Research articles for the 2019-04-03

A Machine Learning approach to Risk Minimisation in Electricity Markets with Coregionalized Sparse Gaussian Processes
Daniel Poh,Stephen Roberts,Martin Tegnér

The non-storability of electricity makes it unique among commodity assets, and it is an important driver of its price behaviour in secondary financial markets. The instantaneous and continuous matching of power supply with demand is a key factor explaining its volatility. During periods of high demand, costlier generation capabilities are utilised since electricity cannot be stored and this has the impact of driving prices up very quickly. Furthermore, the non-storability also complicates physical hedging. Owing to these, the problem of joint price-quantity risk in electricity markets is a commonly studied theme.

We propose using Gaussian Processes (GPs) to tackle this problem since GPs provide a versatile and elegant non-parametric approach for regression and time-series modelling. However, GPs scale poorly with the amount of training data due to a cubic complexity. These considerations suggest that knowledge transfer between price and load is vital for effective hedging, and that a computationally efficient method is required. To this end, we use the coregionalized (or multi-task) sparse GPs which addresses the aforementioned issues.

To gauge the performance of our model, we use an average-load strategy as comparator. The latter is a robust approach commonly used by industry. If the spot and load are uncorrelated and Gaussian, then hedging with the expected load will result in the minimum variance position.

Our main contributions are twofold. Firstly, in developing a coregionalized sparse GP-based approach for hedging. Secondly, in demonstrating that our model-based strategy outperforms the comparator, and can thus be employed for effective hedging in electricity markets.

Age‐Dependent Increasing Risk Aversion and the Equity Premium Puzzle
DaSilva, Amadeu,Farka, Mira,Giannikos, Christos
We introduce a new preference structure—age‐dependent increasing risk aversion (IRA)—in a three‐period overlapping generations model with borrowing constraints, and examine the behavior of equity premium in this framework. We find that IRA preferences generate results that are more consistent with U.S. data for the equity premium, level of savings and portfolio shares, without assuming unreasonable levels of risk aversion. We find that the relative difference between the two risk aversions (how much more risk‐averse old agents are relative to the middle‐aged) matters more than the average risk aversion in the economy (how much more risk‐averse both cohorts are). Our findings are robust with respect to a number of model generalizations.

Altcoin-Bitcoin Arbitrage
Zura Kakushadze,Willie Yu

We give an algorithm and source code for a cryptoasset statistical arbitrage alpha based on a mean-reversion effect driven by the leading momentum factor in cryptoasset returns discussed in Using empirical data, we identify the cross-section of cryptoassets for which this altcoin-Bitcoin arbitrage alpha is significant and discuss it in the context of liquidity considerations as well as its implications for cryptoasset trading.

An Empirical Study of the Impact of Intellectual Capital on the Financial Performance of Indian IT Sector
Khan, Musa
In the present scenario, intellectual capital has been established as an important corporate asset because conventional performance measurement techniques are incapable of measuring the intangible dimensions of corporate performance. It is a challenge, especially for knowledge driven firms, to measure the impact of intangibles on their financial performance. The main objective of this study is to show the impact of intellectual capital on the financial performance of the Indian IT sector. In order to conduct the study, the sample was drawn from the IT sector for which the sector index of BSE, namely the BSE IT, had been selected. In all, data from 51 companies from the Information Technology (IT) sector for the financial years ranging from 2006 to 2016 were taken. The data used in this study was extracted from the CMIE’s Prowess.The VAICTM was used to measure the intangibility of these firms. The results show thatonly the VAICTM had a significant positive association with profitability of the Indian IT sector, while it had an insignificant relationship with productivity and market valuation. The CEE had a significant positive relationship with productivity and profitability in the IT sector, while, in the case of market valuation, it had an insignificant impact. The HCE had aninsignificant impact on profitability and productivity, while, in the case of market valuation, it had a negative significant impact. The SCE had a significant positive association with market valuation only while it had an insignificant relationship with the productivity and profitability of the Indian IT sector.

Behavioral Motives of the Payout Policy Choice: Literature Review
Anilov, Artem
The question of the significance of the payout policy in terms of value creation has been in the works for over 50 years now. These endeavors have led to the establishment of some classic theories that explain the different patterns in a company’s payout policy choices such as the signaling theory, the agency costs theory, the clientele theory and the catering theory. However, the results are not always consistent among different authors, which means that these theories cannot be used universally. Results vary widely among different samples and different time periods. The classic theories assume that all agents on the market are fully rational, which is rather unrealistic since an agent’s actions cannot always be explained by financial theories. These two facts led to the development of the behavioral explanation for the payout policy choice. This approach focuses on the behavioral characteristics of managers that are responsible for the decision-making process in the company. Thus, the payout policy, according to this approach, is considered to be a function of the behavioral characteristics of managers (overconfidence, optimism, risk preferences, etc.) rather than a function of the financial variables. The main difficulty here is how to measure the behavior of managers.This particular article reviews the research that covers the classic and modern theories of payout policy. This article covers the logic of the development of different views on the payout policy. The authors cover articles that test different theories, analyze the main results and conclusions, and investigate the reasons for the development of these theories. The main focus has been on the behavioral approach, which is considered to be the most fruitful direction for future research. The authors also cover the methodology of the existing papers, the variables that measure behavioral characteristics and the results.

