Research articles for the 2020-09-11
All About the State: Fifty Years of Innovative Technology to Deliver an Inclusive Financial Sector
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This paper documents the long-term nature of technological innovations which have transformed retail finance and addressed financial exclusion. The paper also contributes to the body of literature on the state as an entrepreneur. The roots of financial inclusion are traced back to the 1960s with a discussion of the role played by the state, in contrast to that of the private sector and disruptive innovation. The case of the world-recognized mobile payment service M-Pesa is then examined. This service, aimed at expanding access to retail financial markets to the previously ‘un-banked’, is credited with transforming access to financial services in Africa. The empirical results suggest that the state was actively involved in the development and deployment of applications of information and communication technologies which led to M-Pesa. This study provides support for policies that promote mobile banking technology as a means of enhancing financial inclusion. The study also confirms that public-private partnerships, together with an enabling regulatory environment, facilitate technological innovation.
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This paper documents the long-term nature of technological innovations which have transformed retail finance and addressed financial exclusion. The paper also contributes to the body of literature on the state as an entrepreneur. The roots of financial inclusion are traced back to the 1960s with a discussion of the role played by the state, in contrast to that of the private sector and disruptive innovation. The case of the world-recognized mobile payment service M-Pesa is then examined. This service, aimed at expanding access to retail financial markets to the previously ‘un-banked’, is credited with transforming access to financial services in Africa. The empirical results suggest that the state was actively involved in the development and deployment of applications of information and communication technologies which led to M-Pesa. This study provides support for policies that promote mobile banking technology as a means of enhancing financial inclusion. The study also confirms that public-private partnerships, together with an enabling regulatory environment, facilitate technological innovation.
Bank Leverage and Capital Bias Adjustment Through the Macroeconomic Cycle
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We assess the quantitative effects of the recent proposal for more robust bank capital adequacy (Admati and Hellwig, 2013; Myerson, 2014). Our theoretical proof and evidence accord with the core thesis that banks become more stable by increasing its equity capital cushion to absorb extreme losses in times of severe financial stress. This analysis contributes to the ongoing policy debate on total capital adequacy. Our Monte Carlo simulation helps develop an analytical solution for the default probability adjustment through the macroeconomic cycle. This study poses a conceptual challenge to the normative view that banks should maintain high leverage over time.
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We assess the quantitative effects of the recent proposal for more robust bank capital adequacy (Admati and Hellwig, 2013; Myerson, 2014). Our theoretical proof and evidence accord with the core thesis that banks become more stable by increasing its equity capital cushion to absorb extreme losses in times of severe financial stress. This analysis contributes to the ongoing policy debate on total capital adequacy. Our Monte Carlo simulation helps develop an analytical solution for the default probability adjustment through the macroeconomic cycle. This study poses a conceptual challenge to the normative view that banks should maintain high leverage over time.
Banks' Reactions to Creditor Rights Changes
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We study how banks adjust their portfolios in response to a deterioration in creditor rights. We construct a comprehensive creditor rights index based on a series of quasi-natural experiments in Italy and exploit a unique proprietary credit-level database of one of the largest Italian banks. Our data includes the universe of the bank’s portfolio over time, allowing us to provide evidence on the banks’ reaction to changes in creditor rights. We document a fall in recovery rates, an increase in interest rates, and a reduction in credit. There is also a movement away from smaller firms and towards secured loans with floating rates. Features such as the strength of lending relationships and the bank’s market power mitigate the magnitudes of these responses. Our analysis reveals that these features constitute important tools to attenuate the effect of poor creditor rights on firms’ access to financing. Our results support the seminal works of Rajan (1992) and Petersen and Rajan (1995).
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We study how banks adjust their portfolios in response to a deterioration in creditor rights. We construct a comprehensive creditor rights index based on a series of quasi-natural experiments in Italy and exploit a unique proprietary credit-level database of one of the largest Italian banks. Our data includes the universe of the bank’s portfolio over time, allowing us to provide evidence on the banks’ reaction to changes in creditor rights. We document a fall in recovery rates, an increase in interest rates, and a reduction in credit. There is also a movement away from smaller firms and towards secured loans with floating rates. Features such as the strength of lending relationships and the bank’s market power mitigate the magnitudes of these responses. Our analysis reveals that these features constitute important tools to attenuate the effect of poor creditor rights on firms’ access to financing. Our results support the seminal works of Rajan (1992) and Petersen and Rajan (1995).
Causal Relationship Between Real Exchange Rate and Economic Growth in Asia â€" Pacific Region
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The main purpose of this study is to examine the causal relationship between Real Exchange Rate and Economic Growth Variables in the Asia â€" Pacific region. Granger Causality Test was employed, to examine the causal relationship between the dependent and independent variables, with the sample economies, over the period from 2006 to 2017, under quarterly frequency. The researcher did not find any signs of causal relationship between the variables, in majority of the sample countries.
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The main purpose of this study is to examine the causal relationship between Real Exchange Rate and Economic Growth Variables in the Asia â€" Pacific region. Granger Causality Test was employed, to examine the causal relationship between the dependent and independent variables, with the sample economies, over the period from 2006 to 2017, under quarterly frequency. The researcher did not find any signs of causal relationship between the variables, in majority of the sample countries.
Correlation between Corporate Social Performance and Corporate Financial Performance: Evidence from Indian Companies
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This study examines the relationship between Corporate Social Performance and Corporate Financial Performance in Indian firms. This study proposes to examine the various dimensions of relationship between corporate social performance and corporate financial performance in India. The Corporate Social Performance variables such as Employee, Environment, Community, Size and Salary and Wages and variables like ROA, ROE, ROS, ROCE, EPS and Sales for Corporate Financial Performance, were identified and used in the study. It was found from the analysis that there was significant and positive relationship among CSP and CFP sample variables, used in the study.
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This study examines the relationship between Corporate Social Performance and Corporate Financial Performance in Indian firms. This study proposes to examine the various dimensions of relationship between corporate social performance and corporate financial performance in India. The Corporate Social Performance variables such as Employee, Environment, Community, Size and Salary and Wages and variables like ROA, ROE, ROS, ROCE, EPS and Sales for Corporate Financial Performance, were identified and used in the study. It was found from the analysis that there was significant and positive relationship among CSP and CFP sample variables, used in the study.
