Research articles for the 2019-05-03
A Closer Look at Lottery-Related Anomalies: A Fundamental Analysis Approach
SSRN
This paper documents that firm fundamentals play a significant role in explaining lottery-related anomalies. Using three different measures of lottery features, we document that lottery-related anomalies are stronger among stocks with weak fundamentals because lottery-like stocks with weak (strong) fundamentals are (not) lottery stocks. Lottery measures with inconsistent (consistent) fundamentals do (not) predict lower future returns. The significant role of firm fundamentals in lottery-related anomalies is robust after controlling for some related variables, the arrival of public fundamental information, and the market conditions. The lottery measures of lottery stocks may be driven by nonfundamental shocks and investors overreact to these shocks.
SSRN
This paper documents that firm fundamentals play a significant role in explaining lottery-related anomalies. Using three different measures of lottery features, we document that lottery-related anomalies are stronger among stocks with weak fundamentals because lottery-like stocks with weak (strong) fundamentals are (not) lottery stocks. Lottery measures with inconsistent (consistent) fundamentals do (not) predict lower future returns. The significant role of firm fundamentals in lottery-related anomalies is robust after controlling for some related variables, the arrival of public fundamental information, and the market conditions. The lottery measures of lottery stocks may be driven by nonfundamental shocks and investors overreact to these shocks.
Adverse Consequences of the Binding Constitutional Interest Rate Cap in the State of Arkansas
SSRN
In the United States, the lowest interest rate cap on small-dollar installment loansâ€"17 percentâ€"is in Arkansas. No small-dollar installment lenders operate within Arkansas, while they do in all six states bordering Arkansasâ€"providing a natural experiment to examine the effects of a binding interest rate cap. Arkansas residents obtain installment loans from lenders in other states. Arkansas residents in the perimeter counties hold 96.8 percent of these loans. We document an installment loan “credit desert†in the interior counties of Arkansas. Overall, Arkansas residents borrow $1,051, on average, and freely contract at an average annual percentage rate (APR) of 80 percent. Incorporating estimated travel costs, the average APR is 93 percent.
SSRN
In the United States, the lowest interest rate cap on small-dollar installment loansâ€"17 percentâ€"is in Arkansas. No small-dollar installment lenders operate within Arkansas, while they do in all six states bordering Arkansasâ€"providing a natural experiment to examine the effects of a binding interest rate cap. Arkansas residents obtain installment loans from lenders in other states. Arkansas residents in the perimeter counties hold 96.8 percent of these loans. We document an installment loan “credit desert†in the interior counties of Arkansas. Overall, Arkansas residents borrow $1,051, on average, and freely contract at an average annual percentage rate (APR) of 80 percent. Incorporating estimated travel costs, the average APR is 93 percent.
Averting the Multiemployer Pension Solvency Crisis
SSRN
The Pension Benefit Guaranty Corporation (PBGC) multiemployer pension insurance program faces projected insolvency, driven by systemic underfunding of multiemployer pension plans. To address this brewing crisis, Congress has established a joint select committee to develop multiemployer pension reforms. Primary causes of the crisis include lax funding rules and inaccurate valuations of pension assets and liabilities. Explanations frequently offered for underfunding, such as financial market downturns and the declining proportion of active workers, fail to account for the relative weakness of multiemployer pension finances. Reforms should establish accurate asset and liability measurements, safeguards against further deterioration of underfunded plans, improved incentives for plan trustees, stronger funding requirements, and risk-based premiums. Legislators may wish to consider authorizing the PBGC to relieve plans of so-called orphan liabilities, subject to strict requirements that any relief must reduce projected claims on pension insurance. Lawmakers must be firm in declaring that no taxpayer funds will be used to bail out multiemployer pensions.
SSRN
The Pension Benefit Guaranty Corporation (PBGC) multiemployer pension insurance program faces projected insolvency, driven by systemic underfunding of multiemployer pension plans. To address this brewing crisis, Congress has established a joint select committee to develop multiemployer pension reforms. Primary causes of the crisis include lax funding rules and inaccurate valuations of pension assets and liabilities. Explanations frequently offered for underfunding, such as financial market downturns and the declining proportion of active workers, fail to account for the relative weakness of multiemployer pension finances. Reforms should establish accurate asset and liability measurements, safeguards against further deterioration of underfunded plans, improved incentives for plan trustees, stronger funding requirements, and risk-based premiums. Legislators may wish to consider authorizing the PBGC to relieve plans of so-called orphan liabilities, subject to strict requirements that any relief must reduce projected claims on pension insurance. Lawmakers must be firm in declaring that no taxpayer funds will be used to bail out multiemployer pensions.
