Structural and Empirical Corporate Finance, Mergers and Acquisitions, Corporate Investment, Corporate Governance, Banking, Financial Intermediation, Macro-finance, Innovation and Growth.
Style Over Substance? Advertising, Innovation, and Endogenous Market Structure
with Laurent Cavenaile, Murat Alp Celik, and Pau Roldan-Blanco.
Conferences and Seminars: AFA 2023 Annual Meeting, SED Annual Meeting, NFA 2021, FMA 2021 (Semi-finalist, Best Paper Award in Corporate Finance), Banco de España 4th Annual Research Conference, CMSG 2021, Econometric Society Winter Meeting 2021, CEA 2022, BSE Summer Forum, EARIE 2022, MMF 2022.
Abstract: Firms use both innovation and advertising to increase their profits, markups, and market shares. While these two investments serve the same purpose from the firms' perspective, their broader implications vary substantially. In this paper, we study the interaction between these two intangible inputs and analyze the implications for competition, industry dynamics, economic growth, and social welfare. To this end, we develop an oligopolistic general-equilibrium growth model with firm heterogeneity in which market structure is endogenous, and firms' production, innovation, and advertising decisions interact strategically. We estimate the model to fit the non-linear relationship between innovation, advertising, and market share observed in the data. We find that advertising has significant macroeconomic effects: it improves static allocative efficiency through reducing misallocation, but it also depresses economic growth through a substitution effect with R\&D. On the net, advertising is found to be welfare-improving. It is responsible for one quarter of the observed average net markup and its dispersion. We next study the optimal linear taxation/subsidization of advertising. We find that the optimal advertising tax is quite high. Such taxation could simultaneously increase dynamic efficiency, contain excessive spending on advertising due to an inefficient rat race between firms, and raise revenue while still maintaining most of the benefits of advertising via improving efficiency in resource allocation.
Keywords: innovation, advertising, markups, growth, industry dynamics, misallocation, business dynamism.
Identifying the Heterogeneous Impact of Highly Anticipated Events Using Options: Evidence from the Tax Cuts and Jobs Act
with Paul Borochin, Murat Alp Celik, and Toni M. Whited.
Conferences and Seminars: WFA Meeting 2023 (scheduled), SFS Cavalcade 2022 North America, AEA 2022, FMA 2021 (Semi-finalist, Best Paper Award in Investment).
Abstract: We develop a method for estimating individual firm heterogeneity in the stock market impact of aggregate events, using data on both stock and options prices. Our method impounds the effects of event anticipation. We apply the method to the passage of the Tax Cuts and Jobs Act (TCJA), which exhibits both anticipation and heterogeneity. We estimate that the market anticipated the probability of passage to be 95% 30 days before the event. The full value impact of the TCJA is 12.36%, compared to 0.68% when market anticipation is ignored. Large, innovative firms with high growth prospects are the largest winners.
Keywords: event study, market anticipation, options, tax policy, innovation.
Investor Demand, Firm Investment, and Capital Misallocation, with Jaewon Choi, Yufeng Wu, and Mahyar Kargar.
Conferences and Seminars: WFA Meeting 2022, AFA 2023 Annual Meeting, MFA Meeting 2023, ITAM Finance Conference 2023, Federal Reserve Board, Texas A&M University, University of Florida.
Abstract: Fluctuations in investor demand dramatically affect firms' valuation and access to capital. To quantify their real impacts, we develop a dynamic investment model that endogenizes the demand- and supply-side of equity capital. Strong demand dampens price impacts of issuance, facilitating investment and financing, while weak demand encourages opportunistic repurchases, crowding out investment. We estimate the model using indirect inference by matching the endogenous relationship between investor demand and firm policies. Our estimation suggests that investor demand is an important driver of misallocation, compared with financial and real frictions and heterogeneous risk premia. Eliminating excess demand reduces dispersion in the marginal product of capital by 23.8% and productivity losses by 22.3%. With demand fluctuations, firms hold higher cash savings and tend to be larger---excess demand allows firms with financial market power to profit from financial market transactions, contributing to the emergence of superstar firms.
