Top 25 Cited Recent Articles

A collection of the most cited articles published in the Journal of Finance over the last 5 years.

A Pyrrhic Victory? Bank Bailouts and Sovereign Credit Risk

Published: 11/2014,  Volume: 69,  Issue: 6  |  DOI: 10.1111/jofi.12206  |  Cited by: 275

VIRAL ACHARYA, ITAMAR DRECHSLER, PHILIPP SCHNABL

We model a loop between sovereign and bank credit risk. A distressed financial sector induces government bailouts, whose cost increases sovereign credit risk. Increased sovereign credit risk in turn weakens the financial sector by eroding the value of its government guarantees and bond holdings. Using credit default swap (CDS) rates on European sovereigns and banks, we show that bailouts triggered the rise of sovereign credit risk in 2008. We document that post‐bailout changes in sovereign CDS explain changes in bank CDS even after controlling for aggregate and bank‐level determinants of credit spreads, confirming the sovereign‐bank loop.


Does Academic Research Destroy Stock Return Predictability?

Published: 1/2016,  Volume: 71,  Issue: 1  |  DOI: 10.1111/jofi.12365  |  Cited by: 269

R. DAVID MCLEAN, JEFFREY PONTIFF

We study the out‐of‐sample and post‐publication return predictability of 97 variables shown to predict cross‐sectional stock returns. Portfolio returns are 26% lower out‐of‐sample and 58% lower post‐publication. The out‐of‐sample decline is an upper bound estimate of data mining effects. We estimate a 32% (58%–26%) lower return from publication‐informed trading. Post‐publication declines are greater for predictors with higher in‐sample returns, and returns are higher for portfolios concentrated in stocks with high idiosyncratic risk and low liquidity. Predictor portfolios exhibit post‐publication increases in correlations with other published‐predictor portfolios. Our findings suggest that investors learn about mispricing from academic publications.


Measuring Readability in Financial Disclosures

Published: 7/2014,  Volume: 69,  Issue: 4  |  DOI: 10.1111/jofi.12162  |  Cited by: 232

TIM LOUGHRAN, BILL MCDONALD

Defining and measuring readability in the context of financial disclosures becomes important with the increasing use of textual analysis and the Securities and Exchange Commission's plain English initiative. We propose defining readability as the effective communication of valuation‐relevant information. The Fog Index—the most commonly applied readability measure—is shown to be poorly specified in financial applications. Of Fog's two components, one is misspecified and the other is difficult to measure. We report that 10‐K document file size provides a simple readability proxy that outperforms the Fog Index, does not require document parsing, facilitates replication, and is correlated with alternative readability constructs.


Financial Intermediaries and the Cross-Section of Asset Returns

Published: 11/2014,  Volume: 69,  Issue: 6  |  DOI: 10.1111/jofi.12189  |  Cited by: 216

TOBIAS ADRIAN, ERKKO ETULA, TYLER MUIR

Financial intermediaries trade frequently in many markets using sophisticated models. Their marginal value of wealth should therefore provide a more informative stochastic discount factor (SDF) than that of a representative consumer. Guided by theory, we use shocks to the leverage of securities broker‐dealers to construct an intermediary SDF. Intuitively, deteriorating funding conditions are associated with deleveraging and high marginal value of wealth. Our single‐factor model prices size, book‐to‐market, momentum, and bond portfolios with an R2 of 77% and an average annual pricing error of 1%—performing as well as standard multifactor benchmarks designed to price these assets.


The Global Crisis and Equity Market Contagion

Published: 11/2014,  Volume: 69,  Issue: 6  |  DOI: 10.1111/jofi.12203  |  Cited by: 205

GEERT BEKAERT, MICHAEL EHRMANN, MARCEL FRATZSCHER, ARNAUD MEHL

We analyze the transmission of the 2007 to 2009 financial crisis to 415 country‐industry equity portfolios. We use a factor model to predict crisis returns, defining unexplained increases in factor loadings and residual correlations as indicative of contagion. While we find evidence of contagion from the United States and the global financial sector, the effects are small. By contrast, there has been substantial contagion from domestic markets to individual domestic portfolios, with its severity inversely related to the quality of countries’ economic fundamentals. This confirms the “wake‐up call” hypothesis, with markets focusing more on country‐specific characteristics during the crisis.


