Forthcoming Articles

Why Do Directors Join Poorly Performing Firms?

Ying Dou and Emma Jincheng Zhang

Prior research has suggested that sitting on the board of a poorly performing firm can be undesirable to directors. Yet, almost 60% of such firms are able to appoint new directors following director departures. Contrary to a quality matching explanation, we do not find that only poorly performing directors join these firms. Upon joining poorly performing firms, directors are more likely to fill leadership positions without necessarily receiving higher pay. These directors subsequently receive career benefits, especially those who are relatively junior in the pool. As such, the evidence is consistent with the leadership positions providing a certification effect.

Short Selling Equity Exchange Traded Funds and Its Effect on Stock Market Liquidity

Egle Karmaziene and Valeri Sokolovski

We examine short selling of equity exchange traded funds (ETFs) using the 2008 short-sale ban. Contrasting the previously documented contractions in bearish strategies during the ban, we find a significant increase in short sales of the largest, most liquid ETF, the S&P 500 Spider. We offer evidence suggesting this upsurge was driven primarily by investors circumventing the ban. We show that the ban’s detrimental effect on stock liquidity was around 30% less severe for the Spider’s constituents. Our results suggest that ETF shorts can substitute for short sales of individual stocks, thereby alleviating short-sale constraints’ adverse effect on liquidity.

Naïve Style-Level Feedback Trading in Passive Funds

Markus Broman

Passive Exchange-Traded Funds (ETFs) are ideally suited to style-level feedback trading because of their high liquidity, ease of short-selling, and pure play on investment styles. I find strong evidence of short-term style momentum trading in ETFs. Institutional investors that use ETFs do not act as arbitrageurs by trading against style momentum. Institutions, especially less sophisticated ones, are themselves style momentum traders. Moreover, recent style-level demand predicts style-level return reversals. These findings suggest that uninformed positive feedback trading by less sophisticated market participants can destabilize financial markets in the short run.

Systemic Banking Crises, Institutional Environment, and Corporate Leverage

Ozde Oztekin

This study examines corporate leverage during systemic banking crises in an international setting including 85 countries from 1987 to 2017. Using the historically determined component of institutions and exogenous variations in institution building, the analyses show that leverage cyclicality varies substantially across institutional settings. Leverage is strongly counter-cyclical under more binding constraints on the capital supply, suggesting important supply effects of such crises on leverage. Weak institutions are more conducive to crises and uncertainty. Leverage counter-cyclicality is more pronounced during crises that coincide with higher uncertainty, whereas leverage is pro-cyclical with stronger legal systems and information sharing in capital markets.

Activist-Appointed Directors

Jun-Koo Kang, Hyemin Kim, Jungmin Kim, and Angie Low

We examine the value impact of independent directors nominated by activists (Activist IDs). Firms appointing Activist IDs experience larger value increases than firms appointing other directors, particularly when Activist IDs have private firm experience and when their nominators remain as shareholders. This value increase persists over a long period and is greater than that of activism events without director appointments. The increase is also higher among firms with greater monitoring needs and entrenched boards. Moreover, the appointments of Activist IDs are greeted more positively by the market, and Activist IDs obtain more favorable shareholder votes and additional future directorships.

Counterparty Risk in Over-the-Counter Markets

Christoph Frei, Agostino Capponi, and Celso Brunetti

We study trading and risk management decisions of banks in over-the-counter markets, accounting for two types of risk: payoff risk from loans and counterparty risk from trading activities. Our model provides empirically supported predictions on the structure of the interbank credit default swap (CDS) market: (i) banks with high default probabilities either buy or sell CDS contracts; (ii) because of the counterparty risk friction, payoff risk is only partially shared; and (iii) safe banks act as intermediaries and help diversify counterparty risk. Banks manage their default probabilities to become creditworthy counterparties, but they do so in a socially inefficient way.

Why Do Mutual Funds Hold Lottery Stocks?

Vikas Agarwal, Lei Jiang, and Quan Wen

We provide evidence regarding mutual funds’ motivation to hold lottery stocks. Funds with higher managerial ownership invest less in lottery stocks, suggesting that managers themselves do not prefer such stocks. The evidence instead supports that managers cater to fund investors’ preference for such stocks. In particular, funds with more lottery holdings attract larger flows after portfolio disclosure compared to their peers, and poorly performing funds tend to engage in risk shifting by increasing their lottery holdings towards year-ends. Funds’ aggregate holdings of lottery stocks contribute to their overpricing.

Credit Ratings and Corporate Information Production: Evidence from Sovereign Downgrades

Sicong Wang and Wensi Xie

Exploiting exogenous variations in corporate ratings due to sovereign credit downgrades and sovereign ceiling policies, we assess how firms respond to a reduction in credit ratings. We find that firms bounded by the sovereign ceiling significantly increase information production in response to a sovereign downgrade. The effects are stronger for firms relying more heavily on external finance and operating in a more opaque environment. Enhanced information production, in turn, affects firms’ subsequent access to bond markets. These findings suggest that firms actively manage information environments to maintain access to public debt markets.