o Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches, Review of Financial Studies, Review of Financial Studies, January, 2009, Volume 22, pp 435-480.
In corporate finance and asset pricing empirical work, researchers are often confronted with panel data. In these data sets, the residuals may be correlated across firms or across time, and OLS standard errors can be biased. Historically, researchers in the two literatures have used different solutions to this problem. This paper examines the different methods used in the literature and explains when the different methods yield the same (and correct) standard errors and when they diverge. The intent is to provide intuition as to why the different approaches sometimes give different answers and give researchers guidance for their use.
o Programming advice. I have posted brief instructions on how I programmed the standard errors discussed in this paper. I hope that that this will make it easier for researchers to use these methods. In addition, there is a short description of the simulation program as well.
o Additional tables. Not all of the paper’s results are included in the paper’s tables. Additional tables, including those referred to in the paper (e.g. results available from author) are contained in this file. I have posted these additional tables and results in case readers are interested. Descriptions follow the tables
o Does the Source of Capital Affect Capital Structure? (joint with Michael Faulkender) Review of Financial Studies, Spring 2006, Volume 19, pp-45-79.
Prior work on leverage implicitly assumes capital availability depends solely on firm characteristics. However, market frictions that make capital structure relevant may be associated with a firm’s source of capital. Examining this intuition, we find firms which have access to the public bond markets, as measured by having a debt rating, have significantly more leverage. Although firms with a rating are fundamentally different, these differences do not explain our findings. Even after controlling for firm characteristics which determine observed capital structure, and instrumenting for the possible endogeneity of having a rating, firms with access have 35 percent more debt.
o Does Function Follow Organizational Form? Evidence From the Lending Practices of Large and Small Banks (joint with Allen N. Berger, Nathan H. Miller, Raghuram G. Rajan, and Jeremy C. Stein) Journal of Financial Economics, May 2005, Volume 76, pp. 237-269.
Theories based on incomplete contracting suggest that small organizations may do better than large organizations in activities that require the processing of soft information. We explore this idea in the context of bank lending to small firms, an activity that is typically thought of as relying heavily on soft information. We find that large banks are less willing than small banks to lend to informationally “difficult” credits, such as firms that do not keep formal financial records. Moreover, controlling for the endogeneity of bank-firm matching, large banks lend at a greater distance, interact more impersonally with their borrowers, have shorter and less exclusive relationships, and do not alleviate credit constraints as effectively. All of this is consistent with small banks being better able to collect and act on soft information than large banks.
o Does Distance Still Matter: The Information Revolution in Small Business Lending Journal of Finance, December 2002, Volume 57, pp. 2533-2570 (joint with Raghuram Rajan).
The distance between small firms and their lenders is
increasing, and they are communicating in more impersonal ways. After
documenting these systematic changes, we demonstrate they do not arise from
small firms locating differently, consolidation in the banking industry, or
biases in the sample. Instead, improvements in lender productivity appear to
explain our findings. We also find distant firms no longer have to be the
highest quality credits, indicating they have greater access to credit. The
evidence indicates there has been substantial development of the financial
sector, even in areas such as small business lending.
o Risk Measurement and Hedging: With and Without Derivatives (joint with S. Ramu Thiagarajan), Financial Management, Winter, 2000, Volume 29, 5-30.
This paper examines a setting where the two firm's derivative strategies are known but completely different. American Barrick aggressively hedges its gold price risk using derivatives, while Homestake Mining uses no derivatives. Instead they use a combination of operating and financial decisions to manage their risk. The different choice of methods is a result of different abilities to adjust operating costs and different needs for investment capital. Different investment strategies imply that Homestake Mining's capital needs are more highly correlated with gold prices, and thus cashflow hedging has less value. Managerial incentives also play a role. Although risk averse managers have an incentive to reduce risk, how and how much they hedge depends upon how they are compensated. The multitude of risk management methods used by similar firms means that tests of risk management theory must account for different opportunities and different objectives when examining firm's risk management strategies.
o Trade Credit: Theories and Evidence, (joint with Raghuram G. Rajan), Review of Financial Studies, Fall, 1997, Volume 10, pp. 661-692.
In addition to borrowing from financial institutions, firms may be financed by their suppliers. Although there are many theories explaining why non financial firms lend money, there are few comprehensive empirical tests of these theories. This paper attempts to fill the gap. We focus on a sample of small firms whose access to capital markets may be limited. We find evidence that firms use trade credit relatively more when credit from financial institutions is not available. Thus while short term trade credit may be routinely used to minimize transactions costs, medium term borrowing against trade credit is a form of financing of last resort. Suppliers lend to firms no one else lends to because they may have a comparative advantage in getting information about buyers cheaply, they may have a better ability to liquidate goods, and they may have a greater implicit equity stake in the firm's long term survival. We find some evidence that trade credit is used as a means of price discrimination. Finally, we find that firms with better access to credit from financial institutions offer more trade credit. This supports the view that trade credit may be a channel through which monetary policy affects firms outside the banking system.
o The Effect of Credit Market Competition on Lending Relationships, Quarterly Journal of Economics, May, 1995, Volume 110, pp. 407-444, (joint with Raghuram G. Rajan).