Communicating Culture Consistently: Evidence from Banks
Grennan, Jillian
Regulators and executives say corporate culture has a meaningful effect on performance, yet identifying when culture is misaligned with aspiration is challenging. This makes implementing solutions to improve culture even more difficult. This study shows a simple mechanism -- communicating culture consistently -- is linked to superior performance. The data for testing the mechanism comes from publicly available information, signifying its value as a potential diagnostic tool. Using historical versions of websites from 2004 to 2017 for 300 U.S. banks, I extract the content of cultural values (e.g., integrity). A majority of banks inconsistently communicate their values across website themes (e.g., about us, career, community, culture, and investor relations). The banks that communicate their cultural values consistently before the onset of the financial crisis have better operating and stock performance during the crisis. While banks significantly improve consistency after the crisis, the positive association is evident over the full sample. Additional findings that compare holdings of private mortgage-backed securities and bad loans suggest that the positive influence of communicating culture consistently derives from aligning employees' expectations, especially when unforeseen events arise.

De totstandkoming van de introductieprijs bij IPO’s (The Process of Setting the IPO Offer Price)
van den Assem, Martijn J.,van der Sar, Nico,van Logtestijn, Geert-Jan,Haanen, Roeland,Krol, Robartus
Dutch Abstract: Aan de hand van bevindingen van veertig diepte-interviews met direct betrokken bestuurders verschaffen we inzicht in het proces van de totstandkoming van de introductieprijs bij een beursgang. Onze resultaten betreffen eerste waarde-indicaties, de modelmatige waardering, tussentijdse ontwikkelingen en de keuze van de uiteindelijke prijs van een aandelenintroductie. Opvallend blijkt de invloed van premarketing en de hiermee verkregen informatievoorsprong voor de begeleidende bank versus de beursgaande onderneming. We stellen dat een formelere inrichting van het premarketingproces wenselijk is. Niet alleen ten behoeve van de oorspronkelijke aandeelhouders, maar ruimer gesteld met het oog op de efficiëntie van de primaire markt.English Abstract: Based on forty interviews with CEOs and CFOs who were closely involved in an Initial Public Offering (IPO) in the Netherlands, we provide insights into the process of setting the IPO offer price. Our results pertain to the first valuations exercises, valuation models, revisions, and the final offer price. One particular finding is the influential role of pre-marketing and the related informational advantage of the lead manager over the firm. We call for a more formal organization of the pre-marketing process, not just in the interest of existing shareholders but also to promote the efficiency of the primary market.

Dealers as Information Intermediaries in Over-the-Counter Market
Li, Wei,Song, Zhaogang
We model the role of dealers in information diffusion in over-the-counter (OTC) markets. A dealer maintains relationships with a network of both informed customers who trade to profit from private information pertaining to asset values and risk averse liquidity customers who trade to meet idiosyncratic liquidity needs. Knowing the type of every customer in her relationship network, a dealer in our model serves as an information intermediary by first willingly losing to informed customers to learn information from them and then relaying that information to risk averse liquidity customers through trading. We characterize the effects of a dealer's intermediation-profit driven choice of informativeness on liquidity trading and informational efficiency. We also study how the dealer size affects bid-ask spreads and trading volume, as well as how public information affects the dealers' informativeness.

Debt Market Crisis and Its impact on Debt Mutual Funds
Manda, Vijaya Kittu,Beatrice, Betsy Babu
Indian Mutual Funds are managing assets worth Rs. 24.12 trillion (Jan 2019). 29% of these assets are in debt schemes. 54% of these debt fund investments are individual investor monies. Indian debt market is under severe pressure in recent times and this is cascading into mutual funds segment. Higher exposure to debt securities of Non-banking Finance Companies (NBFC), defaults by IL&FS and its associate companies, trouble at DHFL and Zee groups and depletion of collateral value of loans given to company promoters because of the downslide in the equity market etc. are some reasons forcing debt schemes to mark-to-market their exposure. Individual investors who perceived debt mutual funds to be “as safe as fixed deposits” are now experiencing brief negative returns. Market regulator Securities and Exchange Board of India (SEBI) introduced a series of regulations including re-categorization of schemes, side-pocketing etc. to strengthen the market.This paper examines the recent trends and issues surrounding the debt mutual funds. A survey is done to understand the individual investor perception towards debt mutual funds and statistical findings are presented. Findings from this research can help the mutual fund industry and the market regulator in building debt fund products.

Discrete Time Affine Term Structure Models With Squared Gaussian Shocks (DTATSM-SGS)
Realdon, Marco
The tractability of discrete time affine term structure models (DTATSM) is fully preserved when adding squared Gaussian shocks (SGS) to factor processes. SGS guarantee non-negative factors under parameter restrictions that do not affect market prices of risk. DTATSM-SGS mirror continuous time affine models, but need no Feller conditions. New affine specifications become admissible. Changes of measure can alter not only the conditional mean, but also the conditional covariance of factors and yields through the second-order Esscher transform. This enables DTATSM-SGS to better match US Treasury yields volatility, while the conditional moments of factors and yields are still in closed form. The empirical comparison of DTATSM-SGS and similar models based on autoregressive Gamma processes reveals no clear winner in fitting US Treasury yields.

