Real Effect of Financial Markets...−Cohen, Diether and Malloy (2013) “Legislating Stock...

Real Effect of Financial Markets

Adrien Matray

The plan

− The asset pricing view (passive view of corporatefinance)

− Asset pricing corporate finance variables

− The ``real effects’’ of institutional investors

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The plan




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Corporate finance variables affect asset prices

− The “fundamental value” approach

𝑝𝑝 = ∑𝑡𝑡∞𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹

(1+𝑟𝑟)𝑡𝑡

Any var that affects CF should be priced

− Classic questions:− How fast the info is incorporated?

− Do stock prices really incorporate all info?

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The fundamental value approach

− How fast the info is incorporated?− Cohen, L., & Frazzini, A. (2008). Economic Links and

Predictable Returns. Journal of Finance

− Cohen, Diether and Malloy (2013) “Legislating Stock Prices”

Journal of Financial Economics

− LAZY STOCK PRICES

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− How fast the info is incorporated?− Cohen, L., & Frazzini, A. (2008). Economic Links and

Predictable Returns. Journal of Finance

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− Cohen, Diether and Malloy (2013) “Legislating StockPrices” Journal of Financial Economics

− In this paper we demonstrate that legislation has a simple, yet previously undetectedimpact on firm stock prices. While it is understood that the government and firms havean important relationship, it remains difficult to determine which firms any given pieceof legislation will affect, and how it will affect them. By observing the actions oflegislators whose constituents are the affected firms, we can gather insights into thelikely impact of government legislation on firms. Specifically, focusing attention on"interested" legislators' behavior captures important information seemingly ignored bythe market. A long-short portfolio based on these legislators' views earns abnormalreturns of over 90 basis points per month following the passage of legislation. Further,the more complex the legislation, the more difficulty the market has in assessing theimpact of these bills. Consistent with the legislator incentive mechanism, the moreconcentrated the legislator's interest in the industry, the more informative are hervotes for future returns.

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The fundamental value approach: stock price incorporate all the info?

− Cohen, Diether and Malloy (2013) “MisvaluingInnovation” RFS

We demonstrate that a firm's ability to innovate is predictable, persistent,

and relatively simple to compute, and yet the stock market appears to

ignore the implications of past successes when valuing future innovation.

We show that two firms that invest the same in R&D can have quite

divergent, but predictably divergent, future paths based on their past

track records. A long-short portfolio strategy that takes advantage of the

information in past track records earns abnormal returns of roughly 11%

annually. Importantly, these past track records also predict divergent

future real outcomes in patents, patent citations, and new product

innovations.

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Corporate finance variables affect asset prices

− The “fundamental value” approach

𝑝𝑝 = ∑𝑡𝑡∞𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹


Any var that affects CF should be priced

− The “CAPM” approach: non-idiosyncratic risks should bepriced

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The “CAPM” approach: three recent examples

− Price flexibility− Weber (2016) “Nominal Rigidities and Asset Pricing”: sticky

prices can reduce profit, in particular during downturn

− Human capital and asset pricing− Labor saving techno (Zhang, 2016)

− Hiring frictions (Belo et al. 2016)

− Import penetration− Barrot, Loualiche and Sauvagnat (2016): “The Globalization

Risk Premium”. High exposure industries to tariff cut have a

higher cost of capital

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Be careful though

− Harvey, C. R., Liu, Y., & Zhu, H. (2015) . . . . and theCross-Section of Expected Returns. Review of FinancialStudies

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The plan




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Impact on corporate finance variables

1. Capital structure− Market timing

− Debt: firms as liquidity / maturity providers

− Equity

− Implicit assumption: rational managers / biased market

2. Investment− Financial channel

− Pressure channel

− learning

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− Equity




− learning

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Capital structure: ``benevolent CFOs’’

− Baker and Wurgler (2002): weighted average of past M-B has high determinant of leverage why?

