spreads and greater comovement with equity and that the magnitude of the effects is consistent with model predictions for investment-grade bonds. Our results highlight the importance of bond-specific credit risk for understanding corporate bond prices.

U.S. Tick Size Pilot
Barbara Rindi and Ingrid Werner
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The U.S. equity markets recently increased the tick size from one to five cents for smaller capitalization stocks. We show that the larger tick size raised the cost for retail-sized liquidity demanding orders by almost fifty percent, and raised profits to liquidity providers by forty percent. The bulk of the effects occurred for tick-constrained stocks for which trading costs more than doubled. Trading costs for unconstrained stocks declined by more than ten percent. Finally, we document significant changes in market quality for control stocks relative to similar stocks that were not part of the study.

Aggregation, Capital Heterogeneity, and the Investment CAPM
Andrei S. Gonçalves, Chen Xue and Lu Zhang
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A detailed treatment of aggregation and capital heterogeneity substantially improves the performance of the investment CAPM. Firm-level predicted returns are constructed from firm-level accounting variables and aggregated to the portfolio level to match with portfolio-level stock returns. Working capital forms a separate productive input besides physical capital. The model fits well the value, momentum, investment, and profitability premiums simultaneously and partially explains the positive stock-fundamental return correlations, the procyclical and short-term dynamics of the momentum and profitability premiums, as well as the countercyclical and long-term dynamics of the value and investment premiums. However, the model falls short in explaining momentum crashes.

Do CEOs Make Their Own Luck? Relative versus Absolute Performance Evaluation and Firm Risk
Karen H. Wruck and YiLin Wu
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Influenced by their compensation plans, CEOs make their own luck through decisions that affect future firm risk. After adopting a relative performance evaluation (RPE) plan, total and idiosyncratic risk are higher, and the correlation between firm and industry performance is lower. The opposite is true for firms that adopt absolute performance evaluation (APE) plans. Plans including accounting-based performance metrics and/or cash payouts have weaker risk-related incentives. The higher idiosyncratic risk associated with RPE increases a firm’s exposure to downside stock return risk and lowers credit quality. Our findings are economically consistent with observed differences in firms’ financial and investment policies.

The Politics of Foreclosures
Sumit Agarwal, Gene Amromin, Itzhak Ben-David, and Serdar Dinc
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U.S. House of Representatives Financial Services Committee considered many important banking reforms in 2009-2010 including the Dodd-Frank Act. We show that during this period, the foreclosure starts on delinquent mortgages were delayed in the districts of committee members even though there was no difference in delinquency rates between committee and non-committee districts. In these areas, banks delayed the start of the foreclosure process by 0.5 months (relative to the 12-month average). The total estimated cost of delay to lenders is an order of magnitude greater than the campaign contributions by the Political Action Committees of the largest mortgage servicing banks to the committee members in that period and is comparable to these banks' lobbying expenditures.

The Economics of PIPEs
Jongha Lim, Michael W. Schwert, and Michael S. Weisbach
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Private investments in public equities (PIPEs) are an important source of finance for public corporations. PIPE investor returns decline with holding periods, while time to exit depends on the issue’s registration status and underlying liquidity. We estimate PIPE investor returns adjusting for these factors. Our analysis, which is the first to estimate returns to investors rather than issuers, indicates that the average PIPE investor holds the stock for 384 days and earns an abnormal return of 19.7%. More constrained firms tend to issue PIPEs to hedge funds and private equity funds in offerings that have higher expected returns and higher volatility. PIPE investors’ abnormal returns appear to reflect compensation for providing capital to financially constrained firms.

Does Borrowing from Banks Cost More than Borrowing from the Market?
Michael W. Schwert
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This paper investigates the pricing of bank loans relative to capital market debt. The analysis relies on a novel sample of syndicated loans matched with bond spreads from the same firm on the same date. After accounting for seniority, banks earn an economically large premium relative to the market price of credit risk. To quantify the premium, I apply a structural model that accounts for priority structure, prices the firm's bonds, and matches expected losses given default and secondary market bid-ask spreads. In a sample of secured term loans to non-investment-grade firms, the average loan premium is 143 bps, equal to 43% of the all-in-drawn spread. These findings are the first direct evidence of firms' willingness to pay for the unique qualities of bank loans and raise questions about the nature of competition in the loan market.

Government Debt and Bank Leverage Cycle: An Analysis of Public and Intermediated Liquidity
Yi Li
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Financial intermediaries issue the majority of liquid securities, and nonfinancial firms have become net savers, holding intermediaries' debt as cash. This paper shows that intermediaries' liquidity creation stimulates growth -- firms hold their debt for unhedgeable investment needs -- but also breeds instability through procyclical intermediary leverage. Introducing government debt as a competing source of liquidity is a double-edged sword: firms hold more liquidity in every state of the world, but by squeezing intermediaries' profits and amplifying their leverage cycle, public liquidity increases the frequency and duration of intermediation crises, raising the likelihood of states with less liquidity supplied by intermediaries. The latter force dominates and the overall impact of public liquidity is negative, when public liquidity cannot satiate firms' liquidity demand and intermediaries are still needed as the marginal liquidity suppliers.

Political Uncertainty and Commodity Prices
Kewei Hou, Ke Tang, and Bohui Zhang
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Using a comprehensive sample of 87 commodities, we examine the effect of political uncertainty on commodity prices. We show that political uncertainty surrounding U.S. presidential elections has a significant negative impact on commodity prices worldwide, likely due to shrinking demand before the elections. On average, commodity prices decline by 6.4% in the quarter leading up to U.S. elections. This effect holds true for gold, and is stronger for close elections and elections during recessions. On the other hand, political uncertainty in commodity producing countries with little demand pushes commodity prices up by 5.4% in the quarter before their national elections.

Decreasing Returns or Mean-reversion of Luck? The Case of Private Equity Fund Growth
Andrea Rossi
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In private equity fund data, there exists a strong negative association between fund growth and performance at the partnership level. As a consequence, there is a consensus that decreasing returns are particularly large. I argue that this inference is unwarranted. In essence, Bayesian-informed expectations reveal that the partnerships whose funds grew the most were on average lucky in the past; as that luck reverts to zero, a spurious negative association between growth and returns is generated in the data. Controlling for this bias, the effect of growth on performance is about 80% smaller and statistically insignificant for both buyout and venture capital funds. Furthermore, I show that, historically, decreasing returns do not seem to have played a major role in the erosion of performance persistence in private equity. These results have implications for fund managers’ and investors’ decisions, and for our understanding of the private equity industry.

How Do Financial Constraints Affect Product Pricing? Evidence from Weather and Life Insurance Premiums
Shan Ge
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I identify effects of financial constraints on firms’ product pricing decisions, using a sample of insurance groups (conglomerates) that contain both life and P&C (property & casualty) subsidiaries. P&C subsidiaries’ losses can tighten financial constraints for the life subsidiaries through internal capital markets. I present a model that predicts following P&C losses, premiums should fall for life policies that initially increase insurers’ statutory capital, and rise for policies that initially decrease capital. Empirically, I find that P&C losses cause changes in life insurance premiums as my model predicts. The effects are concentrated in more financially constrained groups. Evidence also indicates that life subsidiaries increase capital transfers to P&C subsidiaries following larger P&C losses. These results hold when instrumenting for P&C losses using data on weather damages, implying that P&C losses do cause changes in life insurance premiums and internal capital transfers. My findings suggest that when financial constraints tighten, firms change product prices to relax the constraints, and how prices change depends on the initial impact of selling the products on firms’ financial resources.

Corporate Deleveraging and Financial Flexibility
Harry DeAngelo, Andrei S. Gonçalves, René M. Stulz
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Most firms deleverage from their historical peak market-leverage (ML) ratios to near-zero ML, while also markedly increasing cash balances to high levels. Among 4,476 nonfinancial firms with five or more years of post-peak data, median ML is 0.543 at the peak and 0.026 at the later trough, with a six-year median time from peak to trough and with debt repayment and earnings retention accounting for 93.7% of the median peak-to-trough decline in ML. The findings support theories in which firms deleverage to restore ample financial flexibility and are difficult to reconcile with most firms having materially positive leverage targets.

Does the Stock Market Make Firms More Productive?
Benjamin Bennett, René M. Stulz, Zexi Wang
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Management, directly or indirectly, learns from its firm’s stock price, so that a more informative stock price should make the firm more productive. We show that stock price informativeness increases firm productivity. We predict and confirm that the productivity of smaller and younger firms, better governed firms, more specialized firms, and firms with more competition is more strongly related to the informativeness of their stock price. We address endogeneity concerns with fixed effects, instrumental variables, and the use of brokerage house research department closures and S&P 500 additions as plausibly exogenous events. 1

The Finance Uncertainty Multiplier
Iván Alfaro, Nicholas Bloom, and Xiaoji Lin
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We show how real and financial frictions amplify the impact of uncertainty shocks. We build a model with real frictions, and find adding financial frictions roughly doubles the impact of uncertainty shocks. Higher uncertainty alongside financial frictions induces the standard real-options effects on investment and hiring, but also leads firms to hoard cash, further reducing investment and hiring. We then test the model using a panel of US firms and a novel instrumentation strategy for uncertainty exploiting differential firm exposure to exchange rate and price volatility. These results highlight why in periods with greater financial frictions uncertainty can be particularly damaging.

Day of the Week and the Cross-Section of Returns
Justin Birru
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Long-short anomaly returns are strongly related to the day of the week. Anomalies for which the speculative leg is the short (long) leg experience the highest (lowest) returns on Monday. The opposite pattern is observed on Fridays. The effects are large; Monday (Friday) alone accounts for over 100% of returns for all anomalies examined for which the short (long) leg is the speculative leg. Consistent with a mispricing explanation, the pattern is driven by the speculative leg. The observed patterns are consistent with the abundance of evidence in the psychology literature that mood increases on Friday and decreases on Monday.

Systemic Default and Return Predictability in the Stock and Bond Markets
Jack Bao, Kewei Hou, and Shaojun Zhang
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We construct a measure of systemic default defined as the probability that many firms default at the same time. We account for correlations in defaults between firms through exposures to common shocks. Systemic default spikes during recessions, is correlated with macroeconomic indicators, and predicts future realized defaults. More importantly, it predicts future equity and corporate bond index returns both in- and out-of-sample. Finally, we find that the cross-section of average stock returns is related to firm-level exposures to systemic default risk.

Institutional Investments in Pure Play Stocks and Implications for Hedging Decisions
Bernadette A. Minton and Catherine Schrand
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We show that institutions invest in stocks within an industry that maintain exposure to their underlying industry risk factor. These "pure play" stocks have greater numbers of institutional investors and institutions systematically overweight them in their portfolios while underweighting low industry-exposure stocks of firms in the same nominal industry. Pure play stocks also have greater liquidity measured by stock turnover and price impact. An implication of these results is that catering to these preferences could be an important variable in firms’ risk management decisions, potentially offsetting incentives to reduce volatility via hedging. We further characterize institutions’ investments for pure play stocks across institution type, industries, and over time.

Hedging Interest Rate Risk Using a Structural Model of Credit Risk
Jing-Zhi Huang and Zhan Shi
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Recent evidence has shown that structural models fail to capture interest rate sensitivities of corporate debt. We consider a structural model that incorporates a three-factor dynamic term structure model (DTSM) into the Merton (1974) model. We show that the proposed model largely captures the interest rate exposure of corporate bonds. We also find that for investment-grade bonds, hedging effectiveness substantially improves under the proposed model. Our results indicate that to better capture and hedge the interest rate exposure of corporate bonds, we need to incorporate a more realistic DTSM in the existing structural models.

Liquidity Transformation in Asset Managment: Evidence from the Cash Holdings of Mutual Funds
Sergey Chernenko and Adi Sunderman
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We study liquidity transformation in mutual funds using a novel data set on their cash holdings.To provide investors with claims that are more liquid than the underlying assets, funds engage in substantial liquidity management. Specifically, they hold substantial amounts of cash, which they use to accommodate inflows and outflows rather than transacting in the underlying portfolio assets. This is particularly true for funds with illiquid assets and at times of low market liquidity. We provide evidence suggesting that mutual funds’ cash holdings are not large enough to fully mitigate price impact externalities created by the liquidity transformation they engage in.

How Management Risk Affects Corporate Debt
Yihui Pan, Tracy Yue Wang, and Michael Weisbach
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We evaluate whether management risk, coming from uncertainty about management’s value added, affects firms’ default risks and debt pricing. We find that, regardless of the reason for the turnover, CDS spreads, loan spreads and bond yield spreads all increase at the time of management turnover, when management risk is highest, and decline over the first three years of CEO tenure. The effects increase with the prior uncertainty about the new management. These results are consistent with the view that management risk affects firms’ default risk. An understanding of management risk yields a number of implications for corporate finance.

Why does fast loan growth predict poor performance for banks?
Rüdiger Fahlenbrach, Robert Prilmeier, and René M. Stulz
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From 1973 to 2014, the common stock of U.S. banks with loan growth in the top quartile of banks over a three-year period significantly underperforms the common stock of banks with loan growth in the bottom quartile over the next three years. The benchmark-adjusted cumulative difference in performance over three years exceeds twelve percentage points. The high growth banks also have significantly higher crash risk over the three-year period. This poor performance is explained by fast loan growth as asset growth separate from loan growth is not followed by poor performance. These banks reserve less for loan losses when their loans grow quickly than other banks. Subsequently, they have a lower return on assets and increase their loan loss reserves. The poorer performance of the fast growing banks is not explained by merger activity and loan growth through mergers is not accompanied by the same poor loan performance. The evidence is consistent with fast-growing banks, analysts, and investors failing to properly appreciate the extent to which the fast loan growth results from making riskier loans and failing to charge for these risks correctly.

Industry Familiarity and Trading: Evidence from the Personal Portfolios of Industry Insiders
Itzhak Ben-David, Justin Birru, and Andrea Rossi
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We study whether industry familiarity is an advantage in stock trading by exploring the trading patterns of industry insiders in their own personal portfolios. To do so, we identify accounts of industry insiders in a large dataset provided by a retail discount broker. We find that insiders trade firms from their own industry
more frequently. Furthermore, they earn abnormal returns exclusively when trading own-industry stocks, especially obscure stocks (small, low analyst coverage, high volatility). In a battery of tests, we find no evidence of the use of private information. The results are most consistent with the interpretation that industry familiarity is an advantage in stock trading.

Systematic Mistakes in the Mortgage Market and Lack of Financial Sophistication
Sumit Agarwal, Itzhak Ben-David, and Vincent Yao
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Institutions often offer a menu of contracts to consumers in an attempt to create a separating equilibrium that reveals borrower types and provides better pricing. We test the effectiveness of a specific set of contracts in the mortgage market: mortgage points. Points allow borrowers to exchange an upfront amount for a decrease in the mortgage rate. We document that, on average, points takers lose about $700. Also, points takers are less financially savvy (less educated, older), and they make mistakes on other dimensions (e.g., inefficiently refinancing their mortgages). Overall, our results show that borrowers overestimate how long they will stay with the mortgage.

Government Debt and the Returns to Innovation
Mariano Croce, Thien T. Nguyen, Steve Raymond, and Lukas Schmid
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Elevated levels of government debt raise concerns about their effects on long-term growth prospects. Using the cross section of US stock returns, we show that (i) high-R&D firms are more exposed to government debt and pay higher expected returns than low-R&D firms, and (ii) higher levels of the debt-to-GDP ratio predict higher risk premiums for high-R&D firms. Furthermore, rises in the cost of capital for innovation-intensive firms predict declines in subsequent productivity and economic growth. We propose a production-based asset pricing model with endogenous innovation and fiscal policy shocks that can rationalize key aspects of the empirical evidence. Our study highlights a novel and distinct risk channel shaping the link between government debt and future growth.

The Liquidity Cost of Private Equity Investments: Evidence from Secondary Market Transactions
Taylor D. Nadauld, Berk A. Sensoy, Keith Vorkink, and Michael S. Weisbach
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This paper uses proprietary data from a leading intermediary to understand the magnitude and determinants of transaction costs in the secondary market for private equity stakes. Most transactions occur at a discount to net asset value. Buyers average an annualized public market equivalent of 1.023 compared to 0.976 for sellers, implying that buyers outperform sellers by a market-adjusted five percentage points annually. Both the cross-sectional pattern of transaction costs and the identity of sellers and buyers suggest that the market can be characterized as one in which relatively flexible buyers earn returns by supplying liquidity to investors wishing to exit.

The Structure of Banker’s Pay
Benjamin Bennett, Radhakrishnan Gopalan, and Anjan Thakor
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While executive compensation is often blamed for the excessive risk taking by banks, little is known about the operating performance incentives used in the finance industry both prior to and subsequent to the recent crisis. We provide a comprehensive analysis of incentive design -- the link of compensation to operating performance -- in financial firms and compare incentive structures in financial firms to those in non-financial firms. Top executives in financial firms are paid less than their counterparts in non-financial firms of similar size and performance. Banks (and insurance firms) link a larger fraction of top executive pay to short-term accounting metrics like ROE and EPS and a smaller fraction to (long-term) stock price. Performance targets for bankers are not related to the risk of the bank, and ROE targets are not appropriately adjusted for leverage. Consequently, the design of executive compensation in banking may encourage both high leverage and risk-taking, and our evidence provides a potential explanation for the strong positive correlation that we document between the extent of short-term pay for bank CEOs and the risk of the bank before the financial crisis.

Why does idiosyncratic risk increase with market risk?
Söhnke M. Bartram, Gregory Brown, and René M. Stulz
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From 1963 through 2015, idiosyncratic risk (IR) is high when market risk (MR) is high. We show that the positive relation between IR and MR is highly stable through time and is robust across exchanges, firm size, liquidity, and market-to-book groupings. Though stock liquidity affects the strength of the relation, the relation is strong for the most liquid stocks. The relation has roots in fundamentals as higher market risk predicts greater idiosyncratic earnings volatility and as firm characteristics related to the ability of firms to adjust to higher uncertainty help explain the strength of the relation. Consistent with the view that growth options provide a hedge against macroeconomic uncertainty, we find evidence that the relation is weaker for firms with more growth options.

Measuring Institutional Investors’ Skill from Their Investments in Private Equity
Daniel R. Cavagnaro, Berk A. Sensoy, Yingdi Wang, and Michael S. Weisbach
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Using a large sample of institutional investors’ investments in private equity funds raised between 1991 and 2011, we estimate the extent to which investors’ skill affects their returns. Bootstrap analyses show that the variance of actual performance is higher than would be expected by chance, suggesting that some investors consistently outperform. Extending the Bayesian approach of Korteweg and Sorensen (2017), we estimate that a one standard deviation increase in skill leads to an increase in annual returns of between one and two percentage points. These results are stronger in the earlier part of the sample period and for venture funds.

Why does capital no longer flow more to the industries with the best growth opportunities?
Dong Lee, Hyun-Han Shin, and René M. Stulz
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With functionally efficient capital markets, we expect capital to flow more to the industries with the best growth opportunities. As a result, these industries should invest more and see their assets grow more relative to industries with the worst growth opportunities. We find that industries that receive more funds have a higher industry Tobin’s q until the mid-1990s, but not since then. Since industries with a higher funding rate grow more, there is a negative correlation not only between an industry’s funding rate and industry q but also between capital expenditures and industry q since the mid-1990s. We show that capital no longer flows more to the industries with the best growth opportunities because, since the middle of the 1990s, firms in high q industries increasingly repurchase shares rather than raise more funding from the capital markets.

Municipal Bond Liquidity and Default Risk
Michael Schwert
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This paper examines the pricing of bonds issued by states and local governments. I use three distinct, complementary approaches to decompose municipal bond spreads into default and liquidity components, finding that default risk accounts for 74% to 84% of the average municipal bond spread after adjusting for tax-exempt status. The first approach estimates the liquidity component using transaction data, the second measures the default component with credit default swap data, and the third is a quasi-natural experiment that estimates changes in default risk around pre-refunding events. The price of default risk is high given the rare incidence of municipal default and implies a high risk premium.

Bank Capital and Lending Relationships
Michael Schwert
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This paper investigates the mechanisms behind the matching of banks and firms in the loan market and the implications of this matching for lending relationships, bank capital, and the provision of credit. I find that bank-dependent firms borrow from well capitalized banks, while firms with access to the bond market borrow from banks with less capital. This matching of bank-dependent firms with stable banks smooths cyclicality in aggregate credit provision and mitigates the effects of bank shocks on the real economy.

Loan Product Steering in Mortgage Markets
Sumit Agarwal, Gene Amromin, Itzhak Ben-David, and Douglas D. Evanoff
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We present evidence of a particular type of loan steering in which lenders lead borrowers to take out high margin mortgage products. We identify this activity by comparing borrowers who were rejected by lenders but were subsequently approved by their affiliates (steered borrowers) to other initially rejected borrowers who obtained loans elsewhere. Although steered borrowers default less, they pay significantly higher interest rates and are more likely to borrow through contracts with unconventional features, such as negative amortization or prepayment penalties. Female borrowers, single borrowers with no co-signers, and borrowers in low-income locations are more likely to be steered.

(Priced) Frictions
Kewei Hou, Sehoon Kim, and Ingrid M. Werner
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We propose a parsimonious measure based solely on daily stock returns to characterize the severity of microstructure frictions at the individual stock level and assess the impact of frictions on the cross section of stock returns. Stocks with the largest frictions command a value-weighted return premium as large as 10% per year on a risk-adjusted basis. The friction premium is stronger among small, low price, volatile, value, and illiquid stocks. Return spreads associated with momentum and idiosyncratic volatility are smaller and statistically less significant than previously documented after screening out stocks with high microstructure frictions. Using UK data, we show that our measure is useful in settings where the availability of quality data on trading volume, bid-ask prices, and intraday high-low prices is limited.

Investment, Tobin's Q, and Interest Rates
Xiaoji Lin, Chong Wang, Neng Wang, and Jinqiang Yang
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To study the impact of stochastic interest rates and capital illiquidity on investment and firm value, we incorporate a widely-used arbitrage-free term structure model of interest rates into a standard q-theoretic framework. Our generalized q model informs us to use corporate credit-risk information to predict investments when empirical measurement issues of Tobin's average q are significant (e.g., equity is much more likely to be mis-priced than debt) as in Philippon (2009). Consistent with our theory, we find that credit spreads and bond q have significant predictive powers on micro-level and aggregate investments corroborating the recent empirical work of Gilchrist and Zakrajšek (2012). We also show that the quantitative effects of the stochastic interest rates and capital illiquidity on investment, Tobin's average q, the duration and user cost of capital, as well as the value of growth opportunities are substantial. These findings are particularly important in today's low interest-rate environment.

Corporate Deleveraging
Harry DeAngelo, Andrei S. Gonçalves, and René M. Stulz
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Proactive deleveraging from all-time peak market leverage (ML) to near-zero ML and negative net debt is the norm among 4,476 nonfinancial firms with five or more years of post-peak data. ML is 0.543 at the historical peak and 0.026 at the later trough for the median firm in this sample, with a six-year median time from peak to trough. These deleveraging episodes are largely proactive, with debt repayment and earnings retention accounting for 93.7% of the peak-to-trough decline in ML for the median firm. Attenuated deleveraging, with ML staying well above zero, is the norm at 3,118 firms that are delisted due to financial distress within four years of peak. Leverage is path dependent, with the key to explaining whether ML is high or low at the post-peak trough being how high it was at the peak and prior trough and whether the firm has had only a short time to deleverage, e.g., due to distress-related delisting. The findings are consistent with proactive deleveraging to avoid distress and to restore financial flexibility, and are hard to reconcile with materially positive target leverage ratios.

Exchange Traded Funds (ETFs)
Itzhak Ben-David, Francesco A. Franzoni, and Rabih Moussawi
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Over nearly a quarter of a century, ETFs have become one of the most popular passive investment vehicles among retail and professional investors due to their low transaction costs and high liquidity. By the end of 2016, the market share of ETFs topped over 10% of the total market capitalization traded on US exchanges, while representing more than 30% of the overall trading volume. ETFs revolutionized the asset management industry by taking market share from traditional investment vehicles such as mutual funds and index futures. Because ETFs rely on arbitrage activity to synchronize their prices with the prices of the underlying portfolio, trading activity at the ETF level translates to trading of the underlying securities. Researchers found that while ETFs enhance price discovery, they also inject non-fundamental volatility to market prices and affect the correlation structure of returns. Furthermore, ETFs impact the liquidity of the underlying portfolios, especially during events of market stress.

Is the American public corporation in trouble?
Kathleen Kahle and René M. Stulz
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We examine the current state of the American public corporation and how it has evolved over the last forty years. There are fewer public corporations now than forty years ago, but they are much older and larger. They invest differently, as the importance of R&D investments has grown relative to capital expenditures. On average, public firms have record high cash holdings and in most recent years they have more cash than long-term debt. They are less profitable than they used to be and profits are more concentrated, as the top 100 firms now account for most of the net income of American public firms. Accounting statements are less informative about the performance and the value of firms because firms increasingly invest in intangible assets that do not appear on their balance sheets. Firms’ total payouts to shareholders as a percent of net income are at record levels, suggesting that firms either lack opportunities to invest or have poor incentives to invest. The credit crisis appears to leave few traces on the course of American public corporations.

Do Firms Issue More Equity When Markets Become More Liquid?
Rogier M. Hanselaar, René M. Stulz, and Mathijs A. van Dijk
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Using quarterly data on IPOs and SEOs in 38 countries over the period 1995-2014, we show that changes in equity issuance are significantly and positively related to lagged changes in aggregate local market liquidity. This relation is at least as economically significant as the well-known relation between equity issuance and lagged stock returns. It survives the inclusion of proxies for market timing, capital market conditions, growth prospects, asymmetric information, and investor sentiment, as well as the exclusion of the financial crisis. Changes in liquidity are less relevant for firms that face greater financial pressures, firms in less financially developed countries, and during the financial crisis.

