Forthcoming Articles

The Effect of Credit Competition on Banks’ Loan Loss Provisions

Yiwei Dou, Stephen G. Ryan, and Youli Zou

Exploiting differential interstate branching deregulation across contiguous counties of adjacent states, we investigate the effect of entry threat on incumbent banks’ loan loss provisions. Incumbents exposed to entry threat have offsetting incentives; lower provisions make their loan underwriting quality appear better, deterring entry, while local economic conditions appear better, encouraging entry. We find that the incentive to increase apparent loan underwriting quality dominates on average. We further find that this incentive is stronger in counties with a higher proportion of heterogeneous loans, and that the other incentive dominates in counties with both few heterogeneous loans and highly volatile economic conditions.

Managerial Risk-Taking Incentives and Merger Decisions

Chen Lin, Micah S. Officer, and Beibei Shen

We provide evidence concerning the effect of managerial risk-taking incentives on merger and acquisition (M&A) decisions and outcomes for different types of mergers: vertical, horizontal, and diversifying. Using chief executive officer (CEO) relative inside leverage to proxy for the incentives of risk-averse managers, we find that CEOs with higher inside leverage are more likely to engage in vertical mergers, and those mergers generate lower announcement returns for shareholders. This effect of CEO relative inside leverage on returns for shareholders in vertical acquisitions is more pronounced when the acquirer has a higher degree of informational opacity, weak governance, and excess cash.

Corporate Resilience to Banking Crises: The Roles of Trust and Trade Credit

Ross Levine, Chen Lin, and Wensi Xie     

Are firms more resilient to systemic banking crises in economies with higher levels of social trust? Using firm-level data in 34 countries from 1990 through 2011, we find that liquidity-dependent firms in high-trust countries obtain more trade credit and suffer smaller drops in profits and employment during banking crises than similar firms in low-trust economies. The results are consistent with the view that when banking crises block the normal banking-lending channel, greater social trust facilitates access to informal finance, cushioning the effects of these crises on corporate profits and employment.

Firm Default Prediction: A Bayesian Model Averaging Approach

Jeffrey Traczynski

I develop a new predictive approach using Bayesian model averaging to account for incomplete knowledge of the true model behind corporate default and bankruptcy filing. I find that uncertainty over the correct model is empirically large, with far fewer variables significant predictors of default compared to conventional approaches. Only the ratio of total liabilities to total assets and the volatility of market returns are robust default predictors in the overall sample and individual industry groups. Model averaged forecasts that aggregate information across models or allow for industry-specific effects substantially outperform individual models.

Market Sentiment and Innovation Activities

Tri Vi Dang and Zhaoxia Xu

We investigate potential mechanisms through which market-wide sentiment affects firms’ innovation activities. We provide evidence for the financing channel by showing that financially constrained firms are more likely to issue equity and invest more in research and development (R&D) than financially unconstrained firms at high market sentiment. Using time-varying manager sentiment measures, we find suggestive evidence for a sentiment spillover channel whereby market sentiment affects R&D investments through influencing manager sentiment. Furthermore, better patent portfolios are produced from R&D investments stimulated by high market sentiment. Market sentiment has a stronger impact on R&D than capital expenditures of financially constrained firms.

Short-Term Interest Rates and Stock Market Anomalies

Paulo Maio and Pedro Santa-Clara

We present a simple two-factor model that helps explaining several CAPM anomalies (value premium, return reversal, equity duration, asset growth, and inventory growth). The model is consistent with Merton’s ICAPM framework and the key risk factor is the innovation on a short-term interest rate: the Fed funds rate or the T-bill rate. This model explains a large fraction of the dispersion in average returns of the joint market anomalies. Moreover, the model compares favorably with alternative multifactor models widely used in the literature. Hence, short-term interest rates seem to be relevant for explaining several dimensions of cross-sectional equity risk premia.

Does the Political Power of Nonfinancial Stakeholders Affect Firm Values? Evidence from Labor Unions

Jared Stanfield and Robert Tumarkin     

While corporate political connections are known to enhance equity values, we demonstrate that union political activity can have the opposite effect. We examine the consequences of a recent Australian state law that restricts union political activity, but does not change collective bargaining rights. In the wake of this law, the equity values of affected unionized firms significantly increase and, consistent with this market reaction, these firms are able to bargain for more favorable labor contracts than their unionized peers in other states. The evidence strongly suggests that unions use political activism to extract rents from shareholders and benefit their members.

Time-Varying Beta and the Value Premium

Hui Guo, Chaojiang Wu, and Yan Yu

We model conditional market beta and alpha as flexible functions of state variables identified via a formal variable selection procedure. In the post-1963 sample, beta of the value premium comoves strongly with unemployment, inflation, and price-earnings ratio in a countercyclical manner. We also uncover a novel nonlinear dependence of alpha on business conditions: It falls sharply and even becomes negative during severe economic downturns but is positive and flat otherwise. The conditional CAPM performs better than the unconditional CAPM but this does not fully explain the value premium. Our findings are consistent with a conditional CAPM with rare disasters.

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