Review of Corporate Finance Studies

Jeffrey L. Coles

Zhichuan (Frank) Li

The determinants of executive compensation packages are fraught with empirical difficulties due to unobserved firm-level, CEO-level, and assortative matching characteristics. In the paper “Managerial Attributes, Incentives, and Performance,” just published in the August 2020 issue (Volume 9, Issue 2), Jeff Coles and Frank Li examine the relative importance of observable and unobservable firm- and manager-specific characteristics in determining two fundamental attributes of executive incentives, delta and vega. They find that manager fixed effects, that can capture managerial talent and risk aversion, account for a very significant portion of the variation in these executive incentives. This result is important because it sheds light on the limitations of empirical investigation on executive compensation so far: it is hard to find appropriate and comprehensive measures of these managerial characteristics among the observable managerial characteristics used in the existing literature. Jeff and Frank also find that managerial fixed effects of these compensation incentives could explain future firm policy, risk, and performance. It is quite surprising that some established relationships between executive incentives and firm outcomes are indeed driven by the manager-fixed-effects portions of delta and vega only. Importantly, the significant relative explanatory power of unobserved managerial heterogeneity found in this paper would suggest that both theoretical and empirical work will benefit from focusing on the roles and attributes of top managers.

Spotlight by Andrew Ellul
Photos courtesy of Jeffrey L. Coles and Zhichuan (Frank) Li

“The Macroeconomics of Corporate Debt” by Markus K. Brunnermeier  and Arvind Krishnamurthy

“The risk of being a fallen angel and the corporate dash for cash in the midst of COVID” by Viral Acharya and Sascha Steffen

“The COVID-19 Shock and Equity Shortfall: Firm-level Evidence from Italy” by Elena Carletti, Tommaso Oliviero, Marco Pagano, Loriana Pelizzon, and Marti G. Subrahmanyam

The Editor’s Choice paper for 9(2) is “Banks’ Non-interest Income and Systemic Risk” by Markus K. Brunnermeier, Gang Nathan Dong, and Darius Palia. You can read the paper free online.

Fabiano Schivardi

Enrico Sette

Guido Tabellini

The impact of COVID-19 has driven many firms into financial distress, and policymakers around the world have responded with various emergency measures to support the business sector. While the immediate priority has been to get support out quickly to firms, over time more active decisions will have to be made on which firms should be supported. A potential danger that arises is that firms that should be allowed to shut down are kept alive as “zombie firms” through the provision of subsidized financing. The literature has found that diverting resources to zombie firms has a negative effect on healthy firms in the same industry. However, in the paper “Identifying the Real Effects of Zombie Lending,” Fabiano Schivardi, Enrico Sette, and Guido Tabellini argue that the literature may suffer from a serious identification problem. Often implicitly, and sometimes explicitly, firm performance is used to identify zombie firms. This is problematic, because a downturn in an industry may be associated with both declining performance of healthy firms and a narrowing of the performance gap between healthy and weak firms. There will therefore be a bias toward finding that healthy firms too suffer in a sector with a high proportion of zombie firms. In analyzing the effects of COVID-19, determining the extent to which zombie financing is a problem will be an important issue both for policymakers and for researchers.

Spotlight by Uday Rajan
Photos courtesy of Fabiano Schivardi, Enrico Sette, and Guido Tabellini

“Wages and Firm Performance: Evidence from the 2008 Financial Crisis” by Paige Parker Ouimet and Elena Simintzi

“Short-termism, Managerial Talent, and Firm Value” by Richard T. Thakor

“Resiliency of environmental and social stocks: an analysis of the exogenous COVID-19 market crash” by Rui Albuquerque, Yrjo Koskinen, Shuai Yang, and Chendi Zhang

“Identifying the Real Effects of Zombie Lending” by Fabiano Schivardi, Enrico Sette, and Guido Tabellini

Lei Li

Philip E. Strahan

Song Zhang

The COVID-19 pandemic induced an unprecedented “stress test” on the financial system and the ability of banks to supply liquidity to the real economy. A new paper by Lei Li, Phil Strahan, and Song Zhang entitled “Banks as Lenders of First Resort: Evidence from the COVID-19 Crisis” starts with the following important observation: In the last three weeks of March 2020, banks faced the largest increase in takedowns under existing credit lines ever observed – a weekly growth in demand for bank commercial and industrial loans that is 50 times the average weekly growth of the last half century! This unexpected increase in demand for liquidity, due to the COVID-19 shock, created the stress test on banks. The authors find that large banks serving large customers absorbed most of the demand. And, most importantly, pre-COVID financial conditions did not constrain these large banks’ liquidity supply.

Spotlight by Isil Erel
Photos courtesy of Lei Li, Philip E. Strahan, and Song Zhang

Stanislava Nikolova

Kathleen Weiss Hanley

One major lesson from the 2008-09 financial crisis that subsequently shaped in part the regulatory framework that emerged in the last decade was that downgrades of securities occurring in an interconnected financial system create a need for capital relief for regulated entities. This happens because banks’ and insurers’ capital requirements are based on credit ratings. The question is what kind of short-term and long-term incentives arise from such relief programs. In “Rethinking the Use of Credit Ratings in Capital Regulations: Evidence From the Insurance Industry,” Kathleen Weiss Hanley and Stanislava Nikolova examine a change in how insurance regulators assess capital adequacy for certain mortgage-backed securities (RMBS and CMBS) in the wake of the 2008-09 financial crisis. They find that the new regulations result in $17.6 billion of required and statutory capital savings. Insurers change their investment behavior as a result of the relief, perhaps an unintended consequence of the new capital regulations. First, sales of distressed RMBS/CMBS and gains trading in corporate bonds are less likely, and insurers with larger regulatory capital savings are less likely to engage in these asset-sale practices. Second, insurers are also less likely to raise external capital. Third, the average rating of insurers’ secondary market RMBS/CMBS purchases worsens and the proportion of low-rated RMBS/CMBS purchased increases. Even more interesting is the finding that insurers whose portfolio fared worse during the financial crisis were more likely to purchase low-rated assets. Overall, these findings point toward some very important consequences of the regulatory reform: there were short-term benefits, but it may have incentivized risk taking and left some insurers excessively exposed to market risk.

Spotlight by Andrew Ellul
Photos courtesy of Kathleen Weiss Hanley & Stanislava Nikolova