Does Stock Liquidity Enhance or Impede Firm Innovation?

Published: 9/2014,  Volume: 69,  Issue: 5  |  DOI: 10.1111/jofi.12187  |  Cited by: 200

VIVIAN W. FANG, XUAN TIAN, SHERI TICE

We aim to tackle the longstanding debate on whether stock liquidity enhances or impedes firm innovation. This topic is of interest because innovation is crucial for firm‐ and national‐level competitiveness and stock liquidity can be altered by financial market regulations. Using a difference‐in‐differences approach that relies on the exogenous variation in liquidity generated by regulatory changes, we find that an increase in liquidity causes a reduction in future innovation. We identify two possible mechanisms through which liquidity impedes innovation: increased exposure to hostile takeovers and higher presence of institutional investors who do not actively gather information or monitor.


Sovereign Default, Domestic Banks, and Financial Institutions

Published: 3/2014,  Volume: 69,  Issue: 2  |  DOI: 10.1111/jofi.12124  |  Cited by: 192

NICOLA GENNAIOLI, ALBERTO MARTIN, STEFANO ROSSI

We present a model of sovereign debt in which, contrary to conventional wisdom, government defaults are costly because they destroy the balance sheets of domestic banks. In our model, better financial institutions allow banks to be more leveraged, thereby making them more vulnerable to sovereign defaults. Our predictions: government defaults should lead to declines in private credit, and these declines should be larger in countries where financial institutions are more developed and banks hold more government bonds. In these same countries, government defaults should be less likely. Using a large panel of countries, we find evidence consistent with these predictions.


Product Market Threats, Payouts, and Financial Flexibility

Published: 1/2014,  Volume: 69,  Issue: 1  |  DOI: 10.1111/jofi.12050  |  Cited by: 186

GERARD HOBERG, GORDON PHILLIPS, NAGPURNANAND PRABHALA

We examine how product market threats influence firm payout policy and cash holdings. Using firms' product text descriptions, we develop new measures of competitive threats. Our primary measure, product market fluidity, captures changes in rival firms' products relative to the firm's products. We show that fluidity decreases firm propensity to make payouts via dividends or repurchases and increases the cash held by firms, especially for firms with less access to financial markets. These results are consistent with the hypothesis that firms' financial policies are significantly shaped by product market threats and dynamics.


Do Peer Firms Affect Corporate Financial Policy?

Published: 1/2014,  Volume: 69,  Issue: 1  |  DOI: 10.1111/jofi.12094  |  Cited by: 183

MARK T. LEARY, MICHAEL R. ROBERTS

We show that peer firms play an important role in determining corporate capital structures and financial policies. In large part, firms' financing decisions are responses to the financing decisions and, to a lesser extent, the characteristics of peer firms. These peer effects are more important for capital structure determination than most previously identified determinants. Furthermore, smaller, less successful firms are highly sensitive to their larger, more successful peers, but not vice versa. We also quantify the externalities generated by peer effects, which can amplify the impact of changes in exogenous determinants on leverage by over 70%.


CEO Turnover and Relative Performance Evaluation

Published: 9/2015,  Volume: 70,  Issue: 5  |  DOI: 10.1111/jofi.12282  |  Cited by: 178

DIRK JENTER, FADI KANAAN

This paper shows that CEOs are fired after bad firm performance caused by factors beyond their control. Standard economic theory predicts that corporate boards filter out exogenous industry and market shocks from firm performance before deciding on CEO retention. Using a hand‐collected sample of 3,365 CEO turnovers from 1993 to 2009, we document that CEOs are significantly more likely to be dismissed from their jobs after bad industry and, to a lesser extent, after bad market performance. A decline in industry performance from the 90th to the 10th percentile doubles the probability of a forced CEO turnover.


