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Indiana University Bloomington

PROFESSOR OF FINANCE

Working Papers

Big Fish in Small Ponds: Human Capital Mobility and the Rise of Boutique Banks (with Janet Gao and Wenyu Wang)

We document a rise of boutique banks in the M&A advisory industry that is traditionally dominated by bulge bracket banks. We show that high-performing individuals are more likely to migrate from bulge bracket to boutique banks, and that their clients and colleagues tend to follow. The performance of losing (gaining) banks in the transitioning bankers’ specialized industries subsequently deteriorates (improves), potentially contributing to the prosperity of boutique advisors. To establish causality, we exploit the cross-department subsidization within bulge bracket banks that exogenously affects the skilled labor supply to boutique advisors. Our findings highlight how human capital mobility shapes industry structures.

Torpedo Your Competition: Strategic Reporting and Peer Firm IPO (with Matt Billett and Mark Ma)

A firm’s initial public offering (IPO) generates negative externalities to its industry competitors. We show that to mitigate this threat, incumbent firms manage their earnings downwards when their industry peers file for an IPO. The negative accruals reverse if there are no peers attempting an IPO. Incumbents manage earnings more aggressively when the cost of doing so appears small or the benefit is large. Such strategic disclosure leads to a depressed valuation multiple, which is commonly used by investors to price IPOs. As a result, issuing firms suffer from lower offer prices, raise smaller amounts of capital, and are more likely to withdraw from the offering; they also invest less, hoard more cash, and experience lower profitability post IPO. By contrast, incumbents benefit from improved operating performance. Our results highlight the role of strategic reporting on product market competition and identify a new cost of going public.

Panda Games: Corporate Disclosure in the Eclipse of Search (with Kemin Wang and Bohui Zhang)

We show that firms strategically alter their disclosure behavior when investors’ access to information via search engines is interrupted. We conduct a textual analysis and exploit an exogenous event—Google’s 2010 surprising withdrawal from mainland China, which significantly hampered domestic investors’ ability to search for foreign information but did not affect their access to domestic information. Following Google’s exit, Chinese firms’ announcements on their foreign transactions become more bullish in comparison to similar announcements prior to the exit and to those that involve only domestic transactions. This effect is mitigated in the presence of foreign investors or analysts affiliated with foreign brokers, who are not subject to foreign information censorship by the Chinese government. Moreover, compared to those that operate domestically, firms with foreign operations issue rosier annual reports and manage earnings to a greater extent after Google’s departure; their stock prices also become less informative. These optimistic announcements or annual reports allow insiders to sell more shares at a higher price.

Negation of Sanctions: The Personal Effect of Political Contributions (with Sarah Fulmer and April Knill)

We show that political contributions affect the severity of civil and criminal sanctions for fraudulent executives. Contributing executives receive smaller monetary fines, are banned fewer years as an officer or director of a public company, and serve less time in prison or on probation. Importantly, political contributions facilitate a shift in penalties from fraudulent managers to shareholders, thereby decreasing the probability of their termination after the fraud. The entrenchment of these managers leads to further damage to shareholders. Our findings highlight an agency cost arising from political contributions and identify a mechanism that undermines regulations’ disciplining effect for fraudulent managers.

Transporting Transparency: Director Foreign Experience and Corporate Information Environment (with Guanmin Liao and Mark Ma)

This paper examines how board directors’ foreign experience affects a firm’s information environment in emerging markets. Using data on publicly traded companies in China and exploiting the adoption of policies to attract emigrants that increases the supply of individuals with foreign experience in different provinces at different times, we document a positive, causal effect of directors’ foreign experience on the informativeness of the firm’s stock price. We examine potential channels, and find that after individuals with foreign experience join the board, earnings transparency increases, and firms are more likely to hire high-quality auditors and to engage in voluntary disclosure. Furthermore, the informational benefit brought by directors with foreign experience spills over to peer firms. These findings provide direct evidence on how board directors help shape corporate transparency in emerging markets.

Standing out from the Crowd: The Real Effects of Outliers (with Qianqian Du and Frank Yu)

We examine the real effects of outlier opinions in the context of extreme analyst optimism. Instead of ignoring them as noise, managers appear to respond to the arrival of outlier forecasts with more aggressive earnings management. When identifying potential channels, we find that an outlier forecast subsequently generates more optimistic forecasts by peer analysts and greater market reactions. Further analyses reveal that issuing outlier forecast engenders career benefit, increasing an analyst’s chance to cover more important clients of his employer. Outlier forecasts are also more likely to take place when an analyst’s reputation cost is lower. These findings suggest that the propensity for expressing extreme views is situational, and that personal incentives are the likely cause at play.