Cultivating Quality: Ten Tools Managers Can Use to Get Long-Term Committed Shareholders
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Special Note:This Article is part of The Quality Shareholder Initiative at the Center for Law, Economics and Finance (C-LEAF), at The George Washington University Law School, Prof. Lawrence A. Cunningham, Faculty Director. Considerable effort goes into forging tools a corporation can use to shape its shareholder base. Much effort is geared toward promoting long investor time horizons, presumed to be a valuable but rare appetite among many shareholders. Less attention has been focused on promoting greater commitment, though attracting shareholders willing to stake large percentages of their portfolio in a given company’s stock may prove way more valuable than having numerous large index funds on the shareholder list. In three ways, this article adds to the toolkit on shareholder cultivation. First, this article stresses that a shareholder’s relative portfolio concentration in a particular company’s stock is as important as average holding periods. Such an orientation is unusual in corporate life. But today’s world is dominated by index fund investors whose portfolio diversification limits their ability to act as informed shareholders. A focus on relative portfolio concentration is therefore becoming critical. Second, this discussion introduces, and is motivated by, new evidence showing a correlation between a high density of such shareholders and superior corporate performance. In fact, shareholders exhibiting both traitsâ€"patience and convictionâ€"have long been cultivated by an elite group of companies whose long-term performance has benefited. The most famous is Warren Buffett’s Berkshire Hathaway and there are scores of other less famous but equally accomplished. Third, focusing on such quality shareholders, as Buffett long ago dubbed them, this article offers numerous tools a corporation may use to achieve a shareholder base with a high density of quality shareholders. These include communications strategies, such as stressing long-term performance metrics in corporate disclosure, and substantive practices, such as prioritizing the art of capital allocation. Managers and quality shareholders themselves are the target audience.
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Special Note:This Article is part of The Quality Shareholder Initiative at the Center for Law, Economics and Finance (C-LEAF), at The George Washington University Law School, Prof. Lawrence A. Cunningham, Faculty Director. Considerable effort goes into forging tools a corporation can use to shape its shareholder base. Much effort is geared toward promoting long investor time horizons, presumed to be a valuable but rare appetite among many shareholders. Less attention has been focused on promoting greater commitment, though attracting shareholders willing to stake large percentages of their portfolio in a given company’s stock may prove way more valuable than having numerous large index funds on the shareholder list. In three ways, this article adds to the toolkit on shareholder cultivation. First, this article stresses that a shareholder’s relative portfolio concentration in a particular company’s stock is as important as average holding periods. Such an orientation is unusual in corporate life. But today’s world is dominated by index fund investors whose portfolio diversification limits their ability to act as informed shareholders. A focus on relative portfolio concentration is therefore becoming critical. Second, this discussion introduces, and is motivated by, new evidence showing a correlation between a high density of such shareholders and superior corporate performance. In fact, shareholders exhibiting both traitsâ€"patience and convictionâ€"have long been cultivated by an elite group of companies whose long-term performance has benefited. The most famous is Warren Buffett’s Berkshire Hathaway and there are scores of other less famous but equally accomplished. Third, focusing on such quality shareholders, as Buffett long ago dubbed them, this article offers numerous tools a corporation may use to achieve a shareholder base with a high density of quality shareholders. These include communications strategies, such as stressing long-term performance metrics in corporate disclosure, and substantive practices, such as prioritizing the art of capital allocation. Managers and quality shareholders themselves are the target audience.
Does Competition Induce Analyst Effort? Evidence from a Natural Experiment of Broker Mergers
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Hong and Kacperczyk (2010) document that decreases in analyst competition due to broker mergers encourage analysts to please managers, leading to greater consensus optimism bias. We propose three additional effects of analyst competition. The analyst effort hypothesis suggests that weaker competition reduces analysts’ incentives to collect and analyze information. The herding hypothesis argues that weaker competition reduces analysts’ career concerns, which in turn reduces herding incentives. The strategic deviation hypothesis implies that weaker competition alleviates analysts’ incentives to strategically deviate from others. We find that after broker mergers, analysts follow fewer firms and switch their coverage from firms with more to those with less R&D expenses. They weigh their private information less when it is unfavorable. At the same time, their forecasts become more dispersed. All these findings appear to be more consistent with the analyst effort hypothesis than the herding or strategic deviation hypothesis.
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Hong and Kacperczyk (2010) document that decreases in analyst competition due to broker mergers encourage analysts to please managers, leading to greater consensus optimism bias. We propose three additional effects of analyst competition. The analyst effort hypothesis suggests that weaker competition reduces analysts’ incentives to collect and analyze information. The herding hypothesis argues that weaker competition reduces analysts’ career concerns, which in turn reduces herding incentives. The strategic deviation hypothesis implies that weaker competition alleviates analysts’ incentives to strategically deviate from others. We find that after broker mergers, analysts follow fewer firms and switch their coverage from firms with more to those with less R&D expenses. They weigh their private information less when it is unfavorable. At the same time, their forecasts become more dispersed. All these findings appear to be more consistent with the analyst effort hypothesis than the herding or strategic deviation hypothesis.
Does Firm's Environmental Footprint Mitigate the Market Reaction to COVID-19 Uncertainty?
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This paper investigates how firms with high environmental performance have reacted to the feverish stock market movements caused by the COVID-19 uncertainty. Our analysis focuses on a sample of 3,869 non-financial listed companies from 21 advanced economies. We find that high environmentally sustainable practices are associated with lower market performance during the COVID-19 crisis, especially when the pandemic began to spread globally. This relation is explained by the stronger contractions in earnings and cash flows forecasts. The cost structure of firms that have already implemented environmental initiatives makes them more exposed to the unexpected global demand shock. Overall, our findings suggest that, in the short-term, periods of high uncertainty and feverish market movements negatively affect environmentally-friendly firms.
