Research articles for the 2020-09-12

Analysis of the Vulnerability of the Existing Functioning Principles within the World Economy
Lutsyshyn, Zoriana,Mazur, Mykola,Katrych, Olena
The study focuses on the contemporary realities of globalization trends, the coronary crisis and the principles of the world economy.The paper examines current trends in the world economy, its ability to respond to the challenges of time under uncertain conditions and adaptability to new realities under the influence of the pandemic «COVID-19». The analysis showed that one of the most problematic areas is the fragility of the Western system of economies, over-production of capitalism, which reveals the contradictions, paradoxes and main trends of financial, economic, political, social and resource crisis. Here the world’s major players behind the curtain of the COVID-19 pandemic are trying to improve their economic positions, get out of the long recession and redistribute economic resources, and reformat the nature and directions of cooperation and integration.Such general scientific methods as analysis and synthesis in assessing real GDP and debt to GDP in developed countries and developing countries were used to study the world economic system and financial and economic crises. The historical method was also used in the analysis of conceptual approaches and the development of crises in ge-neral, the statistical method was used in the analysis of statistical data; structural and factor analysis, extrapolation method. This made it possible not only to carry out a comparative analysis of existing trends, but also to identify bottlenecks in the existing mechanisms of the world economic system. To the problematic areas we refer the significant bubble, the fiction of the Anglo-Saxon model of the world’s financial system, the lack of institutions in the world economy and the lack of adequate financial and economic instruments to respond rapidly to pandemics (so-called contingencies) At the same time, it showed a renaissance of the role of the state in a pandemic. Additionally, it provided an opportunity to address the urgency of changing the principles of the current world economic system and to change the philosophy of organization, structure and perception of the world economy as a whole.

Are CEOS Paid Extra for Riskier Pay Packages?
Albuquerque, Ana M.,Albuquerque, Rui A.,Carter, Mary Ellen,Dong, Flora
This paper quantifies the cost of CEO incentive compensation by estimating an elasticity of pay to the variance of pay. Using US CEO compensation data and a variety of empirical approaches, we find that CEOs with riskier pay packages are paid more. However, increasing incentives by 20% is associated with an increase in expected pay of only 2%, on average. This small elasticity suggests that incentive pay is not too costly for firms as these seem to be able to substitute incentive pay for salary. In the context of a theorical model, we show that the small elasticity implies a low risk aversion coefficient for CEOs.

Banking Sector Performance During the COVID-19 Crisis
Demirgüç-Kunt, Asli,Pedraza, Alvaro,Ruiz Ortega, Claudia
This paper analyzes bank stock prices around the world to assess the impact of the COVID-19 pandemic on the banking sector. Using a global database of policy responses during the crisis, the paper also examines the role of financial sector policy announcements on the performance of bank stocks. Overall, the results suggest that the crisis and the countercyclical lending role that banks are expected to play have put banking systems under significant stress, with bank stocks underperforming their domestic markets and other non-bank financial firms. The effectiveness of policy interventions has been mixed. Measures of liquidity support, borrower assistance, and monetary easing moderated the adverse impact of the crisis, but this is not true for all banks or in all circumstances. For example, borrower assistance and prudential measures exacerbated the stress for banks that are already undercapitalized and/or operate in countries with little fiscal space. These vulnerabilities will need to be carefully monitored as the pandemic continues to take a toll on the world’s economies.

Bankruptcy and the COVID-19 Crisis
Wang, Jialan,Yang, Jeyul,Iverson, Benjamin Charles,Kluender, Raymond
We examine the impact of the COVID-19 economic crisis on business and consumer bankruptcies in the United States using real-time data on the universe of filings. Historically, bankruptcies have closely tracked the business cycle and contemporaneous unemployment rates. However, this relationship has reversed during the COVID-19 crisis thus far. While aggregate filing rates were very similar to 2019 levels prior to the severe onset of the pandemic, filings by consumers and small businesses dropped dramatically starting in mid-March, contrary to media reports and many experts' expectations. The total number of bankruptcy filings is down by 27 percent year-over-year between January and August. Consumer and business Chapter 7 filings rebounded moderately starting in mid-April and stabilized around 20 percent below 2019 levels, but Chapter 13 filings remained at 55-65 percent below 2019 levels through the end of August. In contrast to the 2007-9 recession, states with a larger increase in unemployment between April and July experienced greater drops in bankruptcies. Although they make up a small share of overall bankruptcies, Chapter 11 filings by large corporations have increased since 2019, and are up nearly 200 percent year-over-year from January through August. These patterns suggest that the financial experiences of consumers, small businesses, and large corporations have diverged during the COVID-19 crisis. Large businesses have continued to seek and receive relief from the bankruptcy system as they would during a normal recession, and relatively wealthy homeowners have on average benefited from the fiscal stimulus and housing moratoria mandated by the CARES Act and other policies. However, non-homeowners and small businesses may face financial, physical, and technological barriers to accessing the bankruptcy system, especially in the areas hardest-hit by unemployment.

