Sovereign Credit Ratings, Transparency and International Portfolio Flows

We examine the response of equity mutual fund flows to sovereign rating changes in a wide sample of countries during the crisis prone years from 1996-2002. We find that Sovereign downgrades are strongly associated with outflows of capital from the downgraded country while improvements in a country’s sovereign rating are not associated with discernable changes in equity flows. Transparency, as proxied by the level of corruption matters: more transparent (i.e., less corrupt) countries experience smaller outflows around downgrades. Moreover, abnormal flows around downgrades are consistent with a ‘flight to quality’ phenomenon. That is, less corrupt non-event countries are net recipients of capital inflows, and these inflows increase with the severity of the cumulative downgrade abroad. The results remain after controlling for country size, legal traditions, market liquidity, crisis versus non-crisis periods. Taken together, the results suggest that increasing transparency could mitigate some of the perceived negative effects often associated with global capital flows

Refi nancing Risk and Cash Holdings.

Abstract: Although a firm's use of shorter-term debt can potentially help it to reduce agency costs of debt and align managers' interests with those of shareholders, the use of this type of debt increases the firm's refinancing risk. We hypothesize that firms with debt that has a shorter maturity hold larger cash reserves to reduce important costs they could incur if they have difficulty refinancing their debt. Using a simultaneous equations framework that accounts for the joint determination of cash holdings and debt maturity, we find that firms that shorten (lengthen) the maturity of their debt increase (decrease) their cash holdings. Additionally, we document that U.S. firms have markedly shortened the maturity of their debt over the 1980-2008 period and that this can explain a large fraction of the increase in the cash holdings of these firms over this period. We also show that the market value of a dollar of cash holdings is higher for firms whose debt has a shorter maturity. Further, the inverse associations between the maturity of a firm's debt with the level and market value of its cash holdings are more pronounced during periods when credit market conditions are tighter and refinancing risk is consequently higher. Finally, we show that larger cash holdings help to mitigate underinvestment problems resulting from refinancing risk. Overall, our findings suggest that refinancing risk is a key determinant of corporate cash holdings

Transparency and Liquidity: A Controlled Experiment on Corporate Bonds.

Abstract This paper reports the results of an experiment designed to assess the impact of last-sale trade reporting on the liquidity of BBB corporate bonds. Overall, adding transparency has either a neutral or positive effect on liquidity. Increased transparency is not associated with greater trading volume. Except for very large trades, spreads on newly-transparent bonds decline relative to bonds that experience no transparency change. However, we find no effect on spreads for very infrequently traded bonds. The observed decrease in transactions costs is consistent with investors' ability to negotiate better terms of trade once they have access to broader bond pricing data

Are Banks Still Special When There is a Secondary Market for Loans?

When a borrowing firm\u27s existing loans trade for the first time in the secondary loan market, it elicits a significant positive stock price response by the borrowing firm\u27s equity investors. We show that underlying this response is the impact of loan sales in alleviating a borrowing firm\u27s financial constraints. In particular, we show in a differences-in-differences framework that firms that are smaller, younger, without a bond rating or that are distressed are more likely to benefit from loan sales as compared to other borrowers. We also find that new loan announcements are associated with a positive stock price announcement effect even when prior loans made to the same borrower already trade on the secondary market. Overall, we conclude that the role of banks, in terms of their specialness to borrowers, has changed due to their ability to create an active secondary loan market while simultaneously maintaining their traditional specialness as monitors and information producers for outside agents

Can Ownership Restrictions Enhance Security Value? Evidence from a Natural Experiment

