Forthcoming Articles

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.

EPS-Sensitivity and Mergers

Sudipto Dasgupta, Jarrad Harford, and Fangyuan Ma

Announcements of mergers very often discuss the immediate impact of the deal on the acquirer’s earnings per share (EPS). We argue that the focus on EPS reflects the difficulty of evaluating and communicating deal synergy in M&A practice, and provide supporting evidence. We show that the acquirer’s EPS focus affects how deals are structured, the premium that is paid, and the types of deals that are done. EPS-driven M&A decisions are also associated with costly distortions in the acquirer’s financial and investment policies.

What Can Volatility Smiles Tell Us About the Too Big to Fail Problem?

Phong T. H. Ngo and Diego L. Puente

We exploit the information content of option prices to construct a novel measure of bank tail-risk. We document a persistent increase in tail-risk for the U.S. banking industry following the global financial crisis, except for banks designated as systemically important by the Dodd–Frank Act. We show that this post-crisis difference in tail-risk for large and small banks is consistent with the too-big-to-fail (TBTF) status of large banks being reinforced by the Dodd–Frank designation: Naming the banks whose failure could threaten the financial stability of the U.S. gave investors a list of banks the government deemed as TBTF.

Bringing Innovation to Fruition: Insights from New Trademarks

Lucile Faurel, Qin Li, Devin Shanthikumar, and Siew Hong Teoh

We build a novel comprehensive dataset of new product trademarks as an output measure of product development innovation. We show that risk-taking incentives in CEO compensation motivate this type of innovation and that this innovation improves firm performance. Using an exogenous shock to executive compensation, we find that reductions in stock option compensation cause reductions in new product development. We also find that firms undertaking new product development experience increases in future cash flow from operations and return on assets. These findings suggest the importance of product development innovation to firms and new trademarks as a novel innovation measure.

Withholding Bad News in the Face of Credit Default Swap Trading: Evidence from Stock Price Crash Risk

Jinyu Liu, Jeffrey Ng, Dragon Yongjun Tang, and Rui Zhong

Credit default swaps (CDS) are a major financial innovation related to debt contracting. Because CDS markets facilitate bad news being incorporated into equity prices via cross-market information spillover, CDS availability may curb firms’ information hoarding. We find that CDS trading on a firm’s debt reduces the future stock price crash risk. This effect is stronger in active CDS markets, when the main lenders are CDS market dealers with securities trading subsidiaries, or when managers have more motivation to hoard information. Our findings suggest that debt market financial innovations curtail the negative equity market effects of firms withholding bad news.