Research articles for the 2019-09-06

A Model of Stock Market-Based Rulemaking
Lee, Yoon-Ho Alex
We consider the extent to which a government regulator can harness information about its proposed regulation from stock-price movements of affected firms â€" information the regulator may in turn use to deliberate whether to move forward with the regulation. We find that if the proposed rule’s ex ante value is positive and the regulator relies on the market completely, then as the number of firms increases, stock prices will exhibit maximal informativeness. When the rule’s ex ante value is negative, however, the regulator’s reliance on the market will dampen speculators’ incentive to gather information, and stock prices become uninformative. This latter effect, however, can be mitigated if the regulator’s reliance is only partial. In extensions, we consider the presence of a stakeholder who may be motivated to manipulate the market and steer the regulator to a privately beneficial outcome. We find that, as the number of firms increases, the stakeholders’ incentives to manipulate the market will dissipate and they will find it beneficial to trade in a manner consistent with speculators. The theoretical findings of this paper suggest potential benefits for the regulator to engage in stock market-based rulemaking in the absence of other forms of reliable empirical evidence.

Anti-Pledging Policy, CEO Compensation, and Investment
Bae, Jihun,Zhang, Ruishen
We study the implications of a recent governance practice promoted by proxy advisors, namely an anti-pledging policy, which limits managers' ability to unwind their equity-based compensation. Using a sample of S&P 1500 firms, we find that CEOs' pay-for-performance sensitivity (i.e., delta) and risk-taking incentives (i.e., vega) as well as firms' investment growth and investment-Q sensitivity decrease after the adoption of an anti-pledging policy. Meanwhile, adoption mitigates opposition from proxy advisors. Taken together, our findings suggest that limiting compensation flexibility to cater to proxy advisors may produce unfavorable outcomes for firms, which calls into question a one-size-fits-all approach to governance policies.

Bagehot's Giant Bubble Failure
Odlyzko, Andrew
Walter Bagehot is remembered today primarily as a proponent of the doctrine of lender of last resort, in which central banks pump money into the economy to ameliorate the damage from a financial crisis. But none of the growing number of publications about him appear to investigate in depth whether, as the editor of "The Economist," he warned his readers about the bubble that collapsed in the famous Overend crash of 1866. This paper shows that while Bagehot did express serious misgivings about that bubble in its early stages, he did not understand just how large it was, and he did not succeed in penetrating the depths of "financial engineering" that concealed the ugly reality that led to the crisis. Since none of the other prominent observers of the time appear to have done better, this may not have been a giant failure, but it was a failure to identify a giant bubble. It suggests we should not expect regulators to be able to detect bubbles in the future.

Bank Credit and Trade Credit: Evidence from Natural Experiments
Chen, Shenglan,Ma, Hui,Wu, Qiang
Prior studies find mixed evidence about the substitution relation between bank credit and trade credit. In this paper, using two bank interest rate deregulations in China, we revisit the substitution hypothesis by examining how exogenous increases in the availability of bank credit affect trade credit. We find that firms with higher credit risk increased their use of bank credit and reduced their use of trade credit after the 2004 bank interest rate ceiling deregulation, whereas firms with lower credit risk increased their use of bank credit and reduced their use of trade credit after the 2013 bank interest rate floor deregulation. Our results provide supportive evidence for the substitution hypothesis that firms reduce their use of trade credit after the relaxation of bank credit and suggest that bank credit is more favorable short-term financing than trade credit.

Contagion and Return Predictability in Asset Markets: An Experiment With Two Lucas Trees
Popescu, Andreea Victoria,, Charles Noussair
Using a laboratory experiment, we investigate whether contagion can emerge between two risky assets despite an absence of correlation in their fundamentals. To guide our experimental design, we use the ‘Two trees’ asset pricing model developed by Cochrane, Longstaff and Santa-Clara (2007). We draw on the model to make predictions regarding changes in the time-series and cross-section of returns in response to fundamental value shocks. We observe positive autocorrelation in the shocked asset, and a positive contemporaneous correlation between assets, as the model predicts. The dividend-price ratio forecasts the returns of risky assets, both in the time series and in the cross-section. There is more support for the model’s predictions in markets in which traders have greater cognitive ability.

