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3) 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.
4) 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.
Papers Under Revision:
Sitting Bucks: Zero Returns and Stale Pricing in Fixed Income Funds (with Jaewon Choi and Jimmy Ji Yeol Oh)
Revise & Resubmit, Journal of Financial Economics
Awards: AIM Investment Conference Distinguished Paper Award (2019); FMA Best paper on Investments semifinalist (2019)
[Conferences: WFA (2020), EFA (2020), SEC Financial Regulation conference (2020), AIM Investment Conference (2019), World Symposium on Investment Research (2019), Kentucky Finance Conference (2019), Univ of Connecticut Finance Conference (2019), European Winter Finance Summit (2019), MFA (2019), FMA (2019), CAFM (2018)]
Zero returns are widely prevalent among fixed-income funds: on over 30% of trading days, net asset values (NAVs) do not change. We show that this high prevalence of zero returns is a symptom of stale pricing by funds that exercise valuation discretion over illiquid security holdings. Further evidence indicates that a strategic unwillingness of funds to immediately reflect losses also drives stale pricing. Because of stale NAVs, fund returns are predictable at daily, weekly, and even monthly horizons. Opportunistic traders withdraw capital from overvalued funds, exacerbating the risk of fund runs, while buy-and-hold investors face annual dilution costs of around $3 billion. Our results highlight adverse consequences from insufficient fair-valuation practices that persist even after corrective regulations that followed the 2003 market-timing scandal.
Current Working Papers:
The Role of Assets in Place: Loss of Market Exclusivity and Investment [with Matt Higgins, Ji Min Park, and Joshua Pollet] NEW!
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, scheduled)]
We study how incentives to boost short-term performance affect longer-term innovation output. Share repurchases that are motivated by an incentive to meet current-quarter EPS targets are associated with an increase in the quality of innovation outputs such as forward citation counts and the economic value of patents. These results appear to be driven by a shift in firms’ innovation strategy. Firms are more likely to explore newer technologies and to increase the scope of innovative activities following EPS-driven repurchases. Our evidence points out to a bright side of short-termist pressures, which can nudge firms towards more creative and impactful innovation.
Do Firms Save Too Much Cash? Evidence from a Tax on Corporate Savings (with Hwanki Brian Kim and Woojin Kim)
[Conferences: SFS Cavalcade (2020), MFA (2020), NFA (2020), BYU Red Rock (2019), ESSFM Gerzensee (2019), FMA (2019), Korea Securities Association (2019)]
We study whether corporate cash holdings are optimal or excessive by exploiting a Korean tax reform that imposes a new tax on earnings not paid out to shareholders or reinvested. Firms treated by the reform reduce cash savings, and market participants react favorably. Increases in value are concentrated among firms subject to memories from the 1997 Asian financial crisis and among well-governed firms, and these firms spend more on payouts. By contrast, no value increases are observed among poorly governed firms, and these firms instead spend more on investments. Overall, our results are consistent with excessive savings before the reform.
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: 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 incentives to increase earnings-per-share cause firm to increase stock repurchases and reduce investment and employment. It is natural to expect firms to cut less productive investment and employment first, which could lead to a positive effect on firm-level productivity. However, using Census data, we find that firms make cuts across the board irrespective of plant productivity. This pattern seems to be associated with frictions in the labor market. Specifically, we find evidence that unionization of the labor force may prevent firms from doing efficient downsizing, forcing them to engage in easy or expedient downsizing instead. As a result of this inefficient downsizing, firms experience deterioration in long-term productivity. Our findings show that allocating more power to a stakeholder could enhance corporate short-termism.
Older Working Papers:
The Market Reaction to Stock Split Announcements: Earnings Information After All (with Alon Kalay)
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