REVISION: The Market for Financial Adviser Misconduct
We construct a novel database containing the universe of financial advisers in the United States from 2005 to 2015, representing approximately 10% of employment of the finance and insurance sector. We provide the first large-scale study that documents the economy-wide extent of misconduct among financial advisers and the associated labor market consequences of misconduct. Seven percent of advisers have misconduct records, and this share reaches more than 15% at some of the largest advisory firms. Roughly one third of advisers with misconduct are repeat offenders. Prior offenders are five times as likely to engage in new misconduct as the average financial adviser. Firms discipline misconduct: approximately half of financial advisers lose their jobs after misconduct. The labor market partially undoes firm-level discipline by rehiring such advisers. Firms that hire these advisers also have higher rates of prior misconduct themselves, suggesting "matching on misconduct." These firms are ...
REVISION: Fintech, Regulatory Arbitrage, and the Rise of Shadow Banks
We study the rise of shadow banks in the largest consumer loan market in the US. The market share of shadow banks in originating residential mortgages nearly doubled from 2007-2015. Shadow banks gained a larger market share among less creditworthy borrowers, with a significant share of loans being originated-to-distribute to GSEs. Difference in difference tests suggest that traditional banks contracted origination activity in markets in which they faced more capital and regulatory constraints; these gaps were partly filled by shadow banks. Shadow banks with predominately online mortgage application process, “fintech” lenders, accounted for roughly a quarter of shadow bank loan originations by 2015. Relative to non-fintech shadow banks, fintech lenders serve more creditworthy borrowers and are more active in the refinancing market. They appear to use different information in setting interest rates, consistent with a big data component of technology, and charge a convenience premium of ...
REVISION: Financial Market Frictions and Diversification
We find new facts that relate the evolution of firm scope to the changing frictions in external capital markets over the last three decades. We find that large, diversified publicly traded firms increase their scope during times of high external capital market frictions, such as in the recent Great Recession. Moreover, during these times firms diversify their investment needs and cash flow across industries. We also find similar phenomena outside diversified public firms. Examining the mergers and acquisitions activity of stand-alone and diversified private firms, we uncover similar patterns. In aggregate data, we find that the composition of mergers shifts from focused to diversifying and back with changes in external market conditions. Our evidence is broadly consistent with the notion that firms diversify their scope in response to tightening in external capital markets.
REVISION: When Harry Fired Sally: The Double Standard in Punishing Misconduct
We examine gender discrimination in the financial advisory industry. We study a less salient mechanism for discrimination, firm discipline following missteps. There are substantial differences in the punishment of misconduct across genders. Although both female and male advisers are disciplined for misconduct, female advisers are punished more severely. Following an incidence of misconduct, female advisers are 20% more likely to lose their jobs and 30% less likely to find new jobs relative to male advisers. Females face harsher punishment despite engaging in less costly misconduct and despite a lower propensity towards repeat offenses. Relative to women, men are three times as likely to engage in misconduct, are twice as likely to be repeat offenders, and engage in misconduct that is 20% costlier. Evidence suggests that the observed behavior is not driven by productivity differences across advisers. Rather, we find supporting evidence for taste-based discrimination. For females, a ...
REVISION: Advertising Expensive Mortgages
Using information on advertising and mortgages originated by subprime lenders, we study whether advertising helped consumers find cheaper mortgages. Lenders that advertise more within a region sell more expensive mortgages, measured as the excess rate of a mortgage after accounting for borrower, contract, and regional characteristics. These effects are stronger for mortgages sold to less sophisticated consumers. We exploit regional variation in mortgage advertising induced by the entry of Craigslist and other tests to demonstrate that these findings are not spurious. Analyzing advertising content reveals that initial/introductory rates are frequently advertised in a salient fashion, where reset rates are not.