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This paper investigates how firms with high environmental performance have reacted to the feverish stock market movements caused by the COVID-19 uncertainty. Our analysis focuses on a sample of 3,869 non-financial listed companies from 21 advanced economies. We find that high environmentally sustainable practices are associated with lower market performance during the COVID-19 crisis, especially when the pandemic began to spread globally. This relation is explained by the stronger contractions in earnings and cash flows forecasts. The cost structure of firms that have already implemented environmental initiatives makes them more exposed to the unexpected global demand shock. Overall, our findings suggest that, in the short-term, periods of high uncertainty and feverish market movements negatively affect environmentally-friendly firms.
Efficient Simulation of Stochastic Differential Equations Based on Markov Chain Approximations With Applications
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We propose a novel Monte Carlo simulation method for two-dimensional stochastic differential equation (SDE) systems based on approximation through continuous-time Markov chains (CTMCs). Specifically, we propose an efficient simulation framework for asset prices under general stochastic local volatility (SLV) models arising in finance, which includes the Heston and the stochastic alpha beta rho (SABR) models as special cases. Our simulation algorithm is constructed based on approximating the latent stochastic variance process by a CTMC. Compared with time-discretization schemes, our method exhibits several advantages, including flexible boundary condition treatment, weak continuity conditions imposed on coefficients, and a second order convergence rate in the spatial grids of the approximating CTMC under suitable regularity conditions. Replacing the stochastic variance process with a discrete-state approximation greatly simplifies the direct sampling of the integrated variance, thus enabling a highly efficient simulation scheme.Extensive numerical examples illustrate the accuracy and efficiency of our estimator, which outperforms \textit{both biased and unbiased} simulation estimators in the literature in terms of root mean squared error (RMSE) and computational time. This paper is focused primarily on the simulation of SDEs which arise in finance, but this new simulation approach has potential for applications in other contextual areas in operations research, such as queuing theory. Note: this is an earlier version of the work "Efficient Simulation of Generalized SABR and Stochastic Local Volatility Models based on Markov Chain Approximations".
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We propose a novel Monte Carlo simulation method for two-dimensional stochastic differential equation (SDE) systems based on approximation through continuous-time Markov chains (CTMCs). Specifically, we propose an efficient simulation framework for asset prices under general stochastic local volatility (SLV) models arising in finance, which includes the Heston and the stochastic alpha beta rho (SABR) models as special cases. Our simulation algorithm is constructed based on approximating the latent stochastic variance process by a CTMC. Compared with time-discretization schemes, our method exhibits several advantages, including flexible boundary condition treatment, weak continuity conditions imposed on coefficients, and a second order convergence rate in the spatial grids of the approximating CTMC under suitable regularity conditions. Replacing the stochastic variance process with a discrete-state approximation greatly simplifies the direct sampling of the integrated variance, thus enabling a highly efficient simulation scheme.Extensive numerical examples illustrate the accuracy and efficiency of our estimator, which outperforms \textit{both biased and unbiased} simulation estimators in the literature in terms of root mean squared error (RMSE) and computational time. This paper is focused primarily on the simulation of SDEs which arise in finance, but this new simulation approach has potential for applications in other contextual areas in operations research, such as queuing theory. Note: this is an earlier version of the work "Efficient Simulation of Generalized SABR and Stochastic Local Volatility Models based on Markov Chain Approximations".
Einflussfaktoren Von CDS-Spreads Als Maß Für Das Aktuelle Bonitätsrisiko: Liefert Das Rating Eine Erklärung? (Factors Influencing CDS-Spreads)
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German Abstract: Die vorliegende Arbeit untersucht, welche Faktoren einen Einfluss auf die Beurteilung der Zahlungsfähigkeit eines Unternehmens haben. Dazu werden zwei empiri- sche Untersuchungen durchgeführt. Zunächst wird geklärt, welche makroökonomischen Fak- toren und unternehmensspezifischen Kennzahlen einen expliziten Einfluss auf die Beurteilung der Zahlungsfähigkeit von Unternehmen haben. Als Indikator für die Bonität eines Unter- nehmens werden fünfjährige Credit-Default-Swap-Spreads (CDS-Spreads) herangezogen. Es kann gezeigt werden, dass ausgewählte makroökonomische Variablen einen stärkeren Ein- fluss auf die Preisbildung am CDS-Markt besitzen als Ratings und unternehmensspezifische Kennzahlen. Diejenigen Faktoren, die in der Panel-Studie als signifikant identifiziert werden und täglich messbar sind, werden in einer zweiten Untersuchung auf Wechselwirkungen mit den CDS-Spreads analysiert. Diese Untersuchung gelangt zum Resultat, dass bei kurzfristiger Betrachtung nicht die in der Panel-Analyse als signifikant identifizierten erklärenden Fakto- ren, sondern die Eigendynamik des CDS-Marktes selbst die größten Auswirkungen auf die Bildung der Marktpreise hat. English Abstract: Which factors have an influence on the assessment of companies’ financial solvency? The following study answers this question by means of two empirical analyses. At first, it is clarified which macroeconomic factors and company-specific performance figures have explicit influence on the assessment of companies’ financial solvency. Credit Default Swap Spreads (CDS Spreads) referring to a five-year period are used as the indicator for companies’ credit-worthiness. The analysis concludes that selected macroeconomic variables exhibit a more pronounced influence on price fixing within the CDS market than ratings and company- specific performance figures. Those factors that are identified as being significant in the panel study and, at the same time, allow for daily measurement, are examined for inter-dependencies in a second analysis. This analysis concludes that, in short-term view, not the explaining fac- tors that were identified as being significant in the panel study have the greatest influence on the setting of market prices, but the momentum of the CDS market itself has.
