Research articles for the 2020-02-21
Cost Shielding in Executive Bonus Plans
SSRN
Executive bonus plans often incorporate performance measures that disregard certain costs â€" a phenomenon we refer to as “cost shielding.†We develop measures of cost shielding and examine whether boards use cost shielding to alleviate agency conflicts between executives and shareholders. Consistent with predictions from agency theory, we find that boards select performance measures to shield executives from costs that are (i) incurred prior to their associated benefits, or (ii) the result of previous executives’ actions. We also find that many of these patterns are more pronounced among firms with more financial expertise on the board. Collectively, our results provide evidence that boards use cost shielding in executive bonus plans in response to potential agency conflicts and suggest that directors’ financial expertise facilitates incentive-compensation contracting efficiency.
SSRN
Executive bonus plans often incorporate performance measures that disregard certain costs â€" a phenomenon we refer to as “cost shielding.†We develop measures of cost shielding and examine whether boards use cost shielding to alleviate agency conflicts between executives and shareholders. Consistent with predictions from agency theory, we find that boards select performance measures to shield executives from costs that are (i) incurred prior to their associated benefits, or (ii) the result of previous executives’ actions. We also find that many of these patterns are more pronounced among firms with more financial expertise on the board. Collectively, our results provide evidence that boards use cost shielding in executive bonus plans in response to potential agency conflicts and suggest that directors’ financial expertise facilitates incentive-compensation contracting efficiency.
Economic Expectations and Stock Returns: Evidence from China Pakistan Economic Corridor
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The ongoing hype of China Pakistan Economic Corridor (CPEC) as a game-changer for the economy of Pakistan has induced a lot of expectations among all the countrymen. In this paper, we have tried to investigate whether the CPEC driven economic expectations reflect in stock market returns. We, use weekly search volume data from millions of internet users across the country to reveal CPEC driven economic attitude. By combining the volume of Internet queries such as, “CPECâ€, “CPEC Jobsâ€, “Taxâ€, “CPEC routeâ€, “Transport†and so forth, we create an economic attitude (Expectations) revealed by search volume index, as a measure of investor sentiments. We find that Expectations predict stock returns in the short-run, and this effect is consistent across all the main business sectors. Moreover, we also find that the conditional variation in stock returns positively correlates with the conditional variation in Expectations. These results have important implications for active investors and fund managers.
SSRN
The ongoing hype of China Pakistan Economic Corridor (CPEC) as a game-changer for the economy of Pakistan has induced a lot of expectations among all the countrymen. In this paper, we have tried to investigate whether the CPEC driven economic expectations reflect in stock market returns. We, use weekly search volume data from millions of internet users across the country to reveal CPEC driven economic attitude. By combining the volume of Internet queries such as, “CPECâ€, “CPEC Jobsâ€, “Taxâ€, “CPEC routeâ€, “Transport†and so forth, we create an economic attitude (Expectations) revealed by search volume index, as a measure of investor sentiments. We find that Expectations predict stock returns in the short-run, and this effect is consistent across all the main business sectors. Moreover, we also find that the conditional variation in stock returns positively correlates with the conditional variation in Expectations. These results have important implications for active investors and fund managers.
Emerging and Developing Economies: Ten Years After the Global Recession
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Although emerging market and developing economies (EMDEs) weathered the global recession a decade ago relatively well, they now appear less well placed to cope with the substantial downside risks facing the global economy. In many EMDEs, the room for monetary and fiscal policies to respond to shocks has eroded; underlying growth potential has slowed; and the momentum for improving policy frameworks, institutions, and business climates seems to have slackened. The experience of the 2009 global recession highlights once again the critical role of policy room in shielding economic activity during adverse shocks. The subsequent decade of anemic growth underlines the need for sound policy frameworks, institutions, and business environments to promote sustained growth. With the global growth outlook weakening and vulnerabilities rising, the policy priority for EMDEs is now to improve resilience to shocks and to lift long-term growth prospects.