Do Hospital Data Breaches Reduce Patient Care Quality?
Sung J. Choi,M. Eric Johnson

Objective: To estimate the relationship between a hospital data breach and hospital quality outcome

Materials and Methods: Hospital data breaches reported to the U.S. Department of Health and Human Services breach portal and the Privacy Rights Clearinghouse database were merged with the Medicare Hospital Compare data to assemble a panel of non-federal acutecare inpatient hospitals for years 2011 to 2015. The study panel included 2,619 hospitals. Changes in 30-day AMI mortality rate following a hospital data breach were estimated using a multivariate regression model based on a difference-in-differences approach.

Results: A data breach was associated with a 0.338[95% CI, 0.101-0.576] percentage point increase in the 30-day AMI mortality rate in the year following the breach and a 0.446[95% CI, 0.164-0.729] percentage point increase two years after the breach. For comparison, the median 30-day AMI mortality rate has been decreasing about 0.4 percentage points annually since 2011 due to progress in care. The magnitude of the breach impact on hospitals' AMI mortality rates was comparable to a year's worth historical progress in reducing AMI mortality rates.

Conclusion: Hospital data breaches significantly increased the 30-day mortality rate for AMI. Data breaches may disrupt the processes of care that rely on health information technology. Financial costs to repair a breach may also divert resources away from patient care. Thus breached hospitals should carefully focus investments in security procedures, processes, and health information technology that jointly lead to better data security and improved patient outcomes.

Does Corporate Financial Architecture of Innovative Companies Differ? The Evidence From USA
Ivashkovskaya, Irina,Evdokimov, Sergei
Each company operates within the framework of interrelated structures: ownership, corporate governance and capital structure. The particular combination of these dimensions determines the corporate financial architecture of the company. Despite the growing body of literature on the challenges of the knowledge economy to the structural dimensions of companies, still little is known about the financial architecture of innovative firms. At the same time it is widely recognized that such companies substantially differ from traditional types of businesses in their business models and dynamics. Meanwhile, the financial architecture of a company generates the distribution of the incentives to enhance innovations affecting interests and risk-sharing among stakeholders. To address the lack of research into the interaction of corporate structures and their distinct features in innovative companies, this paper aims at identifying the robust financial architecture patterns of innovative companies. Using a sample of more than 1,300 publicly traded US-based manufacturing companies, we use an agglomerative hierarchical clustering method to identify relevant patterns and compare them to the firms which are not considered to be ‘knowledge intensive’. The empirical results allow the identification of seven robust financial architecture patterns within innovative companies. Our findings show that the first major difference between the financial architecture of innovative and non-innovative firms is in the higher role of activist institutional investors in the ownership. The second notable difference is related to CEO-duality, which plays a significant role in corporate governance only in innovative firms. Moreover, innovative companies are less leveraged than non-innovative firms. In addition, mature innovative companies demonstrate better financial performance.

Drivers of Fundraising Success in Equity Crowdfunding
Correia, Sandra Isabel,Sousa, Miguel,Brandao, Elisio
Using an unique hand-collected database of 1,256 campaigns from the two major platforms of equity crowdfunding in the United Kingdom, between 2015 and 2018, we find that the factors that most influence the campaign success are: (i) the quality of the project, signalized by equity retention and the presence of a large investor; (ii) the information disclosure and (iii) the early investments. There is no evidence economic potential of the firm are relevant for investor decisions. Investors probably use other signals (than growth and profitability perspectives) to evaluate the economic potential of firms and project quality.

Due Diligence Procedures and Principles for Financial Analysis and Corporate Governance
Grove, Hugh,Clouse, Mac
An initial set of seven procedures is developed for assessing a company’s common stock. A second set of ten procedures is developed for performing stealth or external financial (forensic) analysis on a company’s common stock. Also, a set of eight corporate governance principles, developed in secret over one year by 13 prominent CEOs of U.S. based, global companies, are elaborated for analyzing a company’s corporate governance practices in this paper. The purpose of this paper is to portray how these procedures and principles can be used by financial analysts and Boards of Directors in helping to assess the viability of the companies they are analyzing or serving and to develop key questions to ask of corporate executives. Thus, the first set of procedures elaborates seven reasons to consider in assessing a company’s stock. The second set of procedures develops ten steps of stealth forensics to investigate the possibility of financial shenanigans or fraud by a company. The last set of eight principles assesses the strength of corporate governance in a company. The importance of these principles is demonstrated by matching them with the practices of just 18 mainly global companies that managed to destroy $1.5 trillion of market capitalization. All these twenty-five procedures and principles will help strengthen financial analysis and corporate governance, especially for the role of financial analysts and Boards of Directors in assessing the value of companies’ common stock for investors.

