2007–2008

Market Variance and Asset Prices

Federico Bandi, Associate Professor of Econometrics and Statistics

Summary: A large amount of recent work has been devoted to the relevance of variance in cross-sectional asset pricing models. The existing work has largely focused on innovations in market variance as a priced systematic factor as well as on the pricing of idiosyncratic variance. Bandi and coauthor Benoit Perron (University of Montreal) invoke the correlation between past market variance and long-run market risk-premia (documented in their previous work) to propose an additional channel through which variance might play an important role in helping our understanding of price formation in financial markets. As their initial results appear to suggest, scaling by (or conditioning on) past market variance drastically reduces the mispricing of the size and value-sorted portfolios (at virtually all return horizons) in the context of well-known pricing paradigms. They intend to study this channel. Among other issues, they seek to (1) evaluate the relevance of past market variance as a conditioning variable vis-à-vis variables that have successfully been used in conditional asset pricing tests and (2) evaluate conditional asset pricing models which include past market variance as a scaling factor vis-à-vis extant multifactor models.

​Course Development: Doing Business in Asia

Brian Barry, Clinical Associate Professor of Economics

Summary: International Business II - Doing Business in Asia. The course examines several overarching trends that will confront managers and investors doing business in or with Asia, especially China and India. These include rapid urbanization in parts of the region; the rise of the mass consumer; the challenges of domestic integration in two giant and fast-developing economies (China and India); and the increasing clout and economic integration of East Asia as a whole.

The course establishes a framework in the first few weeks to help students navigate this breadth and variety. This includes applying economic and related analytical tools, which are taught elsewhere in the Chicago Booth curriculum, to Asian markets, institutions and firms.

This project will develop background analysis of several important sectors in Asia, including especially retailing and consumer goods, finance and infrastructure in China and India. This analysis will be used in the latter part of the course, to connect aggregate trends in the region to specific business problems and strategies.

How Do Family Business Groups Allocate Managerial Talent? Evidence from Korean Chaebols

Marianne Bertrand, Chris P. Dialynas Professor of Economics

Summary: This research project (joined with Francisco Perez-Gonzales and Woochan Kim) focuses on the allocation of managerial talent in Korean Chaebols. Our primary research objectives are to 1) document how different types of top managers (family members, non-family members recruited from the outside labor market, non-family members recruited from the group's internal labor market) are allocated in Korean Chaebols and 2) make some progress in testing the different theories that have been proposed to explain such allocation of managerial talent, and in particular the presence of family members in key managerial positions. To address these questions, we construct a rich panel dataset that covers both public and private firms since the late 1980s; the main advantage of this dataset is the rich information it contains on the educational, family and professional background of the top managers.

​Financial Literacy, Cognitive Biases and Payday Lending

Marianne Bertrand, Chris P. Dailynas Professor of Economics
Adair Morse, Assistant Professor of Finance

Summary: Our goal is to provide some new insights on the rationality of high-interest payday borrowing by assessing the relative merits of two opposite views of payday borrowing: Either individuals borrow rationally to smooth income/expenditure shocks, or borrowing behavior reflects one or more cognitive limitation(s) (e.g., an inability to understand the fee structure, a lack of self-control, overconfidence about repayment ability, etc.). We have obtained unique access to a large payday lender, where we will survey customers' concerning their education, level of self-control, need for the loan, and expectation of payback time. We then intend to perform a simple randomized field experiment, which will allow us to directly estimate the effect of financial literacy and biased expectations (if any) on individuals' ability to repay payday loans quickly. Combining the survey with the experiment results should enable us to better understand the circumstances under which people borrow from payday lenders and to determine whether further (and which specific) policy interventions in the industry have the potential to be welfare-enhancing.

The Geography of Prices

Christian Broda, Associate Professor of Economics

Summary: The lack of reliable price and quantity data for individual goods have lead researchers to use disaggregate price indices to measure deviations from the law of one price across locations. Typically researchers find that the volatility of these disaggregate price indexes is greater between city pairs that are far apart from each other (e.g., New York and Los Angeles) than in city pairs that are close to each other (e.g. , New York and Boston). Intuitively, they interpret their results as suggesting that deviations from the law of one price are larger the larger the distance between cities. In prior work Broda has found that simple “composition effects” in the calculation of disaggregate price indices can explain these patterns and that the law of one price does not fail as argued by previous papers. This project includes the purchase of the time-series data for individual goods purchased in different cities in the US and Canada to carefully highlight the limitations and potentially misleading conclusions of existing work based on price indexes.