− Stock overvalued equity issues lower leverage

− Compute historical overvaluation

− Baker, Greenwood and Wurgler (2003): when firms issuemore long term debt, future cost of LT vs ST is low

Debt maturity timing (Greenwood, Hanson and Stein,2010

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Capital structure: ``benevolent CFOs’’

− Firms as macro liquidity providers− Government always first in long maturities

− If gov chooses LT firms issue more ST

− Corporations “fill the gap” (DSSW model. Firms are the

sophisticated liquidity providers)

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− Equity




− learning

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Is the stock market a side-show?

− Financing channel: cost of capital− Baker et al., 2003

− Pressure channel (Stein, 1988, 1989)− Big debate: are private firms less myopic than listed firms?

− Learning: 𝑝𝑝 = ∑𝑡𝑡∞𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹


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− Financing

− Pressure

− Learning

Financing channel

− Assumption: CEOs / CFOs are able to “time the market”− Baker and Wurgler (2002)

− Baker et al. 2003: “overvaluation” capex forconstrained firms

− Kahn, Kogan, Serafeim (2012): firms issues SEOs whenMB increase because of mutual fund trading

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− Financing

− Pressure

− Learning

Pressure channel

− CEOs try to manipulate the stock price (cut capex / R&Dto boost short-term earning reduction in future profits)

Basic critic for why it should not matter?

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Pressure channel: stock price manipulation

− Bhojraj, S., Hribar, P., Picconi, M., and McInnis, J.(2009). Making Sense of Cents: An Examination of FirmsThat Marginally Miss or Beat Analyst Forecasts. Journalof Finance

− Firms that just "beat" analyst forecast likely to manipulate

(SR)

− Firms that just "missed" analyst forecast likely to not care

(LR)

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− Data− Analysts’ earning forecasts: IBES

− Recently used to measure expectation stickiness à la Coibion and

Gorodnichenko (2012): Bouchaud et al. (2016)

− Other forecasts available

− Can be matched with CRSP and Compustat

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Extra mass

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Short term gain

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Long term loss

Similar result for profitability

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Firms that “beat” forecast experienced a drop in ROA

Pressure channel: the private vs listed firm debate

− The classic setting:

𝐼𝐼𝐼𝐼𝐼𝐼𝑖𝑖𝑡𝑡 = 𝐼𝐼𝐼𝐼𝐼𝐼.𝑂𝑂𝑝𝑝𝑝𝑝𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝐼𝐼𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 × 𝐿𝐿𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝐿𝐿𝑖𝑖𝑡𝑡 + 𝛼𝛼𝑖𝑖 + 𝛿𝛿𝑡𝑡

− Potential problem?

− First suggested solution: look at ``switcher’’ intuition?Remaining problem?

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Bank risk-taking and pressure to maximize ST earnings

− Falato, A., & Scharfstein, D. (2016). The Stock Marketand Bank Risk-Taking. NBER Working Paper, (22689).

− Focus on short-term stock prices rather than long-run value

induces financial institutions to increase the risk they take

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Bank risk-taking and pressure to maximize ST earnings

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Strange? Alternative explanation?

Debate differences in behaviors listed / private for investment

− Asker, J., Farre-Mensa, J., & Ljungqvist, A. (2015).Corporate Investment and Stock Market Listing: APuzzle? Review of Financial Studies,

VS

− Maskimovic, Phillips and Yang (2018) Do Public FirmsRespond to Industry Opportunities More than PrivaFirms? The Impact of Initial Firm Quality, WP

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Private and public are potentially two very different animals

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Getting there...

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Baseline spe

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S = sale

Z = operating income

Why Z x Public? Why not just Z alone?Interpretation of single term Z here?

Why Z and S alone but not Public?

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Interpretation?

Remaining Problems? Solutions?

Testing reflexes: what to check in this table?

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Debate: MPY 2018

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Unconditionally, public firms are bigger and more productive than private firms

Comparison with AFL

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Noticeable facts?

