Words Speak Louder Without Actions
Published: 07/12/2019 | DOI: 10.1111/jofi.12834
Information and control rights are central aspects of leadership, management, and corporate governance. This paper studies a principal‐agent model that features both communication and intervention as alternative means to exert influence. The main result shows that a principal's power to intervene in an agent's decision limits the ability of the principal to effectively communicate her private information. The perverse effect of intervention on communication can harm the principal, especially when the cost of intervention is low or the underlying agency problem is severe. These novel results are applied to managerial leadership, corporate boards, private equity, and shareholder activism.
Funding Liquidity without Banks: Evidence from a Shock to the Cost of Very Short‐Term Debt
Published: 07/06/2019 | DOI: 10.1111/jofi.12832
FELIPE RESTREPO, LINA CARDONA‐SOSA, PHILIP E. STRAHAN
In 2011, Colombia instituted a tax on repayment of bank loans, which increased the cost of short‐term bank credit more than long‐term credit. Firms responded by cutting short‐term loans for liquidity management purposes and increasing the use of cash and trade credit. In industries in which trade credit is more accessible (based on U.S. Compustat firms), we find substitution into accounts payable and little effect on cash and investment. Where trade credit is less available, firms increase cash and cut investment. Thus, trade credit provides an alternative source of liquidity that can insulate some firms from bank liquidity shocks.
Diagnostic Expectations and Stock Returns
Published: 07/06/2019 | DOI: 10.1111/jofi.12833
PEDRO BORDALO, NICOLA GENNAIOLI, RAFAEL LA PORTA, ANDREI SHLEIFER
We revisit La Porta's (1996) finding that returns on stocks with the most optimistic analyst long‐term earnings growth forecasts are lower than those on stocks with the most pessimistic forecasts. We document the joint dynamics of fundamentals, expectations, and returns of these portfolios, and explain the facts using a model of belief formation based on the representativeness heuristic. Analysts forecast fundamentals from observed earnings growth, but overreact to news by exaggerating the probability of states that have become more likely. We find support for the model's predictions. A quantitative estimation of the model accounts for the key patterns in the data.
Pledgeability, Industry Liquidity, and Financing Cycles
Published: 07/04/2019 | DOI: 10.1111/jofi.12831
DOUGLAS W. DIAMOND, YUNZHI HU, AND RAGHURAM G. RAJAN
Why do firms choose high debt when they anticipate high valuations, and underperform subsequently? We propose a theory of financing cycles where the importance of creditors’ control rights over cash flows (“pledgeability”) varies with industry liquidity. The market allows firms take on more debt when they anticipate higher future liquidity. However, both high anticipated liquidity and the resulting high debt limit their incentives to enhance pledgeability. This has prolonged adverse effects in a downturn. Because these effects are hard to contract upon, higher anticipated liquidity can also reduce a firm's current access to finance.
Over‐the‐Counter Market Frictions and Yield Spread Changes
Published: 06/30/2019 | DOI: 10.1111/jofi.12827
We empirically study whether systematic over‐the‐counter (OTC) market frictions drive the large unexplained common factor in yield spread changes. Using transaction data on U.S. corporate bonds, we find that marketwide inventory, search, and bargaining frictions explain 23.4% of the variation in the common component. Systematic OTC frictions thus substantially improve the explanatory power of yield spread changes and account for one‐third of their total explained variation. Search and bargaining frictions combined explain more in the common dynamics of yield spread changes than inventory frictions. Our findings support the implications of leading theories of intermediation frictions in OTC markets.
Learning from Coworkers: Peer Effects on Individual Investment Decisions
Published: 06/30/2019 | DOI: 10.1111/jofi.12830
Using unique data on employee stock purchase plans (ESPPs), we examine the influence of networks on investment decisions. Comparing employees within a firm during the same election window with metro‐area fixed effects, we find that the choices of coworkers in the firm's ESPP exert a significant influence on employees’ own decisions to participate and trade. Moreover, we find that the presence of high‐information employees magnifies the effects of peer networks. Given participation in an ESPP is value‐maximizing, our analysis suggests the potential of networks and targeted investor education to improve financial decision‐making.
Women's Liberation as a Financial Innovation
Published: 06/29/2019 | DOI: 10.1111/jofi.12829
MOSHE HAZAN, DAVID WEISS, HOSNY ZOABI
In one of the greatest extensions of property rights in human history, common law countries began giving rights to married women in the 1850s. Before this “women's liberation,” the doctrine of coverture strongly incentivized parents of daughters to hold real estate, rather than financial assets such as money, stocks, or bonds. We exploit the staggered nature of coverture's demise across U.S. states to show that women's rights led to shifts in household portfolios, a positive shock to the supply of credit, and a reallocation of labor towards nonagriculture and capital‐intensive industries. Investor protection thus deepened financial markets, aiding industrialization.
YOLO: Mortality Beliefs and Household Finance Puzzles
Published: 06/29/2019 | DOI: 10.1111/jofi.12828
RAWLEY Z. HEIMER, KRISTIAN OVE R. MYRSETH, RAPHAEL S. SCHOENLE
We study the effect of subjective mortality beliefs on life‐cycle behavior. With new survey evidence, we document that survival is underestimated (overestimated) by the young (old). We calibrate a canonical life‐cycle model to elicited beliefs. Relative to calibrations using actuarial probabilities, the young undersave by 26%, and retirees draw down their assets 27% slower, while the model' s fit to consumption data improves by 88%. Cross‐sectional regressions support the model's predictions: distorted mortality beliefs correlate with savings behavior while controlling for risk preferences, cognitive, and socioeconomic factors. Overweighting the likelihood of rare events contributes to mortality belief distortions.