Beyond Pangloss: Financial Sector Origins of Inefficient Economic Booms
Malherbe, Frederic,McMahon, Michael
Government guarantees to banks are ubiquitous. We study an equilibrium model where, in the presence of such guarantees, the equilibrium allocation can be characterised as Panglossian: it corresponds to that of a deterministic economy where the best possible state always occurs. However, GDP is inefficiently high and expected consumption inefficiently low. Financial sophistication magnifies this distortion, taking the allocation beyond the Panglossian outcome (i.e. with even higher GDP and even lower expected consumption). We argue that this mechanism is empirically relevant for advanced economies and suggest that the Great Recession, partly, reversed a Great Distortion.

Comparing Forecast Performance with State Dependence
Odendahl, Florens,Rossi, Barbara,Sekhposyan, Tatevik
We propose a novel forecast comparison methodology to evaluate models' relative forecasting performance when the latter is a state-dependent function of economic variables. In our bench¬mark case, the relative forecasting performance, measured by the forecast loss differential, is modeled via a threshold model. Importantly, we allow the threshold that triggers the switch from one state to the next to be unknown, leading to a non-standard test statistic due to the presence of a nuisance parameter. Existing tests either assume a constant out-of-sample forecast performance or use non-parametric techniques robust to time-variation; consequently, they may lack power against state-dependent predictability. Importantly, our approach is applicable to point forecasts as well as predictive densities. Monte Carlo results suggest that our proposed test statistics perform well in finite samples and have better power than existing tests in selecting the best forecasting model in the presence of state dependence. Our test statistics uncover "pockets of predictability" in U.S. equity premia forecasts; the pockets are a state-dependent function of stock market volatility. Models using economic predictors perform significantly worse than a simple mean forecast in periods of high volatility, but, in periods of low volatility, the use of economic predictors may lead to small forecast improvements.

Corporate Bond Liquidity During the COVID-19 Crisis
Kargar, Mahyar,Lester, Benjamin R.,Lindsay, Daivd,Liu, Shuo,Weill, Pierre-Olivier,Zúñiga, Diego
We study liquidity conditions in the corporate bond market during the COVID-19 pandemic, and the effects of the unprecedented interventions by the Federal Reserve. We find that, at the height of the crisis, liquidity conditions deteriorated substantially, as dealers appeared unwilling to absorb corporate debt onto their balance sheets. In particular, we document that the cost of risky-principal trades increased by a factor of five, forcing traders to shift to slower, agency trades. The announcements of the Federal Reserve's interventions coincided with substantial improvements in trading conditions: dealers began to "lean against the wind" and bid-ask spreads declined. To study the causal impact of the interventions on market liquidity, we exploit eligibility requirements for bonds to be purchased through the Fed's corporate credit facilities. We find that, immediately after the facilities were announced, trading costs for eligible bonds improved significantly while those for ineligible bonds did not. Later, when the facilities were expanded, liquidity conditions improved for a wide range of bonds. We develop a simple theoretical framework to interpret our findings, and to estimate how the COVID-19 shock and subsequent interventions affected consumer surplus and dealer profits.

Corporate Governance in the Presence of Active and Passive Delegated Investment
Corum, Adrian Aycan,Malenko, Andrey,Malenko, Nadya
We examine the governance role of delegated portfolio managers. In our model, investors decide how to allocate their wealth between passive funds, active funds, and private savings, and asset management fees are endogenously determined. Funds' ownership stakes and asset management fees determine their incentives to engage in governance. Whether passive fund growth improves aggregate governance depends on whether it crowds out private savings or active funds. In the former case, it improves governance even if accompanied by lower passive fund fees, whereas in the latter case, it improves governance only if it does not increase fund investors' returns too much. Regulations that decrease funds' costs of engaging in governance may decrease total welfare. Moreover, even when such regulations are welfare improving and increase firm valuations, they can be opposed by both fund investors and fund managers.

