How smart is smart money? Evidence from mutual funds’ Exposure on corporate misconduct
Dongmin Kong, Zhao Zhao

We examine how mutual funds’ trading and performance respond to corporate misconduct. We exploit a combined dataset of corporate misconduct and holding information of mutual funds and find that mutual funds tend to not only sell but also buy more stocks of corporations with misconduct. Moreover, the exposure to misconduct stocks is negatively related to mutual funds’ future performance. The top quintile portfolio of funds with the highest level of misconduct exposure underperforms the bottom quintile by 1.57% to 1.97% on an annualized basis. This performance gap is wider when it is easier for fund managers to gain information advantages.
View full article here

Understanding the cross-section of CDS returns using equity options
Diep Duong, Sunjin Park

We examine the cross-section of credit default swap (CDS) returns by forming CDS portfolios based on the implied volatility curves of equity options. We document that CDS protection sellers earn higher average returns for: (1) firms with higher at-the-money implied volatility and (2) firms with steeper volatility skew when conditioning on high implied volatility. We find that, relative to bond returns, CDS returns are better explained by our proposed measures interacted with standard credit determinants. Our reasoning is that the large degree of informed trading in the CDS market makes it more in sync with the equity options market, which is also known to attract informed traders.
View full article here

The pervasiveness of matching rights in merger agreements: Impact on shareholder wealth
Sridhar Gogineni, John Puthenpurackal

Matching rights provisions have become ubiquitous in merger agreements in recent years prompting calls for an evaluation of their usage. Using a sample of 2,640 M&A agreements announced between 2003 and 2018, we conduct the first comprehensive analysis of the impact of matching rights provisions on initial and final target premiums, controlling for other merger provisions, deal and firm characteristics. We do not find evidence to suggest that the indiscriminate usage of matching rights in the 2011–2018 period has been detrimental to target shareholders. Moreover, for the 2003–2010 period, we find a positive association between matching rights and target premiums. We also find a positive or non-negative impact on target premiums for different subsamples of potential concern based on selling method, bidder type, termination fee size, and information asymmetry. Finally, we do not find evidence that matching rights deter competing bids. Overall, the usage of matching rights appears consistent with efficient contracting, assuaging concerns raised by Restrepo and Subramanian (2017).
View full article here

The efficacy of market timing and value creation
Chunhua Lan

In this article, I use a total timing measure that differentiates between cash-flow timing and discount-rate timing to assess value creation among actively managed US equity mutual funds. My findings indicate that some funds exhibit cash-flow timing skills. Collectively, the top 20% of timing funds generate $3.4 billion annually in constant January 2000 dollars. Both sector rotation and individual stock selection contribute to executing timing techniques. Skilled timing funds shift their stockholdings toward cyclical sectors when anticipating positive changes in aggregate cash flows and toward defensive sectors when anticipating negative changes. Sector funds demonstrate similar cash-flow timing skills through their individual stock bets.
View full article here

Unintended consequences of discrimination litigation caps
Spencer Barnes

On July 14, 1992, the U.S. Equal Employment Opportunity Commission (EEOC) implemented a policy that caps punitive damage payouts from discrimination litigation at different employee counts allowing for a “difference-in-discontinuities” design. I find that these kink points incentivize firms to restrict their number of employees, which reduces their maximum discrimination litigation exposure to between 40% and 60% of their yearly median revenues. In turn, firm growth decreases for firms below these EEOC thresholds after the implementation of the policy. These firms reduce financing and are not motivated to decrease growth by relative changes in cash flows from discrimination risk exposure.
View full article here

The effects of bank mergers on listed U.S. borrowers
Shuangshuang Ji, David C. Mauer, Yilei Zhang

We examine the effects of U.S. bank mergers on listed U.S. borrowers. Target bank borrowers receive lower loan spreads and no change in loan amount post-merger in comparison to pre-merger. In contrast, acquiring bank borrowers receive an increase in loan amount and a relatively small decrease in loan spread in the post-merger period. Analysis shows that these benefits are available only when borrowers have bargaining power through lending relationships with non-merging banks. We examine how borrower size, merger type, bank size, and borrower relationship intensity affect our results. Overall, our analysis suggests that efficiency gains from bank consolidation outweigh market power effects.
View full article here

Debt financing, the pandemic, and federal reserve interventions
Grace E. Arnold, Takeshi Nishikawa, Meredith E. Rhodes

Using data on newly issued corporate bonds and syndicated loans, we investigate the effects of the Federal Reserve’s interventions during the pandemic on corporate debt activity. We document heterogeneous effects for participation rates across firm credit ratings and debt maturity, consistent with a default risk channel of policy transmission. Investment-grade firms disproportionately participate in debt markets following the Fed’s announcements, which is driven by the riskiest firms (A and BBB ratings). We also find that BBB and BB-rated firms drive increased participation in short-term debt markets. These results provide evidence that the Fed’s interventions improved credit market access to investment-grade firms and the highest-rated noninvestment-grade firms.
View full article here

Dividend mispricing: Evidence from all-stock merger deals
Kerron Joseph, Palani-Rajan Kadapakkam

Stock prices of targets in all-stock merger deals should reflect acquirer share values, net of expected dividend payments before deal completion. This setting provides a unique opportunity to examine whether market prices of target stocks reflect the price reducing impact of impending acquirer dividends. We find evidence that target stock returns on the acquirer ex-day are negatively related to the size of the dividend payments, indicating an incomplete adjustment on the last cum-day. However, given the size of typical quarterly dividends, the magnitude of the estimated 30% incomplete adjustment to the dividend does not represent a viable arbitrage opportunity. Examining a longer window, we find that roughly 70% of the acquirer dividend is incorporated into the target stock price in the period two days after the dividend announcement to the ex-day. Overall, our results are consistent with target stock prices adjusting slowly over time to reflect impending acquirer dividends.
View full article here

