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Empirical Essays in Corporate Finance
(2005-04-20) Minnick, Kristina Leigh; Senbet, Lemma; Prabhala, Nagpurnanand; Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
Over the past twenty years, write-offs have grown in popularity. With the increased usage of write-offs, it is becoming more important to understand the mechanisms behind why companies take write-offs and how write-offs affect company performance. In this paper, I examine the cross-sectional determinants of the decision to take write-offs. I use a hand-collected dataset on write-offs that is much more comprehensive than existing write-off datasets. Contrary to much hype and scandals surrounding a few write-offs, I find that quality of governance is positively related to write-off decisions in the cross-section. My results also suggest that poor governance companies wait to take write-offs until it becomes inevitable, while well-monitored companies take write-offs sooner. As a result, the charge is substantially larger than the average write-off charge. When these poor governance companies announce write-offs, the announcement generates negative abnormal returns. However, when good corporate governance companies announce write-offs, the charge is substantially smaller than the average charge. These well-monitored companies take write-offs immediately following a problem. Following the write-off announcements of these types of companies, average announcement day effects exceed a positive six percent. These results suggest that companies with quality monitoring mechanisms use write-offs in a manner that is consistent with enhancing shareholder value. In my second essay I examine the effect of write-off announcements on the stock market liquidity of firms taking write-offs from 1980 to 2000. I find that there are substantial improvements in stock market liquidity following corporate write-offs. Spreads decrease and turnover volume increases after write-off announcements, which indicates an improvement in liquidity. The liquidity improvement is greater for better governed companies. I decompose bid-ask spreads and show that adverse selection costs decrease substantially as market participants respond to the write-off announcement. The evidence suggests a liquidity benefit of write-offs that must be weighed against any other perceived cost of write-offs. Such a liquidity benefit may validate that write-offs convey favorable information about the firm.
Essays in Corporate Finance
(2017) Hu, Xiaoyuan; Maksimovic, Vojislav; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation presents two essays about corporate finance, product market, and corporate governance. The first essay shows that, depending on product market structure, firms adjust executive compensation differently in response to shocks to firm risk. Using a natural experiment that increases firm risk due to discoveries of carcinogens, I find that treated firms increase CEO risk-taking incentives to mitigate underinvestment. This result is mainly driven by treated firms in less affected industries, which suggests that firms respond to shocks more strongly when fewer rivals face the same shock, and extends existing work on executive compensation adjustments based on industry-level analyses. The second essay provides evidence that the effect of product market competition on corporate performance depends on the overlap in customer base. Competition between firms supplying to a same customer mitigates the decline in firms' operating performance after the passage of a business combination law. This finding is more evident when the common customer is the only major customer or when firms produce specific inputs. In addition, competition between firms supplying to different customers has little effect on firm performance. These results highlight the impact of the structure of production cluster, defined as a group of same-industry firms that supply to a same customer, on corporate outcomes.
Essays in Corporate Finance
(2017) Duquerroy, Anne Nicole; Faulkender, Michael W; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation presents two essays in Corporate Finance. In the first essay, I study how political institutions affect corporate investment through the policy uncertainty channel. I examine investment response to changes in the ability of the governing party to implement its political agenda due to checks and balances. I use US gubernatorial elections from 1978 to 2010 and a regression discontinuity design to estimate the causal effects of giving a single party full versus split control over a state government. I find that shifts from a divided to a unified government depress investment and job creation. Investment drops by an average of 3 to 5 percent in the year after the election giving a single party control of the government. The effect is not limited to public firms, is stronger for firms operating in a single state and firms with more irreversible investment. The findings support the hypothesis that moving from divided to unified government translates into policy uncertainty, which in turn affects the investment and employment cycles. The second essay is joint with William Mullins and Christophe Cahn. How to support private lending to SMEs during aggregate contractions is a crucial but still open policy question. This paper exploits an unexpected drop in 2012 in the cost of funding bank loans to some firms but not others in France to uncover how banks adjust their SME lending portfolios in a crisis. The cost reduction causes bank debt to rise and payment defaults with suppliers to fall, providing evidence that funding cost can be an effective policy lever. The effect is driven by firms with only one bank relationship, a numerous but understudied group. The size of the effect varies, with additional credit flowing to firms with stronger observables, to high growth firms, to firms with high demand, and to firms with a deeper banking relationship. Further, a richer relationship appears to substitute for stronger observables in the lending decision. Finally, we provide suggestive evidence that, compared to multi-bank firms, single bank firms are particularly credit constrained in crisis periods.
