“Sharing R&D Risk in Healthcare via FDA Hedges” by Adam Jorring, Andrew Lo, Tomas J. Philipson,
Manita Singh, and Richard T. Thakor
“Information asymmetry, financial intermediation, and wealth effects of project finance loans” by Andrew Ferguson and Peter Lam
Murray Z. Frank
Despite the large theoretical literature that asserts the importance of taxes on corporate investment and financing decisions, the empirical literature often fails to demonstrate the effects of taxes in a convincing way. One reason for the discrepancy could be measurement error in variables. In “The Effect of Taxation on Corporate Financing and Investment,” Hong Chen and Murray Z. Frank take issue with the theoretical predictions themselves. They construct a model with a household and a firm that are both infinitely-lived. The government collects taxes from both parties. In the steady-state equilibrium of the model, many personal taxes are irrelevant to corporate decision-making, and other forms of taxation affect particular corporate decisions only. Specifically, (i) a small change in many personal taxes (including on consumption, dividend, or capital gains) has no effect on the firm’s investment or financing policies, (ii) a small change in the personal tax on interest income affects leverage but not investment, and (iii) a small change in the corporate tax rate affects leverage and investment, but not the interest rate on corporate debt. The first-order conditions pin down the optimal policies of the firm and the consumer, and the authors show that in a steady-state equilibrium, these conditions are not affected by some of the tax rates (significantly, including the dividend tax rate). A numerical example shows the change in the steady-state equilibrium outcomes to a change in various tax rates. If the theory on tax effects does not match the data, perhaps the theory needs to be reconsidered, and this paper represents an important step in that direction.
Spotlight by Uday Rajan
Photos courtesy of Hong Chen and Murray Z. Frank
“P2P Lenders versus Banks: Cream Skimming or Bottom Fishing?” by Calebe DeRoure, Loriana Pelizzon, and Anjan V. Thakor
The Call for Papers for the ECGI Corporations and COVID-19 conference is now available. The conference, which features a dual submission option with RCFS and RFS, will take place June 2, 2022. The RCFS sponsoring editor is Andrew Ellul and the RFS sponsoring editors are Itay Goldstein and Holger Mueller. The submission deadline is October 29, 2021. For more details, please see the ECGI website.
The Editor’s Choice paper for issue 10(3) is “Skilled Labor Risk and Corporate Policies” by Yue Qiu and Tracy Yue Wang. You can read the paper free online.
The 2022 RCFS Winter Conference is now accepting submissions. Please see the Call for Papers and the Call for Registered Reports/Proposals on “Finance for the Greater Good” for more details. The conference, which features a dual submission option with RCFS, will take place February 19-20, at the Margaritaville Hollywood Beach Resort in Florida.
The sponsoring editors are Andrew Ellul, Isil Erel, Camelia Kuhnen, and Robert Marquez. The submission deadline is November 19, 2021, for papers and December 5, 2021, for registered reports.
“Public Firm Borrowers of the US Paycheck Protection Program” by Anna Cororaton and Samuel Rosen
“Foreign Banks, Liquidity Shocks, and Credit Stability” by Daniel Belton, Leonardo Gambacorta, Sotirios Kokas, and Raoul Minetti
Initial coin offerings are fast becoming a new type of crowdfunding for blockchain-related startups. In this type of offerings, an entrepreneur raises capital through the creation and selling of virtual currencies or “tokens,” which themselves give rights to their holders (for example, access to a platform). As is to be expected, there are severe problems of information asymmetry associated with these instruments and capital raising mechanisms, especially due to the lack of the traditional underwriting process. These challenges could lead to failures of these crowdfunding exercises. In the paper “The Wisdom of Crowds in FinTech: Evidence from Initial Coin Offerings,” Jongsub Lee, Tao Li, and Donghwa Shin investigate whether the void created by the absence of an underwriter can be filled by the “wisdom of crowds” instead, defined as the collective opinion of a group of individuals rather than that of a single expert. The authors use the weighted average of ratings issued by analysts active on a prominent rating platform to capture the wisdom of the crowds. The paper finds that favorable ratings issued by analysts with diverse backgrounds are associated with fundraising success, aggressive initial token subscriptions, and long-run returns. Interestingly, analyst ratings predict potential fraud and token-price volatility, areas of considerable interest of regulators and market participants. Put together, these results point to an important role played by online analysts to deal with information problems in blockchain-related startups. These results have implications that go beyond the initial coin offerings, since the wisdom of crowds phenomenon is becoming more pervasive among FinTech platforms.
Spotlight by Andrew Ellul
Photos courtesy of Jongsub Lee, Tao Li, Donghwa Shin
It is not just managers that can have a short-term orientation—the forthcoming theoretical paper “Competition for Flow and Short-Termism in Activism,” by Mike Burkart and Amil Dasgupta, shows that activist funds too can focus on the short term. In the model, activists add value by preventing wastage by the manager. To signal their type to their own investors, they take a short-term action such as boosting leverage to make a high payout. However, in the long term, a debt overhang problem can arise, resulting in a positive NPV project being forgone in some states. A similar dilemma comes up with other actions that boost the firm in the short term at the expense of long-term performance, such as reducing R&D expenditure. Actions by activist funds therefore exacerbate the exposure of the firm to the business cycle, with interventions in good times leading to investor payouts, and subsequent economic downturns placing the firm under greater stress. This pattern has been observed recently with some private equity financed firms, and the model applies well to hedge funds as well. The paper highlights that while activist funds have a valuable role to play in corporate governance, they may introduce their own frictions into the process, by acting as short-term investors.
Spotlight by Uday Rajan
Photos courtesy of Mike Burkart and Amil Dasgupta
First published December 11, 2020