Dynamic Standards Competition and Tipping: The Case of 32/64 Bit Video Game Consoles

Pradeep Chintagunta
Jean-Pierre Dubé, Professor of Marketing and Neubauer Faculty Fellow
Guenter Hitsch

Summary: This project looks at price competition in the video game consoles market during the 32/64-bit console generation. At that time, the market was dominated primarily by two large Japanese Oligopolists, Nintendo, and Sony.  Both firms were competing head-to-head with incompatible console standards, each with its own set of complementary video games. Our specific interest is to use data from this market to calibrate a dynamic oligopoly model and to use the model to analyze the conditions under which we get tipping (i.e., one standard dominates the market). Effectively, this is a project about standards wars and the potential emergence of monopoly market structures based on natural competitive forces.

Social Networks in Financial Markets

Andrea Frazzini, Assistant Professor of Finance

Summary: The project is on identifying the effects of information flow and influence within and among organizations, which result in real and measurable outcomes for security prices, firms, and shareholders. The identification strategy Frazzini and coauthors Lauren Cohen (Yale) and Chris Malloy (LBS) use is through relationships developed from board links to other firms and other organizations. They will consider both information dissemination and less formal types of influence through these relationships. The first link they plan to examine is a social network in the form of educational ties between firm boards and portfolio managers. Specifically, they plan to examine whether information is passed along social networks formed on common educational institutions. One benefit of using attended educational institution to define their social network is that the networks were formed in most cases decades before the information transfer, and most likely have nothing to do with the information being transferred (ex. Earnings news). In addition, they have a predictable flow of information along this network from firm boards to portfolio managers, and can observe the behavior of the latter to test their incorporation of any information received from the former. They also plan to examine additional board information-influence links and corresponding behavior, such as linked managers’ merger practices and adoption of other firm policies.

The Impact of Mass Media Ownership and Regulation on Coverage of Government Corruption

Matthew Gentzkow, Professor of Economics
Jesse Shapiro, Assistant Professor of Economics

Summary: This project has two goals. First, to use automated searches of international databases to measure differences across news outlets in coverage of government corruption. Second, to study the extent to which state ownership of media, media regulation, and protection of press freedom drive these differences. Gentzkow and Shapiro’s current plan is to focus on news coverage in Latin America, although they may expand the project to include other regions.

Hedge Funds: Internal Controls, Reporting Systems, and Investor Rights

Joseph Gerakos, Assistant Professor of Accounting

Summary: In contrast with traditional investment vehicles, hedge funds are subject to minimal regulation. Therefore, hedge fund managers are relatively unfettered by regulation in their choices and implementations of internal controls and performance reporting systems, and in their negotiations with investors over fees and redemption rights. Hedge funds thereby provide a setting to examine investment fund structure and financial contracting in an unregulated environment. Using a proprietary database of comprehensive due diligence reports for over 420 hedge funds, Gerakos and his coauthor Gavin Cassar (Wharton) will investigate how hedge fund managers choose and implement internal controls and performance reporting systems, the extent that investors value internal controls and reporting systems, and how investors negotiate with fund managers over fees and redemption rights. Finally, Cassar and Gerakos will investigate the extent to which reporting systems that allow greater managerial discretion are associated with predictable variations in reported performance, which are consistent with manipulation.

Taxes Subsidies, Fuel Economy, and the Purchases of Large SUVs

Austan Goolsbee, Robert P. Gwinn Professor of Economics

Summary: The tax cuts of the early 2000s included provisions allowing the self-employed to immediately expense vehicles up to $100,000.  The law did not apply to cars but the weight restrictions chosen allowed people to use the subsidy to buy very large SUVs, not just trucks, which had been the law's original intent.  High end SUVs like the Cadillac Escalade, the Porsche Cayenne, or the Chevy Suburban were available to high-income people with self-employment income at, effectively, one third off.  Since these vehicles have the lowest fuel economy of any passenger vehicles, this policy had the unintended effect of subsidizing poor gas mileage.  Goolsbee will examine how price sensitive the purchases of large SUVs are and, as a consequence, evaluate the potential impact of government policies to address automobiles' greenhouse gas emissions.