Essays in Corporate Finance
(2016) Starkweather, George Austin; Maksimovic, Vojislav; Faulkender, Michael; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
Prior research has been divided regarding how firms respond to bankruptcy risk, largely revolving around two competing forces. On the one hand, asset substitution encourages firms to increase the riskiness of assets to extract value from creditors. On the other, firms want to minimize bankruptcy risk, either by reducing cash flow risk or through increasing the size of the firm. I test these two theories using a natural experiment of chemicals used in production processes being newly identified as carcinogenic to explore how firms may respond to potential negative cash flow resulting from litigation risk. I use plantlevel chemical data to study firm exposure to risk. I examine how responses between firms of differing levels of chemical exposure may vary within the industry, how firm financial distress affects firm response and whether public and private firms respond differently. In general, my research provides support for the asset substitution theory. My first paper studies how investment response varies based on level of carcinogenic exposure. I find that firms with moderate levels of exposure make efforts to mitigate their cash flow risk and reduce their exposure. At the same time, firms with high levels of exposure increase their exposure and riskiness of future cash flows. These findings are consistent with asset substitution theory. My second paper analyzes the interaction of financial distress and risk exposure. I find that firms in a stronger financial position are more likely to limit their exposure by reducing the number of exposed facilities. On the other hand, not only do firms in weaker financial position not decrease their exposure, I find that, in some instances, they increase their exposure to carcinogens. This work again supports the theory of asset substitution. Finally, in my third paper, I explore if public firms respond differently to a potential negative cash flow shock than do private firms. I test whether existing public firms are more likely to attempt to minimize their cash flow risk and thus reduce their carcinogen exposure than are private firms. I do not find evidence that public firms respond differently to this shock than do private firms.
Essays in Corporate Finance
(2016) Bowen III, Donald Eugene; Faulkender, Michael; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation is comprised of three essays about investment, technology transfer, and corporate governance mandates. The first essay, “Patent Acquisition, Investment, and Contracting”, examines the transfer of intellectual property via the secondary market for patents and asks how patent acquisitions interact with firm investment policy. I find that patent acquirers subsequently invest in more R&D, increase internal patenting, and eventually make new investments in CAPX. Firms with more technological expertise and investment opportunities acquire more patents. Patent sales are the dominant type of contract and maximize investment incentives; patent licenses frequently contain royalties, which induce underinvestment problems. Nevertheless, licensing can be explained in part by financial and strategic considerations. Licensing is more likely when buyers become financially constrained, when revenue can be shifted to low tax sellers, and when the buyer is a competitor acquiring rights to a valuable patent. Overall, these results suggest patent acquisitions are motivated by the pursuit of investment synergies, rather than innovation substitution, commercialization motives, or legal threats. The second essay, “What's your Identification Strategy? Innovation in Corporate Finance Research”, co-authored with Laurent Fresard and Jerome P. Taillard, studies the diffusion of techniques designed to identify causal relationships in corporate finance research. We estimate the diffusion started in the mid-nineties, lags twenty years compared to economics, and is now used in the majority of corporate finance articles. Consistent with recent theories of technology diffusion, the adoption varies across researchers based on individuals' expected net benefits of adoption. Younger scholars, holders of PhDs in economics, and those working at top institutions adopt faster. Adoption is accelerated through networks of colleagues and alumnis and is also facilitated by straddlers who cross-over from economics to finance. Our findings highlight new forces that explain the diffusion of innovation and shape the norms of academic research. The third essay, “Were non-independent boards really captured before SOX?”, exploits the legal implementation of rules used by the major US stock exchanges following Sarbanes-Oxley (SOX) to study the pre-SOX optimality of board structure. The rules allowed firms to change the legal independence of their board without changing personnel by reclassifying a director from non-independent to independent. Many firms required to change their board structure used reclassification in order to minimize the alterations they made to their pre-SOX board structure, and I call these “placebo firms”. This observation makes feasible a DDD test that identifies the effect of the mandate by comparing treatment firms to placebo firms. Consistent with the view that boards are chosen optimally, real outcomes (profitability) are better for placebo firms than treatment firms. The magnitude of the difference, 4.9 percentage points, is economically meaningful, implying that the constraint is a significant impediment to the conduct of firms targeted by the regulations. Increased profitability is accounted for by increased revenue and typically flat expenses, including investment levels.