Avoiding Taxes to Fix the Tax Code
SSRN
Most corporate tax codes distort capital investment decisions because the deductibility of the cost of capital investment is limited. We examine whether this tax code friction leads firms to avoid taxes to mitigate this capital investment distortion. Exploiting increases in capital deepening incentives stemming from stricter employment protection, we find that firms avoid more taxes and their capital deepening response increases with tax avoidance opportunities, both especially when the deductibility of the cost of capital investment is limited. These findings suggest that tax avoidance helps firms reap investment opportunities that they would otherwise have forgone because of tax code frictions.
SSRN
Most corporate tax codes distort capital investment decisions because the deductibility of the cost of capital investment is limited. We examine whether this tax code friction leads firms to avoid taxes to mitigate this capital investment distortion. Exploiting increases in capital deepening incentives stemming from stricter employment protection, we find that firms avoid more taxes and their capital deepening response increases with tax avoidance opportunities, both especially when the deductibility of the cost of capital investment is limited. These findings suggest that tax avoidance helps firms reap investment opportunities that they would otherwise have forgone because of tax code frictions.
Can Microblogging Information Disclosure Reduce Stock Price Synchronicity? Evidence From China
SSRN
We study the relationship between stock price synchronicity and information disclosure of firms listed in the Chinese stock market, using hand-collected data on firms’ official microblogging content in Sina Weibo, a popular microblogging service in China. We find that after controlling for the impact of traditional media, the number of Weibo tweets is related negatively to stock price synchronicity, indicating that stock prices incorporate firm-specific information disclosed in the firm’s official Weibo. Number of microblogging fans can strengthen this negative relationship. Our result is robust to alternative measures of stock price synchronicity, microblogging information disclosure, and to endogeneity issues.
SSRN
We study the relationship between stock price synchronicity and information disclosure of firms listed in the Chinese stock market, using hand-collected data on firms’ official microblogging content in Sina Weibo, a popular microblogging service in China. We find that after controlling for the impact of traditional media, the number of Weibo tweets is related negatively to stock price synchronicity, indicating that stock prices incorporate firm-specific information disclosed in the firm’s official Weibo. Number of microblogging fans can strengthen this negative relationship. Our result is robust to alternative measures of stock price synchronicity, microblogging information disclosure, and to endogeneity issues.
Clawback Provisions and Firm Risk
SSRN
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.
SSRN
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.
Collusion Risk and Responsibility in Public Cryptocurrency Protocol Development
SSRN
Cryptocurrencies are based on cryptography-based asset disposals broadcasted peer-to-peer to be validated in a decentralized way according to consented protocols. The cryptocurrency protocols offer the participants various mechanisms for decentralized validation protecting the integrity of the transactions without trusted third parties. Public cryptocurrencies are also decentralized when it comes to protocol development. However, fewer formal decentralized mechanisms are offered when it comes to protecting the integrity of such development. Protocol development is associated with risks, and there are conflicts of interests. Collusion may exacerbate such risks. This paper explores collusion risks and associated responsibilities. Responsibility gives some, but not sufficient, protection against such risks. Additional policies to mitigate risks are discussed.
SSRN
Cryptocurrencies are based on cryptography-based asset disposals broadcasted peer-to-peer to be validated in a decentralized way according to consented protocols. The cryptocurrency protocols offer the participants various mechanisms for decentralized validation protecting the integrity of the transactions without trusted third parties. Public cryptocurrencies are also decentralized when it comes to protocol development. However, fewer formal decentralized mechanisms are offered when it comes to protecting the integrity of such development. Protocol development is associated with risks, and there are conflicts of interests. Collusion may exacerbate such risks. This paper explores collusion risks and associated responsibilities. Responsibility gives some, but not sufficient, protection against such risks. Additional policies to mitigate risks are discussed.
Decomposing changes in the functioning of the sterling repo market
RePEC
We identify the degree to which changes in gilt repo market functioning have been driven by changes in the supply of — and the demand for — market intermediation. To do so, we use a structural vector auto regression (SVAR) model with sign and zero restrictions. We find that changes in gilt repo market functioning over the past five years have been driven largely by changes in the supply of repo market intermediation by dealers, rather than by changes in the demand of end-users. Following the introduction of the UK leverage ratio, our model suggests that an increase in demand for repo by end-users results in a larger increase in the cost of repo transactions and a smaller increase in their volume. This effect is stronger in the case of transactions that are not nettable via central counterparties. These findings are consistent with the notion that the leverage ratio may reduce dealers' ability and/or willingness to act as repo market intermediaries. This may have implications for the resilience of repo markets in future periods of stress.
