Working Papers

max EPS Payout Policy
Itzhak Ben-David and Alex Chinco
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Holding cash has a cost. For an EPS-maximizing CEO, that cost equals her firm's earnings yield. EPS maximizers retain cash when they can get an even higher yield by investing the money. Otherwise, they return cash to shareholders. This is the EPS-maximizing payout policy. Growth stocks (EY < rf) never return cash because they can clear their low earnings-yield hurdle by investing in riskfree bonds. Value stocks (EY > rf) face a higher hurdle, which makes cash their cheapest source of capital but also raises the opportunity cost of retention. Value stocks return cash when they cannot invest in enough high-yield projects to make up for the higher cost. Paradoxically, the firms that are most likely to distribute cash—deep value stocks (EY >> rf)—are also the ones for whom internal cash is cheapest relative to external financing. Dividends and buybacks both deliver the same value to shareholders, but only buybacks can be accretive. Hence, EPS-maximizing CEOs prefer to distribute via buybacks. Some firms pay dividends for reasons outside our model. Such departures should concentrate among marginal value stocks (EY ≈ rf) where the accretive pull of buybacks is weakest. Empirically, this logic explains which firms return cash, how they distribute the money, and time-series trends.

The max EPS Paradigm for Corporate Finance
Itzhak Ben-David and Alex Chinco
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There are three classic problems in corporate finance: capital structure, real investment, and payout policy. In three companion papers, we characterize the max EPS solution to each one. The max EPS approach delivers an optimal leverage ratio even in the absence of frictions, an investment rule based on comparing yields rather than using a risk-adjusted discount rate, and a payout policy where accretive buybacks are preferred to neutral dividends. Our max EPS model draws a bright line between growth and value. Growth stocks have earnings yields below the riskfree rate; value stocks have earnings yields above it. This single comparison leads the two kinds of firms to pursue different constellations of EPS-maximizing policies. The model also produces easy-to-follow calculations that closely mirror what practitioners actually do. This review article ties together these results to form a new max EPS paradigm for corporate-finance research.

Geopolitical Risk in Currency Markets 
Alessandro Melone and Andreas Stathopoulos
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We document that sorting currencies into portfolios on the exposure of their expected returns to the level of global geopolitical turmoil yields a substantial return spread that cannot be explained by loadings to standard currency risk factors. We, then, propose a traded currency factor that reflects global geopolitical risk and show that it is priced in the cross-section of currency returns. Furthermore, we show that geopolitical risk factor loadings are related to the sensitivity of expected capital flows to geopolitical turmoil: countries that tend to attract higher-than-average net capital flows in times of turmoil have currencies that hedge geopolitical risk, whereas countries that experience the opposite have geopolitically risky currencies. In contrast, geopolitical factor loadings are unrelated to the exposure of currency expected returns to measures of policy uncertainty.

On the Recovery of Demand Elasticities in Dynamic Settings
Carter Davis, Mahyar Kargar, Jiacui Li, and Dejanir Silva
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We recover structural demand elasticities in dynamic asset markets. When instruments affect both current prices and expected future demand conditions, static estimates mix contemporaneous and forward-looking demand coefficients. We recover the dynamic demand kernel from instrument-induced response paths under a rank condition. Recovery requires neither observing investors’ expectations or state variables nor adding external instruments beyond those needed for static estimation. In weekly order-flow data, the naive static estimate is about 0.36, compared with a recovered own-price elasticity of about 5. Stock-specific demand is nearly myopic, whereas systematic demand is forward-looking, with cross-portfolio substitution patterns that vary across horizons. Shifting outside-demand shocks toward the market direction substantially amplifies prices and generates cross-asset spillovers.

Complexity Breaks Arbitrage Pricing Theory 
Carter Davis and Alejandro Lopez-Lira
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Arbitrage Pricing Theory predicts pricing errors vanish as markets grow. Three findings reverse this prediction. First, under estimation uncertainty, equilibrium pricing errors scale as 𝑁/𝑡 (number of assets over sample size), with a persistent component from time-varying fundamentals that no estimator can eliminate. Second, the stochastic discount factor loads primarily on estimation errors rather than fundamental risk factors, explaining why risk-based factor models fail to price assets. Third, multiple strategies achieve high Sharpe ratios with low cross-correlations as they exploit distinct dimensions of the growing estimation error space. When investors disagree about expected returns, mispricing persists even with informed investors because risk aversion prevents them from taking sufficiently large positions to eliminate complexity-driven pricing errors. Empirically, individual stock returns require 145 principal components to explain half their variance. Systematic hedge funds’ active positions exhibit near-zero correlations (average 0.07), consistent with exploitation of distinct estimation-error dimensions.

Investment-based Costs of Equity
Yicheng Liu, Chen Xue, and Lu Zhang
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The q 5-characteristics model estimates costs of equity as Lewellen's (2015) out-of-sample forecasts from cross-sectional regressions. The q 5-cost of equity is competitive in evaluation tests, outperforming the accounting implied cost of equity in predicting cross-sectional returns. The q 5-cost of equity is precise at the industry level and aligned with average factor premiums. Its firm-level distribution is weakly left-skewed, whereas the accounting implied cost of equity is right-skewed. However, the accounting cost of equity outperforms in the time series. Factor models perform poorly in out-of-sample tests. Gradient-boosted trees improve on cross-sectional regressions, but not reliably.

When Does Acquisition Integration Succeed? Evidence from Inside the Integration Black Box
Sinan Gokkaya, Xi Liu, and René M. Stulz
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We penetrate the black box of post-acquisition integration by examining whether business unit leaders (BULs)-executives responsible for integrating and operating acquired targets-shape integration outcomes. Using natural language processing-based measures of realized integration outcomes and financial metrics, we find that BULs' target-industry experience increases (decreases) integration success (failures) through superior realization of transaction synergies. Other BUL attributes are unrelated to integration outcomes. Consistent with the importance of integration for acquisition success, such experience enhances acquisition performance. BULs' target-industry experience improves integration planning and their post-acquisition career outcomes but is unrelated to earlier stages of the acquisition process.

The Origins of the Factor Zoo: Investors Weakly Substitute Across Stocks 
Aditya Chaudhry and Carter Davis
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We propose a simple explanation for the “factor zoo” in expected stock returns: investors weakly substitute across individual stocks. In classical asset-pricing models, substitution is strong: investors readily reallocate across assets that comove, so differences in expected returns are explained by the few factors that create the most comovement across stocks. In contrast, we show that substitution is empirically weak using evidence from cross-sectional return predictability, cross-price multipliers, and cross-price elasticities. This weak substitution gives rise to the factor zoo: expected returns depend on many factors, including weak factors that create little comovement. Moreover, weak substitution rationalizes why equilibrium Sharpe ratios remain moderate even though weak factors contribute to expected returns. Additionally, weak substitution implies that misspecified substitution patterns create only small biases in price elasticity and multiplier estimates.

Crimes Against Campbell-Shiller
Itzhak Ben-David and Alex Chinco
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 The Campbell and Shiller (1988) log-linear approximation is widely viewed as a model-free accounting identity that always holds: in sample, in expectation, and under arbitrary subjective beliefs. None of these claims is true. The formula is far from automatic even in realized data. Many companies do not pay dividends, making the calculation ill-defined. For dividend payers, the results are not always what they seem. The formula registers buybacks and new issuance as phantom cash-flow shocks. Taking expectations comes with its own complications. Researchers see the forward-looking version of Campbell-Shiller as a dynamic Gordon model, but this interpretation requires investors to consistently think in present-value terms and to know the cap rate with basis-point precision. Both are strong assumptions that do not always hold in the data. Finally, the formula generically fails under arbitrary subjective beliefs. The exceptions represent knife-edge cases where forecast errors obey a precise adding-up condition. Insisting that Campbell-Shiller always holds makes it harder to learn about the true pricing model in the many cases where it does not.

Organization capital, large startups, and the dearth of IPOs
Rüdiger Fahlenbrach, Leandro Sanz, René M. Stulz
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Many startups in the 2000s have remained private after achieving large valuations, a pattern that funding availability alone cannot explain. We propose that startups relying heavily on organization capital to achieve economies of scale and network effects through digital technologies are more likely to become large private firms than exit earlier via an IPO or acquisition. Using LinkedIn data, we construct a novel measure of organization capital intensity for startups. Exploiting a legal shock that strengthened organization capital protection, we provide causal evidence that organization-capital-intensive startups are more likely to remain private and grow large rather than exit early.

Who Sets the Price? The Vertical Origins of Uniform Pricing
Alvin Chen, Leandro Sanz, and Michael D. Wittry
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Retail prices in U.S. consumer markets are jointly produced by manufacturers and retailers, but we show that the systematic component of price-setting originates primarily upstream. Using manufacturer-product scanner data spanning approximately 5 billion UPC-store-month observations, we decompose retail price variation into manufacturer and retailer components. Manufacturer identity accounts for approximately 90 percent of explained variation in price levels and 97 percent in price changes. Price dispersion is shaped by both layers of the chain, though manufacturers remain the largest source of explained variation. We show that pricing practices change after brand acquisitions: acquired UPCs converge toward the acquirer's incumbent pricing behavior when the acquirer already operates in the target's category, but diverge from the acquirer's broader pricing behavior in expansionary acquisitions. Private-label products, which compress the manufacturer-retailer information wedge, exhibit greater geographic dispersion and responsiveness to local conditions than national brands. Finally, consistent with a reduction in upstream information frictions, products sold by more AI-exposed manufacturers exhibit greater geographic dispersion, more frequent repricing, and lower prices after the introduction of scalable generative AI APIs, with stronger responsiveness to local conditions. The results indicate that retail pricing rigidities reflect upstream informational frictions that technology can relax, rather than immutable features of retail markets.

Consumption Anchors Stock Prices
Carlo A. Favero, Alessandro Melone, Sean Myers, and Andrea Tamoni
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Aggregate stock prices and aggregate consumption share a common stochastic trend. We estimate this long-run relation in real time and recover a price–consumption cycle that captures transitory deviations of stock prices from their consumption-implied value. These deviations mean-revert over business-cycle horizons and predict future returns on the aggregate market and characteristics sorted portfolios, both in- and out-of-sample, from one quarter to two years ahead. The cycle does not forecast consumption growth, but contains information about future dividend growth, and its return-predictive power disappears when consumption is excluded from the long-run relation. A simple model with permanent and transitory consumption shocks rationalizes these findings and the time variation in the estimated price–consumption loading. The evidence identifies consumption as a macroeconomic anchor for asset prices and departures from this anchor as a source of time-varying expected returns.

Investment Targets as Reference Points
Aleksi Pitkäjärvi, Matteo Vacca, and Petra Vokata
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We provide the first evidence of forward-looking reference points in investor behavior. Combining administrative data on option traders with a stacked difference-in-differences design, we show that investors' propensity to sell options spikes precisely when the underlying asset crosses the strike price, which retail investors frequently select to match their target price. The effect is difficult to explain using the standard disposition effect, nominal returns, salience, option Greeks, or complex option trading strategies. Moreover, the effect is present only for options bought out of the money, for which the strike price acts as a natural target, but absent for options bought in the money, for which it does not. The evidence is most consistent with investors evaluating gains and losses relative to a forward-looking target, in sharp contrast with the backward-looking purchase price widely used in the disposition effect literature. Our findings suggest that standard tests of reference dependence in selling decisions are misspecified when investors evaluate outcomes relative to reference points other than the purchase price.

The Cov-lite Liquidity Advantage, Regulatory Pressures, and the Evolution of the Leveraged Loan Market
Robert Prilmeier and René M. Stulz
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Following the global financial crisis (GFC), regulators made it harder for banks to retain leveraged loan exposure. We conjecture their actions increased the share of leveraged loan issuances with no maintenance covenants (cov-lite loans) because such loans are easier to sell. We find that, post-GFC, the share of cov-lite loan issuance increased more for banks facing stricter regulation, failing to pass a stress test outright, or exhibiting greater vulnerability to the severely adverse stress test scenario. We show that, as expected from theory, cov-lite loans have a liquidity advantage that lowers their credit spread and is higher for private firms.

Price Discovery in Private Credit: Evidence from BDCs
Reena Aggarwal, Isil Erel, and Changyang Song
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Business Development Companies (BDCs) combine periodic reporting of illiquid private credit with continuously traded equity, providing a unique setting to evaluate private credit performance. During periods of credit stress, performance drops and stock-to-NAV discounts widen sharply as stock prices fall faster than reported NAVs. Market discounts and pre-announcement stock returns predict subsequent NAV markdowns and weaker profitability, although their predictive power is limited for larger BDCs and those with more diversified portfolios. Crucially, market metrics have limited ability to anticipate discrete distress events such as non-accruals and payment-in-kind (PIK) amendments. We find that quarterly NAV announcements contain significant, value-relevant incremental information that results in immediate stock price reactions.

Investing in Human Capital Incubation
Seung Hyeong Lee, Bryan Seegmiller, Yufeng Wu, and Miao Ben Zhang
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Using U.S. Census Bureau matched employer-employee data, we provide the first direct empirical evidence that firms’ intangible investments raise their employees’ portable human capital, designating these firms as “human capital incubators.” We introduce a model where workers’ preferences for skill development shape labor supply, giving incubators a labor market advantage and an additional motive to invest in intangibles. Consistent with the model, incubation correlates positively with firm profitability, market power, and inflows of young workers. For top-tercile incubators, the present value of incubation is worth about 13% of firm value: roughly 43% of this value is internalized by incubating firms as wage savings, while 57% accrues as a spillover to workers and downstream employers. The aggregate externality across the whole distribution is worth 7% of total income. In a counterfactual equilibrium where workers cannot differentially price firms’ incubation capacity, diminished investment incentives lead to losses in aggregate income, intangible capital stock, and average worker skill.

AI Valuations: Bubble or Fundamentals? 
Kris Shen
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Do high stock valuations during the emergence of a general-purpose technology such as AI reflect price bubbles? I propose a new framework that measures the AI premium gap—the wedge between objective expected returns from full-information econometric benchmarks and subjective expected returns from analyst forecasts, for AI firms relative to non-AI firms. A negative gap is consistent with bubbles. From 2009 to 2024, the gap is positive. Applied to the dot-com era of the 1990s, the same framework yields a negative gap, consistent with a dot-com bubble. This contrast suggests the AI era differs fundamentally, highlighting the framework’s broader applicability.

Human Capital in Venture Capital: Evidence From 100,000 Venture Capitalists
Blake Jackson and Ilya A. Strebulaev 
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We study human capital in venture capital (VC) using a new dataset covering over 100,000 professionals affiliated with U.S. VC firms. Investment success is extremely concentrated: fewer than 40% of VCs with any investments are ever credited with a successful investment, and 90% of investment profits are generated by 5% of VCs. Differences in education, prior work experience, and demographics predict career progression and investment outcomes, consistent with persistent investor-specific skills. Quasi-experimental variation from marginal inclusions on the Forbes Midas List shows that achieving superstar status increases access to highly-valued startups, complementing other human capital and contributing to concentration.

The Unintended Consequences of Rebalancing
Campbell R. Harvey, Michele G. Mazzoleni, and Alessandro Melone
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Institutional investors engage in trillions of dollars of regular portfolio rebalancing, often based on calendar schedules or deviations from allocation targets. We document that such rebalancing has a market-wide impact and generates predictable price patterns. When stocks are overweight, funds sell stocks and buy bonds, leading to a decrease in equity returns of 17 basis points over the next day. Our results are robust to controls for momentum, reversals, and macroeconomic information. Importantly, we estimate that current rebalancing practices cost investors about $16 billion annually—or $200 per U.S. household. Moreover, the predictability of these trades enables certain market participants to profit by front-running the orders of large institutional funds. While rebalancing remains a fundamental tool for investors, our findings highlight the costs associated with prevailing strategies and emphasize the need for innovative approaches to mitigate these costs.

Real Time Investor Alphas and the Survival of the Anomaly Zoo 
Andrei S. Gonçalves, Johnathan A. Loudis, and Richard E. Ogden
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Anomaly strategies generate positive and significant CAPM alphas even after becoming public information. Common explanations emphasize non-market risks, trading costs, and investment frictions. This paper introduces a complementary channel: allocation uncertainty. Investors who learn about an anomaly remain uncertain about the optimal weight for combining it with the market portfolio, making its future factor regression alpha unattainable. We introduce the real time investor alpha, which measures the Sharpe ratio improvement from adding an anomaly to the market portfolio using weights estimated in real time. Empirically, anomalies retain positive factor regression alphas after publication, but their average real time investor alpha is close to zero. Investors can profitably combine multiple anomalies, but only with shrinkage. We show theoretically that this uncertainty-induced shrinkage makes investors trade less aggressively than full information investors, allowing CAPM alphas to survive in equilibrium. This model explains 15% to 30% of the cross-sectional variation in anomaly alphas.

Uninsured Deposits and Bank Stock Returns
Jack Bao, Claire Y. Hong, Kewei Hou, and Thien T. Nguyen
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We document that banks more reliant on uninsured deposits exhibit significantly higher average stock returns. During the March 2023 banking turmoil, banks with higher levels of uninsured deposits were more adversely affected; however, they experience higher returns during stable periods, resulting in higher average unconditional returns. The relation between uninsured deposits and returns is evident in all banks except the largest and is particularly pronounced in those with liabilities sensitive to interest rate changes, significant asset-liability mismatch, and lower capital ratios. We present a stylized model that can rationalize many of these empirical regularities.

The lessons of Michael C. Jensen
René M. Stulz
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This paper assesses the contributions of Michael C. Jensen to financial economics and to American business. His work on agency theory is the cornerstone of modern corporate finance. He influenced how American business operates by helping make the internal and external governance of firms more efficient. He changed how knowledge in financial economics is diffused both through the founding of the Journal of Financial Economics and of the Social Science Research Network. I question the claim made by some that he recanted his ideas in the 2000s.

Are there too few publicly listed firms in the US?
Craig Doidge, G. Andrew Karolyi, Kris Shen, and René M. Stulz
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Doidge, Karolyi, and Stulz (2017) show that from 1999 to 2012 the US develops a listing gap relative to other countries, meaning that it has abnormally few publicly listed firms. In this paper, we update their evidence to 2023 and find that the listing gap increases, but at a low rate. By 2023, the US has about half as many listed firms per capita as other developed countries. We discuss some of the important questions raised by the existence and increase of the listing gap to which we hope researchers will find answers.

Production and Externalities: How Corporate Governance Shapes Social Costs
Alvin Chen and Michael D. Wittry
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We study how corporate governance affects social costs, focusing on the tension between mitigating managerial moral hazards and limiting negative externalities. We develop a parsimonious principal-agent model with negative production externalities, which predicts that when monitoring costs rise, firms substitute toward performance-based compensation, leading to socially costly production decisions. Using asset-level data from the U.S. coal industry, we find that ownership dispersion—the canonical proxy for rising monitoring costs—leads to an 11% increase in production and a 33% rise in safety violations. To establish causality, we exploit politically motivated coal divestment mandates that forced key monitoring institutions to exit, generating plausibly exogenous increases in monitoring costs. Consistent with our model, affected firms raised managerial bonus thresholds and experienced higher production and more safety violations. Our findings reveal how governance choices can inadvertently amplify social costs, with implications for sustainable investing and corporate governance design.

Nocturnal Trading
Gregory W. Eaton, Andriy Shkilko, and Ingrid M. Werner
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While several venues have offered trading prior to the U.S. equity market open and after the close for decades, only recently have alternative trading systems started offering trading between 8 p.m. in the evening and 4 a.m. the next day – nocturnal trading. This innovation enables U.S. retail investors to trade U.S. stocks and exchange traded products 24 hours, five days a week. Importantly, it also enables Asian investors to trade U.S. stocks during Asian business hours. We document the explosive growth of nocturnal trading in the last three years – a development that has recently motivated several additional venues to seek SEC approval to also offer nocturnal trading. We find that while effective spreads during the nocturnal hours are worse than during regular trading hours, realized spreads are about the same or better. We also find that significant price discovery takes place between 8 p.m. and 4 a.m., particularly for exchange-traded products. Finally, we rely on a quasi-natural experiment to study how nocturnal trading affects pre-open, regular, and after-hours trading.

A Tale of Two Anomalies: The Implications of Investor Attention for Price and Earnings Momentum
Kewei Hou, Roger K. Loh, Lin Peng, and Wei Xiong
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We study how investor attention affects two well-known stock market anomalies: price momentum and earnings momentum. Using a comprehensive set of investor attention measures, we find a striking contrast. Stocks that attract more attention show stronger price momentum but weaker earnings momentum. This suggests attention plays two opposing roles: when investors pay less attention and ignore earnings news, stock prices underreact, leading to stronger earnings momentum; but when attention is high, behavioral biases intensify and fuel overreaction-driven price momentum. We also find that different types of attention—from institutions versus retail investors, and active versus passive attention—have distinct effects.

Climate Boards: Do Natural Disaster Experiences Make Directors More Prosocial?
Sehoon Kim, Bernadette A. Minton, and Rohan G. Williamson
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We document that corporate directors’ past experience with abnormally severe climatic natural disasters shape their prosocial preferences and influence firm climate policies. Using detailed data on director career histories and county-level natural disasters, we identify Directors with Abnormal Disaster Experiences (DADEs). DADEs are significantly more likely to be affiliated with nonprofit organizations, consistent with heightened prosocial preferences. Importantly, firms with more DADEs on their boards exhibit lower scope 1 and 2 greenhouse gas emission intensities and are more likely to implement climate-related policies, including board climate oversight, emission targets, and management incentives to reduce emissions. These effects are driven by influential DADEs serving on governance, audit, or ESG committees, but absent among DADEs on finance, compensation, or risk committees, supporting a preference-based rather than risk-based mechanism. Independent directors, rather than the influence of CEOs, play a central role. The effects are stronger when disaster experiences are accumulated over longer histories and in large or high-emission firms. The results are muted in smaller disasters and not driven by recent trends in attention to climate change. Despite the role of preferences, firms with more DADEs do not exhibit worse financial or operational performance. Using director deaths as plausibly exogenous shocks, we provide causal evidence. Our findings show that directors’ experiences heighten their prosocial preferences that lead them to influence corporate climate policy.

The Pricing of Geopolitical Tensions over a Century
Andrei S. Gonçalves, Alessandro Melone, and Andrea Ricciardi 
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We study capital allocation and asset pricing consequences of geopolitical tensions using nearly 100 years of data. Leveraging widely adopted news-based geopolitical risk indices, we find that geopolitical threats (GPT) and acts (GPA) have markedly different implications. GPT closely tracks geopolitical risk perceptions and capital allocation decisions of investors and firms, is priced across different asset cross-sections, and predicts country-level equity premia. By contrast, GPA has weaker and less stable links to beliefs, capital allocation, and risk premia. These results are incremental to existing news-based measures of macro-financial uncertainty, including indices capturing war-related discourse and economic and trade policy risk.

Do GSEs Subsidize Mortgage Lending?
Thomas Flanagan
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A key function of government-sponsored enterprises (GSEs) is to insure mortgage default risk, yet little is known about whether these guarantees are fairly priced. Using a replicating portfolio and market prices of reinsured mortgage default risk to value the net cash flows from guaranteeing $5 trillion mortgages, I show that GSEs shifted from providing a subsidy of 20 basis points (bps) pre-crisis to generating risk-adjusted profits of 30 bps in the post-crisis period. Using a regression discontinuity design around the conforming loan limit, I document that this higher pricing is passed on to borrowers via higher conforming mortgage rates. Following this increase, banks reduce their reliance on GSE securitization but still securitize most mortgages through GSEs despite paying an above-market rate. Overall, these findings imply lenders value using GSEs for reasons other than government-subsidized funding in the post-crisis period.

What are the costs of weakening shareholder primacy? Evidence from a U.S. quasi-natural experiment
Benjamin Bennett, René M. Stulz, and Zexi Wang
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We study the economic consequences of weakening shareholder primacy using Nevada Senate Bill 203 as a quasi-natural experiment. A difference-in-differences analysis shows that affected Nevada firms experience a decline in firm value of more than 4%, as measured by Tobin’s q. Rather than responding with stronger governance to reassure capital providers, affected firms experience a worsening of their governance. We document significant real effects through the investment channel: treated firms undertake worse acquisitions and exhibit reduced efficiency in both capital expenditures and R&D spending. Weakening shareholder primacy does not improve how stakeholders are treated, as environmental and social performance worsens.

Borrowers in the Shadows: The Promise and Pitfalls of Alternative Credit Data
Mark Jansen, Sam Kruger, Gonzalo Maturana, and Amin Shams
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Alternative credit data, such as payday lending records, can be informative for assessing credit risk. Using the staggered adoption of the largest alternative credit database and examining outcomes in the auto loan market, we show that alternative credit scores predict loan performance and loan terms. However, alternative credit history comes with significant downsides, even for borrowers with relatively high alternative credit scores. After adoption, borrowers with payday loan histories experience higher delinquency rates, face higher interest rates, and have reduced loan origination rates. Consequently, use of alternative credit data limits credit availability and raises borrowing costs for most users of alternative financial services.

From Bonds to Dividend Strips: Decomposing the Equity Premia Term Structure 
Spencer Andrews and Andrei S. Gonçalves
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We construct a Stochastic Discount Factor that jointly prices nominal and real bonds as well as various equity portfolios from 1972 to 2022. Combining it with yield dynamics across these markets, we estimate term structures of risk premia for real bonds, nominal bonds, and equities. We then decompose equity risk premia into term, inflation, and cash flow risk premia components—where cash flow risk premia denote expected returns of dividend strips in excess of maturity-matched nominal bond strips. Term and inflation risk premia rise with maturity, while cash flow risk premia are hump-shaped and relatively low at long maturities. Moreover, short-maturity equity risk premia variation over time is mainly driven by cash flow risk premia, whereas long-maturity equity risk premia variation is dominated by term and inflation risk premia. These findings imply that credible explanations for the equity excess volatility puzzle must operate through bond risk premia dynamics.