Early Movers Advantage? Evidence from Short Selling During After‐Hours on Earnings Announcement Days
Jain, Archana,Jain, Chinmay,Jiang, Christine X.
We examine short sellers' after‐hours trading (AHT) following quarterly earnings announcements released outside of the normal trading hours. Our innovation is to use the actual short trades immediately after the announcements. We find that on these earnings announcement days, there is significant shorting activity in AHT relative to shorting activity both during AHT on nonannouncements days and during regular trading sessions around announcements. Short sellers who trade after‐hours on announcement days earn an excess return of 0.82% and 1.40% during before‐market‐open (BMO) and after‐market‐close (AMC)sessions, respectively. The magnitude of these returns increases to 1.48 (3.92%) for BMO (AMC) earnings announcements with negative surprise. We find that the reactive short selling during AHT has information in predicting future returns. Short sellers' trades have no predictive power if they wait for the market to open to trade during regular hours. In addition, we find that the weighted price contribution during AHT increases with an increase in after‐hours short selling. Overall, our results suggest that short sellers in AHT are informed. Our findings remain robust using alternative holding periods and after controlling for macroeconomic news announcements during BMO sessions.

Earnings Management: New Evidence From Bank Holding Companies
Mukherjee, Tarun K.,Pana, Elisabeta
In this paper, we investigate the role played by the organizational structure of bank holding companies in the earnings management of bank subsidiaries. Our results suggest that bank holding companies manage their subsidiaries to optimize the reporting outcome at the consolidated level. We find that parent characteristics explain the earnings management of subsidiaries over and above the characteristics of subsidiaries. We also find that subsidiary’s integration, the public status of bank holding companies and the distance between subsidiaries and headquarters explain the proclivity of bank subsidiaries to engage in earnings management. Our results yield important insights on the drivers of earnings management within bank holding companies and highlight the need for their integration in regulatory design.

Economic Growth Model with Constant Pace and Dynamic Memory
Valentina V. Tarasova,Vasily E. Tarasov

The article discusses a generalization of model of economic growth with constant pace, which takes into account the effects of dynamic memory. Memory means that endogenous or exogenous variable at a given time depends not only on their value at that time, but also on their values at previous times. To describe the dynamic memory we use derivatives of non-integer orders. We obtain the solutions of fractional differential equations with derivatives of non-integral order, which describe the dynamics of the output caused by the changes of the net investments and effects of power-law fading memory.

Economic and Political Uncertainty: The Case of U.S. Acquiring Firms
Sakaki, Hamid,Pana, Elisabeta,Jory, Surendranath
We examine the impact of economic and political uncertainty on the choice made by U.S. firms to expand through domestic or cross-border mergers and acquisitions. Using recently developed indexes of economic and political uncertainty, we document that U.S. firms use cross-border mergers and acquisitions to diversify the risk arising from policy uncertainty. We find that the investment horizon of institutional investors plays a significant role in mitigating the uncertainty affecting the deals. Overall, our results provide support to the argument that stable institutional investors are effective monitors of corporate strategies.

Elusive Longer-Run Impacts of Head Start: Replications Within and Across Cohorts
Remy J.-C. Pages,Dylan J. Lukes,Drew H. Bailey,Greg J. Duncan

Using an additional decade of CNLSY data, this study replicated and extended Deming's (2009) evaluation of Head Start's life-cycle skill formation impacts in three ways. Extending the measurement interval for Deming's adulthood outcomes, we found no statistically significant impacts on earnings and mixed evidence of impacts on other adult outcomes. Applying Deming's sibling comparison framework to more recent birth cohorts born to CNLSY mothers revealed mostly negative Head Start impacts. Combining all cohorts shows generally null impacts on school-age and early adulthood outcomes.

Financial Architecture in the Different Life Cycle Stages
Stepanova, Anastasia,Kazaryan, Izabella
In this article, we consider the relation between capital structure, corporate governance, ownership structure and performance of a company depending on its life cycle stages. The central aim of this study is to define the most sustainable and effective types of financial architecture by using the cluster and regression analysis. This study describes the three stages of the life cycle of a company: the first stage is growth, followed by maturity and finally the stage of decline, but for our research we only examine companies in the maturity stage. The research includes 11 countries from emerging markets and the primary sample includes 4,675 non-financial companies from 2011 to 2015. As the measure of a company’s performance, we used Tobin’s Q coefficient and total shareholder return. The primary sample was divided into the 3 life cycle stages by using the approach of comparing the growth rates of revenues at the average rate of revenue growth in the industry (Cao, 2010); however, we did not consider the earlier stages of the life cycle due to the specificity of the sample. A cluster analysis was performed on the sample for the growth and maturity stages in order to show the difference between the clusters that depends on the life cycle stages. We analyzed the clusters’ sustainability by regression analysis in each cluster. We described the influence of the financial architecture component on market performance. The results indicate more than one sustainable cluster and demonstrate the influence of the ownership structure, capital structure and the board characteristics on the company’s efficiency depending on the stage of the life cycle, which proves there is a need to take into account the issues of the life cycle. The managers and directors of a company can use results of this study when developing a company’s strategy, especially during the transition period from one life cycle to another.