Behind the Scenes: The Corporate Governance Preferences of Institutional Investors

Published: 11/2016,  Volume: 71,  Issue: 6  |  DOI: 10.1111/jofi.12393  |  Cited by: 177

JOSEPH A. McCAHERY, ZACHARIAS SAUTNER, LAURA T. STARKS

We survey institutional investors to better understand their role in the corporate governance of firms. Consistent with a number of theories, we document widespread behind‐the‐scenes intervention as well as governance‐motivated exit. These governance mechanisms are viewed as complementary devices, with intervention typically occurring prior to a potential exit. We further find that long‐term investors and investors that are less concerned about stock liquidity intervene more intensively. Finally, we find that most investors use proxy advisors and believe that the information provided by such advisors improves their own voting decisions.


Corporate Innovations and Mergers and Acquisitions

Published: 9/2014,  Volume: 69,  Issue: 5  |  DOI: 10.1111/jofi.12059  |  Cited by: 173

JAN BENA, KAI LI

Using a large and unique patent‐merger data set over the period 1984 to 2006, we show that companies with large patent portfolios and low R&D expenses are acquirers, while companies with high R&D expenses and slow growth in patent output are targets. Further, technological overlap between firm pairs has a positive effect on transaction incidence, and this effect is reduced for firm pairs that overlap in product markets. We also show that acquirers with prior technological linkage to their target firms produce more patents afterwards. We conclude that synergies obtained from combining innovation capabilities are important drivers of acquisitions.


Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle

Published: 9/2015,  Volume: 70,  Issue: 5  |  DOI: 10.1111/jofi.12286  |  Cited by: 173

ROBERT F. STAMBAUGH, JIANFENG YU, YU YUAN

Buying is easier than shorting for many equity investors. Combining this arbitrage asymmetry with the arbitrage risk represented by idiosyncratic volatility (IVOL) explains the negative relation between IVOL and average return. The IVOL‐return relation is negative among overpriced stocks but positive among underpriced stocks, with mispricing determined by combining 11 return anomalies. Consistent with arbitrage asymmetry, the negative relation among overpriced stocks is stronger, especially for stocks less easily shorted, so the overall IVOL‐return relation is negative. Further supporting our explanation, high investor sentiment weakens the positive relation among underpriced stocks and, especially, strengthens the negative relation among overpriced stocks.


Rise of the Machines: Algorithmic Trading in the Foreign Exchange Market

Published: 9/2014,  Volume: 69,  Issue: 5  |  DOI: 10.1111/jofi.12186  |  Cited by: 166

ALAIN P. CHABOUD, BENJAMIN CHIQUOINE, ERIK HJALMARSSON, CLARA VEGA

We study the impact of algorithmic trading (AT) in the foreign exchange market using a long time series of high‐frequency data that identify computer‐generated trading activity. We find that AT causes an improvement in two measures of price efficiency: the frequency of triangular arbitrage opportunities and the autocorrelation of high‐frequency returns. We show that the reduction in arbitrage opportunities is associated primarily with computers taking liquidity. This result is consistent with the view that AT improves informational efficiency by speeding up price discovery, but that it may also impose higher adverse selection costs on slower traders. In contrast, the reduction in the autocorrelation of returns owes more to the algorithmic provision of liquidity. We also find evidence consistent with the strategies of algorithmic traders being highly correlated. This correlation, however, does not appear to cause a degradation in market quality, at least not on average.


The Flash Crash: High-Frequency Trading in an Electronic Market

Published: 4/2017,  Volume: 72,  Issue: 3  |  DOI: 10.1111/jofi.12498  |  Cited by: 156

ANDREI KIRILENKO, ALBERT S. KYLE, MEHRDAD SAMADI, TUGKAN TUZUN

We study intraday market intermediation in an electronic market before and during a period of large and temporary selling pressure. On May 6, 2010, U.S. financial markets experienced a systemic intraday event—the Flash Crash—where a large automated selling program was rapidly executed in the E‐mini S&P 500 stock index futures market. Using audit trail transaction‐level data for the E‐mini on May 6 and the previous three days, we find that the trading pattern of the most active nondesignated intraday intermediaries (classified as High‐Frequency Traders) did not change when prices fell during the Flash Crash.