Endogenous Elasticities: Price Multipliers Are Smaller for Larger Demand Shocks 
Aditya Chaudhry and Jiacui Li
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How well can markets absorb large demand shocks? We address this question using price multipliers: the per-unit price adjustment investors require to absorb shocks. We find stock-level multipliers are smaller for larger contemporaneous and cumulative past shocks. Using holdings data, we find investors endogenously become more price elastic as larger shocks create larger price dislocations. These results are consistent with models where investors become more willing to absorb shocks when large dislocations create large profit opportunities, such as fixed adjustment costs or endogenous inattention. Our findings suggest large shocks expand rather than exhaust the capacity of markets to absorb shocks.
 

What Do Early-Stage Investors Ask? An LLM Analysis of Expert Calls
Victor Lyonnet, Amin Shams, and Shaojun Zhang
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We analyze 5,230 expert network calls using large language models (LLMs) to study how early-stage investors conduct due diligence. Applying a novel LLM-based topic modeling approach combined with SHAP analysis, we find that firms receiving expert calls have 44% higher odds of securing investment in the next quarter. The predictive content of these calls varies systematically with both discussion topics and firm characteristics: Positive discussions about technology integration and customer acquisition further increase deal odds by 31% and 15%, respectively. These effects are concentrated among younger firms, suggesting that expert validation can at least partially substitute for traditional financial metrics. However, while positive signals predict investment decisions, negative assessments on risk management are associated with 0.2 standard deviation lower long-term firm performance. This divergence between what predicts deals versus ultimate success is consistent with investors optimizing for power-law returns rather than success rates.

Democratizing Private Markets: Private Equity Performance of Individual Investors
Cynthia Balloch, Federico Mainardi, Sangmin S. Oh, and Petra Vokata
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Using new data on wealthy U.S. households, we provide the first systematic study of private equity performance by individual investors. We identify two innovations that democratize access to private equity: the proliferation of funds with low minimum commitments and pooling capital via advisors. Contrary to concerns about poor performance, we find that aggregate individual investments in private equity perform similarly to institutions and outperform public markets. In the cross-section, the most affluent investors outperform the less affluent by 6 to 10 percentage points in public market equivalent. We show that advisor skill is more likely to explain the performance gap rather than preferential access. Using both observed and simulated intermediary fees, we show that fees impose a sizable drag on performance, especially for less affluent investors.

Political Uncertainty and Commodity Markets
Kewei Hou, Ke Tang, Yubo Tao, and Bohui Zhang
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In this study, we comprehensively analyze how election-induced political uncertainty affects commodity markets from both theoretical and empirical perspectives. Consistent with our theoretical predictions, commodity prices decrease (increase) by 5.9% (4.0%), while convenience yields increase (decrease) by 1.4% (2.0%) in the quarter leading up to national elections in major commodity-consuming (-producing) countries. Additional tests show that the impact of demand-side political uncertainty is stronger during recessions and for closely contested elections. Lastly, holding precious metals could effectively hedge against election-induced political uncertainty on the supply side but not on the demand side.

Capital Budgeting For EPS Maximizers 
Itzhak Ben-David and Alex Chinco
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To increase a company's earnings, a project must generate enough income next year to pay for its own financing. Hence, a manager who wants to maximize her EPS (earnings per share) should only invest in accretive projects that have income yields above the firm's cheapest financing option. This is the max EPS analog to the positive-NPV (net present value) rule. Maximizing EPS ≠ minimizing investment. EPS maximizers use real investment to arbitrage between asset and capital markets. This framework rationalizes the pervasive use of IRRs (internal rates of return) and payback periods. An IRR effectively measures how accretive a project will be. A payback period expresses the project's income yield as a multiple. Empirically, a simple max EPS model explains M&A payment method and investment-cash flow sensitivity. It also predicts which firms have higher proportions of convertible debt and capitalized interest expense.

Human Capital Metrics and CEO Pay
Zhexu Ai, M. Diane Burton, Lingling Wang, and Karen H. Wruck
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Using a hand-coded sample of over 45,000 CEO compensation performance plans from 1998 to 2023, we conduct a pioneering analysis of the use of human capital-based (HC) performance metrics in CEO pay. In our sample, the percentage of firms adopting HC-based plans rose from 4% in 1998 to 57% in 2023. The magnitude of pay values under HC plans has also increased from around 0.1 times salary in 1998 to over 1.8 times salary in 2023. Firms with larger workforces and greater reliance on human capital are more likely to adopt HC plans and to grant higher pay values under these plans. HC performance metrics are classified into three types: Health and Safety (HS), Talent and Culture (TC), and Diversity, Equity and Inclusion (DEI). While HC plans exist in all industries, most firms adopt just one type. About two-thirds of HS plans use quantitative metrics, compared with 43% of DEI plans and only 18% of TC plans. There are notable jumps in the prevalence of TC plans in 2018 and of DEI plans in 2021; these jumps align with shifts in investor perspectives and preferences. Interestingly, CEOs with DEI plans based on qualitative metrics, HC plans with multiple metric types, and HC plans with a high number of metrics, receive significantly higher pay (without delivering better firm performance) than CEOs without HC plans. This raises concerns about agency problems in firms that adopt HC plans with characteristics that are inherently difficult for shareholders to monitor. Overall, our findings challenge the common practice of lumping E, S, and G metrics together and highlight the need to analyze each type of incentive metric separately.

What Moves Equity Markets? A Term Structure Decomposition for Stock Returns
Andrei S. Gonçalves
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Several papers decompose stock returns into cash flow and discount rate news to study equity volatility. This paper develops an alternative decomposition based on variation in dividend present values with different maturities. From 1960 to 2021, roughly 60% of US equity volatility comes from the value of dividends with maturities beyond 20 years, implying an “equity volatility duration” above 30 years. Extending the data over time and across countries, I also show a secular increase in the importance of long-term dividends in driving equity volatility. Finally, standard asset pricing models understate the role of long-term dividends in explaining equity volatility.

Juicing the Coupon Yield: How Banks Extract Rents from Behavioral Biases
Petra Vokata
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The fees on yield enhancement products increase strongly with coupons, despite minimal pass-through of coupons to returns. As a result, higher coupons paradoxically lead to lower net expected returns. Demand estimates exploiting pricing shocks show investors pay over 35 basis points for one percentage point of coupon. Banks engineer coupons using exotic, hard-to-value options that artificially increase coupons, but much less so returns. These patterns are inconsistent with standard reaching-for-yield models and instead point to investor inattention to shrouded attributes. I show that the resulting rents extracted by banks are several times larger than those documented in other financial markets.

Selling to Yourself: Continuation Funds in Private Equity
Rustam Abuzov, Will Gornall, Sophie Shive, Ilya A. Strebulaev, and Michael S. Weisbach
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Continuation funds (CFs) are a recent financial innovation in which PE managers raise new funds to purchase assets from their existing funds. CFs have surged in popularity, accounting for 9% of PE exits in 2024 and raising twice as much as US IPOs. We show that CFs emerge when LPs are more heterogeneous and fund managers have earned carried interest in legacy funds. Assets transferred to CFs are better performing and larger than other assets in legacy funds. LPs overwhelmingly choose to exit rather than invest in CFs, the decision that appears to be driven by time-varying LP liquidity demands.

Acquiring Supplier Networks: Domestic Mergers for International Supply Chain Resilience
Ling Cen, Sudipto Dasgupta, Isil Erel, and Yanru Han 
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Long-standing international supplier relationships represent valuable and hard-to-replicate intangible assets that mitigate the search and contracting frictions inherent in global value chains. We propose and show that domestic mergers and acquisitions (M&A) serve as a key strategic vehicle for acquiring these established supplier networks, providing a novel source of merger synergy. Using detailed transaction-level shipment data from 2007–2020, we find that post-merger, acquirers systematically adopt the target’s supplier relationships, with a pronounced preference for those that are long-standing. This adoption occurs for both inputs the acquirer already sources (enhancing resilience) and new inputs (facilitating expansion). Consistent with this type of synergy, the likelihood of a merger increases with the similarity of the firms’ imported input portfolios, especially during periods of heightened supply-chain risk, when the value of a target's vetted network is highest. Furthermore, these mergers generate competitive advantages through foreclosure-like effects on target rivals when their supply chains overlap with the acquirer’s, leading to improved valuations and sales growth for target firms. Overall, we show that a primary synergy in many M&As is the acquisition of “relational capital” embedded in the target’s supply chain.

Subjective Beliefs and the Portfolio Allocations of Institutional Investors
Aleksandar Andonov, Spencer J. Couts, Andrei S. Gonçalves, Johnathan Loudis, and Andrea Rossi
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We study how subjective beliefs shape the portfolio allocations of institutional investors. Linking the multi-asset allocations of U.S. public pension funds to the long-term capital market assumptions of their consultants, we examine the extent to which differences in subjective expected returns, volatilities, and correlations map into differences in portfolio weights. We embed these belief inputs in a mean-variance framework that incorporates fund-consultant belief wedges, heterogeneous risk aversion, non-negative weight constraints, and a benchmarking incentive due to frictions. We find that pension fund allocations are significantly linked to belief implied mean variance efficient allocations across asset classes, across pension funds, and over time. Accounting for frictions is essential: it dramatically increases the pass through and explanatory power of beliefs to portfolio allocations. Overall, our results show that beliefs play a central role in institutional portfolio decisions and that frictions critically shape their transmission into observed allocations.

Green Waste
Ingvil Gaarder, Morten Grindaker, Tom G. Meling, and Magne Mogstad
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We develop and apply a framework to test for and measure green waste: the misallocation of public subsidies for green investment projects. Our context is a major Norwegian subsidy program to reduce carbon emissions. We apply the framework to detailed project-level data on carbon emissions and subsidy amounts for both marginal and inframarginal projects. We find that the decision-maker could have achieved the same level of emission reductions at less than half the cost. To isolate the sources of this green waste, we use data on both ex-ante expected and ex-post realized emission reductions for each project. We find that the decision-maker is able ex-ante to identify the projects with the highest ex-post emission reductions but unwilling to select them.

A First Look at the Historical Performance of the New NAV REITs
Spencer J. Couts and Andrei S. Gonçalves 
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Private Commercial Real Estate (CRE) funds offer institutional investors access to CRE markets, but most remain inaccessible to retail investors. This paper examines the early performance (2016–2024) of a growing class of non-listed CRE funds available to retail investors, such as Blackstone REIT (BREIT). Known as Net Asset Value (NAV) REITs, these funds have become a major alternative to publicly traded REITs, offering indirect CRE exposure. We find that NAV REIT returns exhibit smoothness due to lagged pricing updates, making unsmoothing essential for risk-adjusted performance analysis. While NAV REITs delivered positive alphas relative to public indices historically, we cannot reject the hypothesis that these alphas stemmed from unexpected positive returns to NAV REITs over our sample. Lastly, we highlight limitations in traditional alpha analysis for short samples and propose an alternative approach, suggesting that NAV REITs’ alphas were economically meaningful but substantially lower than traditional alpha estimates.

Unsmoothing Returns of Illiquid Funds
Spencer J. Couts, Andrei S. Gonçalves, and Andrea Rossi
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Funds that invest in illiquid assets report returns with spurious autocorrelation. Consequently, investors need to unsmooth these funds’ returns when evaluating their risk exposures. We show that funds with similar investments have a common source of spurious autocorrelation not fully resolved by traditional unsmoothing methods, leading to underestimation of systematic risk. As such, we propose a generalized unsmoothing technique and apply it to hedge funds and private commercial real estate funds. Our method significantly improves the measurement of funds’ risk exposures and risk-adjusted performance, especially for highly illiquid funds. Overall, the average illiquid fund alpha is lower than previously thought.

Beyond Carry: The Prospective Interest Rate Differential and Currency Excess Returns
Mengmeng Dong, Shingo Goto, Kewei Hou, Yan Xu, and Yuzhao Zhang
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We use a Beveridge-Nelson decomposition to link expected foreign currency excess returns to the “prospective interest rate differential” – the infinite sum of expected future interest rate differentials. Empirically, we find that the prospective interest rate differential is a stronger predictor of currency excess returns than carry, in both portfolio sorts and Fama-MacBeth regressions. A factor based on the prospective interest rate differential is also useful in explaining the returns of a broad set of currency test portfolios.

Is There Information in Corporate Acquisition Plans?
Sinan Gokkaya, Xi Liu, and René M. Stulz
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For many firms, the acquisition process begins with the development of an acquisition plan that is communicated to investors. Using a novel dataset, we provide the first study of acquisition plans and offer new perspectives on the acquisition process. We find that acquisition plan announcements are informative and incrementally predict subsequent acquisition activity. These results are more pronounced for firms announcing commitment to acquisitions from an internal pipeline. Acquisition plans improve acquisition performance due to learning from market feedback and reduce acquisition-related uncertainty. Communication of acquisition plans does not increase takeover premiums but is less common in more competitive industries.

Understanding Factor Value
Shaojun Zhang
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The value spread of factors fluctuates over time because of changes in market equity or book value but predicts factor returns only through the component driven by market equity changes (the dme spread). Exploiting cross-sectional mispricing, the dme spread captures 90 years of sentiment and subsumes the predictability in existing sentiment measure. Factor predictability concentrates on factors most predictable by sentiment and factors more subject to asymmetric limits of arbitrage. A factor value strategy exploiting the predictability outperforms and explains cross-sectional value factors. The value premium is not an independent factor but summarizes time-varying factor returns conditional on sentiment.

Risk-Adjusting the Returns to Private Debt Funds
Isil Erel, Thomas Flanagan, Michael Weisbach
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Private debt funds are the fastest-growing segment of the private capital market. We evaluate their realized risk and risk-adjusted returns for funds originated from 1992 to 2015, applying cash-flow-based methods to construct replicating portfolios that mimic their payoffs. A typical private credit fund contains not only credit risk but also equity risk and delivers insignificant abnormal returns to its investors. However, gross-of-fee abnormal returns are positive, and ignoring equity risk also results in positive abnormal returns. The rates at which private debt funds lend appear to be high enough to offset funds’ fees and risks, but not high enough to exceed investors’ fees and risk-adjusted rates of return.

When Protectionism Kills Talent
Mehmet Canayaz, Isil Erel, Umit G. Gurun, and Yufeng Wu
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We study how protectionist policies reshape the US chip-manufacturing workforce and talent pipeline—from prospective student interest and degree completion to skill composition and innovation capacity. We show that science and engineering employment has declined in response to protectionist measures—particularly in entry-level roles and at firms exposed to tariffs and reliant on foreign talent. Patent output fell and recruitment shifted overseas, while fewer domestic students pursued chip-related degrees, reducing the US share of global chip-manufacturing expertise. Our conceptual framework shows that a high share of foreign workers and inelastic labor supply contribute to the adverse effects of protectionist policies.

Unexpected Gains: How Fewer Community Banks Boost Local Investment and Economic Development 
Bernadette A. Minton, Alvaro G. Taboada, and Rohan Williamson
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Our research examines the impact of dwindling community bank numbers on community investment and economic development. Initially, we confirm the vital role of community banks’ small business lending in local development. Contrary to popular belief, we find that a decrease in community banks positively affects community investment, through small business loan (SBL) originations. Key factors include the local presence of other community banks and the continuity of the consolidating bank's presence. Interestingly, the effect remains neutral in underserved or distressed counties and diminishes when a large bank acquires a community bank without maintaining a local presence. Post-consolidation, community banks emerge larger and more robust, capable of issuing larger SBLs, while larger banks and Fintech firms contribute by providing smaller SBLs. Overall, our findings reinforce the critical contribution of community banks to local development, suggesting that a reduction in their numbers leads to a stronger, more stable banking infrastructure in the small business lending landscape.

Creative Destruction, Stock Return Volatility, and the Number of Listed Firms
Söhnke M. Bartram, Gregory W. Brown, and René M. Stulz
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Average idiosyncratic volatility and firm idiosyncratic volatility increase with the number of listed firms. Average industry idiosyncratic volatility increases with the number of listed firms in the industry. We ex-plain the relation between idiosyncratic volatility and the number of listed firms through Schumpeterian creative destruction. We show that Schumpeterian creative destruction increases as the number of listed firms increases. However, there is no consistent evidence of an incremental effect of the number of non-listed firms on idiosyncratic volatility either in the aggregate or at the industry level, suggesting that listed firms play a unique role in the dynamism of the economy.

Why do startups become unicorns instead of going public?
Daria Davydova, Rüdiger Fahlenbrach, Leandro Sanz, and René M. Stulz
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Unicorns are startups that choose to stay private even though they are large enough to go public. We propose an efficiency explanation for their existence. Startups relying highly on organization capital are more vulnerable to expropriation of their organization capital if they go public before their position is sufficiently secure. Our main empirical findings are that shocks to the fragility of organization capital decrease the IPO likelihood, unicorn status enables startups to stay private longer by giving them access to new sources of capital, and unicorns and their industries have higher organization capital intensity than other startups.

Bank payout policy, regulation, and politics
Rüdiger Fahlenbrach, Minsu Ko and René M. Stulz
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Bank payout policy is strongly affected by regulation and politics, especially for the largest banks. Banks, but not industrial firms, have consistently lower payouts in times of high regulation uncertainty and under democratic presidents. After the Global Financial Crisis, bank regulators’ influence on payout policies of the largest banks increases sharply and repurchases become more important than dividends for these banks. Repurchases respond more to regulatory climate changes than dividends. The stock-price reaction of the largest banks to the election of Donald Trump is larger than for small banks or industrial firms, and their repurchases increase sharply afterwards.

Alternative Data in Active Asset Management
T. Clifton Green and Shaojun Zhang
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Alternative data are data gathered from nontraditional sources beyond company filings and analyst research. Alternative data are crucial in investing, offering unique insights and competitive advantages. The demand for alternative data has skyrocketed in the past two decades, due to the regulatory changes and the growing importance of intangible assets such as intellectual property. Alternative data cover various sources, including firm-released information, government-released information, information about investor attention and trading, and third-party information. However, alternative data landscape is constantly evolving due to alpha decay, technological advancements, regulatory changes, and market efficiency. These challenges require investors to continuously adapt their strategies, discover new data sources, and develop sophisticated analysis techniques to maintain an edge in an increasingly data-driven financial world.

Crypto Tax Evasion
Tom G. Meling, Magne Mogstad, and Arnstein Vestre
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We quantify and explain the extent of crypto tax noncompliance and evasion, and assess the efficacy of alternative tax enforcement interventions. The context of the study is Norway. This context allows us to address key measurement challenges by combining de-anonymized crypto trading data with individual tax returns, survey data, and information from tax enforcement interventions. We find that crypto tax noncompliance is pervasive, even among investors trading on exchanges that share identifiable trading data with tax authorities. However, since most crypto investors owe little in crypto-related taxes, enforcement strategies need to be well-targeted or cheap for benefits to outweigh costs.

Digital Payments and Monetary Policy Transmission
Pauline Liang, Matheus Sampaio, and Sergey Sarkisyan
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We examine the impact of digital payments on the transmission of monetary policy by leveraging administrative data on Brazil’s Pix, a digital payment system. We find that Pix adoption reduces banks’ market power, making them respond more to changes in policy rates. We estimate a dynamic banking model in which digital payments amplify deposit demand elasticity. Our counterfactual results reveal that digital payments intensify the monetary transmission by reducing banks’ market power – banks respond more to policy rate changes, and loans decrease more after monetary policy hikes. We find that digital payments impact monetary transmission primarily through deposit market power.

Risk, the Limits of Financial Risk Management, and Corporate Resilience
René M. Stulz
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Existing evidence shows convincingly that expected cash flows of non-financial firms can be negatively affected by their total risk, so that non-financial firms can create shareholder wealth by managing their total risk. After reviewing theories that demonstrate links between firm value and total risk, I examine how financial risk management is used to manage firm total risk. I conclude from the evidence that the use of financial risk management is mostly limited to near-term risk in non-financial firms. I offer explanations for this limited role of financial risk management. I argue that the limitations of financial risk management make it important for firms to also focus on resilience and call for more research on the costs and benefits of resilience.

Default Risk Shocks of Financial Institutions as a Systemic Risk Indicator
Jack Bao, Kewei Hou, and Zenon Taoushianis
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We construct a measure of systemic risk, DRSFIN, that combines the high frequency information available in equity returns with a simple structural model of default. DRSFIN predicts future bank failures even after controlling for bank characteristics, macroeconomic conditions, uncertainty, and existing measures of aggregate systemic risk. We then show that DRSFIN is able to predict aggregate loan growth and nonfinancial firm failure, indicating that it not only predicts disruption in the financial sector, but also has real effects. Finally, we show that DRSFIN is also associated with elevated market uncertainty and stress in international markets.

Institutional Investors’ Subjective Risk Premia: Time Variation and Disagreement
Spencer Couts, Andrei S. Goncalves, Yicheng Liu, and Jonathan Loudis
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We study the role of institutional investors’ subjective risk premia in explaining variation in their subjective expected returns (both over time and across investors). Our analysis uses long-term Capital Market Assumptions from asset managers and investment consultants from 1987 to 2022. Perceived market risk premia account for most of the countercyclicality and overall time variation in subjective expected returns, with the remainder driven by alphas (perceived mispricing). The risk premia effect stems almost entirely from time variation in perceived risk quantities rather than risk price (risk aversion). Additionally, market risk premia explain most of the expected return disagreement, but here alphas play a significant role, and risk price and risk quantities contribute roughly equally to the risk premia effect. These results provide benchmark moments that asset pricing models should match to be consistent with institutional investors’ beliefs.

Expected EPS × Trailing P/E
Itzhak Ben-David and Alex Chinco
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Sell-side analysts describe how they price their own subjective earnings expectations in the text of each report. We read a representative sample of 513 reports and find that most do not set price targets using present-value logic. Instead, the majority of analysts multiply a company’s expected EPS (earnings per share) times its trailing P/E (price-to-earnings) ratio. This simple equation accounts for the bulk of price-target variation in the broader IBES sample. Trailing P/Es produce price targets that are roughly correct on average accounting for selection. Our trailing P/E model predicts how both price targets and market prices respond to news.

Resolving Estimation Ambiguity
Paul H. Décaire, Denis Sosyura, and Michael D. Wittry
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Economic models develop conceptual frameworks for fundamental decisions but rarely prescribe a specific estimation approach. Using novel data on the inputs and assumptions in professional stock valuations, we study how financial analysts address estimation ambiguity when calculating a firm’s cost of capital. Analysts use the same return-generating model (CAPM) but diverge in their estimation choices for key inputs, such as equity betas. Such estimation choices are driven by idiosyncratic analyst specific criteria, persist throughout their career and across brokerages, and generate large cross-analyst variation in discount rates for the same stock. The dispersion in discount rates is associated with higher market measures of investor disagreement, such as trading volume. Overall, we provide micro evidence on how financial experts resolve estimation uncertainty.

The Private Capital Alpha
Gregory W. Brown, Andrei S. Gonçalves, and Wendy Hu
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Alpha is the standard risk-adjusted performance metric for most asset classes. Private capital is a notable exception because the usual alpha estimation method ignores the economic realities of investing in private markets. In this paper, we propose a frame-work to estimate the alphas of private capital asset classes for typical limited partners through simulations that account for the illiquidity and underdiversification inherent to private markets. We then combine a large sample of 5,028 U.S. buyout, venture capital, and real estate funds from 1987 to 2022 to estimate the alphas of these private capital asset classes. We find that buyout as an asset class generated a significant annual alpha of 2.5% during our sample period. In contrast, over our sample period, the venture capital and real estate alphas were positive but statistically unreliable.

Common Investors Across the Capital Structure: Private Debt Funds as Dual Holders
Tetiana Davydiuk, Isil Erel, Wei Jiang, and Tatyana Marchuk
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This paper examines the dual role of Business Development Companies (BDCs) as both creditors and  shareholders in funding middle-market firms. We find that dual-holder BDCs charge 45 basis points higher loan spreads than pure creditors, controlling for loan characteristics and unobserved time-varying heterogeneity in firm credit quality and lender funding conditions. We examine three mechanisms: enhanced monitoring, capital injections as “public good,” and hold-up behavior by dual holders. Differentiating tests indicate that monitoring is the primary channel driving the loan pricing differential.  Our study highlights the real economic impact of private credit, beyond merely filling gaps left by regulation-constrained banks.

From Anecdotes to Insights: Streamlining the Research Idea Generation Process
Itzhak Ben-David
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This paper explores strategies for generating and evaluating novel research ideas. Researchers can identify promising ideas by systematically exposing themselves to new, practitioner-relevant information and by contrasting emerging facts with existing theories. Additionally, by identifying the necessary conditions that are required for an idea to become a viable research project, researchers can quickly discard low-prospect ideas, freeing up mental space and time to evaluate new research opportunities.

Do Households Matter for Asset Prices?
Samuli Knüpfer, Jens Soerlie Kvaerner, Bahar Sen-Dogan, and Petra Vokata
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Contrary to the common assertion that households have little impact on stock prices, we find their relevance is of first order. We quantify their impact using an asset-demand system applied to the complete ownership data for all Norwegian stocks from 2007 to 2020. Households contribute the most to stock market volatility relative to their market share. Even in absolute terms, they come second, surpassed only by institutional investors. Our granular data on households reveal a strong factor structure in household demand: The demand of the rich is distinct from less affluent investors, accounts for the bulk of volatility attributable to households, tilts away from ESG, and is informative about future firm fundamentals. We conclude by using the demand system to measure the profits one can make from trading on household demand shocks.

Oil-Driven Greenium
Shaojun Zhang and Zhan Shi 
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An influential view attributes the “greenium”—the cost-of-capital gap between carbon-intensive and greener firms—to climate risks and investor preferences. We challenge this by showing that oil shocks are pivotal: rising prices, driven by foreign supply or sector-specific demand shocks, reduce energy firms’ cost of capital by enhancing their growth opportunities, creating a divergence from other brown firms. This energy specific component explains 20% of greenium fluctuations, peaking at 50%. Reassessing events like the Paris Agreement suggests the impact of investor discipline weakens when oil’s role is considered. Overall, markets price climate risks less effectively than assumed.

