Items where Author is "Schmalz, Martin C."

When Bayesian risk-averse investors are uncertain about their assets' cash flows' exposure to systematic risk, stock prices react more to news in downturns than in upturns, implying higher volatility in downturns and negatively skewed returns. The reason is that, in good times, less desirable assets with low average cash flows and high loading on market risk perform similar to more desirable assets with high average cash flows and low market risk, rendering them difficult to distinguish. However, their relative fundamental performance diverges in downturns, enabling better inference. Consistent with these predictions, stocks' reaction to earnings news is up to 70% stronger in downturns than in upturns.

Many natural competitors are jointly held by a small set of large institutional investors. In the US airline industry, taking common ownership into account implies increases in market concentration that are 10 times larger than what is “presumed likely to enhance market power” by antitrust authorities. Within-route changes in common ownership robustly correlate with route-level changes in ticket prices, even when we only use variation in ownership due to the combination of two large asset managers. We conclude that a hidden social cost – reduced product market competition – accompanies the private benefits of diversification and good governance.

The question of whether and how partial common-ownership links between strategically interacting firms affect firm objectives and behavior has been the subject of theoretical inquiry for decades. Since then, the growth of intermediated asset management and consolidation in the asset-management sector has led to more pronounced common ownership links at the beneficial-owner level. Recent empirical research has provided evidence consistent with the literature's prediction that common ownership concentration (CoOCo) can affect product market outcomes. The resulting antitrust concerns have received worldwide attention. However, because CoOCo can change the objective function of the firm, the potential implications span all fields of economics that involve corporate conduct, including corporate governance, strategy, industrial organization, and financial economics. This article connects the papers establishing the theoretical foundations, reviews the empirical and legal literatures, and discusses challenges and opportunities for future research.

This paper establishes a new empirical fact: Mutual funds’ flow-performance sensitivity is a hump-shaped function of aggregate risk-factor realizations. Explanations based on extant theories can explain only a fraction of the pattern. We thus develop a new parsimonious model. It assumes Bayesian investors who are uncertain about the degree to which fund returns are exposed to systematic risk. Fund performance is then less informative about manager skill when factor realizations are larger in absolute value. The data also support the out-of-sample prediction that the hump shape is more pronounced for funds with more uncertain risk loadings.

The share of stocks beneficially owned by institutional investors has increased substantially over the last three decades. Together with a high and increasing level of concentration in the asset management industry, this trend implies that a small number of institutional investors now constitute the largest shareholders of most publicly traded firms in the U.S. and in other developed economies. When the same set of investors owns most firms, they are bound to own several firms in the same industry. Such overlapping ownership interests among competitors, or “common ownership,” may imply a reduction in firms’ incentives to compete, compared to a situation in which competitors are controlled by separate sets of investors, and may thus create antitrust risks. Recent empirical research shows evidence for such anti-competitive effects of common ownership. These findings have since ignited a debate on the antitrust risk posed by institutional investors, its legal implications and potential solutions.

This article first illustrates the extent of present-day common ownership and discusses the economic logic of why common ownership leads to reduced incentives to compete and may cause anti-competitive outcomes. We then review some of the empirical evidence to date, discuss critiques of the same and explain the conceptual problems inherent with all potential policy solutions. The legal debate around these findings is discussed by a fast-growing literature, including contributions by other authors in this issue.

Many natural competitors have become jointly held and
partially controlled by a small number of investors over
the past two decades. For example, five institutions (BlackRock, Vanguard, State Street Global Advisers, Fidelity, and Berkshire Hathaway) now make up four out of the top five beneficial owners of each of America’s largest banks. The largest seven beneficial owners of American Airlines hold 49.56 per cent of the shares—and
each one of them is also among the largest ten investors in
American’s direct competitors.

We show that collateral constraints restrict firm entry and postentry growth, using French administrative data and cross-sectional variation in local house-price appreciation as shocks to collateral values. We control for local demand shocks by comparing treated homeowners to controls in the same region that do not experience collateral shocks: renters and homeowners with an outstanding mortgage, who (in France)cannot take out a second mortgage. In both comparisons, an increase in collateral value leads to a higher probability of becoming an entrepreneur. Conditional on en-try, treated entrepreneurs use more debt, start larger firms, and remain larger in the long run.

We model an anxious agent as one who is more risk averse with respect to imminent risks than with respect to distant risks. Based on a utility function that captures individual subjects’ behavior in experiments, we provide a tractable theory relaxing the restriction of constant risk aversion across horizons and show that it generates rich implications. We first apply the model to insurance markets and explain the high premia for short-horizon insurance. Then, we show that costly delegated portfolio management, investment advice, and withdrawal fees emerge as endogenous features and strategies to cope with dynamic inconsistency in intratemporal risk-return trade-offs.

Firms until recently were effectively constrained to hold liquid assets in non-interest-bearing accounts. As a result, the cost of capital of firms’ liquid-assets portfolios exceeded the return, especially when the risk-free interest rate was high. The spread between cost and return is the cost of carry. Changes in the cost of carry explain the dynamics of corporate “cash” holdings both in the United States and abroad, and the level of cost of carry explains the level of liquid-asset holdings across countries. We conclude that current US corporate cash holdings are not abnormal in a historical or international comparison.