SSRN
Although emerging market and developing economies (EMDEs) weathered the global recession a decade ago relatively well, they now appear less well placed to cope with the substantial downside risks facing the global economy. In many EMDEs, the room for monetary and fiscal policies to respond to shocks has eroded; underlying growth potential has slowed; and the momentum for improving policy frameworks, institutions, and business climates seems to have slackened. The experience of the 2009 global recession highlights once again the critical role of policy room in shielding economic activity during adverse shocks. The subsequent decade of anemic growth underlines the need for sound policy frameworks, institutions, and business environments to promote sustained growth. With the global growth outlook weakening and vulnerabilities rising, the policy priority for EMDEs is now to improve resilience to shocks and to lift long-term growth prospects.
From Primitive Barter to Inflationary Dollar: A Warless Economic Weapon of Mass Destruction
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Trade among people dates back to prehistoric times; before invention of money, a primitive system of exchange called barter existed. Barter has reemerged as an alternative to the dollar, attributable to high-magnitude financial crises such as the 2006 mortgage debacle and the ensuing global credit crisis (2008). It has been observed that bartering is more frequently used in malignant economic times than in benign economic times. The advantage of barter is that it does not revolve around expanding or contracting the aggregate money supply via credit, therefore people do not end up with massive debt hangover. The evolution of American imperialism and the dollar’s hegemony are closely interlinked. History has witnessed that imperialism was in America’s DNA even before its birth when European settlers arrived in the new world and began killing American Indians to gain land; at that moment, the seeds of an imperial nation were planted and flourished with more blood. President Trump and some branches of the US government feel agitated that there is a situation of diminishing U.S. power (and dollar). Anonymity of Bitcoin (pseudoanonymous) and the upcoming Libra is exactly one of these ire situations; just to protect the dollar’s hegemony, the Trump administration chooses to brutally attack cryptocurrencies as Trump said “one real currency in the USAâ€. But regulators must be real careful because running headlong into backlash to Libra just to punish Facebook due to its tarnished reputation of past privacy abuse and exploitation of users’ data (i.e. Cambridge Analytica) could adversely affect any potential future innovation, and in the process, harm consumers. Like any life-changing event or invention, Bitcoin and Libra (i.e. cryptocurrencies) will continue to forge ahead unabated regardless of ongoing efforts by doubters, pessimists, doomsayers, skeptics, disbelievers, and short-sighted/blindfolded politicians who are very much eager to put another nail in the coffin. One wonders, when will it end? How many more lives must be perished and the world’s resources must be exploited to serve the U.S. to keep enjoying its “exorbitant privilege†of dollar hegemony?
SSRN
Trade among people dates back to prehistoric times; before invention of money, a primitive system of exchange called barter existed. Barter has reemerged as an alternative to the dollar, attributable to high-magnitude financial crises such as the 2006 mortgage debacle and the ensuing global credit crisis (2008). It has been observed that bartering is more frequently used in malignant economic times than in benign economic times. The advantage of barter is that it does not revolve around expanding or contracting the aggregate money supply via credit, therefore people do not end up with massive debt hangover. The evolution of American imperialism and the dollar’s hegemony are closely interlinked. History has witnessed that imperialism was in America’s DNA even before its birth when European settlers arrived in the new world and began killing American Indians to gain land; at that moment, the seeds of an imperial nation were planted and flourished with more blood. President Trump and some branches of the US government feel agitated that there is a situation of diminishing U.S. power (and dollar). Anonymity of Bitcoin (pseudoanonymous) and the upcoming Libra is exactly one of these ire situations; just to protect the dollar’s hegemony, the Trump administration chooses to brutally attack cryptocurrencies as Trump said “one real currency in the USAâ€. But regulators must be real careful because running headlong into backlash to Libra just to punish Facebook due to its tarnished reputation of past privacy abuse and exploitation of users’ data (i.e. Cambridge Analytica) could adversely affect any potential future innovation, and in the process, harm consumers. Like any life-changing event or invention, Bitcoin and Libra (i.e. cryptocurrencies) will continue to forge ahead unabated regardless of ongoing efforts by doubters, pessimists, doomsayers, skeptics, disbelievers, and short-sighted/blindfolded politicians who are very much eager to put another nail in the coffin. One wonders, when will it end? How many more lives must be perished and the world’s resources must be exploited to serve the U.S. to keep enjoying its “exorbitant privilege†of dollar hegemony?
