Economic Activity of Firms and Asset Prices

In this review we survey the recent research on the fundamental determinants of stock returns. These studies explore how firms' systematic risk and their investment and production decisions are jointly determined in equilibrium. Models with production provide insights into several types of empirical patterns, including (a) the correlations between firms' economic characteristics and their risk premia, (b) the comovement of stock returns among firms with similar characteristics, and (c) the joint dynamics of asset returns and macroeconomic quantities. Moreover, by explicitly relating firms' stock returns and cash flows to fundamental shocks, models with production connect the analysis of financial markets with the research on the origins of macroeconomic fluctuations

Time-varying managerial overconfidence and pecking order preference

This paper examines whether managerial overconfidence enhances or weakens pecking order preference. We construct time-varying managerial words-based (i.e. tone of Chairman’s Statement) and action-based (i.e. firm investment and directors’ trading) overconfidence measures. Both optimistic tone and industry-adjusted investment have significant and negative impacts on the pecking order coefficient in the Shyam-Sunder and Myers (J Financ Econ 51:219–244, 1999) regression framework. Overconfident managers tend to use more equity than debt to finance deficits. This new evidence is consistent with the proposition that overconfident managers who underestimate the riskiness of future earnings believe that their debt (equity) is undervalued (overvalued) and therefore prefer equity to debt financing. Thus, managerial overconfidence can lead to a reverse pecking order preference. We also find that managerial overconfidence significantly weakens pecking order preference especially in firms with high earnings volatility and small firms

International Capital Allocations and the Lucas Paradox Redux

This paper studies the marginal product of private capital (MPK) with new data and a new framework to obtain a better understanding of international capital allocations and the Lucas Paradox (LP). Our point of departure is three influential studies of MPK’s and, based on the most recently available data, the LP is either sustained, inverted, or rejected. We then introduce three improvements in measuring spot MPK’s, and the LP clearly reemerges. While these results are provocative, they may be misleading because they do not recognize the dynamics of the capital accumulation process toward steady-states. We develop and estimate a model that allows us to map spot MPK’s into steady-state MPK’s. The LP remains; the steady-state MPK’s for poor countries is 48% to 77% higher than for rich countries. Four policy implications follow from these estimates. First, there is a great deal of misallocated capital globally: 14% to 21% of the global capital stock. Second, this misallocation is primary due to the difference between country-specific steady-state MPK’s and the global MPK that would maximize world output. Third, the benefits of optimally reallocating capital and eliminating the LP are modest: 1.0% to 1.5% of global output or $873 to$1,309 billions of 2019 US dollars. Fourth, the estimates for both misallocation and reallocation depend crucially on the elasticity of substitution between capital and labor. Our empirical work uncovered three new puzzles that have emerged beginning in 1990, 1) the MPK’s for both poor and rich countries have been rising sharply, 2) the gap has been widening, and 3) the steady-state MPK’s exceed the average spot-MPK’s. The later result is inconsistent with the Dynamic Inefficiency, Saving Glut, or Secular Stagnation hypotheses

Markup cyclicality and input factor adjustments

Markups, Business cycles, Panel data, Adjustment costs, E32, D92,