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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.
Out of Sight No More? The Effect of Fee Disclosures on 401(k) Investment Allocations (with Veronika K. Pool, Clemens Sialm, and Irina Stefanescu)
Journal of Financial Economics, forthcoming
NBER Working Paper No. w27573
Awards: FMA Best paper on Investments (2019)
We examine the effects of a 2012 regulatory reform that mandated fee and performance disclosures for the investment options in 401(k) plans. We show that participants became significantly more attentive to expense ratios and short-term performance after the reform. The disclosure effects are stronger among plans with large average contributions per participant and weaker for plans with many investment options. Additionally, these results are not driven by secular changes in investor behavior or sponsor-initiated changes to the investment menus. Our findings suggest that providing salient fee and performance information can mitigate participants’ inertia in retirement plans.
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, scheduled), 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:
Do Short-term Incentives Hurt Innovation? [with Heitor Almeida, Vyacheslav Fos, Po-Hsuan Hsu, and Kevin Tseng] NEW!
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.
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 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, scheduled), 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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