Macroprudential Policy Measures: Macroeconomic Impact and Interaction with Monetary Policy
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This paper examines the interactions of macroprudential and monetary policies. We find, using a range of macroeconomic models used at the European Central Bank, that in the long run, a 1% bank capital requirement increase has a small impact on GDP. In the short run, GDP declines by 0.15-0.35%. Under a stronger monetary policy reaction, the impact falls to 0.05-0.25%. The paper also examines how capital requirements and the conduct of macroprudential policy affect the monetary transmission mechanism. Higher bank leverage increases the economy's vulnerability to shocks but also monetary policy's ability to offset them. Macroprudential policy diminishes the frequency and severity of financial crises thus eliminating the need for extremely low interest rates. Counter-cyclical capital measures reduce the neutral real interest rate in normal times.
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This paper examines the interactions of macroprudential and monetary policies. We find, using a range of macroeconomic models used at the European Central Bank, that in the long run, a 1% bank capital requirement increase has a small impact on GDP. In the short run, GDP declines by 0.15-0.35%. Under a stronger monetary policy reaction, the impact falls to 0.05-0.25%. The paper also examines how capital requirements and the conduct of macroprudential policy affect the monetary transmission mechanism. Higher bank leverage increases the economy's vulnerability to shocks but also monetary policy's ability to offset them. Macroprudential policy diminishes the frequency and severity of financial crises thus eliminating the need for extremely low interest rates. Counter-cyclical capital measures reduce the neutral real interest rate in normal times.
Momentum and the Cross-Section of Stock Volatility
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Recent literature shows that momentum strategies exhibit significant downside risks over certain periods, or called "momentum crashes." We find that the high uncertainty of momentum strategies is sourced from the cross-sectional volatility of individual stocks. Stocks with high realised volatility over the formation period tend to lose momentum effect, while stocks with low realised volatility show strong momentum. A new approach, generalised risk-adjusted momentum (GRJMOM), is introduced to mitigate the negative impact of high momentum risks. GRJMOM is proven to be more profitable and less risky than the existing momentum ranking approaches in multiple asset classes, including the UK stock, commodity, global equity index, and fixed income markets.
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Recent literature shows that momentum strategies exhibit significant downside risks over certain periods, or called "momentum crashes." We find that the high uncertainty of momentum strategies is sourced from the cross-sectional volatility of individual stocks. Stocks with high realised volatility over the formation period tend to lose momentum effect, while stocks with low realised volatility show strong momentum. A new approach, generalised risk-adjusted momentum (GRJMOM), is introduced to mitigate the negative impact of high momentum risks. GRJMOM is proven to be more profitable and less risky than the existing momentum ranking approaches in multiple asset classes, including the UK stock, commodity, global equity index, and fixed income markets.
Monetary Policy and Bank Stability: The Analytical Toolbox Reviewed
SSRN
The response of major central banks to the global financial crisis has revived the debate around the interactions between monetary policy (MP) and bank stability. This technical paper sheds light, quantitatively, on the different mechanisms underlying the relationship between MP and bank stability. It does so by reviewing microeconometric studies from the academic literature as well as those conducted internally at the ECB. The paper proceeds chronologically, using the recent crisis as a touchstone. First, it provides a brief overview of the main theoretical channels linking bank stability and the transmission of MP. It then analyses the evidence from the pre-crisis period in the light of the structural trends leading up to the crisis. As the crisis erupted, unconventional monetary policy (UMP) measures were deployed, and the paper suggests that these were essential to buttress bank stability and halt a systemic crisis. At the same time, these measures involved trade-offs, and the adverse spillovers on banks’ intermediation capacity and risk-taking require close monitoring. The paper ends by offering a critical review of the methodologies employed and suggestions for the areas where analytical efforts should be focussed in the future.
SSRN
The response of major central banks to the global financial crisis has revived the debate around the interactions between monetary policy (MP) and bank stability. This technical paper sheds light, quantitatively, on the different mechanisms underlying the relationship between MP and bank stability. It does so by reviewing microeconometric studies from the academic literature as well as those conducted internally at the ECB. The paper proceeds chronologically, using the recent crisis as a touchstone. First, it provides a brief overview of the main theoretical channels linking bank stability and the transmission of MP. It then analyses the evidence from the pre-crisis period in the light of the structural trends leading up to the crisis. As the crisis erupted, unconventional monetary policy (UMP) measures were deployed, and the paper suggests that these were essential to buttress bank stability and halt a systemic crisis. At the same time, these measures involved trade-offs, and the adverse spillovers on banks’ intermediation capacity and risk-taking require close monitoring. The paper ends by offering a critical review of the methodologies employed and suggestions for the areas where analytical efforts should be focussed in the future.
