Forthcoming Articles

Creditor Rights and Bank Loan Losses

Amanda Rae Heitz and Gans Narayanamoorthy

We develop hypotheses regarding the association between two types of creditor rights and bank loan losses.  Contrary to prior research conclusions, bank lending risk is negatively associated with both restrictions on reorganization and the secured creditor being paid first.  Using accounting disclosures, we develop novel empirical measures of the probability of default (PD) and loss given default (LGD) at the loan portfolio-level.  Different types of creditor rights have differential effects pertaining to PD and LGD and exhibit significant intertemporal variation.  We corroborate our cross-country findings using the Bankruptcy Abuse Prevention and Consumer Protection Act shock to creditor rights.

Neglecting Peter to Fix Paul: How Shared Directors Transmit Bank Shocks to Non-Financial Firms

Leonid Pugachev and Andrea Schertler

We trace a corporate governance channel of bank shock transmission into the real economy. Using 1,245 U.S. bank enforcement actions (EAs) issued between 1990 and 2017, we show that when a non-financial firm (NFF) and bank share a common director, NFF stock prices fall around bank EAs. Severe EAs elicit more negative returns. During enforcement, valued directors substitute NFF board meeting attendance with bank board meeting attendance. Impaired credit relationships, director reputational damage, and endogenous director selection cannot fully explain our results. These findings imply that shared directors could transmit larger bank shocks into the real economy.

Stakeholder Orientation and the Cost of Debt: Evidence from State-Level Adoption of Constituency Statutes

Huasheng Gao, Kai Li, and Yujing Ma

We examine the causal effect of stakeholder orientation on firms’ cost of debt. Our test exploits the staggered state-level adoption of constituency statutes, which allows directors to consider stakeholders’ interests when making business decisions. We find a significant drop in loan spreads for firms incorporated in states that adopted such statutes relative to firms incorporated elsewhere. We further show that constituency statutes reduce the cost of debt through the channels of mitigating conflicts of interest between residual and fixed claimants and between holders of liquid claims and holders of illiquid claims, limiting legal liability, and lowering takeover threats.

Algorithmic Trading and Market Quality: International Evidence

Ekkehart Boehmer, Kingsley Fong, and Juan (Julie) Wu

We study the effect of algorithmic trading (AT) on market quality between 2001 and 2011 in 42 equity markets around the world. We use exchange co-location service that increases AT as an exogenous instrument to draw causal inferences of AT on market quality. On average, AT improves liquidity and informational efficiency but increases short-term volatility. Importantly, AT also lowers execution shortfalls for buy-side institutional investors. Our results are surprisingly consistent across markets and thus across a wide range of AT environments. We further document that the beneficial effect of AT is stronger in large stocks than in small stocks.

Liquidity Regulation and Financial Intermediaries

Marco Macchiavelli and Luke Pettit

The Liquidity Coverage Ratio (LCR) requires banks to hold enough liquidity to withstand a 30-day run. We study the effects of the LCR on broker-dealers, the financial intermediaries at the epicenter of the 2007–2009 crisis. The LCR brings some financial stability benefits, including a significant maturity extension of triparty repos backed by lower-quality collateral, and the accumulation of larger liquidity pools. However, it also leads to less liquidity transformation by broker-dealers. We also discuss the liquidity risks not addressed by the LCR. Finally, we show that a major source of fire-sale risk was self-corrected before the introduction of post-crisis regulations.

Why Did the Investment-Cash Flow Sensitivity Decline over Time?

Zhen Wang and Chu Zhang
We propose an explanation for why corporate investment used to be sensitive to cash flow and why the sensitivity declined over time. The sensitivity results from the informational role of cash flow in inferring the productivity of tangible capital in the old economy. Over time, more new-economy firms enter the market, which have reduced tangible capital productivity and reduced cash flow predictability. Theoretical and empirical analyses support the notion that the average investment-cash flow sensitivity declined as a result of declined tangible capital productivity and declined predictive power of current cash flow for future cash flow.

 

Portfolio Choice: Familiarity, Hedging, and Industry Bias

Xin Che, Andre P. Liebenberg, and Andrew A. Lynch
Investors may under-diversify their portfolios by overweighting securities in which they perceive an informational advantage or by underweighting securities to hedge risks outside the portfolio. We investigate under-diversification in institutional portfolio construction by examining the under/overweighting of industries in U.S. Property-Liability (PL) insurers’ equity portfolios. We find that PL insurers underweight their own industry in their portfolios, as well as highly correlated industries. This underweighting is larger for PL insurers exposed to higher underwriting risk. While PL insurers have an informational advantage in investing in their peers, their underwriting risk drives them to underweight stocks in their industry.

Institutional Debt Holder Governance

Aneel Keswani, Anh Tran, and Paolo Volpin
Using data on the universe of US-based mutual funds, we find that two out of five fund families hold corporate bonds of firms in which they also own an equity stake. We show that the greater the fraction of debt a fund family holds in a given firm, the greater its propensity to vote in line with the interests of firm debt holders at shareholder meetings, even when against ISS recommendation. Voting has direct policy consequences as firms that receive more votes in favor of creditors make corporate decisions more in line with the interests of debt holders.

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