Corporate Finance

November 4, 2016
Malcolm Baker and Samuel Hanson, both of Harvard University, Organizers


Jason R. Donaldson, Washington University in St Louis; Denis Gromb, INSEAD; and Giorgia Piacentino, Washington University in St. Louis

The Paradox of Pledgeability

In this paper, Donaldson, Gromb, and Piacentino develop a model in which collateral serves to protect creditors from the claims of competing creditors. The researchers find that borrowers rely most on collateral when cash flow pledgeability is high, because this is when it is easy to take on new debt, diluting existing creditors. Creditors thus require collateral for protection against being diluted. This causes a collateral rat race that results in all borrowing being collateralized. But collateralized borrowing has a cost: it encumbers assets, constraining future borrowing and investment, i.e. there is a collateral overhang. The researchers' results suggest that increasing the supply of collateral can have adverse effects.

Marco Di Maggio, Harvard University and NBER; Amir Kermani, University of California at Berkeley and NBER; and Christopher Palmer, University of California at Berkeley

How Quantitative Easing Works: Evidence on the Refinancing Channel (NBER Working Paper No. 22638)

Despite massive large-scale asset purchases (LSAPs) by central banks around the world since the global financial crisis, there is a lack of empirical evidence on whether and how these programs affect the real economy. Using rich borrower-linked mortgage-market data, Di Maggio, Kermani, and Palmer document that there is a "flypaper effect" of LSAPs, where the transmission of unconventional monetary policy to interest rates and (more importantly) origination volumes depends crucially on the assets purchased and degree of segmentation in the market. For example, QE1, which involved significant purchases of GSE-guaranteed mortgages, increased GSE-eligible mortgage originations significantly more than the origination of GSE-ineligible mortgages. In contrast, QE2's focus on purchasing Treasuries did not have such differential effects. The researchers find that the Fed's purchase of MBS (rather than exclusively Treasuries) during QE1 resulted in an additional $600 billion of refinancing, substantially reducing interest payments for refinancing households, leading to a boom in equity extraction, and increasing consumption by an additional $76 billion. This de facto allocation of credit across mortgage market segments, combined with sharp bunching around GSE eligibility cutoffs, establishes an important complementarity between monetary policy and macroprudential housing policy. The researchers' counterfactual simulations estimate that relaxing GSE eligibility requirements would have significantly increased refinancing activity in response to QE1, including a 20% increase in equity extraction by households. Overall, the results imply that central banks could most effectively provide unconventional monetary stimulus by supporting the origination of debt that would not be originated otherwise.

Sumit Agarwal, Georgetown University; Souphala Chomsisengphet, Office of the Comptroller of the Currency; Johannes Stroebel, New York University and NBER; and Neale Mahoney, University of Chicago and NBER

Do Banks Pass Through Credit Expansions to Consumers Who Want To Borrow? Evidence from Credit Cards (NBER Working Paper No. 21567)

Agarwal, Chomsisengphet, Stroebel, and Mahoney propose a new approach to studying the pass-through of credit expansion policies that focuses on frictions, such as asymmetric information, that arise in the interaction between banks and borrowers. The researchers decompose the effect of changes in banks' shadow cost of funds on aggregate borrowing into the product of banks' marginal propensity to lend (MPL) to borrowers and those borrowers' marginal propensity to borrow (MPB), aggregated over all borrowers in the economy. The researchers apply this framework by estimating heterogeneous MPBs and MPLs in the U.S. credit card market. Using panel data on 8.5 million credit cards and 743 credit limit regression discontinuities, they find that the MPB is declining in credit score, falling from 59% for consumers with FICO scores below 660 to essentially zero for consumers with FICO scores above 740. The researchers use a simple model of optimal credit limits to show that a bank's MPL depends on a small number of "sufficient statistics" that capture forces such as asymmetric information, and that can be estimated using credit limit discontinuities. For the lowest FICO score consumers, higher credit limits sharply reduce profits from lending, limiting banks' optimal MPL to these consumers. The negative correlation between MPB and MPL reduces the impact of changes in banks' cost of funds on aggregate household borrowing, and highlights the importance of frictions in bank-borrower interactions for understanding the pass-through of credit expansions.