RePEC
We identify the degree to which changes in gilt repo market functioning have been driven by changes in the supply of — and the demand for — market intermediation. To do so, we use a structural vector auto regression (SVAR) model with sign and zero restrictions. We find that changes in gilt repo market functioning over the past five years have been driven largely by changes in the supply of repo market intermediation by dealers, rather than by changes in the demand of end-users. Following the introduction of the UK leverage ratio, our model suggests that an increase in demand for repo by end-users results in a larger increase in the cost of repo transactions and a smaller increase in their volume. This effect is stronger in the case of transactions that are not nettable via central counterparties. These findings are consistent with the notion that the leverage ratio may reduce dealers' ability and/or willingness to act as repo market intermediaries. This may have implications for the resilience of repo markets in future periods of stress.
Financial Leverage and Competitive Strategy of Cross-Listing Firms
SSRN
This study investigates the relationship between financial leverage and competitive strategies based on the investigation into the cross-listing announcements, through which the financial condition of a firm might shape the competition outcome. The empirical evidence shows that cross-listing announcements normally attract positive market responses to cross-listed firms but incur negative market responses to rival firms, especially upon the strategic substitutes competition. Cross-listed firms obtain more positive market responses if their financial leverage is lower, but the firms have no advantages when they are financially constrained. Less leveraged rival firms could weaken the negative impact and even gain positive market responses upon the strategic complements competition.
SSRN
This study investigates the relationship between financial leverage and competitive strategies based on the investigation into the cross-listing announcements, through which the financial condition of a firm might shape the competition outcome. The empirical evidence shows that cross-listing announcements normally attract positive market responses to cross-listed firms but incur negative market responses to rival firms, especially upon the strategic substitutes competition. Cross-listed firms obtain more positive market responses if their financial leverage is lower, but the firms have no advantages when they are financially constrained. Less leveraged rival firms could weaken the negative impact and even gain positive market responses upon the strategic complements competition.
Financial Structure and Economic Growth Nexus Revisited
SSRN
This paper empirically reassesses the long-debated relationship between financial structure and economic growth. Specifically, we examine whether the effect of financial structure on economic growth is affected by the financial structure disproportion, banking crisis, economic volatility, and level of financial development. We employ the generalized method of moments estimation to a large panel of 100 countries over the 1971-2015 period. Although the main result supports market-based view, the positive effect of stock market development relative to banking system decreases significantly if financial structure is unbalanced. Our findings are robust to a variety of sensitivity check, including different measures of financial structure, periods, and model specifications.
SSRN
This paper empirically reassesses the long-debated relationship between financial structure and economic growth. Specifically, we examine whether the effect of financial structure on economic growth is affected by the financial structure disproportion, banking crisis, economic volatility, and level of financial development. We employ the generalized method of moments estimation to a large panel of 100 countries over the 1971-2015 period. Although the main result supports market-based view, the positive effect of stock market development relative to banking system decreases significantly if financial structure is unbalanced. Our findings are robust to a variety of sensitivity check, including different measures of financial structure, periods, and model specifications.
Matching Methods in Valuation with Finite Cash Flows: An Almost Perfect Textbook Example
SSRN
In this note, we extend a numerical example in the textbook by Berk & DeMarzo that matches methods for only when KTS is equal to KD. We show that there is a generalized formulation for the return to levered equity KE that works for any value of KTS, the appropriate discount rate for the tax shield. We debunk the view that the CFE (Cash Flow to Equity) method is “apparently simple but practically confusing and useless.†Due diligence in professional valuation demands that we practice triangulation as Standard Operating Procedure (SOP). This formula is irrelevant for anyone who believes in the Pablo Fernandez (PF) approach to valuation because the concept of a “discount rate for the tax shield†is obviously nonsensical and almost surely absurd.
SSRN
In this note, we extend a numerical example in the textbook by Berk & DeMarzo that matches methods for only when KTS is equal to KD. We show that there is a generalized formulation for the return to levered equity KE that works for any value of KTS, the appropriate discount rate for the tax shield. We debunk the view that the CFE (Cash Flow to Equity) method is “apparently simple but practically confusing and useless.†Due diligence in professional valuation demands that we practice triangulation as Standard Operating Procedure (SOP). This formula is irrelevant for anyone who believes in the Pablo Fernandez (PF) approach to valuation because the concept of a “discount rate for the tax shield†is obviously nonsensical and almost surely absurd.