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German Abstract: Die vorliegende Arbeit untersucht, welche Faktoren einen Einfluss auf die Beurteilung der Zahlungsfähigkeit eines Unternehmens haben. Dazu werden zwei empiri- sche Untersuchungen durchgeführt. Zunächst wird geklärt, welche makroökonomischen Fak- toren und unternehmensspezifischen Kennzahlen einen expliziten Einfluss auf die Beurteilung der Zahlungsfähigkeit von Unternehmen haben. Als Indikator für die Bonität eines Unter- nehmens werden fünfjährige Credit-Default-Swap-Spreads (CDS-Spreads) herangezogen. Es kann gezeigt werden, dass ausgewählte makroökonomische Variablen einen stärkeren Ein- fluss auf die Preisbildung am CDS-Markt besitzen als Ratings und unternehmensspezifische Kennzahlen. Diejenigen Faktoren, die in der Panel-Studie als signifikant identifiziert werden und täglich messbar sind, werden in einer zweiten Untersuchung auf Wechselwirkungen mit den CDS-Spreads analysiert. Diese Untersuchung gelangt zum Resultat, dass bei kurzfristiger Betrachtung nicht die in der Panel-Analyse als signifikant identifizierten erklärenden Fakto- ren, sondern die Eigendynamik des CDS-Marktes selbst die größten Auswirkungen auf die Bildung der Marktpreise hat. English Abstract: Which factors have an influence on the assessment of companies’ financial solvency? The following study answers this question by means of two empirical analyses. At first, it is clarified which macroeconomic factors and company-specific performance figures have explicit influence on the assessment of companies’ financial solvency. Credit Default Swap Spreads (CDS Spreads) referring to a five-year period are used as the indicator for companies’ credit-worthiness. The analysis concludes that selected macroeconomic variables exhibit a more pronounced influence on price fixing within the CDS market than ratings and company- specific performance figures. Those factors that are identified as being significant in the panel study and, at the same time, allow for daily measurement, are examined for inter-dependencies in a second analysis. This analysis concludes that, in short-term view, not the explaining fac- tors that were identified as being significant in the panel study have the greatest influence on the setting of market prices, but the momentum of the CDS market itself has.
Estimating Nominal Interest Rate Expectations: Overnight Indexed Swaps and the Term Structure
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No-arbitrage dynamic term structure models (DTSMs) have regularly been used to estimate interest rate expectations and term premia, but are beset by empirical challenges. I propose augmenting DTSMs with overnight indexed swap (OIS) rates to better estimate the decomposition along the term structure at daily frequencies. A Gaussian affine DTSM, augmented with 3 to 24-month OIS rates, generates estimates of US expectations that closely correspond to survey-implied measures out to a 10-year horizon and are more stable across sub-samples, compared to existing models. In addition, I provide narrative evidence, in the form of an event study around US unconventional monetary policy announcements, to further exemplify the benefits from OIS augmentation.
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No-arbitrage dynamic term structure models (DTSMs) have regularly been used to estimate interest rate expectations and term premia, but are beset by empirical challenges. I propose augmenting DTSMs with overnight indexed swap (OIS) rates to better estimate the decomposition along the term structure at daily frequencies. A Gaussian affine DTSM, augmented with 3 to 24-month OIS rates, generates estimates of US expectations that closely correspond to survey-implied measures out to a 10-year horizon and are more stable across sub-samples, compared to existing models. In addition, I provide narrative evidence, in the form of an event study around US unconventional monetary policy announcements, to further exemplify the benefits from OIS augmentation.
Evaluation of Multi-Asset Investment Strategies with Digital Assets
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The drastic growth of the cryptocurrencies market capitalization boosts investigation of their diversification benefits in portfolio construction. In this paper with a set of classical and modern measurement tools, we assess the out-of-sample performance of eight portfolio allocation strategies relative to the naive 1=N rule applied to traditional and crypto-assets investment universe. Evaluated strategies include a range from classical Markowitz rule to the recently introduced LIBRO approach, Trimborn et al. (2019). Furthermore, we also compare three extensions for strategies with respect to input estimators applied. The results show that in the presence of alternative assets, such as cryptocurrencies, Mean-Variance strategies under-perform the benchmark portfolio. In contrast, CVaR optimization tends to outperform the benchmark as well as geometric optimization. Furthermore, we find evidence that liquidity-bounded strategies tend to perform very well. Thus, our findings underscore the non-normal distribution of returns as well as the necessity to control for liquidity constraints at alternative assets markets.
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The drastic growth of the cryptocurrencies market capitalization boosts investigation of their diversification benefits in portfolio construction. In this paper with a set of classical and modern measurement tools, we assess the out-of-sample performance of eight portfolio allocation strategies relative to the naive 1=N rule applied to traditional and crypto-assets investment universe. Evaluated strategies include a range from classical Markowitz rule to the recently introduced LIBRO approach, Trimborn et al. (2019). Furthermore, we also compare three extensions for strategies with respect to input estimators applied. The results show that in the presence of alternative assets, such as cryptocurrencies, Mean-Variance strategies under-perform the benchmark portfolio. In contrast, CVaR optimization tends to outperform the benchmark as well as geometric optimization. Furthermore, we find evidence that liquidity-bounded strategies tend to perform very well. Thus, our findings underscore the non-normal distribution of returns as well as the necessity to control for liquidity constraints at alternative assets markets.
FASB was Right: Earnings Beat Cash Flows when Predicting Future Cash Flows
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Do accruals-based accounting earnings provide better information to investors about future operating cash flows than operating cash flows themselves, as predicted by FASB's conceptual framework? The most recent evidence (Nallareddy et al., 2020) is that operating cash flows, when measured correctly using cash ow statement data, consistently outperform earnings. However this evidence is based on \bottom line" earnings, which handicaps earnings by including non-operating components with no corresponding operating cash flow. Operating earnings consistently dominate operating cash flow's predictive ability in a battery of tests, especially after addressing cross-sectional differences among firms.
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Do accruals-based accounting earnings provide better information to investors about future operating cash flows than operating cash flows themselves, as predicted by FASB's conceptual framework? The most recent evidence (Nallareddy et al., 2020) is that operating cash flows, when measured correctly using cash ow statement data, consistently outperform earnings. However this evidence is based on \bottom line" earnings, which handicaps earnings by including non-operating components with no corresponding operating cash flow. Operating earnings consistently dominate operating cash flow's predictive ability in a battery of tests, especially after addressing cross-sectional differences among firms.
Governance by Constraint: The Corporate Governance Implications of an Anomaly
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We study the corporate governance implications of the "beta anomaly," generated by the fact that major equity investors overweight their portfolios toward high-beta stocks because of leverage constraints. We hypothesize that the resulting higher portfolio concentration will increase the monitoring incentives of "leverage-constrained" investors and reduce the agency costs of the firms they own. We test this hypothesis by quantifying a measure of leverage constraint of mutual funds and relating it to their monitoring behavior and the portfolio firms' governance quality. We find that leverage-constrained funds monitor more actively â€" vote more often against management in contentious proposals and are more likely to induce CEO turnovers. Consequently, the portfolio firms have a higher value of cash holdings, lower need to alleviate agency problems through payouts, and higher investment efficiency. These effects are more pronounced as the beta anomaly becomes more acute, i.e., when the security market line gets flattened. We identify a causal effect using extreme fund outflows and the number of nearby banks as instruments for fund leverage constraints.