Limited Investment Capital and Credit Spreads
Published: 04/18/2019 | DOI: 10.1111/jofi.12777
Using proprietary credit default swap (CDS) data, I investigate how capital shocks at protection sellers impact pricing in the CDS market. Seller capital shocks—measured as CDS portfolio margin payments—account for 12% of the time‐series variation in weekly spread changes, a significant amount given that standard credit factors account for 18% during my sample. In addition, seller shocks possess information for spreads that is independent of institution‐wide measures of constraints. These findings imply a high degree of market segmentation, and suggest that frictions within specialized financial institutions prevent capital from flowing into the market at shorter horizons.
Income Hedging, Dynamic Style Preferences, and Return Predictability
Published: 04/18/2019 | DOI: 10.1111/jofi.12775
JAWAD M. ADDOUM, STEFANOS DELIKOURAS, GEORGE M. KORNIOTIS, ALOK KUMAR
We propose a theoretical measure of income hedging demand and show that it affects asset prices. We focus on the value factor and first demonstrate that our demand estimates are correlated with the actual demands of retail and mutual fund investors. We then show that the aggregate high‐minus‐low (HML) demand predicts HML returns. Exploiting the state‐level variation in income risk, we demonstrate that state‐level hedging demands predict state‐level HML returns. A long‐short portfolio that exploits this hedging‐induced predictability earns an annualized risk‐adjusted return of 6%.
The Globalization Risk Premium
Published: 04/18/2019 | DOI: 10.1111/jofi.12780
JEAN‐NOËL BARROT, ERIK LOUALICHE, JULIEN SAUVAGNAT
In this paper, we investigate how globalization is reflected in asset prices. We use shipping costs to measure firms' exposure to globalization. Firms in low shipping cost industries carry a 7% risk premium, suggesting that their cash flows covary negatively with investors' marginal utility. We find that the premium emanates from the risk of displacement of least efficient firms triggered by import competition. These findings suggest that foreign productivity shocks are associated with times when consumption is dear for investors. We discuss conditions under which a standard model of trade with asset prices can rationalize this puzzle.
Proxy Advisory Firms: The Economics of Selling Information to Voters
Published: 04/17/2019 | DOI: 10.1111/jofi.12779
We analyze how proxy advisors, which sell voting recommendations to shareholders, affect corporate decision‐making. If the quality of the advisor's information is low, there is overreliance on its recommendations and insufficient private information production. In contrast, if the advisor's information is precise, it may be underused because the advisor rations its recommendations to maximize profits. Overall, the advisor's presence leads to more informative voting only if its information is sufficiently precise. We evaluate several proposals on regulating proxy advisors and show that some suggested policies, such as reducing proxy advisors' market power or decreasing litigation pressure, can have negative effects.
Nonlinearity and Flight‐to‐Safety in the Risk‐Return Trade‐Off for Stocks and Bonds
Published: 04/17/2019 | DOI: 10.1111/jofi.12776
TOBIAS ADRIAN, RICHARD K. CRUMP, ERIK VOGT
We document a highly significant, strongly nonlinear dependence of stock and bond returns on past equity market volatility as measured by the VIX. We propose a new estimator for the shape of the nonlinear forecasting relationship that exploits variation in the cross‐section of returns. The nonlinearities are mirror images for stocks and bonds, revealing flight‐to‐safety: expected returns increase for stocks when volatility increases from moderate to high levels while they decline for Treasuries. These findings provide support for dynamic asset pricing theories in which the price of risk is a nonlinear function of market volatility.
Capital Share Dynamics When Firms Insure Workers
Published: 03/30/2019 | DOI: 10.1111/jofi.12773
BARNEY HARTMAN‐GLASER, HANNO LUSTIG, MINDY Z. XIAOLAN
Although the aggregate capital share of U.S. firms has increased, capital share at the firm‐level has decreased. This divergence is due to mega‐firms that produce a larger output share without a proportionate increase in labor compensation. We develop a model in which firms insure workers against firm‐specific shocks, with more productive firms allocating more rents to shareholders, while less productive firms endogenously exit. Increasing firm‐level risk delays exit and increases the measure of mega‐firms, raising (lowering) the aggregate (average) capital share. An increase in the level of rents magnifies this effect. We present evidence that supports this mechanism.
Capital Share Risk in U.S. Asset Pricing
Published: 03/30/2019 | DOI: 10.1111/jofi.12772
MARTIN LETTAU, SYDNEY C. LUDVIGSON, SAI MA
A single macroeconomic factor based on growth in the capital share of aggregate income exhibits significant explanatory power for expected returns across a range of equity characteristic portfolios and nonequity asset classes, with risk price estimates that are of the same sign and similar in magnitude. Positive exposure to capital share risk earns a positive risk premium, commensurate with recent asset pricing models in which redistributive shocks shift the share of income between the wealthy, who finance consumption primarily out of asset ownership, and workers, who finance consumption primarily out of wages and salaries.