This paper provides a simple framework showing that the extent of competition in credit markets is important in determining the value of lending relationships. Creditors are more likely to finance credit constrained firms when credit markets are concentrated because it is easier for these creditors to internalize the benefits of assisting the firms. The paper offers evidence from small business data in support of this hypothesis.
o The Benefits of Lender Relationships: Evidence from Small Business Data, Journal of Finance, March, 1994, Volume 49, pp. 3-37, (joint with Raghuram G. Rajan).
This paper empirically examines how ties between a firm and its creditors affects the availability and cost of funds to the firm. We analyze data collected in a survey of small firms by the Small Business Administration. The primary benefit of building close ties with an institutional creditor is that the availability of financing increases. We find smaller effects on the price of credit. Attempts to widen the circle of relationships by borrowing from multiple lenders increases the price and reduces the availability of credit. In sum, relationships are valuable and appear to operate more through quantities rather than prices.
o Cashflow Variability and Firm's Pension Choice: A Role for Operating Leverage, Journal of Financial Economics, December, 1994, Volume 36, pp. 361-383.
When financial markets are imperfect or financial distress is costly, firms may choose to reduce their risk by lowering financial or operating leverage. This paper examines the role of operating leverage in the firm's pension choice. Contributions to defined contribution plans are more flexible than contributions to defined benefit plans. Firms may therefore reduce their operating leverage by selecting a defined contribution plan. I find empirical support for this hypothesis which is robust to controls for labor market factors and the continuing trend toward defined contribution pension plans.
o Posted versus effective spreads: Good prices or bad quotes?, Journal of Financial Economics, June, 1994, Volume 35, pp. 269-292 (joint with David Fialkowski).
When trades are executed inside the posted bid-ask spread,
the posted spread is no longer an accurate measure of transactions costs faced
by investors. Using two samples of market orders, one based on orders submitted
by retail brokers and one based on orders submitted electronically to the NYSE,
we document a significant difference between the posted spread and the
effective spread paid by investors. For most orders, the effective spread
averages half the posted spread. In addition, when the posted spread widens,
only 10 to 22 % of the increase appears in the effective spread. These results
have significant implications for any empirical work that uses the posted
spread as a measure of the cost of trading. Our findings also document a
significant difference in the expected execution price across exchanges. This
finding is robust to controls for the type of order, and implies that
o Pension Reversions and Worker-Stockholder Wealth Transfers, Quarterly Journal of Economics, August, 1992, Volume 35, pp. 1035-1056.
This paper examines the relative importance of transfers from workers to shareholders in the firm's decision to terminate their overfunded defined benefit pension plans. In contrast to earlier studies, I find evidence that firms terminate their pension plans to relieve themselves of implicit promises to workers of future compensation. In addition, financing and tax considerations influence the reversion decision. The results suggest that the 1986 excise tax on asset reversions reduced termination for reversion by 36 percent in 1986.
Banks and the Role of Lending Relationships:
Evidence from the
One characteristic which may distinguish banks from other financial institutions is the role of relationships between the bank and its borrowers. These firm-lender relationships can help resolve market failures and thus provide a role for banks. This paper describes the theoretical role of lending relationships in financial markets. Relationships can generate useful information as well as be used to constrain borrowers. Empirically, relationships appear to have the greatest effect on the provision of credit opposed to the price at which firms are able to borrow. Finally the paper examines current changes in financial markets and their impact on the durability of lending relationships as well as their continued role in modern financial markets.assets.
Assets and Discounting Cash Flows: Pension Plan Finance Pensions, Savings,
and Capital Markets, Eds. Phyllis A Fernandez, John A. Turner, and Richard
P. Hinz. (
This paper examines two pension decisions which firms must make when they offer a defined benefit pension plan: how to pick the appropriate rate for discounting pension liabilities and how to allocate the assets in the pension plan. The correct allocation of assets must be driven by frictions which occur in real world financial markets. In the absence of market frictions, the asset allocation decision is irrelevant. The paper first reviews the theory which describes the optimal asset allocation in the presence of distortionary taxes and imperfect capital markets. This allows us to examine the role played by the pension plan in the financial structure of the firm. It also provides us the background for examining the actual asset allocation of defined benefit pension assets. The paper then turns to the choice of discount rates. If the goal is to value the pension liabilities, the correct discount rate should depend upon the type of risk inherent in the pension promise. The paper begins by developing the theory behind choosing the discount rate in a world without market frictions and then extends the analysis to the presence of market imperfections. I then compare the theory to the actual discount rates chosen by firms. I find that the discount rates are significantly lower than equivalent market rates and are very insensitive to changes in market rates. The framework of the paper provides a background for discussing the implications of the shift from defined benefit to defined contribution pension plans on capital markets -- given the perceived difference in how these two types of plans invest their assets.
401(k) Plans Replace Other Employer-Provided Pensions? Advances in the
Economics of Aging, Eds. David A. Wise (
This paper reports the findings from a new survey of firms that provide 401(k) plans for their employees. Our results suggest that few 401(k) plans replaced pre-existing defined benefit pension plans, although a substantial fraction replaced previous defined contribution thrift and profit sharing plans. Our survey results also provide new evidence on patterns of 401(k) participation. We find significant persistence in firm-level participation rates from one year to the next, which supports the view that 401(k) participants are not making marginal decisions of whether or not to contribute to the plan in a given month, or even year, but rather make long-term commitments to participate in these plans.