Unleashing Innovation (with Yifei Mao and Xuan Tian)

Using a sample of venture capital (VC)-backed initial public offering (IPO) firms, we study the effect of financial intermediaries’ tight leash on entrepreneurs’ innovation productivity. We find that financial intermediaries’ tight leash impedes innovation: IPO firms are significantly less innovative when VCs interfere with their development more frequently through staging—as measured by a larger number of VC financing rounds. To establish causality, we exploit plausibly exogenous variation in the frequency of direct flights between VC domiciles and IPO firm headquarters that are due to airline restructuring. Our identification tests suggest a negative, causal effect of VC staging on firm innovation. Furthermore, staging is more detrimental to innovation when innovation is more difficult to achieve and when VCs are less experienced with the industry in which their entrepreneurial firms operate. By documenting a previously under-recognized adverse consequence of VC stage financing, our evidence suggests that contract mechanisms are at play so that short-termist incentives can be cultivated even in a private equity market populated with long-term, sophisticated investors.

The "Real" Value of Conflicted Analyst Coverage (with Stacey Jacobsen and Irina Stefanescu)

Existing literature examines how analysts’ conflicts of interest affect investors. Empirically, however, it has been challenging to isolate the impact of analysts’ conflicts of interest, and there is less evidence on how such conflicts affect the firms under coverage. In this paper we develop a novel approach to identify a sample of firms whose coverage is likely driven exclusively by analysts’ private incentives to generate investment banking revenue. We find that the loss of conflicted analyst coverage has little adverse effect on information efficiency, capital investment, cost of capital, and equity issuance. Since conflicted research provides no real benefit to the firm under coverage, our results suggest that firms attain little benefit when offering investment banking business in exchange for analyst coverage.

Ownership Structure, Liquidity, and Investment Efficiencies

By altering the fraction of shares held by shareholders with significant liquidity needs, a firm's ownership structure affects the degree of informed trading in the firm's stock. Extensive informed trading in the firm's shares increases the losses of shareholders who are subject to liquidity shocks, but it improves the information present in share prices, which in turn may improve the firm's investment decisions. Unless shareholders' liquidity shocks are especially severe, a firm with few growth opportunities may favor a structure that places more shares in the hands of a large shareholder that trades infrequently, whereas a firm with significant growth opportunities will prefer a more diffuse ownership structure that favors increased liquidity trading. When small investors' liquidity shocks are especially severe, this result is reversed. If the large shareholder also has access to information about the firm's growth opportunities, it may be optimal to have the large shareholder hold shares with trading restrictions so as to prevent other informed traders from being crowded out.

Is Board Structure "One-Size-Fits-All"? The Unintended Informational Consequence of the Sarbanes-Oxley Act (with Huijing Fu)

In this paper we examine how board structure affects the informativeness of board members by comparing the returns earned by officers and independent directors from purchasing the firm’s stock. We investigate whether an exogenous shock to the board structure – the 2002 Sarbanes-Oxley Act and the related mandates – leads to a shift in information asymmetry between officers and independent directors. We find that improvement in board’s information environment is limited to firms whose boards are previously controlled by outsiders. In contrast, information asymmetry rises among firms whose boards are previously dominated by insiders: An increase in independent directors is followed by a significantly larger difference in buy-and-hold returns between officers and independent directors. In addition, the deterioration in board’s information environment is associated with a poor firm operating performance.

Does Money Follow the Flag? (with Nandini Gupta)

We examine whether bilateral political relations can explain investment and trade flows between the United States and other countries. We treat political relations as endogenous using instrumental variable analysis and investigate whether an exogenous shock to political relations, the 2003 war in Iraq, leads to a shift in economic flows. The results suggest that a deterioration in bilateral relations is followed by a significant decrease in economic flows between the United States and that country. These results are robust to country fixed effects, income, industry growth, financial market development, and risk.

Business Cycles, Firm Size and Market Reaction to News (with Yiming Qian)

We study whether market reactions to earnings news vary over the business cycle. Using a sample of quarterly earnings reports from 1984 through 2003, we find market reactions to earnings news differ between periods of expansion and contraction. The difference depends on firm size - market reactions to small firms' earnings news are stronger during expansions than during contractions, but market reactions to large firms' earnings news are weaker during expansions than during contractions. Further analysis shows that the result is mainly driven by bad earnings news. Our findings cannot be explained by the distinction between value and growth stocks, the entry and exit of new firms in the economy, earnings management, pre-announcements, time-varying earnings persistence, or time-varying investor attention.