Capital gains
Investment in a Smaller World: The Implications of Air Travel for Investors and Firms
Zhi Da et al.
Management Science, forthcoming
Abstract:
A large literature reports that proximity influences investment. We extend the measurement of proximity beyond distance and report that air travel reduces local investment bias. This result is confirmed using the initiation of connecting flights through recently opened air hubs because investment at destinations served by these connecting flights increases after, not before, their initiation. Air travel also broadens the investor base of firms and lowers their cost of equity by approximately 1%. Overall, air travel improves the diversification of investor portfolios and lowers the cost of equity for firms.
Can Ethics be Taught? Evidence from Securities Exams and Investment Adviser Misconduct
Zachary Kowaleski, Andrew Sutherland & Felix Vetter
MIT Working Paper, September 2019
Abstract:
We study the consequences of a 2010 change in the investment adviser qualification exam that reallocated coverage from the rules and ethics section to the technical material section. Comparing advisers with the same employer in the same location and year, we find those passing the exam with more rules and ethics coverage are one-fourth less likely to commit misconduct. The exam change appears to affect advisers’ perception of acceptable conduct, and not just their awareness of specific rules or selection into the qualification. Those passing the rules and ethics-focused exam are more likely to depart employers experiencing scandals. Such departures also predict future scandals. Our paper offers the first archival evidence on how rules and ethics training affects conduct and labor market activity in the financial sector.
Who Benefits from Innovations in Financial Technology?
Roxana Mihet
NYU Working Paper, November 2019
Abstract:
Financial technology affects both efficiency and equity in the stock market. The impact is non-trivial because several key technological developments have altered multiple dimensions of investors' opportunity sets at the same time. For example, better and faster computing has made it cheaper for retail investors to participate and to find funds that meet their needs. However, it has also made it cheaper for sophisticated investors to learn about asset returns. Some experts believe these innovations will increase financial inclusion. Others worry about possible anti-competitive effects that can lead to more unequal rent distribution. To address this debate, I first build a theoretical model of intermediated trading under asymmetric information that allows me to differentiate between the effects of each innovation. Second, I interpret US macro data from the last 40 years through the lens of my model and find that, although the gains from financial technology were accruing to low-wealth investors throughout the 1990s, they have been accruing to high-wealth investors since the early 2000s. The key theoretical finding is that, even if investors have access to the equity premium through cheap funds, improvements in financial technology disproportionately benefit informed, sophisticated traders. This reduces the participation rate of low-wealth investors, improves price informativeness, enlarges (but, at the same time, consolidates) the sophisticated asset management industry, and amplifies capital income inequality. Further advances in modern computing, big data, and artificial intelligence in asset management, in the absence of any gains redistribution, may accelerate the rate of change.
The Black Box of SEC Monitoring and Regulatory Spillover
Lorien Stice-Lawrence
University of Southern California Working Paper, November 2019
Abstract:
In spite of its focus on transparency, the SEC remains a black box. I peer into this black box by analyzing downloads of regulatory filings by SEC employees to provide granular evidence on how the SEC allocates its scarce monitoring resources. I document that SEC employees respond quickly to potential monitoring triggers and that this disclosure monitoring “spills over” among firms. That is, firms are subject to greater monitoring if the SEC has recently monitored the disclosures of their industry peers. Further, restatements and spikes in negative media coverage, whose timing is relatively exogenous with respect to internal SEC activities, both lead to large increases in SEC disclosure monitoring and subsequent spillover, ruling out scheduled industry sweeps as an alternative explanation. In addition, regulatory spillover is strongest when there is evidence of noncompliance and between firms that are assigned to the same regional or industry SEC office. These results suggest that knowledge spillovers allow SEC employees to reapply information obtained about individual firms to identify and monitor similar targets at a lower cost.
Don't Take Their Word For It: The Misclassification of Bond Mutual Funds
Huaizhi Chen, Lauren Cohen & Umit Gurun
NBER Working Paper, November 2019
Abstract:
We provide evidence that mutual fund managers misclassify their holdings, and that these misclassifications have a real and significant impact on investor capital flows. In particular, we provide the first systematic study of bond funds’ reported asset profiles to Morningstar against their actual portfolios. Many funds report more investment grade assets than are actually held in their portfolios, making these funds appear significantly less risky. This results in pervasive misclassifications across the universe of US fixed income mutual funds by Morningstar, who relies on these reported holdings. The problem is widespread- resulting in about 30% of funds being misclassified with safer profiles, when compared against their actual, publicly reported holdings. “Misclassified funds” – i.e., those that hold risky bonds, but claim to hold safer bonds– outperform the actual low-risk funds in their peer groups. “Misclassified funds” therefore receive higher Morningstar Ratings (significantly more Morningstar Stars) and higher investor flows due to this perceived outperformance. However, when we correctly classify them based on their actual risk, these funds are mediocre performers. Misreporting is stronger following several quarters of large negative returns, and it is strong at the fund family level. We report those families that have the highest percentage of misreported funds in the sample.
Social Capital and Financial Misconduct: Evidence from Individual Financial Advisers
John (Jianqiu) Bai et al.