Do Production Frictions Affect the Impact of Sustainable Investing?
Cynthia Yin
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Prior studies focus on how investors’ sustainability preferences incentivize firms to reallocate resources from dirty to clean physical capital. However, the impact of investors’ preferences on capital allocation depends critically on whether clean capital and dirty capital are substitutable. I develop a novel empirical strategy showing that dirty capital and clean capital are highly complementary. Theoretically, I explore firms’ investment decisions, assuming that investors dislike carbon emissions through both risk and nonpecuniary utility channels. Given the current level of complementarity, investors’ preferences have a limited impact on investment decisions, underscoring the need for technological innovation to address this production friction.

Public Sentiment Decomposition and Shareholder Actions
Reena Aggarwal, Hoa Briscoe-Tran, Isil Erel and Laura T. Starks
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Using unique public sentiment data and a novel measure of shareholder concerns, we document a strong relation between public sentiment and shareholder actions. We show that the number of shareholder proposals effectively captures investor dissatisfaction and, unlike voting outcomes, is well-defined for all firms, retaining informative signals even in the absence of proposals. Negative sentiment related to financial, environmental, social and governance issues is significantly associated with a larger number of shareholder proposals, and our instrumental variable analysis supports a causal link. Further, firms with more shareholder proposals are associated with higher turnover among CEOs and directors.

How Do Financial Conditions Affect Professional Conduct? Evidence from Opioid Prescriptions
Isil Erel, Shan Ge, and Pengfei Ma
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Can personal finances affect professional conduct? We find that healthcare providers increase opioid prescriptions when experiencing unfavorable home value changes, a proxy for wealth shocks. Results hold with office-by-year fixed effects and hold for providers living far from their offices, largely ruling out patient demand explanations. Effects are stronger among lower-income providers, those practicing in lower-income ZIP codes, and those treating minority patients. Higher opioid prescriptions predict more future business. Providers with lower housing returns also perform more preference-sensitive surgeries, but not urgent ones. Our findings show how personal financial pressure shapes professional conduct, with implications beyond healthcare.

Does greater public scrutiny hurt a firm’s performance?
Benjamin Bennett, René M. Stulz, and Zexi Wang
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Public attention to a firm may provide valuable monitoring, but it may also have a dark side by constraining management’s decisions and distracting it. We use inclusion in the S&P 500 index as a positive shock to public attention. Media coverage, Google searches, SEC downloads, SEC comment letters, shareholder proposals, analyst coverage, and lawsuits increase following inclusion. Post-inclusion performance falls and is negatively related to the increase in attention. Included firms’ investment and payout policies become more similar to those of index peers and the increase in similarity is positively related to the size of the attention increase.

Finding Anomalies in China
Kewei Hou, Fang Qiao, and Xiaoyan Zhang
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To study the cross-section of returns in the Chinese stock market, we follow the anomaly literature and construct 454 strategies between 2000 and 2020, based on 208 firm-level trading and accounting signals. With the conventional single-testing t-statistic cutoff of 1.96, 101 strategies have significant value-weighted raw returns, and 20 remain significant after risk adjustments. To avoid false discoveries, we recalibrate the t-statistic cutoff to 2.85 to accommodate multiple testing. 36 strategies survive the higher hurdle rate in value-weighted raw returns, while none remains significant after risk adjustments. When we use machine learning techniques to combine information from multiple signals, the resulting composite strategies mostly have significant returns after risk adjustments, even with the higher t-statistic cutoff. We relate Chinese anomaly returns to aggregate economic conditions and find that they comove with financial market development, accounting quality, market liquidity, and government regulations.

Debt Maturity Structure and Corporate Investment
Claire Y. Hong, Kewei Hou, and Thien T. Nguyen
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We show that firms’ debt maturity structure has an important impact on investment above and beyond that of leverage. Firms with a longer debt maturity structure tend to invest more. This result is stronger for firms with higher profitability and growth potential. We rationalize our results in a model in which debt maturity structure is determined by the trade-off between liquidity cost and the repayment flexibility of long-term debt. In our model, highly productive firms invest more and prefer to use
long-term debt to free up funds for future investment. This mechanism is supported by the data. Our findings highlight the importance of debt maturity structure in understanding corporate investment decisions.

Stereotypes about Successful Entrepreneurs
Victor Lyonnet and Léa H. Stern
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What comes to mind when thinking about a successful entrepreneur? Belief formation models suggest that what comes to mind is an oversimplified picture of the characteristics of successful entrepreneurs, i.e, stereotypes about successful entrepreneurs. Using French administrative data on 48,767 new firms, we show that some characteristics are stereotypical of success and have distributions that can generate miscalibrated beliefs. To illustrate how stereotypical thinking can lead to biased assessments, we report the discrepancies between the implied fraction of successful entrepreneurs under Bayesian vs. stereotypical thinking for several stereotypes. We discuss the consequences of stereotyping for venture capital allocation.

How Do Managers’ Expectations Affect Share Repurchases?
Minsu Ko
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It is widely believed that undervaluation is an important determinant of share repurchases. However, empirical evidence on undervaluation remains mixed. This paper considers a novel measure of undervaluation that relies on the difference between management earnings forecasts and the corresponding consensus analyst forecasts. It finds that firms repurchase significantly more shares when they expect higher future earnings relative to market expectations, which is consistent with the undervaluation hypothesis. This finding holds regardless of the level of underlying valuations. The results do not appear to be driven by managerial misvaluation or bias. Rather, my findings suggest that firms utilize insider information to time the market with respect to share repurchase decisions.

Modeling Managers As EPS Maximizers
Itzhak Ben-David and Alex Chinco
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Textbook corporate-finance models assume managers maximize the NPV (net present value) of expected future equity payouts. But, in practice, the people running large public companies often seem more concerned with increasing EPS (earnings per share). Perhaps this is a mistake. Or maybe EPS growth is a good second-best proxy for value creation. Whatever the reason, we show that the simplest possible EPS-maximizing model can explain a number of important corporate policies such as firm leverage, share repurchases, cash accumulation, and M&A payment method. There are two different routes to maximizing EPS, depending on whether a firm’s earnings yield is above or below the riskfree rate. We document strong empirical support for our model’s predictions.

Salient Attributes and Household Demand for Security Designs
Petra Vokata
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Using a large database of complex securities, I study how salient attributes of security design distort household investment decisions. I show banks add non-standard (fine-print) conditions to artificially increase advertised rates of headline return and downside protection-a phenomenon I term "enhancement." Enhancement increases headline returns by 11 percentage points, on average, but does not increase realized returns. Flexibly controlling for all other product attributes and using high-frequency shocks to structuring costs of enhancement for identification, I find demand is highly elastic to enhancement. Enhancement is costly to investors: a one standard deviation decrease implies savings of more than $1 billion in fees.

FinTech Lending with LowTech Pricing
Mark J. Johnson, Itzhak Ben-David, Jason Lee, and Vincent Yao
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FinTech lending—known for using big data and advanced technologies—promised to break away from the traditional credit scoring and pricing models. Using a comprehensive dataset of FinTech personal loans, our study shows that loan rates continue to rely heavily on conventional credit scores, including 45% higher rates for nonprime borrowers. Other known default predictors are often neglected. Within each segment(prime/nonprime) loan rates are not very responsive to default risk, resulting in realized loan-level returns decreasing with risk. The pricing distortions result in substantial transfers from nonprime to prime borrowers and from low- to high-risk borrowers within segment.

Bank liquid assets, the portfolio motive, and capital requirements
René M. Stulz, Alvaro G. Taboada, and Mathijs A. van Dijk
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Banks hold large amounts of liquid assets. These amounts grow sharply for the largest banks after the global financial crisis (GFC). The standard transaction and precautionary motives for holding liquid assets cannot explain the size and evolution of bank liquid asset holdings. Motivated by the deposit view of banks, we introduce a portfolio motive such that banks hold more liquid assets when they have poorer lending opportunities, making loans and liquid assets substitutes. We find support for the portfolio motive and for its prediction that capital requirement increases help explain the post-GFC growth in the largest banks’ liquid asset holdings.

Crisis Risk and Risk Management
René M. Stulz
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This paper assesses the current state of knowledge about crisis risk and its implications for risk management. Better data that became available since the Global Financial Crisis (GFC) has improved our understanding of crisis risk. These data have been used to show that some types of crises become predictable when one accounts for interactions between risks. Specifically, a financial crisis is much more likely in the years following both high credit growth and high asset valuations. However, some other types of crises do not seem predictable. There is no evidence that the frequency of economic and financial crises is increasing. The existing data show that political crises make economic crises more likely, so that, as suggested by the concept of polycrisis, feedback between non-economic crises and economic crises can be important, but there is no comparable evidence for climate events. Strategies that increase firm operational and financial flexibility appear successful at reducing the adverse impact of crises on firms.

The Real Effects of Sentiment and Uncertainty
Justin Birru and Trevor Young
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The effects of sentiment should be strongest during times of heightened valuation uncertainty. As such, we document a significant amplifying role for market uncertainty in the relation between sentiment and aggregate investment. A one-standard-deviation increase in uncertainty more than doubles the effect of sentiment on investment. Moreover, allowing uncertainty-dependent sentiment effects substantially increases explanatory power (i.e., R²). Our results are robust to many sentiment, uncertainty, and investment measures. We also document similar effects for aggregate equity issuance. Consistent with theory, we find even stronger results in the cross-section of valuation uncertainty. The evidence suggests that the importance of sentiment for corporate decisions varies over time and depends crucially on the underlying level of market uncertainty.

The Politics of Academic Research
Matthew C. Ringgenberg, Chong Shu, and Ingrid M. Werner
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We develop a novel measure of political slant in research to examine whether political ideology influences the content and use of academic research. Our measure examines the frequency of citations from think tanks with different political ideologies and allows us to examine both the supply and demand for research. We find that research in Economics and Political Science displays a liberal slant, while Finance and Accounting research exhibits a conservative slant, and these differences cannot be accounted for by variations in research topics. We also find that the ideological slant of researchers is positively correlated with that of their Ph.D. institution and research conducted outside universities appears to cater more to the political party of the current President. Finally, political donations data confirms that the ideological slant we measure based on think tank citations aligns with the political values of researchers. Our findings have important implications for the structure of research funding.

*No author has received financial support for this research. Ringgenberg and Shu have nothing further to disclose. Werner is an independent director for Dimensional U.S. Mutual Funds and ETF Trust, is a director for the Fourth Swedish Pension Fund (AP4), and serves on the Prize Committee for Riksbanken's Prize in Economic Sciences in Memory of Alfred Nobel.

Systematic Default and Return Predictability in the Stock and Bond Markets
Jack Bao, Kewei Hou, and Shaojun Zhang
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We construct a measure of systematic default defined as the probability that many firms default at the same time. We account for correlations in defaults between firms through exposures to common shocks. Systematic default spikes during recessions, is correlated with macroeconomic indicators, and predicts future realized defaults. More importantly, it predicts future equity and corporate bond index returns both in- and out-of-sample. Finally, we find that the cross-section of average stock returns is related to firm-level exposures to systematic default risk.

The Subjective Risk and Return Expectations of Institutional Investors
Spencer J. Couts, Andrei S. Gonçalves and Johnathan A. Loudis
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We use the long-term Capital Market Assumptions of major asset managers and investment consultants from 1987 to 2022 to study their subjective risk and return expectations across 19 asset classes. We find a strong and positive subjective risk-return tradeoff, with most of the level and variation in subjective expected returns arising from risk premia (beta compensation) rather than alphas. Subjective expected returns predict future realized returns both across asset classes and over time, with subjective risk premia driving most of this predictability. Subjective risk also predicts future realized risk, with stronger predictability across asset classes than over time.

Monetary Policy Transmission Through Online Banks
Isil Erel, Jack Liebersohn, Constantine Yannelis and Samuel Earnest
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Financial technology has the potential to alter the transmission of monetary policy by lowering search costs and expanding banking markets. This paper studies the reaction of online banks to changes in the federal funds rate. We find that a 100 basis points increase in the federal funds rate leads to a 30 basis points larger increase in the deposit rates of online banks relative to traditional banks. Consistent with the rate movements, online bank deposits experience inflows, while traditional banks experience outflows. Results are similar across markets with differing competitiveness and demographics, but vary with the stickiness of depositors.

The Role of Domestic and Foreign Sentiment for Cross-Border Portfolio Flows
Justin Birru and Matthew M. Wynter
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We provide evidence that market-based psychological anchors can influence demand for foreign stocks, as identified by international portfolio flows between US investors and investors in 44 other countries. US anchors appear to drive flows to a greater extent than foreign anchors. The impact of price anchors on flows is not captured by uncertainty and sentiment proxies. We also find that anchoring influences perception of foreign asset value, as measured by country closed-end-fund discounts. Finally, we show that return predictability of anchors does not align with the implications of anchors for flows, suggesting that anchoring-induced flows do not reflect optimal behavior.

The Value of Bank Lending
Thomas Flanagan
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Using a novel dataset of realized syndicated loan cash-flows and a risk-adjustment methodology adapted from the private equity literature, I provide a measure of risk-adjusted returns for bank loan cash-flows. Banks, on average, generate 190 bps in gross risk-adjusted returns and earn higher returns when they lend to financially constrained borrowers. However, shareholders earn nearly zero net risk-adjusted returns once bank staff are compensated for their effort in lending. Overall, these findings offer evidence that banks provide valuable services to mitigate borrowers’ financing frictions, and the present value of loan cash-flows pays for the costs of the bank providing these services.

Habit with Noisy Consumption
Alessandro Melone
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In the Campbell–Cochrane model, the surplus consumption ratio predicts annual returns with an R² of 12%, yet its empirical counterpart captures only 40% of this predictability. Using a simulated economy, I show that realistic measurement error in consumption can explain this discrepancy and use time-series filters to recover surplus consumption proxies more robust to noisy consumption. Empirically, these proxies predict returns as in the model, generating annual utility gains exceeding 4%. I also discuss implications for SDF construction and currency portfolios. Overall, the weak empirical performance of surplus consumption appears to reflect measurement error rather than evidence against the model.

New Technology and Business Dynamics
Hans K. Hvide and Tom Meling
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We examine business dynamics following a natural experiment: the staggered roll-out of a new technology, broadband internet, throughout Norway. The new technology led to a large, almost 25% increase in per-capita startup rates. Quality measures for these startups did not decline. In contrast, we do not find effects on the survival, employment or assets of established firms. Applications to literatures on business dynamics, entrepreneurship, and technology adoption are discussed. Overall, our findings support ideas from Schumpeter (1934) and Arrow (1962) that startups play an important role in adapting the economy to new technology.

Reversal Patterns in Risk-Adjusted Anomaly Returns
Carlo A. Favero, Alessandro Melone, and Andrea Tamoni
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According to the no-arbitrage condition, risk-adjusted returns should be unpredictable. Using several prominent factor models and a large cross-section of anomalies, we find that past cumulative risk-adjusted returns negatively predict future anomaly returns. We interpret these cumulative returns as deviations of an anomaly price from the value implied by the given factor model, introducing a novel anomaly-specific predictor endogenous to any test asset-factor model combination. The observed reversal pattern in risk-adjusted returns is consistent with a transitory component in prices, suggesting excess volatility in anomaly prices beyond what can be attributed to discount rate dynamics implied by standard factor models.

The US equity valuation premium, globalization, and climate change risks
Craig Doidge, G. Andrew Karolyi, and René M. Stulz
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In the 2000s, US firms have higher valuations than comparable non-US firms listed only outside the US but not non-US firms cross-listed in the US. Though one would expect this US valuation premium to fall over time because of globalization, it widens for firms in developed markets by 36% and falls for firms in emerging markets by 20% after the global financial crisis of 2007-2008. This evolution is explained in part by the decreased valuation of brown firms in other developed countries relative to the US. Other potential explanations are explored and rejected.

Payout-Based Asset Pricing
Andrei S. Gonçalves and Andreas Stathopoulos
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We propose a payout-based approach for the evaluation of the asset pricing implications of production models. Our approach recovers the implicit return process of an optimizing firm from its observed payout processes without the need to measure firm investment or specify investor preferences, by answering the following question: given the firm’s production and financing technology, what are the equity and debt rates of return that induce the firm to optimally provide the observed equity and debt payouts? We simulate the canonical representative firm model and use our approach to explore whether the model-implied U.S. aggregate returns match the properties of their empirical counterparts. We find that the canonical model gives rise to three important asset pricing puzzles regarding aggregate equity and debt returns, indicating the need for additional features that generate more realistic asset pricing properties.

Climate Change, Demand Uncertainty, and Firms’ Investments: Evidence from Planned Power Plants
Chen Lin, Thomas Schmid, and Michael S. Weisbach
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How does demand uncertainty affect firms’ investment decisions? We consider this issue from the perspective of electricity-producing firms and their planned investments in new power plants. Using plausibly exogenous variations in temperature predictions across scientific climate models to measure uncertainty about future electricity demand, we find that uncertainty increases investments in plants with flexible production technologies but depresses non-flexible investments. The net effect of uncertainty on investments is positive if firms have access to flexible investment opportunities. These results are consistent with models in which the impact of uncertainty on investments depends on the investments’ production flexibility.

Factor Value
Shaojun Zhang
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This paper finds that the value anomaly summarizes time series predictability in other factors using value and reversal spreads, representing differences in log value-weighted book-to-market ratios and minus past long-term stock returns between factor legs. Factors only yield significantly positive returns when the spreads exceed historical median. Employing value and reversal spreads, factor value strategy outperforms and explains various value-style anomalies. Value anomalies time other factors with factor loading increasing in the spreads. Factor predictability is consistent with persistent overpricing correction and asymmetric limits of arbitrage, introducing additional restrictions for models explaining cross-sectional and time-series equity returns simultaneously.

Supply Network Fragility, Inventory Investment, and Corporate Liquidity
Leandro Sanz
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This study uses a novel dataset of over 11,000 foreign suppliers to U.S. manufacturers to investigate the impact of supply network fragility on corporate policies. The scarcity of suppliers offering specialized inputs emerges as a key driver of fragility. Both theoretical and empirical evidence indicate that firms with fragile supply networks maintain more input inventories, less cash, and higher leverage. Moreover, plausible exogenous variation in fragility from technology adoption and disruptions supports a causal interpretation of the results. My findings indicate that because specialized inputs lack a spot market post-disruptions, firms with fragile supply networks favor operational over financial hedging.

Firm-level Irreversibility
Hang Bai, Erica X.N. Li, Chen Xue, and Lu Zhang
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Contradicting Cooper and Haltiwanger (2006), Clementi and Palazzo (CP, 2019) report a largely symmetric investment rate distribution in Compustat, with a large fraction of negative investment rates, 18.2%, and conclude “no sign of irreversibility (p. 289).” CP’s analysis is flawed. A data error on depreciation rates understates gross investment and shifts the whole gross investment rate distribution leftward. Nonstandard sample screens on age and acquisitions further curb its right tail, which is then truncated at 0.2. Fixing these problems restores the heavily asymmetric investment rate distribution with a fat right tail. The fraction of negative investment rates is small, only 4.9%–6.2%.

Relationship-Specific Investments and Firms’ Boundaries: Evidence from Textual Analysis of Patents
Jan Bena, Isil Erel, Daisy Wang, and Michael S. Weisbach
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Acquisitions increase inventors’ incentives to undertake relationship-specific investments, as suggested by Hart and Moore (1990). Using inventor-level patent data for U.S. public and private M&As, we measure the complementarity between inventors’ pre-merger knowledge base and the counterparty firm’s patent portfolio, and innovation specificity based on the extent to which post-merger patents draw on technologies distinctive to the counterparty’s portfolio. High-complementarity inventors are more likely to stay with the combined firm and, after completed deals, increase innovation specificity by economically large amounts. A falsification exercise shows no such shift when inventors join via hiring without patent ownership transfers.

Quantifying Risk Transformation in Bank Lending
Thomas Flanagan
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How different is the cost of capital when banks finance a loan compared to the rate required by direct household investors? This paper quantifies this difference by estimating the prices both investors would be willing to pay for an identical set of loan cash flows when markets are segmented and households are subject to idiosyncratic consumption shocks. Using recently developed methods from the private equity literature, I find that banks are willing to pay 70% more than households for the same loans, which equates to a 2% pp lower cost of capital for banks. This difference in cost of capital arises because loans are more ‘diversifiable’ in the bank’s portfolio than they are in a household’s portfolio, which is subject to idiosyncratic consumption shocks. Additionally, this cost of capital advantage increases when banks lend to riskier firms and possess a larger deposit base. Overall, these findings corroborate classic theories of bank risk-sharing, in which banks invest on behalf of risk-averse households in an effectively more risk-tolerant fashion, providing a lower cost of finance.

Steering Labor Mobility through Innovation
Song Ma, Wenyu Wang, and Yufeng Wu
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This paper argues that firms proactively use innovation decisions to influence the mobility and human capital accumulation of their workers. We develop a dynamic model in which workers conduct R&D projects, accumulating both general and firm-specific human capital. Firms choose the scope of innovation, influencing the type of human capital workers accumulate during the process. Pursuing more general innovation leads to increased knowledge redeployability for the firm at the cost of more difficult employee retention. We estimate the model using granular innovation production and mobility data of three million inventors. Our model closely matches the observed mobility and innovation specificity over inventors' life cycles. Empirical estimates of the model parameters imply that 24% of observed innovation specificity among U.S. firms is driven by their labor market considerations, which enhances the firm value but lowers the inventors' surplus.

Diving Into Dark Pools
Sabrina Buti, Barbara Rindi,and Ingrid Werner
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We study 2009 and 2020 dark trading for U.S. stocks. Dark trading is lower when volume is low, volatility high, and in periods of markets stress. Dark pools are more active for large caps, while internalization is more common for small caps. Traders use dark pools to jump the queue for large caps in 2009, and to avoid crossing the spread for small caps in both years. Internalization is higher when spreads are wide and depth is high. Dark pool trading improves spreads in 2009, but worsens market quality for large caps in 2020. We discuss explanations for the change.

Venture Capital (Mis)Allocation in the Age of AI
Victor Lyonnet and Léa H. Stern
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We use machine learning to study how venture capitalists (VCs) make investment decisions. Using a large administrative data set on French entrepreneurs that contains VC-backed as well as non-VC-backed firms, we use algorithmic predictions of new ventures’ performance to identify the most promising ventures. We find that VCs invest in some firms that perform predictably poorly and pass on others that perform predictably well. Consistent with models of stereotypical thinking, we show that VCs select entrepreneurs whose characteristics are representative of the most successful entrepreneurs (i.e., characteristics that occur more frequently among the best performing entrepreneurs relative to the other ones). Although VCs rely on accurate stereotypes, they make prediction errors as they exaggerate some representative features of success in their selection of entrepreneurs (e.g., male, highly educated, Paris-based, and high-tech entrepreneurs). Overall, algorithmic decision aids show promise to broaden the scope of VCs’ investments and founder diversity.

Asymmetric Investment Rates
Hang Bai, Erica X. N. Li, Chen Xue, Lu Zhang
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Integrating national accounting with financial accounting, we provide firm-specific estimates of current-cost capital stocks for the entire Compustat universe, as well as an array of estimates of investment flows, economic depreciation rates, and capital and investment price deflators. The firm-level current-cost investment rate distribution is heavily right-skewed, with a small fraction of negative investment rates, 5.51%, but a huge fraction of positive investment rates, 91.64%. Despite a tiny fraction of inactive investment rates, 2.85%, firm-level investment also seems lumpy, featuring a fraction of 32.66% for positive spikes (investment rates higher than 20%). For a typical firm, 39% of total investment is completed within 20% of the sample years.

Evolution of Debt Financing toward Less-Regulated Financial Intermediaries in the United States
Isil Erel and Eduard Inozemtsev
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Nonbank lenders have been playing an increasing role in supplying debt, especially after the Great Recession. How important are the distortions in the greater regulation of banks that differentially limit risk-taking across alternative providers of credit? How might the growing role of nonbanks in credit markets affect financial stability? This selective review addresses these questions and discusses how banks and nonbanks helped provide liquidity to the nonfinancial sector during the COVID-19 pandemic shock. We argue that tighter bank regulation has created incentives for nonbanks to increase their participation in credit markets, a trend that creates concerns about financial stability.

The Determinants of Bank Liquid Asset Holdings
René M. Stulz, Alvaro G. Taboada, Mathijs A. van Dijk
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Bank liquid asset holdings vary significantly across banks and through time. The determinants of liquid asset holdings from the corporate finance literature are not useful to predict banks’ liquid asset holdings. Banks have an investment motive to hold liquid assets, so that when their lending opportunities are better, they hold fewer liquid assets. We find strong support for the investment motive. Large banks hold much more liquid assets after the Global Financial Crisis (GFC), and this change cannot be explained using models of liquid asset holdings estimated before the GFC. We find evidence supportive of the hypothesis that the increase in liquid assets of large banks is due at least in part to the post-GFC regulatory changes.

Carbon Returns Across the Globe
Shaojun Zhang
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The carbon return refers to the excess return associated with brown firms and is central to the debate on climate-aware investment. Emissions grow with firm sales, and the emission data are only available to investors with significant lags. The positive carbon return documented in previous studies arises from the forward-looking firm performance information contained in emissions instead of the risk premium. After accounting for the data release lag, carbon returns turn negative in the U.S. and insignificant globally. Developed markets experience lower carbon returns due to intense climate concern shocks, while countries with stringent climate policies exhibit higher carbon returns.

The Rise of Anti-Activist Poison Pills
Ofer Eldar, Tanja Kirmse, and Michael D. Wittry
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We examine the contractual evolution of poison pill design, focusing on lower ownership triggers, acting-in-concert provisions, and synthetic equity clauses that tailor pills to defend against shareholder activism. Using novel data on hedge funds’ access to SEC filings as a proxy for intervention threats, we find that firms facing heightened activist threats are more likely to adopt anti-activist pills. Relative to comparable firms under activist scrutiny, pill adopters experience fewer subsequent activist interventions and are less likely to pursue activist-favored policies, such as reduced investment and increased buybacks. These findings contribute to policy debates over defensive measures against activist interventions.