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We study the corporate governance implications of the "beta anomaly," generated by the fact that major equity investors overweight their portfolios toward high-beta stocks because of leverage constraints. We hypothesize that the resulting higher portfolio concentration will increase the monitoring incentives of "leverage-constrained" investors and reduce the agency costs of the firms they own. We test this hypothesis by quantifying a measure of leverage constraint of mutual funds and relating it to their monitoring behavior and the portfolio firms' governance quality. We find that leverage-constrained funds monitor more actively â€" vote more often against management in contentious proposals and are more likely to induce CEO turnovers. Consequently, the portfolio firms have a higher value of cash holdings, lower need to alleviate agency problems through payouts, and higher investment efficiency. These effects are more pronounced as the beta anomaly becomes more acute, i.e., when the security market line gets flattened. We identify a causal effect using extreme fund outflows and the number of nearby banks as instruments for fund leverage constraints.
How Will the TCJA of 2017 Change the Tax Benefits of Debt? â€" The Unintended Industry Effect of the Cap on Interest Expense
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Using a production-based structural model, calibrated with data for the period 2001-2017, we find that the cap on the deduction of interest expense enshrined in the Tax Cuts and Jobs Act of 2017 reduces the net tax benefits of debt differentially across industries by 1% to 2.2% of un-levered firm-value on average. The new tax provisions make firms’ current capital structure policies considerably less conservative - a typical firm can double its existing interest burden compared to increasing it more than six-fold earlier, before marginal net tax benefits decline; the impact is larger for capital intensive industries that employ more leverage. A change in the mix of factor inputs, that depends on technology flexibility in that industry, can preserve a part of the tax benefits in some industries. Collectively our results show that the well documented positive relationship between firm leverage and physical capital employed will decline on average.
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Using a production-based structural model, calibrated with data for the period 2001-2017, we find that the cap on the deduction of interest expense enshrined in the Tax Cuts and Jobs Act of 2017 reduces the net tax benefits of debt differentially across industries by 1% to 2.2% of un-levered firm-value on average. The new tax provisions make firms’ current capital structure policies considerably less conservative - a typical firm can double its existing interest burden compared to increasing it more than six-fold earlier, before marginal net tax benefits decline; the impact is larger for capital intensive industries that employ more leverage. A change in the mix of factor inputs, that depends on technology flexibility in that industry, can preserve a part of the tax benefits in some industries. Collectively our results show that the well documented positive relationship between firm leverage and physical capital employed will decline on average.
Impact of Fintech Development on Savings, Borrowing and Remittances: A Comparative Study of Emerging Economies
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Fintech is rapidly changing the landscape for financial services in terms of accessibility and affordability, especially in this post-COVID era. Digital finance now has the potential to be a game changer for the nearly two billion financially excluded persons in the developing and emerging world. Non-bank providers such as mobile money services have expanded and are leapfrogging ahead of conventional banking services. This study investigates the linkages between fintech development and demand for financial services using data from the world’s first global ranking of fintech ecosystems - the Global Fintech Index (GFI). The GFI is an industry tool which scores 65 countries based on the size of their fintech ecosystem, the performance, and the business environment. We use a min-max method and geometric mean approach to normalize and weight the GFI Score to assess the effects of fintech development on demand for savings, borrowing, and remittances for 16 of the world’s largest emerging economies. Our results show that the development of fintech ecosystems plays a key role in improving financial inclusion in emerging economies, but considerable heterogeneities still exist across populations in terms of gender, age, education, and socioeconomic status. Regional heterogeneities are also observed, especially when comparing Latin American and Asian economies to other regions of the world. While more developed fintech ecosystems appear to translate to greater accessibility of financial services, additional evidence suggests that access may not directly translate to greater usage of those services. The findings have important implications for key public and private-sector stakeholders in the emerging world, considering the groundbreaking role that fintech and other digital technologies can play in the development of new models for financial inclusion, especially for populations most vulnerable to digital transformations.
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Fintech is rapidly changing the landscape for financial services in terms of accessibility and affordability, especially in this post-COVID era. Digital finance now has the potential to be a game changer for the nearly two billion financially excluded persons in the developing and emerging world. Non-bank providers such as mobile money services have expanded and are leapfrogging ahead of conventional banking services. This study investigates the linkages between fintech development and demand for financial services using data from the world’s first global ranking of fintech ecosystems - the Global Fintech Index (GFI). The GFI is an industry tool which scores 65 countries based on the size of their fintech ecosystem, the performance, and the business environment. We use a min-max method and geometric mean approach to normalize and weight the GFI Score to assess the effects of fintech development on demand for savings, borrowing, and remittances for 16 of the world’s largest emerging economies. Our results show that the development of fintech ecosystems plays a key role in improving financial inclusion in emerging economies, but considerable heterogeneities still exist across populations in terms of gender, age, education, and socioeconomic status. Regional heterogeneities are also observed, especially when comparing Latin American and Asian economies to other regions of the world. While more developed fintech ecosystems appear to translate to greater accessibility of financial services, additional evidence suggests that access may not directly translate to greater usage of those services. The findings have important implications for key public and private-sector stakeholders in the emerging world, considering the groundbreaking role that fintech and other digital technologies can play in the development of new models for financial inclusion, especially for populations most vulnerable to digital transformations.
Investor Heterogeneity and Momentum-based Trading Strategies in China
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The conventional momentum strategy performs poorly overall in China, because stock prices behave very differently when markets are open for trading versus when they are closed. Stocks that are past intraday (overnight) winners persistently outperform those that are past intraday (overnight) losers in the subsequent intraday (overnight) periods. However, the same intraday- (overnight-) momentum strategy suffers dramatically in the subsequent overnight (intraday) periods. Further analysis shows that past intraday (overnight) winners tend to be more (less) speculative stocks which are highly demanded during the day (night). Overall, our results are consistent with investor heterogeneity, and this persistent tug of war virtually eliminate the effectiveness of investors pursuing the momentum-based trading strategy in China.