Limited Risk Sharing and International Equity Returns
Shaojun Zhang
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Limited stock market participation can potentially explain the disconnect between international asset prices and macro quantities. An incomplete markets model in which risk sharing for stockholders is high, generates highly correlated equity returns and relatively smooth exchange rates. Risk sharing for non-stockholders is limited because of their non-participation in stock markets and borrowing constraints, lowering aggregate consumption correlation and the correlation between aggregate consumption differentials and exchange rates. Further, financial integration widens the disconnect by benefiting stockholders but hurting non-stockholders. Survey data indicate that international risk sharing for stockholders is better than that for non-stockholders, lending support to the predictions.

Understanding the Variation in the Information Content of Earnings: A Return Decomposition Analysis
Kewei Hou, Yinglei Zhang and Zili Zhuang
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We use the Campbell (1991) return decomposition framework to reexamine the variation in the information content of earnings between profit firms and loss firms and over time. We show that current earnings surprises are more strongly correlated with the discount rate news component of returns for loss firms and in the recent period. This stronger correlation offsets the positive relation between current earnings surprises and the earnings news component of returns, causing the overall earnings-return relation to be weaker for loss firms and during the recent period. Consistent with these findings, we also find that discount rate news is a more important driver of the return variation of loss firms and in the recent period. Our results highlight the importance of time-varying discount rates for understanding the information content of earnings.

Are Firms in "Boring" Industries Worth Less?
Jia Chen, Kewei Hou and René M. Stulz
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Using theories from the behavioral finance literature to predict that investors are attracted to industries with more salient outcomes and that therefore firms in such industries have higher valuations, we find that firms in industries that have high industry-level dispersion of profitability have on average higher market-to-book ratios than firms in low dispersion industries. This positive relation between market-to-book ratios and industry profitability dispersion is economically large and statistically significant and is robust to controlling for variables used to explain firm-level valuation ratios in the literature. Consistent with the mispricing explanation of this finding, we show that firms in less boring industries have a lower implied cost of equity and lower realized returns. We explore alternative explanations for our finding, but find that these alternative explanations cannot explain our results.

The CAPM Strikes Back? An Investment Model with Disasters
Hang Bai, Kewei Hou, Howard Kung and Lu Zhang
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Value stocks are more exposed to disaster risk than growth stocks. Embedding disasters into an investment-based asset pricing model induces strong nonlinearity in the pricing kernel. Our single-factor model reproduces the failure of the CAPM in explaining the value premium in finite samples in which disasters are not materialized, and its relative success in samples in which disasters are materialized. The relation between pre-ranking market betas and average returns is flat in simulations, despite a strong positive relation between true market betas and expected returns. Evidence in the long U.S. sample from 1926 to 2014 lends support to the model’s key predictions.

Tick Size: Theory and Evidence
Ingrid Werner, Yuanji Wen, Barbara Rindi, Francesco Consonni, and Sabrina Buti
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We model a public limit order book where rational traders decide whether to demand or supply liquidity, and where liquidity builds endogenously. The model predicts that a reduction of the tick size will cause spreads and welfare to deteriorate for illiquid but improve for liquid books. We find empirical support for these predictions based on European and U.S. data. The model also generates predictions for volume, but we find less empirical support for these predictions which we attribute to opportunistic High-Frequency-Traders selectively entering the market.

A Comparison of New Factor Models
Kewei Hou, Chen Xue and Lu Zhang
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Using hundreds of significant anomalies as testing portfolios, this paper compares the performance of major empirical asset pricing models. The q-factor model and a closely related five-factor model are the two best performing models among a long array of models. The q-factor model outperforms the five-factor model in factor spanning tests and in explaining momentum and profitability anomalies, but the five-factor model has an edge in explaining value-versus-growth anomalies. Investment and profitability, not liquidity, are the key driving forces in the broad cross section of expected stock returns.

Bank Sovereign Bond Holdings, Sovereign Shock Spillovers, and Moral Hazard During the European Crisis
Andrea Beltratti and René M. Stulz
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From 2010 to 2012, the relation between bank stock returns from European Union (EU) countries and the returns on sovereign CDS of peripheral (GIIPS) countries is negative. We use days with tail sovereign CDS returns of peripheral countries to identify the effects of shocks to the cost of borrowing of these countries on EU banks from other countries. A CDS tail return affects banks with greater exposure to the country experiencing that return more, but it has an impact on banks regardless of exposure. Shocks to peripheral countries that are more pervasive impact the returns of banks from countries that experience no shock more than shocks to small individual peripheral countries. In general, the impact of tail returns is asymmetric in that banks suffer less from adverse shocks to peripheral countries than they gain from favourable shocks to such countries.

The U.S. Listing Gap
Craig Doidge, George Andrew Karolyi, René M. Stulz
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Relative to other countries, the U.S. now has abnormally few listed firms. This “U.S. listing gap” is consistent with a decrease in the net benefit of a listing for U.S. firms. Since the listing peak in 1996, the propensity to be listed is lower for all firm size categories and industries, the new list rate is low, and the delist rate is high. The high delist rate accounts for 46% of the listing gap and the low new list rate for 54%. The high delist rate is explained by an unusually high rate of acquisitions of publicly listed firms.

How much for a haircut? Illiquidity, secondary markets, and the value of private equity
Nicolas P.B. Bollen and Berk A. Sensoy
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Limited partners (LPs) of private equity funds commit to invest with extreme levels of illiquidity and significant uncertainty regarding the timing of capital flows. Secondary markets have emerged which alleviate some of the associated cost. This paper develops a subjective valuation model incorporating these institutional features. Model-implied breakeven returns are close to empirically observed average fund returns for moderately risk tolerant LPs with private equity allocations up to 40%. Likewise, optimal portfolio allocations for these LPs are similar to those observed in practice. More risk averse LPs optimally place little, but not zero, weight on private equity.

The Granular Nature of Large Institutional Investors
Itzhak Ben-David, Francesco Franzoni, Rabih Moussawi, and John Sedunov
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Large institutional investors own an increasing share of the equity markets in the U.S. The implications of this development for financial markets are still unclear. The paper presents novel empirical evidence that ownership by large institutions predicts higher volatility and greater noise in stock prices as well as greater fragility in times of crisis. When studying the channel, we find that large institutional investors exhibit traits of granularity, i.e., subunits within a firm display correlated behavior, which reduces diversification of idiosyncratic shocks. Thus, large institutions trade larger volumes and induce greater price impact.

Private Equity Performance: A Survey
Steven N. Kaplan and Berk A. Sensoy
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We survey the literature on private equity performance, focusing on venture capital and buyout funds rather than portfolio companies. We describe recent findings on performance measures, average fund returns, risk adjustments, cyclicality and liquidity, persistence, interim returns and self-reported net asset values, the performance of different types of investors in funds, and the links between management contracts and fund returns. Buyout funds have outperformed the S&P 500 net of fees on average by about 20% over the life of the fund. Venture capital funds raised in the 1990s outperformed the S&P 500 while those raised in the 2000s underperformed. The results are consistent across a number of datasets and papers. Before the 2000s, buyout and venture capital fund performance showed strong evidence of persistence. Since 2000, buyout fund persistence has declined, while venture capital fund persistence has remained equally strong.

Fire Sale Discount: Evidence from the Sale of Minority Equity Stakes
Serdar Dinc, Isil Erel, Rose Liao
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Most of the existing empirical studies estimate the impact of fire sales either without the benefit of market prices from frequent trades, as with aircraft sales, or without observing the prices received by distressed sellers, as with the sales of equity securities by mutual funds facing outflows. We study transactions where the selling firm sells minority equity stakes it holds in publicly-listed third parties. In these transactions, market prices from frequent trades in the shares of those third parties are available and the transaction prices received by the sellers are reported. We estimate the industry-adjusted distressed sale discount based on the four-week window to be about 8% while controlling for the liquidity of the shares sold. This discount magnitude is higher than the 4% estimated for forced sales of stocks by mutual funds without the benefit of observing transaction prices. The discount we estimate becomes 13-14% if the stake sold is more than 5% of the firm or if the stake is sold as a block. Prices recover after the distressed sale.

The Dark Side of Specialization: Evidence from Risk Taking by CDO Collateral Managers
Sergey Chernenko
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I study the incentives of the collateral managers who selected securities for ABS CDOs-securitizations that figured prominently in the financial crisis. Specialized managers without other businesses that could suffer negative reputational consequences invested in low quality securities underwritten by the CDO's arranger. These securities perform significantly worse than observationally similar securities. Managers investing in these securities were rewarded with additional collateral management assignments. Diversified managers that did assemble CDOs suffered negative reputational consequences during the crisis: institutional investors withdrew from their mutual funds. Overall, the results are consistent with a quid pro quo between collateral managers and CDO underwriters.

Management Risk and the Cost of Borrowing
Yihui Pan, Tracy Yue Wang, and Michael S. Weisbach
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Management risk occurs because uncertainty about future managerial decisions increases a firm’s overall risk. This paper documents the importance of management risk in determining firms’ cost of borrowing. CDS spreads, loan spreads and bond yield spreads all increase at the time of CEO turnover, when management risk is highest, and decline over the first three years of CEO tenure, regardless of the reason for the turnover. Similar but smaller patterns occur around CFO turnovers. The increase in the CDS spread at the time of the CEO departure announcement, the change in the spread when the incoming CEO takes office, as well as the sensitivity of the spread to the new CEO’s tenure, all depend on the amount of prior uncertainty about the new management. In response to these short-term increases in borrowing costs early in their CEOs’ tenure, firms adjust their propensities to issue external debt, precautionary cash holding, and reliance on internal funds. All of these results suggest that management risk appears to be an important factor in the pricing of corporate debt.

Bank Capital Requirements: A Quantitative Analysis
Thien T. Nguyen
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This paper examines the welfare implications of bank capital requirements in a general equilibrium model in which a dynamic banking sector endogenously determines aggregate growth. Due to government bailouts, banks engage in risk-shifting, thereby depressing investment efficiency; furthermore, they over-lever, causing fragility in the financial sector. Capital regulation can address these distortions and has a first-order effect on both growth and welfare. In the model, the optimal level of minimum Tier 1 capital requirement is 8%, greater than that prescribed by both Basel II and III. Increasing bank capital requirements can produce welfare gains greater than 1% of lifetime consumption.

The Nominal Price Premium
Justin Birru and Baolian Wang
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Motivated by the evidence that investors tend to be overly optimistic about low-priced stocks, we examine how nominal price affects the cross section of stock returns. To circumvent the mechanical inverse relationship between price and expected return, we construct a novel way of examining the effect of nominal price on the cross section of stock returns. In the cross-section, a portfolio exploiting this strategy generates a value-weighted (equal-weighted) four-factor alpha of 85 (88) basis points per month. Consistent with a mispricing-based explanation, the results are stronger for hard-to-arbitrage stocks and following high sentiment periods, and strategy returns are highly correlated with contemporaneous changes in sentiment. Evidence from earnings surprises and analyst price target forecasts confirms that beliefs are overly optimistic for low-priced stocks. Providing further evidence that the results reflect a belief-based rather than purely a preference-based channel, we find that the effect is distinct from other gambling related proxies that have been used in the past such as extreme returns, idiosyncratic volatility, and skewness.

Banks’ Internal Capital Markets and Deposit Rates
Itzhak Ben-David, Ajay Palvia, and Chester Spatt
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A common view is that deposit rates are determined primarily by supply: depositors require higher deposit rates from risky banks, thereby creating market discipline. An alternative perspective is that market discipline is limited (e.g., due to deposit insurance and/or enhanced capital regulation) and that internal demand for funding by banks determines rates. Using branch-level deposit rate data, we find little evidence for market discipline as rates are similar across bank capitalization levels. In contrast, banks’ loan growth has a causal effect on deposit rates: e.g., branches’ deposit rates are correlated with loan growth in other states in which their bank has some presence, suggesting internal capital markets help reallocate the bank's funding.

The Elephant in the Room: The Impact of Labor Obligations on Credit Markets
Jack Favilukis, Xiaoji Lin, and Xiaofei Zhao
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We show that labor market frictions are first-order for understanding credit markets. Wage growth and labor share forecast aggregate credit spreads and debt growth as well as or better than alternative predictors. They also predict credit risk and debt growth in a cross-section of international firms. Finally, high labor share firms choose lower financial leverage. A model with labor market frictions and risky long-term debt can explain these findings, and produce large credit spreads despite realistically low default probabilities. This is because pre-committed payments to labor make other committed payments (i.e. interest) riskier.

Prices and Volatilities in the Corporate Bond Market
Jack Bao, Jia Chen, Kewei Hou, and Lei Lu
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We document a strong positive cross-sectional relation between corporate bond yield spreads and bond return volatilities. As corporate bond prices are generally attributable to both credit risk and illiquidity as discussed in Huang and Huang (2012), we apply a decomposition methodology to quantify the relative contributions of credit and illiquidity. Overall, our credit and illiquidity proxies can explain almost three quarters of the yield spread-bond volatility relation with credit and illiquidity contributing in a 70:30 ratio. Furthermore, we find that the credit portion of the yield spread-bond volatility relation is important even after controlling for equity volatility. The relation between yield spreads and volatilities is robust to different sample periods, including the financial crisis. We also find the ratio to be smaller for the investment-grade sub-sample, consistent with credit risk being relatively more important for understanding the yield spread-volatility relation in speculative-grade bonds.

The Investment CAPM
Lu Zhang
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A new class of Capital Asset Pricing Models arises from the first principle of real investment for individual firms. Conceptually as “causal” as the consumption CAPM, yet empirically more tractable, the investment CAPM emerges as a leading asset pricing paradigm. Firms do a good job in aligning investment policies with costs of capital, and this alignment drives many empirical patterns that are anomalous in the consumption CAPM. Most important, integrating the anomalies literature in finance and accounting with neoclassical economics, the investment CAPM succeeds in mounting an efficient markets counterrevolution to behavioral finance in the past 15 years.

Why Don't All Banks Practice Regulatory Arbitrage? Evidence from Usage of Trust Preferred Securities
Nicole Boyson, Rüdiger Fahlenbrach, and Rene M. Stulz
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We investigate why only some banks use regulatory arbitrage. We predict that banks wanting to be riskier than allowed by capital regulations (constrained banks) use regulatory arbitrage while others do not. We find support for this hypothesis using trust preferred securities (TPS) issuance, a form of regulatory arbitrage available to almost all U.S. banks from 1996 to Dodd-Frank. We also find support for predictions that constrained banks are riskier, perform worse during the crisis, and use multiple forms of regulatory arbitrage. We show that neither too-big-to-fail incentives nor misaligned managerial incentives are first-order determinants of this type of regulatory arbitrage.

Holdup by Junior Claimholders: Evidence from the Mortgage Market
Sumit Agarwal, Gene Amromin, Itzhak Ben-David, Souphala Chomsisengphet, and Yan Zhang
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When borrowers are delinquent, senior debtholders prefer liquidation whereas junior debtholders prefer to maintain their option value by delaying resolution or modifying the loan. In the mortgage market, a conflict of interest (“holdup”) arises when servicers of securitized senior liens are also the owners of the junior liens on the same property. We show that holdup servicers are able to delay action on the first-lien mortgage. When they do act, servicers are more likely to choose resolutions that maintain their option value, favoring modification and soft foreclosures over outright foreclosures. Holdup behavior is more likely to result in borrower self-curing.

Psychological Barriers, Expectational Errors, and Underreaction
Justin Birru
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This paper provides evidence that the 52-week high serves as a psychological barrier, inducing expectational errors and underreaction to news. Two clear predictions emerge and are confirmed in the data. First, nearness to a 52-week high induces expectational errors; evidence from earnings surprises and analyst price targets indicate that investor and analyst expectations are biased in a downward direction for stocks near a 52-week high and biased in an upward direction for stocks trading far from a 52-week high. Second, nearness to a 52-week high induces underreaction to news. Among positive earnings surprise stocks, post-announcement drift exists only for those stocks near a 52-week high. The evidence suggests that in contrast to currently offered preference-based explanations, a belief-based explanation may better explain the previously documented 52-week high anomalies.

Understanding Corporate Governance Through Learning Models of Managerial Competence
Benjamin E. Hermalin and Michael S. Weisbach
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A manager’s shareholders, board of directors, and potential future employers are continually assessing his ability. A rich literature has documented that this insight has profound implications for corporate governance because assessment generates incentives (good and bad), introduces assorted risks, and affects the various battles that rage among the relevant actors for corporate control. Consequently, assessment (or learning) is a key perspective from which to study, evaluate, and possibly even regulate corporate governance. Moreover, because learning is a behavior notoriously subject to systematic biases, this perspective is a natural avenue through which to introduce behavioral and psychological insights into the study of corporate governance.

Can Taxes Shape an Industry? Evidence from the Implementation of the “Amazon Tax”
Brian Baugh, Itzhak Ben-David, and Hoonsuk Park
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For years, online retailers have maintained a price advantage over brick-and-mortar retailers by not collecting sales tax at the time of sale. Recently, several states have required that online retailer Amazon collect sales tax during checkout. Using transaction-level data, we document that households living in these states reduced Amazon purchases by 9.4% after sales tax laws were implemented, implying elasticities ranging from –1.2 to –1.4. The effect is more pronounced for large purchases, for which we estimate a reduction of 29.1% in purchases, corresponding to an elasticity of –3.9. Studying competitors in the electronics field, we detect some evidence of substitution toward competing retailers.

Do U.S. Firms Hold More Cash
Lee Pinkowitz, Rene M. Stulz, and Rohan Williamson
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Using medians, U.S. firms do not hold more cash than similar foreign firms, irrespective of whether the foreign firms come from countries with good investor protection or not. With means, they do. The means, in contrast to the medians, are affected by U.S. multinationals. U.S. multinationals with high R&D expenditures hold 38.7% more cash than comparable foreign firms, but there is evidence that these high cash holdings may result more from high R&D expenditures than from multinationality. The crisis leaves only small traces in the recent cash holdings of firms. Firms throughout the world decreased their cash holdings during the crisis and replenished their cash holdings afterwards as expected with the precautionary motive for cash holdings. However, U.S. firms hold more cash than firms from countries where the stock market fell less during the crisis. There is no evidence that the determinants of cash holdings changed from before the crisis to after the crisis.

New Entropy Restrictions and the Quest for Better Specified Asset Pricing Models
Gurdip Bakshi and Fousseni Chabi-Yo
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Under the setting that stochastic discount factors (SDFs) jointly price a vector of returns, this paper features entropy-based restrictions on SDFs, and its correlated multiplicative components, to evaluate asset pricing models. Specifically, our entropy bound on the square of the SDFs is intended to capture the time-variation in the conditional volatility of the log SDF as well as distributional non-normalities. Each entropy bound can be inferred from the mean and the variance-covariance matrix of the vector of asset returns. Extending extant treatments, we develop entropy codependence measures and our bounds generalize to multi-period SDFs. Our approach offer ways to improve model performance.

External Equity Financing Shocks, Financial Flows, and Asset Prices
Frederico Belo, Xiaoji Lin, and Fan Yang
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The ability of corporations to raise external equity financing varies with macroeconomic conditions. We develop a dynamic model economy with external equity financing frictions to evaluate the impact of variation of the aggregate cost of equity issuance on firms’ asset prices and financing policies. Our central finding is that time variation in external equity financing costs is important for the model to quantitatively capture the joint dynamics of firms’ asset prices, real quantities, and financial flows. In the model, growth firms and high investment firms can substitute more easily debt financing for equity financing when it becomes more costly to raise external equity, which tend to occur at times when marginal utility is high. Hence, these firms are less risky in equilibrium. The model also replicates the failure of the unconditional CAPM in pricing the cross section of stock returns. Guided by the theory, we construct an empirical proxy of the aggregate shock to the cost of equity issuance using cross sectional data on U.S. publicly traded firms. We show that the model-implied shock captures systematic risk, and that exposure to this shock helps price the cross section of stock returns of book-to-market, investment, and industry portfolios.

Were there fire sales in the RMBS market?
Craig B. Merrill, Taylor D. Nadauld, René M. Stulz, and Shane M. Sherlund
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Many observers have argued that the fall in RMBS prices during the crisis was partly caused by fire sales. We provide an explanation for why financial institutions may have engaged in fire sales using a unique dataset of RMBS transactions for insurance companies. We show that risk-sensitive capital requirements and mark-to-market accounting can jointly create incentives for capital-constrained financial institutions to engage in fire sales of stressed securities because the increased risk can make it too expensive to hold such securities. Further, we find that, in general, RMBS prices behaved as would be expected in the presence of fire sales.

Goverance, Risk Management, and Risk-Taking in Banks
Rene M. Stulz
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This paper examines how governance and risk management affect risk-taking in banks. It distinguishes between good risks, which are risks that have an ex ante private reward for the bank on a stand-alone basis, and bad risks, which do not have such a reward. A well-governed bank takes the amount of risk that maximizes shareholder wealth subject to constraints imposed by laws and regulators. In general, this involves eliminating or mitigating all bad risks to the extent that it is cost effective to do so. The role of risk management in such a bank is not to reduce the bank’s total risk per se. It is to identify and measure the risks the bank is taking, aggregate these risks in a measure of the bank’s total risk, enable the bank to eliminate, mitigate and avoid bad risks, and ensure that its risk level is consistent with its risk appetite. Organizing the risk management function so that it plays that role is challenging because there are limitations in measuring risk and because, while more detailed rules can prevent destructive risk-taking, they also limit the flexibility of an institution in taking advantage of opportunities that increase firm value. Limitations of risk measurement and the decentralized nature of risk-taking imply that setting appropriate incentives for risk-takers and promoting an appropriate risk culture are essential to the success of risk management in performing its function.

Unemployment Crises
Nicolas Petrosky-Nadeau and Lu Zhang
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A search and matching model, when calibrated to the mean and volatility of unemployment in the postwar sample, can potentially explain the unemployment crisis in the Great Depression. The limited responses of wages from credible bargaining to labor market conditions, along with the congestion externality from matching frictions, cause the unemployment rate to rise sharply in recessions but decline gradually in booms. The frequency, severity, and persistence of unemployment crises in the model are quantitatively consistent with U.S. historical time series. The welfare gain from eliminating business cycle fluctuations is large.

Influence of Public Opinion on Investor Voting and Proxy Advisors
Reena Aggarwal, Isil Erel, and Laura Starks
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Institutional investors vote corporate proxies on behalf of underlying investors and beneficiaries. We show a strong relation between this voting and public opinion on corporate governance (as reflected in media coverage and surveys), with similarly strong results for voting by mutual funds. We also find that proxy advisors’ recommendations are associated with public opinion. Our results suggest that institutional investors and proxy advisors pay attention to the changing opinions of their beneficiaries and shareholders, as reflected in their voting decisions, and that the proxy voting process serves as a channel for the public to influence corporate behavior.

Corporate Fire Sales
Isil Erel

Does Uncertainty about Management Affect Firms' Costs of Borrowing?
Yihui Pan, Tracy Yue Wang, Michael Weisbach
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Uncertainty about management appears to affect firms’ cost of borrowing and financial policies. In a sample of S&P 1500 firms between 1987 and 2010, CDS spreads, loan spreads and bond yield spreads all decline over the first three years of CEO tenure, holding other macroeconomic, firm, and security level factors constant. This decline occurs regardless of the reason for the prior CEO’s departure. Similar but smaller declines occur following turnovers of CFOs. The spreads are more sensitive to CEO tenure when the prior uncertainty about the CEO’s ability is likely to be higher: when he is not an heir apparent, is an outsider, is younger, and when he does not have a prior relationship with the lender. The spread-tenure sensitivity is also higher when the firm has a higher default risk and when the debt claim is riskier. These patterns are consistent with the view that the decline in spreads in a manager’s first three years of tenure reflects the resolution of uncertainty about management. Firms adjust their propensities to issue external debt, precautionary cash holding, and reliance on internal funds in response to these short-term increases in borrowing costs early in their CEOs’ tenure.

The Risks of Old Capital Age: Asset Pricing Implications of Technology Adoption
Xiaoji Lin, Berardino Palazzo, and Fang Yang
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We study the impact of technology adoption on asset prices in a dynamic model that features a stochastic technology frontier. In equilibrium, firms operating with old capital are riskier because costly technology adoption restricts their flexibilities in upgrading to the latest technology, making them more exposed to technology frontier shocks. Consistent with the model predictions, a long-short portfolio sorted on firm-level capital age earns an average value-weighted return of 9% per year among U.S. public companies. A proxy for technology frontier shocks captures the variation of the capital age portfolios with a positive risk price, corroborating the model mechanism.

The Rise and Fall of Demand for Securitizations
Sergey Chernenko, Samuel G. Hanson, Adi Sunderam
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Collateralized debt obligations (CDOs) and private-label mortgage-backed securities (MBS) backed by nonprime loans played a central role in the recent financial crisis. Little is known, however, about the underlying forces that drove investor demand for these securitizations. Using micro-data on insurers’ and mutual funds’ bond holdings, we find considerable heterogeneity in investor demand for securitizations in the pre-crisis period. We argue that both investor beliefs and incentives help to explain this variation in demand. By contrast, our data paints a more uniform picture of investor behavior in the crisis. Consistent with theories of optimal liquidation, investors largely traded in more liquid securities such as government-guaranteed MBS to meet their liquidity needs during the crisis.

Uninformative Feedback and Risk Taking
Itzhak Ben-David, Justin Birru, Viktor Prokopenya
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We document evidence consistent with retail day traders in the Forex market attributing random success to their own skill and, as a consequence, increasing risk taking. Although past performance does not predict future success for these traders, traders increase trade sizes, trade size variability, and number of trades with gains, and less with losses. There is a large discontinuity in all of these trading variables around zero past week returns: e.g., traders increase their trade size dramatically following winning weeks, relative to losing weeks. The effects are stronger for novice traders, consistent with more intense “learning” in early trading periods.