Total EmpWage

(in $000) Firm Age Sales/Emp

Growth(last 3 years)

Growth (next 3 Years)

Public Unmatched 25703 45 21 10768 0.084 0.011Public Matched 2479 62 17 2666 -0.104 -0.099Private Matched 1343 43 17 1553 0.037 -0.008Private Unmatched 22 29 12 135 0.000 0.000

Probability of Being Public and Subsequent Size

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Top 1% Firms: Public vs. Private

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Initial Size and Subsequent Size

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050

010

0015

00Em

ploy

men

t

1 3 5 7 9 11 13 15Age

P1 to P99 P99 to P100

By Initial Size

Initial Size and Subsequent Growth

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02

46

810

Cum

Gro

wth

1 3 5 7 9 11 13 15Age

P1 to P99 P99 to P100

By Initial Size


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− Financing

− Pressure

− Learning

Learning

− Managers have imperfect information about growthopportunities

− Can gather information internally (i.e., within the firm) orexternally (i.e., looking for signals)

− Possible external source: stock prices

− But: stock prices are noisy signals and managers canhave imperfect ability to extract the info from the signal

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Learning

− Wurgler, J. (2000). Financial markets and the allocationof capital. Journal of Financial Economics, 58(1-2), 187–214

− Stock price depends on− Aggregate shock: “price synchronicity” (Morck et al. 2000)

− Specific info about future CF / demand marginal Q

is the stock market able to “channel” resources to moreefficient firms?

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Learning

− For country c, industry i, time t (V=value added):

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− Does the country increase investment in growingindustries?

Learning

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Still don’t know why exactly

Learning: stock price informativeness

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Learning: stock price informativeness

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− Remaining problems?

Learning: shock on noise

− Learning: most interested channel as:− Affect both listed and private firms

− Effect even if:

− Good corporate governance (≠ pressure channel)

− No credit constraints (≠ financing channel)

− Dessaint, Fresard, Foucault, Matray (2018)

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The plan




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Institutional Investors: the past / present / future (?)

− The classic: institutional investors as a proxy forcorporate governance

𝑌𝑌𝑖𝑖𝑡𝑡 = 𝑆𝑆𝑆𝑆𝑆𝑂𝑂𝑂𝑂 𝑆𝑆𝑂𝑂𝑂𝑂𝑆𝑆𝑆𝑆 𝐼𝐼𝐼𝐼𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑖𝑖𝑡𝑡 + 𝛼𝛼𝑖𝑖 + 𝛿𝛿𝑡𝑡

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Issues?

Solution:Index inclusion (e.g. Crane, Michenaud and Weston

(2016) "The Effect of Institutional Ownership on Payout

Policy: Evidence from Index Thresholds”, RFS)


− The ``refinement’’: not all investors are created equal− measure of investor horizon

𝑌𝑌𝑖𝑖𝑡𝑡 = % 𝐿𝐿𝐿𝐿 𝐼𝐼𝐼𝐼𝐼𝐼𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑖𝑖𝑡𝑡 + % 𝑆𝑆𝑂𝑂𝑂𝑂𝑆𝑆𝑆𝑆 𝐼𝐼𝐼𝐼𝐼𝐼𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑖𝑖𝑡𝑡 + 𝛼𝛼𝑖𝑖 + 𝛿𝛿𝑡𝑡

− How % LT Investors is identified? Why do you need %Investors?

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− Measuring investor horizon from 13-f:− Churn rate

− Example of papers:− Aghion, P., Van Reenen, & Zingales, L. (2013). Innovation and

institutional ownership. AER

− “In between” (use only % institutional investors)

− Derrien, F., Kecskés, A., & Thesmar, D. (2013). Investor Horizons and

Corporate Policies. JFQA = When a firm is undervalued, greater long-

term investor ownership is associated with more investment, more

equity financing, and less payouts to shareholders

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Institutional Investors: the future (?)

− Koijen and Yogo (2016):− Institutional investors have stable preferences shock to

inflows / outflows might have an impact on the supply of

capital for different regions / sectors

− But where changes in savings are coming from?

− Price impact of stock issuance strongly vary both in the x-

section and the time series effect on firm ability to finance

investment? Effect on incentive to go public? Impact on

elasticity between debt vs equity issuance and impact of

negative credit shock?

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