Currency-Induced External Balance Sheet Effects at the Onset of the Covid-19 Crisis
Hale, Galina,Juvenal, Luciana
At the onset of the COVID-19 economic crisis, as in other crisis episodes, the flight to safety

Disclosure Regulation, Investor Behavior, and Market Integration: Evidence from Form 20-F Reconciliation Elimination
Kim, Yongtae,Pinto, Jedson,Sul, Edward
In 2007, the SEC eliminated the Form 20-F reconciliation requirement for cross-listed firms that prepare financial statements under IFRS (IFRS filers). We examine the effect of this elimination on investors’ information acquisition decisions and how accounting information is used across multiple markets. Using a difference-in-differences analysis with non-IFRS filers as a control sample, we show that investors download fewer Form 20-F filings after the elimination, if IFRS filers’ 20-Fs are filed with a significant delay. Consistent with a shift of investors’ attention away from Form 20-Fs to local earnings announcements, we also find greater US market reactions to IFRS filers’ home-country earnings announcements. In addition, we find that the reconciliation elimination increases return co-movement between the US ADR market and IFRS filers’ home-country stock market, especially during months of IFRS filers’ home-country earnings announcements. Our results bring novel insights regarding the cross-market impact of the disclosure policy change.

Financial Returns to Household Inventory Management
Baker, Scott R.,Johnson, Stephanie,Kueng, Lorenz
Households tend to hold substantial amounts of non-financial assets in the form of inventory. Households can obtain significant financial returns from strategic shopping and optimally managing these inventories of consumer goods. In addition, they choose to maintain liquid savings - household working capital - not just for precautionary motives but also to support this inventory management. We demonstrate that households earn high returns from inventory management at low levels of inventory, though returns decline rapidly as inventory levels increase. We provide evidence using scanner and survey data that supports this conclusion. High returns from inventory management that are declining in wealth offer a new rationale for poorer households not to participate in risky financial markets, while wealthier households invest in both financial assets and working capital.

Gender Diversity Goals, Supply Constraints, and the Market for Seasoned Female Directors: The U.S. Evidence
Boyallian, Patricia,Dasgupta, Sudipto,HomRoy, Swarnodeep
We show that over the last decade, growing public pressure for board gender diversity and awareness of gender equality issues in the U.S. has manifested in "seasoned" female board members accumulating multiple board appointments at a rate faster than seasoned male directors. The larger firms have been the most active in attracting seasoned female directors, at the expense of the smaller firms. This has likely contributed to the smaller firms lagging behind the larger firms in the pursuit of more gender balance. Our evidence is highly consistent with "supply constraints", as reflected in high costs of recruiting first-time female directors, which the larger firms manage to avoid and the smaller firms find too costly to incur. Gender quota mandates are likely to expose the smaller firms even more to these costs; however, the absence of mandates may also not be optimal. Given growing public pressure, it may be necessary to mandate that larger firms maintain the ratio of first-time to seasoned female appointments above some level.

Global Business and Financial Cycles: A Tale of Two Capital Account Regimes
Acalin, Julien,Rebucci, Alessandro
Using a new equity price-based measure of the global financial cycle, this paper evaluates the relative importance of global financial shocks for quarterly equity returns and output growths in a large sample of advanced and emerging economies, as well as in South Korea and China--two countries on different sides of the trilemma triangle of international finance. We document that global financial shocks in both China and South Korea explain a substantial share of equity return variability (20 and 50 percent of total variance, respectively), but a much smaller portion of real output fluctuations (less than 10 percent in Korea and negligible in the case of China). We also find that the combination of a closer capital account and a more rigid exchange rate regime, as in China, is associated with some costs in terms of diversification opportunities quantified by very large exposures to domestic financial and real shocks, dwarfing the contribution of any other shock in the model. More surprisingly, the combination of a relatively open capital account and a flexible exchange rate, as in South Korea, not only is associated with a higher exposure to the global financial cycle than in China but also with a significant incidence of domestic financial shocks on output fluctuations.

Network Centrality and Managerial Market Timing Ability
Evgeniou, Theodoros,Peress, Joel,Vermaelen, Theo,YUE, Ling
We document that long-run excess returns following announcements of share buyback authorizations and insider purchases are a U-shape function of firm centrality in the input-output trade flow network. These results conform to a model of investors endowed with a large but finite capacity for analyzing firms. Additional links weaken insiders' informational advantage in peripheral firms (simple firms whose cash flows depend on few economic links) provided investors' capacity is large enough, but eventually amplify that advantage in central firms (firms with many links) due to investors' limited capacity. These findings shed light on the sources of managerial market timing ability.

