We show that firms with more illiquid real assets have a higher cost of capital. This effect is stronger when real illiquidity arises from lower within-industry acquisition activity. Real asset illiquidity increases the cost of capital more for firms that face more competition, have less access to external capital, or are closer to default, and for those facing negative demand shocks. The effect of real asset illiquidity is distinct from that of firms’ stock illiquidity or systematic liquidity risk. These results suggest that real asset illiquidity reduces firms’ operating flexibility and through this channel their cost of capital.

We examine whether a firm’s debt maturity structure affects its credit quality. Consistent with theory, we find that firms with greater exposure to rollover risk (measured by the amount of long-term debt payable within a year relative to assets) have lower credit quality; long-term bonds issued by those firms trade at higher yield spreads, indicating that bond market investors are cognizant of rollover risk arising from a firm’s debt maturity structure. These effects are stronger among firms with a speculative-grade rating and declining profitability, and during recessions.

In this paper, we formally show that the cross-sectional variance of stock returns is a consistent and asymptotically efficient estimator for aggregate idiosyncratic volatility. This measure has two key advantages: It is model free and observable at any frequency. Previous approaches have used monthly model-based measures constructed from time series of daily returns. The newly proposed cross-sectional volatility measure is a strong predictor for future returns on the aggregate stock market at the daily frequency. Using the cross section of size and book-to-market portfolios, we show that the portfolios’ exposures to the aggregate idiosyncratic volatility risk predict the cross section of expected returns.

How does the market value “toxic” structured-credit securities? We study the valuation of what is possibly the most toxic of all toxic assets: the equity tranche of a collateralized debt obligation (CDO). In theory, CDO equity should be similar in nature to bank stock since both represent residual claims on a portfolio of loans. We find CDO equity returns are much more related to stock returns than to fixed-income returns. CDO equity returns track the returns of financial stocks much more closely than any other industry. Nearly two-thirds of the variation in CDO returns can be explained by fundamentals.

This paper introduces and analyzes a new form of contingent convertible: a call option enhanced reverse convertible (COERC). If an issuing bank’s market value of capital breaches a trigger, COERCs convert to many new equity shares that would heavily dilute existing shareholders, except that shareholders have the option to purchase these shares at the bond’s par value. COERCs have low risk: They are almost always fully repaid in cash. Yet, they reduce government bailouts by replenishing a bank’s capital. COERCs’ design also avoids problems with market-value triggers, such as manipulation or panic, while reducing moral hazard and debt overhang.

This paper presents the first empirical analysis of the choice of firms regarding whether to release private information (“prepare the market”) in advance of a possible dividend cut and the consequences of such market preparation. We use a hand-collected data set of dividend cutting firms, which allows us to distinguish between prepared and nonprepared dividend cutters and to test the implications of two alternative theories: the “signaling through market preparation” theory and the “stock return volatility reduction” theory. We document several important differences between prepared and nonprepared dividend cutters. Overall, our empirical results are consistent with the signaling theory.

In this paper, we develop a state-dependent sensitivity value-at-risk (SDSVaR) approach that enables us to quantify the direction, size, and duration of risk spillovers among financial institutions as a function of the state of financial markets (tranquil, normal, and volatile). For four sets of major financial institutions (commercial banks, investment banks, hedge funds, and insurance companies), we show that while small during normal times, equivalent shocks lead to considerable spillover effects in volatile market periods. Commercial banks and, especially, hedge funds appear to play a major role in the transmission of shocks to other financial institutions.

This paper develops a multi-asset mixture distribution hypothesis model to investigate commonality in stock returns and trading volume. The model makes two main predictions: First, the factor structures of returns and trading volume are independent although they stem from the same valuation fundamentals and jointly depend on a latent information flow; second, cross-sectional positive volatility-volume relations arise solely from the dynamic features of the information flow. Empirical analyses at the market level support these predictions. Furthermore, the results indicate that removing the information flow significantly reduces the return volatility persistence and the extent of the reduction exhibits a size pattern.

This paper studies the effect of hedge-fund trading on idiosyncratic risk. We hypothesize that while hedge-fund activity would often reduce idiosyncratic risk, high initial levels of idiosyncratic risk might be further amplified due to fund loss limits. Panel-regression analyses provide supporting evidence for this hypothesis. The results are robust to sample selection and are further corroborated by a natural experiment using the Lehman bankruptcy as an exogenous adverse shock to hedge-fund trading. Hedge-fund capital also explains the increased idiosyncratic volatility of high-idiosyncratic-volatility stocks as well as the decreased idiosyncratic volatility of low-idiosyncratic-volatility stocks over the past few decades.

We study the distinct impacts of own and rival actions on risk and return when firms strategically compete in the product market. Contrary to simple intuition, a competitor’s options to adjust capacity reduce own-firm risk. For example, if a rival possesses a growth option, an increase in industry demand directly enhances profits but also encourages value-reducing competitor expansion. The rival option thus acts as a natural hedge. Within the industry, we obtain endogenous differences in expected returns. In a leader-follower equilibrium, own-firm and competitor risks and required returns move together through contractions and oppositely during expansions, providing testable new predictions.

