Papers

PUBLICATIONS

Information, Trading, and Product Market Interactions: Cross‐Sectional Implications of Informed Trading, 2008, Journal of Finance 63(1), 379‐413.

I present a simple model of informed trading in which asset values are derived from imperfectly competitive product markets and private information events occur at individual firms. The model predicts that informed traders may have incentives to make information-based trades in the stocks of competitors, especially when events occur at firms with large market shares. In the context of 759 earnings announcements, I use intraday transactions data to test the  hypothesis that net order flow and returns in the stocks of nonannouncing competitors have information content for announcing firms. [LINK]

Convertible Bond Arbitrage, Liquidity Externalities, and Stock Prices, with Darwin Choi and Mila Getmansky, 2009, Journal of Financial Economics 91(2), 227‐251.

In the context of convertible bond issuance, we examine the impact of arbitrage activity on underlying equity markets. In particular, we use changes in equity short interest following convertible bond issuance to identify convertible bond arbitrage activity and analyze its impact on stock market liquidity and prices for the period 1993 to 2006. There is considerable evidence of arbitrage-induced short selling resulting from issuance. Moreover, we find strong evidence that this activity is systematically related to liquidity improvements in the stock.
These results are robust to controlling for the potential endogeneity of arbitrage activity. [LINK]

Firm Diversification and Equilibrium Risk Pooling: The Korean Financial Crisis as a Natural Experiment, with Robert Masson and Taejong Um, 2009, Emerging Markets Review 10(1), 1‐22. Lead article.

We use the Korean Financial Crisis as a natural laboratory for examining interactions among firm diversification, equilibrium capital structure and tail probability events. When the crisis hit in 1997, several major firms, including a large number of highly leveraged conglomerates (Chaebols), experienced bankruptcies. We show how diversified Chaebols obtain higher equilibrium leverage than non-Chaebols (a “cosigner effect”). In the event of a low probability macro-economic shock, the model predicts a systematic change in relative bankruptcy risks of Chaebol firms. To examine this implication, we introduce an empirical methodology that decomposes equilibrium debt into demand, supply and Chaebol-specific factors, for use in a bankruptcy prediction model. We find that the primary cause of Chaebol firm bankruptcies was not idiosyncratic leverage, but leverage systematically related to greater equilibrium access to debt during normal times. [LINK]

Convertible Bond Arbitrageurs as Suppliers of Capital, with Darwin Choi, Mila Getmansky and Brian Henderson, 2010, Review of Financial Studies 23(6), 2492‐2522.

This article examines the potential impact of capital supply on security issuance. We focus on the role of convertible bond arbitrageurs as suppliers of capital to convertible bond issuers. We estimate a simultaneous equations model of demand and supply of convertible bond capital, linking the time series of aggregate convertible bond issuance to measures of capital supply: convertible bond arbitrage hedge fund flows, returns, and a proxy for arbitrageurs’ use of leverage. We find that issuance is positively and significantly related to increases in all three supply measures. To provide further interpretation, we use the September/October 2008 short-selling ban as a natural experiment to examine the impact of an exogenous shock to the supply of capital from arbitrageurs. Results from both empirical approaches provide evidence that the supply of capital from convertible bond arbitrageurs impacts issuance. [LINK]

Voluntary and Mandatory Skin in the Game: Understanding Outside Directors’ Stock Holdings, with Sanjai Bhagat, 2012, European Journal of Finance 18(3‐4), 191‐297. Lead article.

Reprinted in: Cressy, Robert, Douglas Cummings and Chris Mallin, 2013, Entrepreneurship, Finance, Governance and Ethics, Springer.

We examine the determinants of equity ownership by outside directors as well as the relationship between ownership and operating performance. Unlike previous studies of equity ownership by directors, we use hand-collected data on firm-level policies requiring director ownership for S&P 500 firms during the years 2003 and 2005. Ownership requirements allow us to shed further light on the determinants of director holdings and to separate voluntary from mandatory holdings of directors. If ownership requirements reflect optimal ownership levels (from the firm’s perspective), they provide a useful identification tool in the examination of ownership–performance relationships. Our primary findings are that mandatory holdings are unrelated to future performance; this is consistent with the theory that ownership requirements reflect optimal ownership levels. By contrast, voluntary holdings are positively and significantly related to future performance, suggesting that they perform an incentivizing role for directors. [LINK]

Do Investment Banks’ Relationships with Investors Impact Pricing? The Case of Convertible Bond Issues, with Brian Henderson, 2012, Management Science 58(2), 2272‐2291.

This study examines the role of repeat interactions between placement agents (investment banks) and investors in the initial pricing of convertible bonds. Under the assumption that attracting repeat investors can reduce search frictions in primary issue markets, we test the hypothesis that banks’ relationships with investors actually allow more favorable pricing for issuing firms (in contrast to the “favoritism” hypothesis, under which banks use underpricing to reward favored clients). In the empirical analysis we also allow for a potentially important alternative channel through which search frictions might impact initial pricing: expected after-market liquidity. Using a sample of 601 Rule 144A issues for the years 1997-2007, we document robust negative relationships between at-issue discounts and both types of frictions. Our findings suggest that search frictions play a meaningful role in initial convertible bond pricing and, specifically, that intermediaries can add substantial value through repeated interactions with investors. [LINK]

Dynamic Competition, Valuation, and Merger Activity, with Matthew Spiegel, 2013, Journal of Finance 68(1), 125‐172.