Essays in Corporate Finance
(2024) Wu, Chengjun; Maksimovic, Vojislav; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation contains three essays that explore topics in corporate finance and banking. Chapter 1 studies the role of board's political connections in corporate misconduct. Leveraging a policy shock in China that mandated politically connected directors to resign from corporate boards, I find that following the disruption in political connections, firms become less prone to commit misconduct while their misconduct is more likely to be detected. The elimination of political connections on board is particularly effective in deterring and detecting high-level offenses. The effects of the policy are also more pronounced for non-state-owned enterprise and firms in regions with lower level of corruption. I also find that firms affected by the shock are more inclined to initiate Directors and Officers insurance coverage and executives from such firms exhibit more negative sentiments in communications. Overall, the results suggest that political connections may shape firm compliance and facilitate a more lenient regulatory environment for the firm, thereby posing significant challenges to effective regulatory oversight. In Chapter 2, we argue that bank holding companies (BHCs) extend shadow insurance to the prime institutional money market funds (PI-MMFs) they sponsor and that PI-MMFs price this shadow insurance by charging investors significantly higher expense ratios and paying lower net yields. We provide evidence that after September 2008, expense ratios at BHC-sponsored PI-MMFs increased more than at non-BHC-sponsored PI-MMFs. Despite higher expense ratios, BHC-sponsored PI-MMFs did not experience larger redemptions than non-BHC-sponsored PI-MMFs. In addition, we show that expense ratios increased with BHCs' financial strength and the likelihood of their support; however, this expense ratio differential disappeared after the 2016 MMF reform. Chapter 3 studies how the revelation of financial misconduct affects the peer firms of the accused firm. I find that such spillover effect exists in both equity and debt markets using event study approach and staggered difference-in-differences design. In the equity market, the peer firms of the accused firm suffer significant negative cumulative abnormal returns. In the debt markets, both loans and bonds of the peer firms exhibit significantly higher spread over the benchmark risk-free rate following the misconduct revelation. Peer firms that employ the same auditor as the accused firm are more adversely affected. These peer firms not only experience even lower cumulative abnormal returns but also face tighter terms from creditors including collateral requirements and more restrictive covenants. They are also more likely to replace their auditors to distance themselves from the accused firm. The findings are consistent with the notion that financial misconduct erodes the trust in capital markets, prompting market participants to reassess the credibility of the non-accused peer firms.
Essays in Financial Economics
(2022) Zhou, Wei; Kyle, Albert S; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation contains two essays in market microstructure and institutional asset management. The first essay studies a dynamic model of strategic trading where the parameters of temporary price impact (how price depends on a trader's current rate of trading) and permanent price impact (how price depends on the cumulative quantity traded over time) are endogenous and time-varying. A monopolistic informed speculator trades with oligopolistic uninformed speculators. They agree to disagree about the precision of the informed speculator's private Gaussian information flow. In the interval-trading Nash equilibrium with linear Markov strategies, trade starts if the disagreement is high enough and stops when the decaying alpha becomes insufficient to generate further trading benefits. Equilibrium permanent price impact parameters encapsulate the counteracting effects of descending residual uncertainty and diminishing trading opportunities. Equilibrium temporary price impact parameters capture traders' inter-temporal trade-offs between the benefits of learning and trading. The second essay was motivated by the observation that active institutional investors anticipate potential unwinding costs when accumulating positions. In this essay, I develop a dynamic model to study how strategic traders' accumulation and unwinding motives interact and evolve when facing a decaying profit opportunity. The unwinding pressures come from quadratic (regulatory) holding costs and price impacts of competitors' trades. The model shows that (i) with unwinding pressures, traders are reluctant to exploit persistent opportunities and profit most from those with an intermediate decaying rate; (ii) competition alleviates the unwinding pressure from holding costs but strengthens that from competitors' price impacts; and (iii) with increased regulatory costs, traders' most profitable opportunities shift to more transient ones.
Essays in Financial Economics
(2006-04-26) Ullrich, Carl; Bakshi, Gurdip; Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
Essay 1, Constrained Capacity and Equilibrium Forward Premia in Electricity Markets, develops a refinement of the equilibrium electricity pricing model in Bessembinder and Lemmon (2002). The refined model explicitly accounts for constrained capacity, an important feature in electricity markets. Explicitly including a role for capacity allows the model to reproduce the price spikes observed in wholesale electricity markets. The refined model implies that the equilibrium forward premium, defined to be the forward price minus the expected spot price, is decreasing in spot price variance when the expected spot electricity price is low, but is increasing in the spot price variance when the expected spot electricity price is high. Further, the refined model implies that, ceteris paribus, the equilibrium forward premium is increasing in the ratio of the expected spot electricity price to the fixed retail price. The implications of this model are closer to reality. How does currency return volatility evolve over time and what are the properties of volatility dynamics? Is the drift of currency return volatility non-linear? What forms of non-linearities are admitted in the drift and diffusion functions? The purpose of essay 2, Estimation of Continuous-Time Models for Foreign Exchange Volatility, is to estimate a large class of volatility processes and explore these issues using weekly data on two currency pairs: U.S. dollar-British pound and Japanese Yen-U.S. dollar. The estimation approach is based on maximum-likelihood estimation that relies on closed-form density approximations (A\"it-Sahalia 1999, 2002). Based on volatility implied by currency options, the constant elasticity of variance specification provides a reasonable characterization of the variance of variance function. Extending the diffusion function beyond the CEV specification does not improve the fit of the model, regardless of the assumed form of the drift function. Further, I find that certain types of non-linearities in the drift function improve the goodness of fit statistics, though no generalizations can be made.