This paper examines the role of ownership restrictions in raising capital from niche clienteles. Extant literature suggests that limiting availability of securities to only certain classes of investors constricts demand, and hence decreases prices. We argue that ownership restrictions can have positive implications for prices when viewed in the overall context of security design. We provide empirical evidence through an in-depth analysis of a natural experiment: multiple events of capital raising by an emerging market company with ownership restrictions, namely $4.2 billion and$5.5 billion of bonds offered by India\u27s largest bank, State Bank of India exclusively to Indians living abroad at approximately 150 basis points below comparable benchmarks leading to a bottom line savings of $1.08 billion. This is an intriguing issue because it raises the question, how can an emerging market issuer with junk bond ratings obtain such yields? We argue that ownership restrictions can lead to value enhancement as well as value transfer from holders of other securities. Ownership restrictions can enhance value by circumventing the deadweight costs of prolonged negotiations, particularly when a security is restricted to a homogenous clientele that values the underlying collateral higher than other investors. Restricting the ownership further ensures that investment is limited to a homogenous class of investors that the issuer cares about. It thus serves as a precommitment to ensuring an efficient ex-post renegotiation in the potential default states, resulting in a lower ex-ante offering yield (and a higher offer price). This can result in an implicit seniority of holders of these restricted bonds vis-a-vis holders of unrestricted bonds. We empirically test and find support for both value enhancement as well as for value transfer from ownership restrictions. In particular, we find evidence of a transfer of wealth from existing holders of foreign currency denominated bonds of other Indian firms. However, the implicit seniority accounts for some but not all the difference in yields suggesting that ownership restrictions also enhance value through other avenues such as higher collateral valuation and lower renegotiation costs. Overall, our results suggest that firms with niche clienteles can benefit from designing securities with ownership restrictions, by offering new securities exclusively to investors who value them the most

CEO Compensation and Risk-Taking at Financial Firms: Evidence from U.S. Federal Loan Assistance

We examine whether risk-taking among the largest financial firms in the U.S. is related to CEO equity incentives before the 2008 financial crisis. Using data on U.S. Federal Reserve emergency loans provided to these firms, we find that the amount of emergency loans and total days the loans are outstanding are increasing in pre-crisis CEO risk-taking incentives – “vega.” Our results are robust to accounting for endogeneity in CEO equity incentives and selection of financial firms into emergency loan programs. We also rule out the possibility that our results are driven by a bank’s funding base, bank complexity, CEO overconfidence, or matching of CEOs to select banks. We conclude that equity incentives (vega) embedded in CEO compensation contracts were positively associated with risk-taking in financial firms which resulted in potential solvency problems. We also find some evidence, although somewhat weaker, that higher incentive alignment (“delta”) mitigated such problems in those financial firms

Sovereign Credit Ratings, Transparency and International Portfolio Flows

We examine the response of equity mutual fund flows to sovereign rating changes in a wide sample of countries during the crisis prone years from 1996-2002. We find that Sovereign downgrades are strongly associated with outflows of capital from the downgraded country while improvements in a country’s sovereign rating are not associated with discernable changes in equity flows. Transparency, as proxied by the level of corruption matters: more transparent (i.e., less corrupt) countries experience smaller outflows around downgrades. Moreover, abnormal flows around downgrades are consistent with a ‘flight to quality’ phenomenon. That is, less corrupt non-event countries are net recipients of capital inflows, and these inflows increase with the severity of the cumulative downgrade abroad. The results remain after controlling for country size, legal traditions, market liquidity, crisis versus non-crisis periods. Taken together, the results suggest that increasing transparency could mitigate some of the perceived negative effects often associated with global capital flows.

Shareholder Initiated Class Action Lawsuits: Shareholder Wealth Effects and Industry Spillovers

This paper documents significantly negative stock price reactions to shareholder initiated class action lawsuits. We find that shareholders partially anticipate these lawsuits based on lawsuit filings against other firms in the same industry and capitalize part of these losses prior to a lawsuit filing date. We show that the more likely a firm is to be sued, the larger is the partial anticipation effect (shareholder losses capitalized prior to a lawsuit filing date) and smaller is the filing date effect (shareholder losses measured on the lawsuit filing date). Our evidence suggests that previous research that typically focuses on the filing date effect understates the magnitude of shareholder losses, and such an understatement is greater for firms with a higher likelihood of being sued

Sovereign Credit Ratings, Transparency and International Portfolio Flows

We examine the response of equity mutual fund flows to sovereign rating changes in a wide sample of countries during the crisis prone years from 1996-2002. We find that Sovereign downgrades are strongly associated with outflows of capital from the downgraded country while improvements in a country’s sovereign rating are not associated with discernable changes in equity flows. Transparency, as proxied by the level of corruption matters: more transparent (i.e., less corrupt) countries experience smaller outflows around downgrades. Moreover, abnormal flows around downgrades are consistent with a ‘flight to quality’ phenomenon. That is, less corrupt non-event countries are net recipients of capital inflows, and these inflows increase with the severity of the cumulative downgrade abroad. The results remain after controlling for country size, legal traditions, market liquidity, crisis versus non-crisis periods. Taken together, the results suggest that increasing transparency could mitigate some of the perceived negative effects often associated with global capital flows.