Stock-Oil Comovement: Cash Flows or Discount Rates?
Alessandro Melone, Otto Randl, Leopold Sögner, and Josef Zechner
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The return correlation between U.S. stocks and oil has shifted from negative to positive since 2008. We use a return decomposition framework to show that an underlying reason for this structural change is a shift in the correlation between cash flow news for both assets. The U.S. oil production is a key driver of both the stock-oil correlation and the cash flow news correlation. Post-2008, positive oil demand shocks are good news for the cash flows of both assets. Our findings help to understand the set of potential determinants of equity-commodity correlations and the diversification benefits of investing in commodities.

Corporate Takeover Defenses
Jonathan M. Karpoff and Michael D. Wittry
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Takeover defenses, also called antitakeover provisions, reflect decades of innovation in the interplay of offensive and defensive tactics in the market for corporate control. This paper summarizes research on how firms use takeover defenses and how defenses affect firm value and operations. Recent evidence shows that defenses convey both costs and benefits that vary across firms and over an individual firm’s life – helping to explain the mixed empirical results in many earlier studies. We also review evidence on the extent to which takeover defenses work to forestall takeovers, and the costs and benefits of adding or removing takeover defenses. We conclude by identifying unresolved issues about takeover defenses and questions for future research.

All Clear for Takeoff: Evidence from Airports on the Effects of Infrastructure Privatization
Sabrina T. Howell, Yeejin Jang, Hyeik Kim, and Michael S. Weisbach
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We study how privatization and four variants of private ownership type affect infrastructure performance, focusing on global airports over 25 years. Privatization in general does not improve performance. However, private equity (PE) ownership has strong and persistent positive effects on measures of efficiency, volume, and quality. To address selection, we use close auctions in which both PE and non-PE firms bid. The disparities across ownership types are related to fees charged to airlines, physical capacity expansion, local state capacity, and the presence of a state-owned flag carrier. Overall, PE-owned airports benefit from high-powered incentives and access to capital.

Cross-Border Mergers and Acquisitions
Isil Erel, Yeejin Jang,and Michael S. Weisbach
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One of the most consequential events in any firm’s lifetime is a major acquisition. Because of their importance, mergers and acquisitions (M&As) have been an enormous area of research. However, the vast majority of this research and survey papers summarizing this research have focused on domestic deals. Cross-border ones, however, constitute about 30% of the total number and 37% of the total volume of M&As around the world since the early 1990s. We survey the literature on cross-border M&As, focusing on international factors that can lead firms to acquire a firm in another country. Such factors include differences in economic development, laws, institutions, culture, labor rights, protection of intellectual property, taxes, and corporate governance.

The Unicorn Puzzle
Daria Davydova, Rüdiger Fahlenbrach, Leandro Sanz, and René M. Stulz
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From 2010 to 2021, 639 US VC-funded firms achieved unicorn status. We investigate why there are so many unicorns and why controlling shareholders give investors privileges to obtain unicorn status. We show that unicorns rely more than other VC-funded firms on organizational capital as well as network effects and the internet. Unicorn status enables startups to access new sources of capital. With this capital, they can invest more in organizational intangible assets with less expropriation risk than if they were public. As a result, they are more likely to capture the economies of scale that make their business model valuable.

Expert Network Calls
Sean S. Cao, T. Clifton Green, Lijun Lei, Shaojun Zhang
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Expert networks provide investors with in-depth discussions with subject matter experts. Expert call demand is higher for younger, technology-oriented firms and those with greater intangible assets, consistent with demand for information on hard-to-value firms. Expert calls are more (less) likely to emphasize technology and operational (financial) topics relative to earnings calls. We find that expert call volume is associated with hedge fund position changes and greater price efficiency. The relation is asymmetric, with call volume preceding hedge fund sales, greater short interest, and negative firm performance. The evidence suggests that expert networks help investors discern complicated bad news.

The Retail Execution Quality Landscape
Anne Haubo Dyhrberg, Andriy Shkilko, and Ingrid M. Werner
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We show that off-exchange (wholesaler) executions provide significant trading cost savings to retail investors. Despite industry concentration, three findings suggest that wholesalers do not abuse market power. First, brokers closely monitor and reward wholesalers offering low liquidity costs with more order flow. Second, the largest wholesalers offer the lowest costs due to economies of scale. Finally, the entry of a new large wholesaler does not reduce liquidity costs. Drawing from these insights, we discuss the implications of two proposed alternatives to the status quo: (i) pooling retail and institutional flows on exchanges and (ii) sending retail flow to order-by-order auctions.

*Werner is an independent director for DFA US Mutual Funds and ETF Trust, is a director for the Fourth Swedish Pension Fund (AP4), and serves on the Prize Committee for the Riksbanken's Prize in Economic Sciences in Memory of Alfred Nobel.

Competition for Attention in the ETF Space
Itzhak Ben-David, Francesco Franzoni, Byungwook Kim, and Rabih Moussawi
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The interplay between investors’ demand and providers’ incentives has shaped the evolution of exchange-traded funds (ETFs). While early ETFs invested in broad-based indexes and therefore offered diversification at low cost, more recent products track niche portfolios and charge high fees. Strikingly, over their first 5 years, specialized ETFs lose about 30% (risk-adjusted). This underperformance cannot be explained by high fees or hedging demand. Rather, it is driven by the overvaluation of the underlying stocks at the time of the launch. Our results are consistent with providers catering to investors’ extrapolative beliefs by issuing specialized ETFs that track attention grabbing themes.

The Cash Flow Sensitivity of Cash: Replication, Extension, and Robustness
Heitor Almeida, Murillo Campello, and Michael S. Weisbach
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This paper reexamines the empirical evidence on the cash flow sensitivity of cash presented by Almeida, Campello, and Weisbach (2004). The original paper introduces a model in which financially constrained firms choose to save cash out of incremental cash flows but financially unconstrained do not. The authors find evidence consistent with this hypothesis on a sample of U.S. public firms between 1971 and 2000. This paper extends that analysis in a number of ways. In particular, it uses a larger sample covering the 1971–2019 window, considers a number of alternative definitions of financial constraints, and incorporates new methods and tests suggested by Welch (2020), Almeida, Campello, and Galvao (2010), and Grieser and Hadlock (2019). The original empirical findings are robust to these alternative specifications.

Discontinued Positive Feedback Trading and the Decline of Return Predictability
Itzhak Ben-David, Jiacui Li, Andrea Rossi, and Yang Song
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We show that demand effects generated by institutional frictions can influence systematic return predictability patterns in stocks and mutual funds. Identification relies on a reform to the Morningstar rating system, which we show caused a structural break in style-level positive feedback trading by mutual funds. As a result, momentum-related factors in stocks, as well as performance persistence and the "dumb money effect" in mutual funds, experienced sharp decline. Consistent with the proposed channel, return predictability declined right after the reform, was limited to the U.S. market, and was concentrated in factors and mutual funds most exposed to the mechanism.

Discount Rate Risk in Private Equity: Evidence from Secondary Market Transactions
Brian Boyer, Taylor D. Nadauld, Keith P. Vorkink, and Michael S. Weisbach
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Standard measures of PE performance based on cash flows overlook discount rate risk. An index constructed from prices paid in secondary market transactions indicates that PE discount rates vary considerably. While the standard alpha for our index is zero, measures of performance based on cash flow data for funds in our index are large and positive. To illustrate that results are not driven by idiosyncrasies of PE secondary markets, we obtain similar results using cash flows and returns of synthetic funds that invest in small cap stocks. Ignoring variation in PE discount rates can lead to a misallocation of capital.

Is Public Equity Deadly? Evidence from Workplace Safety and Productivity Tradeoffs in the Coal Industry
Erik P. Gilje and Michael D. Wittry
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We study how public listing status relates to the balance between workplace safety and labor productivity. Theory offers competing hypotheses on how listing-related frictions may affect this tradeoff. We exploit asset-level data in the U.S. coal industry and find that workplace safety deteriorates under public firm ownership, primarily in mines that experience the largest productivity increases. The tradeoff towards higher productivity and poorer workplace safety for public firms is concentrated when information asymmetry problems between managers and shareholders are likely exacerbated, and when the transition to public ownership occurs in communities where the prior private owner had stronger local ties.

Do Firms with Specialized M&A Staff Make Better Acquisitions?
Sinan Gokkaya, Xi Liu, and René M. Stulz
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We open the black box of the M&A decision process by constructing a comprehensive sample of US firms with specialized M&A staff. We investigate whether specialized M&A staff improves acquisition performance or facilitates managerial empire building instead. We find that firms with specialized M&A staff make better acquisitions when acquisition performance is measured by stock price reactions to announcements, long-run stock returns, operating performance, divestitures, and analyst earnings forecasts. This effect does not hold when the CEO is powerful, overconfident, or entrenched. Acquisitions by firms without specialized staff do not create value, on average. We provide evidence on mechanisms through which specialized M&A staff improves acquisition performance. For identification, we use the staggered recognition of inevitable disclosure doctrine as a source of exogenous variation in the employment of specialized M&A staff.

Keeping up with the Joneses and the Real Effects of S&P 500 Inclusion
Benjamin Bennett, René M. Stulz, and Zexi Wang
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Firms added to the S&P 500 index join a prestigious and exclusive club. They want to fit in the club, which creates a “keeping up with the Joneses” effect. Firms pay more attention to their index peers after inclusion and their investment, external financing, and payouts comove more with their index peers. These effects do not appear to result from the increased coordination among investors posited by the common ownership literature as inclusion does not cause a decrease in competition. Since index inclusion does not increase shareholder wealth permanently, these peer effects do not appear to benefit shareholders.

Scammed and Scarred: Effects of Investment Fraud on its Victims
Samuli Knüpfer, Ville Rantala, and Petra Vokata
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We study the effects of investment-fraud victimization using information on thousands of Ponzi scheme participants combined with register data on the Finnish population. A difference-in-differences analysis reveals the victims earn 5% less income after the scheme collapses. This persistent loss arises from a combination of unemployment, absenteeism, mobility, and labor force exit, and its long-run value exceeds the direct investment loss. Victims also experience higher indebtedness and more divorces and shy away from investments delegated to asset managers. These scars from fraud victimization add to the social cost of fraud and are relevant for optimal regulatory design.

Beyond Reverse Splits: How Do Fallen Angels Restructure?
Abed El Karim Farroukh, Jennifer L. Koski, and Ingrid M. Werner
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Firms with very low stock prices face a unique set of frictions that affect trading and liquidity. We study the restructuring actions of firms whose stock prices experience a sharp decline to a low-price level – fallen angels. We find that, relative to a control sample, fallen angels implement more reverse stock splits. However, we find no significant relation between reverse splits and subsequent returns for fallen angels, and reverse splits are associated with negative future returns for control stocks. We therefore explore alternative restructuring actions and find that fallen angels cut investments in fixed assets and reduce employment more than control firms. Retrenching firms experience higher subsequent returns, but worse operating performance and higher asset volatility. Overall, our findings suggest that low-price firms must engage in actions beyond reverse splits to boost stock prices, and these actions are costly.

Leverage and Cash Dynamics
Harry DeAngelo, Andrei S. Gonçalves, and René M. Stulz
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This paper documents new and empirically important interactions between cash-balance and leverage dynamics. Cash ratios typically vary widely over extended horizons, with dynamics remarkably similar to (and complementary with) those of capital structure. Leverage and cash dynamics interact approximately as predicted by the internal-versus-external funding regimes in Myers and Majluf (1984). Leverage is quite volatile when cash ratios are stable and vice-versa, while net-debt ratios are almost always volatile. Most firms increase leverage sharply as cash balances (internal funds) become scarce. Capital structure models that extend Hennessy and Whited (2005) to include cash-balance dynamics explain some, but not all, aspects of the observed relation between cash squeezes and leverage increases.

Directors’ Incentives from Potential Regulatory Penalties: Evidence from their Voting
Wenzhi Ding, Chen Lin, Thomas Schmid, and Michael S. Weisbach
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What makes independent directors perform their monitoring duty? One possible reason is that they are concerned about being sanctioned by regulators if they do not monitor sufficiently well. Using unique features of the Chinese financial market, we estimate the extent to which independent directors’ perceptions of the likelihood of receiving a regulatory penalty affect their monitoring. Our results suggest that they are more likely to vote against management after observing how another director in their board network received a regulatory penalty related to negligence. This effect is long-lasting and stronger if the observing and penalized directors share the same professional background or gender and if the observing director is at a firm that is more likely to be penalized. These results provide direct evidence suggesting that the possibility of receiving penalties is an important factor motivating directors.

Why do bank boards have risk committees?
René M. Stulz, James Tompkins, Rohan Williamson, and Zhongxia (Shelly) Ye
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We develop a theory of bank board risk committees that explains why such committees can be valuable to shareholders even when they do not reduce bank risk. As predicted by our theory (1) many large and complex banks voluntarily chose to have a risk committee before the Dodd-Frank Act forced bank holding companies with assets in excess of $10 billion to have a board risk committee, and (2) establishing a board risk committee does not reduce a bank’s risk on average. Using unique interview data, we show that the work of risk committees is consistent with our theory.

Specialized Investments and Firms’ Boundaries: Evidence from Textual Analysis of Patents
Jan Bena, Isil Erel, Daisy Wang, and Michael S. Weisbach
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Inducing firms to make specialized investments through bilateral contracts can be challenging because of potential holdup problems. Such contracting difficulties have long been argued to be an important reason for acquisitions. To evaluate the extent to which this motivation leads to mergers, we perform a textual analysis of the patents filed by the same lead inventors of the target firms before and after the mergers. We find that patents of inventors from target firms become 28.9% to 46.8% more specific to those of acquirers’ inventors following completed mergers, benchmarked against patents filed by targets and a group of counterfactual acquirers. This pattern is stronger for vertical mergers that are likely to require specialized investments. There is no change in the specificity of patents for mergers that are announced but not consummated. Overall, we provide empirical evidence that contracting issues in motivating specialized investment can be a motive for acquisitions.

Why Did Small Business FinTech Lending Dry Up During the COVID-19 Crisis?
Itzhak Ben-David, Mark Johnson, and René M. Stulz
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FinTech small business lenders fund loans mostly through credit facilities and securitizations. This business model could make them financially constrained when a shock reduces the value of existing loans. We find evidence supporting this prediction using detailed applicant-level and lender-level data from a platform that intermediates loans between dozens of FinTech lenders and small businesses. Despite the increased demand for credit at the onset of the COVID crisis, the credit supply quickly dwindled, regardless of borrowers' credit quality. Overall, our analysis demonstrates the fragility of the FinTech lending model in the face of a crisis.

Waiting on a Friend: Strategic Learning and Corporate Investment
Paul H. Décaire and Michael D. Wittry
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Using detailed project-level data, we document a novel mechanism through which information externalities distort investment. Firms anticipate information spillover from peers’ investment decisions and delay project exercise to learn from their peers’ outcomes. To establish a causal interpretation of our results, we exploit local exogenous variation from the 1800s that shapes the number of peers that a firm can learn from today. The incentive to wait is most salient for projects with uncertain profitability, when peers’ underlying assets are similar, and in environments where peers are skilled. Finally, our results suggest that the anticipation of peer information dampens aggregate investment.

Corporate Transactions in Hard-to-Value Stocks
Itzhak Ben-David, Byungwook Kim, Hala Moussawi, and Darren Roulstone
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Hard-to-value stocks provide opportunities for managers to exploit their informational advantage through trading on their firms' and their own personal accounts. In contrast to the prediction that such transactions reflect private information about future events, they are contrarian and heavily depend on past returns. Corporate transactions in hard-to-value stocks outperform those in easy-to-value stocks in the early part of our sample, but this difference disappears after 2002, coinciding with a general decline in the profitability of stock market anomalies. Our evidence is consistent with managers' perception of mispricing, rather than private information, being a key motivator of their transactions.

Payment Risk and Bank Lending
Ye Li and Yi Li
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Deposits finance bank lending and serve as means of payment for bank customers. Under uncertain payment flows, deposits are debts with random maturities. Payment outflows drain reserves, and the risk is most prominent when funding markets are under stress and banks are unable to smooth out payment shocks. We provide the first evidence on the negative impact of payment risk on bank lending, bridging the literatures on payment systems and credit supply. An interquartile increase in payment risk is associated with a decline in loan growth rate that is 10% of standard deviation. Our findings are stronger in times of funding stress and robust across banks of different sizes and loans of long and short maturities. Banks with higher payment risk raise deposit rates to expand customer base and internalize payment flows. Finally, we show that payment risk dampens the bank lending channel of monetary policy transmission.

Buyouts: A Primer
Tim Jenkinson, Hyeik Kim and Michael S. Weisbach
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This paper provides an introduction to buyouts and the academic literature about them. Buyouts are initiated by “buyout funds”, which are limited partnerships raised from mostly institutional investors. The funds earn returns for their investors by improving the operations of the firms they acquire and exiting them for a profit. Buyout funds have grown substantially and currently raise more than $400 billion annually in capital commitments. We first discuss the institutional environment that developed to foster such buyouts and to provide incentives for general partners and firm managers to earn returns for the fund’s investors. We then describe various strategies that funds use to increase the values of their portfolio companies. The paper provides up to date statistics on all aspects of the buyout industry. Finally, we present a summary of the academic literature on buyouts. This literature has paid particular attention to the extent to which buyouts earn risk-adjusted abnormal returns for their investors, as well as the sources of those returns.

The Persistent Effects of Financial Crises on the Composition of Real Investment
Shelia Jiang, Ye Li and Douglas Xu
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Our paper provides the first cross-country evidence on the distinct dynamics of tangible and intangible investments during and after the global financial crisis. The pre-crisis rise of intangible-to-tangible capital ratio was reversed due to a greater decline of intangible investment relative to tangible investment during the crisis and a much slower recovery of intangible investment after the crisis. Tangible capital can be externally financed, and its post-crisis recovery benefits from the restoration of credit supply. In contrast, Intangible investment relies on firms' liquidity holdings that were drawn down in the crisis and can only be rebuilt gradually through retained profits. We provide a unified account of the findings through a dynamic model of corporate investment and liquidity management. Consistent with our model predictions, the divergence between tangible and intangible investments is more prominent in countries with weaker intellectual property protection (less external financing options for intangibles) and riskier government bonds (less robust corporate liquidity holdings).

Cross-Border Activities as a Source of Information: Evidence from Insider Trading during the Covid-19 Crisis
Leandro Sanz
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Insider trading during the early months of the COVID-19 pandemic provides a unique opportunity to study how corporate insiders benefit from information flows in their network of business contacts. I find that insiders at firms with activities in China sell more shares of their companies than other insiders and do so earlier. Consistent with an information channel, I show that firms with supply-chain relationships and subsidiaries in China, more local assets and employees, and insiders overseeing global operations drive these effects. Insiders' private information seems to have been forward-looking, which allowed them to avoid significant losses during the period.

Do Employees Have Useful Information About Firms’ ESG Practices?
Hoa Briscoe-Tran
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This paper investigates whether employees have useful information for assessing firms’ environmental, social, and governance (ESG) practices. I analyze 10.4 million anonymous employee reviews via a word-embedding model to construct an inside view of corporate ESG practices. The inside view has useful information beyond external ratings in predicting a firm’s future misconduct, governance issues, downside risk, growth, and valuation. In addition, the inside view appears robust to greenwashing, both theoretically and empirically. In various settings including a novel exogenous shock, I show that low-cost changes in a firm’s stated ESG policies do not affect the inside view while more expensive changes do.

Bank Credit and Money Creation on Payment Networks: A Structural Analysis of Externalities and Key Players
Ye Li, Yi Li and Huijun Sun
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This paper documents a strong connection between payment system and credit supply. The dual role of deposits as financing instruments for banks and means of payment for bank customers implies spillover effects of bank lending. After a bank finances loans with new deposits, the deposit holders' payments cause reserves and deposits to flow from the lending bank to the payees' banks. The change in liquidity conditions for both banks and their customers gives rise to two opposing forces that generate respectively strategic complementarity and strategic substitution in banks' lending decisions. We model bank lending through a linear-quadratic game on a random graph of payment flows and structurally estimate the spillover effects using Fedwire data to quantify the probability distribution of payment-flow network. Payment network externalities reduce the average level of aggregate credit supply by 9% while amplify the volatility by 20%. We identify a small subset of banks that have a disproportionately large influence on credit supply due to their special positions in the payment-flow network.

The Corporate Finance of Multinational Firms
Isil Erel, Yeejin Jang, and Michael S. Weisbach
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An increasing fraction of firms worldwide operate in multiple countries. We study the costs and benefits of being multinational in firms’ corporate financial decisions and survey the related academic evidence. We document that, among U.S. publicly traded firms, the prevalence of multinationals is approximately the same as domestic firms, using classification schemes relying on both income-based and a sales-based metrics. Outside the U.S., the fraction is lower but has been growing. Multinational firms are exposed to additional risks beyond those facing domestic firms coming from political factors and exchange rates. However, they are likely to benefit from diversification of cash flows and flexibility in capital sources. We show that multinational firms, indeed, have a better access to foreign capital markets and a lower cost of debt than otherwise identical domestic firms, but the evidence on the cost of equity is mixed.

Why Does Equity Capital Flow Out of High Tobin’s q Industries?
Dong Lee, Han Shin and René M. Stulz
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High Tobin’s q industries receive more funding from capital markets than low Tobin’s q industries from 1971 to 1996. Since then, the opposite is true. The key to understanding this shift is that large firms for which q is more a proxy for rents than for investment opportunities have become more important within industries. For these firms, repurchases increase with q but capital expenditures do not, so that q explains more the variation of repurchases than of capital expenditures. Consequently, equity capital flows out of high q industries because, for these industries, stock repurchases are high and issuances are low.

Are Corporate Payouts Abnormally High in the 2000s?
Kathleen Kahle and René M. Stulz
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Adjusting for inflation, the annual amount paid out through dividends and share repurchases by public non-financial firms is three times larger in the 2000s than from 1971 to 1999. We find that an increase in aggregate corporate income explains 38% of the increase in the average of aggregate annual payouts from 1971-1999 to the 2000s, while an increase in the aggregate payout rate explains 62%. At the firm level, changes in firm characteristics explain 71% of the increase in average payout rate for the population and 49% of the increase in the average payout rate of firms with payouts. Though there is a negative relation between payouts and investment, most of the increase in payouts is unrelated to the decrease in investment. Models estimated over 1971-1999 underpredict the payout rate of firms with payouts in the 2000s. These models perform better when we forecast non-debt-financed payouts for a sample of larger firms, but not for the sample as a whole. Payouts are more responsive to firm characteristics in the 2000s than before, which is consistent with management having stronger payout incentives.

Regional Divergence and House Prices
Greg Howard and Jack Liebersohn
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This paper develops a model of the U.S. housing market that explains much of the time series of rents and house prices since World War II. House prices depend on expectations of future rents. We show that rents are tied to regional income inequality, and therefore, house prices are determined by how much faster incomes are growing in richer regions. This theory also matches many cross-sectional facts, including regional variation in rents and prices, differing house price sensitivities to national trends, patterns of inter-state migration, and surveys of income expectations. An industry shift-share instrument provides causal evidence for our channel. The model implies that while interest rates have an ambiguous effect on house price levels, low rates increase house price volatility.

Is financial globalization in reverse after the 2008 global financial crisis? Evidence from corporate valuations
Craig Doidge, G. Andrew Karolyi, and René M. Stulz
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For the last two decades, non-US firms have lower valuations than similar US firms. We study the evolution of this valuation gap to assess whether financial markets are less integrated after the 2008 global financial crisis (GFC). The valuation gap for firms from developed markets increases by 31% after the GFC – a reversal in financial globalization – while the gap for firms from emerging markets (excluding China) stays stable. There is no evidence of greater segmentation for non-US firms cross-listed on major US exchanges and the typical valuation premium of such firms relative to domestic counterparts stays unchanged. However, the number of such firms shrinks sharply, so that the importance of US cross-listings as a mechanism for market integration diminishes.

Crisis Poison Pills
Ofer Eldar and Michael D. Wittry
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We show that a large number of firms adopt poison pills during periods of market turmoil. Specifically, during the coronavirus pandemic, many firms adopted poison pills following declines in valuations, and stock prices increased upon the announcement of firms’ poison pill adoption. Stock price increases are driven by (1) firms in which activist shareholders acquire ownership stakes and (2) firms in industries that had high exposure to the crisis. Likewise, we find a positive reaction to pills with provisions directed at stalling activists’ interventions. Our results suggest that crisis pills that target potentially disruptive ownership changes may benefit current shareholders.

How valuable is financial flexibility when revenue stops? Evidence from the COVID-19 crisis
Rüdiger Fahlenbrach, Kevin Rageth, and René M. Stulz
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Firms with greater financial flexibility should be better able to fund a revenue shortfall resulting from the COVID-19 shock and benefit less from policy responses. We find that firms with high financial flexibility within an industry experience a stock price drop lower by 26% or 9.7 percentage points than those with low financial flexibility. This differential return persists as stock prices rebound. The firms more exposed to the COVID-19 shock benefit more from cash holdings. There is no evidence that recent payouts made the average firm’s stock price drop worse. Our results cannot be explained by a leverage effect.

Housing Risk and the Cross-Section of Returns Across Many Asset Classes
Sai Ma and Shaojun Zhang
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This paper documents that a single-factor model based on shocks to the residential investment share, or the ratio of residential-to-nonresidential investment, exhibits strong explanatory power for expected returns across various characteristic-sorted portfolios in equity and other asset classes. The residential investment share captures time-varying demand for housing services and is a state variable of the economy. Consequently, innovations to the share emerge as a risk factor in asset prices in the cross-section. The empirical results are robust to controlling for other factor models based on durable consumption, financial intermediaries, household heterogeneity, and return-based multifactor models designed to price these assets.