Financial and Institutional Determinants of Cash Holdings in the Oil and Gas Industry
Gancherka, Sergei,Westerman, Wim
At the same time that a dramatic plunge in energy commodities pressured companies in the energy sector to initiate a down-cycle drill by cutting capital expenditures, selling non-core assets, and laying off personnel, the world’s top producers still maintained over half a trillion dollars in liquid assets. The reasons for phenomena such as this in the global oil and gas sector are manifold. The research question for this composition is: What are the determinants, both financial and institutional, which drive oil and gas companies to hold a certain amount of cash on their balances? This paper aims to analyse these determinants in various geographical markets of the European continent over the period of 2010-2014, using models derived from both the ‘tradeoff’ theory and the ‘pecking order’ theory. The empirical results from 800 firms were acquired with panel data regression analyses. They suggest that cash holdings in the sector are negatively affected by the net working capital, leverage, collateral, and firm size, while cash flows and capital expenditures have a positive influence on cash reserves. Besides the financial determinants, we also studied the institutional determinants for the cash levels. Our findings offer evidence that firms in countries with strong governance (as measured by the World Governance Index) hold more liquidity. Furthermore, the state of financial market development (as measured by the Global Financial Centers Index) is also positively related to cash holdings with the consequence that the financial market effect dominates the influence of governance. Our empirical evaluation will be of concern to managers in the oil and gas sector, who should take into consideration the settings of their companies when making corporate cash policy choices.

Forward Rank-Dependent Performance Criteria: Time-Consistent Investment Under Probability Distortion
Xue Dong He,Moris S. Strub,Thaleia Zariphopoulou

We introduce the concept of forward rank-dependent performance processes, extending the original notion to forward criteria that incorporate probability distortions. A fundamental challenge is how to reconcile the time-consistent nature of forward performance criteria with the time-inconsistency stemming from probability distortions. For this, we first propose two distinct definitions, one based on the preservation of performance value and the other on the time-consistency of policies and, in turn, establish their equivalence. We then fully characterize the viable class of probability distortion processes, providing a bifurcation-type result. Specifically, it is either the case that the probability distortions are degenerate in the sense that the investor would never invest in the risky assets, or the marginal probability distortion equals to a normalized power of the quantile function of the pricing kernel. We also characterize the optimal wealth process, whose structure motivates the introduction of a new, distorted measure and a related market. We then build a striking correspondence between the forward rank-dependent criteria in the original market and forward criteria without probability distortions in the auxiliary market. This connection also provides a direct construction method for forward rank-dependent criteria. A byproduct of our work are some new results on the so-called dynamic utilities and on time-inconsistent problems in the classical (backward) setting.

From Carry Trades to Trade Credit: Financial Intermediation by Nonfinancial Corporations
Hardy, Bryan,Saffie, Felipe
We use unique firm level data from Mexico to document that non-financial corporations engage in carry trades by borrowing in foreign currency and lending in domestic currency, largely to related partners (trade credit), accumulating currency risk in the process. The interest rate differential between local and foreign currency borrowing largely drives this behavior at a quarterly frequency, inducing an expansion in gross trade credit and sales. Firms that were active in carry-trade have decreased investment following a large depreciation, independent of currency exposure levels and export status, but maintain their supply of trade credit.

How Do Lenders Price Energy Efficiency? Evidence From Personal Consumption Loans
Giraudet, Louis-Gaëtan,Petronevich, Anna,Faucheux, Laurent
At least ex ante, energy efficiency improvements increase investor’s solvency. Associated loans should therefore carry lower interest rates than do otherwise conventional loans. We test this hypothesis using unique weekly panel data on posted interest rates scraped from loan simulators made available online by French credit institutions during 2015-2016. On average, we find that lenders charged a green premium in 2015 but offered a green discount in 2016. We also find that, absent green attributes, interest rates are higher for home retrofit loans than for vehicle loans, which suggests that lenders use the loan purpose as a screening device of unobserved borrower characteristics. Our results together imply that loans for home energy renovation were consistently charged relatively high interest rates, with adverse consequences for scaling up home energy renovation.

Initial Crypto-Asset Offerings (ICOs), Tokenization and Corporate Governance
Blemus, Stéphane,Guegan, Dominique
This interdisciplinary paper by a mathematician and a legal counsel, both from the Paris 1 Panthéon-Sorbonne University, discusses the potential impacts of the so-called “initial coin offerings”, and of several developments based on distributed ledger technology (“DLT”), on corporate governance. While many academic papers focus mainly on the legal qualification of DLT and crypto-assets, and most notably in relation to the potential definition of the latter as securities/financial instruments, the authors analyze some of the use cases based on DLT technology and their potential for significant changes of the corporate governance analyses.The authors examine in depth the opportunities and risks raised by ICOs, tokenization and distributed ledger technology in terms of corporate governance. First the concepts of ICO and tokenization, and beyond the consequences of distributed ledger technology, will be discussed in the context of a corporate governance perspective; secondly the potential rights granted by different types of crypto-asset holders (whether utility tokens or security tokens) will be carefully analyzed; thirdly the possible governance of a decentralized and distributed organization trying to answer the previous questions will be addressed.