Commodity tail risk and equity risk premia
Zhenyu Lu, Ying Jiang, Xiaoquan Liu

We explore the asset pricing implication of the commodity tail risk, constructed by aggregating individual commodity’s exposure to left-tail realizations of systematic risks, in cross-sectional stock returns. Using Chinese data from 2005 to 2022, we find that the risk-adjusted return differential between extreme portfolios is highly significant at 1.39% per month. The economic rationale is that a high level of commodity tail risk signals adverse economic conditions, and stocks that hedge the tail risk offer a low premium. Our findings highlight the informational role of commodity futures prices and the link between commodity and equity markets in China.
View full article here

Do dividends and share repurchases convey information about financial strength? An exploration of the disparities between banks and industrial firms
Yi Zheng, S. Drew Peabody, Jinglin Jiang

Differing from prior literature, this article suggests dividends are positively associated with financial strength for both financial institutions (i.e., banks) and non-financial firms (i.e., industrials), and that this relationship is much more pronounced for banks. We also find that the signaling impacts of dividend changes on financial strength are asymmetric for these two groups as a decrease (increase) in dividends is more powerful than an increase (decrease) for banks (industrials). This suggests that dividend cuts send a more significant negative signal of bank financial strength than similar decreases by industrial firms, and that dividend increases say more about industrials’ improvements in financial strength than those by banks. Similar to dividends, share repurchases are indications of financial strength for industrials but not for banks. This suggests that share repurchases serve more as a buffer (substitute) of dividends for banks (industrials).
View full article here

Variance of deviation from optimal leverage
Mustafa O. Caglayan, Diogo Duarte, Xiaomeng Lu

We show that deviations from the firm’s target leverage are priced in the cross-section of stock returns and that the relation between these quantities is nonlinear. The concave nonlinear relation between deviation from the target leverage and next-period return is strong during economic expansions and vanishes during recessions. Our portfolio analysis provides support for the concave relation between deviation from the target leverage and next-period returns as well. We develop a factor named variance of deviation from optimal leverage (VDOL) and show that it is an important risk factor that has been omitted in the literature.
View full article here

Selection effects in the births of mutual funds
André de Souza

Newborn funds disproportionately hold popular stocks, representing long-lived strategic choices. This suggests that when choosing strategies in which to launch new funds, families do not consider only expectations for their own performance but also consider investor sentiment toward those strategies. The two motives for entry result in an interaction effect between competitive entry and strategy popularity, which affects performance and flows for both existing and newborn funds. Newborn funds’ expectations for performance are partly driven by fund manager skill in those strategies, but this is not the only factor, leaving a role for time-varying investment opportunities.
View full article here

Lending discrimination and the role of community banks
Arthur M. Tran, Drew B. Winters

First-time minority borrowers often receive less desirable outcomes than first-time White borrowers. Relationship lenders, who use both hard information and soft (community) information about new borrowers, can gain insights into a borrower’s creditworthiness even without an existing bank–borrower relationship and provide more loan opportunities for new minority borrowers than transactional lenders. Our results show that borrowing from a relationship lender reduces lending outcome discrepancies between new minority borrowers and new White borrowers, not only in loan acceptance rates but also in borrower perceptions. These results suggest that borrowers’ soft information is an important part of relationship lenders’ decision-making process.
View full article here

‘And forgive us our debts’: Do Christian moralities influence over-indebtedness?
Iftekhar Hasan, Felix Noth, Konstantin Kiesel

This paper analyzes whether Christian moralities and rules formed differently by Catholics and Protestants impact the likelihood of households becoming over-indebted. We find that over-indebtedness is lower in regions in which Catholics outweigh Protestants, indicating that Catholics’ forgiveness culture and stricter enforcement of rules by Protestants serve as explanations for our results. Our results provide evidence that religion affects the financial situations of individuals and show that even 500 years after the split between Catholics and Protestants, the differences in the mindsets of both denominations play an important role in situations of severe financial conditions.
View full article here

Local labor match and corporate investments: Evidence from new flight routes
Nasim Sabah, Linh Thompson

We exploit new flight connections from small cities to international airports as a quasi-natural experiment to study the effects of local labor match on corporate investments. Using a cosine similarity of occupational makeups, we find that corporate investment rates are higher for firms with human capital profiles that are more similar to those of the local labor. The effects are more pronounced among financially constrained firms and less evident among firms with higher unionization membership and coverage. Firms with better local labor match are also more likely to downsize their employments when experiencing negative cash flow shocks. Collectively, our findings suggest that local labor match spurs corporate investments by lowering labor costs and increasing ex-ante investment incentives.
View full article here

Deposit flows and the January effect in deposit rates
Vladimir Kotomin, Artem Meshcheryakov

Noninterest-bearing deposits (NIBDs) flow out of U.S. banks in January and February. Banks respond to this seasonal outflow by increasing interest-bearing deposit (IBD) rates. We document that branch-level deposit spreads are 4 to 11 basis points higher in January than in December. Increasing rates works as banks replace four-fifths of the lost NIBDs with IBDs. We also find that, following NIBD outflows, banks resist cutting lending but pass the increases in the cost of funds onto borrowers. Banks do cut lending in response to total deposit outflows, but only in the pre-crisis period.
View full article here