Keywords: investor demand, capital misallocation, investor sentiment, demand estimation, firm investment, financial market power.
Voluntary or Forced CEO Turnover? Asymmetric Information, Disclosure Strategies, and Market Reactions
with Kose John, Y. Christine Liu, and Haofei Zhang.
Conferences and Seminars: FARS Midyear Meeting, NFA, CAAA Annual Conference, Hawaii Accounting Research Conference.
Abstract: Using a hand-collected sample of 1419 CEO turnover announcements gathered from Factiva News, we study the market reaction to CEO turnover announcements in the presence of information frictions. We find that the market reaction to forced CEO turnovers tends to be negative when the level of asymmetric information between corporate insiders and its investors is high. For voluntary CEO turnovers, the market reaction is negligible and is unrelated to the level of asymmetric information. We also find that in cases where information asymmetry is high, companies attempt to disclose forced turnovers as voluntary and this elicits a less negative market response. Overall, our results suggest that firms act strategically when disclosing information about CEO turnover to avoid a negative market reaction. The existing degree of asymmetric information combined with strategic disclosure by firms produce the equilibrium announcement effect of CEO turnovers.
Keywords: CEO turnover, information asymmetry, corporate governance, information disclosure, market reaction.
Are Markups Too High? Competition, Strategic Innovation, and Industry Dynamics, with Laurent Cavenaile and Murat Alp Celik.
Revise and resubmit, Review of Economic Studies.
Conferences and Seminars: MWM 2019, CEPR 2019, SED 2021, NBER Summer Institute, NFA 2021, RCEA Growth, Innovation and Entrepreneurship Conference, Virtual Growth and Innovation Seminar Series.
Abstract: In the last four decades, the U.S. witnessed significant changes in firm dynamics within and across industries. Industries are increasingly dominated by a small number of large firms ("superstars''). Markups, market concentration, profits, and R&D spending are increasing, whereas business dynamism, productivity growth, and the labor share are in decline. We develop a unified framework to explore the underlying economic mechanisms driving these changes, and the implications for economic growth and social welfare. The model combines a detailed oligopolistic competition model featuring endogenous entry and exit with a new Schumpeterian growth model. Within each industry, there are an endogenously determined number of superstars that compete a la Cournot and a continuum of small firms which collectively constitute a competitive fringe. Firms dynamically choose their innovation strategy, cognizant of other firms' choices. The model is consistent with the changes in the macroeconomic aggregates, and it replicates the observed hump-shaped relationship between innovation and competition within and across industries. We estimate the model to disentangle the effects of separate mechanisms on the structural transition, which yields striking results: (1) While the increase in the average markup causes a significant static welfare loss, this loss is overshadowed by the dynamic welfare gains from increased innovation in response to higher profit opportunities. (2) The decline in productivity growth is largely driven by the increasing costs of innovation, i.e. ideas are getting harder to find.
Keywords: innovation, markups, growth, strategic investment, industry dynamics, business dynamism.
Do Financial Frictions Explain Chinese Firms' Saving and Misallocation? NBER WP NO. 24436, with Yan Bai and Dan Lu.
Revise and resubmit, American Economic Journal: Macroeconomics.
Conferences and Seminars: China Meeting of Econometric Society, World Congress of Comparative Economics, SED Annual Meeting, CEA Annual Meeting, Econometric Society Annual Meeting.
Abstract: We use firm-level data to identify financial frictions in China and explore the extent to which they can explain firms' saving and capital misallocation. We first document the features of the data in terms of firm dynamics and debt financing. State-owned firms have higher leverage and pay much lower interest rates than non-SOEs. Among privately owned firms, smaller firms have lower leverage, face higher interest rates, and operate with a higher marginal product of capital. We then develop a heterogeneous firm model with endogenous borrowing constraints rising from default risk and fixed costs of issuing loans. Using evidence on the firm size distribution and financing patterns, we estimate the model and find it can explain aggregate firms' saving and investment and around 50 percent of the dispersion in the marginal product of capital within private firms, which translates into a TFP loss as high as 12%.