Is Financial Flexibility a Priced Factor in the Stock Market?
Kumar, Suresh,Wongchoti, Udomsak,Chen, Jianguo,Faff, Robert
This paper develops a factor analysis–based measure for shifts in corporate financial flexibility (FFLEX) that can be observed from public accounting information. Companies that experience positive shifts in FFLEX are associated with higher future investment growth opportunities. We show that FFLEX is a robust determinant of future stock returns. Firms that have increased their financial flexibility are associated with lower stock returns in the subsequent period. A zero‐cost return portfolio produces a significant positive monthly premium of 0.69%, which is driven by covariance (risk). Risk inherent in the flexibility factor is not explained away by either prominent pricing characteristics or factors.

Is Stricter Regulation of Incentive Compensation the Missing Piece?
Wall, Larry D.
Although a number of steps have been taken to reduce the risk of financial stability, some significant weaknesses remain. This paper examines whether stricter regulation of incentive compensation is the missing piece needed to reduce risk to acceptable levels. Unfortunately, this review of the literatures on the relationship of risk to bank chief operating officer and bank employee compensation suggest both have some potential but that significant concerns remain in both cases. At this point, we cannot confidently say that compensation regulation is the missing piece.

Parity Co-determination at the Board Level and Labor Investment Efficiency: Evidence on German Listed Firms
Lopatta, Kerstin,Böttcher, Katarina,Lodhia, Sumit K.,Tideman, Sebastian A.
This study examines whether parity codetermination at German supervisory boards improves labor investment efficiency at firm level. We focus on labor, as it is an important production factor. Labor investment decisions are not easily reversible in the short term, given that hiring and firing costs are usually quite high due to labor regulation in Germany. As labor representatives are legally entitled to 50% voting rights at the supervisory board level (parity codetermination), we expect them to contribute insider knowledge to the supervisory board. As they have access to internal documents, we also expect them to reduce information asymmetry and potential agency conflicts between management on the one hand and outsiders such as investors or capital suppliers on the other. Both smaller information asymmetries and reduced agency conflicts, in turn, ought to increase a firm’s labor investment efficiency. Labor investment proxies for deviations from a firm’s optimal level of investment in labor in the form of over- and underinvestment, defined as hiring fewer employees than required to run profitable projects (underhiring) or retaining employees who are occupied with non-profitable projects (overhiring). We measure labor investment efficiency using such a net hiring optimum for a sample of German listed firms between 1995 and 2015. The results indicate that parity codetermination causes a lower deviation from the net hiring optimum. Our results are interesting for various stakeholders, especially for policymakers, managers, shareholders and employees who may not be aware of the importance of codetermination for firm efficiency, as well as for firms that are considering circumventing German legislation.

Probability-free models in option pricing: statistically indistinguishable dynamics and historical vs implied volatility
Damiano Brigo

We investigate whether it is possible to formulate option pricing and hedging models without using probability. We present a model that is consistent with two notions of volatility: a historical volatility consistent with statistical analysis, and an implied volatility consistent with options priced with the model. The latter will be also the quadratic variation of the model, a pathwise property. This first result, originally presented in Brigo and Mercurio (1998, 2000), is then connected with the recent work of Armstrong et al (2018), where using rough paths theory it is shown that implied volatility is associated with a purely pathwise lift of the stock dynamics involving no probability and no semimartingale theory in particular, leading to option models without probability. Finally, an intermediate result by Bender et al. (2008) is recalled. Using semimartingale theory, Bender et al. showed that one could obtain option prices based only on the semimartingale quadratic variation of the model, a pathwise property, and highlighted the difference between historical and implied volatility. All three works confirm the idea that while historical volatility is a statistical quantity, implied volatility is a pathwise one. This leads to a 20 years mini-anniversary of pathwise pricing through 1998, 2008 and 2018, which is rather fitting for a talk presented at the conference for the 45 years of the Black, Scholes and Merton option pricing paradigm.

Regulatory Soft Interventions in the Chinese Market: Compliance Effects and Impact on Option Market Efficiency
Hilliard, Jimmy E.,Zhang, Haoran
Securities Laws in China are administered by the China Securities Regulatory Commission (CSRC). The CSRC has great flexibility in administering securities laws since the committee represents the will of the state. Under the state‐controlled financial system, the CSRC works closely with state‐controlled financial firms and suggests, but does not mandate, actions to be taken in the equity market, especially during periods of extreme market stress. These suggestions, or soft interventions, have been used to block trades associated with short sales, significantly reducing short‐sales volume. With daily and intraday data, we investigate the impact of these interventions on put‐call parity and implied volatilities. There is overwhelming evidence of increased deviations from put‐call parity and changes in implied volatility after soft interventions. Our results are robust after allowing for bid‐ask spreads, taxes, transaction costs, and difference‐in‐differences comparisons with control securities in the Hong Kong market.

