Forthcoming Articles

The Real Effects of Equity Markets on Innovation

Chris Mace

In theory, financial markets promote innovation by selectively allocating capital to high-quality projects. In this paper, I show that equity markets can also inhibit innovation.  In public firms, I find that short-term equity market declines cause pharmaceutical companies to abandon early-stage drug developments, irrespective of drug quality or changes in a firm’s stock price. I show that financing constraints drive this behavior, highlighting that even short-term market fluctuations can have long-term effects on pharmaceutical innovation and prevent potentially life-saving drugs from progressing to the market.

The Effect of Organization Capital on the Cost of Bank Loans

Anna Danielova, Bill B. Francis, Haimeng Teng, and Qiang Wu

We find that organization capital is negatively related to the cost of bank loans. This finding is robust to additional analyses including those that address omitted variable bias and reverse causality. In addition, we find that organization capital reduces all-in-spread-undrawn . When we decompose the bank loan cost, we find that organization capital increases facility fees due to its risk-engendering characteristics. Finally, we find that organization capital is positively associated with a high likelihood of the presence of inventors and innovation output, consistent with the argument that organization capital is embedded in the key talent within a firm.

The Growth of Finance Is Not Remarkable

James R. Brown, Gustav Martinsson, and Bruce Petersen

An important literature emphasizes that finance grew rapidly after WWII relative to the full economy and the services sector, but these are poor benchmarks because they mask a broad structural shift from low- to high-skill services. We show that: i) finance is among the most skill-intensive service industries, ii) the evolution of the finance income share closely tracks other high-skill service industries, and iii) finance grew slower than the rest of high-skill services over the past 50 years.  The rise of modern finance is not as remarkable as prior research suggests, providing context for debates about the size of finance.

The Role of Creditor Protection in Lending and Tax Avoidance

Antonio De Vito and Martin Jacob

We examine how creditor rights affect the trade-off between non-debt and debt tax shields. Using four bankruptcy reforms and a panel of private and public firms from Italy, we show that laws empowering creditors reduce tax avoidance and increase debt financing, consistent with firms substituting non-debt tax shields with debt tax shields. We corroborate the validity of our findings using a panel of public firms across 33 countries. Additionally, we document that the impact of creditor protection laws is mitigated by tax system characteristics, which significantly reduce the incentives to substitute tax avoidance with debt.

Indirect Evergreening Using Related Parties: Evidence from India

Nishant Kashyap, Sriniwas Mahapatro, and Prasanna Tantri

We identify a novel way of evergreening loans in India. A low-quality bank lends to a related party of an insolvent borrower, and the loan recipient transfers the funds to the insolvent borrower using internal capital markets. Incremental investments, interest rates charged, and loan delinquency rates collectively indicate evergreening. These loans are unlikely to represent arm’s-length transactions or rescue of troubled related firms by stronger firms to prevent group-wide spillover effects. Indirect evergreening is less likely to be detected by regulatory audits. It has significant real consequences at the firm and industry levels.

ESG Preference, Institutional Trading, and Stock Return Patterns

Jie (Jay) Cao, Sheridan Titman, Xintong (Eunice) Zhan, and Weiming (Elaine) Zhang

Socially responsible (SR) institutions tend to focus more on the ESG performance and less on quantitative signals of value. Consistent with this difference in focus, we find that SR institutions react less to quantitative mispricing signals. Our evidence suggests that the increased focus on ESG may have influenced stock return patterns. Specifically, abnormal returns associated with these mispricing signals are greater for stocks held more by SR institutions. The link between SR ownership and the efficacy of mispricing signals only emerges in recent years with the rise of ESG investing, and is significant only when there are arbitrage-related funding constraints.

Positive Bank-to-Bank Spillovers

Shasta Shakya

This paper provides the first evidence of positive bank-to-bank spillovers. I show that geographic linkages between banks that engage in home lending in the same geographic region transmit positive shocks from one bank to another. I exploit shocks to the deposit base of banks located in counties experiencing shale oil booms and show that a non-shocked bank in a non-boom county expands lending more if its linkages have greater exposure to shale booms. Results show that the shock exposure of linkages has a positive impact on home prices of non-boom counties, and non-shocked banks located therein respond with increased lending.

Derivatives and Market (Il)liquidity

Shiyang Huang, Bart Zhou Yueshen, and Cheng Zhang

We study how derivatives (with nonlinear payoffs) affect the underlying asset’s liquidity. In a rational expectations equilibrium, informed investors expect low conditional volatility and sell derivatives to the others. These derivative trades affect different investors’ utility differently, possibly amplifying liquidity risk. As investors delta hedge their derivative positions, price impact in the underlying drops, suggesting improved liquidity, because informed trading is diluted. In contrast, effects on price reversal are ambiguous, depending on investors’ relative delta hedging sensitivity, i.e., the gamma of the derivatives. The model cautions of potential disconnections between illiquidity measures and liquidity risk premium due to derivatives trading.