Dionysius Lardner, the Denigrated Sage of Early Railways
Odlyzko, Andrew
Dionysius Lardner has a very poor reputation in the railway history literature. In most other fields he also tends to be remembered either for a few of his occasionally spectacular mistakes or at most as a minor science and technology popularizer. He has not received proper credit for his striking 1846 survey of the railway industry, "Railways at home and abroad." Published at the peak of the Railway Mania, it provided an excellent overview of that rapidly developing industry. Further, although in an inconspicuous way, it punctured several important misconceptions that motivated investors. Had proper heed been paid to Lardner's warnings, much of the investment disaster of the Mania could have been averted. This episode of financial exuberance can be shown to have been doomed to fail, and among contemporary observers Lardner provided the most convincing and comprehensive arguments to demonstrate this. However, little attention was paid to his warnings. This episode provides another illustration of the difficulty in persuading the public as well as policy makers that a dangerous bubble is in progress and bound to fail.

Do Institutional Investors Manage Factor Exposures Strategically?
Broeders, Dirk,Jansen, Kristy A.E.
Do institutional investors manage factor exposures at the asset class level strategically? This is a key asset and risk management question because factor exposures significantly contribute to return and risk. We answer the question by an empirical assessment of (un)conditional factor exposures of large institutional investors using proprietary data on occupational pension plans. The answer depends on the asset class. Based on two key findings we claim that pension funds manage equity factor exposures strategically. First, value, momentum, carry, and low beta factors contribute significantly to cross-sectional heterogeneity in unconditional equity returns. Second, time variation in conditional factor exposures for equities is limited. By contrast, support for strategic decision-making in fixed income factor exposures cannot be found. Market exposures drive the heterogeneity in unconditional fixed income returns, and the time variation in conditional factor exposures is much larger than strategic decision-making suggests. The average fixed income factor exposures can get as low as -0.6 and as high as 0.8. We also find that exogenous events and pension fund characteristics influence factor exposures through regulations. A high funding ratio and a high fraction of retirees to total participants lowers market exposures and increases exposures to credit risk, carry, and low beta. Furthermore, size does not influence factor exposures while delegated asset managers do.

Do Non-Intermediation Services Tell Us More in the Financeâ€"Growth Nexus?: Causality Evidence from Eight OECD Countries
Cheng, Su-Yin,Hou, Han
This paper provides new evidence on a traditional financeâ€"growth nexus through dividing financial services into financial intermediation and non-intermediation services and examining their relationships with economic growth. Applying time-series cointegration techniques and Granger causality tests for eight Organization for Economic Cooperation and Development (OECD) countries, reveals several results. First, there is a long-run equilibrium relationship among economic growth, intermediation activities, and non-intermediation activities in Austria, France, and Korea. Second, non-intermediation services impede long-run economic growth in Austria and France, whereas non-intermediation business and financial intermediation services accelerate Korea’s long-term growth. Third, weak exogeneity tests support long-run bi-directional causality and the supply-leading hypothesis in terms of the relationship between financial services and economic growth. Finally, the influences of intermediation and non-intermediation activities on economic growth vary across countries, financial services, and time periods, indicating that countries should adopt different financial services to enhance long- or short-term economic growth. This paper emphasizes the importance of non-intermediation activities in the growth process and in the development of intermediation services.

Downsides of Corporate Political Connections: Evidence from Mass Shootings
Zhang, Song
This paper studies the negative impacts of corporate political connections on firm outcomes. Employing 20 years of mass shootings, I find that when mass shootings take place, companies which primarily support gun-rights politicians experience negative stock price reactions and worse operating performance. Depending on the number of fatalities in a mass shooting, one-week Cumulative Abnormal Returns (CARs) are about 1% to 2.5% lower for these firms. Operating performance of these firms also shows a substantial decline after mass shootings. The decline lasts for at least one year. After mass shootings, firms significantly reduce corporate political donations to gun-rights politicians. Further tests suggest that damages to corporate reputations rather than loss of corporate political connections to gun-rights politicians explain negative stock price reactions and worse operating performance of these firms in response to mass shootings.