Netflix Approach to Governance: Genuine Transparency with the Board
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The hallmark of good corporate governance is an independent board of directors to oversee management. However, it is not clear that independent directors receive the information they need to make fully informed decisions on all key matters. Partly, this is due to an information gap, whereby outside directors know substantially less about the business and market because of their limited exposure to the day-to-day activities of the company.
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The hallmark of good corporate governance is an independent board of directors to oversee management. However, it is not clear that independent directors receive the information they need to make fully informed decisions on all key matters. Partly, this is due to an information gap, whereby outside directors know substantially less about the business and market because of their limited exposure to the day-to-day activities of the company.
Nonlinear Effect of R&D Expenditures and Intangible Assets on Financial Performance: A Panel Threshold Analysis
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The financial outcomes of research and development (R&D) expenditures and intangible assets are not instantaneous and straightforward. To explore the varied perspectives of these relationships, this study employs panel threshold analysis. Analysis reveals significant variances in multiple regimes. The findings provide insights in the risk-return paradigm of R&D investment, dynamics of threshold points and the successive return, besides helping the policy makers to settle the priority sector to get the expected result in line with country’s investment policy.
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The financial outcomes of research and development (R&D) expenditures and intangible assets are not instantaneous and straightforward. To explore the varied perspectives of these relationships, this study employs panel threshold analysis. Analysis reveals significant variances in multiple regimes. The findings provide insights in the risk-return paradigm of R&D investment, dynamics of threshold points and the successive return, besides helping the policy makers to settle the priority sector to get the expected result in line with country’s investment policy.
Oil Price Shocks, Global Financial Markets and Their Connectedness
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This paper extends the literature on the relationship between oil price shocks and financial markets by examining the effect of oil shocks on the sovereign bond markets of a large number of advanced and emerging economies and exploring the impact of oil shocks on the degree of connectedness among international financial markets. We show that the effect of oil price shocks is not only limited to stock market returns, but also extends to bond markets, even after controlling for discount rate shocks as well as aggregate capital market effects. Unlike the case for stock markets, the effect on sovereign bonds is found to be rather heterogeneous (in terms of size and sign) and primarily driven by demand related shocks. We also show that oil price shocks serve as a driver of connectedness patterns across global financial markets, although the effect on connectedness depends on the nature of the oil market shock and the economic characteristics of the countries. Overall, the findings highlight the role of crude oil as a driver of not only of return dynamics in global stock and bond markets, but also of global financial connectedness patterns.
SSRN
This paper extends the literature on the relationship between oil price shocks and financial markets by examining the effect of oil shocks on the sovereign bond markets of a large number of advanced and emerging economies and exploring the impact of oil shocks on the degree of connectedness among international financial markets. We show that the effect of oil price shocks is not only limited to stock market returns, but also extends to bond markets, even after controlling for discount rate shocks as well as aggregate capital market effects. Unlike the case for stock markets, the effect on sovereign bonds is found to be rather heterogeneous (in terms of size and sign) and primarily driven by demand related shocks. We also show that oil price shocks serve as a driver of connectedness patterns across global financial markets, although the effect on connectedness depends on the nature of the oil market shock and the economic characteristics of the countries. Overall, the findings highlight the role of crude oil as a driver of not only of return dynamics in global stock and bond markets, but also of global financial connectedness patterns.
Overpricing in China’s Corporate Bond Market
SSRN
Using a comprehensive dataset of Chinese corporate bond issuances, we uncover substantial evidence of issuance overpricing: the yield spread of newly issued bonds at their first secondary-market trading day is on average 5.35 bps higher than the issuance spread. This overpricing is robust across subsamples of bond issuances with different credit ratings, maturities, issuance types, and issuer status. We further provide extensive evidence to support a hypothesis that competition among underwriters drives this overpricing through two specific channels â€" either through rebates to participants in issuance auctions or through direct auction bidding by the underwriters for themselves or their clients.