Keywords: financial frictions, firms debt financing, capital misallocation, saving and investment.
Acquiring Innovation Under Information Frictions, with Murat Alp Celik and Wenyu Wang.
Review of Financial Studies, 2022, 35(10): 4474-4517.
Conferences and Seminars: SFS Cavalcade 2020 North America, NFA 2020, SED 2021.
Abstract: Acquiring innovation through M&A is subject to information frictions, as acquirers find it challenging to assess the value of innovative targets. We find an inverted U-shaped relation between firm innovation and takeover exposure; equity usage increases with target innovation; and deal completion rate drops with innovation. We develop and estimate a model of acquiring innovation under information frictions, featuring endogenous merger, innovation, and offer composition decisions. Our estimates suggest that acquirers' due diligence reveals only 30% of private information possessed by targets. Eliminating information frictions increases capitalized merger gains by 59%, stimulates innovation, and boosts productivity, business dynamism, and social welfare.
Keywords: information frictions, adverse selection, innovation, M&A.
Agency Frictions, Managerial Compensation, and Disruptive Innovations, with Murat Alp Celik.
Review of Economic Dynamics, forthcoming.
Conferences and Seminars: SED 2018, CICF 2018 , MWM 2018, CEF 2018 , CICM 2018, Princeton Growth Conference, Bank of Italy-CEPR- EIEF Conference, SFS Cavalcade 2020 North America; Coverage: Columbia Law School's Blog on Corporations and the Capital Markets
Abstract: Whether a manager leads the innovation efforts of a firm in line with shareholder preferences has a substantial impact on the firm's market value and growth. This in turn influences aggregate productivity growth and welfare. Using data on US public firms, we find that (i) firms with better corporate governance tend to adopt highly incentivized contracts rich in stock options and (ii) such contracts are more likely to lead to disruptive innovations -- patented inventions that are in the upper tail of the distribution in terms of quality and originality. We develop and estimate a new dynamic general equilibrium model of firm-level innovation with agency frictions and endogenous determination of executive contracts. The model is used to study the joint dynamics of corporate governance, managerial compensation, and disruptive innovations, as well as the consequent macroeconomic impact. Better corporate governance can reduce the influence of the manager in determination of the compensation structure. This leads to more incentivized contracts and boosts innovation, with substantial benefits for the shareholders as well as the broader economy through knowledge spillovers. Reducing agency frictions leads to an increase in long-run output growth, which translates into a significant welfare gain in consumption-equivalent terms. An extended model with short-term earnings pressure on the manager reveals that short-termism only slightly dampens the gains from reducing manager influence; it is quantitatively less detrimental in comparison; and alleviating both frictions at the same time leads to amplified gains in growth and welfare.
Keywords: agency frictions, corporate governance, innovation, managerial compensation, short-termism.
The Dynamic Effects of Antitrust Policy on Growth and Welfare, with Laurent Cavenaile and Murat Alp Celik.
Journal of Monetary Economics, 2021, 121: 42-59.
Abstract: Motivated by concerns regarding the lack of dynamic considerations in models of antitrust, we develop and estimate the first general equilibrium model with Schumpeterian innovation, oligopolistic product market competition, and endogenous M&A decisions to shed light on the dynamic effects of antitrust policy on growth and welfare. The estimated model reveals that: (1) Existing policies generate moderate gains in growth and welfare. (2) Strengthening antitrust enforcement could deliver substantially higher gains. (3) The dynamic long-run effects of antitrust policy on social welfare are an order of magnitude larger than the static gains from higher allocative efficiency in production. (4) Current HHI-based antitrust rules leave the majority of anticompetitive acquisitions undetected, highlighting the need for alternative guidelines. Overall, our results suggest that the long-run impact on innovation policy and aggregate productivity growth should receive much higher consideration in the design of antitrust policies.