Dynamic Portfolio Choice with Annuities When the Interest Rate Is Stochastic
Dillschneider, Yannick,Maurer, Raimond,Schober, Peter
This paper studies the optimal life cycle consumption and portfolio choice problem taking into account annuity risk due to stochastic interest rates. When the purchase of annuities is restricted to the retirement date, the annuitant is exposed to the risk of meeting low interest rates at the purchase date. This annuity risk can be diversified by spreading annuity purchases over the whole pre-retirement period. The numerical results of our life cycle model show that such temporal diversification enhances welfare for retirees up to 9% of certainty equivalent consumption and that welfare gains increase with higher interest rate risk.

Financial Instability, Institutional Development and Economic Crisis in Eastern Europe
Grytten, Ola Honningdal,Koilo, Viktoriia
This paper sheds light on the financial crisis of 2008â€"2010 in eleven emerging Eastern European economies (EE11): Armenia, Azerbaijan, Belarus, Bulgaria, Georgia, Kazakhstan, the Kyrgyz Republic, Moldova, Romania, Tajikistan and Ukraine. The aim is twofold. In the first place it seeks to find out if the financial instability hypothesis, as put forward by Minsky and Kindleberger, is a valid explanatory factor for the crisis. Secondly, it tries to map if general institutional frameworks of these countries were developed in order to stand against the factors leading into the financial crisis.To answer these research problems the paper maps cycles of three parameters representing the real economy, i.e. gross domestic product, manufacturing output and unemployment and four parameters representing the financial markets, i.e. money supply, credit volumes, inflation and government debt. The cycle approach is carried out with the help of a structural time series analysis to isolate cycles in time series. The paper concludes that there were substantial positive financial cycles previous to the financial crisis mirrored by similar cycles in the real economy.Similarly, the results show negative cycles in the same parameters during the years of crisis. It seems that an uncontrolled increase in money and credit caused the economy to overheat and thereafter contract into financial and real economy crises.Also, the paper compiles twelve different indices of institutional development. These are standardized and presented in an institutional development matrix, showing that the general institutional framework for the eleven economies was weak previous to and under the meltdown of the economies.The construction of an integrated institutional development index on the basis of the same twelve parameters confirms institutional shortcomings, which may have made the economies less able to guard themselves from a crisis initiated by both domestically and internationally financial instability.

Financial Reporting Quality and Dual-Holding of Debt and Equity
Peyravan, Leila
I investigate whether the financial reporting quality (FRQ) of a firm influences the propensity of institutional investors to simultaneously hold the firm’s debt and equity (i.e., dual-holders). I predict that the underlying reason for institutional dual-holding in firms with low FRQ is access to better information that is available only to lenders. Accordingly, I find that dual-holders are more likely to participate in firms with low FRQ. I predict that dual-holders trade on the additional information received from the borrower. Consistent with this prediction, I find that dual-holders achieve excess returns of 8% on their trades in the borrower’s equity, and the direction of their trades predicts the direction of borrowers’ news on earnings announcement day. Finally, I demonstrate that dual-holders’ trades generate excess returns only in firms with low FRQ, suggesting that investors become dual-holders in firms with low FRQ because informed trades in such firms offer higher returns.

Foreign Bank Entry and Stock Price Crash Risk: Insights from Staggered Regulatory Changes
Lin, Tse-Chun,Liu, Jinyu,Ni, Xiaoran
Exploring staggered quasi-exogenous regulatory changes in China, we find that banking sector FDI significantly reduces likelihood of stock price crashes of domestic listed firms. The effect is more pronounced among firms with ex-ante lower information quality and worse performances, which is supportive of a monitoring spillover effect of foreign bank penetration on the domestic firms. Moreover, we find evidence of reduced overall financing costs and extended loan maturity after foreign bank entry. Our findings highlight an unexplored role of the banking sector marketization in terms of curtailing tail risks and improving the stability of stock market.