Limited Partner Performance and the Maturing of the Private Equity Industry
Berk A. Sensoy, Yingdi Wang, and Michael S. Weisbach
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We evaluate the performance of limited partners’ (LPs) private equity investments over time. Using a sample of 14,380 investments by 1,852 LPs in 1,250 buyout and venture funds started between 1991 and 2006, we find that the superior performance of endowment investors in the 1991-1998 period, documented in prior literature, is mostly due to their greater access to the top-performing venture capital partnerships. In the subsequent 1999-2006 period, endowments no longer outperform, and neither have greater access to funds who are likely restrict access nor make better investment selections than other types of institutional investors. We discuss how these results are consistent with the general maturing of the industry, as private equity has transitioned from a niche, poorly understood area to a ubiquitous part of institutional investors’ portfolios.

Why Did Financial Institutions Sell RMBS at Fire Sale Prices During the Financial Crisis?"
Craig Merrill, Taylor Nadauld, René M. Stulz,and Shane M. Sherlund
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Much attention has been paid to the large decreases in value of non-agency residential mortgage-backed securities (RMBS) during the financial crisis. Many observers have argued that the fall in prices was partly caused by fire sales. We use capital requirements and accounting rules to identify circumstances where financial institutions had incentives to engage in fire sales and then examine whether such sales occurred. For financial institutions subject to credit-sensitive capital requirements, capital requirements increase as an asset’s credit becomes impaired. When accounting rules require such an asset’s value to be marked-to-market and the fair value loss to be recognized in earnings, a capital-constrained firm can improve its capital position by selling the credit-impaired asset even if it has to accept a liquidity discount to do so. In contrast, a financial firm whose fair value losses are not recognized in earnings for the purpose of calculating capital requirements is more likely to satisfy capital requirements by selling liquid assets whose value has not fallen and hence would be unlikely to engage in fire sales. Using a sample of 5,000 repeat transactions of non-agency RMBS by insurance companies from 2006 to 2009, we show that insurance companies that became more capital-constrained because of operating losses (uncorrelated with RMBS credit quality) and also recognized fair value losses sold comparable RMBS at much lower prices than other insurance companies during the crisis.

Do Acquisitions Relieve Target Firms' Financial Constraints?
Isil Erel, Yeejin Jang, and Michael S. Weisbach
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Managers often claim that an important source of value in acquisitions is the acquiring firm’s ability to finance investments for the target firm. This claim implies that targets are financially constrained prior to being acquired and that these constraints are eased following the acquisition. We evaluate these predictions on a sample of 5,187 European acquisitions occurring between 2001 and 2008, for which we can observe the target’s financial policies both before and after the acquisition. We examine whether target firms’ post-acquisition financial policies reflect improved access to capital. We find that the level of cash target firms hold, the sensitivity of cash to cash flow, and the sensitivity of investment to cash flow all decline significantly, while investment significantly increases following the acquisition. These effects are stronger in deals that are more likely to be associated with financing improvements. These findings are consistent with the view that acquisitions ease financial frictions in target firms.

Brand Capital and Firm Value
Frederico Belo, Xiaoji Lin, and Maria Ana Vitorino
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We study the role of brand capital - a primary form of intangible capital - for firm valuation and risk in the cross-section of publicly traded firms. Using a novel empirical measure of brand capital stock constructed from firm level advertising expenditures data, we show that: (i) firms with low brand capital investment rates have higher average stock returns than firms with high brand capital investment rates, a difference of 5.2% per annum; (ii) more brand capital intensive firms have higher average stock returns than less brand capital intensive firms, a difference of 4.6% per annum; and (iii) investment in both brand capital and physical capital is volatile and is procyclical. A neoclassical investment-based model augmented with brand capital simultaneously matches the asset pricing facts and key properties of firm-level brand capital and physical capital investment. The model also provides a novel explanation for the empirical links between advertising expenditures and stock returns around seasoned equity offerings (SEO) documented in previous studies. Our findings highlight the importance of brand capital for understanding firms’ market value and risk.

Learning About CEO Ability and Stock Return Volatility
Yihui Pan, Tracy Yue Wang , and Michael S. Weisbach
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When there is uncertainty about a CEO’s quality, news about the firm causes rational investors to update their expectation of the firm’s profitability for two reasons: Updates occur because of the direct effect of the news, and also because the news can cause an updated assessment of the CEO’s quality, affecting expectations of his ability to generate future cash flows. As a CEO’s quality becomes known more precisely over time, the latter effect becomes smaller, lowering the stock price reaction to news, and hence lowering the stock return volatility. Thus, in addition to uncertainty about fundamentals, uncertainty about CEO quality is also a source of stock return volatility, which decreases over a CEO’s tenure as the market learns the CEO’s quality more accurately. We formally model this idea, and evaluate its implications using a large sample of CEO turnovers in U.S. public firms. Our estimates indicate that there is statistically significant and economically important market learning about CEO ability, even for CEOs whose appointments appear to be unrelated to their predecessors’ performance. Also consistent with the learning model is the fact that the learning curve appears to be convex in time, and learning is faster when there is higher ex ante uncertainty about the CEO’s ability and more transparency about the firm’s prospects. Overall, uncertainty about management quality appears to be an important source of stock return volatility.

Indirect Incentives of Hedge Fund Managers
Jongha Lim, Berk A. Sensoy, and Michael S. Weisbach
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Indirect incentives exist in the money management industry when good current performance increases future inflows of capital, leading to higher future fees. For the average hedge fund, indirect incentives are at least 1.4 times as large as direct incentives from incentive fees and managers’ personal stakes in the fund. Combining direct and indirect incentives, manager wealth increases by at least $0.39 for a $1 increase in investor wealth. Younger and more scalable hedge funds have stronger flow-performance relations, leading to stronger indirect incentives. These results have a number of implications for our understanding of incentives in the asset management industry.

Is there a U.S. high cash holdings puzzle after the financial crisis?
Lee Pinkowitz, René M. Stulz, and Rohan Williamson
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Defining normal cash holdings as the holdings a firm with the same characteristics would have had in the late 1990s, we find that the average abnormal cash holdings of U.S. firms after the financial crisis amount to 10% of cash holdings, which represents an 87% increase in abnormal cash holdings from before the crisis. The increase in abnormal cash holdings of U.S. firms is concentrated among highly profitable firms. Strikingly, abnormal cash holdings do not increase more for U.S. firms than for firms in advanced countries from before the crisis to after the crisis. Though abnormal cash holdings of U.S. multinational firms increase sharply in the early 2000s while cash holdings of purely domestic firms do not, there is no increase in abnormal cash holdings by U.S. multinational firms from before the crisis to after. Further evidence shows that the tax explanation for the cash holdings of U.S. multinational firms cannot explain the large abnormal holdings of these firms. In sum, while the high cash holdings of U.S. firms before the crisis are a U.S.-specific puzzle, the increase in cash holdings of U.S. firms from before the crisis to after is not.

Why High Leverage is Optimal for Banks
Harry DeAngelo and René M. Stulz
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Liquidity production is a central role of banks. When there is a market premium for the production of (socially valuable) liquid financial claims and no other departures from the Modigliani and Miller (1958, MM) assumptions, we show that high leverage is optimal for banks. In this model, high leverage is not the result of distortions from agency problems, deposit insurance, or tax motives to borrow. The model can explain (i) why bank leverage increased over the last 150 years or so without invoking any of these distortions, and (ii) why high bank leverage per se does not necessarily cause systemic risk. MM’s leverage irrelevance theorem is inapplicable to banks: Because debt-equity neutrality assigns zero weight to the social value of liquidity, it is an inappropriately equity-biased criterion for assessing whether the high leverage ratios of real-world banks are excessive or socially destructive.

The Twilight Zone: OTC Regulatory Regimes and Market Quality
Ulf Brüggemann, Aditya Kaul, Christian Leuz, and Ingrid M. Werner
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We analyze a comprehensive sample of more than 10,000 U.S. OTC stocks. We first show that the OTC market is a large, diverse, and dynamic trading environment with a rich set of regulatory and disclosure regimes, comprising venue rules and state laws beyond SEC regulation. We then exploit this institutional richness to analyze two key dimensions of market quality, liquidity and crash risk, across firms and regulatory regimes. We find that OTC firms that are subject to stricter regulatory regimes and disclosure requirements have higher market quality (higher liquidity and lower crash risk). Our analysis points to an important trade-off in regulating the OTC market and protecting investors: Lowering regulatory requirements (e.g., for disclosure) reduces the compliance burden for smaller firms, but it also reduces market quality.

Do firms issue more equity when markets are more liquid?
René M. Stulz, Dimitrios Vagias, and Mathijs A. van Dijk
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This paper investigates how public equity issuance is related to stock market liquidity. Using quarterly data on IPOs and SEOs in 36 countries over the period 1995-2008, we show that equity issuance is significantly and positively related to contemporaneous and lagged innovations in aggregate local market liquidity. This relation survives the inclusion of proxies for market timing, capital market conditions, growth prospects, asymmetric information, and investor sentiment. Liquidity considerations are as important in explaining equity issuance as market timing considerations. The relation between liquidity and issuance is driven by the quarters with the greatest deterioration in liquidity and is stronger for IPOs than for SEOs. Firms are more likely to carry out private instead of public equity issues and to postpone public equity issues when market liquidity worsens. Overall, we interpret our findings as supportive of the view that market liquidity is an important determinant of equity issuance that is distinct from other determinants examined to date.

Comovement of Corporate Bonds and Equities
Jack Bao and Kewei Hou
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We study heterogeneity in the comovement of corporate bonds and equities, both at the bond level and at the rm level. Using an extended Merton model, we illustrate that corporate bonds that mature late relative to the rest of the bonds in its issuer's maturity structure should have stronger comovement with equities. In contrast, endogenous default models suggest that a bond's position in its issuer's maturity structure has little relation with the strength of the comovement between bonds and equities. Empirically, we nd results consistent with the prediction of the extended Merton model. In addition, we nd that comovement between bonds and equities is stronger for rms with higher credit risk as proxied by the book-to-market ratio and distance-to-default even after controlling for ratings. Our evidence suggests that market participants are able to assess credit quality at a more granularlevel than ratings.

CEO Investment Cycles
Yihui Pan, Tracy Yue Wang, and Michael S. Weisbach
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This paper documents the existence of a CEO Investment Cycle, in which disinvestment decreases over CEO tenure while investment increases, leading to “cyclical” firm growth in assets as well as in employment. The estimated variation in investment rate over the CEO cycle is of the same order of magnitude as the differences caused by business cycles or financial constraints. This investment cycle appears to reflect CEOs’ preference for investment growth, which leads to increasing investment quantity and decreasing investment quality over time as the CEO gains more control over his board.

Limited Managerial Attention and Corporate Aging
Claudio Loderer, René Stulz, and Urs Waelchli
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As firms have more assets in place, more of management’s limited attention is focused on managing assets in place rather than developing new growth options. Consequently, as firms grow older, they have fewer growth options and a lower ability to generate new growth options. This simple theory predicts that Tobin’s q falls with age. Further, competition in the product market is expected to slow down the decrease in Tobin’s q because it forces firms to look for alternative sources of rents. Similarly, greater competition in the labor market reduces the decrease in Tobin’s q with age because old firms are in a better position to hire employees that can help with innovation. In contrast, competition in the market for corporate control should accelerate the decline because it forces management to focus more on managing assets in place whose performance is more directly observable than on developing growth options where results may not be observable for some time. We find strong support for these predictions in tests using exogenous variation in competition.

Tick Size Regulations and Sub-Penny Trading
Sabrina Buti, Barbara Rindi, Yuanji Wen, and Ingrid Werner
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We show that following a tick size reduction in a decimal public limit order book (PLB) market quality and welfare fall for illiquid but increase for liquid stocks. If a Sub-Penny Venue (SPV) starts competing with a penny-quoting PLB, market quality deteriorates for illiquid, low priced stocks, while it improves for liquid, high priced stocks. As all traders can demand liquidity on the SPV, traders’ welfare increases. If the PLB facing competition from a SPV lowers its tick size, PLB spread and depth decline and total volume and welfare increase irrespective of stock liquidity.

Corporate Liquidity Management: A Conceptual Framework and Survey
Heitor Almeida, Murillo Campello, Igor Cunha,and Michael Weisbach
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Ensuring that a firm has sufficient liquidity to finance valuable projects that occur in the future is at the heart of the practice of financial management. Yet, while discussion of these issues goes back at least to Keynes (1936), a substantial literature on the ways in which firms manage liquidity has developed only recently. We argue that many of the key issues in liquidity management can be understood through the lens of a framework in which firms face financial constraints and wish to ensure efficient investment in the future. We present such a model and use it to survey many of the empirical findings on liquidity management. Much of the variation in the quantity of liquidity can be explained by the precautionary demand for liquidity. While there are alternatives to cash holdings such as hedging or lines of credit, cash remains “king”, in that it still is the predominate way in which firms ensure future liquidity for future investments. We discuss theories on the choice of liquidity measures and related empirical evidence. In addition, we discuss agency-based theories of liquidity, the real effects of liquidity choices, and the impact of the 2008-9 Financial Crisis on firms’ liquidity management.

External Habit in a Production Economy
Andrew Chen
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A unified framework for understanding asset prices and aggregate fluctuations is critical for understanding both issues. I show that a real business cycle model with external habit preferences and capital adjustment costs provides one such framework. The estimated model matches the first two moments of the equity premium and risk-free rate, return and dividend predictability regressions, and the second moments of output, consumption, and investment. The model also endogenizes a key mechanism of consumption-based asset pricing models. In order to address the Shiller volatility puzzle, external habit, long-run risk, and disaster models require the assumption that the volatility of marginal utility is countercyclical. In the model, this countercyclical volatility arises endogenously. Production makes precautionary savings effects show up in consumption. These effects lead to countercyclical consumption volatility and countercyclical volatility of marginal utility. External habit amplifies this channel and makes it quantitatively significant.

The Term Structures of Co-Entropy in International Financial Markets
Fousseni Chabi-Yo and Riccardo Colacito
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We propose a new entropy-based correlation measure (co-entropy) to evaluate the performance of international asset pricing models. Co-entropy summarizes in a single number the extent of co-dependence between two variables beyond normality. We document that the co-entropy of international stochastic discount factors (SDFs) can be decomposed into a series of entropy-based correlations of permanent and transitory components of the SDFs. We derive bounds and restrictions on co-entropies of these components, which we then use to analyze the composition of co-dependence of international SDFs. A large cross-section of countries is employed to provide empirical evidence on the entropy-based correlations at various horizons. We find that the co-entropy of the transitory components is always sizably smaller than the co-entropy of the permanent components, with the latter usually being very close to one. Furthermore, the entropy based correlation of transitory components of SDFs increases with the investment horizon, which features an upward sloping term structure of co-entropies. We confront several state-of-the-art international finance models with these empirical regularities, and find that existing models cannot account for the composition of codependence at all horizons.

Sub-Penny and Queue-Jumping
Sabrina Buti, Francesco Consonni, Barbara Rindi, Yuanji Wen, and Ingrid Werner
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We develop a model where a public limit order book (PLB) competes with a Sub-Penny Venue, which allows Sub-Penny Trading (SPT). SPT occurs when a trader undercuts orders in the PLB by less than one penny, a practice we call queue-jumping (QJ). QJ is higher for NASDAQ than for NYSE stocks. We confirm the model's predictions that QJ increases in liquidity and in the tick-to-price ratio. We also find that QJ is associated with improved PLB market quality, especially for large capitalization stocks. Finally, we show that High Frequency Trading is negatively related to QJ.

Is Sell-Side Research More Valuable in Bad Times?
Roger K. Loh and René Stulz
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Because uncertainty is high in bad times, investors find it harder to assess firm prospects and, hence, should value analyst output more. However, higher uncertainty makes analysts’ tasks harder so it is unclear if analyst output is more valuable in bad times. We find that, in bad times, analyst revisions have a larger stock-price impact, earnings forecast errors per unit of uncertainty fall, reports are more frequent and longer, and the impact of analyst output increases more for harder-to-value firms. These results are consistent with analysts working harder and investors relying more on analysts in bad times.

Asymmetric Consumption Smoothing
Brian Baugh, Itzhak Ben-David, Hoonsuk Park, and Jonathan A. Parker
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Analyzing account-level data from an account aggregator, we find that households increase consumption when they receive (expected) tax refunds, as if they face liquidity constraints. However, these same households smooth consumption when making payments in other years, primarily by transferring funds among liquid accounts. Even households carrying credit card debt smooth consumption when making payments, and even highly-liquid households spend out of refunds. This behavior is inconsistent with pure liquidity constraints or hand-to-mouth behavior and most consistent with a mental accounting life-cycle model.

Endogenous Disasters
Nicolas Petrosky-Nadeau, Lu Zhang, and Lars-Alexander Kuehn
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Market economies are intrinsically unstable. The standard search model of equilibrium unemployment, once solved accurately with a globally nonlinear algorithm, gives rise endogenously to rare dis- asters. Intuitively, in the presence of cumulatively large negative shocks, inertial wages remain relatively high, and reduce profits. The marginal costs of hiring run into downward rigidity, which stems from the trading externality of the matching process, and fail to decline relative to profits. Inertial wages and rigid hiring costs combine to stifle job creation flows, depressing the economy into disasters. The disaster dynamics are robust to extensions to home production, capital accumulation, and recursive utility.

Access to Capital, Investment, and the Financial Crisis
Kathleen M. Kahle and René M. Stulz
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During the recent financial crisis, the impact of an impaired supply of bank credit on non-financial firms is minor compared to the impact of leverage-related financial fragility and a general flight to quality. Although banks were sharply affected by the credit crisis in the fall of 2007, the crisis did not negatively affect capital expenditures or net debt issuance of publicly held non-financial firms during its first year. This is true even for small and unrated firms, which are generally viewed as more dependent on bank financing. After September 2008, capital expenditures and net debt issuance fell sharply and firms hoarded cash. Capital expenditures did not fall more for more bank-dependent firms, but they decreased more for firms that were highly levered before the crisis, regardless of whether these firms had previously accessed public debt markets. In contrast to the response expected from a contraction in bank credit per se, the decrease in net equity issuance for small and unrated firms is greater than the decrease in net debt issuance during the crisis.

Globalization, Country Governance, and Corporate Investment Decisions: An Analysis of Cross-Border Acquisitions
Jesse Ellis, Sara B. Moeller, Frederik P. Schlingemann and René M. Stulz
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Using a sample of control cross-border acquisitions from 56 countries from 1990 to 2007, we find that acquirers from better governed countries gain more from such acquisitions and their gains are higher when targets are from worse governed countries. Other acquirer country characteristics, including the indices for laws protecting investors the earlier literature focuses on, are not consistently related to acquisition gains. However, globalization leaves a strong mark on acquisition returns. Acquisition returns are affected by global factors at least as much as they are by acquirer country factors. First, across all acquisitions, the acquirer’s industry and the year of the acquisition explain more of the stock-price reaction than the country of the acquirer. Second, for acquisitions of private firms or subsidiaries, acquirers gain more when acquisition returns are high for acquirers from other countries. A country’s governance and global mergers and acquisitions activity are important predictors of mergers and acquisitions activity in that country. Finally, we find strong evidence that at the firm-level better alignment of interests between insiders and minority shareholders is associated with greater acquirer returns and weaker evidence that this effect mitigates the adverse impact of poor country governance for the bidder.

The Quiet Run of 2011: Money Market Funds and the European Debt Crisis
Sergey Chernenko and Adi Sunderam
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We show that money market funds transmitted distress across firm during the European sovereign debt crisis. Using a novel data set of US money market fund holdings, we show that funds with large exposures to Eurozone banks suffered significant outflows between June and August 2011. These outflows have significant short-run spillover effects on other firms: non-Eurobank issuers that typically rely on these funds raise less financing in this period. The results are not driven by issuer riskiness or direct exposure to Europe: for the same issuer, money market funds with greater exposure to Eurozone banks decrease their holdings more than other funds. Our results illustrate that instabilities associated with money market funds persist despite recent changes to the regulations governing them..

Equity-Holding Institutional Lenders: Do They Receive Better Terms?
Jongha Lim, Bernadette A. Minton and Mike Weisbach
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The past decade has seen significant changes in the structure of the corporate lending market, with non-commercial bank institutional investors playing larger roles than they historically have played. In addition, non-commercial bank institutional lenders are often equity holders in their borrowing firms. In our sample of 11,137 tranches of institutional “leveraged” loans, 2,008 (18%) have a non-commercial bank institution that also owns at least 0.1% of the firm‟s equity. Such “dual holder” loan tranches have higher spreads than otherwise similar loan tranches without equity holder participation. The dual holder premium is present for both revolver and term loans, and exists within all non-investment grade credit rating classes. Contrary to risk-based explanations of this finding, dual holder tranches are priced with premiums relative to other tranches of the same loan package. Dual holding premiums are higher when the equity-holder‟s stake is larger, when the dual-holder‟s share in the loan is larger, and when the equity holder is a hedge fund or a private equity fund. These premiums likely represent additional compensation to dual holders for providing capital to firms when the firms are having difficulty raising capital otherwise.

Financing-Motivated Acquisitions
Isil Erel, Yeejin Jang and Mike Weisbach
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Managers often claim that an important source of value in acquisitions is the acquiring firm’s ability to finance investments for the target firm. This claim implies that targets are financially constrained prior to being acquired and that these constraints are eased following the acquisition. We evaluate these predictions on a sample of 5,187 European acquisitions occurring between 2001 and 2008, for which we can observe the target’s financial policies following the acquisition. We examine whether these post acquisition financial policies reflect improved access to capital. We find that the level of cash target firms hold, the sensitivity of cash to cash flow, and the sensitivity of investment to cash flow all decline significantly, while investment significantly increases following the acquisition. These effects are stronger in deals that are more likely to be associated with financing improvements. These findings are consistent with the view that acquisitions ease financial frictions in target firms.

Do Loan Officers' Incentives Lead to Lax Lending Standards?
Sumit Agarwal and Itzhak Ben-David
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We study a controlled experiment in which bank’s loan officers were incentivized to prospect for new applications. The dollar volume of approved loans increased; however, we find that loan officers did not source new applications and that the expected default rate did not change. Instead, the bank relied on favorable hard information when approving loans and ignored unfavorable soft information. Furthermore, loan officers convinced approved applicants to borrow larger amounts. Both factors contributed to an ex post higher default rate and to the loss of the predictive power of the bank’s credit default model.

Predatory Lending and the Subprime Crisis
Sumit Agarwal, Gene Amromin, Izthak Ben-David, Souphala Chomsisengphet, and Douglas D. Evanoff
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It is typically argued that predatory lending generated significant social costs and played a central role in creating the subprime crisis. However, there are few estimates of its true effect. We estimate the effect of predatory lending on the residential mortgage default rate using an anti-predatory program implemented in Chicago in 2006. Under the legislation, risky borrowers and risky mortgages triggered mandatory counseling. Following the legislation, market activity decreased by about 35%, where risky borrowers, risky products, and lenders who typically made riskier loans were most affected. Despite the sharp decline in market activity, 18- and 36-month default rates in the treated group exhibited a relative improvement of 12% and 7%, respectively. We estimate that predatory loans have a 6-7% higher default rate than nonpredatory loans. Our results suggest that predatory lending may have not been instrumental in precipitating the financial crisis as often believed.

Does Aggregate Riskiness Predict Future Economic Downturns
Turan G. Bali, Nusret Cakici, and Fousseni Chabi-Yo
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Aumann and Serrano (2008) and Foster and Hart (2009) introduce riskiness measures based on the physical return distribution of gambles. This paper proposes model-free options’ implied measures of riskiness based on the risk-neutral distribution of financial securities. In addition to introducing the forward-looking measures of riskiness, the paper investigates the significance of aggregate riskiness in predicting future economic downturns. The results indicate strong predictive power of aggregate riskiness even after controlling for the realized volatility of the U.S. equity market, the implied volatility of S&P 500 index options (VIX) proxying for financial market uncertainty, as well as the TED spread proxying for interbank credit risk and the perceived health of the banking system.

Multinationals and the High Cash Holding Puzzle
Lee Pinkowitz, René M. Stulz, and Rohan Williamson
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Defining as normal cash holdings the holdings a firm with the same characteristics would have had in the late 1990s, we find that the abnormal cash holdings of U.S. firms after the crisis represent on average 1.86% of assets. While U.S. firms held less cash than comparable foreign firms in the late 1990s, by 2010 they hold more. However, only U.S. multinational firms experience an increase in abnormal cash holdings during the 2000s. U.S. multinational firms had cash holdings similar to those of purely domestic firms in the late 1990s, but they hold over 3% more assets in cash than comparable purely domestic firms after the crisis. Further, U.S. multinationals increased their cash holdings since the late 1990s relative to foreign multinationals by roughly the same percentage as they increased their cash holdings relative to U.S. domestic firms. A detailed analysis shows that the increase in cash holdings of multinational firms cannot be explained by the tax treatment of profit repatriations, that it is intrinsically linked to their R&D intensity, and that firms that become multinational do not increase their abnormal cash holdings after they become multinational. There is no evidence that poor investment opportunities, regulation, or poor governance can explain the abnormal cash holdings of U.S. firms after the crisis.