Hong Ru, Nanyang Technological University, and Antoinette Schoar, MIT and NBER

Do Credit Card Companies Screen for Behavioral Biases? (NBER Working Paper No. 22360)

This paper analyzes the supply side of credit card markets, and the pricing and marketing strategies of issuers. First, Ru and Schoar show that card issuers target less-educated customers with more steeply back-loaded and more hidden fees (e.g., lower introductory APRs but higher default APRs, late fees, and over-limit fees) compared to offers made to educated customers, holding constant other borrower characteristics. Second, issuers use rewards programs to screen for unobservable borrower types. Finally, the researchers show that card issuers seem to trade-off short term maximization of fees versus increases in credit risk, when using back-loaded and hidden fees. The researchers use increases in state-level unemployment insurance as a shock to household creditworthiness and show that card issuers rely more heavily on back-loaded and hidden fees when customers are less exposed to negative cash flow shocks, especially for less-educated customers.


Olivier Dessaint, University of Toronto; Thierry Foucault, HEC School of Management; Laurent Frésard, University of Maryland; and Adrien Matray, Princeton University

Ripple Effects of Noise on Corporate Investment

Dessaint, Foucault, Frésard, and Matray show that firms reduce their investment in response to non-fundamental drops in the stock price of their product-market peers. This spillover is economically significant and consistent with the hypothesis that managers rely on stock prices as a source of information but cannot perfectly filter out the noise in these prices (the faulty informant hypothesis). As predicted by this hypothesis, the influence of the noise in peers' stock prices on a firm's investment is stronger when peers prices are more informative, and weaker when managers are better informed. These findings suggest a new channel through which local non-fundamental shocks to the market valuation of a group of firms have real effects for other firms.

Jean-Noel Barrot, MIT, and Ramana Nanda, Harvard University and NBER

Can Paying Firms Quicker Affect Aggregate Employment? (NBER Working Paper No. 22420)

In 2011, the federal government accelerated payments to their small business contractors, spanning virtually every county and industry in the US. Barrot and Nanda study the impact of this reform on county-sector employment growth over the subsequent three years. Despite firms being paid just 15 days sooner, the researchers find payroll increased nearly 10 cents over three years for each accelerated dollar of sale, with two-thirds of the effect coming from an increase in new hires and the balance from an increase in earnings. Importantly, however, the researchers document substantial crowding out of nontreated firms employment, particularly in counties with low rates of unemployment. The researchers' results highlight an important channel through which financing constraints can be alleviated for small firms, but also emphasize the general-equilibrium effects of large-scale interventions, which can lead to a substantially lower net impact on aggregate outcomes.


Yael Hochberg, Rice University and NBER; Aleksander Andonov, Erasmus University; and Joshua Rauh, Stanford University and NBER

Political Representation and Governance: Evidence from the Investment Decisions of Public Pension Funds

Hochberg, Andonov, and Rauh examine how political representatives affect the governance of organizations. The researchers' laboratory is public pension funds and their investments in the private equity asset class. Representation on pension fund boards by state officials or those appointed by them — often determined by statute decades past — is strongly and negatively related to the performance of private equity investments made by the fund. This underperformance is driven both by investment category allocation and by poor selection of managers within category. Funds whose boards have high fractions of members who were appointed by a state official or sit on the board by virtue of their government position (ex officio) invest more in real estate and funds of funds, explaining 20-30% of the performance differential. These pension funds also choose poorly within investment categories, overweighting investments in small funds, in-state funds, and in inexperienced GPs with few other investors. Lack of financial experience contributes to poor performance by boards with high fractions of other categories of board members, but does not explain the underperformance of boards heavily populated by state officials. Political contributions from the finance industry to elected state officials on pension fund boards are strongly and negatively related to performance, but do not fully explain the performance differential.

Alan M. Benson, University of Minnesota- Twin Cities; Danielle Li, Harvard University; and Kelly Shue, University of Chicago and NBER

Can Promotion Tournaments Produce Bad Managers? Evidence of the "Peter Principle"

The best worker is not always the best candidate for manager. In these cases, do firms promote the best potential manager or the best worker in their current job? Using microdata on the performance of sales workers at 214 firms, Benson, Li, and Shue find evidence consistent with the Peter Principle: firms prioritize current job performance when making promotion decisions at the expense of other observable characteristics that better predict managerial performance. The researchers estimate that the costs of managerial mismatch are substantial, suggesting that firms make inefficient promotion decisions or the incentive benefits of emphasizing current performance is also high.

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