Does Going Public Affect Innovation?

Published: 7/2015,  Volume: 70,  Issue: 4  |  DOI: 10.1111/jofi.12275  |  Cited by: 154

SHAI BERNSTEIN

This paper investigates the effects of going public on innovation by comparing the innovation activity of firms that go public with firms that withdraw their initial public offering (IPO) filing and remain private. NASDAQ fluctuations during the book‐building phase are used as an instrument for IPO completion. Using patent‐based metrics, I find that the quality of internal innovation declines following the IPO, and firms experience both an exodus of skilled inventors and a decline in the productivity of the remaining inventors. However, public firms attract new human capital and acquire external innovation. The analysis reveals that going public changes firms' strategies in pursuing innovation.


Risk Premiums in Dynamic Term Structure Models with Unspanned Macro Risks

Published: 5/2014,  Volume: 69,  Issue: 3  |  DOI: 10.1111/jofi.12131  |  Cited by: 153

SCOTT JOSLIN, MARCEL PRIEBSCH, KENNETH J. SINGLETON

This paper quantifies how variation in economic activity and inflation in the United States influences the market prices of level, slope, and curvature risks in Treasury markets. We develop a novel arbitrage‐free dynamic term structure model in which bond investment decisions are influenced by output and inflation risks that are unspanned by (imperfectly correlated with) information about the shape of the yield curve. Our model reveals that, between 1985 and 2007, these risks accounted for a large portion of the variation in forward terms premiums, and there was pronounced cyclical variation in the market prices of level and slope risks.


Private Equity Performance: What Do We Know?

Published: 9/2014,  Volume: 69,  Issue: 5  |  DOI: 10.1111/jofi.12154  |  Cited by: 152

ROBERT S. HARRIS, TIM JENKINSON, STEVEN N. KAPLAN

We study the performance of nearly 1,400 U.S. buyout and venture capital funds using a new data set from Burgiss. We find better buyout fund performance than previously documented—performance has consistently exceeded that of public markets. Outperformance versus the S&P 500 averages 20% to 27% over a fund's life and more than 3% annually. Venture capital funds outperformed public equities in the 1990s, but underperformed in the 2000s. Our conclusions are robust to various indices and risk controls. Performance in Cambridge Associates and Preqin is qualitatively similar to that in Burgiss, but is lower in Venture Economics.


Money Doctors

Published: 1/2015,  Volume: 70,  Issue: 1  |  DOI: 10.1111/jofi.12188  |  Cited by: 150

NICOLA GENNAIOLI, ANDREI SHLEIFER, ROBERT VISHNY

We present a new model of investors delegating portfolio management to professionals based on trust. Trust in the manager reduces an investor's perception of the riskiness of a given investment, and allows managers to charge fees. Money managers compete for investor funds by setting fees, but because of trust, fees do not fall to costs. In equilibrium, fees are higher for assets with higher expected return, managers on average underperform the market net of fees, but investors nevertheless prefer to hire managers to investing on their own. When investors hold biased expectations, trust causes managers to pander to investor beliefs.


Time-Varying Fund Manager Skill

Published: 7/2014,  Volume: 69,  Issue: 4  |  DOI: 10.1111/jofi.12084  |  Cited by: 144

MARCIN KACPERCZYK, STIJN VAN NIEUWERBURGH, LAURA VELDKAMP

We propose a new definition of skill as general cognitive ability to pick stocks or time the market. We find evidence for stock picking in booms and market timing in recessions. Moreover, the same fund managers that pick stocks well in expansions also time the market well in recessions. These fund managers significantly outperform other funds and passive benchmarks. Our results suggest a new measure of managerial ability that weighs a fund's market timing more in recessions and stock picking more in booms. The measure displays more persistence than either market timing or stock picking alone and predicts fund performance.