We model the interactions between product market competition and investment valuation within a dynamic oligopoly. To our knowledge, the model is the first continuous‐time corporate finance model in a multiple firm setting with heterogeneous products. The model is tractable and amenable to estimation. We use it to relate current industry characteristics with firm value and financial decisions. Unlike most corporate finance models, it produces predictions regarding parameter magnitudes as well their signs. Estimates of the model’s parameters indicate strong linkages between model‐implied and actual values. The paper uses the estimated parameters to predict rivals’ returns near merger announcements. [LINK]

Corporate Leverage, Debt Maturity, and Credit Default Swaps: The Role of Credit Supply, with Alessio Saretto, 2013, Review of Financial Studies 26(5), 1190‐1247.

Does the ability of suppliers of corporate debt capital to hedge risk through credit default swap (CDS) contracts impact firms’ capital structures? We find that firms with traded CDS contracts on their debt are able to maintain higher leverage ratios and longer debt maturities. This is especially true during periods in which credit constraints become binding, as would be expected if the ability to hedge helps alleviate frictions on the supply side of credit markets. [LINK]

Related Securities and Equity Market Quality: The Case of CDS, with Ekkehart Boehmer and Sudheer Chava, 2015, Journal of Financial and Quantitative Analysis 50(3), 509‐541.

We document that equity markets become less liquid and equity prices become less efficient when markets for single-name credit default swap (CDS) contracts emerge. This finding is robust across a variety of market quality measures. We analyze the potential mechanisms driving this result and find evidence consistent with negative trader-driven information spillovers that result from the introduction of CDS. These spillovers greatly outweigh the potentially positive effects associated with completing markets (e.g., CDS markets increase
hedging opportunities) when firms and their equity markets are in “bad” states. In “good” states, we find some evidence that CDS markets can be beneficial. [LINK]

Trader Leverage and Liquidity, with Bige Kahraman, 2017, Journal of Finance 72(4) 1567–1610.

Does trader leverage drive equity market liquidity? We use the unique features of the margin trading system in India to identify a causal relationship between traders’ ability to borrow and a stock’s market liquidity. To quantify the impact of trader leverage, we employ a regression discontinuity design that exploits threshold rules that determine a stock’s margin trading eligibility. We find that liquidity is higher when stocks become eligible for margin trading and that this liquidity enhancement is driven by margin traders’ contrarian strategies. Consistent with downward liquidity spirals due to deleveraging, we also find that this effect reverses during crises. [LINK]

How Does Hedge Designation Impact the Market’s Perception of Credit Risk? with Sriya Anbil and Alessio Saretto, 2019, Journal of Financial Stability 41, 25‐42.

Non-financial corporations typically cite risk management as the primary reason for their derivatives use. If hedging programs are effective, then firms using derivatives should have lower credit risk than those that do not. Consistent with this idea, we find that CDS spreads are lower for firms with derivatives positions that are designated as accounting hedges (typically low basis risk) compared to firms without the accounting hedge designation as well as firms that do not use derivatives. Surprisingly, we find that firms with derivatives positions without a hedge accounting designation have higher CDS spreads than firms that do not hedge with derivatives at all. We do not find evidence that these non-designated positions are associated with future credit realizations, as captured by changes in either credit ratings or CDS spreads. We examine alternative explanations and find evidence that is consistent with a market penalty for high basis risk positions when overall market conditions are poor. [LINK]

Why Does an IPO Impact Rival Firms? with Matthew Spiegel, 2020, Review of Financial Studies 33(7), 3205-324.

IPO firms’ rivals tend to experience performance declines following an IPO in the industry. Why? We estimate a dynamic structural oligopoly model to distinguish among alternative theories that can explain an industry’s evolution post-IPO. We find that most changes in rivals’ performance are due to industry trends that also drive IPOs. However, there are also some “competitive” IPOs where the IPO enhances the IPO firm’s performance, at the expense of competitors. These findings help reconcile prior evidence of average performance reductions of both IPO firms and their rivals with well-known cases in which firms have benefited from going public. [LINK]

Margin Trading and Comovement During Crises, with Bige Kahraman, 2020, Review of Finance 24(4), 813-846.

We exploit threshold rules governing margin trading eligibility in India to identify a causal link between margin trading and increased comovement during crises. Margin trading explains more than one quarter of the increase return comovement that we observe during crises. To understand the mechanisms driving this result, we evaluate the relative importance of stock connections through common brokers (who provide margin financing) versus common margin traders. We find that common brokers are most important. Margin-eligible stocks that are more connected through common brokers experience larger crisis-period increases in pairwise return comovement, especially when those brokers’ clients have experienced recent portfolio losses, when their clients have outstanding margin loans in more volatile stocks, and when the brokers are large. These findings are consistent with Brunnermeier and Petersen (2009), in which initial shocks propagate due to the tightening of margin constraints imposed by financial intermediaries. [LINK]

What Explains Differences in Finance Research Productivity During the Pandemic? With Brad Barber, Wei Jiang, Adair Morse, Manju Puri, and Ingrid Werner, 2021, Journal of Finance 76(4), 1655-1697.

