Research articles for the 2020-08-29
A Case for Higher Corporate Tax Rates
SSRN
In this report, Fox and Liscow argue that, while conventional wisdom holds that we should lower taxes on corporations because of international competition, two recent changes militate in favor of higher corporate taxes, which would close the deficit, fund social programs, and reduce inequality. First, changes in tax law have increasingly targeted the corporate tax at economic “rents,†the supersized returns that businesses receive when they enjoy advantages like market power. Because taxing rents is progressive and does little to harm economic activity, a higher rate is justified. Second, shifts in the American economy have allowed companies to earn more economic rents, increasing the revenue a tax on rents could raise â€" and increasing the appeal of the tax as a deterrent to harmful behaviors like lobbying government officials to get or maintain market power. Although the authors cannot say exactly what the corporate rate should be, principally because the international dimension remains so important, they offer reasons to favor a higher rate and describe reforms that could help ease the adoption of higher, but still efficient, taxes on corporate returns. Fox and Liscow suggest that, at minimum, proponents of lower corporate tax rates present an incomplete picture and that the “lower corporate tax rates†conclusion is a nonobvious one.
SSRN
In this report, Fox and Liscow argue that, while conventional wisdom holds that we should lower taxes on corporations because of international competition, two recent changes militate in favor of higher corporate taxes, which would close the deficit, fund social programs, and reduce inequality. First, changes in tax law have increasingly targeted the corporate tax at economic “rents,†the supersized returns that businesses receive when they enjoy advantages like market power. Because taxing rents is progressive and does little to harm economic activity, a higher rate is justified. Second, shifts in the American economy have allowed companies to earn more economic rents, increasing the revenue a tax on rents could raise â€" and increasing the appeal of the tax as a deterrent to harmful behaviors like lobbying government officials to get or maintain market power. Although the authors cannot say exactly what the corporate rate should be, principally because the international dimension remains so important, they offer reasons to favor a higher rate and describe reforms that could help ease the adoption of higher, but still efficient, taxes on corporate returns. Fox and Liscow suggest that, at minimum, proponents of lower corporate tax rates present an incomplete picture and that the “lower corporate tax rates†conclusion is a nonobvious one.
An Information-Based Model From the Producer Theory of Value for Equilibrium Stock Returns
SSRN
Financing expenses for producers are necessary costs of business but for suppliers of financial capital these same cash flows represent a return on investment. The producer theory of value paradigm enables a specification for the cost of financial capital that satisfies a dynamic no-arbitrage condition on discounted financing expenses. This specification depicts a return generating process for equilibrium stock returns that complements asset pricing models from the consumer theory of value paradigm. Whereas asset pricing models explain how returns relate to risk factors facing consumer/investors, however, the model herein explains how returns relate to information that drives producer/manager investment behavior.
SSRN
Financing expenses for producers are necessary costs of business but for suppliers of financial capital these same cash flows represent a return on investment. The producer theory of value paradigm enables a specification for the cost of financial capital that satisfies a dynamic no-arbitrage condition on discounted financing expenses. This specification depicts a return generating process for equilibrium stock returns that complements asset pricing models from the consumer theory of value paradigm. Whereas asset pricing models explain how returns relate to risk factors facing consumer/investors, however, the model herein explains how returns relate to information that drives producer/manager investment behavior.
Average Period, User Cost, and Implications for Value, Interest, and Term Structure
SSRN
This study weds the user cost of capital with average period in a modern analytical relationship and offers three implications. One, a real capital stock’s fundamental value as a proportion of its current replacement cost depends on a ratio of average periods. Two, the effect on fundamental value of an increasing discount rate may be positive or negative and it too depends on a ratio of average periods. Three, an increase in average period of debt maturity allows an increase in the flow of interest from capital and, consequently, the yield curve is upward sloped irrespective of all else.
SSRN
This study weds the user cost of capital with average period in a modern analytical relationship and offers three implications. One, a real capital stock’s fundamental value as a proportion of its current replacement cost depends on a ratio of average periods. Two, the effect on fundamental value of an increasing discount rate may be positive or negative and it too depends on a ratio of average periods. Three, an increase in average period of debt maturity allows an increase in the flow of interest from capital and, consequently, the yield curve is upward sloped irrespective of all else.
Debt Maturity and the Cost of Capital
SSRN
A new expression is derived in which the cost of capital is an explicit function of debt maturity structure and the underlying real asset cash flow stream. In special cases the cost of capital expression reduces to the standard weighted average cost of capital, but generally the standard formulation is invalid. Reliance on a correctly specified cost of capital expression has implications for capital budgeting and capital market studies.
SSRN
A new expression is derived in which the cost of capital is an explicit function of debt maturity structure and the underlying real asset cash flow stream. In special cases the cost of capital expression reduces to the standard weighted average cost of capital, but generally the standard formulation is invalid. Reliance on a correctly specified cost of capital expression has implications for capital budgeting and capital market studies.
