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3) Do Bond Issuers Shop for Favorable Credit Ratings?
Management Science, 2020
[SSRN working paper version]
This paper provides evidence of ratings shopping in the corporate bond market. By estimating systematic differences in agencies’ biases about any given firm’s bonds, I show that new bonds are more likely to be rated by agencies that are positively biased towards the firm—a pattern that is strongest among bonds that have only one rating. The paper also shows that issuers often delay less favorable ratings until after a bond is sold. Consistent with theoretical models of ratings shopping, these effects are strongest among more complex bonds that are more difficult to rate. Bonds with upward-biased ratings are more likely to be downgraded and default, but investors account for this bias and demand higher yields when buying these bonds.
4) Reaching for Yield by Corporate Bond Mutual Funds
(with Jaewon Choi)
Review of Financial Studies, 2018
[SSRN working paper version]
We examine “reaching for yield” in U.S. corporate bond mutual funds. We define reaching for yield as tilting portfolios toward bonds with yields higher than the benchmarks. We find that funds generate higher returns and attract more inflows when they reach for yield, especially in periods of low interest rates. Returns for high reaching-for-yield funds nevertheless tend to be negative on a risk-adjusted basis. Funds engage in rank-chasing behavior by reaching for yield, although these incentives are moderated by the illiquid nature of corporate bonds. High reaching-for-yield funds hold less cash and less liquid bonds, exacerbating redemption risks.
5) The Real Effects of Share Repurchases
(with Heitor Almeida and Vyacheslav Fos)
Journal of Financial Economics, 2016
[SSRN working paper version]
We employ a regression discontinuity design to identify the real effects of share repurchases on other firm outcomes. The probability of share repurchases that increase earnings per share (EPS) is sharply higher for firms that would have just missed the EPS forecast in the absence of the repurchase, when compared with firms that “just beat” the EPS forecast. We use this discontinuity to show that EPS-motivated repurchases are associated with reductions in employment and investment, and a decrease in cash holdings. Our evidence suggests that managers are willing to trade off investments and employment for stock repurchases that allow them to meet analyst EPS forecasts.
Current Working Papers:
Do Corporations Retain Too Much Cash? Evidence from a Natural Experiment (with Hwanki Brian Kim and Woojin Kim)
Revise & Resubmit, Review of Financial Studies
[Conferences: SFS Cavalcade (2020), MFA (2020), NFA (2020), BYU Red Rock (2019), ESSFM Gerzensee (2019), FMA (2019), Korea Securities Association (2019)]
Corporations have accumulated record amounts of cash. We study whether firms’ cash retention has been excessive by exploiting a Korean reform that introduced a new tax on earnings retained as cash. Difference-in-differences tests show that treated firms reduce cash retention and instead increase payouts and investments. Market participants react favorably to the reform, consistent with excessive cash retention. The valuation effects and the alternative uses of the cash are associated with behavioral and agency frictions. Firms affected by behavioral biases increase payouts, resulting in relatively higher valuations, while poorly governed firms allocate more to investment and experience relatively lower valuations.
The Role of Assets in Place: Loss of Market Exclusivity and Investment [with Matt Higgins, Ji Min Park, and Joshua Pollet]
[Conferences: WFA (2021)]
NBER Working Paper No. w27588
We utilize a novel identification strategy to analyze the impact of assets in place on firms’ decisions for future projects. We exploit the context in the pharmaceutical industry, where the loss of market exclusivity for a branded drug can be used to separate the impact of cash flows generated by a firm’s current assets in place from the characteristics of its future investment opportunities. We first show that around the exclusivity losses in our sample of large drugs, the affected firms’ profitability drops significantly. The timing of this profitability decrease was predetermined many years ago, and therefore, arguably independent of current investment opportunities. Nevertheless, we find that R&D spending drops by approximately 25% over two years following the loss of exclusivity of these pre-existing drugs. We also find that stock repurchases and cash balances decline significantly. Our findings do not support the predictions of traditional capital budgeting, but are more consistent with the pecking order theory. These results further point to a lack of long-term lifecycle management that could mitigate the effect of predictable negative shocks to cash flows.
Do Short-term Incentives Hurt Innovation? [with Heitor Almeida, Vyacheslav Fos, Po-Hsuan Hsu, and Kevin Tseng]
[Conferences: FIRS (2021), CICF (2021) ]
We study how incentives to boost short-term performance affect longer-term innovation outputs. We find evidence that short-term pressures to raise earnings per share using buybacks have positive effects on firms’ innovative efficiency, owing to improved allocation of resources and greater focus on novel innovation. These effects manifest as increases in the quality of future innovation outputs, measured as forward citations and the economic value of patents, but only for firms that are relatively better at producing new innovation ex-ante. Our findings illustrate that not all actions that appear short-termist have adverse long-term consequences but instead can have a bright side.
Does Equity-based Compensation Cause Firms to Manage Earnings Per Share? (with Xing Gao)
Awards: NFA 2018 Best Paper on Derivatives
[Conferences: WFA (2019), FMA (2018), NFA (2018)]
Equity-based compensation causes increases in firms’ share count and dilutes Earnings Per Share (EPS), which provides firms with an incentive to raise EPS using either share buybacks or earnings management. We employ a regression discontinuity framework to provide evidence of a causal link between equity-based pay and EPS management. Our tests compare firms experiencing dilution from “just-in-the-money” option exercises with firms whose options end up narrowly out-of-the-money. We find that firms engage in real- and accruals-based earnings management, but not buybacks, to boost EPS around these plausibly exogenous dilutive events. These effects are stronger when executives’ bonuses depend directly on EPS.
Does Shareholder Scrutiny Affect Executive Compensation? Evidence from Say-on-Pay Voting (with Shastri Sandy)
Featured on the Harvard Law School Forum on Corporate Governance
[Conferences: SFS Cavalcade (2016), Young Scholars Finance Conference (2015), European Finance Association (2015), Paris December Finance Conference (2015), Northern Finance Association (2015), Financial Management Association (2014), Mid-Atlantic Research Conference (2014)]
We study whether shareholder scrutiny affects CEO pay. Our identification strategy exploits the fact that recent “say-on-pay” regulation allowed firms to hold votes every two or three years. Depending on their voting frequency, firms experience alternating years where scrutiny on compensation varies following a plausibly exogenous cyclical pattern. In vote-years, firms reduce salaries and golden parachutes, but compensate for these cuts by increasing less-scrutinized compensation such as pensions. Total pay is similar across vote and no-vote years, and pay-for-performance is not stronger in vote years. These results are most consistent with greater window-dressing of compensation in times when firms are subject to heightened shareholder scrutiny.
Do Short-Term Incentives Affect Long-Term Productivity? [with Heitor Almeida, Nuri Ersahin, Vyacheslav Fos, and Rustom M. Irani]
[Conferences: AFA (2022), EFA (2020), SFS Cavalcade (2020), Finance Organizations and Markets [FOM] Research Group (2019)]
ECGI Working Paper No. 662/2020, CEPR Discussion Paper DP13894
Previous research shows that short-term incentives lead the firm to increase stock buybacks, reducing investments in capital and employment. It is natural to expect that such firms will cut their less productive projects first, with little or even a positive effect on firm-level productivity. Yet, using detailed plant-level Census data, we find that firms make cuts across the board irrespective of each plant’s productivity in response to short-term incentives. Unionization of the labor force drives these results by preventing firms from doing efficient downsizing, suggesting that stakeholders can amplify negative consequences of corporate short-termism.
Older Working Papers:
The Market Reaction to Stock Split Announcements: Earnings Information After All (with Alon Kalay)
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