Did Capital Requirements and Fair Value Accounting Spark Fire Sales in Distressed Mortgage-Backed Securities?
Craig B. Merrill, Taylor D. Nadauld, René M. Stulz, and Shane M. Sherlund
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Much attention has been paid to the large decreases in value of non-agency residential mortgage-backed securities (RMBS) during the financial crisis. Many observers have argued that the fall in prices was partly driven by decreased liquidity and fire sales. We investigate whether capital requirements and accounting rules at financial institutions contributed to the selling of RMBS at fire sale prices. For financial institutions subject to credit-sensitive capital requirements, capital requirements increase as an asset’s credit becomes impaired. When accounting rules require such an asset’s value to be marked-to-market and the fair value loss to be recognized in earnings, a capital-constrained firm can improve its capital position by selling the credit-impaired asset even if it has to accept a liquidity discount to do so. Using a sample of 5,014 repeat transactions of non-agency RMBS by insurance companies from 2006 to 2009, we show that insurance companies that became more capital-constrained because of operating losses (uncorrelated with RMBS credit quality) and also recognized fair value losses sold comparable RMBS at much lower prices than other insurance companies during the crisis.

Financial globalization and the rise of IPOs outside the U.S.
Craig Doidge, G. Andrew Karolyi, and René M. Stulz
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From 1990 to 2011, the share of the world’s initial public offering (IPO) activity outside the U.S. increased with financial globalization. In the 1990s, when financial globalization was lower, there were 0.37 U.S. IPOs for each non-U.S. IPO compared to only 0.12 in the 2000s. Consistent with theoretical predictions, we find that greater financial globalization is associated with a decrease in the importance of national institutions as determinants of a country’s domestic IPO activity. One reason for this decrease is that greater financial globalization makes it easier for firms going public to access foreign capital markets and use foreign institutions. As a result, a large part of the increase in non-U.S. IPO activity occurred through an increase in global IPOs by both small and large firms. U.S. IPO activity did not benefit from increased financial globalization and, consequently, the U.S. share of world IPOs fell. It did so most dramatically for small-firm IPOs, for which its market share fell from 31% in the 1990s to 5% in the 2000s. Our evidence highlights the role of financial globalization in explaining the drop in the U.S. share but it also suggests that some of the drop is due to U.S.-specific factors.

Long Run Productivity Risk and Aggregate Investment
Jack Favilukis and Xiaoji Lin
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We study the implications of long-run risk type shocks - shocks to the growth rate of productivity - for aggregate investment in a DSGE model. Our model offers an alternative to microfrictions explanation of aggregate investment non-linearities, in particular the heteroscedasticity of investment rate. Additionally, consistent with the data, these shocks imply that investment rate is history dependent (rising through an expansion), investment rate growth is positively autocorrelated, and is positively correlated with output growth at various leads and lags. A standard model with shocks to the level of productivity either predicts the opposite or fails to quantitatively capture these features in the data.

Syndicated Loan Spreads and the Composition of the Syndicate
Jongha Lim, Bernadette A. Minton, and Michael S. Weisbach
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The past decade has seen significant changes in the structure of the corporate lending market, with non-bank institutional investors playing larger roles than they historically have played. These non-bank institutional lenders typically have higher required rates of return than banks, but invest in the same loan facilities. We hypothesize that non-bank institutional lenders invest in loan facilities that would not otherwise be filled by banks, so that the arranger has to offer a higher spread to attract the non-bank institution. In a sample of 20,031 leveraged loan facilities originated between 1997 and 2007, we find that, loan facilities including a non-bank institution in their syndicates have higher spreads than otherwise identical bank-only facilities. Contrary to risk-based explanations of this finding, non-bank facilities are priced with premiums relative to bank-only facilities of the same loan package. These premiums for non-bank facilities are substantially larger when a hedge or private equity fund is one of the syndicate members. Consistent with the notion that firms are willing to pay spread premiums when loan facilities are particularly important to the firm, we find that firms spend the capital raised by loan facilities priced at a premium faster than other loan facilities, especially when the premium is associated with a non-bank institutional investor.

Wage Rigidity: A Solution to Several Asset Pricing Puzzles
Jack Favilukis and Xiaoji Lin
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In standard models wages are too volatile and returns too smooth. We make wages sticky through infrequent resetting, resulting in both (i) smoother wages and (ii) volatile returns. Furthermore, the model produces other puzzling features of financial data: (iii) high Sharpe Ratios, (iv) low and smooth interest rates, (v) time-varying equity volatility and premium, and (vi) a value premium. In standard models, highly pro-cyclical and volatile wages are a hedge. The residual - profit - becomes unrealistically smooth, as do returns. Smoother wages act like operating leverage, making profits more risky. Bad times and unproductive firms are especially risky because committed wage payments are high relative to output.

Labor Hiring, Investment, and Stock Return Predictability in the Cross Section
Santiago Bazdresch, Frederico Belo, and Xiaoji Lin
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We study the impact of labor market frictions on asset prices in the cross section of US publicly traded firms. On average, firms with low hiring rates have higher future stock returns than firms with high hiring rates, a difference of 5.2% per annum. Interpreting a hiring decision as analogous to an investment decision, we propose a dynamic neoclassical investment-based model with labor and capital adjustment costs to explain this hiring return spread. Firms that are hiring relatively more have lower macroeconomic risk which explains why high hiring rates predicts low stock returns. The model matches the observed levels of the hiring return spread, key properties of the firm-level hiring and investment rates, and other empirical regularities. Our analysis suggest that labor market frictions can have a significant impact on asset prices in financial markets.

Reverse Mergers: The Chinese Experiences
Jan Jindra, Torben Voetmann,and Ralph Walking
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Chinese reverse mergers (CRMs) claim to provide easy entry to the U.S. and international markets. Recently, a large number of Chinese firms using reverse merger transactions have been listed on the U.S. stock exchanges. We review the historical use and mechanics of these reverse mergers, and contrast them with initial public offerings (IPOs). We also explore settlements of securities class action lawsuits involving Chinese firms. Our analysis shows that larger, more reputable Chinese firms are significantly less likely to pursue reverse mergers. We also find that CRM firms are more likely to be subject to class action litigation in the U.S and that the settlement amounts are smaller for CRM firms than for Chinese IPO firms. Our analysis further indicates that CRM firms significantly underperform the Chinese IPO firms. Thus, the evidence suggests that CRMs are not substitutes for Chinese IPOs.

Does Wage Rigidly Make Firms Riskier? Evidence From Long-Horizon Return Predictability.
Jack Favilukis and Xiaoji Lin
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We explore the relationship between sticky wages and risk. Like operating leverage, sticky wages are a source of risk for the firm. Firms, industries, regions, or times with especially high or rigid wages are especially risky. If wages are sticky, then wage growth should negatively forecast future stock returns because falling wages are associated with even bigger falls in output, and increases in operating leverage. Indeed, this is the case in aggregate, industry, and U.S. state level data. Furthermore, this relation is stronger in industries and U.S. states with higher wage rigidity.

Policy Intervention in Debt Renegotiation: Evidence from the Home Affordable Modification Program
Sumit Agarwala, Gene Amromina, Itzhak Ben-David,Souphala Chomsisengphetc, Tomasz Piskorskid, and Amit Serue
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The main rationale for policy intervention in debt renegotiation is to enhance such activity when foreclosures are perceived to be inefficiently high. We examine the ability of the government to influence debt renegotiation by empirically evaluating the effects of the 2009 Home Affordable Modification Program that provided intermediaries (servicers) with sizeable financial incentives to renegotiate mortgages. A difference-in-difference strategy that exploits variation in program eligibility criteria reveals that the program generated an increase in the intensity of renegotiations while adversely affecting effectiveness of renegotiations performed outside the program. Renegotiations induced by the program resulted in a modest reduction in rate of foreclosures but did not alter the rate of house price decline, durable consumption, or employment in regions with higher exposure to the program. The overall impact of the program will be substantially limited since it will induce renegotiations that will reach just one-third of its targeted 3 to 4 million indebted households. This shortfall is in large part due to low renegotiation intensity of a few large servicers that responded at half the rate than others. The muted response of these servicers cannot be accounted by differences in contract, borrower, or regional characteristics of mortgages across servicers. Instead,their low renegotiation activity—which is also observed before the program—reflects servicer specific factors that appear to be related to their preexisting organizational capabilities. Our findings reveal that the ability of government to quickly induce changes in behavior of large intermediaries through financial incentives is quite limited, underscoring significant barriers to the effectiveness of such polices.

Digesting Anomalies: An Investment Approach
Kewei Hou, Chen Xue, and Lu Zhang
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Motivated from investment-based asset pricing, we propose a new factor model consisting of the market factor, a size factor, an investment factor, and a return on equity factor. The new factor model outperforms the Carhart four-factor model in pricing portfolios formed on earnings surprise, idiosyncratic volatility, financial distress, net stock issues, composite issuance, as wellas on investment and return on equity. The new model performs similarly as the Carhart model in pricing portfolios formed on size and momentum, abnormal corporate investment, as well as on size and book-to-market, but underperforms in pricing the total accrual deciles. The new model’s performance, combined with its clear economic intuition, suggests that it can be used as a new workhorse model for academic research and investment management practice..

Endogenous technological progress and the cross section of stock returns
Xiaoji Lin
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I study the cross-sectional variation of stock returns and technological progress using a dynamic equilibrium model with production. Technological progress is endogenously driven by research and development (R&D) investment and is composed of two parts. One part is devoted to product innovation; the other, to increasing the productivity of physical investment. The latter is embodied in new tangible capital. The model breaks the symmetry assumed in standard models between tangible and intangible capital, in which the accumulation processes of tangible and intangible capital stock do not a ect each other. Qualitatively and, in many cases, quantitatively,the model explains well-documented empirical regularities.

The Inventory Growth Spread
Frederico Belo and Xiaoji Lin
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Previous studies show that firms with low inventory growth outperform firms with high inventory growth in the cross-section of publicly traded firms. In addition, inventory investment is volatile and procyclical, and inventory-to-sales is persistent and countercyclical. We embed an inventory holding motive into the investment-based asset pricing framework by modeling inventory as a factor of production with convex and non-convex adjustment costs. The augmented model simultaneously matches the large inventory growth spread in the data, as well as the time-series properties of the firm level capital investment, inventory investment, and inventory-to-sales. Our conditional single-factor model also implies that traditional unconditional factor models such as the CAPM should fail to explain the inventory growth spread, although not with the same large pricing errors observed in the data.

Probability Weighting of Rare Events and Currency Returns
Fousseni Chabi-Yo and Zhaogang Song
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We show that the probability weighting of rare events, accounting for investors’ attitudes toward extreme downside losses versus upside gains in non-expected utility models, provides a unified explanation for both time-series and cross-sectional variations of currency portfolio returns. We use a simple structural model to show the link between the probability weighting function and pricing kernel, and then estimate them by non-parametric methods using currency options data from 1996 to 2012. The estimates show that a domestic investor over-weights the likelihood of a substantial depreciation or appreciation of foreign currencies, consistent with experimental studies. A global probability weighting measure of left (right) tail events is highly significant in positively (negatively) predicting future currency returns over time series at both individual and portfolios levels. Furthermore, asset pricing tests show that differences in exposure to our global tail weighting measures, of high versus low interest rate currencies and of high versus low past return currencies, can explain the cross-sectional variation in average excess returns across both carry and momentum portfolios. Moreover, our global tail weighting measures remain significant after controlling for existing currency risk factors in the literature, and frequently

Labor-Force Heterogeneity and Asset Prices: The Importance of Skilled Labor
Frederico Belo, Xiaoji Lin, Jun Li, and Xiaofei Zhao
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We investigate the impact of labor-force heterogeneity on asset prices in a neoclassical model with labor and capital adjustment costs, and with aggregate productivity and adjustment cost shocks. We document that the negative firms’ hiring rate-future stock return relation identified in previous studies is significantly steeper in industries that rely relatively more on high skill workers than on low skill workers. A long low hiring rate firms and short high hiring rate firms portfolio earns an average annual stock return of 8.6% in
high skill industries, and only 0.9% in low skill industries. Moreover, this pattern is not explained by the standard CAPM. This finding is consistent with a neoclassical model of investment with labor force heterogeneity if it is more costly to replace high skill than low skill workers. This differential cost makes the returns of the firms in the high skill to be more exposed to the aggregate adjustment cost shock. We provide empirical support for this economic mechanism using a model-implied adjustment cost shock proxy.

Does Target CEO Retention in Aquisition Involving Private Equity Acquirers Harm Target Shareholders
Leonce L. Bargeron, Frederik P. Schlingemann, René M. Stulz, and Chad J. Zutter
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While there is widespread concern that target CEO retention by the acquirer harms target shareholders when the acquirer is a private equity firm, CEO retention can also be valuable to private equity acquirers, and hence potentially benefit shareholders. We find that CEO retention does not harm target shareholders when the acquirer is a private equity firm. In fact, we show that, in acquisitions by private equity firms, better performing CEOs are more likely to be retained and target shareholders gain an additional 10% to 23% of pre-acquisition firm value when the CEO is retained compared to when the CEO is not retained. In contrast, shareholders of targets acquired by operating companies do not benefit from CEO retention. Finally, we find no evidence that the target’s value is artificially depressed ahead of a private equity acquisition where the CEO is retained.

Why Did Holdings of Highly-Rated Securitization Tranches Differ So Much Across Banks?
Isil Erel, Taylor Nadauld and René M. Stulz
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We provide estimates of holdings of highly-rated securitization tranches of American bank holding companies ahead of the credit crisis and evaluate hypotheses that have been advanced to explain these holdings. Our broadest estimates include CDOs as well as holdings in off-balance-sheet conduits. While holdings exceeded Tier 1 capital for some large banks, they were economically trivial for the typical U.S. bank. The banks with high holdings were not riskier before the crisis using conventional measures, but their performance was poorer during the crisis. We find that holdings of highly-rated tranches are explained by a bank’s securitization activity. Theories of highly-rated tranches that are unrelated to a bank’s securitization activity, such as “bad incentives,” “bad governance,” or “bad risk management” theories, have no support in the data.

Have We Solved The Idiosyncratic Volatility Puzzle?
Kewei Hou and Roger K. Loh
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We propose a simple methodology to evaluate a large number of potential explanations for the negative relation between idiosyncratic volatility and subsequent stock returns (the idiosyncratic volatility puzzle). We find that surprisingly many existing explanations explain less than 10% of the puzzle. On the other hand, explanations based on investors’ lottery preferences, short-term return reversal, and earnings shocks show greater promise in explaining the puzzle. Together they account for 60-80% of the negative idiosyncratic volatility-return relation. Our methodology can be applied to evaluate competing explanations for a broad range of topics in asset pricing and corporate finance.

Collateral Valuation and Borrower Financial Constraints: Evidence from the Residential Real-Estate Market
Sumit Agarwal, Itzhak Ben-David and Vincent Yao
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Financially-constrained borrowers have the incentive to influence the appraisal process in order to increase borrowing or reduce the interest rate. The average valuation bias for residential refinance transactions is above 5%. The bias is larger for highly leveraged transactions, and for transactions mediated through a broker, especially where competition is high. Mortgages with inflated valuations default more often; however, lenders partially account for the valuation bias through pricing.

Globalization, Governance, and the Returns to Cross-Border Acquisitions
Jesse Ellis, Sara B. Moeller, Frederik P. Schlingemann,and René M. Stulz
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Using a sample of control cross-border acquisitions from 61 countries from 1990 to 2007, we find that acquirers from countries with better governance gain more from such acquisitions and their gains are higher when targets are from countries with worse governance. Other acquirer country characteristics are not consistently related to acquisition gains. For instance, the anti-self-dealing index of the acquirer has opposite associations with acquirer returns depending on whether the acquisition of a public firm is paid for with cash or equity. Strikingly, global effects in acquisition returns are at least as important as acquirer country effects. First, the acquirer’s industry and the year of the acquisition explain more of the stock-price reaction than the country of the acquirer. Second, for acquisitions of private firms or subsidiaries, acquirers gain more when acquisition returns are high for acquirers from other countries. We find strong evidence that better alignment of interests between insiders and minority shareholders is associated with greater acquirer returns and weaker evidence that this effect mitigates the adverse impact of poor country governance.

The Role of Securitization in Mortgage Renegotiation
Sumit Agarwal, Gene Amromin, Itzhak Ben-David, Souphala Chomsisengphet, Douglas D. Evanoff
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We study the effects of securitization on post-default renegotiation of residential mortgages over the current financial crisis. Unlike prior studies, we employ unique data that directly observes lender renegotiation actions and covers more than 60% of US mortgage market. Exploiting within-servicer variation in this data, we find that bank-held loans are 26% to 36% more likely to be renegotiated than comparable securitized mortgages (4.2 to 5.7% in absolute terms). Also, modifications of bank-held loans are more efficient: conditional on a modification bank-held loans have lower post-modification default rate by 9% (3.5% in absolute terms). Our findings support the view that frictions introduced by securitization create a significant challenge to effective renegotiation of residential loans.

Financial Policies, Investment, and the Financial Crisis: Impaired Credit Channel or Diminished Demand for Capital?
Kathleen M. Kahle and René M. Stulz
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Though much of the narrative of the financial crisis has focused on the impact of a bank credit supply shock, we show that such a shock cannot explain important features of the financial and investment policies of industrial firms. These features are consistent with a dominant role for the increase in risk and the reduction in demand for goods that occurred during the crisis. The net equity issuance of small firms and unrated firms is abnormally low throughout the crisis, whereas an impaired credit supply by itself would have encouraged these firms to increase their net equity issuance. After September 2008, firms increase their cash holdings rather than use them to mitigate the impact of the credit supply shock. Firms that are more bank-dependent before the crisis do not reduce their capital expenditures more than other firms during the crisis. Finally, the evidence is strongly supportive of theories that emphasize the importance of collateral and corporate net worth in financing and investment policies, as firms with stronger balance sheets reduce capital expenditures less after September 2008.

Career Concerns and the Busy Life of the Young CEO
Xiaoyang Li, Angie Low, and Anil K. Makhija
revision:July 2011
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Using U.S. plant-level data for firms across a broad spectrum of industries, we compare how career concerns affect the real investment decisions of younger and older CEOs. In contrast to prior research which has examined some specialized labor markets, we find that younger CEOs undertake more active, bolder investment activities, consistent with an attempt on their part to signal confidence and superior abilities. They are more likely to enter new lines of business, as well as exit from existing lines of business. They prefer growth through acquisitions, while older CEOs prefer to build new plants. This busier investment style of the younger CEOs appears not to hurt firm efficiency since younger CEOs are associated with equally high plant-level efficiency compared to older CEOs.

Do Hedge Funds Manipulate Stock Prices?
Itzhak Ben-David, Francesco Franzoni, Augustin Landier and Rabih Moussawi
revision: June, 2011
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We find evidence that hedge funds significantly manipulate stock prices on critical reporting dates. We document that stocks held by hedge funds experience higher returns on the last day of the quarter, followed by a reversal the next day. For example, the stocks in the top quartile of hedge fund holdings exhibit abnormal returns of 30 basis points on the last day of the quarter and a reversal of 25 basis points on the following day. Using intraday data, we show that a significant part of the return is earned during the last minutes of the last day of the quarter, at an increasing rate towards the closing bell. This evidence is consistent with hedge funds’ incentives to inflate their monthly performance by buying the stocks they hold in their portfolios. Evidence of manipulation is stronger for funds that have higher incentives for improving their ranking relative to their peers and a lower cost of doing so. Such dislocations of market prices constitute a negative externality for agents using end-of-month market prices for benchmarking,contracting, or trading purposes.

Why are U.S. Stocks More Volatile?
Sohnke M. Bartram, Gregory Brown and René M. Stulz
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From 1991 to 2006, U.S. stocks are more volatile than stocks of similar foreign firms. A firm’s stock return volatility in a country can be higher than the stock return volatility of a similar firm in another country for reasons that contribute positively (good volatility) or negatively (bad volatility) to shareholder wealth and economic growth. We find that the volatility of U.S. firms is higher mostly because of good volatility. Specifically, firm stock volatility is higher in the U.S. because it increases with investor protection, stock market development, research intensity at the country level, and firm-level investment in R&D. These are all factors that are related to better growth opportunities for firms and better ability to take advantage of these opportunities. Though it is often argued that better disclosure is associated with greater volatility as more information is impounded in stock prices, we find instead that greater disclosure is associated with lower stock volatility.

Why Do Some CEOs Work for a One-Dollar Salary?
Gilberto Loureiro, Anil K. Makhija and Dan Zhang
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We find evidence consistent with the view that $1 CEO salaries are a ruse hiding the rent seeking pursuits of CEOs adopting these pay schemes. CEOs with these arrangements, despite the drastic cuts in salary, have total compensation that is similar to that at other firms, making up lost salary through not-so-visible forms of equity-based compensation. There is greater likelihood of a $1 CEO salary when the CEO is rich, overconfident, owns a sizeable ownership stake, and institutional ownership is relatively low. These powerful CEOs are in a position to draw significant undue private benefits, and need not replace certain salary dollars with risky future income. However, we find that they are at risk of engendering public outrage over their private benefits, against which the $1 salary constitutes valuable deflection of attention. Shareholders of firms with $1 CEO salaries do not fare well in the aftermath of these adoptions. Thus, rather than being the sacrificial acts they are projected to be, our findings suggest that adoptions of $1 CEO salaries are opportunistic behavior of the wealthier, more overconfident, influential CEOs. Overall, these findings support the Managerial Power Hypothesis in the literature, which claims that CEOs employ camouflage in compensation schemes to avoid public outrage over excessive private benefits.

The U.S. Left Behind: The Rise of IPO Activity Around the World
Craig Doidge, G. Andrew Karolyi and René M. Stulz
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During the past two decades, there has been a dramatic change in IPO activity around the world. Though vibrant IPO activity, attributed to better institutions and governance, used to be a strength of the U.S., it no longer is. IPO activity in the U.S. has fallen compared to the rest of the world and U.S. firms go public less than expected based on the economic importance of the U.S. In the early 1990s, the declining U.S. IPO share was due to the extraordinary growth of IPOs in foreign countries; in the 2000s, however, it is due to higher IPO activity abroad combined with lower IPO activity in the U.S. Global IPOs, which are IPOs in which some of the proceeds are raised outside the firm’s home country, play a critical role in the increase in IPO activity outside the U.S. The quality of a country’s institutions is positively related to its domestic IPO activity and negatively related to its global IPO activity. However, home country institutions are more important in explaining IPO activity in the 1990s than in the 2000s. The evidence is consistent with the view that access to global markets helps firms overcome the obstacles of poor institutions. Finally, we show that the dynamics of global IPO activity and country-level IPO activity are strongly affected by global factors.

Macroeconomic Conditions and Capital Raising
Isil Erel, Brandon Julio, Woojin Kim, and Michael S. Weisbach
revision: July 2011
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Do macroeconomic conditions affect firms’ abilities to raise capital? If so, how do they affect the manner in which the capital is raised? We address these questions using a large sample of publicly-traded debt issues, seasoned equity offers, bank loans and private placements of equity and debt. Our results suggest that a borrower’s credit quality significantly affects its ability to raise capital during macroeconomic downturns. For noninvestment-grade borrowers, capital raising tends to be procyclical while for investment-grade borrowers, it is countercyclical. Moreover, proceeds raised by investment grade firms are more likely to be held in cash in recessions than in expansions. Poor market conditions also affect the structure of securities offered, shifting them towards shorter maturities and more security. Overall, our results suggest that macroeconomic conditions influence the securities that firms issue to raise capital, the way in which these securities are structured and indeed firms’ ability to raise capital at all.

This Time Is the Same: Using Bank Performance in 1998 to Explain Bank Performance During the Recent Financial Crisis
Rüdiger Fahlenbrach, Robert Prilmeier, and René M. Stulz
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We investigate whether a bank’s performance during the 1998 crisis, which was viewed at the time as the most dramatic crisis since the Great Depression, predicts its performance during the recent financial crisis. One hypothesis is that a bank that has an especially poor experience in a crisis learns and adapts, so that it performs better in the next crisis. Another hypothesis is that a bank’s poor experience in a crisis is tied to aspects of its business model that are persistent, so that its past performance during one crisis forecasts poor performance during another crisis. We show that banks that performed worse during the 1998 crisis did so as well during the recent financial crisis. This effect is economically important. In particular, it is economically as important as the leverage of banks before the start of the crisis. The result cannot be attributed to banks having the same chief executive in both crises. Banks that relied more on short-term funding, had more leverage, and grew more are more likely to be banks that performed poorly in both crises.

Variance Bounds on the Permanent and Transitory Components of Stochastic Discount Factors
Gurdip Bakshi and Fousseni Chabi-Yo
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When the transitory component of the stochastic discount factors (SDFs) prices the long-term bond, and the permanent component prices other assets, we develop lower bounds on the variance of the permanent component and the transitory component, and on the variance of the ratio of the permanent to the transitory components of SDFs. A salient feature of our bounds is that they incorporate information from average returns and the variance-covariance matrix of returns corresponding to a generic set of assets. Relevant to economic modeling, we examine the tightness of our bounds relative to Alvarez and Jermann (2005, Econometrica). Exactly solved eigenfunction problems are then used to study the empirical attributes of asset pricing models that incorporate long-run risk, external habit persistence, and rare disasters. Specific quantitative implications are developed for the variance of the permanent and the transitory components,the return behavior of the long-term (infinite-maturity) bond, and the comovement between the transitoryand the permanent components of SDFs.

Liquidity Shocks and Hedge Fund Contagion
Nicole M. Boyson, Christof W. Stahel, and René M. Stulz
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In Boyson, Stahel, and Stulz (2010), we investigate whether hedge funds experience worst return contagion – that is, correlations in extremely poor returns that are over and above those expected from economic fundamentals. We find strong evidence of contagion among hedge funds using eight separate style indices for the period from January 1990 to October 2008: the probability of a worst return in a particular index is increasing in the number of other indices that also have extremely poor returns. We then show that large adverse shocks to asset and funding liquidity strongly increase the likelihood of this contagion. In this paper, we further investigate contagion between hedge funds and main markets. We uncover strong evidence of contagion between hedge funds and small-cap, mid-cap and emerging market equity indices, high yield bonds, emerging market bonds, and the Australian Dollar. Finally, we show that this contagion between hedge funds and markets is also significantly linked to liquidity shocks, especially for small-cap domestic equities, Asian equities, high yield bonds, and the Australian Dollar.