How Important Is Moral Hazard For Distressed Banks?
Itzhak Ben-David, Ajay A. Palvia, and René M. Stulz
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The moral hazard incentives of the bank safety net predict that distressed banks take on more risk and higher leverage. Since many factors reduce these incentives, including charter value, regulation, and managerial incentives, the net economic effect of these incentives is an empirical question. We provide evidence on this question using two distinct periods that include financial crises and are subject to different regulatory regimes (1985–1994, 2005–2014). We find that distressed banks reduce their leverage and decrease observable measures of riskiness, which is inconsistent with the view that, on average, moral hazard incentives dominate distressed bank leverage and risk-taking policies.

Sentiment and Uncertainty
Justin Birru and Trevor Young
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Sentiment should exhibit its strongest effects on asset prices at times when valuations are most subjective. Accordingly, we show that a one-standard-deviation increase in aggregate uncertainty amplifies the predictive ability of sentiment for market returns by two to four times relative to when uncertainty is at its mean. For the cross-section of returns, the predictive ability of sentiment for test assets expected to be most sensitive to sentiment, including existing measures of both risk and mispricing, is substantially larger in times of higher uncertainty. The results hold for both daily and monthly proxies for sentiment and for various proxies for uncertainty.

Cryptocurrency Exchanges and Comovements of Cryptocurrency Returns
Amin Shams
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This paper documents that similarity in cryptocurrencies' investor bases proxied by their trading exchange is the main driver of cryptocurrencies' comovement structure. This comovement structure is far stronger than can be explained by similarities in cryptocurrency characteristics such as size, volume, age, consensus mechanism, and industries. I examine three potential channels for these results. First, evidence from new exchange listings and a quasi-natural experiment shows that unobservable characteristics cannot explain these results. Second, the results are driven by exchange-specific commonalities in demand that lead to global price movements across exchanges. Third, analysis of social media data shows that the demand-driven comovement is significantly larger for cryptocurrencies that rely heavily on organic adoption. Overall, these findings suggest that unique features of cryptocurrencies make demand pressures a first-order driver of cryptocurrency returns.

Bank Mergers, Acquirer Choice and Small Business Lending: Implications for Community Investment
Bernadette A. Minton, Alvaro G. Taboada, and Rohan Williamson
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We examine the effects of bank merger and local market characteristics on local small business lending. Mergers involving small, in-state acquirers are positively associated with small business loan (SBL) originations in counties where target banks are located. Conversely, mergers involving large, out-of-state acquirers are associated with fewer SBL originations. The analysis suggests that the results are driven by acquirer’s choice of target. Small and in-state acquirers target banks that focus more on SBL and targets with strong relationships while large, out-of-state acquirers pursue better performing banks with stronger balance sheets and less focus on SBL. Results are particularly strong in counties with a large number of small firms. Post-merger activity supports banks expanding on their acquisition strategy decisions. The findings suggest that acquirer strategy is important for evaluating the impact of acquisitions on local community development and that one-size-fits-all policy solutions for bank mergers may not produce common local outcomes.

Dynamic Banking and the Value of Deposits
Patrick Bolton, Ye Li, Neng Wang, and Jinqiang Yang
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We propose a dynamic theory of banking where the role of deposits is akin to that of productive capital in the classical Q-theory of investment for non-financial firms. As a key source of leverage, deposits create value for well-capitalized banks. However, unlike capital of nonfinancial firms, deposits can have a negative marginal q for undercapitalized banks. Demand deposit accounts commit banks to allow holders to withdraw or deposit funds at will, so banks cannot perfectly control leverage. When banks have insufficient equity capital to buffer risk, deposit inflows and the associated uncertainty in future leverage can destroy value. Our model predictions on bank valuation and dynamic asset-liability management are broadly consistent with the evidence. Moreover, our model lends itself to a re-evaluation of the costs and benefits of leverage regulation and offers new perspectives on the challenges that banks face in a low interest rate environment.

The Performance of Hedge Fund Performance Fees
Itzhak Ben-David, Justin Birru, Andrea Rossi
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Performance-based fees in asset management contribute to the growing cost of financial intermediation. But how well do these fees align the long-run outcomes of fund managers and investors? In a large 22-year sample of hedge funds, we find that 60% of the gains on which incentive fees are paid are eventually offset by losses. As a result, the effective incentive fee rate is 50% vis-a-vis the nominal 20% rate. Overall, hedge fund fees consume 64% of the gross returns on investors’ capital and are only weakly correlated with actual long-run performance in the cross-section of funds.

Dissecting Currency Momentum
Shaojun Zhang
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This paper shows that currency momentum, which cannot be explained by carry and dollar factors, summarizes the autocorrelation of these factors. A no-arbitrage model postulates that predictable global shock volatility can simultaneously generate factor and currency momentum. Empirically, carry and dollar factors are strongly autocorrelated and only earn significantly positive excess returns following positive factor returns. Future factor volatility drives out the autocorrelation. Factor momentum not only outperforms currency momentum but also explains it, whereas idiosyncratic returns do not generate momentum. Currency momentum longs the factors following positive factor returns and shorts the factors following losses.

Can FinTech Reduce Disparities in Access to Finance? Evidence from the Paycheck Protection Program
Isil Erel and Jack Liebersohn
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New technology promises to expand the supply of financial services to small businesses poorly served by banks. Does it succeed? We study the response of FinTech to financial services demand created by the introduction of the Paycheck Protection Program. Fin-Tech is disproportionately used in ZIP codes with fewer bank branches, lower incomes, and more minority households, and in industries with fewer banking relationships. It is also greater in counties where the economic effects of the COVID-19 pandemic were more severe. Substitution between FinTech and banks is economically small, implying that FinTech mostly expands, rather than redistributes, the supply of financial services.

Does Joining the S&P 500 Index Hurt Firms?
Benjamin Bennett, René M. Stulz, and Zexi Wang
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We investigate the impact on firms of joining the S&P 500 index from 1997 to 2017. We find that the positive announcement effect on the stock price of index inclusion has disappeared and the long-run impact of index inclusion has become negative. Inclusion worsens stock price informativeness and some aspects of governance. Compensation, investment, and financial policies change with index inclusion. For instance, payout policies of firms joining the index become more similar to the policies of their index peers. ROA falls following inclusion. There is no evidence of an impact of inclusion on competition.

The (Missing) Relation Between Acquisition Announcement Returns and Value Creation
Itzhak Ben-David, Utpal Bhattacharya, Ruidi Huang, and Stacey Jacobsen
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Cumulative abnormal returns (CAR) computed around acquisition announcements are widely considered to be market-based assessments of expected value creation. We show, however, that announcement returns do not correlate with commonly used and new measures of ex-post outcomes. A simple characteristics-based model using standard information known at the announcement date can predict these outcomes reasonably well, yet CAR even fails to capture the predictions from this model. Evidence suggests that information about the standalone acquirer dominates CAR, making it virtually impossible to extract deal-related information. We conclude that CAR is an unreliable measure of expected value creation.

Rise of the Machines: The Impact of Automated Underwriting
Mark Jensen, Hieu Quang Nguyen and Amin Shams
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Using a randomized experiment in auto lending, we find that algorithmic underwriting outperforms the human underwriting process, resulting in 10.2% higher loan profits and 6.8% lower default rates. The human and machine underwriters show similar performance for low-risk, less complex loans. However, the performance of human underwritten loans largely declines for riskier and more complex loans, whereas the machine performance stays relatively stable across various risk dimensions and loan characteristics. The performance difference is more pronounced at underwriting thresholds with a high potential for agency conflict. These results are consistent with algorithmic underwriting mitigating agency conflicts and humans’ limited capacity for analyzing complex problems.

Why Are Corporate Payouts So High in the 2000s?
Kathleen Kahle and René M. Stulz
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The average annual inflation-adjusted amount paid out through dividends and repurchases by public industrial firms is more than three times larger from 2000 to 2019 than from 1971 to 1999. We find that an increase in aggregate corporate income accounts for 37% of the increase in aggregate annual payouts and an increase in the payout rate accounts for 63%. Firms have higher payout rates in the 2000s not only because they are older, larger, and have more free cash flow, but also because they pay out more of their free cash flow. Though firms spend less on capital expenditures in the 2000s than before, capital expenditures decrease similarly for the firms with payouts and for firms without.

Engineering Lemons
Petra Vokata
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Recent complex financial products sold to households contradict the basic premise of canonical innovation theories: financial innovation benefits its adopters. In my 2006–2015 sample of over 28,000 yield enhancement products (YEP) the securities offer attractive yields but negative returns. The products lose money both ex ante and ex post due to their embedded fees: on average, YEPs charge 6–7% in annual fees and subsequently lose 6–7% relative to risk-adjusted benchmarks. Simple and cheap combinations of listed options often first-order dominate YEPs. Competition, disclosure, or learning do not eliminate this inferior financial innovation over my sample period.

Have exchange-listed firms become less important for the economy?
Frederik P. Schlingemann and René M. Stulz
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The firms listed on the stock market in aggregate contribute less to total non-farm employment and GDP now than in the 1970s. A major reason for this development is the decline of manufacturing and the growth of the service economy as firms providing services are less likely to be listed on exchanges. A firm’s stock market capitalization is much less instructive about its employment now than in earlier years. Listed stock market superstars account for less employment than they did in the 1970s. Market capitalizations have not become systematically less informative about firms’ contribution to GDP.

Searching for the Equity Premium
Hang Bai and Lu Zhang
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Labor market frictions are crucial for the equity premium in production economies. A dynamic stochastic general equilibrium model with recursive utility, search frictions, and capital accumulation yields a high equity premium of 4.26% per annum, a stock market volatility of 11.8%, and a low average interest rate of 1.59%, while simultaneously retaining plausible business cycle dynamics. The equity premium and stock market volatility are strongly countercyclical, while the interest rate and consumption growth are largely unpredictable. Because of wage inertia, dividends are procyclical despite consumption smoothing via capital investment. The welfare cost of business cycles is huge, 29%.

Who benefits from Analyst “Top Picks”?
Justin Birru, Sinan Gokkaya, Xi Liu, and René M. Stulz
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Following the Global Settlement, analysts extensively use a top pick designation to highlight their highest conviction best ideas. Such a designation enables analysts to provide greater granularity of information, but it can potentially be influenced by conflicts of interest. Examining a comprehensive sample of top picks, we find that they have greater investment value, attract greater media and investor attention, and lead to more trading than buy recommendations. Top picks that have poor ex-post investment performance are more likely to be influenced by strategic objectives. Institutional investors appear to be able to identify such top picks while retail investors do not.

ADHD, financial distress, and suicide in adulthood: A population study
Theodore P. Beauchaine, Itzhak Ben-David, and Marieke Bos
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Attention-deficit/hyperactivity disorder (ADHD) exerts lifelong impairment, including difficulty sustaining employment, poor credit, and suicide risk. To date, however, studies have assessed selected samples, often via self-report. Using mental health data from the entire Swedish population (N = 11.55 million) and a random sample of credit data (N = 189,267), we provide the first study of objective financial outcomes among adults with ADHD, including associations with suicide. Controlling for psychiatric comorbidities, substance use, education, and income, those with ADHD start adulthood with normal credit demand and default rates. However, in middle age, their default rates grow exponentially, yielding poor credit scores and diminished credit access despite high demand. Sympathomimetic prescriptions are unassociated with improved financial behaviors. Last, financial distress is associated with fourfold higher risk of suicide among those with ADHD. For men but not women with ADHD who suicide, outstanding debt increases in the 3 years prior. No such pattern exists for others who suicide.

Ratings-Driven Demand and Systematic Price Fluctuations
Itzhak Ben-David, Jiacui Li, Andrea Rossi, and Yang Song
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We show that mutual fund ratings generate correlated demand that creates systematic price fluctuations. Mutual fund investors chase fund performance via Morningstar ratings. Until June 2002, funds pursuing the same investment style had highly correlated ratings. Therefore, rating-chasing investors directed capital into winning styles, generating style-level price pressures, which reverted over time. In June 2002, Morningstar reformed its methodology of equalizing ratings across styles. Style-level correlated demand via mutual funds immediately became muted, significantly altering the time-series and cross-sectional variation in style returns.

Growth Forecasts and News About Monetary Policy
Nina Karnaukh and Petra Vokata
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We find that 30-minute changes in bond yields around scheduled Federal Open Market Committee (FOMC) announcements are predictable with the pre-FOMC Blue Chip professionals’ revisions in GDP growth forecasts. A positive pre-FOMC GDP growth revision predicts a contractionary policy news shock (positive change in bond yields), a negative GDP growth revision predicts an expansionary policy news shock (negative change in bond yields). Failing to account for this predictability biases the estimates of monetary policy effects on the economy. First, the Fed’s information effect dissipates as the truly unpredictable policy news shock does not affect professionals’ beliefs about the economy. Second,net policy shock has a more negative impact on actual future GDP than the raw policy shock.

Firm Quality Dynamics and the Slippery Slope of Credit Intervention
Wenhao Li and Ye Li
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In crises, low-quality firms face greater financial shortfalls and invest less than high-quality firms. Public liquidity support preserves the overall production capacity but dampens the cleansing effects of crises on firm quality. The trade-off between quantity and quality determines the optimal size of intervention. Policy distortions are self-perpetuating: A downward bias in quality necessitates interventions of greater scales in future crises. Distortions are amplified by low-quality firms’ expectations of liquidity support and overinvestment pre-crisis. Finally, the optimal intervention is larger and distortionary effects stronger in a low interest rate environment where low yields on precautionary savings discourage firms from self-insurance.

Disentangling Anomalies: Risk versus Mispricing
Justin Birru, Hannes Mohrschladt, and Trevor Young
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We examine the cross-section of returns from the perspective of a benchmark model that only includes systematic mispricing factors. In contrast to insight revealed by standard benchmark models, we recover robust positive risk-return relations for many cross-sectional risk, distress, and friction proxies. Our findings are consistent with systematic mispricing that primarily affects speculative stocks and predominantly results in overpricing, predicting lower returns. Hence, failing to control for exposure to systematic mispricing can bias tests of risk-return tradeoffs. Overall, our evidence suggests that a small shift in perspective generates a substantially different interpretation of the same data.

Money Creation in Decentralized Finance: A Dynamic Model of Stablecoin and Crypto Shadow Banking
Ye Li and Simon Mayer
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Stablecoins are at the center of debate surrounding decentralized finance. We develop a dynamic model to analyze the instability mechanism of stablecoins, the complex incentives of stablecoin issuers, and regulatory proposals. The model rationalizes a variety of stablecoin management strategies commonly observed in practice, and we characterize an instability trap: Stability can last for a long time, but once debasement happens, price volatility persists. Capital requirement improves price stability but fails to eliminate debasement. Restricting the riskiness of reserve assets can surprisingly destabilize price. Finally, data privacy regulation has an unintended benefit of reducing price volatility of stablecoins issued by data-driven platforms.

What Explains Differences in Finance Research Productivity During the Pandemic?
Brad M. Barber, Wei Jiang, Adair Morse, Manju Puri, Heather Tookes, and Ingrid M. Werner
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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.

Securities Laws, Bank Monitoring, and the Choice Between Cov-lite Loans and Bonds for Highly Levered Firms
Robert Prilmeier and René M. Stulz
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In contrast to bonds, cov-lite loans do not require SEC registration and are not subject to securities laws. We show that this distinction plays an important role in firms’ choice between funding through cov-lite loans and bonds and helps understand why the market share of cov-lite loans has been so high in recent normal times. Compared to cov-heavy loans, cov-lite loans are closer substitutes for bonds in that they have similar covenants, have tighter bid-ask spreads, have more trading, and are more likely to be used to refinance bonds than cov-heavy loans.

Persistent Government Debt and Aggregate Risk Distribution
Mariano Croce, Thien Nguyen, and Steve Raymond
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When government debt is sluggish, consumption exhibits lower expected growth, more long-run uncertainty, and more long-run downside risk. Simultaneously, the risk premium on the consumption claim (Koijen et al. (2010), Lustig et al. (2013)) increases and features more positive (adverse) skewness. We rationalize these findings in an endogenous growth model in which fiscal policy is distortionary, the value of innovation depends on fiscal risk, and the representative agent is sensitive to the resulting distribution of consumption risk. Our model suggests that committing to a rapid reduction of the debt-to-output ratio can enhance the value of innovation, aggregate wealth, and welfare.

Tick Size, Trading Strategies and Market Quality
Ingrid M. Werner, Yuanji Wen, Barbara Rindi, and Sabrina Buti
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We investigate the effects of a tick size change on market quality by modeling a multi-period public limit order book with endogenous liquidity demand and supply. We single out four channels of transmission and show that layering and mechanical change in spread prevail for liquid, tick size constrained stocks; while undercutting prevails for illiquid stocks. We examine the robustness of our results when order flows migrate to a competing venue. We find empirical support for our predictions by analysing tick size reductions respectively for a market with low (Tokyo Stock Exchange - 2014) and one with high fragmentation (U.S. Tick Size Pilot - 2018).

Real Effects of Climate Policy: Financial Constraints and Spillovers
Söhnke M. Bartram, Kewei Hou, Sehoon Kim
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We document that localized policies aimed at mitigating climate risk can have unintended consequences due to regulatory arbitrage by firms. Using a difference-in-differences framework to study the impact of the California cap-and-trade program with US plant level data, we show that financially constrained firms shift emissions and plant ownership from California to other states. In contrast, unconstrained firms do not make such adjustments. Overall, neither constrained nor unconstrained firms reduce their total emissions when only a subset of their plants are affected by the cap-and-trade rule, undermining the effectiveness of the policy.

What Do Mutual Fund Investors Really Care About?
Itzhak Ben-David, Jiacui Li, Andrea Rossi, and Yang Song
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We show that mutual fund investors rely on simple signals and likely do not engage in sophisticated learning about managers' alpha as widely believed. Simplistic performance chasing best explains aggregate flows to the mutual fund space and flows across funds. These results hold for both actively managed and passive index funds. Empirical patterns commonly interpreted as reflecting learning about managerial skill also appear in falsification tests and are mechanical. Our results are consistent with the view that, on average, households are homo sapiens with limited financial sophistication rather than hyperrational alpha-maximizing agents, as often assumed in the literature.

The Role of Financial Conditions in Portfolio Choices: The Case of Insurers
Shan Ge and Michael S. Weisbach
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Many institutional investors depend on the returns they generate to fund their operations and liabilities. How do these investors’ financial conditions affect the management of their portfolios? We address this issue using the insurance industry because insurers are large investors for which detailed portfolio data are available, and can face financial shocks from exogenous weather events that help us establish causality. Among corporate bonds, for which we can control for regulatory treatment, results suggest that when Property & Casualty (P&C) insurers become more constrained due to operating losses, they shift towards safer bonds. The effect of losses on allocations is likely to be causal since it holds when instrumenting for losses with weather shocks. The change in allocations following losses is larger for smaller or worse-rated insurers and during the financial crisis, suggesting that the shift toward safer securities is driven by concerns about financial flexibility. The results highlight the importance of financial conditions in institutional investors’ portfolio decisions.

The Role of Stock Price Informativeness in Compensation Complexity
Benjamin Bennett, Gerald Garvey, Todd Milbourn, and Zexi Wang
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We study the effect of stock price informativeness (SPI) on executive compensation complexity. Using textual analysis of SEC proxy statements to construct compensation complexity measures for US public firms, we find strong evidence that higher SPI reduces pay complexity. We then use mutual fund redemption as an exogenous decrease in SPI to address endogeneity concerns. When fund flow pressure is high, pay includes more performance metrics, a greater number of vesting periods, and options with longer vesting periods. When stock prices convey information more effectively, executive pay is simpler.

Inferring Expectations from Observables: Evidence from the Housing Market
Itzhak Ben-David, Pascal Towbin, and Sebastian Weber
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We propose a new method to identify shifts in price expectations in the housing market through the accumulation of excess capacity. Expectations of future price increases (due to anticipated future demand for housing services) cause the current supply to increase, creating a temporary vacancy. We implement this intuition in a structural vector autoregression with sign restrictions and explore the effects of price expectations in the U.S. housing market. We find that price expectation shocks were a prime factor explaining the 1996-2006 boom, particularly in the Sand States. Expectation shocks at the boom's peak reflected implausible growth expectations and reversed during the bust.

Costs of Natural Disasters in Public Financing
Benjamin Bennett and Zexi Wang
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We document the dynamics of primary municipal bond (muni) markets after severe natural disasters. We find that yields of muni issuance increase significantly in the first three months after disasters. Disasters have little effect on issuers’ credit risk but can temporarily reduce investors’ demand, which is consistent with the salience theory of choice (Bordalo, Gennaioli, and Shleifer, 2012). Natural disasters significantly increase the proceeds from muni issuances. Reacting to the larger financing costs, muni issuers use shorter maturity and a less complex structure to offset the larger financing costs. The higher yields after disasters provide speculation opportunities.

Do Distressed Banks Really Gamble for Resurrection?
Itzhak Ben-David, Ajay A. Palvia, and René M. Stulz
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We explore the actions of financially distressed banks in two distinct periods that include financial crises (1985-1994, 2005-2014) and differ in bank regulations, especially concerning capital requirements and enforcement. In contrast to the widespread belief that distressed banks gamble for resurrection, we document that distressed banks take actions to reduce leverage and risk, such as reducing asset and loan growth, issuing equity, decreasing dividends, and lowering deposit rates. Despite large differences in regulation between periods, the extent of deleveraging is similar, suggesting that economic forces beyond formal regulations incentivize bank managers to deleverage when their banks are in distress.

Why do Traditional and Shadow Banks Coexist?
Victor Lyonnet and Edouard Chrétien
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Traditional and shadow banks interacted in similar ways in the 2007 and COVID-19 crises, when both assets and liabilities flew out of shadow banks and into traditional banks. We explain these facts in a model of the coexistence of traditional and shadow banks in which liabilities and assets flow from the former to the latter in good times to avoid regulation, and the other way in a crisis to alleviate fire sales. The model sheds light on the (unintended) consequences of regulations for traditional banks on the shadow banking sector.

Why Do Firms Use Equity-Based Pay? Managerial Compensation and Stock Price Informativeness
Benjamin Bennett, Gerald Garvey, Todd Milbourn, and Zexi Wang
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We study the motive of using equity-based pay in executive compensation: the risk-sharing motive versus the performance-measuring motive. The empirical design goes through the relationship between equity-based pay and stock price informativeness (SPI). We find equity-based pay decreases in SPI, which is consistent with the risk-sharing motive but inconsistent with the performance-measuring motive. The SPI effect on compensation is stronger in financially-constrained firms, more diversified firms, and firms with less product market competition. SPI increases pay efficiency through a larger proportion of option pay, fewer perquisites, and greater pay-for-skill. We address potential endogeneity concerns by investigating the changes in compensation of managers switching between firms with different SPI.

Clawback Provisions and Firm Risk
Ilona Babenko, Benjamin Bennett, John M. Bizjak, Jeffrey L. Coles, and Jason J. Sandvik
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Panel OLS and GMM-IV estimates indicate that executives respond to the adoption of a compensation clawback provision by decreasing firm risk. The mechanisms that transmit incentives to decisions and decisions to risk appear to be more conservative investment and financial policies and preemptive management of ESG, legal, and cyberattack risks. The stock market reaction to the announcement of a clawback adoption, as well as post-adoption stock and accounting performance, are significantly and positively related to the actual and predicted reduction in firm risk. The reduction in firm risk, arising from adoption of a clawback policy, appears to benefit shareholders.

Housing Cycles and Exchange Rates
Sai Ma and Shaojun Zhang
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This paper documents that the housing cycle, measured by the residential investment share, is a strong in-sample and out-of-sample predictor for the dollar up to twelve quarters. Housing construction is negatively associated with risk premia in equity and bonds, but positively with foreign currency premia. We study a model with external habit preferences over tradable nonhousing consumption only, which implies counter-cyclical SDF volatility and procyclical demand for nontradable housing consumption. The predictability for excess returns in foreign currencies and other assets arises endogenously. The currency predictability is robust to a host of additional checks and holds for other G10 currencies.

Are Analyst Short-Term Trade Ideas Valuable?
Justin Birru, Sinan Gokkaya, Xi Liu, and René M. Stulz
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Short-term trade ideas are a component of analyst research highly valued by institutional investors. Using a novel and comprehensive database, we find trade ideas have a stock-price impact at least as large as recommendation and target price changes. Trade ideas based on expectations of future events are more informative than those identifying incomplete incorporation of past information in stock prices. Analysts with better access to a firm’s management produce better trade ideas. Institutional investors trade in the direction of trade ideas. Investors following trade ideas can earn significant abnormal returns, consistent with analysts possessing valuable short-term stock picking skills.

Security Analysis: An Investment Perspective
Kewei Hou, Haitao Mo, Chen Xue, and Lu Zhang
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The investment theory, in which the expected return varies cross-sectionally with investment, expected profitability, and expected growth, is a good start to understanding Graham and Dodd’s (1934) Security Analysis. Empirically, the q5 model goes a long way toward explaining prominent equity strategies rooted in security analysis, including Frankel and Lee’s (1998) intrinsic-to-market value, Piotroski’s (2000) fundamental score, Greenblatt’s (2005) “magic formula,” Asness, Frazzini, and Pedersen’s (2019) quality-minus-junk, Buffett’s Berkshire, Bartram and Grinblatt’s (2018) agnostic analysis, as well as Penman and Zhu’s (2014, 2018) and Lewellen’s (2015) expected-return strategies.

Can Risk Be Shared Across Investor Cohorts? Evidence from a Popular Savings Product
Johan Hombert and Victor Lyonnet
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We study how retail savings products can share market risk across investor cohorts, thereby completing financial markets. Financial intermediaries smooth returns by varying reserves, which are passed on between successive investor cohorts, redistributing wealth across cohorts. Using data on euro contracts sold by life insurers in France, we estimate this redistribution to be large: 0.8% of GDP. We develop and provide evidence for a model in which low investor sophistication, while leading to individually sub-optimal decisions, improves risk sharing by allowing inter-cohort risk sharing.

*Part of this research was conducted while Victor Lyonnet was a student. At the time, his research was co-financed by the French Federation of Insurers and the Banque de France.