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The conventional momentum strategy performs poorly overall in China, because stock prices behave very differently when markets are open for trading versus when they are closed. Stocks that are past intraday (overnight) winners persistently outperform those that are past intraday (overnight) losers in the subsequent intraday (overnight) periods. However, the same intraday- (overnight-) momentum strategy suffers dramatically in the subsequent overnight (intraday) periods. Further analysis shows that past intraday (overnight) winners tend to be more (less) speculative stocks which are highly demanded during the day (night). Overall, our results are consistent with investor heterogeneity, and this persistent tug of war virtually eliminate the effectiveness of investors pursuing the momentum-based trading strategy in China.
Jesse / Mehlhorn (2016): Die Aktionärsstruktur Von M&A-Transaktionen Als Erklärungsfaktor Von Kapitalmarktreaktionen â€" Eine Empirische Analyse Am Deutschen Markt (M&A Success and Shareholder Structures of Acquiring Company)
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German Abstract: In dem vorliegenden Beitrag wird der Frage nachgegangen, inwiefern die Erfolgsbeurteilung durch den Kapitalmarkt zum Ankündigungszeitpunkt einer M&A-Transaktion von der Aktio-närsstruktur des übernehmenden Unternehmens abhängig ist. Im Rahmen einer auf den deut-schen Markt fokussierenden Ereignisstudie werden 414 M&A-Transaktionen in einem Unter-suchungszeitraum von fünf Jahren ausgewertet. Die gewonnenen Ergebnisse verdeutlichen, dass der Kapitalmarkt sowohl mit Blick auf die Aktionärskonzentration als auch in Abhän-gigkeit der Aktionärsidentität des akquirierenden Unternehmens den M&A-Erfolg beurteilt.English Abstract: The paper in hand examines whether shareholders judge about the success of M&A on the German capital market distinguishing different shareholder structures of the acquiring companies. Within an event study 414 M&A announcements in an examination period of five years are taken into account. As a result, the success of M&A is dependent on both the share-holder concentration as well as the shareholder identity of the acquiring company.
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German Abstract: In dem vorliegenden Beitrag wird der Frage nachgegangen, inwiefern die Erfolgsbeurteilung durch den Kapitalmarkt zum Ankündigungszeitpunkt einer M&A-Transaktion von der Aktio-närsstruktur des übernehmenden Unternehmens abhängig ist. Im Rahmen einer auf den deut-schen Markt fokussierenden Ereignisstudie werden 414 M&A-Transaktionen in einem Unter-suchungszeitraum von fünf Jahren ausgewertet. Die gewonnenen Ergebnisse verdeutlichen, dass der Kapitalmarkt sowohl mit Blick auf die Aktionärskonzentration als auch in Abhän-gigkeit der Aktionärsidentität des akquirierenden Unternehmens den M&A-Erfolg beurteilt.English Abstract: The paper in hand examines whether shareholders judge about the success of M&A on the German capital market distinguishing different shareholder structures of the acquiring companies. Within an event study 414 M&A announcements in an examination period of five years are taken into account. As a result, the success of M&A is dependent on both the share-holder concentration as well as the shareholder identity of the acquiring company.
Market Manipulation Rules and IPO Underpricing
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Using a large sample of 13,674 initial public offerings (IPOs) from 37 countries, we find that trading rules on market manipulation reduce IPO underpricing. The effect is weaker for IPOs certified by reputable intermediaries, in countries with greater shareholder rights protection, better financial reporting quality, and after the adoption of International Financial Reporting Standards. Better trading rules on market manipulation are also related to higher IPO proceeds, lower investment bank fees, and better long-term post-IPO performance. Our findings are consistent with the notion that exchange trading rules mitigate information asymmetry problems for investors, resulting in lower IPO underpricing.
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Using a large sample of 13,674 initial public offerings (IPOs) from 37 countries, we find that trading rules on market manipulation reduce IPO underpricing. The effect is weaker for IPOs certified by reputable intermediaries, in countries with greater shareholder rights protection, better financial reporting quality, and after the adoption of International Financial Reporting Standards. Better trading rules on market manipulation are also related to higher IPO proceeds, lower investment bank fees, and better long-term post-IPO performance. Our findings are consistent with the notion that exchange trading rules mitigate information asymmetry problems for investors, resulting in lower IPO underpricing.
Measuring Retirement Adequacy in a Dynamic Society
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The determination of retirement adequacy is of interest to governments in setting policies related to government transfers, but different measures can result in different outcomes. This paper uses a broad definition of the components that contribute to retirement adequacy and shows that in aggregate, most countries’ retirees have a satisfactory replacement ratio but a 25% reduction in any of the components contributing to retirement adequacy could significantly change this outcome. The paper demonstrates the need for retirement adequacy determinations to be dynamic to adjust to changes in retirees’ environments, and for the need to adopt a retirement adequacy stress testing methodology when assessing retirement adequacy.
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The determination of retirement adequacy is of interest to governments in setting policies related to government transfers, but different measures can result in different outcomes. This paper uses a broad definition of the components that contribute to retirement adequacy and shows that in aggregate, most countries’ retirees have a satisfactory replacement ratio but a 25% reduction in any of the components contributing to retirement adequacy could significantly change this outcome. The paper demonstrates the need for retirement adequacy determinations to be dynamic to adjust to changes in retirees’ environments, and for the need to adopt a retirement adequacy stress testing methodology when assessing retirement adequacy.
Relationship between Real Exchange Rate and Economic Growth in Asia â€" Pacific Countries
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This study proposes to investigate the link between Real Exchange Rate and Economic Growth in ten Asia - Pacific countries and aims to study how Real Exchange Rate (RER) and Economic Growth (EG) were related to each other. This study decomposed the linear relationship between RER and Economic Growth Variables like FER, GDP, Exports and Imports. It was found that FER, GDP, Exports and Imports did have positive relationship with RER in all the ten sample countries. Real Exchange Rate caused exports in countries like Hong Kong and Thailand. But Japan, the only country, did not report long run relationship between RER and Economic Growth Variables.