Emerging Markets and Financial Intermediaries

Veronica Guerrieri, Assistant Professor of Economics
Peter Kondor, Assistant Professor of Economics

Summary: Over the last fifteen years, emerging economies have experienced abrupt changes in bond spreads and large movements in capital flows. Guerrieri and Kondor propose a simple general equilibrium model where international investors hire fund managers to invest their capital either in the bonds of an emerging economy or in a riskless asset. They model the emerging economy as a small-open economy with an endogenous default decision. There is only an infinitesimal fraction of managers who have information on the fundamentals of the emerging country. This generates career concerns that distort the investment decision of uninformed fund managers. When the probability of default is sufficiently high, they prefer to invest in safe bonds even at a lower expected return to reduce the probability of being fired. This is what Guerrieri and Kondor define "reputational premium". As the economic and financial conditions change, the reputational premium can switch sign. This can generate an overreaction of the market leading to excess volatility of spreads, capital flows and economic activity.

Venezuela and the Economic Effects of Political Polarization

Chang-Tai Hsieh, Ford Foundation Visiting Associate Professor of Economics

Summary: What are the economic effects of political polarization? We study this question using unique information on individual political activity from Hugo Chávez’s Venezuela, the Maisanta database. The names of millions of pro-opposition supporters who signed recall petitions (seeing to remove Chávez from office) during 2002-2003, and the names of pro-government supporters who signed counter-petitions, were made public. We link the individuals in this political database to individuals in the national household survey and to the firm owners in the manufacturing census. We find that pro-opposition individuals experience significant drops in total earnings after 2003. We also find that pro-opposition individuals disproportionately leave public sector employment and pro-government individuals leave private sector employment. Finally, we find that firms owned by pro-opposition individuals have falling total employment, less access to foreign exchange, and rising tax burdens (possibly due to selective audits). We propose to carry out a survey to assess whether these results can be interpreted as rational willingness by members of the Venezuelan opposition to pay for their beliefs.

Understanding Racial Differences in Economic Outcomes

Erik Hurst, Professor of Economics and Neubauer Family Faculty Fellow

Summary: Hurst and coauthor Kerwin Charles (The Harris School) goal is to explore the possibility of conducting a large scale survey to assess the reasons for differences in economic outcomes between otherwise similar Black and White households. There is an abundance of evidence that suggests Blacks obtain less education, have worse health, are more likely to be incarcerated, have lower levels of accumulated wealth, and more instable family structures than similar Whites. While the differences between races have been convincingly documented, understanding the reasons for such differences has not. A primary reason for this is that the existing data sets available for research are limited in their scope and the type of information they collect to shed light on these types of questions. They realize that such a large scale data collection would be a massive undertaking. They are using this project to start the preliminary work of developing the type of questions that need to be asked, the sample frame of the survey, and potential funding sources.

Private Equity: Past, Present, and Future

Steven N. Kaplan, Neubauer Family Professor of Entrepreneurship and Finance

Summary: We are in the middle of a private equity and leveraged buyout (LBO) wave. In this article, Kaplan explains what a typical private equity transaction looks like and how the typical private equity fund is structured. He then provides time series evidence on different aspects of private equity / LBO activity. Next, he will discuss what he knows about the economics of private equity transactions, focusing on the changes that private equity investors implement – financial, governance and operational engineering – and the effect of those changes on measurable outcomes. He will then discuss what he knows about the economics of private equity funds. Next, he will discuss how the current buyout wave compares with the previous wave in the 1980s. Finally, he will identify questions that should be of interest to researchers in the near future.

Which CEO Characteristics and Abilities Matter?