Discrete-time Variance-optimal Deep Hedging in Affine GARCH Models
SSRN
Variance-optimal hedging in a discrete-time framework is a practical options strategy that aims to reduce the residual risk. It has been widely used in volatility trading desks. In this paper, we solve the variance-optimal hedging problem for affine GARCH models both semi-explicitly and through deep learning. Applying the Laplace transform method, we derive semi-explicit formulas for the variance-optimal hedging strategy and initial endowment. We also apply the Long Short-Term Memory (LSTM) recurrent neural network (RNN) architectures and solve for optimal hedging strategies under mean square error loss function with transaction costs. Numerical examples illustrate the hedging performance for different approaches, option styles, hedging frequencies and transaction costs.
SSRN
Variance-optimal hedging in a discrete-time framework is a practical options strategy that aims to reduce the residual risk. It has been widely used in volatility trading desks. In this paper, we solve the variance-optimal hedging problem for affine GARCH models both semi-explicitly and through deep learning. Applying the Laplace transform method, we derive semi-explicit formulas for the variance-optimal hedging strategy and initial endowment. We also apply the Long Short-Term Memory (LSTM) recurrent neural network (RNN) architectures and solve for optimal hedging strategies under mean square error loss function with transaction costs. Numerical examples illustrate the hedging performance for different approaches, option styles, hedging frequencies and transaction costs.
Informed Lenders in the Shorting Market
SSRN
This paper examines the equity loan supply for short selling. Using detailed stock lending data, we show that active equity funds, on average, are informed lenders. The stocks they lend outperform those that they do not. The stocks they recall and sell perform worse in the future than those that remain on loan. These funds avoid lending stocks when lending fees are extremely high and use the shorting market’s signals to form stock-selling decisions. Their behavior contrasts sharply with that of passive index funds. We argue this heterogeneity in informed lending is a previously undocumented source of short-sale constraints.
SSRN
This paper examines the equity loan supply for short selling. Using detailed stock lending data, we show that active equity funds, on average, are informed lenders. The stocks they lend outperform those that they do not. The stocks they recall and sell perform worse in the future than those that remain on loan. These funds avoid lending stocks when lending fees are extremely high and use the shorting market’s signals to form stock-selling decisions. Their behavior contrasts sharply with that of passive index funds. We argue this heterogeneity in informed lending is a previously undocumented source of short-sale constraints.
Interventions by Common Owners
SSRN
Common ownership exists when investors concurrently hold partial and significant shares in competing firms. In this paper, I compile, document, and taxonomize 30 separate cases of intervention to demonstrate how common owners influence firm behavior. Anticompetitive concerns arise when horizontal shareholders use such interventions to reduce competition between commonly-owned firms. Critics have challenged the plausibility of a common owner's capacity and incentive to do so. This paper provides clear evidence from media coverage and investigations that common owners frequently engage in such practices.
SSRN
Common ownership exists when investors concurrently hold partial and significant shares in competing firms. In this paper, I compile, document, and taxonomize 30 separate cases of intervention to demonstrate how common owners influence firm behavior. Anticompetitive concerns arise when horizontal shareholders use such interventions to reduce competition between commonly-owned firms. Critics have challenged the plausibility of a common owner's capacity and incentive to do so. This paper provides clear evidence from media coverage and investigations that common owners frequently engage in such practices.
Mean-Preserving Unawareness in General Equilibrium
SSRN
Sufficient conditions for existence of equilibrium are provided for a general equilibrium with incomplete markets problem augmented with unawareness. In this setup agents do not perceive all states of the world, yet are correct in expectations. The First Fundamental Welfare Theorem fails due to both a default and pecuniary inefficiency, while the Second Fundamental holds for economies with no aggregate risk. Welfare is shown to not necessarily be monotonic in discovery, or the increasing of awareness.
SSRN
Sufficient conditions for existence of equilibrium are provided for a general equilibrium with incomplete markets problem augmented with unawareness. In this setup agents do not perceive all states of the world, yet are correct in expectations. The First Fundamental Welfare Theorem fails due to both a default and pecuniary inefficiency, while the Second Fundamental holds for economies with no aggregate risk. Welfare is shown to not necessarily be monotonic in discovery, or the increasing of awareness.
Mutual Fund Governance: Does a Long-term Relationship with Managers Blind Directors?
SSRN
This paper studies how the strength of social ties between the fund's independent directors and fund managers affects fund governance. Using the duration of past employment in which independent directors and fund managers have worked together as a proxy for the social ties, I find that the longer the connection duration, the worse the funds perform. In addition, managers who have a long-term connection with the independent directors have a higher probability of being hired and a lower chance of being fired. Investors endure a significant cost due to this board entrenchment.