ESSAYS IN INNOVATION AND ENTREPRENEURSHIP
(2024) Ye, Zhen; Tate, Geoffrey A.; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
My dissertation focuses on the topics of innovation and entrepreneurship. In Chapter 1, I study how banks affect their borrowing firms’ green innovation when they reduce credit to firms with high carbon emissions. Using banks’ commitments to carbon neutrality as credit shocks to the borrowing firms, I first show that high-emission firms file fewer green patents following their relationship banks’ commitments to carbon neutrality. At the same time, other borrowing firms that receive increased lending from these committed banks see an increase in green patent filings. Second, I present evidence suggesting that financial constraints and inventor mobility are important mechanisms driving these effects. Third, I find that the value of newly filed green patents by firms in high-emission industries declines post-commitment, whereas there appears to be no discernible impact on the value of green patents filed by other firms. Finally, I develop a novel measure that gauges a patent’s relevance to mitigating climate change impact using text algorithms and show that banks’ commitments lead to lower relevance of green patents filed by high-emission firms. Altogether, the paper highlights an unintended consequence of bank divestment: a decrease in the production of high-quality green patents.Chapter 2 is joint work with Sven Oskarsson and Rafael Ahlskog. This chapter investigates the effects of parental income volatility on individuals’ entrepreneurial decisions in Sweden. Our results indicate that individuals who experience higher uninsurable parental income volatility during adolescence are more likely to become entrepreneurs. Specifically, a one-standard-deviation increase in parental income volatility is associated with an increase in the probability of becoming an entrepreneur by around 45% relative to the mean. Second, we find that firms started by individuals with higher parental income instability have a lower survival rate. Finally, we present evidence in line with higher risk tolerance being an important mechanism driving our findings. We do not find support for alternative mechanisms, including human capital accumulation and financial resources.
ESSAYS IN INTERNATIONAL FINANCE
(2010) Makaew, Tanakorn; MAKSIMOVIC, VOJISLAV; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
My dissertation consists of three essays on international capital flows. In the first essay, titled "Do small firms benefit more from foreign portfolio investment? Evidence from a Natural Experiment," I test whether an increase in the supply of foreign portfolio capital benefits small firms by using the Thai government's unique restriction on capital inflows as a natural experiment. The Thai government imposed a very stringent capital control on December 19, 2006, and then quickly abandoned it one day later. Although many other studies have been plagued with the difficulty of separating the impact of foreign capital from the impact of other concurrent events, this experiment helps me solve the time-series identification problem. My results suggest that foreign portfolio investment helps large firms the most, contrary to existing evidence, which finds a benefit in foreign portfolio investment for small firms. I also investigate the importance of other firm characteristics correlated with size, which includes a firm's exchange rate exposure, foreign ownership, and political connection. The next two essays are on the dynamic patterns of international mergers and acquisitions. In the second essay, I uncover key facts about international M&As by estimating a variety of reduced form models. I find that: (1) Cross-border mergers come in waves that are highly correlated with business cycles. (2) Most mergers occur when both the acquirer and the target economies are booming. (3) Merger booms have both an industry-level component (productivity shocks) and a country-level component (financial shocks). (4) Across over one million observations, acquirers tend to be more productive and targets tend to be less productive, compared to their industry peers. These facts are consistent with the neoclassical theory of mergers in which productive firms expand overseas to seize new investment opportunities, but not with the widely held views that most cross-border mergers occur when the target economies are in a recession or face a financial crisis. In the third essay, I construct a dynamic structural model of cross-border mergers and integrate the important facts above into the model. This dynamic structural approach allows me to quantify the effects of productivity and financial shocks on M&A decisions. In addition, this approach provides a proper analytical framework for conducting policy experiments. As an example of such analyses, I investigate the impact of President Obama's proposal on multinational corporation taxation. My simulation results suggest that the foreign operation tax has economically significant effects on productive firms and can be very distortionary for cross-border mergers.
