Forthcoming Articles

Stock Comovement and Financial Flexibility

Teng Huang, Anil Kumar, Stefano Sacchetto and Carles Vergara-Alert

We develop a dynamic model of corporate investment and financing, in which shocks to the value of collateralizable assets generate variation in firms’ debt capacity. We show that the degree of similarity among firms’ financial flexibility forecasts cross-sectional return correlation. We test the implications of the model using an instrumental variable approach based on shocks to collateralizable corporate assets and the outbreak of the COVID-19 crisis as an event study. We find that firms in the same percentile of the cross-sectional distribution of financial flexibility have 62% higher correlation in stock return residuals than firms 50 percentiles apart.

Online Reputation and Debt Capacity

Francois Derrien, Alexandre Garel, Arthur Petit-Romec, and Jean-Philippe Weisskopf

We explore the effects of online customer ratings on financial policy. Using a large sample of Parisian restaurants, we find a positive and economically significant relationship between customer ratings and restaurant debt. We use the locally exogenous variations in customer ratings resulting from the rounding of scores in regression discontinuity tests to establish causality. Favorable online ratings reduce cash flow risk and increase resilience to demand shocks. Consistent with the view that good online ratings increase the debt capacity of restaurants and their growth opportunities, restaurants with good ratings use their extra debt to invest in tangible assets.

Director Job Security and Corporate Innovation

Po-Hsuan Hsu, Yiqing Lu, Hong Wu, and Yuhai Xuan

In this paper, we show that firms can become conservative in innovation when their directors face job insecurity.  We find that after the staggered enactment of majority voting legislation that strengthens shareholders’ power in director elections, firms produce fewer patents, particularly exploratory patents, and fewer forward citations.  This effect is stronger for directors facing higher dismissal costs or threats and for firms with greater needs for board expertise and is mitigated by institutional investors’ expertise in innovation. Overall, our results suggest that heightened job insecurity induces director myopia, which leads to a reduction in investment in risky, long-term innovation projects.

Getting Back to the Source: A New Approach to Measuring Ex Ante Litigation Risk Using Plaintiff-Lawyer Views of SEC Filings

Antonis Kartapanis and Christopher G Yust

This study introduces a new measure of ex ante litigation risk using scrutiny of SEC filings by the source of securities litigation—plaintiffs’ lawyers—to reduce measurement error, relative to existing measures. We show that plaintiff-lawyer views proxy for the largely unobservable factors that make firms more likely to face litigation risk. Lagged views precede the public bad news revelation that triggers litigation and predict future realized litigation risk (i.e., securities class actions filings and plaintiff-lawyer investigations) and stock market outcomes. Finally, we provide new insights into the plaintiff-lawyer case selection process that otherwise cannot be observed.

Industry Clusters and the Geography of Portfolio Choice

Jawad M. Addoum, Stefanos Delikouras, Da Ke, and George M. Korniotis

Using detailed data on U.S. households’ locations, employment, and financial portfolios, we document that individuals employed in locally clustered industries are more likely to invest in risky assets. This pattern is strongest among individuals with high labor income, employed in skilled occupations, and with strong cognitive skills. Our overall evidence suggests the relation between industry clusters and investment decisions is best explained by clusters enhancing human capital among local industry workers, in turn amplifying their effective risk tolerance. Our findings highlight the important role of local labor market composition in generating household portfolio patterns within and across geographies.

Double Machine Learning: Explaining the Post-Earnings Announcement Drift

Jacob Hald Hansen and Mathias Voldum Siggaard

We demonstrate the benefits of merging traditional hypothesis-driven research with new methods from machine learning that enable high-dimensional inference. Because the literature on post-earnings announcement drift (PEAD) is characterized by a “zoo” of explanations, limited academic consensus on model design, and reliance on massive data, it will serve as a leading example to demonstrate the challenges of high-dimensional analysis. We identify a small set of variables associated with momentum, liquidity, and limited arbitrage that explain PEAD directly and consistently, and the framework can be applied broadly in finance.

Supranational Rules, National Discretion: Increasing versus Inflating Regulatory Bank Capital?

Reint Gropp, Thomas Mosk, Steven Ongena, Ines Simac, and Carlo Wix

We study how banks use “regulatory adjustments” to inflate their regulatory capital ratios and whether this depends on forbearance on the part of national authorities. Using the 2011 EBA capital exercise as a quasi-natural experiment, we find that banks substantially inflated their levels of regulatory capital via a reduction in regulatory adjustments — without a commensurate increase in book equity and without a reduction in bank risk. We document substantial heterogeneity in regulatory capital inflation across countries, suggesting that national authorities forbear their domestic banks to meet supranational requirements, with a focus on short-term economic considerations.

Taking Over the Size Effect: Asset Pricing Implications of Merger Activity

Sara Easterwood, Jeffry Netter, Bradley Paye, and Michael Stegemoller

We show that merger announcement returns account for virtually all of the measured size premium. An empirical proxy for ex ante takeover exposure positively and robustly relates to cross-sectional expected returns. The relation between size and expected returns becomes positive or insignificant, rather than negative, conditional on this takeover characteristic. Asset pricing models that include a factor based on the takeover characteristic outperform otherwise similar models that include the conventional size factor. We conclude that the takeover factor should replace the conventional size factor in benchmark asset pricing models.