Are Investors Really Reluctant to Realize their Losses? Trading Responses to Past Returns and the Disposition Effect
Itzhak Ben-David and David Hirshleifer
revision: December 2011
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We examine how investor preferences and beliefs affect trading in relation to past gains and losses. The probability of selling as a function of profit is V-shaped; for short prior holding periods, investors are much more likely to sell big losers than small ones. There is little evidence of an upward jump in selling probability at zero profits. These findings provide no clear indication that realization preference helps explain investor trading behavior. Furthermore, the disposition effect is not primarily driven by a direct preference for realizing winners rather than losers. Trading based on beliefs can potentially explain these findings.

Do Private Equity Fund Managers Earn their Fees? Compensation, Ownership, and Cash Flow Performance
David T. Robinson and Berk A. Sensoy
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Using a new database of the compensation terms, ownership structures (capital commitments), and quarterly cash flows for a large sample of buyout and venture cap- ital private equity funds from 1984-2010, we investigate the determinants of manager compensation and ownership and how these contract terms relate to the funds’ cash flow performance. Market conditions during fundraising are an important driver of compensation, as pay rises and shifts to fixed components during fundraising booms. We find no evidence that higher compensation or lower managerial ownership are asso- ciated with worse net-of-fee performance, in stark contrast to other asset management settings. Instead, compensation is largely unrelated to net cash flow performance. Our evidence is most consistent with an equilibrium in which compensation terms reflect agency concerns and the productivity of manager skills, and in which managers with higher compensation earn back their pay by delivering higher gross performance.

Covariances versus Characteristics in General Equilibrium
Xiaoji Lin and Lu Zhang
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We question a deep-ingrained doctrine in asset pricing: If an empirical characteristic-return relation is consistent with investor “rationality,” the relation must be “explained” by a risk factor model. The investment approach changes the big picture of asset pricing. Factors formed on characteristics are not necessarily risk factors: Characteristics-based factor models are linear approximations of firm-level investment returns. That characteristics dominate covariances in horse races does not necessarily mean mispricing: Measurement errors in covariances are more likely to blame. Most important, the investment approach completes the consumption approach in general equilibrium, especially for cross-sectional asset pricing.

Why Did U.S. Banks Invest in Highly-Rated Securitization Tranches?
Isil Erel, Taylor Nadauld and René M. Stulz
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We estimate holdings of highly-rated tranches of mortgage securitizations of American deposit-taking banks ahead of the credit crisis and evaluate hypotheses that have been advanced to explain these holdings. We find that holdings of highly-rated tranches were economically trivial for the typical bank, but banks with greater holdings performed more poorly during the crisis. Though univariate comparisons show that banks with large trading books had greater holdings, the holdings of highly-rated tranches are not higher for banks with large trading books in regressions that control for bank size. The ratio of highly-rated tranches holdings to assets increases with bank assets, but not for banks with more than $50 billion of assets. This evidence is inconsistent with explanations for holdings of highly-rated tranches that emphasize the incentives of banks deemed “too-big-to-fail”. Further, the evidence does not provide support for “bad incentives” theories of holdings of highly-rated tranches. We find, however, that banks active in securitization held more highly-rated tranches. Such a result can be consistent with regulatory arbitrage as well as with securitizing banks holding highly-rated tranches to convince investors of the quality of these securities. Our evidence supports the latter hypothesis.

High Leverage and Willingness to Pay: Evidence from the Residential Housing Market
Itzhak Ben-David
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I document a strong correlation between paying the full listing price on homes and borrowing 100% loan-to-value. Homebuyers who do both overpay by 2.8% to 3.9% ($4,800 to $6,700) and are 22.7% more likely to have their properties foreclosed within one year. The correlation is not mechanical: there is a discontinuity in the average leverage around the full listing price. The correlation is stronger for in areas with high fraction of financially constrained and unsophisticated residents, and in areas of high past price growth (potentially indicative of buyer optimism).

Corporate Acquisitions, Diversification, and the Firm’s Lifecycle
Asli M. Arikan and René M. Stulz
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Lifecycle theories of mergers and diversification predict that firms make acquisitions and diversify when their internal growth opportunities become exhausted. Free cash flow theories make similar predictions. In contrast to these theories, we find that the acquisition rate of firms (defined as the number of acquisitions in an IPO cohort-year divided by the number of firms in that cohort-year) follows a u-shape through their lifecycle as public firms, with young and mature firms being equally acquisitive but more so than middle-aged firms. Firms that go public during the merger/IPO wave of the 1990s are significantly more acquisitive early in their public life than firms that go public at other times. Young public firms have a lower acquisition rate of public firms than mature firms, but the opposite is true for acquisitions of private firms and subsidiaries. Strikingly, firms diversify early in their life and there is a 41% chance that a firm’s first acquisition is a diversifying acquisition. The stock market reacts more favorably to acquisitions by young firms than to acquisitions by mature firms except for acquisitions of public firms paid for with stock. There is no evidence that the market reacts more adversely to diversifying acquisitions by young firms than to other acquisitions.

What do Boards Really Do? Evidence from Minutes of Board Meetings
Miriam Schwartz-Ziv and Michael S. Weisbach
revision dates: March 2012, January 2012, November, 2011
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We analyze a unique database from a sample of real-world boardrooms – minutes of board meetings and board-committee meetings of eleven business companies for which the Israeli government holds a substantial equity interest. We use these data to evaluate the underlying assumptions and predictions of models of boards of directors. These models generally fall into two categories: “managerial models” that assume boards play a direct role in managing the firm, and “supervisory models” that assume that boards monitor top management but do not make business decisions themselves. Consistent with the supervisory models, our minutes-based data suggest that boards spend most of their time monitoring management: approximately two-thirds of the issues boards discussed were of a supervisory nature, they were presented with only a single option in 99% of the issues discussed, and they disagreed with the CEO only 2.5% of the time. Nevertheless, at times boards do play a managerial role: Boards requested to receive further information or an update for 8% of the issues discussed, and they took an initiative with respect to 8.1% of them. In 63% of the meetings, boards took at least one of these actions or did not vote in line with the CEO. Taken together our results suggest that boards can be characterized as active monitors.

Do ETFs Increase Volatility
Itzhak Ben-David, Francesco Franzoni and Rabih Moussawi
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Due to their low trading costs, ETFs are potentially a catalyst for short-horizon liquidity traders. The liquidity shocks can propagate to the underlying securities through the arbitrage channel, and ETFs may increase the non-fundamental volatility of the securities in their baskets. We exploit exogenous changes in index membership and find that stocks with higher ETF ownership display significantly higher volatility. ETF ownership increases the negative autocorrelation in stock prices. The increase in volatility appears to introduce undiversifiable risk in prices, because stocks with high ETF ownership earn a significant risk premium of up to 56 basis points monthly.

Profitability Shocks and the Size Effect in the Cross-Section of Expected Stock Returns
Kewei Hou and Mathijs A. van Dijk
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Recent studies report that the size effect in the cross-section of U.S. stock returns has disappeared after the early 1980s. We examine whether the disappearance of the size effect in realized returns can be attributed to unexpected shocks to the profitability of small and big firms. We show that small firms experience large negative profitability shocks after the early 1980s, while big firms experience large positive shocks. As a result, realized returns of small and big firms over this period differ substantially from expected returns. After adjusting for the price impact of profitability shocks, we find that there still is a robust size effect in expected returns. Our results suggest that in-sample cash flow shocks can significantly affect inferences about predictability in the cross-section of stock returns.

Hedge Fund Stock Trading in the Financial Crisis of 2007-2009 (revisied 9/11),(revised 5/11)
Itzhak Ben-David, Francesco Franzoni and Rabih Moussawi
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Hedge funds significantly reduced their equity holdings during the recent financial crisis. In 2008Q3-Q4,hedge funds sold about 29% of their aggregate portfolio. Redemptions and margin calls were the primary drivers of selloffs. Consistent with forced deleveraging, the selloffs took place in volatile and liquid stocks. In comparison, redemptions and stock sales for mutual funds were not as severe. We show that hedge fund investors withdraw capital three times as intensely as mutual fund investors do in response to poor returns. We relate this stronger sensitivity to losses to share liquidity restrictions and institutional ownership in hedge funds.

Pay for Performance from Future Fund Flows: The Case of Private Equity (revised 09/10)
Ji-Woong Chung, Berk A. Sensoy, Léa H. Stern and Michael S. Weisbach
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Lifetime incomes of private equity general partners are affected by their current funds' performance through both carried interest profit sharing provisions, and also by the effect of the current fund's performance on general partners' abilities to raise capital for future funds. We present a learning-based framework for estimating the market-based pay for performance arising from future fundraising. For the typical first-time private equity fund, we estimate that implicit pay for performance from expected future fundraising is approximately the same order of magnitude as the explicit pay for performance general partners receive from carried interest in their current fund, implying that the performance-sensitive component of general partner revenue is about twice as large as commonly discussed. Consistent with the learning framework, we find that implicit pay for performance is stronger when managerial abilities are more scalable and weaker when current performance contains less new information about ability. Specifically, implicit pay for performance is stronger for buyout funds compared to venture capital funds, and declines in the sequence of a partnership's funds. Our framework can be adapted to estimate implicit pay for performance in other asset management settings in which future fund flows and compensation depend on current performance.

The Implied Cost of Capital:A New Approach (revised 12/11)
Kewei Hou, Mathijs A. van Dijk and Yinglei Zhang
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We use earnings forecasts from a cross-sectional model to proxy for cash flow expectations and estimate the implied cost of capital (ICC) for a large sample of firms over 1968-2008. The earnings forecasts generated by the cross-sectional model are superior to analysts’ forecasts in terms of coverage, forecast bias, and earnings response coefficient. Moreover, the model-based ICC is a more reliable proxy for expected returns than the ICC based on analysts’ forecasts. We present evidence on the cross-sectional relation between firm-level characteristics and ex ante expected returns using the model-based ICC.

The Credit Crisis Around the Globe: Why Did Some Banks Perform Better?
Andrea Beltratti and René M. Stulz
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Though overall bank performance from July 2007 to December 2008 was the worst since the Great Depression, there is significant variation in the cross-section of stock returns of large banks across the world during that period. We use this variation to evaluate the importance of factors that have been put forth as having contributed to the poor performance of banks during the credit crisis. Our evidence is inconsistent with the argument that poor governance of banks made the crisis worse, but it is supportive of theories that emphasize the fragility of banks financed with short-run capital market funding. Strikingly, differences in banking regulations across countries are generally uncorrelated with the performance of banks during the crisis, except that banks in countries with more restrictions on banking activities performed better, and are uncorrelated with observable risk measures of banks before the crisis. The better-performing banks had less leverage and lower returns in 2006 than the worst–performing banks.

Dark Pool Trading Strategies, Market Quality and Welfare
Sabrina Buti, Barbara Rindi, and Ingrid M. Werner
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We show that when a continuous dark pool is added to a limit order book that opens illiquid, book and consolidated fill rates and volume increase, but spread widens, depth declines and welfare deteriorates. The adverse effects on market quality and welfare are mitigated when book-liquidity builds but so are the positive effects on trading activity. All effects are stronger when traders' valuations are less dispersed, access to the dark pool is greater, horizon is longer, and relative tick size larger.

Do Independent Director Departures Predict Future Bad Events?
Rüdiger Fahlenbrach, Angie Low, and René M. Stulz
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Following surprise independent director departures, affected firms have worse stock and operating performance, are more likely to restate earnings, face shareholder litigation, suffer from an extreme negative return event, and make worse mergers and acquisitions. The announcement returns to surprise director departures are negative, suggesting that the market infers bad news from surprise departures. We use exogenous variation in independent director departures triggered by director deaths to test whether surprise independent director departures cause these negative outcomes or whether an anticipation of negative outcomes is responsible for the surprise director departure. Our evidence is more consistent with the latter.

Are Acquisition Premiums Lower because of Target CEOs Conflicts of Interest?
Leonce Bargeron, Frederik Schlingemann, René M. Stulz, and Chad Zutter
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CEOs have a conflict of interest when their company is the target of an acquisition attempt: They can bargain for private benefits, such as retention by the acquirer, rather than for a higher premium to be paid to their shareholders. We find that target CEO retention by the bidder does not appear to be driven by the CEO bargaining for his own interests at the expense of shareholders. Retention is not associated with a lower premium. Retention is more likely when it is more valuable to the bidder in running the merged firm, in that the CEO is more likely to be retained when she has skills and knowledge that bidder executives do not have and when the incentives of target insiders are well aligned with those of target shareholders. Regardless of retention, shareholders of acquired firms whose CEO is at retirement age receive lower premiums than shareholders of acquired firms with younger CEOs. This lower premium seems to be explained by the apparent reduced acquisition value of firms led by retirement age CEOs rather than by the target CEO conflict of interest.

Borrow Cheap, Buy High? The Determinants of Leverage and Pricing in Buyouts
Ulf Axelson, Tim Jenkinson, Per Strömberg, and Michael S. Weisbach
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This paper provides an empirical analysis of the financial structure of large buyouts. We collect detailed information on the financing of 1157 worldwide private equity deals from 1980 to 2008. Buyout leverage is cross-sectionally unrelated to the leverage of matched public firms, and is largely driven by factors other than what explains leverage in public firms. In particular, the economy-wide cost of borrowing is the main driver of both the quantity and the composition of debt in these buyouts. Credit conditions also have a strong effect on prices paid in buyouts, even after controlling for prices of equivalent public market companies. Finally, the use of high leverage in transactions negatively affects fund performance, controlling for fund vintage and other relevant characteristics. The results are consistent with the view that the availability of financing impacts booms and busts in the private equity market, and that agency problems between private equity funds and their investors can affect buyout capital structures.

Diving Into Dark Pools
Sabrina Buti, Barbara Rindi, and Ingrid M. Werner
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This paper examines unique data on dark pool activity for a large cross-section of US stocks in 2009. Dark pool activity is concentrated in large firms, stocks with high share volume, high price, low spreads, high depth, and low short-term volatility. NASDAQ (AMEX) stocks have significantly higher (lower) dark pool activity than NYSE stocks controlling for size, share volume, and price. For a given stock, dark pool activity is significantly higher on days with higher share volume, higher depth, and lower intraday volatility. Dark pool activity is significantly lower for days with larger order imbalances relative to share volume and larger absolute returns. We find no evidence supporting the hypothesis that dark pool activity has a detrimental effect on market quality.

Are Stock Acquirers Overvalued? Evidence from Short Selling Activity
Itzhak Ben-David, Michael S. Drake, and Darren T. Roulstone
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We use a novel identification approach to test whether stock acquirers are overvalued prior to merger announcements or whether they have high growth opportunities (Q-theory). We argue that the overvaluation of firms drives both high short selling activity and a higher likelihood of stock mergers. We document that, as early as 12 months before a merger announcement, short selling activity is higher (lower) for firms that eventually make stock (cash) acquisitions. High short interest predicts long-term negative returns following the announcement. Finally, stock (but not cash) acquirers have higher short interest than their targets. We investigate alternative explanations for our results that do not assume short sellers only target overvalued firms and show that these explanations do not appear to explain our results. We conclude that overvalued firms self-select to become stock acquirers and that short selling activity does not completely eliminate acquirer overvaluation.

Managerial Miscalibration
Itzhak Ben-David, John R. Graham, and Campbell R. Harvey
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We test whether top financial executives are miscalibrated using a unique 10-year panel that includes over 13,300 probability distributions of expected stock market returns. We find that executives are severely miscalibrated, producing distributions that are too narrow: realized market returns are within the executives’ 80% confidence intervals only 36% of the time. We show that the lower bound of the forecast confidence interval is lower during times of high market uncertainty; however, ex-post miscalibration is worst during these episodes. We also find that executives who are miscalibrated about the stock market show similar miscalibration regarding their own firms’ prospects. Finally, firms with miscalibrated executives appear to follow more aggressive corporate policies: investing more and using more debt financing.

Financial Policies and the Financial Crisis:How Important Was the Systemic Credit Contraction for Industrial Corporations?
Kathleen M. Kahle and René M. Stulz
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From the start of the financial crisis (third quarter of 2007) to its peak (first quarter of 2009), both large and investment-grade non-financial firms show no evidence of suffering from an exceptional systemic credit contraction. Instead of decreasing their cash holdings as would be expected with a temporarily impaired credit supply, these firms increase their cash holdings sharply (by 17.8% in the case of investment-grade firms) after the collapse of Lehman. Though small and unrated firms have exceptionally low net debt issuance at the peak of the crisis, their net debt issuance in the first year of the crisis is no different from the last year of the credit boom. In contrast, however, the net equity issuance of small and unrated firms is low throughout 2008, whereas an impaired credit supply by itself would have encouraged firms to increase their equity issuance. On average, the cumulative financing impact of the decrease in net equity issuance from the start to the peak of the crisis is approximately twice the cumulative impact of the decrease in net debt issuance. The decrease in net equity issuance and the increase in cash holdings are also economically important for firms with no debt.

Do Independence and Financial Expertise of the Board Matter for Risk Taking and Performance?
Bernadette Minton, Jerome P. A. Taillard, and Rohan Williamson
revision: 6/2011
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During the recent financial crisis, financial expertise among independent directors of commercial banks is negatively related to changes in both firm value and cumulative stock returns. Furthermore, financial expertise is positively associated with risk-taking levels in the run-up to the crisis using both balance-sheet and market-based measures of risk. These results are not driven by powerful CEOs who select independent experts to rubber stamp strategies that satisfy their risk appetite. They are, however, consistent with independent directors with financial expertise recognizing the residual nature of shareholders’ claim and supporting a heightened risk profile for their bank.

The Value Spread: A Puzzle
Frederico Belo, Chen Xue, and Lu Zhang
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The standard dynamic investment model fails to explain the value spread, which is the difference in the market equity-to-capital ratio between extreme book-to-market deciles. Even when the model manages to fit the valuation ratios across some testing assets, the implied expected return errors are large. In contrast to the model’s superior in-sample fit of expected returns, recursive estimation reveals its poor out-of-sample performance. Time series instability and industry heterogeneity of the model parameters are the likely culprits. In all, we conclude that the dynamic investment framework is not yet useful for valuation and expected return estimation in practice.

Did Securitization Affect the Cost of Corporate Debt?
Taylor D. Nadauld and Michael S. Weisbach
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This paper investigates whether the securitization of corporate bank loans had an impact on the price of corporate debt. Our results suggest that loan facilities that are subsequently securitized are associated with a 15 basis point lower spread than that of loans that are not subsequently securitized. To identify the particular role of securitization in loan pricing, we employ a difference in differences approach and consider loan characteristics that are associated with the likelihood of securitization. We document that Term Loan B facilities, facilities originated by banks that originate CLOs, and loans of B-Rated firms are securitized more frequently than other loans. Spreads on facilities estimated to be more likely to be subsequently securitized have lower spreads than otherwise similar facilities. The results are consistent with the view that securitization caused a reduction in the cost of capital.

Investment-Based Momentum Profits
Laura Xiaolei Liu and Lu Zhang
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We offer an investment-based explanation of momentum. The neoclassical theory of investment implies that expected stock returns are related to expected investment returns, defined as the next-period marginal benefits of investment divided by the current-period marginal costs of investment. Empirically, winners have higher expected growth of investment-to-capital and higher expected marginal product of capital and consequently higher expected stock returns than losers. The investment-based expected return model captures well the moment profits across a wide array of momentum portfolios. However, the individual alphas for several testing portfolios are large. All in all, we conclude that momentum is consistent with the value maximization of firms.

Does Risk Explain Anomalies? Evidence from Expected Return Estimates
Jin (Ginger) Wu and Lu Zhang
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Average realized returns equal average expected returns plus average unexpected returns. If anomalies are driven by risk, average expected returns should be close to average realized returns. If anomalies are driven by mispricing, unexpected returns should be more important. We estimate accounting-based expected returns to zero-cost trading strategies formed on anomaly variables such as book-to-market, size, composite issuance, net stock issues, abnormal investment, asset growth, investment-to-assets, accruals, earnings surprises, failure probability, return on assets, and short-term prior returns. Our findings are striking. Except for the value premium, expected return estimates differ dramatically from average return estimates. The evidence suggests that mispricing, not risk, is the main driving force of capital markets anomalies.

Market-Based Loss Mitigation Practices for Troubled Mortgages Following the Financial Crisis
Sumit Agarwal, Gene Amromin, Itzhak Ben-David, Souphala Chomsisengphet and Douglas D. Evanoff
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The meltdown in residential real-estate prices that commenced in 2006 resulted in unprecedented mortgage delinquency rates. Until mid-2009, lenders and servicers pursued their own individual loss mitigation practices without being significantly influenced by government intervention. Using a unique dataset that precisely identifies loss mitigation actions, we study these methods—liquidation, repayment plans, loan modification, and refinancing—and analyze their effectiveness. We show that the majority of delinquent mortgages do not enter any loss mitigation program or become a part of foreclosure proceedings within 6 months of becoming distressed. We also find that it takes longer to complete foreclosures over time, potentially due to congestion. We further document large heterogeneity in practices across servicers, which is not accounted for by differences in borrower population. Consistent with the idea that securitization induces agency conflicts, we confirm that the likelihood of modification of securitized loans is up to 70% lower relative to portfolio loans. Finally, we find evidence that affordability (as opposed to strategic default due to negative equity) is the prime reason for redefault following modifications. While modification terms are more favorable for weaker borrowers, greater reductions in mortgage payments and/or interest rates are associated with lower redefault rates. Our regression estimates suggest that a 1 percentage point decline in mortgage interest rate is associated with a nearly 4 percentage point decline in default probability. This finding is consistent with the Home Affordable Modification Program (HAMP) focus on improving mortgage affordability.

Excess Volatility of Corporate Bonds
Jack Bao and Jun Pan
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This paper examines the connection between the return volatilities of corporate bonds, equities, and Treasuries under the Merton model with stochastic interest rates. Constructing empirical volatilities using bond returns over daily, weekly, and monthly horizons, we find that empirical bond volatilities are too high to be explained by equity and Treasury volatilities. Furthermore, the results are robust to using credit default swaps rather than corporate bonds to measure volatility in the credit market. At the daily return horizon, the excess volatility of corporate bonds is related to known liquidity proxies. However, this relation disappears at the monthly horizon even though corporate bonds continue to be excessively volatile. Thus, there appears to be a disconnect between corporate bonds and equities that goes beyond the illiquidity of corporate bonds.

Cyclicality, Performance Measurement, and Cash Flow Liquidity in Private Equity
David T. Robinson and Berk A. Sensoy
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We study the liquidity properties of private equity cash flows using data from 837 buyout and venture capital funds from 1984-2010. Most cash flow variation at a point in time is diversifiable – either idiosyncratic to a given fund or explained by the fund’s age. Both capital calls and distributions also have a procyclical systematic component. Distributions are more sensitive than calls, implying procyclical aggregate net cash flows. A consequence is that the well-known finding that funds raised in hot markets underperform in absolute terms is sharply attenuated when comparing to public equities. Consistent with a liquidity premium for calling capital in bad times, we find that funds with a relatively high propensity to do so perform better in both absolute and relative terms. Venture capital cash flows and performance are considerably more cyclical than buyout, and the links between cyclical cash flows and performance are likewise stronger.

Financial Constraints, Inflated Home Prices, and Borrower Default during the Real-Estate Boom (revised 06/09)
Itzhak Ben-David
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During the housing boom, many subprime home buyers were not able to make a mortgage down payment and therefore were at risk of being rationed from the market. To resolve the issue, some buyers, sellers and intermediaries artificially expanded the scope of transactions by including items that cannot be collateralized. As a result, observed house prices were higher and mortgages larger, ultimately relaxing buyers' financial constraints. I estimate that between 2005 and 2008, up to 16% of highly leveraged (> 95% loan-to-value) transactions in Cook County, Illinois were inflated (with prices higher by 6% to 15%). Inflated transactions are more likely in low-income neighborhoods and when intermediaries have a high stake in the transaction. Although borrowers were twice as likely to default, their mortgage rates were not higher.

Do target CEOs sell out their shareholders to keep their job in a merger? (revised 09/09)
Leonce Bargeron, Frederik Schlingemann, René M. Stulz, and Chad Zutter
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CEOs have a potential conflict of interest when their company is acquired: They can bargain to be retained by the acquirer and for private benefits rather than for a higher premium to be paid to the shareholders. We investigate the determinants of target CEO retention by the acquirer and whether target CEO retention affects the premium paid by the acquirer. The probability that a CEO is retained increases with a private bidder, the performance of the target, and with the fraction of target shares held by insiders. Regardless of the bidder type, we find no evidence that the premium paid is lower when the CEO is retained by the acquirer. Strikingly, the target stock price increases more at the announcement of an acquisition by a private firm when the CEO is retained than when she is not. This result holds whether the private acquirer is a private equity firm or an operating company and for management buyouts.

Why Do Foreign Firms Leave U.S. Equity Markets? (revised 01/10)(revised 04/09)
Craig Doidge, G. Andrew Karolyi, René M. Stulz
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Foreign firms terminate their SEC registration in the aftermath of the Sarbanes-Oxley Act (SOX) because they no longer require outside funds to finance growth opportunities. Deregistering firms' insiders benefit from greater discretion to consume private benefits without having to raise higher cost funds. Foreign firms with more agency problems have worse stock-price reactions to the adoption of Rule 12h-6 in 2007, which made deregistration easier, than those firms more adversely affected by the compliance costs of SOX. Stock-price reactions to deregistration announcements are negative, but less so under Rule 12h-6, and more so for firms that raise fewer funds externally.