Innovating firms pay more bribes than noninnovators across 25,000 firms in 57 countries. The difference is larger in countries with more bureaucratic regulation and weaker governance. Innovators that pay bribes do not receive better services and do not have greater propensity to engage in other illegal activities such as tax evasion. Thus, innovators are more likely to be victims of corruption than perpetrators. Our findings point to the challenges facing entrepreneurs in developing countries and are consistent with the view that rent seeking by government officials unlike private criminal activity is more likely to target innovators.

This paper examines the relationship between a firm’s exposure to industry downturns that we call industry risk and bank loan pricing. We measure industry risk based on the relationship between a firm’s stock returns and industry returns conditional on an industry downturn. We find industry risk is significantly related to the recovery rates in bankruptcy and the likelihood of the firm experiencing financial distress when its peers are also in distress. More importantly, we find that the spreads on unsecured bank loans are positively related to industry risk measures. These relationships are stronger for firms with more industry-specific assets.

Financial expertise among independent directors of U.S. banks is positively associated with balance-sheet and market-based measures of risk in the run-up to the 2007–2008 financial crisis. While financial expertise is weakly associated with better performance before the crisis, it is strongly related to lower performance during the crisis. Overall, the results are consistent with independent directors with financial expertise supporting increased risk taking prior to the crisis. Despite being consistent with shareholder value maximization ex ante, these actions become detrimental during the crisis. These results are not driven by powerful chief executive officers who select independent financial experts to rubber stamp strategies that satisfy their risk appetite.

Kothari, Lewellen, and Warner (2006) document that aggregate earnings changes in the United States are negatively related to contemporaneous market returns. In this study we show that this negative aggregate earnings-returns relation is unique to the United States. In 28 non-U.S. markets, aggregate earnings changes are positively associated with contemporaneous market returns. Further evidence shows that the aggregate earnings-returns relation becomes less positive in countries with more transparent financial disclosure that helps investors forecast earnings more precisely. Our result supports Sadka and Sadka’s (2009) argument that predictability of aggregate earnings leads to the negative relation between aggregate earnings and market returns in the United States.

We present evidence suggesting that chief executive officer (CEO) connections facilitate investments in corporate innovation. We find that firms with better-connected CEOs invest more in research and development and receive more and higher quality patents. Further tests suggest that this effect stems from two characteristics of personal networks that alleviate CEO risk aversion in investment decisions. First, personal connections increase the CEO’s access to relevant network information, which encourages innovation by helping to identify, evaluate, and exploit innovative ideas. Second, personal connections provide the CEO with labor market insurance that facilitates investments in risky innovation by mitigating the career concerns inherent in such investments.

While recent literature documents that U.S. family firms differ markedly from their nonfamily counterparts, there is a paucity of evidence on how these firms differ in terms of their cost of capital or financial structure. In this paper, we show that family and nonfamily firms differ in their debt maturity and leverage ratios in a manner consistent with the higher expropriation potential of family firms. Moreover, while more transparency causes both family and nonfamily firms to increase the maturity structure of their debt and reduce leverage ratios, the effects are stronger for family firms.

This paper investigates the relation between shareholders’ portfolio concentration and firm performance. Using data on more than 1.3 million unique shareholders, we create an index that measures how concentrated shareholder portfolios are in each firm. We posit that portfolio concentration will affect incentives when shareholders are resource constrained. We find that average shareholder portfolio concentration is positively related to future operational performance and valuation. We also find that portfolio concentration is positively correlated with abnormal stock returns. Our findings suggest that shareholders with concentrated portfolios are more informed and play a governance role through the stock market.

In this study, using data from 46 markets and a 34-year time period, we examine the impact of the illiquidity of U.S. Treasuries on global asset valuation. We find that it predicts equity returns in both developed and emerging markets. This predictive relation remains intact after controlling for various world- and country-level variables. Asset pricing tests further reveal that bond illiquidity is a priced factor even in the presence of other conventional risks. Since the illiquidity of Treasuries is known to reflect monetary and macroeconomic shocks, our results suggest that it can be considered a proxy for aggregate worldwide risks.

Recent empirical evidence suggests that the variance risk premium predicts aggregate stock market returns. We demonstrate that statistical finite sample biases cannot “explain” this apparent predictability. Further corroborating the existing evidence of the United States, we show that country-specific regressions for France, Germany, Japan, Switzerland, the Netherlands, Belgium, and the United Kingdom result in quite similar patterns. Defining a “global” variance risk premium, we uncover even stronger predictability and almost identical cross-country patterns through the use of panel regressions.

This paper examines the role of local attitudes toward gambling on corporate innovative activity. Using a county’s Catholics-to-Protestants ratio as a proxy for local gambling preferences, we find that firms located in gambling-prone areas tend to undertake riskier projects, spend more on innovation, and experience greater innovative output. We contrast the local gambling effect with chief executive officer (CEO) overconfidence, another behavioral effect reported to influence innovation. We find that local gambling preferences are a stronger determinant of innovative activity, with CEO overconfidence being more relevant to innovation in areas where gambling attitudes are strong.