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This study proposes to investigate the link between Real Exchange Rate and Economic Growth in ten Asia - Pacific countries and aims to study how Real Exchange Rate (RER) and Economic Growth (EG) were related to each other. This study decomposed the linear relationship between RER and Economic Growth Variables like FER, GDP, Exports and Imports. It was found that FER, GDP, Exports and Imports did have positive relationship with RER in all the ten sample countries. Real Exchange Rate caused exports in countries like Hong Kong and Thailand. But Japan, the only country, did not report long run relationship between RER and Economic Growth Variables.
Tail Index-Linked Annuity: A Longevity Risk Sharing Retirement Plan
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This paper proposes an innovative retirement product with a focus on longevity risk sharing, a contract we refer to as tail index-linked annuity (TILA). Specifically, the proposed TILA pays out variable annual payments, which will be equal to a regular nominal amount when a reference survival index is lower than a predetermined threshold (i.e., normal evolution of longevity risk), and a reduced, index-dependent payment when the threshold is passed (i.e., highly unfavorable evolution of longevity risk). The proposed TILA aims at not only improving the benefits of the policyholders, which has been the focus in recent literature on innovative retirement products, but also reducing the longevity risk exposure of the insurer, particularly for advanced retirement ages. Using real-world mortality data and stochastic multi-population mortality model, we find that the proposed TILA leads to higher expected lifetime utility than regular annuities for policyholders with different degrees of risk aversions. Meanwhile, numerical analysis shows that the proposed TILA could greatly mitigate the solvency risk of the insurer, leading to substantially lower loss probability and expected (tail-) loss than regular annuities in the presence of longevity shock, and therefore could reduce the insurer's required solvency capital under latest solvency regulations.
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This paper proposes an innovative retirement product with a focus on longevity risk sharing, a contract we refer to as tail index-linked annuity (TILA). Specifically, the proposed TILA pays out variable annual payments, which will be equal to a regular nominal amount when a reference survival index is lower than a predetermined threshold (i.e., normal evolution of longevity risk), and a reduced, index-dependent payment when the threshold is passed (i.e., highly unfavorable evolution of longevity risk). The proposed TILA aims at not only improving the benefits of the policyholders, which has been the focus in recent literature on innovative retirement products, but also reducing the longevity risk exposure of the insurer, particularly for advanced retirement ages. Using real-world mortality data and stochastic multi-population mortality model, we find that the proposed TILA leads to higher expected lifetime utility than regular annuities for policyholders with different degrees of risk aversions. Meanwhile, numerical analysis shows that the proposed TILA could greatly mitigate the solvency risk of the insurer, leading to substantially lower loss probability and expected (tail-) loss than regular annuities in the presence of longevity shock, and therefore could reduce the insurer's required solvency capital under latest solvency regulations.
The COVID-19 Pandemic: Supply Chain Disruption, Wealth Effects, and Corporate Responses
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How did the Covid-19 pandemic affect firm-supplier-customer relationships? We find that, by the end of 2020q1, U.S. firms lost as many as 10.3% of their Chinese suppliers, suffering market value losses of up to $1.4 trillion. Affected U.S. firms were unable to relocate their supply chains, leading to lower inventory, sales, and operating performance. In response, these firms tapped the debt market, and partly built cash reserves. Employment decreased by 5.2%. Chinese suppliers suffered milder consequences. Sourcing from a single manufacturing hub has drawbacks, but policymakers should avoid trade tensions because firms face constraints trying to relocate their supply chains.
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How did the Covid-19 pandemic affect firm-supplier-customer relationships? We find that, by the end of 2020q1, U.S. firms lost as many as 10.3% of their Chinese suppliers, suffering market value losses of up to $1.4 trillion. Affected U.S. firms were unable to relocate their supply chains, leading to lower inventory, sales, and operating performance. In response, these firms tapped the debt market, and partly built cash reserves. Employment decreased by 5.2%. Chinese suppliers suffered milder consequences. Sourcing from a single manufacturing hub has drawbacks, but policymakers should avoid trade tensions because firms face constraints trying to relocate their supply chains.
The Effect of Approach/Avoidance Motivation and Gain/Loss-Framing on the Processing of Information Cues by Non-Professional Investors
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Investor judgment and decision-making (JDM) is influenced by several factors. We examine the effect of dispositional goal orientation (approach and avoidance motivation), as well as situational goal orientation (gain- and loss-framing), on non-professional investors’ JDM. 150 business master students have to evaluate in an experiment the relevance of positive and negative information cues and estimate the resulting expected stock price changes. Results show that approach motivation increases the perceived relevance of positive and negative information cues, which in turn results in greater expected stock price changes. The increasing effect that approach motivation has on the perceived relevance of negative information cues is amplified by gain-framing and dampened by loss-framing. Similarly, the effect that the perceived relevance of positive and negative information cues has on expected stock price changes is amplified under gain-framing and dampened under loss-framing. The results contribute to the JDM literature and have practical implications for non-professional investors.
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Investor judgment and decision-making (JDM) is influenced by several factors. We examine the effect of dispositional goal orientation (approach and avoidance motivation), as well as situational goal orientation (gain- and loss-framing), on non-professional investors’ JDM. 150 business master students have to evaluate in an experiment the relevance of positive and negative information cues and estimate the resulting expected stock price changes. Results show that approach motivation increases the perceived relevance of positive and negative information cues, which in turn results in greater expected stock price changes. The increasing effect that approach motivation has on the perceived relevance of negative information cues is amplified by gain-framing and dampened by loss-framing. Similarly, the effect that the perceived relevance of positive and negative information cues has on expected stock price changes is amplified under gain-framing and dampened under loss-framing. The results contribute to the JDM literature and have practical implications for non-professional investors.