Información Crediticia Para La Formulación De Política Pública: El Caso Del Banco Agrario Y La Sustitución De Cultivos De Uso Ilícito (Using Credit Information to Guide Public Policy: Alternative Development and the Banco Agrario De Colombia)
de Roux, Nicolás,Gafaro, Margarita,Mahecha, Moises,Otero, Guillermo,Parejo, Andrea
Spanish Abstract: La política de sustitución de cultivos de uso ilícito pasa por escoger, para un lugar determinado, unos pocos cultivos como alternativas de sustitución. Esta elección debe hacerse con indicadores de rentabilidad que generalmente no están disponibles por la falta de información. Este artículo propone utilizar información de las bases de datos del Banco Agrario de Colombia para guiar esta decisión. En particular, mostramos cómo se puede usar la información de morosidad de cartera y de colocaciones del banco para construir indicadores de rentabilidad de los cultivos en municipios con cultivos de coca. Estos indicadores se correlacionan positivamente con medidas de ingreso por hectárea a nivel de cultivo-municipio construidas con el Censo Nacional Agropecuario y las Evaluaciones Agropecuarias Municipales. Por último, presentamos para cada municipio los dos cultivos con el mejor desempeño según estos indicadores. Estos cultivos podrían ser alternativas viables de sustitución.English Abstract: Alternative development policies often require the choice of a set of crops to promote as alternatives to coca plantations in a given location. This choice should be based on profitability indicators that are usually not available due to a lack of information. In this article, we show how the administrative records of the Banco Agrario de Colombia can be used to guide this decision. In particular, we use data on loan default and loan disbursements to construct indicators of the profitability of different crops in municipalities with coca plantations. We show that these indicators are correlated with measures of income per hectare at the municipality-crop level that we obtained from the Censo Nacional Agropecuario and the Evaluaciones Municipales Agropecuarias. Finally, we present the two crops with the best performance in each municipality according to our indicators. These crops are possible substitutes for coca plantations.

Predicting Consumer Default: A Deep Learning Approach
Albanesi, Stefania,Vamossy, Domonkos
We develop a model to predict consumer default based on deep learning. We show that the model consistently outperforms standard credit scoring models, even though it uses the same data. Our model is interpretable and is able to provide a score to a larger class of borrowers relative to standard credit scoring models while accurately tracking variations in systemic risk. We argue that these properties can provide valuable insights for the design of policies targeted at reducing consumer default and alleviating its burden on borrowers and lenders, as well as macroprudential regulation.

Short-Term Investments and Indices of Risk
Heller, Yuval,Schreiber, Amnon
We study various decision problems regarding short-term investments in risky assets whose returns evolve continuously in time. We show that in each problem, all risk-averse decision makers have the same (problem-dependent) ranking over short- term risky assets. Moreover, in each of these problems, the ranking is represented by the same risk index as in the case of CARA utility agents and normally distributed risky assets.

Supply and Demand of Information for Firm Valuation
Swanson, Zane L.
The concept that accounting represents the information economics of the firm is a premise for the allocation of scarce resources. The analysis starts with a clean surplus model as a basis for the conceptual framework. Then theoretical firm information economic supply-and-demand features are incorporated within a path diagram. This framework is investigated empirically with simultaneous regression equations and a structural equation model (SEM). Equations have explanatory power. And, a latent variable measure of internally generated intangible assets positively and significantly affects net income. Thus, the study expands the research frontier for SEM financial accounting research.

The Asymmetric Relationship between National Cultural Distance and Target Premiums in Cross-Border M&A
Lim, Jongha,Makhija, Anil K.,Shenkar, Oded
Prior literature routinely assumes symmetric cultural distance (CD) in a given country pair, suggesting an identical role for the home and host countries. However, if the absolute CD is perceived differently depending on the acquirer’s home base, it may yield differential effects in cross-border M&A (CB M&A) transactions. Consistently, we find that the relationship between CD and CB M&A premiums is not uniform, but varies by acquirer origin. While we find a strong negative association between CD and premiums when U.S. firms bid for foreign targets, no such negative association is observed when foreign bidders evaluate U.S. targets. Using traveler flows, student exchanges, and previous acquisitions as proxies for directional cross-cultural familiarity, we provide evidence that familiarity with the target’s national culture is a main driver that mitigates the negative effects of CD on premiums and thus explains the observed asymmetry. Our findings highlight the existence, as well as the source, of the asymmetric property in the relationship between CD and target premiums in CB M&A.