Keywords: antitrust policy, M&A, innovation, growth, social welfare.
Uncertainty and the Shadow Banking Crisis: Estimates from a Dynamic Model
Management Science, 2022, 68(2): 1469-1496.
Abstract: Shadow banks play an important role in the modern financial system and are arguably the source of key vulnerabilities that led to the 2007-2009 financial crisis. I develop a quantitative framework with uncertainty fluctuations and endogenous bank default to study the dynamics of shadow banking. I argue that the increase in asset return uncertainty during the crisis results in a spread spike, making it more costly for shadow banks to roll over their debt in the short-term debt market. As a result, these banks are forced to deleverage, leading to a decrease in credit intermediation. The model is estimated using a bank-level dataset of shadow banks in the United States. The parameter estimates imply that uncertainty shocks can explain 72% of asset contraction and 70% of deleveraging in the shadow banking sector. Maturity mismatch and asset fire-sales amplify the impact of the uncertainty shocks. First-moment shocks to bank asset return, financial shocks, or fire-sale cost shocks alone can not reproduce the large interbank spread spike, dramatic deleveraging or contraction in the U.S. shadow banking sector during the crisis. The model also allows for policy experiments. I analyze how unconventional monetary policies can help to counter the rise in the interbank spread, thus stabilizing the credit supply. Taking bank moral hazard into consideration, I find that government bailout might be counterproductive as it might result in more aggressive risk-taking among shadow banks, especially when bailout decisions are based on bank characteristics.
Keywords: shadow banking, uncertainty, firesale, maturity mismatch, unconventional monetary policy, moral hazard.
Debt and Recession: Is It Banks, Households, or Both? [PDF available upon request] Slides, with Stephen Cecchetti and Tommaso Mancini-Griffoli.
Abstract: Recessions that follow periods of high credit growth tend to be longer and deeper than those that don’t. But why? Is it because banks’ balance sheets become highly levered, so deleveraging creates more severe credit constraints? Or, is it that households become so highly indebted that, when the recession comes, there is a large debt overhang that stifles consumption and investment? This paper investigates these two questions by examining the role of bank leverage and household indebtedness on the probability and severity of recessions using data from 17 countries over the 1970 to 2014 period. We find that the likelihood of a recession, as well as its length and depth, rises the higher leverage or the lower liquidity in the banking system. And, higher household debt makes recessions longer and deeper once they start, but does not increase the probability of a downturn in the first place. Furthermore, the relationship between severity and indebtedness, for both banks and households, is nonlinear, growing more quickly the higher the leverage. For banks, this effect has a threshold above which the impact on a recession’s length and depth is more dramatic. Finally, our analysis shows that heightened asset price volatility increases the probability of recessions when banking system are weak.
Keywords: leverage, liquidity, recession, depth, duration, nonparametric estimation.
Tax Credits, Firm Innovation and Cash Holding: Estimates from a Dynamics Model [PDF available upon request]
Abstract: R&D tax credits induce firms to engage more in innovative activities, reducing their asset tangibility and thus forcing them to keep higher cash stock to insure against financial distress cost. I build an endogenous growth model to study the joint dynamics of firm innovation and cash holding. In my model, a continuum of heterogeneous firms hold cash and long-term debt at the same time and engage in knowledge capital and physical capital investment. The increase of R&D stock limits external debt financing because it complicates contractibility problems by lowering the value that can be captured by creditors in default states. The model is estimated using data from both the Survey of Small Business Finance (SSBF) and Compustat. I find that R&D tax credits can explain 32% of the increase in cash holding. After considering the increased refinancing risk caused by the reduction of debt maturity, the explanatory power of R&D tax credits increase to 51%.
Keywords: R&D tax credit, firm innovation, cash holding, debt maturity, refinancing risk.