The Effect of Institutional Investors on Financial Reporting Comparability in the U.S.: Evidence from Common Institutional Blockholders
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We examine the role of institutional investors, in particular common institutional blockholders, in facilitating the financial reporting comparability of U.S. firms. We define common ownership as a situation where a given institutional investor holds at least 5% of shares in at least two firms in the same industry. We find that common ownership increases the comparability of a firm’s financial statements to those of its industry peers. The effect is stronger when common institutional blockholders invest in a higher number of firms in a given industry, when they hold a longer investment horizon/a larger stake in a firm, and when they rely more on public information. Next, we show that the effect of common ownership on the firm’s reporting comparability takes place through the hiring of industry auditor specialists and discretionary accounting choices (e.g., goodwill impairment, other asset write-downs, and non-recurring items). Finally, common ownership leads to an increased use of accounting-based relative performance evaluation in executive compensation, supporting the argument that common institutional blockholders help improve financial reporting comparability, which allows more efficient monitoring of managers.
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We examine the role of institutional investors, in particular common institutional blockholders, in facilitating the financial reporting comparability of U.S. firms. We define common ownership as a situation where a given institutional investor holds at least 5% of shares in at least two firms in the same industry. We find that common ownership increases the comparability of a firm’s financial statements to those of its industry peers. The effect is stronger when common institutional blockholders invest in a higher number of firms in a given industry, when they hold a longer investment horizon/a larger stake in a firm, and when they rely more on public information. Next, we show that the effect of common ownership on the firm’s reporting comparability takes place through the hiring of industry auditor specialists and discretionary accounting choices (e.g., goodwill impairment, other asset write-downs, and non-recurring items). Finally, common ownership leads to an increased use of accounting-based relative performance evaluation in executive compensation, supporting the argument that common institutional blockholders help improve financial reporting comparability, which allows more efficient monitoring of managers.
The Great Lockdown: Pandemic Response Policies and Bank Lending Conditions
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This study analyses the policy measures taken in the euro area in response to the outbreak and the escalating diffusion of new coronavirus (COVID-19) pandemic. We focus on monetary, microprudential and macroprudential policies designed specifically to support bank lending conditions. For identification, we use proprietary data on participation in central bank liquidity operations, high-frequency reactions to monetary policy announcements, and confidential supervisory information on bank capital requirements. The results show that in the absence of the funding cost relief and capital relief associated with the pandemic response measures, banks’ ability to supply credit would have been severely affected. The results also indicate that the coordinated intervention by monetary and prudential authorities amplified the effects of the individual measures in supporting liquidity conditions and helping to sustain the flow of credit to the private sector. Finally, we investigate the potential real effects of the joint pandemic response measures by estimating the adjustment in labour input variables for firms that in the past have been more exposed to similar policies. We find that, in absence of monetary and prudential policies, the pandemic would lead to a significantly larger decline in firms’ employment.
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This study analyses the policy measures taken in the euro area in response to the outbreak and the escalating diffusion of new coronavirus (COVID-19) pandemic. We focus on monetary, microprudential and macroprudential policies designed specifically to support bank lending conditions. For identification, we use proprietary data on participation in central bank liquidity operations, high-frequency reactions to monetary policy announcements, and confidential supervisory information on bank capital requirements. The results show that in the absence of the funding cost relief and capital relief associated with the pandemic response measures, banks’ ability to supply credit would have been severely affected. The results also indicate that the coordinated intervention by monetary and prudential authorities amplified the effects of the individual measures in supporting liquidity conditions and helping to sustain the flow of credit to the private sector. Finally, we investigate the potential real effects of the joint pandemic response measures by estimating the adjustment in labour input variables for firms that in the past have been more exposed to similar policies. We find that, in absence of monetary and prudential policies, the pandemic would lead to a significantly larger decline in firms’ employment.
The Sustainability Wage Gap
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A large literature documents a positive correlation between a firm’s sustainability or ESG policies and firm value. However, the exact mechanism through which this relation arises remains ambiguous and it is often hard to establish the direction of causation. In this paper we propose and test the Sustainability Wage Gap channel through which firms can benefit from ESG investments by their ability to pay lower wages because of workers’ preferences for sustainable jobs. Using administrative employer-employee matched data from Sweden and a new measure that quantifies the environmental sustainability of different economic activities, we show that workers earn between 10-20% lower wages in more sustainable sectors. Motivated by survey evidence on the heterogeneity of workers’ preferences for sustainable jobs, we also show that this Sustainability Wage Gap is larger for highly talented workers and increasing over time. Providing a battery of additional tests, we argue that our evidence is difficult to reconcile with most alternative interpretations that have been suggested by previous literature.
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A large literature documents a positive correlation between a firm’s sustainability or ESG policies and firm value. However, the exact mechanism through which this relation arises remains ambiguous and it is often hard to establish the direction of causation. In this paper we propose and test the Sustainability Wage Gap channel through which firms can benefit from ESG investments by their ability to pay lower wages because of workers’ preferences for sustainable jobs. Using administrative employer-employee matched data from Sweden and a new measure that quantifies the environmental sustainability of different economic activities, we show that workers earn between 10-20% lower wages in more sustainable sectors. Motivated by survey evidence on the heterogeneity of workers’ preferences for sustainable jobs, we also show that this Sustainability Wage Gap is larger for highly talented workers and increasing over time. Providing a battery of additional tests, we argue that our evidence is difficult to reconcile with most alternative interpretations that have been suggested by previous literature.
Who Bears Risk in China's Non-financial Enterprise Debt?
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This paper analyses of how risk is allocated in China's markets for debt issued by non-financial enterprises. Compared to other major corporate bond markets China's is unusual in that unlisted, state-owned enterprises account for a large fraction of the debt issued and that the foundations of the corporate and bankruptcy law are young and still evolving. The implications of these features are described and quantified. The results show that the major changes in relative pricing across different market segments cannot be explained well by standard measures of solvency and liquidity. Rather, the most successful explanation is that major policy actions have had the effect of withdrawing implicit guarantees from private issuers and making more explicit the limits of guarantees afforded to state issuers.
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This paper analyses of how risk is allocated in China's markets for debt issued by non-financial enterprises. Compared to other major corporate bond markets China's is unusual in that unlisted, state-owned enterprises account for a large fraction of the debt issued and that the foundations of the corporate and bankruptcy law are young and still evolving. The implications of these features are described and quantified. The results show that the major changes in relative pricing across different market segments cannot be explained well by standard measures of solvency and liquidity. Rather, the most successful explanation is that major policy actions have had the effect of withdrawing implicit guarantees from private issuers and making more explicit the limits of guarantees afforded to state issuers.