SSRN
This paper studies how the strength of social ties between the fund's independent directors and fund managers affects fund governance. Using the duration of past employment in which independent directors and fund managers have worked together as a proxy for the social ties, I find that the longer the connection duration, the worse the funds perform. In addition, managers who have a long-term connection with the independent directors have a higher probability of being hired and a lower chance of being fired. Investors endure a significant cost due to this board entrenchment.
Ownership Structures and Firm Performance in Nigeria: A Canonical Correlation Analysis
SSRN
This study examined the relationship between ownership structure and performance of listed non-financial firms in Nigeria. Secondary data on managerial ownership, ownership concentration, foreign ownership, institutional ownership, Tobin q, return on assets, return on equities, and earnings per shares were collected from forty (40) sampled firms. The data were analyzed using canonical correlation and the findings showed that managerial and foreign ownerships are the dominant ownership structures while Tobin q, EPS, and ROA are the dominant performance measures. The study also found that ownership concentration, foreign ownership, and institutional ownership are positively correlated with firm performance, while managerial ownership is negatively correlated with firm performance. The study recommended that listed non-financial firms should encourage foreign investments in their firms and rewards performing managers with shares in the firm.
SSRN
This study examined the relationship between ownership structure and performance of listed non-financial firms in Nigeria. Secondary data on managerial ownership, ownership concentration, foreign ownership, institutional ownership, Tobin q, return on assets, return on equities, and earnings per shares were collected from forty (40) sampled firms. The data were analyzed using canonical correlation and the findings showed that managerial and foreign ownerships are the dominant ownership structures while Tobin q, EPS, and ROA are the dominant performance measures. The study also found that ownership concentration, foreign ownership, and institutional ownership are positively correlated with firm performance, while managerial ownership is negatively correlated with firm performance. The study recommended that listed non-financial firms should encourage foreign investments in their firms and rewards performing managers with shares in the firm.
Social Capital and Entrepreneurial Financing Choice
SSRN
This paper investigates the influence of social capital on young firms’ financing arrangements. Using a sample of U.S. start-ups, I find that social capital, as captured by secular norms and social networks in the entrepreneur’s county, increases access to outside financing and reduces reliance on owner equity to finance the new venture. Social capital also has real effects on the firm: start-ups located in U.S. counties with higher levels of social capital reach peak output sooner and have higher survival rates than firms located in low social-capital counties.
SSRN
This paper investigates the influence of social capital on young firms’ financing arrangements. Using a sample of U.S. start-ups, I find that social capital, as captured by secular norms and social networks in the entrepreneur’s county, increases access to outside financing and reduces reliance on owner equity to finance the new venture. Social capital also has real effects on the firm: start-ups located in U.S. counties with higher levels of social capital reach peak output sooner and have higher survival rates than firms located in low social-capital counties.
The Neoclassical Theory of Term Structure
SSRN
This study presents a specification for the neoclassical user cost of capital that reflects dynamic processes for debt maturity structure and for pretax cash flows. Equivalencing levered and unlevered user costs reveals tradeoffs between equilibrium financing rates and underlying processes that satisfy a dynamic no-arbitrage equilibrium condition between debt, equity, and costless reversible real investment. The primary finding is that an increase in debt ratio or loan term associates with an increase in equilibrium financing rate â€" invariance of the neoclassical user cost to leverage implies an endogenous upward sloped yield curve.
SSRN
This study presents a specification for the neoclassical user cost of capital that reflects dynamic processes for debt maturity structure and for pretax cash flows. Equivalencing levered and unlevered user costs reveals tradeoffs between equilibrium financing rates and underlying processes that satisfy a dynamic no-arbitrage equilibrium condition between debt, equity, and costless reversible real investment. The primary finding is that an increase in debt ratio or loan term associates with an increase in equilibrium financing rate â€" invariance of the neoclassical user cost to leverage implies an endogenous upward sloped yield curve.
What is the Impact of Introducing a Parallel OTC Market? Theory and Evidence from the Chinese Interbank FX Market
SSRN
Chinese Interbank Foreign Exchange trading was originally conducted through a centralized, anonymous limit order book (LOB). We determine the impact of the introduction of a parallel decentralized over-the-counter (OTC) market. We find that: (1) most trading migrated to the OTC, (2) the LOB price function is upward-sloping versus the OTC price function is downward-sloping, and (3) the LOB market has a single price function versus the OTC market has multiple price functions. Next, we develop a theoretical model of parallel markets that can simultaneously explain all of these empirical findings. We test a new model prediction and find support.
SSRN
Chinese Interbank Foreign Exchange trading was originally conducted through a centralized, anonymous limit order book (LOB). We determine the impact of the introduction of a parallel decentralized over-the-counter (OTC) market. We find that: (1) most trading migrated to the OTC, (2) the LOB price function is upward-sloping versus the OTC price function is downward-sloping, and (3) the LOB market has a single price function versus the OTC market has multiple price functions. Next, we develop a theoretical model of parallel markets that can simultaneously explain all of these empirical findings. We test a new model prediction and find support.