Build or Buy? Human Capital and Corporate Diversification
Paul Beaumont, Camille Hebert, and Victor Lyonnet
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Firms either enter new sectors by building on their resources or buying existing companies. Using French administrative data, we propose a measure of human capital distance between a firm and a sector of entry. Using a shift-share instrument, we show that firms build in close sectors and buy in distant sectors in terms of human capital distance. Firms build by hiring new workers, which becomes increasingly costly in distant sectors as it requires not only hiring more workers but also having more organizational capital to integrate these workers. Hence, firms buy in distant sectors to acquire already operational human capital.

Why is There a Secular Decline in Idiosyncratic Risk in the 2000s?
Söhnke M. Bartram, Gregory W. Brown, and René M. Stulz
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Except for relatively short but intense episodes of high market risk, average idiosyncratic risk (IR) falls steadily after 2000 until almost the end of our sample period in 2017. The decrease has been such that from 2012 to 2017 average IR was lower than any time since 1965. The secular decline can be explained by the fact that U.S. publicly listed firms have become larger, older, and their stock more liquid. The same changes that bring about historically low IR lead to increasingly high market-model R-squareds.

FinTech, BigTech, and the Future of Banks
René M. Stulz
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Banks are unique in that they combine the production of liquid claims with loans. They can replicate most of what FinTech firms can do, but FinTech firms benefit from an uneven playing field in that they are less regulated than banks. The uneven playing field enables non-bank FinTech firms to challenge banks for specific products whose success is not tied to what makes banks unique, but they cannot replace banks as such. In contrast, BigTech firms have unique advantages that banks cannot easily replicate and therefore present a much stronger challenge to established banks in consumer finance and loans to small firms. Both Fintech and BigTech are contributing to a secular trend of banks losing their comparative advantage as they have less access to unique information about parties seeking credit.

Reusing Natural Experiments
Davidson Heath, Matthew C. Ringgenberg, Mehrdad Samadi, and Ingrid M. Werner
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After a natural experiment is first used, other researchers often reuse the setting, examining different outcome variables. We use simulations based on real data to illustrate the multiple hypothesis testing problem that arises when researchers reuse natural experiments. We then provide guidance for future inference based on popular empirical settings including difference-in-differences regressions, instrumental variables regressions, and regression discontinuity designs. When we apply our guidance to two extensively studied natural experiments, business combination laws and the Regulation SHO pilot, we find that many results that were statistically significant using single hypothesis testing do not survive corrections for multiple hypothesis testing.

Attention and Biases: Evidence from Tax-Inattentive Investors
Justin Birru, Fernando Chague, Rodrigo De-Losso, and Bruno Giovannetti
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We first provide evidence of investor inattention to a very simple and well-known capital-gains tax exemption in the Brazilian stock market. We then show that tax-inattentive investors exhibit stronger behavioral biases and worse trading performance, even after controlling for several investor-level characteristics. The evidence is consistent with inattention being a common source of behavioral biases.

The Consequences to Directors of Deploying Poison Pills
William C. Johnson, Jonathan M. Karpoff, and Michael D. Wittry
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We examine the labor market consequences for directors who adopt poison pills. Directors who become associated with pill adoption experience a decrease in vote margins, an increase in termination rates across all their directorships, and a decrease in the likelihood of new board appointments. These adverse consequences accrue primarily when pill adoption is costly for the firm. Firms have positive stock price reactions when pill-associated directors die or depart from their boards, compared to zero abnormal returns for other directors. We conclude that directors who become associated with poison pills suffer a decrease in the value of their services.

An Improved Method to Predict Assignment of Stocks into Russell Indexes
Itzhak Ben-David, Francesco Franzoni, and Rabih Moussawi
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A growing literature uses the Russell 1000/2000 reconstitution event as an identification strategy to investigate corporate finance and asset pricing questions. To implement this identification strategy, researchers need to approximate the ranking variable used to assign stocks to indexes. We develop a procedure that predicts assignment to the Russell 1000/2000 with significant improvements relative to previous approaches. We apply this methodology to extend the tests in Ben-David, Franzoni, and Moussawi (2018).

Does Costly Reversibility Matter for U.S. Public Firms?
Hang Bai, Erica X. N. Li, Chen Xue, and Lu Zhang
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Yes, most likely. The firm-level evidence on costly reversibility is even stronger than the prior evidence at the plant level. The firm-level investment rate distribution is highly skewed to the right, with a small fraction of negative investments, 5.79%, a tiny fraction of inactive investments, 1.46%, and a large fraction of positive investments, 92.75%. When estimated via simulated method of moments, the standard investment model explains the average value premium, while simultaneously matching the key properties of the investment rate distribution, including the cross-sectional volatility, skewness, and the fraction of negative investments. The combined effect of costly reversibility and operating leverage is the key driving force behind the model’s quantitative performance.

Demand Volatility and Firms’ Investments in Operating Flexibility: Evidence from Planned Power Plants
Chen Lin, Thomas Schmid, and Michael S. Weisbach
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How does demand volatility affect firms’ investment decisions? We consider this issue from the perspective of electricity-producing firms. Their most important investment decisions concern their new power plants, which vary substantially in their flexibility to adjust their output to changing market conditions. Using an international sample of planned power plants, we find that more volatile demand causes firms to invest more in flexible plants and less in nonflexible plants, while the overall investment level remains unchanged. This effect, which is robust to a number of alternative specifications, including a weather-based IV for demand volatility, is consistent with models in which asset flexibility is an important attribute of investments when demand is volatile.

Public versus Private Equity
René M. Stulz
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The last twenty years or so have seen a sharp decline in public equity. I present a framework that explains the forces that cause the listing propensity of firms to change over time. This framework highlights the benefits and costs of a public listing compared to the benefits and costs of financing with private equity. With this framework, the decline in public equity is explained by the increased supply of funds for private equity and changes in the nature of firms. The increase in the importance of intangible assets makes it costlier for young firms to be public when the alternative is funding through private equity from investors who have specialized knowledge that enables them to better understand the business model of young firms and contribute to the development of that business model in contrast to passive public equity investors.

Token-based Platform Finance
Lin W. Cong, Ye Li, and Neng Wang
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We develop a dynamic model of platform economy where tokens serve as a means of payments among platform users and are issued to finance investment in platform productivity. Tokens are optimally issued to reward platform owners when the productivity-normalized token supply is low and burnt to boost the franchise value when the productivity-normalized normalized supply is high. Although token price is determined in a liquid market, the platform's financial constraint generates an endogenous token issuance cost, causing underinvestment through the conflict of interest between insiders (platform owners) and outsiders (users). Blockchain technology mitigates underinvestment by addressing the platform's time-inconsistency problem.

Paid Leave Pays Off: The Effects of Paid Family Leave on Firm Performance
Benjamin Bennett, Isil Erel, Léa Stern, and Zexi Wang
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We study the effects of state-level Paid Family Leave (PFL) laws on U.S. firms across a broad panel of private and public companies. Following PFL adoption, female employee turnover declines, labor productivity increases, and treated firms experience significant improvements in operating performance. These effects are stronger in regions with a larger supply of childbearing-age female labor, among R&D-intensive firms and firms with high intangible capital, consistent with a mechanism in which PFL reduces job separation expectations and encourages investment in firm-specific human capital. Our findings suggest that PFL can generate tangible firm-level benefits by enhancing workforce stability and productivity.

q-factors and Investment CAPM
Lu Zhang
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The q-factor model shows strong explanatory power and largely summarizes the cross section of average stock returns. In particular, the q-factor model fully subsumes the Fama-French (2018) 6-factor model in head-to-head factor spanning tests. The q-factor model is an empirical implementation of the investment CAPM. The basic philosophy is to price risky assets from the perspective of their suppliers (firms), as opposed to their buyers (investors). As a disruptive innovation, the investment CAPM has broad-ranging implications for academic finance and asset management practice.

(Debt) Overhang: Evidence from Resource Extraction
Michael Wittry
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I study the empirical importance of debt overhang using a unique dataset on resource extraction firms, which provides ex ante measures of investment opportunities and important variation in the terms of a firm’s obligations. In particular, unsecured reclamation liabilities create overhang that is costly to resolve and induces firms to forgo and postpone positive NPV investments. Traditional debt, in contrast, imposes few overhang-related investment distortions. These results show that: (i) the overhang problem is potentially large and applies more broadly to a firm’s non-debt liabilities; and (ii) overhang problems associated with traditional debt can be avoided through contracting and debt composition.

The Cyclicality of CEO Turnover
C. Jack Liebersohn and Heidi A. Packard
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CEO turnover is highly pro-cyclical. This paper aims to explain why. We begin by showing that the cyclicality is driven almost entirely by executives of retirement age. We further provide evidence that executives time their retirement to maximize the value of their pensions. Since CEO pay is pro-cyclical and pensions are based on pay in the final years of tenure, executives have the incentive to retire when the economy is doing well. Cyclicality is particular strong in firms with strong corporate governance, which suggests that retirement cyclicality is a tool firms use to constrain CEO behavior.

Eclipse of the Public Corporation or Eclipse of the Public Markets?
Craig Doidge, Kathleen M. Kahle, G. Andrew Karolyi, and René M. Stulz
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Since reaching a peak in 1997, the number of listed firms in the U.S. has fallen in every year but one. During this same period, public firms have been net purchasers of $3.6 trillion of equity (in 2015 dollars) rather than net issuers. The propensity to be listed is lower across all firm size groups, but more so among firms with less than 5,000 employees. Relative to other countries, the U.S. now has abnormally few listed firms. Because markets have become unattractive to small firms, existing listed firms are larger and older. We argue that the importance of intangible investment has grown but that public markets are not well-suited for young, R&D-intensive companies. Since there is abundant capital available to such firms without going public, they have little incentive to do so until they reach the point in their lifecycle where they focus more on payouts than on raising capital.

Why has Idiosyncratic Risk been Historically Low in Recent Years?
Söhnke M. Bartram, Gregory W. Brown, and René M. Stulz
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Since 1965, average idiosyncratic risk (IR) has never been lower than in recent years. In contrast to the high IR in the late 1990s that has drawn considerable attention in the literature, average market-model IR is 44% lower in 2013-2017 than in 1996-2000. Macroeconomic variables help explain why IR is lower, but using only macroeconomic variables leads to large prediction errors compared to using only firm-level variables. As a result of the dramatic change in the number and composition of listed firms since the late 1990s, listed firms are larger and older. Larger and older firms have lower idiosyncratic risk. Models that use firm characteristics to predict firm-level idiosyncratic risk estimated over 1963-2012 can largely or completely explain why IR is low over 2013-2017. The same changes that bring about historically low IR lead to unusu-ally high market-model R-squareds.

Which Factors
Kewei Hou, Haitao Mo, Chen Xue, and Lu Zhang
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Many recently proposed, seemingly different factor models are closely related. In spanning tests, the q-factor model largely subsumes the Fama-French (2015, 2018) 5-and 6-factor models, and the q5-model captures the Stambaugh-Yuan (2017) model. The Stambaugh-Yuan factors are sensitive to their construction, and once replicated via the standard approach, are close to the q-factors, with correlations of 0.8 and 0.84. Finally, it seems difficult to motivate the Fama-French 5-factor model from valuation theory, which predicts a positive relation between the expected investment and the expected return.

Risk Management, Firm Reputation, and the Impact of Successful Cyberattacks on Target Firms
Shinichi Kamiya, Jun-koo Kang, Jungmin Kim, Andreas Milidonis, and René M. Stulz
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We develop a model where a firm has an optimal exposure to cyber risk. With rational, fully informed agents and with no hysteresis, a successful cyberattack should have no impact on a financially unconstrained target’s reputation and post-attack policies. In contrast, when a successful attack involves the loss of personal financial information, there is a significant shareholder wealth loss, which is much larger than the attack’s out-of-pocket costs. This excess loss is higher when the attack decreases sales growth more and lower when the board pays more attention to risk management before the attack. Further, an attack decreases a firm’s risk appetite as it beefs up its risk management and information technology and decreases the risk-taking incentives of management. Finally, successful cyberattacks adversely affect the stock price of firms in the target’s industry. These results imply that successful attacks with personal financial information loss provide adverse information about cyber risk to target firms, their stakeholders, and their competitors.

Selecting Directors Using Machine Learning
Isil Erel, Léa H. Stern, Chenhao Tan, and Michael S. Weisbach
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Can algorithms assist firms in their decisions on nominating corporate directors? Directors predicted to do poorly by algorithms indeed do poorly compared to a realistic pool of candidates in out-of-sample tests. Predictably bad directors are more likely to be male, accumulate more directorships, and have larger networks than the directors the algorithm would recommend in their place. Companies with weaker governance structures are more likely to nominate them. Our results suggest that machine learning holds promise for understanding the process by which governance structures are chosen and has potential to help real-world firms improve their governance.

The Real Effects of Financial Markets: Do Short Sellers Cause CEOs to Be Fired?
Benjamin Bennett and Zexi Wang
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We study the short-selling effect on forced CEO turnover. Using difference-in-differences analyses based on the SEC Regulation SHO Pilot Program, we find short selling increases the likelihood of forced turnover. Theories suggest two potential mechanisms: informed short sellers reveal negative information (Revelation), while uninformed short sellers manipulate prices (Manipulation). Evidence shows these two mechanisms coexist. Consistent with Revelation, we find stronger effects when firms have more earnings management and less competitive product markets. Consistent with Manipulation, we find stronger effects when firms have more growth opportunities and fewer blockholders. Evidence on long-run stock performance suggests the Manipulation mechanism dominates.

Quants and Market Anomalies
Justin Birru, Sinan Gokkaya, Xi Liu, and Stanimir Markov
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Sell-side quantitative equity research analysts (Quants) conduct econometric analyses of stock returns to uncover market anomalies and assist equity analysts and institutional clients with stock selection. We present novel evidence that establishes their role in helping analysts and mutual fund clients discover market anomalies and capital markets evolve toward greater pricing efficiency. Specifically, we find that analysts and mutual fund clients with greater access to Quants make recommendations and trades that reveal greater knowledge of anomalous cross-sectional return predictability. More importantly, cross-sectional return predictability is weaker in stocks that have higher coverage (ownership) by analysts (mutual fund clients) with access to Quants, and strengthens when quasi-exogenous brokerage house closures reduce the availability of Quants.

Does Capital Flow More to High Tobin’s Q Industries?
Dong Lee, Hyun-Han Shin, and René M. Stulz
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We examine whether capital flows more to high Tobin’s q industries and find that it flows more to high q industries from 1971 until 1996 but not from 1997 to 2014. This change is due to a decrease in the q-sensitivity of equity funding resulting mostly from the increased q-sensitivity of repurchases after 1996. The increase in intangible assets, the aging of American firms, and the impact of the China shock explain much of the change in the q-sensitivity of equity funding and repurchases. The results are robust to how q is estimated and to a non-q measure of growth opportunities.

Financial Constraints and Industry Dynamics
Itzhak Ben-David, Zhi Li, and Zexi Wang
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It is well-established that financially constrained firms scale down their investment activity. The lost investment opportunities, however, could potentially be captured by other firms that are less financially constrained. We test this proposition using the Reg SHO pilot regulation, which relaxed short-selling constraints for about 30% of firms and thus tightened their financial constraints. Following the introduction of the regulation, pilot firms indeed reduced their investments, while their direct competitors increased their investments, expanded their market share, and became more profitable. We conclude that opportunities lost due to financial constraints could be salvaged by competing firms.

q⁵
Kewei Hou, Haitao Mo, Chen Xue, and Lu Zhang
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In a multiperiod investment framework, firms with high expected growth earn higher expected returns than firms with low expected growth, holding investment and expected profitability constant. This paper forms cross-sectional growth forecasts, and constructs an expected growth factor that yields an average premium of 0.82% per month (t = 9.81). The q5 model, which augments the Hou-Xue-Zhang (2015) q-factor model with the new factor, shows strong explanatory power in the cross section, and outperforms other recently proposed factor models such as the Fama-French (2018) 6-factor model.

Network Risk and Key Players: A Structural Analysis of Interbank Liquidity
Edward Denbee, Christian Julliard, Ye Li, and Kathy Yuan
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Using a structural model, we estimate the liquidity multiplier of an interbank network and banks’ contributions to systemic risk. To provide payment services, banks hold reserves. Their equilibrium holdings can be strategic complements or substitutes. The former arises when payment velocity is high and payments begets payments. The latter prevails when the opportunity cost of liquidity is large, incentivising banks to borrow neighbors’ reserves instead of holding their own. Consequently, the network can amplify or dampen individual shocks. Empirically, network topology explains cross-sectional heterogeneity in banks’ contribution to systemic risks while changes in the equilibrium type drive the time-series variation.

Are the Largest Banks Valued More Highly?
Bernadette A. Minton, René M. Stulz, and Alvaro G. Taboada
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Some argue too-big-to-fail (TBTF) status increases the value of the largest banks. In contrast, we find that the value of the largest banks is negatively related to asset size in normal times, but not during the financial crisis when TBTF status was most valuable. Further, shareholders lose when large banks cross a TBTF threshold through acquisitions. The negative relation between bank value and bank size for the largest banks cannot be explained by differences in ROA, ROE, equity volatility, tail risk, distress risk, or equity discount rates, but it can be partly explained by the market’s discounting of trading activities.

Why Do Firms Borrow Directly from Nonbanks?
Sergey Chernenko, Isil Erel, and Robert Prilmeier
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Analyzing hand-collected credit agreements for a sample of middle-market firms over 2010–2015, we find that one-third of all loans are directly extended by nonbank financial intermediaries. Two-thirds of such nonbank lending can be attributed to bank regulations that constrain banks’ ability to lend to unprofitable and highly levered borrowers. Firms with negative EBITDA and debt/EBITDA greater than six are 32% and 15% more likely to borrow from nonbanks. These firms pay significantly higher interest rates, especially following the 2013 leveraged loan guidance revisions. Nonbank borrowers also receive different nonprice terms compared to firms borrowing from banks.

The Dollar Ahead of FOMC Target Rate Changes
Nina Karnaukh
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I find that the U.S. dollar appreciates before contractionary monetary policy decisions at scheduled Federal Open Market Committee meetings and depreciates before expansionary decisions. The federal funds futures rate forecasts these dollar movements with a 22% R². A high federal funds futures spread three days in advance of an FOMC meeting not only predicts the target rate rise, but also predicts a rise in the dollar over the subsequent two-day period. This predictability is concentrated in times of high FX volatility, as the FX traders avoid arbitrage risk earlier than a few days prior to the announcement.

Tokenomics: Dynamic Adoption and Valuation
Lin William Cong, Ye Li and Neng Wang
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We develop a dynamic asset pricing model of cryptocurrencies/tokens that allows users to conduct peer-to-peer transactions on digital platforms. The equilibrium value of tokens is determined by aggregating heterogeneous users' transactional demand rather than discounting cash flows, as is done in standard valuation models. Endogenous platform adoption builds on user network externality and exhibits an S-curve: it starts slow, becomes volatile, and eventually tapers off. The introduction of tokens lowers users' transaction costs on the platform by allowing users to capitalize on platform growth. The intertemporal feedback between user adoption and token price accelerates adoption and dampens user-base volatility.

Rediscover Predictability: Information from the Relative Prices of Long-term and Short-term Dividends
Ye Li and Chen Wang
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The ratio of long- to short-term dividend prices, "price ratio" (pr), predicts one-year stock market return with an out-of-sample R2 of 19%. It subsumes the predictive power of price-to-dividend ratio (pd). The residual from regressing pd on pr predicts one-year dividend with an out-of-sample R2 of 30%. Our results hold outside the U.S. In an exponential-affine model, we show the key to understand these findings is the (lack of) persistence of expected dividend growth. We also characterize the risk of time-varying expected return: (1) the expected return is countercyclical; (2) the response of expected return (rather than expected dividend growth) accounts for the impact of monetary policy on stock price; (3) shocks to prt are priced in the cross-section, which serves as an ICAPM test of prt as an adequate proxy for the expected return.

Why is the Rent So Darn High?
Greg Howard and Jack Liebersohn
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Because of migration. In a spatial equilibrium framework, we show that three quarters of the CPI rent increase in the United States from 2000 to 2018 is due to increased demand to live in ex ante housing-supply-inelastic cities. Moving one person to a less elastic city raises the average rent because the positive effect on rents in the inelastic city outweighs the negative effect in the elastic one. In these years, the quantitative importance of this migration channel is greater if people are mobile in response to rent changes. Empirically, we show that people have high long-run mobility by estimating that income changes have similar effects on rents across cities regardless of housing supply elasticity. Supporting this migration channel, the cross-sectional pattern of migration demand implied by our model matches patterns of labor-market and amenity changes.

Corporate Investment Under the Cloud of Litigation
Benjamin Bennett, Todd Milbourn, and Zexi Wang
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We study the effect of legal risk on firms’ investment. Using legal risk measures based on the number of litigious words in SEC 10-K filings, we find legal risk reduces investment. Underlying mechanisms include both i) a financing channel, whereby legal risk reduces credit ratings, increases bank loan costs, and decreases borrowing, and ii) an attention channel, whereby legal risk consumes top-management’s attention. Accordingly, we find legal risk has negative effects on firms’ investment efficiency and stock performance. We address endogeneity concerns through a DiD analysis utilizing staggered adoptions of universal demand laws across states.

Fragile New Economy: Intangible Capital, Corporate Savings Glut, and Financial Instability
Ye Li
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Intangible-intensive firms in the U.S. hold an enormous amount of liquid assets that are in fact short-term debts issued by financial intermediaries. This paper builds a macro-finance model that captures this structure. A self-perpetuating savings glut emerges in equilibrium. As intangibles become increasingly important for production, firms hoard more liquidity to finance investments in intangibles with limited pledgeability. The resulting low interest rates induce intermediaries to increase leverage and bid up asset prices, which in turn encourages firms to invest more and hoard even more liquidity to fund expansion. Along these secular trends, endogenous risk accumulates in the financial system.

Exporting Pollution: Where Do Multinational Firms Emit CO2?
Itzhak Ben-David, Yeejin Jang, Stefanie Kleimeier, and Michael Viehs
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Despite widespread awareness of the detrimental impact of CO2 pollution on the world climate, countries vary widely in how they design and enforce environmental laws. Using novel microdata about multinational firms’ CO2 emissions across countries, we document that firms headquartered in countries with strict environmental policies perform their polluting activities abroad in countries with relatively weaker policies. These effects are largely driven by tightened environmental policies in home countries that incentivize firms to pollute abroad rather than lenient foreign policies that attract those firms. Although firms headquartered in countries with strict domestic environmental policies are more likely to export pollution to foreign countries, they nevertheless emit less overall CO2 globally.

Private Equity Indices Based on Secondary Market Transactions
Brian Boyer, Taylor D. Nadauld, Keith P. Vorkink, and Michael S. Weisbach
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We propose a new approach to evaluating the performance of private equity investments using actual prices paid for LP shares of funds transacted in secondary markets. Our transaction-based indices exhibit substantially higher CAPM betas and lower alphas than NAV-based indices even after adjusting for staleness in NAVs. Our indices load on an additional funding liquidity factor that is uncorrelated with NAV-based index returns. In comparison, a listed PE index exhibits similar loadings on the market and funding liquidity factor as our indices, but significantly lower average returns. Our indices are useful for quarter-to-quarter benchmarking and valuing illiquid stakes in funds.

Delegation Uncertainty
Yi Li and Chen Wang
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Delegation bears an intrinsic form of uncertainty. Investors hire managers for their superior models of asset markets, but delegation outcome is uncertain precisely because managers' model is unknown to investors. We model investors' delegation decision as a trade-off between asset return uncertainty and delegation uncertainty. Our theory explains several puzzles on fund performances. It also delivers asset pricing implications supported by our empirical analysis: (1) because investors partially delegate and hedge against delegation uncertainty, CAPM alpha arises; (2) the cross-section dispersion of alpha increases in uncertainty; (3) managers bet on alpha, engaging in factor timing, but factors' alpha is immune to the rise of their arbitrage capital - when investors delegate more, delegation hedging becomes stronger. Finally, we offer a novel approach to extract model uncertainty from asset returns, delegation, and survey expectations.

Public Debt, Consumption Growth, and the Slope of the Term Structure
Thien T. Nguyen
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The debt-to-GDP ratio negatively predicts cumulative nominal consumption growth up to a 10-year horizon, resulting from the ratio's ability to forecast lower inflation and real growth. Moreover, the debt-to-GDP ratio is positively associated with yield spreads. I rationalize these facts in a model in which positive shocks to government debt cause lower inflation and growth, making bonds attractive assets. Furthermore, because longer-term bonds are less exposed to current debt shock than are shorter-term bonds, they are better hedges, resulting in high yield spreads in high-debt states. The model highlights the importance of fiscal risk in understanding the Treasury bond market.

Why are Firms with More Managerial Ownership Worth Less?
Kornelia Fabisik, Rüdiger Fahlenbrach, René M. Stulz, and Jérôme P. Taillard
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Using more than 50,000 firm-years from 1988 to 2015, we show that the empirical relation between a firm’s Tobin’s q and managerial ownership is systematically negative. When we restrict our sample to larger firms as in the prior literature, our findings are consistent with the literature, showing that there is an increasing and concave relation between q and managerial ownership. We show that these seemingly contradictory results are explained by cumulative past performance and liquidity. Better performing firms have more liquid equity, which enables insiders to more easily sell shares after the IPO, and they also have a higher Tobin’s q.

Expectations Uncertainty and Household Economic Behavior
Itzhak Ben-David, Elyas Fermand, Camelia M. Kuhnen, and Geng Li
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We show that there exists significant heterogeneity across US households in how uncertain they are in their expectations regarding personal and macroeconomic outcomes, and that uncertainty in expectations predicts households' choices. Individuals with lower income or education, more precarious finances, and living in counties with higher unemployment are more uncertain in their expectations regarding own-income growth, inflation, and national home price changes. People with more uncertain expectations, even accounting for their socioeconomic characteristics, exhibit more precaution in their consumption, credit, and investment behaviors.