Science Quality and the Value of Inventions
Felix Poege,Dietmar Harhoff,Fabian Gaessler,Stefano Baruffaldi

Despite decades of research, the relationship between the quality of science and the value of inventions has remained unclear. We present the result of a large-scale matching exercise between 4.8 million patent families and 43 million publication records. We find a strong positive relationship between quality of scientific contributions referenced in patents and the value of the respective inventions. We rank patents by the quality of the science they are linked to. Strikingly, high-rank patents are twice as valuable as low-rank patents, which in turn are about as valuable as patents without direct science link. We show this core result for various science quality and patent value measures. The effect of science quality on patent value remains relevant even when science is linked indirectly through other patents. Our findings imply that what is considered "excellent" within the science sector also leads to outstanding outcomes in the technological or commercial realm.

Surprises of Corporate Governance and Russian Firms Debt
Teplova, Tamara,Sokolova, Tatiana
Our paper investigates the effects of corporate governance features on the cost of publicly traded debt in the Russian market after the global financial crisis. We consider a wide range of corporate governance mechanisms and focus our analysis on three elements relevant for emerging capital markets: state-owned bond issuers, auditor power (Big 4 or local firms) and CEO power. As control variables, we consider financial and non-financial indicators of bond issuers, including proxies of intellectual capital and transparency indicators, characteristics of bond issues, structure and size of the Board of Directors. We apply linear and multiplication regressions for unbalanced panel data.The original result is that, in the case of a sole executive body, bond spreads are higher. We find an inverse relation between the ex-post cost of public debt and audit power. The analysis also revealed a robust result that disclosing information on intangible assets and a larger Board of Directors reduce debtholder risks. According to our findings, debtholders take into account the risk of the influence of CEOs of large companies on local auditors, while for international auditors such influence is less possible. These results are robust to a large set of firm-specific and bond- specific characteristics.

Testing for Information Asymmetry in the Mortgage Servicing Market
Jedidi, Helmi,Dionne, Georges
Our main objective is to test for evidence of information asymmetry in the mortgage servicing market. Does the sale of mortgage servicing rights (MSR) by the initial lender to a second servicing institution unveil any residual asymmetric information? We analyze the originator’s selling choice of MSR using a large sample of U.S. mortgages that were privately securitized during the period of January 2000 to December 2013 (more than 5 million observations). Our econometric methodology is mainly non-parametric and the main test for the presence of information asymmetry is driven by kernel density estimation techniques (Su and Spindler, 2013). We also employ the non-parametric testing procedure of Chiappori and Salanié (2000). For robustness, we present parametric tests to corroborate our results after controlling for observable risk characteristics, for econometric misspecification error, and for endogeneity issues using instrumental variables. Our empirical results provide strong support for the presence of second-stage asymmetric information in the mortgage servicing market.

The Accounting-And-Finance of a Solar Photovoltaic Plant: Economic Efficiency of a Replacement Project
Magni, Carlo Alberto,Marchioni, Andrea
In this work we illustrate a simple logical framework serving the purpose of assessing the economic profitability and measuring value creation in a solar photovoltaic (PhV) project and, in general, in a replacement project where the cash-flow stream is nonnegative, with some strictly positive cash flows. We use the projected accounting data to compute the average ROI, building upon Magni (2011, 2019) (see also Magni and Marchioni 2018), which enables retrieving information on the role of the project’s economic efficiency and the role of the project scale on increasing shareholders’ wealth. The average ROI is a genuinely internal measure and does not suffer from the pitfalls of the internal rate of return (IRR), which may be particularly critical in replacement projects such as the purchase of a PhV plant aimed at replacing conventional retail supplies of electricity.

The Determinants of Capital Structure: Evidence from Russia
Ilyukhin, Evgeny
The study aims to identify the capital structure determinants of the listed Russian firms. The determinants are the factors that would affect firm financial leverage. The capital structures theories and their applications are considered in the article. The study is based on a sample of 48 publicly-traded non-financial firms over the period 2009-2015. The random-effects model is employed for estimations while the OLS approach is used to measure the industry impact on capital structure. It is found that the most significant capital structure determinants of Russian firms are industry mean leverage, firm size with positive effect and growth opportunities with negative one. Profitability, non-debt tax shields and the stock market conditions with negative impact are less important. Business risk, growth opportunity measured as capital expenditures to total assets, tangibility of assets, uniqueness of assets, average tax rate, industry group of Energy firms, lending and inflation rates are irrelevant determinants. Another finding is that the Oil & Gas and Metal firms tend to have lower debt level compared to the firms from other industries.

The Endogeneity of Trading Volume in Stock and Bond Returns: An Instrumental Variable Approach
Yamani, Ehab Abdel-Tawab,Rakowski, David A.
This paper investigates the joint determination of trading volume and returns. Our approach follows from the argument that trading activity depends on security returns, thus resulting in a reverse causality from returns to trading activity. Using exogenous instruments for security trading activity, we estimate a system of two‐stage simultaneous equations to better model the return‐volume relationship. Our results confirm that returns and trading volume are determined simultaneously in both stock and corporate bond markets and that conclusions about the direction and significance of causality between volume and returns can be reversed once one corrects for the endogeneity of volume.