Essays on Asset Pricing
(2012) Li, Su; Kyle, Albert; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation consists of three essays. The first essay is titled "Speculative Dynamics I: Imperfect Competition and the Implications for High Frequency Trading". In this essay, I analyze the nature of imperfect competition among informed traders who continuously generate and exploit private information about a risky asset's liquidation value which follows either a mean reverting process or random walk. I find the following results: (i) The combined trading of multiple informed traders is much more aggressive than the monopolistic trader in Chau and Vayanos (2008). (ii) The equilibrium price is even more revealing of the informed trader's private information. (iii) Market depth improves as the number of informed traders increases. (iv) In the limit of continuous trading, market is strong form efficient while aggregate profits of the informed traders remain bounded away from zero, in sharp contrast to the corresponding results in Holden and Subrahmanyam (1992), and Foster and Viswanathan (1993). (vi) Informed traders' inventories follows a Brownian motion, therefore enabling them to contribute significantly to total trading volume and price variance. These results shed light on empirical findings regarding high frequency traders by helping explain why they remain protable despite aggressive competition with each other, why their trading volume is very high, to what extent they improve efficiency, and through what mechanism they improve liquidity. The second essay is titled "Speculative Dynamics II: Asymmetric Informed Traders". In this essay, I study the strategic interaction between hierarchical duopolistic informed traders who continuously generate and exploit private information about a risky asset's liquidation value, which follows either a mean reverting process or random walk. I find the following results: (i) Both traders duopolize the private information they both observe and the more informed trader monopolizes the additional exclusive private information. (ii) The common private information is incorporated into prices more efficiently than the monopolistic private information. (iii) In the limit of continuous trading, both traders' inventories based on their shared information follow Brownian motions. (iv) The trader with less superior information has more contribution to the trading volume and price volatility when the frequency of trading is sufficiently high. (v) As trading becomes more frequent, the less informed trader's expected profits may fall but converges to a strictly positive constant in the limit. The third essay is titled "Real Options and Product Differentiation". In this essay, I develop a continuous time real investment model in an oligopoly industry where the products are heterogeneous. Although the heterogeneous products assumption can lower each firm's incentive to exercise the growth options prematurely, the preemption strategy is still profitable.
Essays on Asset Pricing and Financial Stability
(2014) Lee, Jeongmin; Kyle, Albert S.; Loewenstein, Mark; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
My two-essay dissertation revolves around understanding the financial crisis of 2008. First I focus on the repo market, a major funding source of the shadow banking system, and show the repo market can create and amplify the fragility of the system. Then I investigate a broader economy with heterogeneous agents and demonstrate how the dynamics of equilibrium asset prices and wealth distributions are determined. In Essay 1, I develop a dynamic model of collateral circulation in a repo market, where a continuum of institutions borrow from and lend to one another against illiquid collateral. The model emphasizes an important tradeoff. On one hand, easier collateral circulation makes repos liquid and increases steady state investment through several multiplier effects, improving economic efficiency. On the other hand, it can harm financial stability because less capital is sitting on the sidelines waiting for investment opportunities. This fragility is further exacerbated by the endogenous repo spread through a positive feedback loop, and can result in an inefficient repo run. The model is relevant for understanding the repo markets during the financial crisis of 2008. In Essay 2, I study the dynamics of the wealth distribution and asset prices in a general equilibrium model. Agents face heterogeneous portfolio constraints that limit the shares of risky investments relative to wealth. The setup is motivated by empirical evidence that many households do not participate in the stock market and portfolio shares are heterogeneous and persistent conditional on stock market participation. There are two main results. First, one state variable can summarize the wealth distribution regardless of the number of types of agents. Second, when the economy is bad, it becomes more sensitive to additional negative shocks, meaning that not only magnitudes of the shocks but also their frequency matters.
Essays on Asset Purchases and Sales: Theory and Empirical Evidence
(2006-08-09) YANG, LIU; Maksimovic, Vojislav; Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation consists of a theory essay and an empirical essay that investigate a firm's decision to buy or sell corporate assets. It seeks to answer the following research questions: (1) why do firms choose to buy or sell assets? (2) what makes assets in an industry more likely to be traded than assets in other industries? and (3) within an industry, why asset sales come in waves and tend to cluster over a certain time period? In my theory essay, "The Real Determinants of Asset Sales", I develop a dynamic equilibrium model that jointly analyzes firms' decisions to buy or sell assets and the activity of asset sales in the industry. In my model, a firm maximizes its value by making two inter-related decisions: how much to invest in new assets and whether to buy or sell existing assets. These decisions are made under both firm- and industry-level productivity shocks. The model is solved through simulations and it is calibrated using the plant-level data from Longitudinal Research database. I show that most of the empirical evidence documented in the literature on asset sales is consistent with value-maximizing behavior. In my empirical essay, "What Drives Asset Sales - The Empirical Evidence", I test the model's predictions using the plant-level data from Longitudinal Research Database on manufacturing firms in the period of 1973 to 2000. The patterns of transactions (firm-level purchase/sale decisions, and the cross-industry and the time-series variation in asset sales activities) are consistent with my theoretical model.
