Forthcoming Articles

Deleting Unreported Innovation

Ping-Sheng Koh, David M. Reeb, Elvira Sojli, Wing Wah Tham, and Wendun Wang

The absence of observable innovation data for a firm often leads us to exclude or classify these firms as non-innovators. We assess the reliability of six methods for dealing with unreported innovation using several different counterfactuals for firms without reported R&D or patents. These tests reveal that excluding firms without observable innovation or imputing them as zero innovators and including a dummy variable can lead to biased parameter estimates for observed innovation and other explanatory variables. Excluding firms without patents is especially problematic, leading to false-positive results in empirical tests. Our tests suggest using multiple imputation to handle unreported innovation.

 

Skin in the Game: Operating Growth, Firm Performance, and Future Stock Returns

Sean Shun Cao, Zhe Wang, and P. Eric Yeung

Prior research documents that asset growth is negatively associated with future firm performance. In contrast, we show that growth financed by product market stakeholders (i.e., “operating growth”) is positively associated with future firm performance. Investors and security analysts under-estimate the positive effects of operating growth on future performance, resulting in return predictability and overly pessimistic earnings forecasts for firms with high operating growth. Future stock returns largely concentrate around subsequent earnings announcements with declining magnitudes, consistent with the error-in-expectation explanation. Results from cross-sectional tests further support the hypothesis that operating growth signals high future performance but investors underreact to it.

 

Do Capital Markets Punish Managerial Myopia? Evidence from Myopic R&D Cuts

Jamie Yixing Tong and Feida (Frank) Zhang

The extant literature provides conflicting arguments — and mixed results — on whether capital markets punish managerial myopia. Using managers’ cutting R&D to meet short-term earnings goals as a research setting, this study reveals that capital markets penalize managerial myopia, especially for firms with high investor sophistication. Moreover, the negative market reactions to managerial myopia are weaker for firms with overinvestment problems. Overall, the results support that security markets are not shortsighted. In a further analysis, we document that compensation, especially earnings-based compensation, could be among the reasons why managers behave myopically.

 

Investor Heterogeneity and Liquidity

Kalok Chan, Si Cheng, and Allaudeen Hameed

Fund flows are more correlated among funds with similar investment horizon, consistent with correlated demand for liquidity. We find that stocks held by institutions with more heterogeneous investment horizon are more liquid and have lower volatility of liquidity. Identification tests confirm the improvement in stock liquidity holds when the increase in investor heterogeneity arises from (a) addition of a stock to the S&P 500 index, and (b) an exogenous shock due to the 2003 tax reform. Additionally, extreme flow-induced trading by institutional funds has a bigger price impact when stocks have less heterogeneous investor base.

 

The Shadow Costs of Illiquidity

Kristy A. E. Jansen and Bas J. M. Werker

We solve a flexible model that captures transactions costs and infrequencies of trading opportunities for illiquid assets to better understand the shadow costs of illiquidity for different origins of asset illiquidity and heterogeneous investor types. We show that illiquidity that results in suboptimal asset allocation carries low shadow costs, whereas these costs are high when illiquidity restricts consumption. As a result, the shadow costs are high for short-term investors, investors who face substantial liquidity shocks, and investors who desire to allocate a large fraction of their wealth to illiquid assets.

Taxing the Disposition Effect: The Impact of Tax Awareness on Investor Behavior

William J. Bazley, Jordan Moore, and Melina Murren Vosse

Standard portfolio choice models predict that investors consider the tax implications of trading. However, individuals are disposed toward realizing gains and holding losing investments, behaviors that worsen their performance. We show, in an experimental market, that increasing tax salience reduces the disposition effect between 22% and 47%, leading to higher portfolio balances without increasing total trading activity. Using field data, we find that investors’ disposition is sensitive to taxes around tax rate changes, when taxes are likely salient. Our analysis demonstrates that increasing tax awareness can affect households’ portfolio choices, which suggests policy implications for improving financial decision-making.

The Digital Credit Divide: Marketplace Lending and Entrepreneurship

Douglas Cumming, Hisham Farag, Sofia Johan, and Danny McGowan

We conjecture that marketplace lending provokes an increase in the quantity of entrepreneurship, particularly in more regionally disadvantaged areas, albeit at lower average quality. Using a fuzzy regression discontinuity design that exploits exogenous variation in borrowers’ access to marketplace loans along US state borders, we estimate a 10% increase in marketplace lending causes a 0.44% increase in business establishments per capita. The effects are more pronounced for less experienced entrepreneurs, for small and less profitable firms, firms more dependent upon external finance, in industries with lower sunk costs of entry, and for low-income regions with inferior access to financial institutions.

Does CEO Succession Planning (Disclosure) Create Shareholder Value?

John J. McConnell and Qianru Qi

Average cumulative abnormal returns around proxy statements containing “in-depth” disclosures of planning for CEO succession are significantly positive indicating that succession planning is a value-added undertaking. Exploiting a quasi-natural experiment based on a 2009 SEC ruling that induced more succession planning disclosures, we find that succession planning is not value-adding for all firms. Rather, succession planning is value-enhancing for larger, more complex, and more stable firms. Importantly, CEO succession planning appears to be value reducing for smaller, simpler, less stable firms.