New: Deposit Competition and Financial Fragility: Evidence from the US Banking Sector
We develop a structural empirical model of the U.S. banking sector. Insured depositors and run-prone uninsured depositors choose between differentiated banks. Banks compete for deposits and endogenously default. The estimated demand for uninsured deposits declines with banks' financial distress, which is not the case for insured deposits. We calibrate the supply side of the model. The calibrated model possesses multiple equilibria with bank-run features, suggesting that banks can be very fragile. We use our model to analyze proposed bank regulations. For example, our results suggest that a capital requirement below 18% can lead to significant instability in the banking system.
REVISION: Selling Failed Banks
We show that the allocation of failed banks in the Great Recession was likely distorted because potential acquirers of these banks were poorly capitalized. We illustrate this phenomenon within a model of auctions with budget constraints. In our model poor capitalization of some potential acquirers drives a wedge between their willingness to pay and the ability to pay for a failed bank. Using our framework, we infer three characteristics that drive potential acquirers’ willingness to pay for a failed bank in the data: geographic proximity, bank specialization, and increased market concentration. Consistent with predictions of our model, we find that low capitalization of potential acquirers decreases their ability to acquire a failed bank. Finally, we show that the wedge between potential acquirers’ willingness and ability to pay distorts the allocation of failed banks. The costs of this misallocation are substantial, as measured by the additional resolution costs of the FDIC. These ...
REVISION: Debt and Creative Destruction: Why Could Subsidizing Corporate Debt Be Optimal?
We illustrate the welfare benefit of tax subsidies to corporate debt financing and study how the social cost/benefit trade-off of the subsidy changes with the duration of industry distress. To illustrate the benefit, we model two firms, which engage in a socially wasteful competition for survival in a declining industry. Firms differ on two dimensions: exogenous productivity and endogenously chosen amount of debt financing, resulting in a two dimensional war of attrition. Debt financing increases incentives to exit, which, while costly for the firm, is socially beneficial. These benefits decline as industry distress shortens, and the planner trades them off with increased costs of subsidizing corporate debt from the existing literature. In practice, debt payments are only subsidized for profitable firms — this implementation arises naturally in our normative model, even though the goal of the policy is to entice low productivity firms to take on debt.
REVISION: Resource Allocation within Firms and Financial Market Dislocation: Evidence from Diversified Conglomerates
When external capital markets are stressed they may not reallocate resources between firms. We show that resource allocation within firms' internal capital markets provides an important force countervailing financial market dislocation. Using data on U.S. conglomerates we empirically verify that firms shift resources between industries in response to shocks to the financial sector. We estimate a structural model of internal capital markets to separately identify and quantify the forces driving the reallocation decision and illustrate how these forces interact with external capital market stress. The frictions in internal capital markets drive a large wedge between productivity and investment: the weaker (stronger) division obtains too much (little) capital, as though it is 12 (9) percent more (less) productive than it really is. The cost of accessing external capital funds quadruples during extreme financial market dislocations, making resource allocation within firms significantly ...
New: Is an Automaker's Road to Bankruptcy Paved with Customers' Beliefs?
Durable goods producers can face a pernicious feedback loop between their financial health and the demand for their products. Financial distress can reduce demand for a firm’s products if it causes consumers to worry about the firm’s ability to supply flows of goods and services — such as warranties, spare parts, and maintenance — that are typically bundled with the primary durable good. This drop in demand harms the firm’s profitability, exacerbating its financial distress, which in ...
REVISION: Cross-Ownership, Returns and Voting in Mergers
We show that institutional shareholders of acquiring companies on average do not lose money around public merger announcements, because they also hold substantial stakes in the targets and make up for the losses from the former with the gains from the latter. Depending on their holdings in the target, acquirer shareholders may realize different returns from the same merger, some losing money and others gaining. Using a novel dataset we show that this conflict of interests is reflected in the ...
REVISION: Strategic Proxy Voting
Despite its importance, voting in the elections of corporate boards of directors remains relatively unexplored in the empirical literature. We construct a comprehensive dataset of 3,204,890 mutual fund votes in director elections that took place between July 2003 and June 2005. We find substantial systematic heterogeneity in fund voting patterns: some mutual funds are management friendly, and others are less so. We construct and estimate a model of voting in which mutual funds impose ...