Assessing Managerial Ability: Implications for Corporate Governance
Benjamin E. Hermalin and Michael S. Weisbach
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A manager’s current and potential future employers are continually assessing her or his ability. Such assessment is a crucial component of corporate governance and this chapter provides an overview of the research on that aspect of governance. In particular, we review how assessment generates incentives (both good and bad), generates risks that must be faced by both managers and firms, and affects the contractual relationships between those parties in important ways. Assessment (or learning) proves a key perspective from which to study, evaluate, and possibly even regulate corporate governance. Moreover, because learning is a behavior notoriously subject to systematic biases, this perspective is a natural avenue through which to introduce behavioral and psychological insights into the study of corporate governance.

The relation between CEO equity incentives and the quality of accounting disclosures: New evidence
Karen H. Wruck and YiLin Wu
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This paper provides new evidence on the negative relation between CEO equity incentives and accounting disclosure quality. We analyze a comprehensive set of disclosure quality variables, including discretionary accruals quality, the quantity and quality of voluntary disclosures, fineness of reported financial statement information, and the narrative quality of regulatory filings, and use them to create information disclosure quality indices. We address the potential endogeneity of CEO equity incentives by conducting two-stage least squares/IV models and natural experiments created by situations in which there is an exogenous shock to the use or value of CEO stock options. Our results are robust to subsample analyses and to alternative measures of the incentives created by CEO options.

Trading Fees and Intermarket Competition
Marios Panayaides, Barbara Rindi, and Ingrid M. Werner
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We study the 2013 changes in maker-taker pricing fees implemented by BATS on its two European venues, CXE and BXE. The CXE rebate reduction deteriorates market quality and market share, whereas the BXE rebate removal and take-fee reduction improve them. We derive a model of two competing limit order books, in which large (small) stocks are characterized by investors with higher (lower) propensity to supply liquidity and by greater (lower) trading activity. Consistent with our model, we show that traders in large stocks are more reactive to rebate reductions while traders in small stocks are more reactive to take-fee reductions.

What is the Shareholder Wealth Impact of Target CEO Retention in Private Equity Deals?
Leonce Bargeron, Frederik Schlingemann, René M. Stulz, and Chad Zutter
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There is a widespread belief among observers that a lower premium is paid when the target CEO is retained by the acquirer in a private equity deal because the CEO’s potential conflicts of interest leads her to negotiate less aggressively on behalf of the target shareholders. Our empirical evidence is not consistent with this belief. We find that, when a private equity acquirer retains the target CEO, target shareholders receive an acquisition premium that is larger by as much as 18% of pre-acquisition firm value when accounting for the endogeneity of the retention decision. Our evidence is consistent with what we call the “valuable CEO hypothesis.” With this hypothesis, retention of the CEO can be valuable to private equity acquirers because, unlike public operating companies with managers in place, these acquirers have to find a CEO to run the post-acquisition company and the incumbent CEO may be the best choice to do so because she has valuable firm-specific human capital. When a private equity acquirer finds a target with a CEO who can manage the post-acquisition company better than other potential CEOs, we expect target shareholders to receive a larger premium because the post-acquisition value of the target is higher.

Cash, Financial Flexibility, and Product Prices: Evidence from a Natural Experiment in the Airline Industry
Sehoon Kim
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Corporate cash holdings impact firms’ product pricing strategies. Exploiting the Aviation Investment and Reform Act of the 21st Century as a quasi-natural experiment to identify exogenous shocks to competition in the airline industry, I find that firms with more cash than their rivals respond to intensified competition by pricing more aggressively, especially when there is less concern of rival retaliation. Financially flexible firms based on alternative measures respond similarly. Moreover, cash-rich firms experience greater market share gains and long-term profitability growth. The results highlight the importance of strategic interdependencies across firms in the effective use of flexibility provided by cash.

Impulsive Consumption and Financial Wellbeing: Evidence from an Increase in the Availability of Alcohol
Itzhak Ben-David and Marieke Bos
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Increased availability of alcohol may harm individuals if they have present-focused preferences and consume more than initially planned. Using a nationwide experiment in Sweden, we study the credit behavior of low-income households around the expansion of liquor stores' operating hours on Saturdays. Consistent with store closures serving as commitment devices, the policy led to higher credit demand, more default, increased dependence on welfare, and higher crime on Saturdays. The effects are concentrated among the young population due to higher alcohol consumption combined with tight liquidity constraints. The policy's impact on indebtedness is estimated at 4.5 times the expenditure on alcohol.

Accounting-based Compensation and Debt Contracts
Zhi Li, Lingling Wang, and Karen H. Wruck
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We examine how accounting-based compensation plans influence a firm’s contracts with its creditors. After granting long-term accounting-based compensation plans (LTAPs) to CEOs, firms pay lower spreads and have fewer restrictive covenants in new bank loans. Mechanisms leading to lower borrowing cost include improvements in debt repayment ability, reduced shareholder-debtholder conflicts, and reduced risk-taking incentives. Creditors view LTAPs as a substitute for monitoring, adjust covenant design based on LTAP features, and value plans with concave performance-payout functions and reasonable performance targets. A firm’s credit rating improves and CDS spread declines after LTAP grants, suggesting that LTAPs help reduce firms’ credit risk.

Are Larger Banks Valued More Highly?
Bernadette A. Minton, René M. Stulz, and Alvaro G. Taboada
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We investigate whether the value of large banks, defined as banks with assets in excess of the Dodd-Frank threshold for enhanced supervision, increases with the size of their assets using Tobin’s q and market-to-book as our valuation measures. Many argue that large banks receive subsidies from the regulatory safety net, so they should be worth more and their valuation should increase with size. Instead, using a variety of approaches, we find (1) no evidence that large banks are valued more highly, (2) strong cross-sectional evidence that the valuation of large banks falls with size, and (3) strong evidence of a within-bank negative relation between valuation and size for large banks from 1987 to 2006 but not when the post-Dodd-Frank period is included in the sample. The negative relation between bank value and bank size for large banks cannot be systematically explained by differences in ROA or ROE, equity volatility, tail risk, distress risk, and equity discount rates. However, we find that banks with more trading assets are worth less. A 1% increase in trading assets is associated with a Tobin’s q lower by 0.2% in regressions with year and bank fixed effects. This relation between bank value and trading assets helps explain the cross-sectional negative relation between large bank valuation and size. Our results hold when we use instrumental variables for bank size.

Is Post-Crisis Bond Liquidity Lower?
Mike Anderson and René M. Stulz
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Price-based liquidity metrics are much better for small trades after the crisis than before the crisis. For large trades, these metrics are generally worse from 2010 to 2012 and better from 2013 to 2014 than from 2004 to 2006. However, turnover falls sharply after the crisis, which is consistent with investors having more difficulty completing trades on acceptable terms. A frequent concern is that post-crisis liquidity could be low when markets are stressed. We consider three stress events: extreme VIX increases, extreme bond yield increases, and downgrades to high yield. We find evidence that liquidity is lower after the crisis for extreme VIX increases. However, we find no evidence that liquidity related to idiosyncratic stress events is worse after the crisis than before the crisis. Our results emphasize the importance of considering how liquidity reacts to shocks which can affect financial stability and of taking into account the information from non-price liquidity metrics.

Replicating Anomalies
Kewei Hou, Chen Xue, and Lu Zhang
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The anomalies literature is infested with widespread p-hacking. We replicate the entire anomalies literature in finance and accounting by compiling a largest-to-date data library that contains 447 anomaly variables. With microcaps alleviated via New York Stock Exchange breakpoints and value-weighted returns, 286 anomalies (64%) including 95 out of 102 liquidity variables (93%) are insignificant at the conventional 5% level. Imposing the cutoff t-value of three raises the number of insignificance to 380 (85%). Even for the 161 significant anomalies, their magnitudes are often much lower than originally reported. Out of the 161, the q-factor model leaves 115 alphas insignificant (150 with t < 3). In all, capital markets are more efficient than previously recognized.

The International Propagation of Economic Downturns Through Multinational Companies: The Real Economy Channel
Jan Bena, Serdar Dinc, and Isil Erel
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We study how non-financial multinational companies propagate economic declines from their subsidiaries located in countries experiencing an economic downturn to subsidiaries in countries not experiencing one. We find that investment is 18% lower in subsidiaries of these parents relative to the same-industry, same-country subsidiaries of parents that are headquartered in the same parent country but do not have a subsidiary in a country experiencing an economic downturn. The employment growth rate in the affected subsidiaries is zero or negative while it is 1.4% in the subsidiaries of unaffected parents. The aggregate industry-level sales and employment are also negatively impacted in the countries of the affected subsidiaries.

Product Price Risk and Liquidity Management: Evidence from the Electricity Industry
Chen Lin, Thomas Schmid, and Michael S. Weisbach
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Product price risk is a potentially important factor for firms’ liquidity management. A natural place to evaluate the impact of this risk on liquidity management is the electricity industry, since producing firms face substantial price volatility in wholesale markets. Empirically, higher volatility of electricity prices leads to an increase in cash holdings, and this effect is robust to instrumenting for price risk using weather volatility. Cash increases more with price risk in firms using inflexible production technologies and those that cannot easily hedge electricity prices, indicating that operating flexibility and hedging are substitutes for liquidity management.

Corporate Liquidity, Acquisitions, and Macroeconomic Conditions
Isil Erel, Yeejin Jang, Bernadette A. Minton, and Michael S. Weisbach
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This paper evaluates how the relation between firms’ cash holdings and their acquisition decisions changes over macroeconomic cycles using a sample of 47,615 acquisitions from 36 countries between 1997 and 2014. Higher cash holdings and stronger macroeconomic conditions each increase the likelihood that a firm will make an acquisition. However, larger cash holdings decrease the sensitivity of acquisitions to macroeconomic factors, suggesting that cash holdings lower financing constraints during times when the cost of external finance is high. Announcement day abnormal returns for acquirers follow a consistent pattern: they decrease with acquirer cash holdings and with better macroeconomic conditions.

Can Reinvestment Risk Explain the Dividend and Bond Term Structures?
Andrei S. Gonçalves
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Contradicting leading asset pricing models, recent evidence indicates the term structure of dividend discount rates is downward sloping despite the typical upward sloping bond yield curve. This paper empirically shows that reinvestment risk explains both the dividend and bond term structures. Intuitively, dividend claims hedge equity reinvestment risk because dividend present values rise as expected returns decline. This hedge is more effective for longer-term dividend claims because they are more sensitive to discount rate variation, resulting in a downward sloping dividend term structure. For bonds, as expected equity returns decline, nominal interest rates rise, and bond prices fall. Consequently, bonds are exposed to equity reinvestment risk, and this exposure increases with duration, giving rise to an upward sloping bond term structure.

How Important Was Contagion Through Banks During the European Sovereign Crisis?
Andrea Beltratti and René M. Stulz
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We use days with tail sovereign CDS spread changes of peripheral countries to identify the effects of shocks to the cost of borrowing of these countries on stock returns of banks from other countries. We find that tail sovereign GIIPS CDS changes have an asymmetric impact in that bank stocks benefit more from negative CDS spread shocks than they are hurt by positive shocks, which creates moral hazard and is best explained by a “too-systemic-to-fail” effect. The contagion effects are stronger for more pervasive shocks, so that idiosyncratic shocks to small countries, such as Greece, do not have an economically significant impact, but shocks involving large GIIPS countries or multiple GIIPS countries have such an impact. In our benchmark specification, holdings of peripheral country bonds by banks from other countries do not constitute a statistically or economically significant contagion channel for tail spread increases.

The Economics of Value Investing
Kewei Hou, Haitao Mo, Chen Xue, and Lu Zhang
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The investment CAPM provides an economic foundation for Graham and Dodd’s (1934) Security Analysis, without mispricing. Expected returns vary cross-sectionally, depending on firms’ investment, expected profitability, and expected investment growth. Our economic model also offers an appealing alternative to two workhorse accounting models. Empirically, many anomaly variables are associated with future investment growth, in the same direction with future returns. An expected growth factor earns on average 0.56% per month (t = 6.66), and adding it to the q-factor model improves the model’s performance substantially. In all, value investing is consistent with efficient markets.

De Facto Seniority, Credit Risk, and Corporate Bond Prices
Jack Bao and Kewei Hou
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We study the effect of a bond's place in its issuer's maturity structure on credit risk. Using a structural model as motivation, we argue that bonds due relatively late in their issuers' maturity structure have greater credit risk than do bonds due relatively early. Empirically, we find robust evidence that these later bonds have larger yield spreads and greater comovement with equity and that the magnitude of the effects is consistent with model predictions for investment-grade bonds. Our results highlight the importance of bond-specific credit risk for understanding corporate bond prices.

U.S. Tick Size Pilot
Barbara Rindi and Ingrid Werner
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The U.S. equity markets recently increased the tick size from one to five cents for smaller capitalization stocks. We show that the larger tick size raised the cost for retail-sized liquidity demanding orders by almost fifty percent, and raised profits to liquidity providers by forty percent. The bulk of the effects occurred for tick-constrained stocks for which trading costs more than doubled. Trading costs for unconstrained stocks declined by more than ten percent. Finally, we document significant changes in market quality for control stocks relative to similar stocks that were not part of the study.

Aggregation, Capital Heterogeneity, and the Investment CAPM
Andrei S. Gonçalves, Chen Xue and Lu Zhang
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A detailed treatment of aggregation and capital heterogeneity substantially improves the performance of the investment CAPM. Firm-level predicted returns are constructed from firm-level accounting variables and aggregated to the portfolio level to match with portfolio-level stock returns. Working capital forms a separate productive input besides physical capital. The model fits well the value, momentum, investment, and profitability premiums simultaneously and partially explains the positive stock-fundamental return correlations, the procyclical and short-term dynamics of the momentum and profitability premiums, as well as the countercyclical and long-term dynamics of the value and investment premiums. However, the model falls short in explaining momentum crashes.

Do CEOs Make Their Own Luck? Relative versus Absolute Performance Evaluation and Firm Risk
Karen H. Wruck and YiLin Wu
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Influenced by their compensation plans, CEOs make their own luck through decisions that affect future firm risk. After adopting a relative performance evaluation (RPE) plan, total and idiosyncratic risk are higher, and the correlation between firm and industry performance is lower. The opposite is true for firms that adopt absolute performance evaluation (APE) plans. Plans including accounting-based performance metrics and/or cash payouts have weaker risk-related incentives. The higher idiosyncratic risk associated with RPE increases a firm’s exposure to downside stock return risk and lowers credit quality. Our findings are economically consistent with observed differences in firms’ financial and investment policies.

The Politics of Foreclosures
Sumit Agarwal, Gene Amromin, Itzhak Ben-David, and Serdar Dinc
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U.S. House of Representatives Financial Services Committee considered many important banking reforms in 2009-2010 including the Dodd-Frank Act. We show that during this period, the foreclosure starts on delinquent mortgages were delayed in the districts of committee members even though there was no difference in delinquency rates between committee and non-committee districts. In these areas, banks delayed the start of the foreclosure process by 0.5 months (relative to the 12-month average). The total estimated cost of delay to lenders is an order of magnitude greater than the campaign contributions by the Political Action Committees of the largest mortgage servicing banks to the committee members in that period and is comparable to these banks' lobbying expenditures.

The Economics of PIPEs
Jongha Lim, Michael W. Schwert, and Michael S. Weisbach
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Private investments in public equities (PIPEs) are an important source of finance for public corporations. PIPE investor returns decline with holding periods, while time to exit depends on the issue’s registration status and underlying liquidity. We estimate PIPE investor returns adjusting for these factors. Our analysis, which is the first to estimate returns to investors rather than issuers, indicates that the average PIPE investor holds the stock for 384 days and earns an abnormal return of 19.7%. More constrained firms tend to issue PIPEs to hedge funds and private equity funds in offerings that have higher expected returns and higher volatility. PIPE investors’ abnormal returns appear to reflect compensation for providing capital to financially constrained firms.

Does Borrowing from Banks Cost More than Borrowing from the Market?
Michael W. Schwert
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This paper investigates the pricing of bank loans relative to capital market debt. The analysis relies on a novel sample of syndicated loans matched with bond spreads from the same firm on the same date. After accounting for seniority, banks earn an economically large premium relative to the market price of credit risk. To quantify the premium, I apply a structural model that accounts for priority structure, prices the firm's bonds, and matches expected losses given default and secondary market bid-ask spreads. In a sample of secured term loans to non-investment-grade firms, the average loan premium is 143 bps, equal to 43% of the all-in-drawn spread. These findings are the first direct evidence of firms' willingness to pay for the unique qualities of bank loans and raise questions about the nature of competition in the loan market.

Government Debt and Bank Leverage Cycle: An Analysis of Public and Intermediated Liquidity
Yi Li
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Financial intermediaries issue the majority of liquid securities, and nonfinancial firms have become net savers, holding intermediaries' debt as cash. This paper shows that intermediaries' liquidity creation stimulates growth -- firms hold their debt for unhedgeable investment needs -- but also breeds instability through procyclical intermediary leverage. Introducing government debt as a competing source of liquidity is a double-edged sword: firms hold more liquidity in every state of the world, but by squeezing intermediaries' profits and amplifying their leverage cycle, public liquidity increases the frequency and duration of intermediation crises, raising the likelihood of states with less liquidity supplied by intermediaries. The latter force dominates and the overall impact of public liquidity is negative, when public liquidity cannot satiate firms' liquidity demand and intermediaries are still needed as the marginal liquidity suppliers.

Political Uncertainty and Commodity Prices
Kewei Hou, Ke Tang, and Bohui Zhang
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Using a comprehensive sample of 87 commodities, we examine the effect of political uncertainty on commodity prices. We show that political uncertainty surrounding U.S. presidential elections has a significant negative impact on commodity prices worldwide, likely due to shrinking demand before the elections. On average, commodity prices decline by 6.4% in the quarter leading up to U.S. elections. This effect holds true for gold, and is stronger for close elections and elections during recessions. On the other hand, political uncertainty in commodity producing countries with little demand pushes commodity prices up by 5.4% in the quarter before their national elections.

Decreasing Returns or Mean-reversion of Luck? The Case of Private Equity Fund Growth
Andrea Rossi
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In private equity fund data, there exists a strong negative association between fund growth and performance at the partnership level. As a consequence, there is a consensus that decreasing returns are particularly large. I argue that this inference is unwarranted. In essence, Bayesian-informed expectations reveal that the partnerships whose funds grew the most were on average lucky in the past; as that luck reverts to zero, a spurious negative association between growth and returns is generated in the data. Controlling for this bias, the effect of growth on performance is about 80% smaller and statistically insignificant for both buyout and venture capital funds. Furthermore, I show that, historically, decreasing returns do not seem to have played a major role in the erosion of performance persistence in private equity. These results have implications for fund managers’ and investors’ decisions, and for our understanding of the private equity industry.

How Do Financial Constraints Affect Product Pricing? Evidence from Weather and Life Insurance Premiums
Shan Ge
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I identify effects of financial constraints on firms’ product pricing decisions, using a sample of insurance groups (conglomerates) that contain both life and P&C (property & casualty) subsidiaries. P&C subsidiaries’ losses can tighten financial constraints for the life subsidiaries through internal capital markets. I present a model that predicts following P&C losses, premiums should fall for life policies that initially increase insurers’ statutory capital, and rise for policies that initially decrease capital. Empirically, I find that P&C losses cause changes in life insurance premiums as my model predicts. The effects are concentrated in more financially constrained groups. Evidence also indicates that life subsidiaries increase capital transfers to P&C subsidiaries following larger P&C losses. These results hold when instrumenting for P&C losses using data on weather damages, implying that P&C losses do cause changes in life insurance premiums and internal capital transfers. My findings suggest that when financial constraints tighten, firms change product prices to relax the constraints, and how prices change depends on the initial impact of selling the products on firms’ financial resources.

Corporate Deleveraging and Financial Flexibility
Harry DeAngelo, Andrei S. Gonçalves, René M. Stulz
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Most firms deleverage from their historical peak market-leverage (ML) ratios to near-zero ML, while also markedly increasing cash balances to high levels. Among 4,476 nonfinancial firms with five or more years of post-peak data, median ML is 0.543 at the peak and 0.026 at the later trough, with a six-year median time from peak to trough and with debt repayment and earnings retention accounting for 93.7% of the median peak-to-trough decline in ML. The findings support theories in which firms deleverage to restore ample financial flexibility and are difficult to reconcile with most firms having materially positive leverage targets.

Does the Stock Market Make Firms More Productive?
Benjamin Bennett, René M. Stulz, Zexi Wang
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Management, directly or indirectly, learns from its firm’s stock price, so that a more informative stock price should make the firm more productive. We show that stock price informativeness increases firm productivity. We predict and confirm that the productivity of smaller and younger firms, better governed firms, more specialized firms, and firms with more competition is more strongly related to the informativeness of their stock price. We address endogeneity concerns with fixed effects, instrumental variables, and the use of brokerage house research department closures and S&P 500 additions as plausibly exogenous events. 1

The Finance Uncertainty Multiplier
Iván Alfaro, Nicholas Bloom, and Xiaoji Lin
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We show how real and financial frictions amplify the impact of uncertainty shocks. We build a model with real frictions, and find adding financial frictions roughly doubles the impact of uncertainty shocks. Higher uncertainty alongside financial frictions induces the standard real-options effects on investment and hiring, but also leads firms to hoard cash, further reducing investment and hiring. We then test the model using a panel of US firms and a novel instrumentation strategy for uncertainty exploiting differential firm exposure to exchange rate and price volatility. These results highlight why in periods with greater financial frictions uncertainty can be particularly damaging.

Day of the Week and the Cross-Section of Returns
Justin Birru
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Long-short anomaly returns are strongly related to the day of the week. Anomalies for which the speculative leg is the short (long) leg experience the highest (lowest) returns on Monday. The opposite pattern is observed on Fridays. The effects are large; Monday (Friday) alone accounts for over 100% of returns for all anomalies examined for which the short (long) leg is the speculative leg. Consistent with a mispricing explanation, the pattern is driven by the speculative leg. The observed patterns are consistent with the abundance of evidence in the psychology literature that mood increases on Friday and decreases on Monday.

Systemic Default and Return Predictability in the Stock and Bond Markets
Jack Bao, Kewei Hou, and Shaojun Zhang
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We construct a measure of systemic default defined as the probability that many firms default at the same time. We account for correlations in defaults between firms through exposures to common shocks. Systemic default spikes during recessions, is correlated with macroeconomic indicators, and predicts future realized defaults. More importantly, it predicts future equity and corporate bond index returns both in- and out-of-sample. Finally, we find that the cross-section of average stock returns is related to firm-level exposures to systemic default risk.

Institutional Investments in Pure Play Stocks and Implications for Hedging Decisions
Bernadette A. Minton and Catherine Schrand
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We show that institutions invest in stocks within an industry that maintain exposure to their underlying industry risk factor. These "pure play" stocks have greater numbers of institutional investors and institutions systematically overweight them in their portfolios while underweighting low industry-exposure stocks of firms in the same nominal industry. Pure play stocks also have greater liquidity measured by stock turnover and price impact. An implication of these results is that catering to these preferences could be an important variable in firms’ risk management decisions, potentially offsetting incentives to reduce volatility via hedging. We further characterize institutions’ investments for pure play stocks across institution type, industries, and over time.

Hedging Interest Rate Risk Using a Structural Model of Credit Risk
Jing-Zhi Huang and Zhan Shi
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Recent evidence has shown that structural models fail to capture interest rate sensitivities of corporate debt. We consider a structural model that incorporates a three-factor dynamic term structure model (DTSM) into the Merton (1974) model. We show that the proposed model largely captures the interest rate exposure of corporate bonds. We also find that for investment-grade bonds, hedging effectiveness substantially improves under the proposed model. Our results indicate that to better capture and hedge the interest rate exposure of corporate bonds, we need to incorporate a more realistic DTSM in the existing structural models.

Liquidity Transformation in Asset Managment: Evidence from the Cash Holdings of Mutual Funds
Sergey Chernenko and Adi Sunderman
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We study liquidity transformation in mutual funds using a novel data set on their cash holdings.To provide investors with claims that are more liquid than the underlying assets, funds engage in substantial liquidity management. Specifically, they hold substantial amounts of cash, which they use to accommodate inflows and outflows rather than transacting in the underlying portfolio assets. This is particularly true for funds with illiquid assets and at times of low market liquidity. We provide evidence suggesting that mutual funds’ cash holdings are not large enough to fully mitigate price impact externalities created by the liquidity transformation they engage in.

How Management Risk Affects Corporate Debt
Yihui Pan, Tracy Yue Wang, and Michael Weisbach
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We evaluate whether management risk, coming from uncertainty about management’s value added, affects firms’ default risks and debt pricing. We find that, regardless of the reason for the turnover, CDS spreads, loan spreads and bond yield spreads all increase at the time of management turnover, when management risk is highest, and decline over the first three years of CEO tenure. The effects increase with the prior uncertainty about the new management. These results are consistent with the view that management risk affects firms’ default risk. An understanding of management risk yields a number of implications for corporate finance.

Why does fast loan growth predict poor performance for banks?
Rüdiger Fahlenbrach, Robert Prilmeier, and René M. Stulz
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From 1973 to 2014, the common stock of U.S. banks with loan growth in the top quartile of banks over a three-year period significantly underperforms the common stock of banks with loan growth in the bottom quartile over the next three years. The benchmark-adjusted cumulative difference in performance over three years exceeds twelve percentage points. The high growth banks also have significantly higher crash risk over the three-year period. This poor performance is explained by fast loan growth as asset growth separate from loan growth is not followed by poor performance. These banks reserve less for loan losses when their loans grow quickly than other banks. Subsequently, they have a lower return on assets and increase their loan loss reserves. The poorer performance of the fast growing banks is not explained by merger activity and loan growth through mergers is not accompanied by the same poor loan performance. The evidence is consistent with fast-growing banks, analysts, and investors failing to properly appreciate the extent to which the fast loan growth results from making riskier loans and failing to charge for these risks correctly.