The Impact of Privatization on Firm Performance in a Transition Economy
Loc, Truong Dong,Lanjouw, Ger,Lensink, Robert
The Vietnamese privatization programme, launched in 1992, differs from the usual Western privatization programmes in terms of the residual percentage of shares owned by the state and the portion of shares owned by insiders. This begs the question whether these differences influence the effects of the programme on firm performance. This study measures the impact of privatization on firm performance in Vietnam by comparing the pre‐ and post‐privatization financial and operating performance of 121 former state‐owned enterprises (SOEs). We find significant increases in profitability, sales revenues, efficiency and employee income. Results of applying the 'difference‐in‐difference' (DID) method, wherein a control group of firms is used to pick up the influence of other determinants of firm performance, suggest that the performance improvements may indeed be associated with equitization. Regression analyses reveal that firm size, residual state ownership, corporate governance and stock market listing are key determinants of performance improvements.

The Reaction of Russian Public Companies’ Stock Prices to Sanctions Against Russia
Naidenova, Julia,Novikova, Anastasia
The imposition of sanctions by foreign countries against Russia since 2014 and their prolongation for the following several years resulted in significant changes in Russian economics. In the first instance, economic sanctions were aimed towards the weakening of companies by banning exports and imports of certain goods, closeout or suspension of joint venture projects, as well as limiting the provision of financing. However, one can postulate that these sanctions influenced the companies to different extents. This research offers an analysis of the changes in share prices of Russian public companies of the MICEX index in response to sanctions against Russia in 2014â€"2016. The research methodology is based on the event study approach, which allows estimation of a short-term response of the shares’ prices to information release. The results of this paper confirm that imposition and prolongation of sanctions resulted in a significant fall in share prices. With an average daily return on shares of the Russian stock market companies of 0.1%, a fall in return of 0.17% points per day as a result of the imposition of sanctions by the USA is economically significant. Apart from that, the sanctions influenced financially dependent companies to a greater extent. Contrary to theoretical assumptions of a greater influence of sanctions imposed by the countries with which a more close economic cooperation had been established, it transpired that the imposition of sanctions by the USA resulted in the greatest fall in prices for shares. Also, an important result indicated in this paper is the fact that imposition of targeted sanctions against certain companies has not entailed a greater impact of the sanctions on such companies. This is indicative of the ineffectiveness of targeted sanctions imposed on Russia. The influence of the government share in ownership of companies and the differences of response of the shares’ prices depending on the company industry sector have not been confirmed.

Trends in Household Debt and Credit
Haughwout, Andrew,Lee, Donghoon,Scally, Joelle,Thomas, Lauren,van der Klaauw, Wilbert
Since the onset of the 2008 financial crisis, consumer financial and borrowing behavior, once considered a relatively quiet little corner of finance, has been of enormously increased interest to policymakers and researchers alike. Prior to the Great Recession, there was a historic run-up in household debt, driven primarily by housing debt, which coincided with a speculative bubble and sharp rises in home prices. Then, as prices began to fall, millions of households began defaulting on their mortgages, unable to keep up with home payments, and greatly contributing to the onset of the deepest recession since the 1930s. Following the steep increase in debt balances during the boom, households began rapidly paying off their loans during and immediately after the Great Recession. Since 2013, debt has begun to increase and eventually rise above its previous levels, albeit at a much slower rate than before, at least partially owing to stricter lending standards. We examine the trends in household debt before, during, and since the 2000s financial crisis and Great Recession. As we will show, this period is unique in American history in several ways. Our analysis will show the sources of the historic run-up in debt during the bubble period of the early 2000s, the change in borrowing behavior that took place as the financial crisis and Great Recession took hold, and the nature of the recovery that began in 2013. We find that while total household debt has recovered to its previous level in nominal terms, its composition and characteristics have changed dramatically along many dimensions.

Working Capital Optimization in Supply Chains
Zenkevich, Nikolay,Ivakina, Anastasiia
This article is devoted to working capital management and its optimization on an inter-organizational level when supply chain members operate collaboratively. We aim to develop and validate a model of collaborative approach to working capital management in supply chains for cases of constrained liquidity and imposed return requirements using supply chain finance (factoring, reverse factoring and inventory financing). As such, we suggest a tool of working capital optimization using financial terms and cash flows verified on Russian supply chain data. Mathematical modeling is suggested as a method to modify an existing working capital management model on the grounds of collaborative financial cost minimization under industry specific liquidity constraints. These liquidity constraints are constructed in such a way as to eliminate possible violations from companies, because their violation will lead to the inverse relation between liquidity and rate of return. The results of the optimization provide recommended values for cash conversion cycle elements â€" days of inventories, days of accounts payable, days of accounts receivable â€" that guarantee the coordinating effect of collaborative working capital management. Calculation, further optimization and monitoring of cash conversion cycle values sustain effective working capital management on an inter-organizational level while meeting the liquidity and return levels for each company in a chain. The suggested model can be implemented for a day-to-day decision making process by companies oriented to stay competitive in the long run. Besides, the results obtained show the potential for further coordination among the key members of the supply chain in terms of aligning financial, product, and information flows. Despite the fact that the model provides a static solution to the problem of collaborative working capital management, it has potential for the further development of a dynamic algorithm. Future research should seek to investigate the possible imputation options for gained costs reduction values on the grounds of cooperative games with a coalition structure.