Organizing Insurance Supply for New and Undiversifiable Risks
Alary, David,Bobtcheff, Catherine,Haritchabalet, Carole
This paper explores how insurance companies can coordinate to extend their joint capacity for the coverage of new and undiversifiable risks. The undiversifiable nature of such risks causes a shortage of insurance capacity and their limited knowledge makes learning and information sharing necessary. We develop a unified theoretical model to analyse co-insurance agreements. We show that organizing this insurance supply amounts to sharing a common value divisible good between capacity constrained and privately informed insurers with a reserve price.

Pandemics, Vaccines and Corporate Earnings
Hong, Harrison G.,Kubik, Jeffrey D.,Wang, Neng,Xu, Xiao,Yang, Jinqiang
We estimate a model of damage to corporate earnings from COVID-19. An unexpected pandemic lowers current earnings due to costly mitigation and reduces growth rates. Damage depends on the expected arrival of a vaccine that reverts earnings to normal. Using this model, we infer from analysts' earnings forecasts that, as of mid-May 2020, an effective vaccine is expected in 0.96 years (95% bootstrap CI [0.72,1.72]). Growth rates are on average 25% lower during the pandemic. Levered and face-to-face industries would benefit the most from a vaccine arrival. Analysts' expectations imply that the vaccine expected for the middle of 2021 is a silver bullet for corporate earnings.

Security Design with Status Concerns
Basak, Suleyman,Makarov, Dmitry,Shapiro, Alex,Subrahmanyam, Marti G.
This paper provides a status-based explanation for convertible securities. An entrepreneur with status concerns inducing risk-taking decides how to finance the firm and how to dynamically manage it. Solving analytically for the optimal security, we find that it is substantially similar to a convertible security. Our model can explain why convertible securities are mainly issued by start-ups and small firms, as we show that their salient characteristics, higher volatility and dynamic flexibility, accentuate incentives to issue convertible securities. We also provide analytical results relevant to quantifying how status concerns affect credit risk,

Signaling, Random Assignment, and Causal Effect Estimation
Chemla, Gilles,Hennessy, Chris
Causal evidence from random assignment has been labeled "the most credible." We argue it is generally incomplete in finance/economics, omitting central parts of the true empirical causal chain. Random assignment, in eliminating self-selection, simultaneously precludes signaling via treatment choice. However, outside experiments, agents enjoy discretion to signal, thereby causing changes in beliefs and outcomes. Therefore, if the goal is informing discretionary decisions, rather than predicting outcomes after forced/mistaken actions, randomization is problematic. As shown, signaling can amplify, attenuate, or reverse signs of causal effects. Thus, traditional methods of empirical finance, e.g. event studies, are often more credible/useful.

The Fed Takes on Corporate Credit Risk: An Analysis of the Efficacy of the Smccf
Gilchrist, Simon,Wei, Bin,Yue, Zhanwei,Zakrajsek, Egon
We evaluate the efficacy of the Secondary Market Corporate Credit Facility (SMCCF), a program designed to stabilize the corporate bond market in the wake of the Covid-19 shock. The Fed announced the SMCCF on March 23 and expanded the program on April 9. Regression discontinuity estimates imply that these announcements reduced credit spreads on bonds eligible for purchase 70 basis points. We refine this analysis by constructing a sample of bonds--issued by the same set of companies--which differ in their SMCCF eligibility. A diff-in-diff analysis shows that both announcements had large effects on credit spreads, narrowing spreads 20 basis points on eligible bonds relative to their ineligible counterparts within the same set of issuers across the two announcement periods. The March 23 announcement also reduced bid-ask spreads ten basis points within ten days of the announcement. By lowering credit spreads and improving liquidity, the April 9 announcement had an especially pronounced effect on "fallen angels.'' The actual purchases lowered credit spreads by an additional five basis points and bid-ask spreads by two basis points. These results confirm that the SMCCF made it easier for companies to borrow in the corporate bond market.