Behavioral Consistency in Corporate Finance: CEO Personal and Corporate Leverage (revised 06/10)
Henrik Cronqvist, Anil K. Makhija, and Scott E. Yonker
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We show empirically that firms behave remarkably similarly to how their CEOs behave personally in the context of leverage choices. Using a database of CEOs' leverage in their most recent home purchases, we find a positive, economically significant, robust relation between personal home leverage and corporate leverage in the cross-section and when we examine CEO turnover. The results are consistent with an endogenous matching of CEOs with firms based on leverage preferences on both sides, as well as with CEOs imprinting their personal preferences on the firms they manage, especially when governance is weaker. Besides extending our understanding of the determinants of corporate leverage, this paper shows empirically that CEOs' behavioral consistency across personal and professional situations can, at least in part, predict the corporate financial behavior of the firms they manage.

Why Do Foreign Firms Have Less Idiosyncratic Risk than U.S. Firms?
Söhnke M. Bartram, Gregory Brown, and René M. Stulz
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Using a large panel of firms across the world from 1991-2006, we show that the median foreign firm has lower idiosyncratic risk than a comparable U.S. firm. Country characteristics help explain variation in the level of idiosyncratic risk, but less so than firm characteristics. Idiosyncratic risk falls as government stability and respect for the rule of law improve. Idiosyncratic risk is positively related to stock market development but negatively related to bond market development. Surprisingly, we find that idiosyncratic risk is generally negatively related to corporate disclosure quality. Finally, idiosyncratic risk generally increases with shareholder protection. Though there is evidence that R2 increases with creditor rights and falls with the quality of disclosure, these results are driven by the relations between these variables and systematic risk rather than by the impact of these variables on idiosyncratic risk.

Macroeconomic Conditions and the Structure of Securities (revised 02/10)(revised 12/09)(revised 04/09)
Isil Erel, Brandon Julio, Woojin Kim, and Michael S. Weisbach
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Economic theory, as well as commonly-stated views of practitioners, suggests that macroeconomic conditions can affect both the ability and manner in which firms raise external financing. Theory suggests that downturns should be associated with a shift toward less information-sensitive securities, as well as a ‘flight to quality,’ in which firms can issue high-rated securities but not low-rated ones. We evaluate these hypotheses on a large sample of publicly-traded debt issues, seasoned equity offers, and bank loans. We find that worse macroeconomic conditions lead firms to use less information-sensitive securities. In addition, poor market conditions affect the structure of securities offered, shifting them towards shorter maturities and more security. Furthermore, market conditions affect the quality of securities offered, with worsening conditions substantially lowering the number of low-rated debt issues. Overall, these findings suggest that macroeconomic conditions are important factors in firms’ capital raising decisions.

When are Analyst Recommendation Changes Influential? (revised 05/10)
Roger K. Loh and René M. Stulz
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Typically, the literature evaluates the significance of analyst recommendation changes by their average stock-price impact. With such an approach, recommendation changes can have a significant impact even if no recommendation change has a stock-price impact large enough to be noticed at the stock level. We call a recommendation change that affects the stock price sufficiently to be detectable at the stock level an influential recommendation change and investigate the extent to which recommendation changes are influential. We show that roughly 12% of recommendation changes are influential. We find a similar fraction of recommendation changes are influential using an alternative definition which looks at abnormal turnover at the stock level. Leader, star, and previously influential analysts are more likely to make influential recommendation changes. Recommendation changes away from consensus or accompanied by any sort of earnings forecast are more likely to be influential. Growth, small, high institutional ownership, and high analyst forecast dispersion firms are also more likely to have influential recommendation changes. Strikingly, the frequency of influential recommendation changes increases after Reg FD and the Global Analyst Settlement. Finally, we show that impactful sell-side research tends to be communicated through a recommendation change rather than an earnings forecast.

Does Governance Travel Around the World? Evidence from Institutional Investors (revised 05/10)(revised 06/09)(revised 04/09)
Reena Aggarwal, Isil Erel, Miguel A. Ferreira, and Pedro P. Matos
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We examine whether institutional investors affect corporate governance by analyzing portfolio holdings of institutions in companies from 23 countries during the period 2003-2008. We find that firm-level governance is positively associated with international institutional investment. Changes in institutional ownership over time positively affect subsequent changes in firm-level governance, but the opposite is not true. Foreign institutions and institutions from countries with strong shareholder protection play a crucial role in promoting governance improvements outside of the U.S. Institutional investors affect not only which corporate governance mechanisms are in place, but also outcomes. Firms with higher institutional ownership are more likely to terminate poorly performing CEOs and exhibit improvements in valuation over time. Our results suggest that international portfolio investment by institutional investors promote good corporate governance practices around the world.

The Role of the Securitization Process in the Expansion of Subprime Credit
Taylor D. Nadauld
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We analyze the structure and attributes of subprime mortgage-backed securitization deals originated between 1997 and 2007. Our data set allows us to link loan-level data for over 6.7 million subprime loans to the securitization deals into which the loans were sold. We show that the securitization process, including the assignment of credit ratings, provided incentives for securitizing banks to purchase loans of poor credit quality in areas with high rates of house price appreciation. Increased demand from the secondary mortgage market for these types of loans appears to have facilitated easier credit in the primary mortgage market. To test this hypothesis, we identify an event which represents an external shock to the relative demand for subprime mortgages in the secondary market. We show that following the SEC’s adoption of rules reducing capital requirements on certain broker dealers in 2004, five large deal underwriters disproportionately increased their purchasing activity relative to competing underwriters in ZIP codes with the highest realized rates of house price appreciation but lower average credit quality. We show that these loans subsequently defaulted at marginally higher rates. Finally, using the event as an instrument, we demonstrate a causal link between the demand for mortgages in the secondary mortgage market and the supply of subprime credit in the primary mortgage market.

A Theory Of Risk Capital
Isil Erel, Stewart C. Myers, and James A. Read, Jr.
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We demonstrate that financial firms should allocate capital to lines of business based on marginal default values. The marginal default value for a line of business is the derivative of the value of the firm’s option to default with respect to the scale of the line. Marginal default values give a unique allocation of capital that adds up exactly, regardless of the joint probability distribution of returns. Capital allocations follow from the conditions for the bank’s optimal portfolio. The allocations are systematically different from allocations based on VaR or contribution VaR. We also show how regulation based on risk-weighted capital requirements distorts a bank’s investment decisions, even if regulatory arbitrage can be eliminated.

Determinants of Cross-Border Mergers and Acquisitions
(revised March 2011)
Isil Erel, Rose C. Liao, and Michael S. Weisbach
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Despite the fact that one-third of worldwide mergers involve firms from different countries, the vast majority of the academic literature on mergers studies domestic mergers. What little has been written about cross-border mergers has focused on public firms, usually from the United States. Yet, the vast majority of cross-border mergers involve private firms that are not from the United States. We provide an analysis of a sample of 56,978 cross-border mergers occurring between 1990 and 2007. In addition to the factors that motivate domestic mergers,national borders are associated with additional factors that also affect the likelihood that two firms choose to merge. Specifically, geography, the quality of accounting disclosure, and bilateral trade increase the likelihood of mergers between two countries. In addition, valuation appears to play a role in motivating mergers; firms in countries whose stock market has increased in value, whose currency has recently appreciated, and who have a relatively high market to book value tend to be purchasers, and firms from weaker-performing economies tend to be targets.

Why Did Some Banks Perform Better During the Credit Crisis? A Cross-Country Study of the Impact of Governance and Regulation
Andrea Beltratti and René M. Stulz
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Though overall bank performance from July 2007 to December 2008 was the worst since at least the Great Depression, there is significant variation in the cross-section of stock returns of large banks across the world during that period. We use this variation to evaluate the importance of factors that have been discussed as having contributed to the poor performance of banks during the credit crisis. More specifically, we investigate whether bank performance is related to bank-level governance, country-level governance, country-level regulation, and bank balance sheet and profitability characteristics before the crisis. Banks that the market favored in 2006 had especially poor returns during the crisis. Using conventional indicators of good governance, banks with more shareholder-friendly boards performed worse during the crisis. Banks in countries with stricter capital requirement regulations and with more independent supervisors performed better. Though banks in countries with more powerful supervisors had worse stock returns, we provide some evidence that this may be because these supervisors required banks to raise more capital during the crisis and that doing so was costly for shareholders. Large banks with more Tier 1 capital and more deposit financing at the end of 2006 had significantly higher returns during the crisis. After accounting for country fixed effects, banks with more loans and more liquid assets performed better during the month following the Lehman bankruptcy, and so did banks from countries with stronger capital supervision and more restrictions on bank activities.

Bank CEO Incentives and the Credit Crisis (revised 08/10)(revised 03/10)(revised 12/09)
Rüdiger Fahlenbrach and René M. Stulz
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We investigate whether bank performance during the recent credit crisis is related to chief executive officer (CEO) incentives before the crisis. We find some evidence that banks with CEOs whose incentives were better aligned with the interests of shareholders performed worse and no evidence that they performed better. Banks with higher option compensation and a larger fraction of compensation in cash bonuses for their CEOs did not perform worse during the crisis. Bank CEOs did not reduce their holdings of shares in anticipation of the crisis or during the crisis. Consequently, they suffered extremely large wealth losses in the wake of the crisis.

Do Investment Banks Have Skill? Performance Persistence of M&A Advisors
Jack Bao and Alex Edmans
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We document significant persistence in the average announcement returns to acquisitions advised by an investment bank. Advisors in the top quintile of returns over the past two years outperform the bottom quintile by 1.04% over the next two years, compared to a full-sample average return of 0.72%. Persistence continues to hold after controlling for the component of returns attributable to the acquirer. These results suggest that advisors possess skill, and contrast earlier studies which use bank reputation and market share to measure advisor quality and find no link with returns. Our findings thus advocate a new measure of advisor quality – past performance. However, acquirers instead select banks based on market share, even though it is negatively associated with future performance. The publication of league tables based on value creation, rather than market share, may improve both clients’ selection decisions and advisors’ incentives to turn away bad deals.

When Constraints Bind
Karl B. Diether and Ingrid M. Werner
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We create proxies for constrained supply of lendable shares by combining unique data on loan fees, stock lending activity, and failures to deliver to examine how often contrarian short sale strategies are affected by constraints. We find that constraints, as captured by our measures, clearly affect the strategies of NYSE and Nasdaq short sellers. In some cases 30%-40% of the cross-section experiences a significant reduction in the contrarian response of short sellers to past returns. However, only for extremely high levels of our constraint measures (top 1%) is contrarian behavior by short sellers completely eliminated. We also find that high minus low daily short selling activity portfolios produce abnormal returns for both constrained and unconstrained stock.

Credit Default Swaps and the Credit Crisis
René M. Stulz
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Many observers have argued that credit default swaps contributed significantly to the credit crisis. Of particular concern to these observers are that credit default swaps trade in the largely unregulated over-the-counter market as bilateral contracts involving counterparty risk and that they facilitate speculation involving negative views of a firm’s financial strength. Some observers have suggested that credit default swaps would not have made the crisis worse had they been traded on exchanges. I conclude that credit default swaps did not cause the dramatic events of the credit crisis, that the over-the-counter credit default swaps market worked well during much of the credit crisis, and that exchange trading has both advantages and costs compared to over-the-counter trading. Though I argue that eliminating over-the-counter trading of credit default swaps could reduce social welfare, I also recognize that much research is needed to understand better and quantify the social gains and costs of derivatives in general and credit default swaps in particular.

Expected Returns and Volatility of Fama-French Factors
Fousseni Chabi-Yo
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In this paper, I show that the variance of Fama-French factors, the variance of the momentum factor, as well as the correlation between these factors, predict an important fraction of the time-series variation in post-1990 aggregate stock market returns. This predictability is particularly strong from one month to one year, and it dominates that afforded by the variance risk premium and other popular predictor variables such as P/D ratio, the P/E ratio, the default spread, and the consumption-wealth ratio. In a simple representative agent economy with recursive preferences, I model the portfolio weight in each asset as a function of a stock's characteristics and show that the market return can be predicted by these variances.

Default Risk, Idiosyncratic Coskewness and Equity Returns
Fousseni Chabi-Yo and Jun Yang
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In this paper, we intend to explain an empirical finding that distressed stocks delivered anomalously low returns. We show that in a model with heterogeneous investors where idiosyncratic skewness is priced, the expected return of risky assets depends on idiosyncratic coskewness betas, which measure the covariance between idiosyncratic variance and the market return. We find that there is a negative (positive) relation between idiosyncratic coskewness and equity returns when idiosyncratic coskewness betas are positive (negative). We construct two idiosyncratic coskewness factors to capture market-wide effect of idiosyncratic coskewness betas. When we control for these two idiosyncratic coskewness factors, the return difference for distress-sorted portfolios becomes insignificant. High stressed firms earn low returns because high stressed firms have high (low) idiosyncratic coskewness betas when idiosyncratic coskewness betas are positive (negative).

Changing the Nexus: The Evolution and Renegotiation of Venture Capital Contracts
Ola Bengtsson and Berk A. Sensoy
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We study empirically how financial contracts evolve and are renegotiated as venture capital (VC)-backed companies secure new rounds of financing. Because VC contract designs vary considerably between companies according to their economic circumstances, it is plausible to expect that the contracts governing successive financing rounds of a quickly-evolving company should often be dissimilar. The data offer little support for this intuitive hypothesis. In fact, the majority of cash flow provisions in a new round contract are recycled from the previous round contract, even when the company has evolved substantially. Such recycling may be beneficial in typical situations because it alleviates information problems in negotiations and reduces the complexity of the company’s nexus of financial contracts (Fama, 1980). However, in some situations restructuring contract design may be necessary to entice investors to provide new capital.Consistent with debt overhang arguments (Myers, 1977), we show that venture capital contracts evolve to include more investor-friendly cash flow provisions when the valuation of the company has not increased since the previous round, when new investors join the new round, or when new round investors hold larger debt-like claims. Although major renegotiations of previous round contracts are rare, minor renegotiations appear to be more common and almost uniformly result in making the previous round contract more similar to the new round contract. Overall, our findings suggest that the tradeoff relevant for changing a company’s nexus of financial contracts is different from the tradeoffs relevant for the initial structuring of this nexus.

The Effects of Stock Lending on Security Prices: An Experiment (revised 08/10)
Steven N. Kaplan, Tobias J. Moskowitz and Berk A. Sensoy
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Working with a sizeable, anonymous money manager, we randomly make available for lending two-thirds of the high-loan fee stocks in the manager’s portfolio and withhold the other third to produce an exogenous shock to loan supply. We implement the lending experiment in two independent phases: the first, from September 5 to 18, 2008, with over $580 million of securities lent; and the second, from June 5 to September 30, 2009, with over $250 million of securities lent. The supply shocks are sizeable and significantly reduce lending fees, but returns, volatility, skewness, and bid-ask spreads remain unaffected. Results are consistent across both phases of the experiment and indicate no adverse effects from securities lending on stock prices.

The State of Corporate Governance Research
Lucian A. Bebchuk and Michael S. Weisbach
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We create proxies for constrained supply of lendable shares by combining unique data on loan fees, stock lending activity, and failures to deliver to examine how often contrarian short sale strategies are affected by constraints. We find that constraints, as captured by our measures, clearly affect the strategies of NYSE and Nasdaq short sellers. In some cases 30%-40% of the cross-section experiences a significant reduction in the contrarian response of short sellers to past returns. However, only for extremely high levels of our constraint measures (top 1%) is contrarian behavior by short sellers completely eliminated. We also find that high minus low daily short selling activity portfolios produce abnormal returns for both constrained and unconstrained stock.

Investor Abilities and Financial Contracting: Evidence from Venture Capital
Ola Bengtsson and Berk A. Sensoy
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Using a large, new database of contractual provisions governing the allocation of cash flow rights between venture capitalists (VCs) and entrepreneurs, we investigate how contract design is impacted by VC abilities to monitor and provide value-added services to the entrepreneur. In doing so, this paper is the first to demonstrate that VC characteristics, in addition to portfolio company characteristics, have a significant impact on VC contract design in the U.S. We find that more experienced VCs, who have superior monitoring and value-added abilities and more frequently join the boards of their portfolio companies, obtain weaker downside-protecting contractual cash flow rights than less experienced VCs. This result is robust to extensive controls and several methods to account for endogenous selection effects. The relation between VC experience and downside protections is weaker when entrepreneurial agency problems are less severe and stronger when VC ownership is greater. The results, together with the existing literature, suggest that VCs with better governance abilities optimally focus less on obtaining downside protections, which are costly from a risk-sharing perspective, and more on upside payoffs and obtaining board representation during negotiations with entrepreneurs. The results also imply that previous estimates of the amount entrepreneurs pay for affiliation with high-quality VCs are overstated.

Learning to Cope: Voluntary Financial Education Programs and Loan Performance During a Housing Crisis
Sumit Agarwal, Gene Amromin, Itzhak Ben-David, Souphala Chomsisengphet and Douglas D. Evanoff
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Mortgage counseling is regarded as an integral tool in ensuring appropriate choices by prospective home buyers. We use micro-level data from an urban voluntary counseling program aimed at disadvantaged households to assess its effectiveness. We find substantially lower expost delinquency rates among program graduates. This finding is robust to an array of controls and several ways of modeling the probability of selection into counseling treatment. We attribute improved performance to the type of mortgage contract extended to the graduates, to the budgeting and credit management skills taught in the program, and to active post-purchase counseling that seeks to cure delinquency at early stages. The effects appear strongest among the least creditworthy households, suggesting an important role for long-term preparation for home ownership.

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Economic Nationalism in Mergers and Acquisitions (revised 9/11), (revised 06/10)
Serdar Dinc and Isil Erel
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This paper studies the government reaction to large corporate merger attempts in the European Union during 1997-2006 using hand-collected data. It documents widespread economic nationalism in which the government prefers the target companies remain domestically owned rather than foreign-owned. This preference is stronger at times and places with strong far-right parties, weaker governments, and against countries for which the people in the target country have little affinity. This nationalism has both direct and indirect economic impact on mergers and impedes capital flows. In particular, nationalist government reactions deter foreign companies from bidding for other companies in that country in future.

How much do banks use credit derivatives to hedge loans?
Bernadette Minton, René M. Stulz, and Rohan Williamson
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This paper examines the use of credit derivatives by US bank holding companies with assets in excess of one billion dollars from 1999 to 2005. Using the Federal Reserve Bank of Chicago Bank Holding Company Database, we find that in 2005 the gross notional amount of credit derivatives held by banks exceeds the amount of loans on their books. Only 23 large banks out of 395 use credit derivatives and most of their derivatives positions are held for dealer activities rather than for hedging of loans. The net notional amount of credit derivatives used for hedging of loans in 2005 represents less than 2% of the total notional amount of credit derivatives held by banks and less than 2% of their loans. Banks hedge less risky loans more than riskier ones. The banks are more likely to be net protection buyers if they have lower capital ratios, a lower net interest rate margin, engage in asset securitization, originate foreign loans, have more commercial and industrial loans in their portfolio, and have fewer agricultural loans. We conclude that the use of credit derivatives by banks to hedge loans is limited because of adverse selection and moral hazard problems and because of the inability of banks to use hedge accounting when hedging with credit derivatives. Our evidence raises important questions about the validity of the often-held view that the use of credit derivatives makes banks sounder.

Investor inattention and the underreaction to stock recommendations
Roger Loh
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Investors’ reaction to stock recommendations is often incomplete so that there is a predictable post-recommendation drift. I investigate whether investor inattention contributes to this drift by using turnover as a proxy for investor attention. I find that the recommendation drift of firms with low prior turnover is more than double in magnitude compared to that of firms with high prior turnover. Additional proxies for attention, such as analyst coverage, institutional ownership, the amount of distracting news in a day, or a measure of residual turnover that controls for liquidity and uncertainty, produce similar results. Volume reactions around the recommendation event show that investors fail to react promptly to recommendations on low attention stocks. Together, the evidence suggests that investor inattention is a plausible explanation for investors’ underreaction to stock recommendations.

Diversification, Productivity, and Financial Constraints: Empirical Evidence from the US Electric Utility Industry?
Mika Goto, Angie Low, and Anil K. Makhija
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We examine the real effects of parent firm diversification on their electric utility operating companies over the period, 1990-2003. Since electric utility operating companies produce a single homogenous product, we can better measure their Total Factor Productivity and make valid comparisons of productivity across firms. We find that, consistent with a diversification discount, greater parent diversification is associated with lower productivity across electric utility operating companies. However, the productivity of the electric utility operating companies improves with greater parent diversification over time. Diversification appears to provide an alternative channel to divert investment dollars away from over-investment in the core electric business. Finally, we find that the improvement in the productivity of the electric utility operating companies from greater parent firm diversification over time is limited to financially constrained firms. This suggests that when managers have no resources to waste, it is more likely that any diversification activities are carefully planned and undertaken for strategic purposes that can help to increase productivity of the core business.

The Changing Nature of Chapter 11
Sreedhar T. Bharath, Venky Panchapegesan, and Ingrid Werner
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The U.S. Chapter 11 bankruptcy system has long been viewed as debtor friendly, with frequency of absolute priority deviations (APD) in favor of equity holders commonplace, as high as 75%, before 1990. In the 1991-2005 period, we find a secular decline in the frequency of APD to 22%, with the frequency as low as 9% for the period 2000-2005. We identify the increasing importance of debtor-in-possession (DIP) financing and key employee retention plans (KERP) in bankruptcy as the key drivers of this secular decline. We also find management turnover in Chapter 11 has increased by 65% since 1990 and that APD are more likely when management has substantial share holdings in the firm. The time spent in bankruptcy has also declined from about 23 months before 1990 to 16 months after 2000. Collectively, these results are consistent with the thesis that Chapter 11 has increasingly become creditor friendly over the years. We discuss the implications of our results for models that assume that equity has a valuable dilatory option in the bankruptcy process.

Shareholder Rights, Boards, and CEO Compensation
Rüdiger Fahlenbrach
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I analyze the role of executive compensation in corporate governance. As proxies for corporate governance, I use board size, board independence, CEO-chair duality, institutional ownership concentration, CEO tenure, and an index of shareholder rights. The results from a broad cross-section of large U.S. public firms are inconsistent with recent claims that entrenched managers design their own compensation contracts. The interactions of the corporate governance mechanisms with total pay-for-performance and excess compensation can be explained by governance substitution. If a firm has generally weaker governance, the compensation contract helps better align the interests of shareholders and the CEO.

Off but Not Gone: A Study of Nasdaq Delistings
Jeffrey H. Harris Venkatesh Panchapegesan, and Ingrid Werner
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We examine 1,098 Nasdaq firms delisted in 1999-2002 that subsequently traded in the OTC Bulletin Board and/or the Pink Sheets. Market quality deteriorates significantly after delisting: share volume declines by two-thirds; quoted spreads almost triple from 12.1 to 33.9 percent; and effective spreads triple from 3.3 to 9.9 percent. Volatility triples from 4.4 to 14.3 percent, but quickly reverts to slightly elevated levels. Deterioration is significantly larger for more severe violations (e.g. bankruptcy) than for lesser infractions (e.g. minimum bid price). We find the OTC Bulletin Board provides a "soft landing" for delisted firms relative to the Pink Sheets. Although the delisting process takes at least 90 days, the drop in market quality is concentrated on the delisting date, highlighting the benefits of Nasdaq listing and the economic rationale for tiered listing fees. We argue that the increased costs resulting from enforcing Nasdaq’s minor (non-core) listing criteria outweigh the benefits.

Commodity price exposure and ownership clienteles
Phil Davies, Bernadette Minton, and Catherine Schrand
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This paper examines the association between commodity price exposure and investor interest in stocks of firms in two commodity-based industries: Gold Mining, and Oil and Gas Exploration. Investors, on average, are attracted to commodity price exposure. Using market-based measures of commodity price exposure, there is robust evidence that commodity stocks with high commodity price exposures have higher turnover and a larger number of institutional investors, in particular mutual fund investors, than commodity stocks with low exposures. We conduct cross-sectional analysis that condition on the source of the exposure, the type of investor, and the performance of the underlying commodity. Overall, investors’ revealed preferences for high exposure stocks appear to reflect a desire to gain exposure to the underlying commodity through an exposed equity security. They are not consistent with an attraction to exposure because of its transparency.

Hedge fund contagion and liquidity
Nicole M. Boyson, Christof W. Stahel, and René M. Stulz
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Using hedge fund indices representing eight different styles, we find strong evidence of contagion within the hedge fund sector: controlling for a number of risk factors, the average probability that a hedge fund style index has extreme poor performance (lower 10% tail) increases from 2% to 21% as the number of other hedge fund style indices with extreme poor performance increases from zero to seven. We investigate how changes in funding and asset liquidity intensify this contagion, and find that the likelihood of contagion is high when prime brokerage firms have poor performance (which would be expected to affect hedge fund funding liquidity adversely) and when stock market liquidity (a proxy for asset liquidity) is low. Finally, we examine whether extreme poor performance in the stock, bond, and currency markets is more likely when contagion in the hedge fund sector is high. We find no evidence that contagion in the hedge fund sector is associated with extreme poor performance in the stock and bond markets, but find significant evidence that performance in the currency market is worse when hedge fund contagion is high, consistent with the effects of an unwinding of carry trades.

Estimating the Effects of Large Shareholders Using a Geographic Instrument (revised 04/09)
Bo Becker, Henrik Cronqvist, and Rüdiger Fahlenbrach
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Large shareholders may play an important role for firm performance and policies, but identifying an effect empirically presents a challenge due to the endogeneity of ownership structures. We develop and test an empirical framework which allows us to separate selection from treatment effects of large shareholders. Unlike other blockholders, individuals tend to hold blocks in public firms located close to where they reside. Using this empirical observation, we develop an instrument - the density of wealthy individuals near a firm’s headquarters - for the presence of a large, non-managerial individual shareholder in a firm. These shareholders have a large impact on firms, controlling for selection effects. Consistent with theories of large shareholders as monitors, we find that they increase firm profitability, increase dividends, reduce corporate cash holdings, and reduce executive compensation. Consistent with the view that there exist conflicts between large and small owners in public firms, we uncover evidence of substitution toward less tax-efficient forms of distribution in firms with blocks. In addition, large shareholders reduce the liquidity of the firm’s stock.