Northeastern University Working Paper, December 2019
Abstract:
We show that social capital has a strong mitigating effect on financial adviser misconduct in the United States. Moreover, advisers who have committed misconduct are also more likely to relocate to counties with a relatively lower level of social capital than that of his previously residing county. These findings provide support for both the deterrence and displacement effects of social capital on financial adviser misconduct, and are robust to tests that address potential endogeneity concerns. Our results shed new light on social capital as an informal governing and monitoring mechanism against individual opportunistic behaviors.
Analyst Forecast Bundling
Michael Drake et al.
Management Science, forthcoming
Abstract:
Changing economic conditions over the past two decades have created incentives for sell-side analysts to both provide their institutional clients tiered services and to streamline their written research process. One manifestation of these changes is an increased likelihood of analysts’ issuing earnings forecasts for multiple firms on the same day. We identify this bundling property and show that bundling has increased steadily over time. We provide field evidence that the practice is a cost-saving measure, a natural by-product of analysts focusing on thematic research, and a reflection of forecast updating that occurs in advance of important events. Our empirical analyses show that bundled forecasts are less accurate, less bold, and less informative to investors than nonbundled forecasts. We also find that analysts who produce bundled forecasts provide valuable specialized services to their institutional clients. Our findings ultimately demonstrate that forecast bundling has important implications for the properties of analysts’ forecasts.
What Matters to Individual Investors? Evidence from the Horse’s Mouth
James Choi & Adriana Robertson
Journal of Finance, forthcoming
Abstract:
We survey a representative sample of U.S. individuals about how well leading academic theories describe their financial beliefs and decisions. We find substantial support for many factors hypothesized to affect portfolio equity share, particularly background risk, investment horizon, rare disasters, transactional factors, and fixed costs of stock market participation. Individuals tend to believe that past mutual fund performance is a good signal of stock-picking skill, actively managed funds do not suffer from diseconomies of scale, value stocks are safer and do not have higher expected returns, and high-momentum stocks are riskier and do have higher expected returns.
Paying for Performance in Private Equity: Evidence from Venture Capital Partnerships
Niklas Hüther et al.
Management Science, forthcoming
Abstract:
We offer the first empirical analysis connecting the timing of general partner (GP) compensation to private equity fund performance. Using detailed information on limited partnership agreements between private equity limited and general partners, we find that “GP-friendly” contracts — agreements that pay general partners on a deal-by-deal basis instead of withholding carried interest until a benchmark return has been earned — are associated with higher returns, both gross and net of fees. This is robust to measures of performance persistence, time period effects, and other contract terms and is related to exit-timing incentives. Timing practices balance GP incentives against limited partner downside protection.
S&P 500 Affiliation and Stock Price Informativeness
Shinhua Liu
Journal of Behavioral Finance, forthcoming
Abstract:
When firms are added to a stock index, more information should be discovered, traded on, and incorporated into their stock prices, making them more informative. We test this hypothesis using a large sample of additions to the S&P 500 index. Using two alternative statistical tests, we find that the stocks added experience more random, less predictable return and, thus, appear to be priced more efficiently information-wise. We further find concurrent increases in institutional ownership and investor awareness, which tend to contribute to the higher pricing efficiency, adding to the literature. These findings should be of interest to academics and practitioners.
Mutual Funds that Borrow
Joseph Warburton & Michael Simkovic
Journal of Empirical Legal Studies, December 2019, Pages 767-806
Abstract:
Securities laws prohibit open‐end mutual funds from borrowing more than one‐third of their capital structure because of concerns that too much borrowing may harm investors. This is the first article to examine the performance of open‐end funds that borrow money within these permissible limits. We construct a database from annual filings of open‐end domestic equity mutual funds covering 17 years from 2000 to 2016. Eighteen percent of funds borrowed money for leverage within that time. We find that borrowing funds underperform their nonborrowing peers by 62 basis points per year on a total return basis, while also incurring greater risk. After accommodating for the greater risk taking, we find that borrowers underperform by 48 to 72 basis points annually. By contrast, funds that use derivatives and other financial instruments perform about as well as unlevered mutual funds, before and after adjusting for risk, and with less volatility. This suggests that many mutual funds use derivatives to hedge risk rather than as a substitute for leverage through the capital structure. Thus borrowing may present a greater risk than derivatives, which have received more attention than borrowing. Fund investors and regulators would benefit from greater transparency into mutual fund capital structure.
How Do Accelerators Impact the Performance of High-Technology Ventures?
Sandy Yu
Management Science, forthcoming
Abstract:
Accelerators aim to help nascent companies reach successful outcomes by providing capital, enabling industry connections, and increasing exposure to investors. Critically, however, accelerators also provide informative signals to founders about the probability of success. Founders use this information to decide whether to continue or shut down. To better understand these issues, I provide a model of accelerator participation and performance and then test empirical predictions from the model using a novel data set of approximately 900 accelerator companies across 13 accelerators and 900 matched nonaccelerator companies. I find that, through accelerator feedback effects, accelerator companies close down earlier and more often, raise less money conditional on closing, and appear to be more efficient investments compared with non-accelerator companies. Additional analysis using a separate sample of rejected accelerator applicants further supports these findings. These results suggest that accelerators help resolve uncertainty around company quality sooner, allowing founders to make funding and exit decisions accordingly.