Shaping Liquidity: On the Causal Effects of Voluntary Disclosure

Published: 9/2014,  Volume: 69,  Issue: 5  |  DOI: 10.1111/jofi.12180  |  Cited by: 143

KARTHIK BALAKRISHNAN, MARY BROOKE BILLINGS, BRYAN KELLY, ALEXANDER LJUNGQVIST

Can managers influence the liquidity of their firms’ shares? We use plausibly exogenous variation in the supply of public information to show that firms actively shape their information environments by voluntarily disclosing more information than regulations mandate and that such efforts improve liquidity. Firms respond to an exogenous loss of public information by providing more timely and informative earnings guidance. Responses appear motivated by a desire to reduce information asymmetries between retail and institutional investors. Liquidity improves as a result and in turn increases firm value. This suggests that managers can causally influence their cost of capital via voluntary disclosure.


Sizing Up Repo

Published: 11/2014,  Volume: 69,  Issue: 6  |  DOI: 10.1111/jofi.12168  |  Cited by: 140

ARVIND KRISHNAMURTHY, STEFAN NAGEL, DMITRY ORLOV

To understand which short‐term debt markets experienced “runs” during the financial crisis, we analyze a novel data set of repurchase agreements (repo), that is, loans between nonbank cash lenders and dealer banks collateralized with securities. Consistent with a run, repo volume backed by private asset‐backed securities falls to near zero in the crisis. However, the reduction is only $182 billion, which is small relative to the stock of private asset‐backed securities as well as the contraction in asset‐backed commercial paper. While the repo contraction is small in aggregate, it disproportionately affected a few dealer banks.


Social Capital, Trust, and Firm Performance: The Value of Corporate Social Responsibility during the Financial Crisis

Published: 5/2017,  Volume: 72,  Issue: 4  |  DOI: 10.1111/jofi.12505  |  Cited by: 133

KARL V. LINS, HENRI SERVAES, ANE TAMAYO

During the 2008–2009 financial crisis, firms with high social capital, as measured by corporate social responsibility (CSR) intensity, had stock returns that were four to seven percentage points higher than firms with low social capital. High‐CSR firms also experienced higher profitability, growth, and sales per employee relative to low‐CSR firms, and they raised more debt. This evidence suggests that the trust between a firm and both its stakeholders and investors, built through investments in social capital, pays off when the overall level of trust in corporations and markets suffers a negative shock.


Refinancing Risk and Cash Holdings

Published: 5/2014,  Volume: 69,  Issue: 3  |  DOI: 10.1111/jofi.12133  |  Cited by: 133

JARRAD HARFORD, SANDY KLASA, WILLIAM F. MAXWELL

We find that firms mitigate refinancing risk by increasing their cash holdings and saving cash from cash flows. The maturity of firms’ long‐term debt has shortened markedly, and this shortening explains a large fraction of the increase in cash holdings over time. Consistent with the inference that cash reserves are particularly valuable for firms with refinancing risk, we document that the value of these reserves is higher for such firms and that they mitigate underinvestment problems. Our findings imply that refinancing risk is a key determinant of cash holdings and highlight the interdependence of a firm's financial policy decisions.


The Importance of Industry Links in Merger Waves

Published: 3/2014,  Volume: 69,  Issue: 2  |  DOI: 10.1111/jofi.12122  |  Cited by: 132

KENNETH R. AHERN, JARRAD HARFORD

We represent the economy as a network of industries connected through customer and supplier trade flows. Using this network topology, we find that stronger product market connections lead to a greater incidence of cross‐industry mergers. Furthermore, mergers propagate in waves across the network through customer‐supplier links. Merger activity transmits to close industries quickly and to distant industries with a delay. Finally, economy‐wide merger waves are driven by merger activity in industries that are centrally located in the product market network. Overall, we show that the network of real economic transactions helps to explain the formation and propagation of merger waves.