Why do firms appoint CEOs as outside directors?
Rüdiger Fahlenbrach, Angie Low, and René M. Stulz
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We examine the determinants of appointments of outside CEOs to boards and how these appointments impact the appointing companies. We find that CEOs are most likely to join boards of large established firms that are geographically close, pursue similar financial and investment policies, and have comparable governance mechanisms to their own firms. It is also more likely that CEOs join firms with low insider ownership and firms with boards that already have other CEO directors. Except for the case of board interlocks, there is no evidence supporting the view that CEO directors have any impact on the appointing firm during their tenure, either positively or negatively. Appointments of CEO directors do not have a significant impact on the appointing firm’s operating performance, its decision-making, the compensation of its CEO, or on the monitoring of management by the board. However, operating performance drops significantly for CEO director appointments when the CEO of the appointing firm already sits on the board of the appointee’s firm.

What Determines the Structure of Corporate Debt Issues?
Brandon Julio, Woojin Kim, and Michael S. Weisbach
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Publicly-traded debt securities differ on a number of dimensions, including quality, maturity, seniority, security, and convertibility. Finance research has provided a number of theories as to why firms should issue debt with different features; yet, there is very little empirical work testing these theories. We consider a sample of 14,867 debt issues in the U.S. between 1971 and 2004. Our goal is to test the implications of these theories, and, more generally, to establish a set of stylized facts regarding the circumstances under which firms issue different types of debt.
Our results suggest that there are three main types of factors that affect the structure of debt issues: First, firm-specific factors such as leverage, growth opportunities and cash holdings are related with the convertibility, maturity and security structure of issued bonds. Second, economy-wide factors, in particular the state of the macroeconomy, affect the quality distribution of securities offered; in particular, during recessions, firms issue fewer poor quality bonds than in good times but similar numbers of high-quality bonds. Finally, controlling for firm characteristics and economy-wide factors, project specific factors appear to influence the types of securities that are issued. Consistent with commonly stated ‘maturity-matching’ arguments, long-term, nonconvertible bonds are more likely to be issued by firms investing in fixed assets, while convertible and short-term bonds are more likely to finance investment in R&D.

Thriving in the midst of financial distress? An analysis of firms exposed to asbestos litigation
Jérôme Ph. A. Taillard
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Asbestos litigation is one of the most important mass tort litigations in the history of the United States. I analyze a comprehensive sample of 270 firms that were exposed to an unprecedented wave of asbestos litigation in the wake of U.S. Supreme Court decisions in Amchem (1997) and Ortiz (1999). Due to insurance coverage, most firms in the sample have manageable cash outflows and do not suffer materially from the litigation. Because of the long delay between exposure to asbestos and its related illnesses, the remaining firms with substantial cash outflows and liabilities offer a rare natural experiment to study financial distress unrelated to economic distress. When analyzing this sub-sample throughout the distress period, I find little evidence of indirect costs of financial distress. This surprising result can be directly related to the strategic use of Chapter 11 as it provides a safe harbor through the stay in litigation and the "channeling injunction", which allows for a definitive solution for the legal liabilities. There is also evidence of a positive role for the disciplinary effects of financial distress as firms subject to increased bank monitoring and increased legal liabilities actively restructure and refocus on core operations.

Securities Laws, Disclosure, and National Capital Markets in the Age of Financial Globalization
René M. Stulz
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As barriers to international investment fall and technology improves, the cost advantages for a firm’s securities to trade publicly in the country in which that firm is located and for that country to have a market for publicly traded securities distinct from the capital markets of other countries will progressively disappear. However, securities laws remain an important determinant of whether and where securities are issued, how they are valued, who owns them, and where they trade. The value of public firms depends on these laws, so that identical firms subject to different laws are likely to have different values. We show that mandatory disclosure through securities laws can decrease agency costs between corporate insiders and minority shareholders, but only provided the investors can act on the information disclosed and the laws cannot be weakened ex post too much through lobbying by corporate insiders. With financial globalization, national disclosure laws can have wide-ranging effects on a country’s welfare, on firms and on investor portfolios, including the extent to which share holdings reveal a home bias. In equilibrium, if firms can choose the securities laws they are subject to when they go public, some firms will choose stronger securities laws than those of the country in which they are located and some firms will do the opposite. These effects of securities laws can be expected to become smaller if differences in national laws and their enforcement decrease and if the costs of private solutions to manage corporate agency conflicts that are substitutes for securities laws fall.

Why Do Foreign Firms Leave U.S. Equity Markets? An Analysis of Deregistrations Under SEC Exchange Act Rule 12h-6
Craig Doidge, G. Andrew Karolyi, and René M. Stulz
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On March 21, 2007, the Securities and Exchange Commission (SEC) adopted Exchange Act Rule 12h-6 which makes it easier for foreign private issuers to deregister and terminate the reporting obligations associated with a listing on a major U.S. exchange. We examine the characteristics of 59 firms that immediately announced they would deregister under the new rules, their potential motivations for doing so, as well as the economic consequences of their decisions. We find that these firms experienced significantly slower growth and lower stock returns than other U.S. exchange-listed foreign firms in the years preceding the decision. There is weak evidence that firms experience negative stock returns when they announce deregistration and stronger evidence that the stock-price reaction is worse for firms with higher growth. When we examine stock-price reactions around events associated with the passage of the Sarbanes-Oxley Act (SOX), we find negative average stock-price reactions with some specifications but not others. Further, there is no evidence that deregistering firms were affected more negatively by SOX than foreign-listed firms that did not deregister. Our evidence supports the hypothesis that foreign firms list shares in the U.S. in order to raise capital at the lowest possible cost to finance growth opportunities and that, when those opportunities disappear, a listing becomes less valuable to corporate insiders so that firms are more likely to deregister and go home.

Why are Buyouts Levered? The Financial Structure of Private Equity Funds
Ulf Axelson, Per Strömberg, and Michael S. Weisbach
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Private equity funds are important actors in the economy, yet there is little analysis explaining their financial structure. In our model the financial structure minimizes agency conflicts between fund managers and investors. Relative to financing each deal separately, raising a fund where the manager receives a fraction of aggregate excess returns reduces incentives to make bad investments. Efficiency is further improved by requiring funds to also use deal-by-deal debt financing, which becomes unavailable in states where internal discipline fails. Private equity investment becomes highly sensitive to economy-wide availability of credit and investments in bad states outperform investments in good states.

Corporate Financial and Investment Policies when Future Financing is not Frictionless
Heitor Almeida, Murillo Campello, and Michael S. Weisbach
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We study a model in which future financing constraints leas firms to have a preference for investments with sorter payback periods, investments with less risk, and investments that utilize more pledgeable assets. The model also shows how investment distortions towards more liquid, safer assets vary with the marginal cost of external financing and with firm internal cash flows. Our theory helps reconcile and interpret a number of patterns reported in the empirical literature, in areas such as risk-taking behavior, capital structure choices, hedging strategies, and cash management policies. For example, contrary to Jensen and Meckling (1976), we show that firms may reduce rather than increase risk when leverage increases exogenously. Furthermore, firms in economies with less developed financial markets will not only take different quantities of investment, but will also take different kinds of investment (safer, short-term projects that are potentially less profitable). We also point out to several predictions that have not been empirically examined. For example, our model predicts that investment safety and liquidity are complementary: constrained firms are specially likely to decrease the risk of their most liquid investments.

Information Disclosure and Corporate Governance (revised 08/09)(revised 06/10)(revised01/30/11)
Benjamin E. Hermalin and Michael S. Weisbach
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In public-policy discussions about corporate disclosure, more is typically judged better than less. In particular, better disclosure is seen as a way to reduce the agency problems that plague firms. We show that this view is incomplete. In particular, our theoretical analysis shows that increased disclosure is a two-edged sword: More information permits principals to make better decisions; but it can, itself, generate additional agency problems and other costs for shareholders, including increased executive compensation. Consequently, there can exist a point beyond which additional disclosure decreases firm value. We further show that larger firms will tend to adopt stricter disclosure rules than smaller firms, ceteris paribus. Firms with better disclosure will tend, all else equal, to employ more able management. We show that governance reforms that have imposed greater disclosure could, in part, explain recent increases in both ceo compensation and ceo turnover rates.

Risk Management Failures: What Are They and When Do They Happen?
René M. Stulz
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A large loss is not evidence of a risk management failure because a large loss can happen even if risk management is flawless. I provide a typology of risk management failures and show how various types of risk management failures occur. Because of the limitations of past data in assessing the probability and the implications of a financial crisis, I conclude that financial institutions should use scenarios for credible financial crisis threats even if they perceive the probability of such events to be extremely small.

Estimating Affine Multifactor Term Structure Models Using Closed-Form Likelihood Expansions (revised 05/09)(revised 07/09)
Robert Kimmel
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We develop and implement a technique for maximum likelihood estimation in closed-form of multivariate affine yield models of the term structure of interest rates. We derive closed-form approximations to the likelihood functions for all nine of the Dai and Singleton (2000) canonical affine models with one, two, or three underlying factors. Monte Carlo simulations reveal that this technique very accurately approximates true maximum likelihood, which is, in general, infeasible for affine models. We also apply the method to a dataset consisting of synthetic US Treasury strips, and find parameter estimates for nine different affine yield models, each using two different market price of risk specifications. One advantage of maximum likelihood estimation is the ability to compare non-nested models using likelihood ratio tests. We find, using these tests, that the choice of preferred canonical model can depend on the market price of risk specification. Comparison to other approximation methods, Euler and QML, on both simulated and real data suggest that our approximation technique is much closer to true MLE than alternative methods.

Financial Education versus Costly Counseling: How to Dissuade Borrowers from Choosing Risky Mortgages? (revised 4/2019)

Sumit Agarwal, Gene Amromin, Itzhak Ben-David, Souphala Chomsisengphet, and Douglas D. Evanoff
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This paper explores the effects of mandatory third-party review of mortgage contracts on consumer choice. The study is based on a legislative pilot carried out in Illinois in 2006, under which mortgage counseling was triggered by applicant credit scores or by their choice of “risky mortgages.” Low-credit score applicants for whom counselor review was mandatory did not materially alter their contract choice. Conversely, higher-credit score applicants who could avoid counseling by choosing non-risky mortgages did so, decreasing their propensity for high-risk contracts between 10 and 40 percent. In the event, one of the key goals of the legislation—curtailment of high-risk mortgage products—was only achieved among the population that was not counseled.

The Role of Boards of Directors in Corporate Governance: A Conceptual Framework & Survey (revised 04/09)
Renée Adams, Benjamin E. Hermalin and Michael S. Weisbach
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This paper is a survey of the literature on boards of directors, with an emphasis on research done subsequent to the Hermalin and Weisbach (2003) survey. The two questions most asked about boards are what determines their makeup and what determines their actions? These questions are fundamentally intertwined, which complicates the study of boards because makeup and actions are jointly endogenous. A focus of this survey is how the literature, theoretical as well as empirically, deals-or on occasions fails to deal-with this complication. We suggest that many studies of boards can best be interpreted as joint statements about both the director-selection process and the effect of board composition on board actions and firm performance.

Investor Demand for Industry Factor Price Exposure (revised 06/10)
Phil Davies, Bernadette Minton, and Catherine Schrand
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Models of information acquisition predict that investors learn about a common risk factor and apply that information to valuations of stocks exposed to the risk factor (category learning). Category learning leads to higher levels of investor interest in stocks exposed to the factor, with investors forgoing portfolio diversification. Industry exposure is a candidate for category learning. Consistent with these predictions, we find that the number of institutions holding a stock is positively associated with the stock’s industry exposure. Moreover, institutional investors systematically overweight (underweight) high (low) industry exposure stocks. Investor preferences for industry exposure are greatest among smaller institutions and institutions that follow a transient investment style, and most pronounced in industries where the returns to learning about industry risk are greatest. Our results are consistent with the notion that investors do engage in category learning.

Discussion of ‘A Lobbying Approach to Evaluating the Sarbanes-Oxley Act of 2002’
G. Andrew Karolyi
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This article discusses the main contributions and findings of Hochberg, Sapienza and Vissing-Jorgensen’s ‘A Lobbying Approach to Evaluating the Sarbanes-Oxley Act of 2002.’ I offer a synopsis of the Journal of Accounting Research conference discussion of the paper as well as provide some broader perspectives on the two main lines of inquiry to which the paper contributes. The first perspective focuses on the impact of the Sarbanes-Oxley Act (SOX) and, in particular, how this study and others face the challenge of benchmarking of the price and quantity effects of the Act. I discuss the strengths and weaknesses of the authors’ identification strategy that separates out firms whose insiders actively lobbied the Securities and Exchange Commission’s rule-making process in the aftermath of SOX. The second perspective considers the motivations for and consequences of lobbying activity. I survey existing research in Economics, Accounting and Management which shows that lobbying propensity is predictable, confirms it is most likely to be conducted by agents most affected by the rule changes, but also warns that there are firm-specific, industry-specific, and even issue-specific factors that can complicate these interpretations.

Changing Times: The Pricing Problem in Non-Linear Models
Robert Kimmel
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Finding conditional moments and derivative prices is a common application in continuous-time financial economics, but these quantities are known in closed-form only for a few specific models. Recent research identifies a large class of models for which solutions to such problems have convergent power series, allowing approximation even when not known in closed-form. However, such power series may converge slowly or not at all for long time horizons, limiting their practical use. We develop the method of time transformation, in which the variable representing time is replaced by a non-linear function of itself. With appropriate choice of the time transformation, power series often converge for much longer time horizons, and also much faster, sometimes uniformly for all time horizons. For applications such as bond pricing, in which the time-to-maturity may be many years, rapid convergence is very important for practical application. The ability to approximate solutions accurately and in closed-form simplifies the estimation of non-a±ne continuous-time term structure models, since the bond pricing problem must be solved for many different parameter vectors during a typical estimation procedure. We show through several examples that the series are easy to derive, and, using term structure models for which bond prices are known explicitly, also show that the series are extremely accurate over a wide range of interest rate levels for arbitrarily long maturities; in some cases, they are many orders of magnitude more accurate than series constructed without time transformations. Other potential applications include pricing of callable bonds and credit derivatives.

Pricing Kernels with Coskewness and Volatility Risk (revised 03/09)
Fousseni Chabi-Yo
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I investigate a pricing kernel in which coskewness and the market volatility risk factors are endogenously determined. I show that the price of coskewness and market volatility risk are restricted by investor risk aversion and skewness preference. The risk aversion is estimated to be between two and five and significant. The price of volatility risk ranges from -1.5% to -0.15% per year. Consistent with theory, I find that the pricing kernel is decreasing in the aggregate wealth and increasing in the market volatility. When I project my estimated pricing kernel on a polynomial function of the market return, doing so produces the puzzling behaviors observed in pricing kernel. Using pricing kernels, I examine the sources of the idiosyncratic volatility premium. I find that nonzero risk aversion and firms' non-systematic coskewness determine the premium on idiosyncratic volatility risk. When I control for the non-systematic coskewness factor, I find no significant relation between idiosyncratic volatility and stock expected returns. My results are robust across different sample periods, different measures of market volatility and firm characteristics.

Does Corporate Culture Matter for Firm Policies?
Henrik Cronqvist, Angie Low, and Mattias Nilsson
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Economic theories suggest that a firm’s corporate culture matters for its policy choices. We construct a parent-spinoff firm panel dataset that allows us to identify culture effects in firm policies from behavior that is inherited by a spinoff firm from its parent after the firms split up. We find positive and significant relations between spinoff firms’ and their parents’ choices of investment, financial, and operational policies. Consistent with predictions from economic theories of corporate culture, we find that the culture effects are long-term and stronger for internally grown business units and older firms. Our evidence also suggests that firms preserve their cultures by selecting managers who fit into their cultures. Finally, we find a strong relation between spinoff firms’ and their parents’ profitability, suggesting that corporate culture ultimately also affects economic performance. These results are robust to a series of robustness checks, and cannot be explained by alternatives such as governance or product market links. The contribution of this paper is to introduce the notion of corporate culture in a formal empirical analysis of firm policies and performance.

A Note on the Dai-Singleton Canonical Representation of Affine Term Structure Models (revised 09/08)
Patrick Cheridito, Damir Filipovic, and Robert L. Kimmel
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Dai and Singleton (2000) study a class of term structure models for interest rates that specify the short rate as an affine combination of the components of an N-dimensional affine diffusion process. Observable quantities of such models are invariant under regular affine transformations of the underlying diffusion process. In their canonical form, the models in Dai and Singleton (2000) are based on diffusion processes with diagonal diffusion matrices. This motivates the following question: Can the diffusion matrix of an affine diffusion process always be diagonalized by means of a regular affine transformation?
We show that if the state space of the diffusion is of the form D = Rm+ x RN - m for integers 0 = m= N satisfying m = 1 or m = N - 1, there exists a regular affine transformation of D onto itself that diagonalizes the diffusion matrix. On the other hand, we provide examples of affine diffusion processes with state space R2+ x R2 whose diffusion matrices cannot be diagonalized through regular affine transformation. This shows that for 2 = m = N - 2, the assumption of diagonal diffusion matrices may impose unnecessary restrictions and result in an avoidable loss of generality.

Hedge Funds: Past, Present, and Future
René M. Stulz
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Assets managed by hedge funds have grown faster over the last ten years than assets managed by mutual funds. Hedge funds and mutual funds perform the same economic function, but hedge funds are largely unregulated while mutual funds are tightly regulated. This paper compares the organization, performance, and risks of hedge funds and mutual funds. It then examines whether one can expect increasing convergence between these two investment vehicles and concludes that the performance gap between hedge funds and mutual funds will narrow, that regulatory developments will limit the flexibility of hedge funds, and that hedge funds will become more institutionalized.

Former CEO Directors: Lingering CEOs or Valuable Resources? (revised 08/10)(revised 01/10)(revised 09/08)
Rüdiger Fahlenbrach, Bernadette A. Minton, and Carrie H. Pan
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We investigate corporate governance experts’ claim that it is detrimental to a firm to reappoint former CEOs as directors after they step down as CEOs. We find that more successful and more powerful former CEOs are more likely to be reappointed to the board multiple times after they step down as CEOs. Firms benefit on average from the presence of former CEOs on their boards. Firms with former CEO directors have better accounting performance, have higher relative turnover-performance sensitivity of the successor CEO, and can rehire their former CEO directors as CEOs after extremely poor firm performance under the successor CEOs.

The Impact of Shareholder Power on Bondholders: Evidence from Mergers and Acquisitions
Angie Low, Anil K. Makhija, and Anthony B. Sanders
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Takeovers result in the transfer of bondholders’ claims from the target to the acquiring firm, providing a setting to examine the impact of shareholder power on bondholders. We find that excess returns to target bondholders at M & A announcements are positively related to the holdings of the top 5 acquirer institutional owners, a measure of shareholder power. This supports the view that stronger shareholder power, through superior monitoring of managers, can be beneficial to bondholders as well. Our findings are robust to various proxies for shareholder power, adjustments for endogeneity, controls for target shareholder power, and other controls for firm and deal characteristics that have been shown to affect bondholders’ wealth during takeovers.

Complex Times: Asset Pricing and Conditional Moments under Non-Affine Diffusions (revised 08/08)
Robert L. Kimmel
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Many applications in continuous-time financial economics require calculation of conditional moments or contingent claims prices, but such expressions are known in closed-form for only a few specific models. Power series (in the time variable) for these quantities are easily derived, but often fail to converge, even for very short time horizons. We characterize a large class of continuous-time non-a±ne conditional moment and contingent claim pricing problems with solutions that are analytic in the time variable, and that therefore can be represented by convergent power series. The ability to approximate solutions accurately and in closed-form simplifies the estimation of latent variable models, since the state vector must be extracted from observed quantities for many different parameter vectors during a typical estimation procedure.

Do Entrenched Managers Pay Their Workers More?
Henrik Cronqvist, Fredrik Heyman, Mattias Nilsson, Helena Svaleryd, and Jonas Vlachos
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Analyzing a large panel that matches public firms with worker-level data, we find that managerial entrenchment affects workers’ pay. CEOs with more control pay their workers more, but financial incentives through ownership of cash flow rights mitigate such behavior. These findings do not seem to be driven by productivity differences, and are not affected by a series of robustness tests. Moreover, we find that entrenched CEOs pay more to (i) workers associated with aggressive unions; (ii) workers closer to the CEO in the corporate hierarchy, such as CFOs, division vice-presidents and other top-executives; and (iii) workers geographically closer to the corporate headquarters. This evidence is consistent with entrenched CEOs paying higher wages to enjoy non-pecuniary private benefits such as lower effort wage bargaining and improved social relations with certain workers. More generally, our results show that managerial ownership and corporate governance can play an important role for labor market outcomes.

Why do private acquirers pay so little compared to public acquirers?
Leonce Bargeron, Frederik Schlingemann, René M. Stulz, and Chad Zutter
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We find that the announcement gain to target shareholders from acquisitions is significantly lower if a private firm instead of a public firm makes the acquisition. Non-operating firms like private equity funds make the majority of private bidder acquisitions. On average, target shareholders receive 55% more if a public firm instead of a private equity fund makes the acquisition. There is no evidence that the difference in premiums is driven by observable differences in targets. We find that target shareholder gains depend critically on the managerial ownership of the bidder. In particular, there is no difference in target shareholder gains between acquisitions made by public bidders with high managerial ownership and by private bidders. Such evidence suggests that the differences in managerial incentives between private and public firms have an important impact on target shareholder gains and that managers of firms with diffuse ownership may pay too much for acquisitions.

Has New York become less competitive in global markets? Evaluating foreign listing choices over time
Craig Doidge, G. Andrew Karolyi, and René M. Stulz
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We study the determinants and consequences of cross-listings on the New York and London stock exchanges from 1990 to 2005. This investigation enables us to evaluate the relative benefits of New York and London exchange listings and to assess whether these relative benefits have changed over time, perhaps as a result of the passage of the Sarbanes-Oxley Act of Congress (SOX) in 2002. We find that cross-listings have been falling on U.S. exchanges as well as on the Main Market in London. This decline in cross-listings is explained by changes in firm characteristics rather than by changes in the benefits of cross-listing. We show that, after controlling for firm characteristics, there is no deficit in cross-listing counts on U.S. exchanges related to SOX. Investigating the valuation differential between listed and nonlisted firms (the "cross-listing premium") from 1990 to 2005, we find that there is a significant premium for U.S. exchange listings every year, that the premium has not fallen significantly in recent years, that it persists when allowing for unobservable firm characteristics, and that there is a permanent premium in event time. In contrast, there is no premium for listings on London’s Main Market for any year. Crosslisting in the U.S. leads firms to increase their capital-raising activity at home and abroad while a London listing has no such impact. Our evidence is consistent with the theory that an exchange listing in New York has unique governance benefits for foreign firms. These benefits have not been seriously eroded by SOX and cannot be replicated through a London listing.

The Impact of Competition and Corporate Structure on Productive Efficiency: The Case of the U.S. Electric Utility Industry, 1990-2004
Mika Goto and Anil K. Makhija
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In this study, we present empirical evidence on the productive efficiency of electric utilities in the United States over the period, 1990-2004. This is a period marked by major attempts to introduce competition in the industry with the expectation that it will lead firms to improve their productive efficiency and ultimately to lower consumer prices. The actual experience has been surprising, since electricity prices have either fallen little or even risen sharply in some states. Relying on recent advances in the estimation of productive efficiency, we find that firms in jurisdictions that adopted competitive mechanisms have lower productive efficiency compared to firms in jurisdictions where rate-of-return regulation was retained. Furthermore, we provide evidence that firms in states that adopted competition have experienced decreases in productive efficiency, while firms in states with traditional regulation saw increases in efficiency over time. Since the introduction of deregulation has brought greater discretion to managers, we also examine the impact of various organizational choices on productive efficiency. Interestingly, the separation of the generation function from other functions, a hallmark of the effort to deregulate the industry, is associated with an adverse impact on productive efficiency. These findings question the claim that competition necessarily fosters higher productive efficiency. Alternatively, true competition may have been circumvented.

Fairness Opinions in Mergers and Acquisitions
Anil K. Makhija and Rajesh P. Narayanan
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Fairness opinions provided by investment banks advising on mergers and acquisitions have been criticized for being conflicted in aiding bankers further their goal of completing the deal as opposed to aiding boards (and shareholders) by providing an honest appraisal of deal value. We find empirical support for this criticism. We find that shareholders on both sides of the deal, aware of the conflict of interest facing advisors, rationally discount deals where advisors provide fairness opinions. The reputation of the advisor serves to mitigate this discount, while the contingent nature of advisory fees appears to have no impact. Furthermore, consistent with the criticism of fairness opinions, we find evidence suggesting that fairness opinions are sought by boards for the legal cover they provide against shareholders unhappy with the deal’s terms. Thus, altogether our findings suggest that investment bankers and boards may be complicit in using fairness opinions to further their own interests at an expense to shareholders.

Managerial ownership dynamics and firm value (revised 01/08)
Rüdiger Fahlenbrach and René M. Stulz
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From 1988 to 2003, the average change in managerial ownership is significantly negative every year for American firms. We find that managers are more likely to significantly decrease their ownership when their firms are performing well, but not more likely to increase their ownership when their firms have poor performance. Because investors learn about the total change in managerial ownership with a lag, changes in Tobin’s q in a period can be affected by changes in managerial ownership in the previous period. In an efficient market, it is unlikely that changes in managerial ownership in one period are caused by future changes in q. When controlling for past stock returns, we find that large increases in managerial ownership increase q. This result is driven by increases in shares held by officers, while increases in shares held by directors appear unrelated to changes in firm value. There is no evidence that large decreases in ownership have an adverse impact on firm value. We argue that our evidence cannot be wholly explained by existing theories and propose a managerial discretion theory of ownership consistent with our evidence.