ESSAYS ON CORPORATE INVESTMENT
(2012) Moon, Seoyeon Katie; Phillips, Gordon; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation is comprised of three essays on corporate investment. The first essay, titled "What If the Firm Does Not Diversify? A Self-Selection Free Bayesian Approach", takes a comprehensive look at the diversification discount. By employing a switching regression model with the Bayesian data augmentation methodology, I compare the actual post-acquisition firm value of diversifying acquirers to the counter-factual alternative which is a non-diversifying acquisition. I find that there is a considerable amount of acquirers that could improve their value by diversifying acquisitions more than what they would improve by non-diversifying acquisitions. When there are negative shocks to the acquirers' primary industries, when these industries are concentrated and the firms are not dominant players in the industries, diversifying acquisitions add values to the firms. The firm-by-firm analysis shows that on average, no diversification discount exists. The next two essays study U.S. manufacturing firms' outsourcing activity, using a unique dataset of purchase obligations from firm 10-Ks. The second essay is titled "Outsourcing and Firm Financial Structure", and the third essay is titled "Firm Risk Taking versus CEO Diversification: Evidence from Outsourcing Firms". In the second essay, I explore the outsourcing decision and its implications on firm investment and capital structure. I first examine what kinds of firms use external contracts to provide a product or service as a major input to their production. I find that relatively young or large firms with a large number of patents are more likely to use external purchase contracts. Within high-technology industries, firms with purchase contracts tend to have higher R&D investment, while in low- technology industries, firms with purchase contracts are more likely to enter new markets. Outsourcing activity has important risk and capital structure implications, as firms that outsource have significantly less leverage. These results are consistent with outsourcing being used by firms to improve their flexibility. Faced with this increased firm flexibility and fewer fixed assets to pledge as collateral, outsourcing firms finance their operations proportionally more with equity. In the third essay, I examine CEO compensation in outsourcing firms. I find that the intensity of outsourcing can significantly explain the variations in CEO compensation; the more the firms do outsourcing, the more they pay to their CEOs. Outsourcing firms promote managerial risk-taking by using proportionally more equity-based compensation. However, they also need to compensate additionally their CEOs for the higher risk exposure to the firms' increased total risks. I show that outsourcing firms determine their compensation level and structure based on this optimal trade-off.
ESSAYS ON EMPIRICAL ASSET PRICING
(2020) xue, jinming; Wermers, Russ; Kyle, Albert; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
In essay 1: This paper measures the time-varying provision of liquidity by buy-side customers (e.g., mutual funds and pension funds), relative to bond dealers, in corporate bond markets using a structural vector autoregression (SVAR) model. As indicated by my simple theory model, shocks to the relative willingness of customers and bond dealers to provide liquidity affect, in opposite directions, the choice of bond dealers between market-making (principal) and matchmaking (riskless principal) transactions. Motivated by this model, my SVAR empirically disentangles these shocks to customers versus bond dealers. My SVAR-derived patterns of these structural shocks provide fundamental insights into the mechanics in corporate bond markets following recent events, such as exposing the increased role of buy-side customers for liquidity provision after the many regulatory changes following the 2008 financial crisis. Furthermore, my empirical approach generates “factors” that provide an improved time-series asset-pricing model for yield spreads of corporate bonds of different credit ratings. In essay 2: We consider an approach to derive the conditional expectation of return quantities under the real-world probability measure, exploiting the form of the projected stochastic discount factor. Our treatment is formulaic in that the real-world expectation can be synthesized from the prices of the risk-free bond, the asset, and options on the asset. The method is free of distributional assumptions, and we use it to study empirical questions related to (i) conditional probability of a disaster and return upside and (ii) spanning hypothesis in the Treasury market. We examine empirical consistency and show that our theoretical treatment is relevant. In essay 3: Based on data until the mid 2000s, oil price changes were shown to predict international equity index returns with a negative predictive slope. Extending the sample to 2015, we document that this relationship has been reversed over the last ten years and therefore has not been stable over time. We then posit that oil price changes are still useful for forecasting equity returns once complemented with relevant information about oil supply and global economic activity. Using a structural VAR approach, we decompose oil price changes into oil supply shocks, global demand shocks, and oil-specific demand shocks. The hypothesis that oil supply shocks and oil-specific demand shocks (global demand shocks) predict equity returns with a negative (positive) slope is supported by the empirical evidence over the 1986--2015 period. The results are statistically and economically significant and do not appear to be consistent with time-varying risk premia.
ESSAYS ON EMPIRICAL ASSET PRICING
(2021) Li, Shuaiqi; Heston, Steven; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation contains two essays empirically exploring the equity option markets. Chapter 1 studies the role played by institutional investors in determining equity option returns. In this chapter, I study whether institutional stock holdings predict equity option returns. I find that institutional concentration in the underlying stock negatively predicts the cross-section of corresponding option returns. Evidence is consistent with a hedging and demand pressure channel: For stocks with more concentrated ownership, some institutional holders are more likely to overweight them and demand more of their options to hedge. To absorb the order imbalances, dealers sell options and charge higher prices, leading to lower option returns. Using option holdings of U.S. equity mutual funds, I document a positive correlation between funds' stock concentration and their option share in the same firms. In Chapter 2 (joint with Steven Heston), we improve continuous-time variance swap approximation formulas to derive exact returns on benchmark VIX option portfolios. The new methodology preserves the variance swap interpretation that decomposes returns into realized variance and option implied-variance. We apply this new methodology to explore return momentum on option portfolios across different S&P 500 stocks. We find that stock options with high historical returns continue to outperform options with low returns. This predictability has a quarterly pattern, resembling the pattern of stock momentum found by Heston and Sadka (2008). In contrast to stock momentum, option momentum lasts for up to five years, and does not reverse.
