Forthcoming Articles

Forward-Looking Policy Rules and Currency Premia

Ilias Filippou and Mark P. Taylor

We evaluate the cross-sectional predictive ability of forward-looking monetary policy reaction functions, or Taylor rules, in both statistical and economic terms. We find that investors require a premium for holding currency portfolios with high implied interest rates while currency portfolios with low implied rates offer negative excess returns. Our forward-looking Taylor rule signals are orthogonal to current nominal interest rates and disconnected from carry trade and other currency investment strategies. The profitability of the Taylor rule strategy is mainly driven by inflation forecasts rather than the output gap and is robust to data snooping and a battery of robustness checks.

Unintended Consequences of the Dodd-Frank Act on Credit Rating Risk and Corporate Finance

Bina Sharma, Binay K. Adhikari, Anup Agrawal, Bruno R. Arthur, and Monika K. Rabarison

Prior research finds that Dodd-Frank Act’s regulations on credit rating agencies (CRAs) increase rated firms’ risk of rating downgrades, regardless of their credit quality (see Dimitrov, Palia, and Tang (2015)). Our difference-in-differences estimates suggest that after Dodd-Frank, low-rated firms, which face steep costs from a further downgrade, significantly reduce their debt issuance and investments compared to similar unrated firms. Our results are not driven by credit supply or the financial crisis. They reveal an unintended consequence of Dodd-Frank: Greater regulatory pressure on CRAs leads to negative spillover effects on firms concerned about credit ratings, regardless of their credit quality.

Private Funds for Ordinary People: Fees, Flows & Performance

Timothy J. Riddiough and Jonathan A. Wiley

We study private funds available to retail investors of modest wealth. Our sample covers unlisted REITs for superior cash flow and fee data. Fee structures are skewed toward performance-insensitive components of the compensation contract, particularly front-end loads. The average unlisted REIT underperforms the listed benchmark by 6.5% per year, 5% of which is attributable to fees. Unlisted REITs underperform institutional-grade private equity real estate funds. Fees paid to investment advisors explain fundraising success, while past realized performance does not. The underperformance is consistent with the consequences of managerial conflicts of interest, inadequate governance mechanisms, opaque disclosure, and poor investment advice.

Relative Versus Absolute Performance Evaluation and CEO Decision-Making

Karen H. Wruck and YiLin Wu

We provide new evidence on how performance-based compensation plans affect CEO decision-making, especially risk-taking. Our main finding is that relative performance evaluation (RPE) plans provide incentives for CEOs to make decisions that generate more idiosyncratic performance outcomes; absolute performance evaluation (APE) plans do not. After switches from APE to RPE, the correlation between firm stock return and industry index return falls and firm idiosyncratic risk increases. Further, switches to RPE are followed by larger deviations in financial, investment, and operating policies from industry norms (i.e., more idiosyncratic strategies). All results are opposite for switches to APE.

Blockholder Disclosure Thresholds and Hedge Fund Activism

Guillem Ordóñez-Calafí and Dan Bernhardt

Blockholder disclosure thresholds shape incentives for hedge fund activism, which are jointly determined with real investment and managerial behavior. Uninformed investors value lower thresholds (greater transparency) when the cost of trading against an informed activist outweighs the benefits of the activist’s disciplining of management. Conversely, activists may desire disclosure thresholds if the threat of their participation discourages managerial malfeasance, which is their source of profits. Hedge fund activism can be excessive: if market opacity sufficiently harms uninformed investors, the costs of reduced real investment outweigh the social benefits from managerial disciplining, and society benefits from lower thresholds.

Do Natural Disaster Experiences Limit Stock Market Participation?

Sreedhar T. Bharath and DuckKi Cho

We examine whether natural disaster experiences affect households’ portfolio choice decisions. Using data from the National Longitudinal Survey of Youth 1979, we find that adversely affected households are less likely to participate in risky asset markets. After a disaster shock, households become more risk-averse and lower their expectations on future stock market returns. Such conservative portfolio choices persist even after households relocate to less disaster-prone areas, consistent with risk preferences being altered by disaster experiences. Overall, our evidence suggests that transient but salient experiences can be an important factor in explaining the limited participation puzzle.

The Geography of Information Acquisition

Honghui Chen, Yuanyu Qu, Tao Shen, Qinghai Wang, and David Xiaoyu Xu

Using detailed data on company visits by Chinese mutual funds, we provide direct evidence of mutual fund information acquisition activities and the consequent informational advantages mutual funds establish in local firms. Mutual funds are more likely to visit local and nearby firms both in and outside of their portfolios, but the ease of travel between fund and firm locations can substantially alleviate geographic distance constraints. Company visits by mutual funds are strongly associated with both fund trading activities and fund trading performance. Our results show that geographic constraints and costly information acquisition amplify information asymmetry in financial markets.

Political Uncertainty and Firm Investment: Project-Level Evidence from M&A Activity

Zhenhua Chen, Mehmet Cihan, Candace E. Jens, and T. Beau Page

We study how firms alter investment projects to mitigate exposure to political uncertainty. We examine deal-level merger data and find that, in addition to delaying and forgoing merger announcements, acquirers: shift merger announcements earlier in time to avoid the period between announcement and effective dates overlapping an election, shift targets geographically away from election states, decrease the size of election-year deals, and shift from equity to cash financing for election-year deals. These results are stronger for acquirers with tighter financial constraints and deals more likely to be financed with equity and show financing matters to firms’ responses to election uncertainty.