SSRN
Using a comprehensive dataset of Chinese corporate bond issuances, we uncover substantial evidence of issuance overpricing: the yield spread of newly issued bonds at their first secondary-market trading day is on average 5.35 bps higher than the issuance spread. This overpricing is robust across subsamples of bond issuances with different credit ratings, maturities, issuance types, and issuer status. We further provide extensive evidence to support a hypothesis that competition among underwriters drives this overpricing through two specific channels â€" either through rebates to participants in issuance auctions or through direct auction bidding by the underwriters for themselves or their clients.
Redrawing the Map of Global Capital Flows: The Role of Cross-Border Financing and Tax Havens
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Global firms finance themselves through foreign subsidiaries, often shell companies in tax havens, which obscures their nationality in aggregate statistics. We associate the universe of traded securities with their issuer’s ultimate parent and restate bilateral investment positions to better reflect the true financial linkages connecting countries around the world. We find that private capital flows from developed countries to firms in large emerging markets are dramatically larger than previously thought. The national accounts of the United States, for example, understate the U.S. position in Chinese firms by nearly $600 billion, while China’s official net creditor position to the rest of the world may be overstated by as much as 50 percent. We additionally show how taking account of offshore issuance is important for our understanding of the currency composition of external liabilities, the nature of foreign direct investment, and the growth of financial globalization.
SSRN
Global firms finance themselves through foreign subsidiaries, often shell companies in tax havens, which obscures their nationality in aggregate statistics. We associate the universe of traded securities with their issuer’s ultimate parent and restate bilateral investment positions to better reflect the true financial linkages connecting countries around the world. We find that private capital flows from developed countries to firms in large emerging markets are dramatically larger than previously thought. The national accounts of the United States, for example, understate the U.S. position in Chinese firms by nearly $600 billion, while China’s official net creditor position to the rest of the world may be overstated by as much as 50 percent. We additionally show how taking account of offshore issuance is important for our understanding of the currency composition of external liabilities, the nature of foreign direct investment, and the growth of financial globalization.
Regulating Fintech: Objectives, Principles, and Practices
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We start by revisiting the true definition of money and identify that electronic money is not a new concept. We explain the spectrum of money in the context of the past, present, and future, and argue that technology can only enhance the way we deal with money and will never change the nature of money. The prospect of digital currency relies on innovation capacity, not only on central banks. We propose that a central bank is similar to a welfare society, and demand for digitalization has always been present due to problems such as nano units and coverage. We recommend tackling each digitization challenge sequentially and with a logical approach.
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We start by revisiting the true definition of money and identify that electronic money is not a new concept. We explain the spectrum of money in the context of the past, present, and future, and argue that technology can only enhance the way we deal with money and will never change the nature of money. The prospect of digital currency relies on innovation capacity, not only on central banks. We propose that a central bank is similar to a welfare society, and demand for digitalization has always been present due to problems such as nano units and coverage. We recommend tackling each digitization challenge sequentially and with a logical approach.
The Gender Gap in Peer-to-Peer Lending: Evidence from the People’s Republic of China
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We document and analyze the gender gap in the online credit market. Using data from Renrendai, a leading peer-to-peer lending platform in the People’s Republic of China (PRC), we show that lending to female borrowers is associated with better loan performance, including a lower probability of default, a higher expected profit, and a lower expected loss than for their male peers. However, despite the higher creditworthiness, we don’t find any measurable gender impact on funding success rate, meaning that female borrowers have to compensate lenders by providing higher profitability to achieve a similar funding probability to their male peers. This evidence indicates the existence of a gender gap that discriminates against female borrowers. Further analysis implies that this gender gap is independent of the amount of information disclosed by borrowers.
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We document and analyze the gender gap in the online credit market. Using data from Renrendai, a leading peer-to-peer lending platform in the People’s Republic of China (PRC), we show that lending to female borrowers is associated with better loan performance, including a lower probability of default, a higher expected profit, and a lower expected loss than for their male peers. However, despite the higher creditworthiness, we don’t find any measurable gender impact on funding success rate, meaning that female borrowers have to compensate lenders by providing higher profitability to achieve a similar funding probability to their male peers. This evidence indicates the existence of a gender gap that discriminates against female borrowers. Further analysis implies that this gender gap is independent of the amount of information disclosed by borrowers.