The International Aspects of Macroprudential Policy
Forbes, Kristin J.
Countries are using macroprudential tools more actively with the goal of improving the resilience of their broader financial systems. A growing body of evidence suggests that these tools can accomplish specific domestic goals and should reduce country vulnerability to many domestic and international shocks. The evidence also suggests, however, that these policies are not an elixir. They will not insulate economies from volatility and they generate leakages to the non-bank financial system and spillovers through international borrowing, lending and other cross-border exposures. Some of these unintended consequences can mitigate the effectiveness of macroprudential policies and generate new vulnerabilities and risks. The "Corona Crisis" provides a lens to evaluate the effectiveness of current macroprudential regulations during a period of extreme market volatility and economic stress. Experience to date suggests that macroprudential tools provide some benefits and should remain a focus of macroeconomic policy, but with realistic expectations about what they can accomplish.

The Performance of the U.S. Energy Sector and Equity Based Portfolios
Gurrib, Ikhlaas
This paper taps into the use of energy sector based portfolios, as opposed to the traditional equity based portfolios. Key contributions are in terms of assessing (i) which U.S. sectors are best to combine with the energy sector, (ii) how a sector based portfolio’s risk and return differ from an equity based one, and (iii) how the COVID-19 event affected the performance of a sector based portfolio, as opposed to an equity based one. The methodology utilizes the traditional Markowitz mean-variance framework to obtain optimized portfolio combinations, rolling correlation to capture the stability in correlations, Sharpe and Sortino measures to capture portfolio performance, and event analysis to capture the effect of COVID-19 on our portfolios. Monthly data ranging from sector based exchange traded funds (ETFs) and equity prices are sourced, spanning from September 2001 to June 2020. Findings suggest (i) the utilities sector to consistently be the most appropriate asset mix for a portfolio comprising of the energy sector, (ii) an Equity based portfolio was superior in performance than its Sector based counterpart, after adjusting for total and downside risk (iii) both Sector and Equity based portfolios shared similar impacts from the COVID-19 event, with the Equity based portfolio maintaining a superior portfolio performance in both pre and post COVID-19.

The Social Value of Debt in the Market for Corporate Control
Burkart, Mike,Lee, Samuel,Petri, Henrik
How should bidders fi nance tender offers when the objective of the takeover is to improve incentives? In such a setting, debt fi nance has bene fits even when bidders have deep pockets: It ampli es incentive gains, imposes Pareto sharing on bidders and free-riding target shareholders, and makes bidding competition more efficient. High leverage, independent of fi nancing needs, can be privately and socially optimal. Although takeover debt dilutes target shareholders, they may benefi t most from it, especially when bidding is competitive.

True Cost of Immediacy
Hendershott, Terrence,Li, Dan,Livdan, Dmitry,Schürhoff, Norman
Traditional liquidity measures can provide a false impression of the liquidity and stability of financial market trading. Using data on auctions (bids wanted in competition; BWICs) from the collateralized loan obligation (CLO) market, we show that a standard measure of liquidity, the effective bid-ask spread, dramatically underestimates the true cost of immediacy because it does not account for failed attempts to trade. The true cost of immediacy is substantially higher than the observed costs for successful BWICs. This cost gap is higher in lower-rated CLOs and stressful market conditions when failure rates exceed 50%. Across our 2012-2020 sample period for trades in senior CLOs, the observed cost is four basis points (bps) while the true cost of immediacy is 13bps. In stressful periods, such as the COVID-19 pandemic, for junior tranches the observed cost of trading increases from an average of 12bps to 25bps while the true cost of immediacy increases from less than 3% to almost 15%.

Which Firms Benefit from Corporate QE During the Covid-19 Crisis? The Case of the Ecb's Pandemic Emergency Purchase Program
Demirgüç-Kunt, Asli,Horváth, Bálint L.,Huizinga, Harry
Using an event study methodology, this paper examines how European firms have been affected by the announcement of the Pandemic Emergency Purchase Program (PEPP) of the ECB. Firms with an investment-grade rating benefit relatively more as evidenced by higher share prices and lower CDS spreads, which reflects that the ECB is restricted to purchasing investment-grade corporate debt securities. The gains to shareholders relative to the total gains of shareholders and debtholders are negatively related to firm leverage, consistent with the existence of debt overhang. Firms more heavily impacted by the pandemic benefit relatively little from the PEPP, which could reflect that the business models of some of these firms are heavily damaged by the pandemic. Monetary policy in the form of the PEPP and national fiscal responses to the pandemic are shown to be complements in the sense that a strong pre-PEPP fiscal response enhances the potential for the PEPP to positively affect equity and debt valuations.