Essays on Empirical Market Microstructure
(2011) Tuzun, Tugkan; Kyle, Albert S; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
The first essay examines the events of May 6, 2010: the ``Flash Crash". The Flash Crash, a brief period of extreme market volatility on May 6, 2010 raised questions about the current structure of the U.S. financial markets. Audit-trail data from U.S. Commodity Futures Trading Commission (CFTC) is used to describe the structure of the E-mini S\&P 500 stock index futures market on May 6. In this study, three questions are asked. How did High Frequency Traders (HFTs) trade on May 6? What may have triggered the Flash Crash? What role did HFTs play in the Flash Crash? There is evidence which supports that HFTs did not trigger the Flash Crash, but their responses to the unusually large selling pressure on that day exacerbated market volatility. The second essay examines the relationship between mutual fund trading and liquidity consumption in financial markets. Using Thompson Mutual Funds holdings data and the Trade and Quotes (TAQ) data, we relate the mutual fund trading to liquidity consumption. Mutual fund trading is positively correlated with liquidity consumption. Mutual fund sensitivity to liquidity consumption differs based on mutual fund investment style. Large trades reveal the trading activity of actively managed mutual funds whereas the trading activity of index funds can be explained by small trades. This is consistent with a plausible explanation that index funds need to use small trades to rebalance their portfolios and information motivates the large trades of active mutual funds. The third essay tests the predictions of trading game invariance using the sample of trades from TAQ dataset from 1993 to 2008. The theory of trading game invariance predicts that the distribution of trade sizes as a fraction of trading volume should vary across stocks proportionally to their trading activity in -2/3 power and that the number of trades should vary across stocks proportionally to their trading activity in 2/3 power. The data supports predictions of the invariance theory. For the number of trades, the estimated power coefficient of 0.69 (with standard errors of 0.001) is especially close to the predicted one of 2/3 on the subsample before 2001. These estimates increases to 0.79 (with standard errors of 0.004) after 2001 following a structural break related to a reduction in tick size and a consequent spread of algorithmic trading. Furthermore, the entire distribution of trade size shifts with the trading activity in a manner predicted by invariance theory. When trade sizes are adjusted for differences in trading activity, then their distribution is stable across stocks and similar to the distribution of a log-normal variable, truncated at the 100-share threshold.
ESSAYS ON EXECUTIVE COMPENSATION, CAPITAL STRUCTURE AND CORPORATE GOVERNANCE
(2013) Tosun, Onur Kemal; Faulkender, Michael; Senbet, Lemma; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation consists of three essays on the relation between executive compensation, capital structure and corporate governance. In the first essay, I examine the relation between CEO option compensation and firm capital structure. The empirical challenge in studying this relation is that these are both choices of the firm that are made simultaneously. Therefore, it is difficult to conclude from the existing literature the causation of this relation. Using the Internal Revenue Code (IRC) 162(m) tax law as an exogenous shock to the compensation structure in a natural experiment setting, I can identify now firm leverage changes as a result of the CEO option compensation changes. The evidence provides strong support for the debt agency theory. The results indicate that firms decrease leverage when CEOs are paid with more option grants and as those options become a higher percentage of the firm's future cash flows. The findings are robust to addition of corporate governance and convertible debt dimensions to estimation. The second essay studies the effect of internal board monitoring on the firm's debt maturity structure. I use the Sarbanes - Oxley Act of 2002 (SOX) and the Securities and Exchange Commission (SEC) regulations as exogenous shocks to board structure in a natural experiment setting. Supporting the agency theory, the findings indicate that firms have debt with longer maturity as board independence increases and internal board monitoring becomes powerful. The results are even stronger for complex and larger firms such as conglomerates. I find the relation between internal monitoring and debt maturity becomes less clear during times of financial instability. The third essay investigates the impact of externally mandated versus organically determined corporate governance modifications on firm performance. SOX and SEC regulations are employed as a natural experiment in order to examine the imposed rules and elucidate the identification issues. The findings suggest that companies which voluntarily determine the necessary corporate governance modifications based on firm specific characteristics and needs perform better than the case where they are all forced to alter their board structure.
