Structural and Empirical Corporate Finance, Banking, Financial Intermediation, Macro-finance, Mergers and Acquisitions, Corporate Investment, Corporate Governance, and Risk Management.
Agency Frictions, Managerial Compensation, and Disruptive Innovations, with Murat Alp Celik
Conference Presentation: SED 2018, CICF 2018 , MWM 2018, CEF 2018 , CICM 2018, Princeton Growth Conference, Bank of Italy-CEPR- EIEF Conference, SFS Cavalcade 2020; 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. 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.
Acquiring Innovation Under Information Frictions, with Murat Alp Celik and Wenyu Wang
Revise and resubmit, The Review of Financial Studies.
Conference Presentation: SFS Cavalcade 2020 North America,NFA 2020,SED 2020(scheduled)
Abstract: An active M&A market incentivizes many firms to specialize in innovation with the anticipation of being acquired in the future. Acquiring innovation, however, is subject to information frictions, because acquirers often find it challenging to assess the value and impact of innovative targets. Using data on US public firms, we document that (1) there is a robust inverted U-shaped relation between a firm's innovation and its takeover exposure; (2) equity usage increases with target innovation, and (3) deal completion rate drops as targets become more innovative. Motivated by these findings, we develop and estimate a model of acquiring innovation under information frictions. Our estimates suggest that acquirers' due diligence reveals only 33% of private information possessed by targets, and eliminating the remaining information frictions can increase firms' expected gains from the M&A market by 36%. This efficiency gain is achieved through a higher probability of mergers and larger value creation in completed transactions. We also find that a more efficient M&A market encourages more firm innovation, resulting in higher firm productivity growth and business dynamism. Firm size distribution becomes more polarized and the fraction of superstar firms increases.
Keywords: information frictions, adverse selection, innovation, M&A.
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.
Conference Presentation: China Meeting of Econometric Society 2014, World Congress of Comparative Economics 2015, SED 2016, CEA 2016, 2017 Econometric Society
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.
Accepted, Management Science.
Conference Presentation: MWM Spring 2015, GCER 2015, 2015 FMA, 2015 MMF, MWM Fall 2015, RES PhD Meeting 2016, RES Conference 2016, FIRS 2016, SITE 2017
Abstract: Shadow 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.
The Dynamic Effects of Antitrust Policy on Growth and Welfare, with Laurent Cavenaile and Murat Alp Celik.
Journal of Monetary Economics, Carnegie-Rochester-NYU Conference on Public Policy, 2020
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.
Are Markups Too High? Competition, Strategic Innovation, and Industry Dynamics, with Laurent Cavenaile and Murat Alp Celik.
Conference Presentation: MWM 2019,CEPR 2019,SED 2020(scheduled),NBER SI.
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.
CEO Turnover Annoucement and Information Frictions, with Kose John, Y. Christine Liu, and Haofei Zhang.
Abstract: This paper analyzes the market reaction to CEO turnover announcements in the presence of information frictions. We find that the market reaction to forced CEO turnover announcements is negatively related to the level of asymmetric information between a firm and its investors. No such relation exists for voluntary turnovers. We also find that in cases where information frictions are high, companies attempt to present forced turnover as voluntary and this behavior leads to 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.
Keywords: CEO turnover, information asymmetry, corporate governance, information disclosure, market reaction.
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.
Identifying the Impact of Highly Anticipated Events Using Options: Evidence from the Tax Cuts and Jobs Act
with Paul Borochin, Murat Alp Celik, and Toni Whited.
Abstract: Many event studies only measure a fraction of an event's full value effect because they do not adjust for market anticipation of the event. The market's reaction at event resolution can be misleading, particularly in the case of a very high degree of market anticipation. Large, or even full, anticipation by market participants means that virtually all of the impact of the event becomes impounded in prices before the event's actual occurrence, and any remaining signal regarding the relative value effects for individual firms may be swamped by noise introduced into prices by liquidity trades. We present an alternative method based on stock and options prices to estimate the full value effect that takes into account market anticipation and is robust to the possibility of the event being good news for some firms and bad for others without specifying which is which ahead of time. We apply the method to the passage of Tax Cuts and Jobs Act (TCJA), which exhibits both properties. Our method estimates the probability of TCJA is already as high as 95% 30 days before the event occurred. The full value impact of TCJA is found to be 12.36%, compared to 0.68% when market anticipation is ignored. The firm-level impact of TCJA is considerably heterogeneous. We investigate what firm characteristics predict winners and losers from the TCJA, and find that large and innovative firms with high growth prospects turn out to be the largest winners.
Keywords: event study, market anticipation, options, tax policy, innovation.