Negative Rates, Bank Lending and Fees & Commissions: Evidence From France
SSRN
What is the impact of negative monetary policy rates on the banking system and the wider economy? This research aims to measure how the European Central Bank’s introduction of negative nominal interest rates on commercial bank's reserves impacted on credit supply and asset allocation. Using confidential monthly data on French banks owned by the Banque de France I find that after the introduction of negative interest rates banks presumably most exposed to negative rates â€" those most dependent on retail deposit funding â€" tend to supply more corporate loans at all maturities, purchase more corporate bonds and report higher net fees & commissions income. These results suggest that negative rates policies are effective in stimulating the real economy through the bank lending channel when normal interest rates reach the zero lower bound, although this comes at the price of greater bank risk taking and steeper fees charged to banks’ customers.
SSRN
What is the impact of negative monetary policy rates on the banking system and the wider economy? This research aims to measure how the European Central Bank’s introduction of negative nominal interest rates on commercial bank's reserves impacted on credit supply and asset allocation. Using confidential monthly data on French banks owned by the Banque de France I find that after the introduction of negative interest rates banks presumably most exposed to negative rates â€" those most dependent on retail deposit funding â€" tend to supply more corporate loans at all maturities, purchase more corporate bonds and report higher net fees & commissions income. These results suggest that negative rates policies are effective in stimulating the real economy through the bank lending channel when normal interest rates reach the zero lower bound, although this comes at the price of greater bank risk taking and steeper fees charged to banks’ customers.
Official demand for US debt: implications for US real rates
RePEC
We estimate a structural term-structure model of US real rates, where arbitrageurs accommodate demand pressures exerted by domestic and foreign official investors. Official demand affects rates by altering the aggregate price of duration risk, and thereby bond risk premiums. While foreign central banks' demand contributed to reduce long-term real rates mainly in the years prior to the global-financial crisis, the Federal Reserve's demand lowered rates during the QE period. Overall, the two-factor model, augmented to account for changing liquidity conditions, offers a good representation of real rates during the 2001–2016 period; however, we flag some caveats and possible extensions.
RePEC
We estimate a structural term-structure model of US real rates, where arbitrageurs accommodate demand pressures exerted by domestic and foreign official investors. Official demand affects rates by altering the aggregate price of duration risk, and thereby bond risk premiums. While foreign central banks' demand contributed to reduce long-term real rates mainly in the years prior to the global-financial crisis, the Federal Reserve's demand lowered rates during the QE period. Overall, the two-factor model, augmented to account for changing liquidity conditions, offers a good representation of real rates during the 2001–2016 period; however, we flag some caveats and possible extensions.
Problems and Prospects for the Development of the Equity Market: In the Association of Georgia with the EU
SSRN
The article reviews current trends in the Georgian equity market and identifies the relationship between legislative infrastructural and institutional changes and the results realized during the period of validity. The purpose of the article is to analyze the functioning of the Georgian equity market and develop recommendations, as well as to generalize the previous period of experience and identify the impeding factors of the securities market development.
SSRN
The article reviews current trends in the Georgian equity market and identifies the relationship between legislative infrastructural and institutional changes and the results realized during the period of validity. The purpose of the article is to analyze the functioning of the Georgian equity market and develop recommendations, as well as to generalize the previous period of experience and identify the impeding factors of the securities market development.
Tax Risk and Asset Prices: Evidence from Dual-class Corporate Bonds in the Early 20th Century
SSRN
This paper exploits a natural experiment from the late 1800s in which many U.S. firms had inadvertently issued both taxable and tax-exempt bonds. Investors paid income tax on taxable bonds, but firms covered income tax on investors' behalf on tax-exempt bonds. Using a unique data-set of these `dual-class' corporate bonds, we derive a novel, market-based measure for tax risk, examine its time-series properties, and investigate if tax risk is priced in asset returns. We find that tax risk is pro-cyclical, is priced in the cross-section of asset returns, and commands a statistically and economically significant positive risk premium.
SSRN
This paper exploits a natural experiment from the late 1800s in which many U.S. firms had inadvertently issued both taxable and tax-exempt bonds. Investors paid income tax on taxable bonds, but firms covered income tax on investors' behalf on tax-exempt bonds. Using a unique data-set of these `dual-class' corporate bonds, we derive a novel, market-based measure for tax risk, examine its time-series properties, and investigate if tax risk is priced in asset returns. We find that tax risk is pro-cyclical, is priced in the cross-section of asset returns, and commands a statistically and economically significant positive risk premium.