Essays on Financial Constraints, R&D Investments, and Competition
(2016) Lin, Danmo; Mathews, Richmond D; Loewenstein, Mark; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation consists of two chapters of theoretical studies that investigate the effect of financial constraints and market competition on research and development (R&D) investments. In the first chapter, I explore the impact of financial constraints on two different types of R&D investments. In the second chapter, I examine the impact of market competition on the relationship between financial constraints and R&D investments. In the first chapter, I develop a dynamic monopoly model to study a firm’s R&D strategy. Contrary to intuition, I show that a financially constrained firm may invest more aggressively in R&D projects than an unconstrained firm. Financial constraints introduce a risk that a firm may run out of money before its project bears fruit, which leads to involuntary termination on an otherwise positive-NPV project. For a company that relies on cash flow from assets in place to keep its R&D project alive, early success can be relatively important. I find that when the discovery process can be expedited by heavier investment (“accelerable” projects), a financially constrained company may find it optimal to “over”-invest in order to raise the probability of project survival. The over-investment will not happen if the project is only “scalable” (investment scales up payoffs). The model generates several testable implications regarding over-investment and project values. In the second chapter, I study the effects of competition on R&D investments in a duopoly framework. Using a homogeneous duopoly model where two unconstrained firms compete head to head in an R&D race, I find that competition has no effect on R&D investment if the project is not accelerable, and the competing firms are not constrained. In a heterogeneous duopoly model where a financially constrained firm competes against an unconstrained firm, I discover interesting strategic interactions that lead to preemption by the constrained firm in equilibrium. The unconstrained competitor responds to its constrained rival’s investment in an inverted-U shape fashion. When the constrained competitor has high cash flow risk, it accelerates the innovation in equilibrium, while the unconstrained firm invests less aggressively and waits for its rival to quit the race due to shortage of funds.
Essays on Financial Markets
(2022) Peppe, Matthew David; Kyle, Albert S; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation contains three essays on financial markets concerning the relationship between short interest and returns in over-the-counter (OTC) equities, the effect of obtaining a rating on municipal bond offering yields, and the use of alternative trading systems (ATS) in the corporate bond market.Chapter 1 studies short positions among over-the-counter domestic common stocks. Short selling plays an important role in maintaining price efficiency, but short-selling in over-the-counter equities is often perceived as extremely rare. Short selling constraints are indeed high in this market, with the median fee to borrow a security being 2% for stocks with no short interest and 10% for stocks with short interest exceeding 1% of shares outstanding. Despite these constraints, 27% of domestic OTC equities have outstanding short interest positions on a given reporting date. Consistent with theories of short selling constraints such as Miller (1977), these high short selling constraints imply a substantial negative relationship between short interest and future returns. A portfolio of securities with short interest exceeding 1% of shares underperforms a portfolio of securities with no short interest by 31% annually and panel regressions show the relationship is robust to accounting for other security characteristics. The negative relationship between short interest and future returns suggests short sellers are trading in the direction of correcting mispricing in the OTC market, but the large magnitude and long time horizon over which short positions outperform suggests that there are large potential price efficiency gains from reducing constraints on short selling. Chapter 2, joint work with Haluk Unal, studies how whether a municipal bond is rated affects its offering yield. Approximately 34% of local municipal bond issues were issued without ratings during 1998 to 2017. We study the circumstances that affect the decision to obtain a rating and whether unrated bonds, controlling for observable risk factors, are more expensive to issue than rated bonds. Results show that issuers are less likely to obtain ratings for smaller issues, negotiated offerings, and bonds with high proxies for risk such as coming from areas with low personal income. We estimate the effect of forgoing a rating on offering yields using a doubly-robust Inverse Probability Weighted Regression Adjustment that controls for confounding that arises from risk and other characteristics affecting both the choice to obtain a rating and the yield. We separately analyze revenue bonds, general obligation bonds, bank qualified, and non-bank qualified bonds and find ratings decrease offering yields by 47, 49, 60, and 42 basis points respectively. The higher offering yields cost municipalities $22.5B in higher interest expense during our sample period. We find the choice of issuers to forgo ratings despite the substantial potential savings appears to be influenced by the underwriters they work with. Underwriters may face a conflict of interest where not obtaining a rating lowers the price investors are willing to pay from the bond, but also lowers the price the underwriter must pay the issuer and thus increases the underwriter’s profit. Chapter 3 is joint work with Matthew Kozora, Bruce Mizrach, Or Shachar, and Jonathan Sokobin. This chapter studies the circumstances when corporate bonds trade via an electronic ATS rather than in the traditional phone market and the relationship between venue choice and transaction costs. Trades on ATS platforms are smaller and more likely to involve investment-grade bonds, suggesting market participants trade via ATS when concerns about information leakage and adverse selection are lower. Trades on ATS platforms are more probable for older, less actively traded bonds from smaller issues, indicating participants are more likely to trade via ATS when search costs are high. Moreover, dealer participation on ATS platforms is associated with lower customer transaction costs of between 24 and 32 basis points.

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