We survey the literature on payout policy, with a particular emphasis on developments in the past two decades. The cross-sectional empirical evidence for the traditional motivations behind firms paying out (agency, signaling, and taxes) is most persuasive with regard to agency considerations. Studies centered on the May 2003 dividend tax cut confirm that differences in the taxation of dividends and capital gains have only a second-order impact on setting payout policy. None of the three traditional explanations can account for secular changes in how payouts have been made over the past 30 years, during which repurchases have replaced dividends as the prime vehicle for corporate payouts. Other payout motivations, such as changes in compensation practices and management incentives, are better able to explain the observed variation in payout patterns over time than the traditional motivations. The most recent evidence suggests that further
insights can be gained from viewing payout decisions as an integral
part of a firm’s larger financial ecosystem, with important implications for financing, investment, and risk management.

When one firm’s strategy affects other firms’ value, optimal executive incentives depend on whether shareholders have interests in only one or in multiple firms. Performance-sensitive contracts induce managerial effort to reduce costs, and lower costs induce higher output. Hence, greater managerial effort can lead to lower product prices and industry profits. Therefore, steep managerial incentives can be optimal for a single firm and at the same time violate the interests of common owners of several firms in the same industry. Empirically, managerial wealth is more sensitive to performance when a firm’s largest shareholders do not own large stakes in competitors.

We address two fundamental critiques of established asset pricing models: that they (1) require a controversial degree of preference for early resolution of uncertainty; and (2) do not match the
term structures of risk premia observed in the data. Inspired by experimental evidence, we construct preferences in which risk aversion decreases with the temporal horizon. The resulting
model implies term structures of risk premia consistent with the evidence, including timevariations and reversals in the slope, without imposing a particular preference for early or late
resolutions of uncertainty or compromising on the ability to match standard moments in the returns distributions.

We document that central banks are significantly more likely to report slightly positive profits than slightly negative profits. The discontinuity in the profit distribution is (i) more pronounced
amid greater political or public pressure, the public’s receptiveness to more extreme political views, and agency frictions arising from governor career concerns, but absent when no such factors are present, and (ii) correlated with more lenient monetary policy inputs and greater inflation. These findings indicate that profitability concerns, while absent from standard theoretical models of central banking, are both present and effective in practice, and inform a
theoretical debate about monetary stability and the effectiveness and riskiness of non-traditional central banking.

We study optimal security design when issuer and market participants disagree about the characteristics of the underlying asset. We show that pooling and tranching assets can be preferable to selling optimal securities backed by individual assets: pooling mitigates belief disagreement between issuer and investors, and tranching allows the issuer to exploit belief disagreement among investors. Interestingly, differences in beliefs can make pooling and tranching complements. Pooling and tranching can be optimal even when the number of securities in the pool is small, and remain optimal even when the issuer sells all tranches, including the most junior ones.

We estimate the term structure of the price of variance risk (PVR), which helps distinguish between competing asset-pricing theories. First, we measure the PVR as proportional to the Sharpe ratio of short-term holding returns of delta-neutral index straddles; second, we estimate the PVR in a Heston (1993) stochastic-volatility model. In both cases, the estimation is performed separately for different maturities. We find the PVR is negative and decreases in absolute value with maturity; it is more negative and its term structure is steeper when volatility is high. These findings are inconsistent with calibrations of established asset-pricing models that assume
constant risk aversion across maturities.

We provide a model that rationalizes variations in confidence of rational agents, both in the time-series and the cross-section. Combining horizon-dependent risk aversion (“anxiety”) and selective memory, we show that over- and underconfidence can arise in the Bayesian equilibrium of an intra-personal game. In
the time-series, overconfidence is more prevalent when actual risk levels are high, while underconfidence occurs when risks are low. In the cross-section, more anxious agents are more prone to biased confidence and their beliefs fluctuate more, leading them to buy in booms and sell in crashes. Lastly, fluctuations in confidence can amplify boom-bust cycles.

We study the extent to which firms rely on the capital markets to fund their payouts. We find that 42% of firms that pay out capital also initiate debt or equity issues in the same year, resulting in 32% of aggregate payouts being externally financed. Most firms that
simultaneously raise and distribute capital do not generate enough free cash flow to fund their payouts internally. Firms devote more external capital to finance share repurchases than to
avoid dividend cuts. Payouts financed by debt, which allow firms to jointly manage their capital structure and liquidity, are by far the most common.

We use a uniquely extensive branch-level dataset on deposit account interest rates, maintenance fees, and fee thresholds, and document substantial time-series and cross-sectional variation in these prices. We then examine whether variation in bank concentration helps explain the variation in prices. The standard measure of concentration, the HHI, is not correlated with any of the outcome variables. We then construct a generalized HHI (GHHI) that captures both common ownership (the degree to which banks are commonly owned by the same investors) and cross-ownership (the extent to which banks own shares in each other). The GHHI is strongly correlated with all prices. We use the growth of index funds as an arguably exogenous source of cross-sectional variation of county-level common ownership growth to suggest a causal link from the GHHI to higher prices for banking products.

What is the effect of unionization on corporate financial policies? The average unionized firm responds with lower cash and higher leverage to a unionization election than the average firm escaping unionization. However, using a regression discontinuity design I find that the causal effect of unionization is close to zero on average, but heterogeneous across firms. For the subset of large and financially unconstrained firms, the causal effect is positive on leverage and negative on cash; the opposite is true for small and financially constrained firms. These results help reconcile controversially discussed views on how corporate finance and labor interact.