Fundamentals, Market Timing, and Seasoned Equity Offerings
Harry DeAngelo, Linda DeAngelo, and René Stulz
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Firms conduct SEOs to resolve a near-term liquidity squeeze, and not primarily to exploit market timing opportunities. Without the SEO proceeds, 62.6% of issuers would have insufficient cash to implement their chosen operating and non-SEO financing decisions the year after the SEO. Although the SEO decision is positively related to a firm’s market-to-book (M/B) ratio and prior excess stock return and negatively related to its future excess return, these relations are economically immaterial. For example, a 150% swing in future net of market stock returns (from a 75% gain to a 75% loss over three years) increases by only 1% the probability of an SEO in the immediately prior year. Strikingly, most firms with quintessential"market timer" characteristics fail to issue stock and a non-trivial number of mature firms do issue stock, with current and former dividend payers raising more than half of all issue proceeds.

Differences in Governance Practice between U.S. and Foreign Firms: Measurement, Causes, and Consequences
Reena Aggarwal, Isil Erel, René Stulz, and Rohan Williamson
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We construct a firm-level governance index that increases with minority shareholder protection. Compared to U.S. matching firms, only 12.68% of foreign firms have a higher index. The value of foreign firms falls as their index decreases relative to the index of matching U.S. firms. Our results suggest that lower country-level investor protection and other country characteristics make it suboptimal for foreign firms to invest as much in governance as U.S. firms do. Overall, we find that minority shareholders benefit from governance improvements and do so partly at the expense of controlling shareholders.

An Assessment of Terrorism-Related Investing Strategies
G. Andrew Karolyi
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Do terrorism-related investing strategies lead to superior investment performance? This study evaluates the risks and returns to two different terrorism-related investment strategies in the U.S. markets over the period from 1994-2006. The first strategy evaluates a sub-portfolio of S&P 500 stocks constructed on the basis of terrorism-related risk scores that measure their operations in countries with a high incidence of terrorism-related activity. The second strategy evaluates a ‘terror-free’ sub-portfolio of S&P 500 stocks in which stocks are screened if they have operations in countries that the U.S. Department of State has designated as state-sponsors of terrorism. I find that the terrorism-related risk exposure portfolio would have earned, on average, an economically small and statistically insignificant 16 basis point premium per month with a tracking error of 2.8% per month and that of the terror-free portfolio an even smaller -1.6 basis point premium per month with a tracking error of 25 basis points per month. Return attribution analysis using a multi-factor model uncovers interesting differences in systematic exposures to market risks, and factors related to size, market-to-book ratios and momentum.

Common Patterns in Commonality in Returns, Liquidity, and Turnover around the World
G. Andrew Karolyi, Kuan-Hui Lee, and Mathijs A. van Dijk
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We uncover similar cross-country and time-series patterns in co-movement or "commonality" in stock returns, liquidity, and trading activity across 40 developed and emerging countries. The extent to which the liquidity and turnover of individual stocks within a country move together is related to the same institutional characteristics as is comovement in stock returns. Commonality is greater in countries with weaker investor protection and a more opaque information environment. Monthly variation in commonality in returns, liquidity, and turnover is also driven by common determinants. Commonality increases during times of high market volatility, large market declines, and high interest rates, and is negatively related to capital market openness. Our results are consistent with theoretical models in which changes in the wealth and collateral value of traders and financial intermediaries endogenously affect liquidity, trading, and pricing.

Do Funds Need Governance? Evidence from Variable Annuity-Mutual Fund Twins
Richard Evans and Rüdiger Fahlenbrach
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We study the roles of traditional governance (boards, sponsors, etc.) and market governance (investors voting with their feet) in mutual funds and variable annuities. We find that market governance is less pronounced for variable annuity investors. Using a matched sample of variable annuity-mutual fund twins, we find that variable annuity investors are less sensitive to poor performance and high fees than mutual fund investors. Given the weaker role played by market governance, we then examine the role played by traditional governance in variable annuities. Variable annuity boards and sponsors add alternative investment options and replace advisors on behalf of their investors after poor performance and high fees. These traditional governance mechanisms are, however, less effective when conflicts of interest exist between variable annuity sponsors and fund advisors.

Relationships, Corporate Governance, and Performance: Evidence from Private Placements of Common Stock (revised 05/08)
Karen H. Wruck and YiLin Wu
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Utilizing a large sample with unique data gathered directly from private placement contracts, we address two important questions that remain unresolved in the literature. First, what types of relationships connect private placement investors and issuers, and how do these relationships affect issuer performance, deal structure and corporate governance? Second, do relationships between issuers and investors, or a lack thereof, shed light on the performance "puzzle" associated with private placements? Our primary finding is a strong, positive association between new relationships formed around the time of a placement and issuer performance at announcement and post-placement. The vast majority of new relationships are governance-related, so our findings are consistent with increased monitoring and/or stronger governance creating value for investors. We also find that relationship investors are more likely to gain governance influence than other investors. Issuers in "new economy" industries and with high specific risk grant investors more governance influence than other issuers, suggesting that access to governance is especially valuable when information asymmetries and/or specific investments are important.

Is there hedge fund contagion?
Nicole M. Boyson, Christof W. Stahel, and René M. Stulz
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We examine whether hedge funds experience contagion. First, we consider whether extreme movements in equity, fixed income, and currency markets are contagious to hedge funds. Second, we investigate whether extreme adverse returns in one hedge fund style are contagious to other hedge fund styles. To conduct this examination, we estimate binomial and multinomial logit models of contagion using daily returns on hedge fund style indices as well as monthly returns on indices with a longer history. Our main finding is that there is no evidence of contagion from equity, fixed income, and foreign exchange markets to hedge funds, except for weak evidence of contagion for one single daily hedge fund style index. By contrast, we find strong evidence of contagion across hedge fund styles, so that hedge fund styles tend to have poor coincident returns.

Co-Movements of Index Options and Futures Quotes (revision 2005-10)
Rüdiger Fahlenbrach and Patrik Sandås
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We re-examine the co-movements of index options and futures quotes first studied in Bakshi, Cao, and Chen (2000). We show that the frequency of quote co-movements that are inconsistent with standard option pricing models is significantly higher around option trades. We examine empirically two explanations for these co-movements. First, we show that in simulations the stochastic volatility model can generate approximately the right frequency of inconsistent co-movements when its parameters are chosen to match observed option prices. But even allowing for different regimes in trade and no-trade periods the model generates virtually the same frequency of inconsistent co-movements. Second, we examine the quote co-movements in event-time around trades and show that they are consistent with either traders picking off stale option quotes or with traders submitting aggressive limit orders. Our evidence suggest that inconsistent co-movements reflect both departures from the univariate diffusion model and market microstructure frictions.

The Accrual Anomaly: Risk or Mispricing?
David Hirshleifer, Kewei Hou, Siew Hong Teoh
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We document considerable return comovement associated with accruals after controlling for other common factors. An accrual-based factor-mimicking portfolio has a Sharpe ratio of 0.15, higher than that of the market factor or the HML factor of Fama and French (1993). In time series regressions, a model that includes the Fama-French factors and the additional accrual factor captures the accrual anomaly in average returns. However, further time series and cross-sectional tests indicate that it is the accrual characteristic rather than the accrual factor loading that predicts returns. These findings favor a behavioral explanation for the accrual anomaly.

Merton Miller
René M. Stulz
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Merton Miller was at the center of the transformation of academic finance from a descriptive field to a science. His principal contribution to this transformation was the introduction of arbitrage arguments which underlie most theoretical contributions in finance and remain central to the way financial economists analyze finance problems to this day. These arbitrage arguments underlie his and Franco Modigliani's famous irrelevance propositions.

Price and Volatility Transmission across Borders
Louis Gagnon and G. Andrew Karolyi
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Over the past forty years, financial markets throughout the world have steadily become more open to foreign investors. With open markets, asset prices are determined globally. A vast literature on portfolio choice and asset pricing has evolved to study the importance of global factors as well as local factors as determinants of portfolio choice and of expected returns on risky assets. There is growing evidence that risk premia are increasingly determined globally. An important outcome of this force of globalization is increased comovement in asset prices across markets. This survey study examines the literature on the dynamics of comovements in asset prices and volatility across markets around the world. The literature began in the 1970s in conjunction with early theoretical developments on international asset pricing models, but it blossomed in the late 1980s and early 1990s with the availability of comprehensive international stock market databases and the development of econometric methodology to model these dynamics.

The Consequences of Terrorism for Financial Markets: What Do We Know?
G. Andrew Karolyi
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The objective of this article is to outline what we, as researchers, know and, more importantly, what we do not yet know about the consequences of terrorism for financial markets. I argue that a number of the efforts used to assess quantitatively the risk of terrorist attacks are limited in scope and are hampered by the limits of the databases used to operationalize such models. I also describe some of the most recent research that has sought to measure the magnitude of the impact of terrorist attacks on financial markets. Most of them have focused on the events surrounding the September 11, 2001 attacks, though a few have broadened the perspective over time and for countries beyond the U.S.

How has CEO Turnover Changed? Increasingly Performance Sensitive Boards and Increasingly Uneasy CEOs
Steven N. Kaplan and Bernadette A. Minton
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We study CEO turnover - both internal (board driven) and external (through takeover and bankruptcy) - from 1992 to 2004 for a sample of large U.S. companies. Annual CEO turnover is higher than that estimated in previous studies over earlier periods. Turnover is 14.5% from 1992 to 2004, implying an average tenure as CEO of less than seven years. In the more recent period since 1998, total CEO turnover increases to 16.1%, implying an average tenure of just over six years. Internal turnover is significantly related to three components of firm performance - performance relative to industry, industry performance relative to the overall market, and the performance of the overall stock market. The relation of internal turnover to performance intensifies after 1997 in that turnover after 1998 is more strongly related to all three measures of performance in the contemporaneous year. External turnover is also related to all three measures of performance over the entire sample period, but there is not a sharp difference between the two sub-periods. We discuss the implications of these finding for various issues in corporate governance.

Investor Overreaction, Cross-Sectional Dispersion of Firm Valuations, and Expected Stock Returns
Danling Jiang
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I develop and test the theoretical predictions that when investor overreaction to market-wide news is larger, firm valuations in the cross section become more dispersed and stocks earn lower expected returns. Consistent with these predictions, measures of cross-sectional dispersion of firm valuations are negatively related to subsequent market and portfolio excess returns, especially for sets of firms with highly subjective valuations and significant limits to arbitrage. Further, these firms underperform those with the opposite characteristics in periods when beginning-of-period firm valuation dispersion is high. In contrast, they overperform when beginning-of-period firm valuation dispersion is low.

What Factors Drive Global Stock Returns? (Current Version: January 2011)
Kewei Hou, G. Andrew Karolyi, and Bong-Chan Kho
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Using monthly returns for over 27,000 stocks from 49 countries over a three-decade period, we show that a multifactor model that includes factor-mimicking portfolios based on momentum and cash flow-to-price captures significant time series variation in global stock returns, and has lower pricing errors and fewer model rejections than the global CAPM or a popular model that uses size and book-to-market factors. We find reliable evidence that the global cash flow-to-price factor is related to a covariance risk model. In contrast, we reject the covariance risk model in favor of a characteristic model for size and book-to-market factors.

The World Price of Liquidity Risk
Kuan-Hui Lee
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This paper specifies and tests an equilibrium asset pricing model with liquidity risk at the global level. The analysis encompasses 25,000 individual stocks from 48 developed and emerging countries around the world from 1988 to 2004. Though we cannot find evidence that the liquidity adjusted capital asset pricing model of Acharya and Pedersen (2005) holds in international financial markets, cross-sectional as well as time-series tests show that liquidity risks arising from the covariances of individual stocks' return and liquidity with local and global market factors are priced. Furthermore, we show that the US market is an important driving force of world-market liquidity risk. We interpret our evidence as consistent with an intertemporal capital asset pricing model (Merton (1973)) in which stochastic shocks to global liquidity serve as a priced state variable.

Information, Trading Volume, and International Stock Return Comovements: Evidence from Cross-listed Stocks (updated 02/07)
Louis Gagnon and G. Andrew Karolyi
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This paper investigates the dynamic relation between returns and trading volume in international stock markets. We test the heterogeneous-agent, rational expectations model of Llorente, Michaely, Saar, and Wang (2002) for a comprehensive sample of 556 foreign stocks cross-listed on U.S. markets from 36 different markets. Their model argues that investors trade to speculate on their private information or to rebalance their portfolios and predicts that returns associated with portfolio rebalancing tend to reverse themselves while returns generated by speculative trades tend to continue themselves. We test this prediction by analyzing the relationship between trading volume and return comovements between the home and U.S. markets for the cross-listed shares. We hypothesize that returns in the home (U.S.) market on high-volume days are more likely to continue to spill over into the U.S. (home) market for those stocks subject to the risk of greater informed trading. Our empirical evidence provides support for this hypothesis, which highlights the link between information, trading volume and international stock return comovements that has eluded previous empirical investigations.

Financial globalization, governance, and the evolution of the home bias
Bong-Chan Kho, René M. Stulz, and Francis E. Warnock
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Despite the disappearance of formal barriers to international investment across countries, we find that the average home bias of U.S. investors towards the 46 countries with the largest equity markets did not fall from 1994 to 2004 when countries are equally weighted but fell when countries are weighted by market capitalization. This evidence is inconsistent with portfolio theory explanations of the home bias, but is consistent with what we call the optimal insider ownership theory of the home bias. Since foreign investors can only own shares not held by insiders, there will be a large home bias towards countries in which insiders own large stakes in corporations. Consequently, for the home bias to fall substantially, insider ownership has to fall in countries where it is high. Poor governance leads to concentrated insider ownership, so that governance improvements make it possible for corporate ownership to become more dispersed and for the home bias to fall. We find that the home bias of U.S. investors decreased the most towards countries in which the ownership by corporate insiders is low and countries in which ownership by corporate insiders fell. Using firm-level data for Korea, we find that portfolio equity investment by foreign investors in Korean firms is inversely related to insider ownership and that the firms that attract the most foreign portfolio equity investment are large firms with dispersed ownership.

It’s SHO Time! Short-Sale Price-Tests and Market Quality (updated 08/07)
Karl B. Diether, Kuan-Hui Lee, and Ingrid M. Werner
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We examine the effects of the SEC mandated temporary suspension of short-sale price-tests for a set of Pilot securities. While short-selling activity increased both for NYSE and NASDAQ-listed Pilot stocks, returns and volatility at the daily level are unaffected. NYSE-listed Pilot stocks experience more symmetric trading patterns and a slight increase in spreads and intraday volatility after the suspension while there is a smaller effect on market quality for NASDAQ listed Pilot stocks. The results suggest that the effect of the price-tests on market quality can largely be attributed to the distortions in order flow created by the price-tests in the first place. Therefore, we believe that the price-tests can safely be permanently suspended.

Large Shareholders and Corporate Policies
Henrik Cronqvist and Rüdiger Fahlenbrach
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We develop an empirical framework that allows us to analyze the effects of heterogeneity across large shareholders, and we construct a new blockholder-firm panel data set in which we can track all unique blockholders among large U.S. public firms. We find statistically significant and economically important blockholder fixed effects in investment, financial, and executive compensation policies. This evidence suggests that blockholders vary in their beliefs, skills, or preferences. Different large shareholders have distinct investment and governance styles: they differ in their approaches to corporate investment and growth, their appetites for financial leverage, and their attitudes towards CEO pay. We also find blockholder fixed effects in firm performance measures, and differences in style are systematically related to firm performance differences. Our results are consistent with influence for activist, pension fund, corporate, individual, and private equity blockholders, but consistent with systematic selection for mutual funds. Finally, we analyze sources of the heterogeneity, and find that blockholders with a larger block size, board membership, direct management involvement as officers, or with a single decision maker are associated with larger effects on corporate policies and firm performance.

Enterprise Risk Management: Theory and Practice
Brian Nocco and René M. Stulz
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In this paper, we explain how enterprise risk management creates value for shareholders. In contrast to the existing finance literature, we emphasize the organizational benefits of risk management. We show how a firm should choose its risk appetite and measure risk when implementing enterprise risk management. We also provide an extensive guide to the implementation issues faced by firms that implement enterprise risk management.

Advertising and Portfolio Choice
Henrik Cronqvist
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This paper examines the role that advertising plays in the mutual fund industry and whether advertising affects investors’ fund and portfolio choices. Content analysis shows that only a small fraction of fund advertising is directly informative about characteristics relevant for rational investors, such as fund fees. Higher quantities of advertising do not signal ex ante higher unobservable fund manager ability, because funds that advertise more are not associated with higher post-advertising excess returns. Fund advertising is shown to affect investors’choices, although it provides little information. These results do not seem to be driven by the endogeneity of advertising, and are robust to a series of robustness checks. Finally, advertising is found to steer people towards portfolios with higher fees and more risk, through higher exposure to equities, more active management, more "hot" sectors, and more home bias. This evidence has implications for welfare analysis, asset pricing and public policy, and may serve as a starting point for broader analysis of marketing and persuasion efforts in financial markets.

Why do U.S. firms hold so much more cash than they used to? (updated 03/07)
Thomas W. Bates, Kathleen M. Kahle, and René M. Stulz
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The average cash to assets ratio for U.S. industrial firms increases by 129% from 1980 to 2004. Because of this increase in the average cash ratio, firms at the end of the sample period can pay back all of their debt obligations with their cash holdings, so that the average firm has no leverage when leverage is measured by net debt. This change in cash ratios and net debt is the result of a secular trend rather than the outcome of the recent buildup in cash holdings of some large firms, but is more pronounced for firms that do not pay dividends. The average cash ratio increases over the sample period because firms change: their cash flow becomes riskier, they hold fewer inventories and accounts receivable, and are increasingly R&D intensive. The precautionary motive for cash holdings appears to explain the increase in the average cash ratio.

Subordinations Levels in Structured Financing
Xudong An, Yongheng Deng, and Anthony B. Sanders
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Subordination levels are of critical importance in the classic senior-subordinated structure for securitized financing (such as collateralized debt obligations and commercial mortgage-backed securities). Subordination levels determine the amount of credit support that the senior bonds (or tranches) require from the subordinated bonds (or tranches) and are provided by the rating agencies. Thus, ratings agencies play an important role in the pricing and risk management of structured finance products.
The finance literature has numerous studies examining whether securities with higher risk (as predicted by asset pricing models, such as the CAPM) earn higher ex-post average returns. In a similar vein, it is of interest to examine whether securities (or tranches) with greater levels of subordination experience higher ex-post levels of delinquencies and default. In this paper, we examine whether bonds (or tranches) with greater levels of subordination do, in fact, experience higher ex-post levels of delinquencies and default.
Recent studies have found that rating agencies follow a "learning by doing" approach in subordination structuring (Riddiough and Chiang, 2004). As expected, the rating agencies were conservative in the early stages with regard to subordination levels given the paucity of information about delinquencies, defaults and prepayments on loans. As time progresses and more information is available regarding loan performance,subordination levels adjusted to new levels. This paper focuses on cross sectional differences in subordination levels. We examine if this relationship between subordination and ex-post delinquencies and defaults is conforming to rational expectation.
We perform both a deal level and a loan level analysis using commercial mortgage-backed securities (CMBS). Our results show that the expected loss for CMBS pools are a statistically significant factor in explaining both AAA and BBB bond subordinations; however, expected loss accounts for less than 30 percent of the variation. Even considering the rating agencies’ practice of incorporating differences in loan terms, borrower quality, deal structural and information quality into their subordination structure, the empirical fit is still too low. These findings indicate the difficulty in determining subordination levels apriori.

The Effect of Bank Mergers on Loan Prices: Evidence from the U.S. (updated 12/07)
Isil Erel
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Bank mergers can increase or decrease loan spreads, depending on whether the increased market power outweighs efficiency gains. Using proprietary loan-level data for U.S. commercial banks, I find that, on average, mergers reduce loan spreads, with the magnitude of the reduction being larger when post-merger cost savings increase. My results suggest that the relation between spreads and the extent of market overlap between merging banks is non-monotonic. Market overlap increases cost savings and consequently lowers spreads, but when the overlap is sufficiently large, spreads increase, potentially due to the market-power effect dominating the cost savings. Furthermore, the average reduction in spreads is significant for small businesses.

Managerial Risk-Taking Behavior and Equity-Based Compensation
Angie Low
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I study managers' risk-taking behavior and how it is affected by equity-based compensation. I find that in response to an exogenous increase in takeover protection in Delaware during the mid-1990s, managers lower firm risk by 5%. I also find that the decrease in firm risk is concentrated among firms with low managerial equity-based incentives. In particular, firms with low CEO portfolio sensitivity to stock return volatility experience more than 10% reduction in risk. Further, firms respond to the increased protection accorded by the regime shift with greater incentives for risk-taking.

The Economics of Conflicts of Interest in Financial Institutions
Hamid Mehran and René M. Stulz
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A conflict of interest exists when a party to a transaction could potentially make a gain from taking actions that are detrimental to the other party in the transaction. This paper examines the economics of conflicts of interest in financial institutions and reviews the growing empirical literature (mostly focused on analysts) on the economic implications of these conflicts. Economic analysis shows that, although conflicts of interest are omnipresent when contracting is costly and parties are imperfectly informed, there are important factors that mitigate their impact and, strikingly, it is possible for customers of financial institutions to benefit from the existence of such conflicts. The empirical literature reaches conclusions that differ across types of conflicts of interest, but overall these conclusions are more ambivalent and certainly more benign than the conclusions drawn by journalists and politicians from mostly anecdotal evidence. Though much has been made of conflicts of interest arising from investment banking activities, there is no consensus in the empirical literature supporting the view that conflicts resulting from these activities had a systematic adverse impact on customers of financial institutions.

List Prices, Sale Prices, and Marketing Time: An Application to U.S. Housing Markets
Donald R. Haurin, Jessica L. Haurin, Taylor Nadauld, and Anthony B. Sanders
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Many goods are marketed after first stating a list price, with the expectation that the eventual sales price will differ. In this paper we first extend search theory to include the seller setting a list price. Holding constant the mean of the buyers’ distribution of potential offers for a good, we assume that the greater the list price, the slower the arrival rate of offers but the greater is the maximal offer. This tradeoff determines the optimal list price, which is set simultaneously with the seller’s reservation price. Comparative statics are derived through a set numerical sensitivity tests, where we show that the greater the variance of the distribution of buyers’ potential offers, the greater is the ratio of the list price to expected sales price. Thus, sellers of atypical goods will tend to set a relatively high list price compared with standard goods. We test this hypothesis using data from the Columbus, Ohio housing market and find substantial support. Other applications could include the market for fine art or autos.

R2 and Price Inefficiency
Kewei Hou, Lin Peng, and Wei Xiong
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Motivated by the recent debate on return R2 as an information-efficiency measure, this paper proposes and examines a new hypothesis that R2 is related to investors’ biases in processing information. We provide a model to show that R2 decreases with the degree of the marginal investor’s overreaction to firm-specific information. This theoretical result motivates an empirical hypothesis that stocks with lower R2 should exhibit more pronounced overreaction-driven price momentum. Empirically, we confirm that such a negative relationship between R2 and price momentum exists, and find this relationship robust to controls for risk as well as several alternative mechanisms, such as slow information diffusion, information uncertainty, fundamental R2 and illiquidity. Furthermore, we also document stronger long-run price reversals for stocks with lower R2. Taken together, our results suggest that return R2 could be related to price inefficiency.

Commercial Mortgage-backed Securities (CMBS) Terminations, Regional and Property-Type Risk
Yongheng Deng, John M. Quigley, and Anthony B. Sanders
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Option theory predicts that mortgage default or prepayment will be exercised if the call or put option is "in the money." We extend our analysis to commercial mortgages using data from commercial mortgage-backed securities (CMBS). The paper presents a model of the competing risks of mortgage termination (default and prepayment) using data from commercial mortgage-backed securities (CMBS) deals. Our results show that the option model explains both default and prepayment for commercial mortgages. We find that loan specific variables (such as loan-to-value ratio, debt service coverage ratio, loan-rate spread and prepayment prevention) are important explanatory variables for both default and prepayment. We also find that default and prepayment vary across regions of the country; given that regional economies do not move in perfect lock-step, we would expect there to be cross-sectional variation in default rates. However, the degree of variation across regions in terms of prepayments is not as predictable. The largest differences are across property types, both in terms of default and prepayment risk.

Do U.S. Firms Have the Best Corporate Governance? A Cross-Country Examination of the Relation between Corporate Governance and Shareholder Wealth
Reena Aggarwal, Isil Erel, René Stulz, and Rohan Williamson
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We compare the governance of foreign firms to the governance of similar U.S. firms. Using an index of firm governance attributes, we find that, on average, foreign firms have worse governance than matching U.S. firms. Roughly 8% of foreign firms have better governance than comparable U.S. firms. The majority of these firms are either in the U.K. or in Canada. When we define a firm’s governance gap as the difference between the quality of its governance and the governance of a comparable U.S. firm, we find that the value of foreign firms increases with the governance gap. This result suggests that firms are rewarded by the markets for having better governance than their U.S. peers. It is therefore not the case that foreign firms are better off simply mimicking the governance of comparable U.S. firms. Among the individual governance attributes considered, we find that firms with board and audit committee independence are valued more. In contrast, other attributes, such as the separation of the chairman of the board and of the CEO functions, do not appear to be associated with higher shareholder wealth.