The Mobile Phone, Information Sharing and Financial Sector Development in Africa: A Quantile Regressions Approach
SSRN
This study investigates linkages between the mobile phone, information sharing offices (ISO) and financial sector development in 53 African countries for the period 2004-2011. ISO are private credit bureaus and public credit registries. The empirical evidence is based on contemporary and non-contemporary quantile regressions. Two main hypotheses are tested: mobile phones complement ISO to enhance the formal financial sector (Hypothesis 1) and mobile phones complement ISO to reduce the informal financial sector (Hypothesis 2). The hypotheses are largely confirmed. This research adds to the existing body of literature by engaging hitherto unexplored dimensions of financial sector development and investigating the role of mobile phones in information sharing for financial sector development.
SSRN
This study investigates linkages between the mobile phone, information sharing offices (ISO) and financial sector development in 53 African countries for the period 2004-2011. ISO are private credit bureaus and public credit registries. The empirical evidence is based on contemporary and non-contemporary quantile regressions. Two main hypotheses are tested: mobile phones complement ISO to enhance the formal financial sector (Hypothesis 1) and mobile phones complement ISO to reduce the informal financial sector (Hypothesis 2). The hypotheses are largely confirmed. This research adds to the existing body of literature by engaging hitherto unexplored dimensions of financial sector development and investigating the role of mobile phones in information sharing for financial sector development.
When Is the Client King? Evidence from Affiliated-Analyst Recommendations in China’s Split-Share Reform
SSRN
China’s split-share reform of 2005 (the Reform) converts the previously restricted shares held by founding shareholders to shares tradable on the open market. Against this backdrop, we study how underwriter-affiliated analysts and firms’ large shareholders interact in the event of the latter’s sales of restricted shares. We document that recommendations made by affiliated analysts are significantly more optimistic when firms’ large shareholders plan to sell their restricted shares. This optimism, however, is associated with negative post-sale stock returns, suggesting that large shareholders profit from share sales but at the cost of public investors. Furthermore, large shareholders sell more restricted shares through the affiliated brokerages with analysts issuing more optimistic recommendations and firms under their control are more likely to appoint such brokerages as lead underwriters when they refinance in the future. For the affiliated analysts, they conduct more site visits to the firms after the share sales, thereby improving their earnings forecast accuracy. Our analysis shows how conflicts of interest by financial intermediaries arise following the Reform and leads to large shareholders’ extraction of rents from public investors. These findings have regulatory implications.
SSRN
China’s split-share reform of 2005 (the Reform) converts the previously restricted shares held by founding shareholders to shares tradable on the open market. Against this backdrop, we study how underwriter-affiliated analysts and firms’ large shareholders interact in the event of the latter’s sales of restricted shares. We document that recommendations made by affiliated analysts are significantly more optimistic when firms’ large shareholders plan to sell their restricted shares. This optimism, however, is associated with negative post-sale stock returns, suggesting that large shareholders profit from share sales but at the cost of public investors. Furthermore, large shareholders sell more restricted shares through the affiliated brokerages with analysts issuing more optimistic recommendations and firms under their control are more likely to appoint such brokerages as lead underwriters when they refinance in the future. For the affiliated analysts, they conduct more site visits to the firms after the share sales, thereby improving their earnings forecast accuracy. Our analysis shows how conflicts of interest by financial intermediaries arise following the Reform and leads to large shareholders’ extraction of rents from public investors. These findings have regulatory implications.
Why Are CEOs of Public Firms Paid More Than CEOs of Private Firms? Evidence from the Effect of Board Reforms on CEO Compensation
SSRN
CEOs of public firms earn more than their counterparts in similar private firms. This can either be because rent extraction is easier in public firms than in private firms or because managing a public firm requires additional legal and institutional responsibilities than does managing an otherwise similar private firm. Using corporate board reform events from 29 countries, we find that board reforms toward greater board diligence for public firms increases CEO pay significantly more for public firms than for private firms, which are not subject to those reforms. Following board reforms, CEO pay increases more for public firms that are subject to higher scrutiny, such as larger firms and firms that are followed by more analysts and institutional investors. These results are consistent with the efficient contracting view of CEO compensation but inconsistent with the rent extraction view.
SSRN
CEOs of public firms earn more than their counterparts in similar private firms. This can either be because rent extraction is easier in public firms than in private firms or because managing a public firm requires additional legal and institutional responsibilities than does managing an otherwise similar private firm. Using corporate board reform events from 29 countries, we find that board reforms toward greater board diligence for public firms increases CEO pay significantly more for public firms than for private firms, which are not subject to those reforms. Following board reforms, CEO pay increases more for public firms that are subject to higher scrutiny, such as larger firms and firms that are followed by more analysts and institutional investors. These results are consistent with the efficient contracting view of CEO compensation but inconsistent with the rent extraction view.