Industry Familiarity and Trading: Evidence from the Personal Portfolios of Industry Insiders
Itzhak Ben-David, Justin Birru, and Andrea Rossi
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We study whether industry familiarity is an advantage in stock trading by exploring the trading patterns of industry insiders in their own personal portfolios. To do so, we identify accounts of industry insiders in a large dataset provided by a retail discount broker. We find that insiders trade firms from their own industry
more frequently. Furthermore, they earn abnormal returns exclusively when trading own-industry stocks, especially obscure stocks (small, low analyst coverage, high volatility). In a battery of tests, we find no evidence of the use of private information. The results are most consistent with the interpretation that industry familiarity is an advantage in stock trading.

Systematic Mistakes in the Mortgage Market and Lack of Financial Sophistication
Sumit Agarwal, Itzhak Ben-David, and Vincent Yao
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Institutions often offer a menu of contracts to consumers in an attempt to create a separating equilibrium that reveals borrower types and provides better pricing. We test the effectiveness of a specific set of contracts in the mortgage market: mortgage points. Points allow borrowers to exchange an upfront amount for a decrease in the mortgage rate. We document that, on average, points takers lose about $700. Also, points takers are less financially savvy (less educated, older), and they make mistakes on other dimensions (e.g., inefficiently refinancing their mortgages). Overall, our results show that borrowers overestimate how long they will stay with the mortgage.

Government Debt and the Returns to Innovation
Mariano Croce, Thien T. Nguyen, Steve Raymond, and Lukas Schmid
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Elevated levels of government debt raise concerns about their effects on long-term growth prospects. Using the cross section of US stock returns, we show that (i) high-R&D firms are more exposed to government debt and pay higher expected returns than low-R&D firms, and (ii) higher levels of the debt-to-GDP ratio predict higher risk premiums for high-R&D firms. Furthermore, rises in the cost of capital for innovation-intensive firms predict declines in subsequent productivity and economic growth. We propose a production-based asset pricing model with endogenous innovation and fiscal policy shocks that can rationalize key aspects of the empirical evidence. Our study highlights a novel and distinct risk channel shaping the link between government debt and future growth.

The Liquidity Cost of Private Equity Investments: Evidence from Secondary Market Transactions
Taylor D. Nadauld, Berk A. Sensoy, Keith Vorkink, and Michael S. Weisbach
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This paper uses proprietary data from a leading intermediary to understand the magnitude and determinants of transaction costs in the secondary market for private equity stakes. Most transactions occur at a discount to net asset value. Buyers average an annualized public market equivalent of 1.023 compared to 0.976 for sellers, implying that buyers outperform sellers by a market-adjusted five percentage points annually. Both the cross-sectional pattern of transaction costs and the identity of sellers and buyers suggest that the market can be characterized as one in which relatively flexible buyers earn returns by supplying liquidity to investors wishing to exit.

The Structure of Banker’s Pay
Benjamin Bennett, Radhakrishnan Gopalan, and Anjan Thakor
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While executive compensation is often blamed for the excessive risk taking by banks, little is known about the operating performance incentives used in the finance industry both prior to and subsequent to the recent crisis. We provide a comprehensive analysis of incentive design -- the link of compensation to operating performance -- in financial firms and compare incentive structures in financial firms to those in non-financial firms. Top executives in financial firms are paid less than their counterparts in non-financial firms of similar size and performance. Banks (and insurance firms) link a larger fraction of top executive pay to short-term accounting metrics like ROE and EPS and a smaller fraction to (long-term) stock price. Performance targets for bankers are not related to the risk of the bank, and ROE targets are not appropriately adjusted for leverage. Consequently, the design of executive compensation in banking may encourage both high leverage and risk-taking, and our evidence provides a potential explanation for the strong positive correlation that we document between the extent of short-term pay for bank CEOs and the risk of the bank before the financial crisis.

Why does idiosyncratic risk increase with market risk?
Söhnke M. Bartram, Gregory Brown, and René M. Stulz
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From 1963 through 2015, idiosyncratic risk (IR) is high when market risk (MR) is high. We show that the positive relation between IR and MR is highly stable through time and is robust across exchanges, firm size, liquidity, and market-to-book groupings. Though stock liquidity affects the strength of the relation, the relation is strong for the most liquid stocks. The relation has roots in fundamentals as higher market risk predicts greater idiosyncratic earnings volatility and as firm characteristics related to the ability of firms to adjust to higher uncertainty help explain the strength of the relation. Consistent with the view that growth options provide a hedge against macroeconomic uncertainty, we find evidence that the relation is weaker for firms with more growth options.

Measuring Institutional Investors’ Skill from Their Investments in Private Equity
Daniel R. Cavagnaro, Berk A. Sensoy, Yingdi Wang, and Michael S. Weisbach
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Using a large sample of institutional investors’ investments in private equity funds raised between 1991 and 2011, we estimate the extent to which investors’ skill affects their returns. Bootstrap analyses show that the variance of actual performance is higher than would be expected by chance, suggesting that some investors consistently outperform. Extending the Bayesian approach of Korteweg and Sorensen (2017), we estimate that a one standard deviation increase in skill leads to an increase in annual returns of between one and two percentage points. These results are stronger in the earlier part of the sample period and for venture funds.

Why does capital no longer flow more to the industries with the best growth opportunities?
Dong Lee, Hyun-Han Shin, and René M. Stulz
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With functionally efficient capital markets, we expect capital to flow more to the industries with the best growth opportunities. As a result, these industries should invest more and see their assets grow more relative to industries with the worst growth opportunities. We find that industries that receive more funds have a higher industry Tobin’s q until the mid-1990s, but not since then. Since industries with a higher funding rate grow more, there is a negative correlation not only between an industry’s funding rate and industry q but also between capital expenditures and industry q since the mid-1990s. We show that capital no longer flows more to the industries with the best growth opportunities because, since the middle of the 1990s, firms in high q industries increasingly repurchase shares rather than raise more funding from the capital markets.

Municipal Bond Liquidity and Default Risk
Michael Schwert
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This paper examines the pricing of bonds issued by states and local governments. I use three distinct, complementary approaches to decompose municipal bond spreads into default and liquidity components, finding that default risk accounts for 74% to 84% of the average municipal bond spread after adjusting for tax-exempt status. The first approach estimates the liquidity component using transaction data, the second measures the default component with credit default swap data, and the third is a quasi-natural experiment that estimates changes in default risk around pre-refunding events. The price of default risk is high given the rare incidence of municipal default and implies a high risk premium.

Bank Capital and Lending Relationships
Michael Schwert
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This paper investigates the mechanisms behind the matching of banks and firms in the loan market and the implications of this matching for lending relationships, bank capital, and the provision of credit. I find that bank-dependent firms borrow from well capitalized banks, while firms with access to the bond market borrow from banks with less capital. This matching of bank-dependent firms with stable banks smooths cyclicality in aggregate credit provision and mitigates the effects of bank shocks on the real economy.

Loan Product Steering in Mortgage Markets
Sumit Agarwal, Gene Amromin, Itzhak Ben-David, and Douglas D. Evanoff
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We present evidence of a particular type of loan steering in which lenders lead borrowers to take out high margin mortgage products. We identify this activity by comparing borrowers who were rejected by lenders but were subsequently approved by their affiliates (steered borrowers) to other initially rejected borrowers who obtained loans elsewhere. Although steered borrowers default less, they pay significantly higher interest rates and are more likely to borrow through contracts with unconventional features, such as negative amortization or prepayment penalties. Female borrowers, single borrowers with no co-signers, and borrowers in low-income locations are more likely to be steered.

(Priced) Frictions
Kewei Hou, Sehoon Kim, and Ingrid M. Werner
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We propose a parsimonious measure based solely on daily stock returns to characterize the severity of microstructure frictions at the individual stock level and assess the impact of frictions on the cross section of stock returns. Stocks with the largest frictions command a value-weighted return premium as large as 10% per year on a risk-adjusted basis. The friction premium is stronger among small, low price, volatile, value, and illiquid stocks. Return spreads associated with momentum and idiosyncratic volatility are smaller and statistically less significant than previously documented after screening out stocks with high microstructure frictions. Using UK data, we show that our measure is useful in settings where the availability of quality data on trading volume, bid-ask prices, and intraday high-low prices is limited.

Investment, Tobin's Q, and Interest Rates
Xiaoji Lin, Chong Wang, Neng Wang, and Jinqiang Yang
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To study the impact of stochastic interest rates and capital illiquidity on investment and firm value, we incorporate a widely-used arbitrage-free term structure model of interest rates into a standard q-theoretic framework. Our generalized q model informs us to use corporate credit-risk information to predict investments when empirical measurement issues of Tobin's average q are significant (e.g., equity is much more likely to be mis-priced than debt) as in Philippon (2009). Consistent with our theory, we find that credit spreads and bond q have significant predictive powers on micro-level and aggregate investments corroborating the recent empirical work of Gilchrist and Zakrajšek (2012). We also show that the quantitative effects of the stochastic interest rates and capital illiquidity on investment, Tobin's average q, the duration and user cost of capital, as well as the value of growth opportunities are substantial. These findings are particularly important in today's low interest-rate environment.

Corporate Deleveraging
Harry DeAngelo, Andrei S. Gonçalves, and René M. Stulz
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Proactive deleveraging from all-time peak market leverage (ML) to near-zero ML and negative net debt is the norm among 4,476 nonfinancial firms with five or more years of post-peak data. ML is 0.543 at the historical peak and 0.026 at the later trough for the median firm in this sample, with a six-year median time from peak to trough. These deleveraging episodes are largely proactive, with debt repayment and earnings retention accounting for 93.7% of the peak-to-trough decline in ML for the median firm. Attenuated deleveraging, with ML staying well above zero, is the norm at 3,118 firms that are delisted due to financial distress within four years of peak. Leverage is path dependent, with the key to explaining whether ML is high or low at the post-peak trough being how high it was at the peak and prior trough and whether the firm has had only a short time to deleverage, e.g., due to distress-related delisting. The findings are consistent with proactive deleveraging to avoid distress and to restore financial flexibility, and are hard to reconcile with materially positive target leverage ratios.

Exchange Traded Funds (ETFs)
Itzhak Ben-David, Francesco A. Franzoni, and Rabih Moussawi
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Over nearly a quarter of a century, ETFs have become one of the most popular passive investment vehicles among retail and professional investors due to their low transaction costs and high liquidity. By the end of 2016, the market share of ETFs topped over 10% of the total market capitalization traded on US exchanges, while representing more than 30% of the overall trading volume. ETFs revolutionized the asset management industry by taking market share from traditional investment vehicles such as mutual funds and index futures. Because ETFs rely on arbitrage activity to synchronize their prices with the prices of the underlying portfolio, trading activity at the ETF level translates to trading of the underlying securities. Researchers found that while ETFs enhance price discovery, they also inject non-fundamental volatility to market prices and affect the correlation structure of returns. Furthermore, ETFs impact the liquidity of the underlying portfolios, especially during events of market stress.

Is the American public corporation in trouble?
Kathleen Kahle and René M. Stulz
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We examine the current state of the American public corporation and how it has evolved over the last forty years. There are fewer public corporations now than forty years ago, but they are much older and larger. They invest differently, as the importance of R&D investments has grown relative to capital expenditures. On average, public firms have record high cash holdings and in most recent years they have more cash than long-term debt. They are less profitable than they used to be and profits are more concentrated, as the top 100 firms now account for most of the net income of American public firms. Accounting statements are less informative about the performance and the value of firms because firms increasingly invest in intangible assets that do not appear on their balance sheets. Firms’ total payouts to shareholders as a percent of net income are at record levels, suggesting that firms either lack opportunities to invest or have poor incentives to invest. The credit crisis appears to leave few traces on the course of American public corporations.

Do Firms Issue More Equity When Markets Become More Liquid?
Rogier M. Hanselaar, René M. Stulz, and Mathijs A. van Dijk
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Using quarterly data on IPOs and SEOs in 38 countries over the period 1995-2014, we show that changes in equity issuance are significantly and positively related to lagged changes in aggregate local market liquidity. This relation is at least as economically significant as the well-known relation between equity issuance and lagged stock returns. It survives the inclusion of proxies for market timing, capital market conditions, growth prospects, asymmetric information, and investor sentiment, as well as the exclusion of the financial crisis. Changes in liquidity are less relevant for firms that face greater financial pressures, firms in less financially developed countries, and during the financial crisis.

Limited Risk Sharing and International Equity Returns
Shaojun Zhang
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Limited stock market participation can potentially explain the disconnect between international asset prices and macro quantities. An incomplete markets model in which risk sharing for stockholders is high, generates highly correlated equity returns and relatively smooth exchange rates. Risk sharing for non-stockholders is limited because of their non-participation in stock markets and borrowing constraints, lowering aggregate consumption correlation and the correlation between aggregate consumption differentials and exchange rates. Further, financial integration widens the disconnect by benefiting stockholders but hurting non-stockholders. Survey data indicate that international risk sharing for stockholders is better than that for non-stockholders, lending support to the predictions.

Understanding the Variation in the Information Content of Earnings: A Return Decomposition Analysis
Kewei Hou, Yinglei Zhang and Zili Zhuang
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We use the Campbell (1991) return decomposition framework to reexamine the variation in the information content of earnings between profit firms and loss firms and over time. We show that current earnings surprises are more strongly correlated with the discount rate news component of returns for loss firms and in the recent period. This stronger correlation offsets the positive relation between current earnings surprises and the earnings news component of returns, causing the overall earnings-return relation to be weaker for loss firms and during the recent period. Consistent with these findings, we also find that discount rate news is a more important driver of the return variation of loss firms and in the recent period. Our results highlight the importance of time-varying discount rates for understanding the information content of earnings.

Are Firms in "Boring" Industries Worth Less?
Jia Chen, Kewei Hou and René M. Stulz
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Using theories from the behavioral finance literature to predict that investors are attracted to industries with more salient outcomes and that therefore firms in such industries have higher valuations, we find that firms in industries that have high industry-level dispersion of profitability have on average higher market-to-book ratios than firms in low dispersion industries. This positive relation between market-to-book ratios and industry profitability dispersion is economically large and statistically significant and is robust to controlling for variables used to explain firm-level valuation ratios in the literature. Consistent with the mispricing explanation of this finding, we show that firms in less boring industries have a lower implied cost of equity and lower realized returns. We explore alternative explanations for our finding, but find that these alternative explanations cannot explain our results.

The CAPM Strikes Back? An Investment Model with Disasters
Hang Bai, Kewei Hou, Howard Kung and Lu Zhang
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Value stocks are more exposed to disaster risk than growth stocks. Embedding disasters into an investment-based asset pricing model induces strong nonlinearity in the pricing kernel. Our single-factor model reproduces the failure of the CAPM in explaining the value premium in finite samples in which disasters are not materialized, and its relative success in samples in which disasters are materialized. The relation between pre-ranking market betas and average returns is flat in simulations, despite a strong positive relation between true market betas and expected returns. Evidence in the long U.S. sample from 1926 to 2014 lends support to the model’s key predictions.

Tick Size: Theory and Evidence
Ingrid Werner, Yuanji Wen, Barbara Rindi, Francesco Consonni, and Sabrina Buti
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We model a public limit order book where rational traders decide whether to demand or supply liquidity, and where liquidity builds endogenously. The model predicts that a reduction of the tick size will cause spreads and welfare to deteriorate for illiquid but improve for liquid books. We find empirical support for these predictions based on European and U.S. data. The model also generates predictions for volume, but we find less empirical support for these predictions which we attribute to opportunistic High-Frequency-Traders selectively entering the market.

A Comparison of New Factor Models
Kewei Hou, Chen Xue and Lu Zhang
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Using hundreds of significant anomalies as testing portfolios, this paper compares the performance of major empirical asset pricing models. The q-factor model and a closely related five-factor model are the two best performing models among a long array of models. The q-factor model outperforms the five-factor model in factor spanning tests and in explaining momentum and profitability anomalies, but the five-factor model has an edge in explaining value-versus-growth anomalies. Investment and profitability, not liquidity, are the key driving forces in the broad cross section of expected stock returns.

Bank Sovereign Bond Holdings, Sovereign Shock Spillovers, and Moral Hazard During the European Crisis
Andrea Beltratti and René M. Stulz
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From 2010 to 2012, the relation between bank stock returns from European Union (EU) countries and the returns on sovereign CDS of peripheral (GIIPS) countries is negative. We use days with tail sovereign CDS returns of peripheral countries to identify the effects of shocks to the cost of borrowing of these countries on EU banks from other countries. A CDS tail return affects banks with greater exposure to the country experiencing that return more, but it has an impact on banks regardless of exposure. Shocks to peripheral countries that are more pervasive impact the returns of banks from countries that experience no shock more than shocks to small individual peripheral countries. In general, the impact of tail returns is asymmetric in that banks suffer less from adverse shocks to peripheral countries than they gain from favourable shocks to such countries.

The U.S. Listing Gap
Craig Doidge, George Andrew Karolyi, René M. Stulz
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Relative to other countries, the U.S. now has abnormally few listed firms. This “U.S. listing gap” is consistent with a decrease in the net benefit of a listing for U.S. firms. Since the listing peak in 1996, the propensity to be listed is lower for all firm size categories and industries, the new list rate is low, and the delist rate is high. The high delist rate accounts for 46% of the listing gap and the low new list rate for 54%. The high delist rate is explained by an unusually high rate of acquisitions of publicly listed firms.

How much for a haircut? Illiquidity, secondary markets, and the value of private equity
Nicolas P.B. Bollen and Berk A. Sensoy
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Limited partners (LPs) of private equity funds commit to invest with extreme levels of illiquidity and significant uncertainty regarding the timing of capital flows. Secondary markets have emerged which alleviate some of the associated cost. This paper develops a subjective valuation model incorporating these institutional features. Model-implied breakeven returns are close to empirically observed average fund returns for moderately risk tolerant LPs with private equity allocations up to 40%. Likewise, optimal portfolio allocations for these LPs are similar to those observed in practice. More risk averse LPs optimally place little, but not zero, weight on private equity.

The Granular Nature of Large Institutional Investors
Itzhak Ben-David, Francesco Franzoni, Rabih Moussawi, and John Sedunov
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Large institutional investors own an increasing share of the equity markets in the U.S. The implications of this development for financial markets are still unclear. The paper presents novel empirical evidence that ownership by large institutions predicts higher volatility and greater noise in stock prices as well as greater fragility in times of crisis. When studying the channel, we find that large institutional investors exhibit traits of granularity, i.e., subunits within a firm display correlated behavior, which reduces diversification of idiosyncratic shocks. Thus, large institutions trade larger volumes and induce greater price impact.

Private Equity Performance: A Survey
Steven N. Kaplan and Berk A. Sensoy
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We survey the literature on private equity performance, focusing on venture capital and buyout funds rather than portfolio companies. We describe recent findings on performance measures, average fund returns, risk adjustments, cyclicality and liquidity, persistence, interim returns and self-reported net asset values, the performance of different types of investors in funds, and the links between management contracts and fund returns. Buyout funds have outperformed the S&P 500 net of fees on average by about 20% over the life of the fund. Venture capital funds raised in the 1990s outperformed the S&P 500 while those raised in the 2000s underperformed. The results are consistent across a number of datasets and papers. Before the 2000s, buyout and venture capital fund performance showed strong evidence of persistence. Since 2000, buyout fund persistence has declined, while venture capital fund persistence has remained equally strong.

Fire Sale Discount: Evidence from the Sale of Minority Equity Stakes
Serdar Dinc, Isil Erel, Rose Liao
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Most of the existing empirical studies estimate the impact of fire sales either without the benefit of market prices from frequent trades, as with aircraft sales, or without observing the prices received by distressed sellers, as with the sales of equity securities by mutual funds facing outflows. We study transactions where the selling firm sells minority equity stakes it holds in publicly-listed third parties. In these transactions, market prices from frequent trades in the shares of those third parties are available and the transaction prices received by the sellers are reported. We estimate the industry-adjusted distressed sale discount based on the four-week window to be about 8% while controlling for the liquidity of the shares sold. This discount magnitude is higher than the 4% estimated for forced sales of stocks by mutual funds without the benefit of observing transaction prices. The discount we estimate becomes 13-14% if the stake sold is more than 5% of the firm or if the stake is sold as a block. Prices recover after the distressed sale.

The Dark Side of Specialization: Evidence from Risk Taking by CDO Collateral Managers
Sergey Chernenko
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I study the incentives of the collateral managers who selected securities for ABS CDOs-securitizations that figured prominently in the financial crisis. Specialized managers without other businesses that could suffer negative reputational consequences invested in low quality securities underwritten by the CDO's arranger. These securities perform significantly worse than observationally similar securities. Managers investing in these securities were rewarded with additional collateral management assignments. Diversified managers that did assemble CDOs suffered negative reputational consequences during the crisis: institutional investors withdrew from their mutual funds. Overall, the results are consistent with a quid pro quo between collateral managers and CDO underwriters.

Management Risk and the Cost of Borrowing
Yihui Pan, Tracy Yue Wang, and Michael S. Weisbach
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Management risk occurs because uncertainty about future managerial decisions increases a firm’s overall risk. This paper documents the importance of management risk in determining firms’ cost of borrowing. CDS spreads, loan spreads and bond yield spreads all increase at the time of CEO turnover, when management risk is highest, and decline over the first three years of CEO tenure, regardless of the reason for the turnover. Similar but smaller patterns occur around CFO turnovers. The increase in the CDS spread at the time of the CEO departure announcement, the change in the spread when the incoming CEO takes office, as well as the sensitivity of the spread to the new CEO’s tenure, all depend on the amount of prior uncertainty about the new management. In response to these short-term increases in borrowing costs early in their CEOs’ tenure, firms adjust their propensities to issue external debt, precautionary cash holding, and reliance on internal funds. All of these results suggest that management risk appears to be an important factor in the pricing of corporate debt.

Bank Capital Requirements: A Quantitative Analysis
Thien T. Nguyen
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This paper examines the welfare implications of bank capital requirements in a general equilibrium model in which a dynamic banking sector endogenously determines aggregate growth. Due to government bailouts, banks engage in risk-shifting, thereby depressing investment efficiency; furthermore, they over-lever, causing fragility in the financial sector. Capital regulation can address these distortions and has a first-order effect on both growth and welfare. In the model, the optimal level of minimum Tier 1 capital requirement is 8%, greater than that prescribed by both Basel II and III. Increasing bank capital requirements can produce welfare gains greater than 1% of lifetime consumption.

The Nominal Price Premium
Justin Birru and Baolian Wang
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Motivated by the evidence that investors tend to be overly optimistic about low-priced stocks, we examine how nominal price affects the cross section of stock returns. To circumvent the mechanical inverse relationship between price and expected return, we construct a novel way of examining the effect of nominal price on the cross section of stock returns. In the cross-section, a portfolio exploiting this strategy generates a value-weighted (equal-weighted) four-factor alpha of 85 (88) basis points per month. Consistent with a mispricing-based explanation, the results are stronger for hard-to-arbitrage stocks and following high sentiment periods, and strategy returns are highly correlated with contemporaneous changes in sentiment. Evidence from earnings surprises and analyst price target forecasts confirms that beliefs are overly optimistic for low-priced stocks. Providing further evidence that the results reflect a belief-based rather than purely a preference-based channel, we find that the effect is distinct from other gambling related proxies that have been used in the past such as extreme returns, idiosyncratic volatility, and skewness.

Banks’ Internal Capital Markets and Deposit Rates
Itzhak Ben-David, Ajay Palvia, and Chester Spatt
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A common view is that deposit rates are determined primarily by supply: depositors require higher deposit rates from risky banks, thereby creating market discipline. An alternative perspective is that market discipline is limited (e.g., due to deposit insurance and/or enhanced capital regulation) and that internal demand for funding by banks determines rates. Using branch-level deposit rate data, we find little evidence for market discipline as rates are similar across bank capitalization levels. In contrast, banks’ loan growth has a causal effect on deposit rates: e.g., branches’ deposit rates are correlated with loan growth in other states in which their bank has some presence, suggesting internal capital markets help reallocate the bank's funding.

The Elephant in the Room: The Impact of Labor Obligations on Credit Markets
Jack Favilukis, Xiaoji Lin, and Xiaofei Zhao
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We show that labor market frictions are first-order for understanding credit markets. Wage growth and labor share forecast aggregate credit spreads and debt growth as well as or better than alternative predictors. They also predict credit risk and debt growth in a cross-section of international firms. Finally, high labor share firms choose lower financial leverage. A model with labor market frictions and risky long-term debt can explain these findings, and produce large credit spreads despite realistically low default probabilities. This is because pre-committed payments to labor make other committed payments (i.e. interest) riskier.

Prices and Volatilities in the Corporate Bond Market
Jack Bao, Jia Chen, Kewei Hou, and Lei Lu
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We document a strong positive cross-sectional relation between corporate bond yield spreads and bond return volatilities. As corporate bond prices are generally attributable to both credit risk and illiquidity as discussed in Huang and Huang (2012), we apply a decomposition methodology to quantify the relative contributions of credit and illiquidity. Overall, our credit and illiquidity proxies can explain almost three quarters of the yield spread-bond volatility relation with credit and illiquidity contributing in a 70:30 ratio. Furthermore, we find that the credit portion of the yield spread-bond volatility relation is important even after controlling for equity volatility. The relation between yield spreads and volatilities is robust to different sample periods, including the financial crisis. We also find the ratio to be smaller for the investment-grade sub-sample, consistent with credit risk being relatively more important for understanding the yield spread-volatility relation in speculative-grade bonds.

The Investment CAPM
Lu Zhang
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A new class of Capital Asset Pricing Models arises from the first principle of real investment for individual firms. Conceptually as “causal” as the consumption CAPM, yet empirically more tractable, the investment CAPM emerges as a leading asset pricing paradigm. Firms do a good job in aligning investment policies with costs of capital, and this alignment drives many empirical patterns that are anomalous in the consumption CAPM. Most important, integrating the anomalies literature in finance and accounting with neoclassical economics, the investment CAPM succeeds in mounting an efficient markets counterrevolution to behavioral finance in the past 15 years.