Based on a survey of AFA members, we analyze how demographics, time allocation, production mechanisms, and institutional factors affect research production during the pandemic. Consistent with the literature, research productivity falls more for women and faculty with young children. Independently, and novel, extra time spent teaching (much more likely for women) negatively affects research productivity. Also novel, concerns about feedback, isolation, and health have large negative research effects, which disproportionately affect junior faculty and PhD students. Finally, faculty who express greater concerns about employers’ finances report larger negative research effects and more concerns about feedback, isolation, and health. [LINK]

Business Restrictions and Covid Fatalities (with Matthew Spiegel), 2021, Review of Financial Studies 34(11), 5266-5308.

We collect a time-series database of business and related restrictions for every county in the United States from March through December 2020. We find strong evidence consistent with the idea that employee mask policies, mask mandates for the general population, restaurant and bar closures, gym closures, and high-risk business closures reduce future fatality growth. Other business restrictions, such as second-round closures of low- to medium-risk businesses and personal care/spa services, did not generate consistent evidence of lowered fatality growth and may have been counterproductive. [LINK]

Female Representation in the Academic Finance Profession, with Mila Getmansky Sherman, 2022, Journal of Finance 77(1), 317-365.

We present new data on female representation in the academic finance profession. In our sample of finance faculty at top-100 U.S. business schools during 2009 to 2017, only 16.0% are women. The gender imbalance manifests in several ways. First, after controlling for research productivity, women hold positions at lower ranked institutions and are less likely to be full professors. Results also suggest that they are paid less. Second, women publish fewer papers. This gender gap exists in research quantity, not quality. Third, women have more female coauthors, suggesting smaller publication networks. Time-series data suggest shrinking gender gaps in recent years.[LINK]

INTERNET APPENDIX

All or Nothing? Partial Business Shutdowns and COVID-19 Fatality Growth, with Matthew Spiegel, 2022, PLOS ONE (forthcoming)

Incomplete vaccine uptake and limited vaccine availability for some segments of the population could lead policymakers to consider re-imposing restrictions to help reduce fatalities.  Early in the pandemic, full business shutdowns were commonplace. Given this response, much of the literature on policy effectiveness has focused on full closures and their impact. But were complete closures necessary?  Using a hand-collected database of partial business closures for all U.S. counties from March through December 2020, we examine the impact of capacity restrictions on COVID-19 fatality growth. For the restaurant and bar sector, we find that several combinations of partial capacity restrictions are as effective as full shutdowns. For example, point estimates indicate that, for the average county, limiting restaurants and bars to 25% of capacity reduces the fatality growth rate six weeks ahead by approximately 43%, while completely closing them reduces fatality growth by about 16%.  The evidence is more mixed for the other sectors that we study. We find that full gym closures reduce the COVID-19 fatality growth rate, while partial closures may be counterproductive relative to leaving capacity unrestricted.  Retail closures are ineffective, but 50% capacity limits reduce fatality growth. We find that restricting salons, other personal services and movie theaters is either ineffective or counterproductive.

WORKING PAPERS

Profitable Price Impact: The Case of Convertible Bond Arbitrage, with Milad Nozari and Michael Pascutti, 2020.

We investigate a potential source of profit to convertible bond arbitrageurs that is new to the literature: anticipatory hedging in advance of convertible bond issues. When the reference stock price in a bond contract is determined after a new issue is announced, anticipatory short selling in the underlying stock can result in “profitable price impact” (PPI). Downward stock price pressure prior to bond pricing creates an abnormally cheap embedded call option. Consistent with PPI, we document issuer stock price declines on bond pricing days that are more concentrated during the last hour of trading and are followed by partial adjustments. [LINK]

Misconduct Synergies (with Emmanuel Yimfor), 2020

Do corporate control transactions discipline the labor force?  We use the investment advisory industry as a laboratory to test for evidence of improvements in employee misconduct following M&A events (“misconduct synergies”).  Consistent with synergies, we find that new disclosures of employee misconduct in the combined firm drop by between 25 and 34 percent following mergers.  However, contrary to the idea that better-performing firms tend to purchase poor-performing ones, we find that both targets and acquirers have better misconduct records than the industry’s average firm. Moreover, we find evidence of assortative matching on misconduct, where low (high) misconduct acquirers tend to purchase low (high) misconduct targets. This suggests complementarities, where target and acquirer mechanisms for monitoring and disciplining employees are more effective when used together, consistent with Rhodes-Kropf and Robinson (2008). Indeed, target and acquiring firm employees have similar pre-merger misconduct records on average, but the sensitivity of employment separation to misconduct increases post-merger, suggesting improved disciplinary mechanisms. [LINK]