Steven N. Kaplan, Neubauer Family Professor of Entrepreneurship and Finance

Summary: Using assessments of CEO candidates for companies involved in private equity transactions (PE) – buyout (LBO) and venture capital (VC) – Kaplan studies how CEO characteristics and abilities relate to hiring decisions, PE investment decisions, and subsequent performance. CEOs are assessed in seven general areas – leadership, personal, intellectual, motivational, interpersonal, technical and functional. The ratings of different characteristics and abilities are generally correlated. PE firms – both LBO and VC – are more likely to hire and invest in more highly rated / talented CEOs. For LBOs, more highly rated CEOs who are hired are more likely to be successful. Abilities related to “hard” or executive skills are associated with greater success (and greater likelihood of being hired) for LBOs. Abilities related to “soft” or team related skills are associated with a greater likelihood of being hired, but not with a greater likelihood of success for both LBOs and VC deals.

Wall Street and Main Street: What Contributes to Increasing Income Inequality?

Steven N. Kaplan, Neubauer Family Professor of Entrepreneurship and Finance

Summary: It is well known that the income distribution in the United States has become increasing unequal over the last two or three decades, particularly at the very top end of the distribution. The sources of this increased inequality, however, are not completely understood. In this paper, Kaplan will consider how much of the inequality today at the top end of the income distribution can be attributed to different sectors of the economy – top executives of non-financial firms (Main Street), financial services sector employees (Wall Street), lawyers, and professional athletes. He also will discuss how those contributions have varied over time. Finally, he will discuss how his results relate to different theories of the source of income inequality.

The Integration of Banking Markets in Europe

Anil K Kashyap, Edward Eagle Brown Professor of Economics and Finance

Summary: As recently at 1985, the US banking industry was quite fragmented, owing largely to regulatory barriers that prevented consolidation. Kashyap and coauthor Reint Gropp (Frankfurt) show that between 1985 and 1995 (just after the abolishment of cross-state branching barriers) rates of return converged substantially. Formal barriers to cross-border banking in Europe disappeared in the 1990s, yet bank profitability still differs considerably across countries. More importantly, the more profitable banks seem to have not gained market share from less efficient banks. This project contrasts the US and European experience and attempts to identify the factors that have prevented convergence of bank profitability across European countries.

Do Conflict of Interest Disclosures Work?

Christian Leuz, Joseph Sondheimer Professor of International Economics, Finance, and Accounting

Disclosure requirements are increasingly used as a public policy instrument in many areas, including pollution control, food safety, and conflicts of interest in medical research and in securities markets, and in many cases in lieu of more conventional regulation. The idea is to compel disclosures, rather than to restrict or mandate certain behaviors or business practices. Despite these trends in practice, the merits of disclosure requirements are heavily debated in the academic literature. In medicine and bioethics, there is an ongoing debate as to whether conflict of interest disclosures are sufficient and yield the desired outcomes. However, there is little evidence on the effects of conflict of interest disclosures. Our research project intends to examine the effect of conflict of interest disclosures in medical research articles on demand for those articles. We deliberately pick a setting where conflicts of interest exist and are a substantial concern. In addition, our study involves a very sophisticated audience that should be able to understand and evaluate the disclosed conflicts of interest. We expect this study to make a significant contribution to the debate about conflict of interest disclosures and more generally to the issue of whether disclosure requirements are a substitute for regulation.

Interaction Between the Tools of Shareholder Oversight: Proxy Voting and the Wall Street Walk

Gregor Matvos, Assistant Professor of Finance

Summary: The purpose of this project is to understand the interaction between two central tools of shareholder oversight: shareholder voting and shareholder portfolio decisions. Through voting, shareholders can directly exercise oversight. Alternatively, shareholders can use the size of their holdings in the company to exert pressure on the management. To obtain a more complete understanding of corporate governance, these two shareholder oversight tools have to be examined jointly. Because of large heterogeneity in fund voting behavior, it is essential that these decisions be examined on the level of individual funds, as opposed to looking at aggregate voting and portfolio data, as had been the case heretofore. By focusing on individual funds, we can explore differences in fund decisions in the cross-section, and can also trace individual funds over time. This approach also allows us to look into sorting of different institutions across firms over time, offering us insight into the impact of holding dynamics on the governance of the firm.

​House Prices, Consumer Credit and Consumption

Atif Mian, Associate Professor of Finance
Amir Sufi, Associate Professor of Finance

Summary: Our research project seeks to obtain precise estimates of how consumer credit, and ultimately consumption, responds to movements in housing prices. Housing is by far the largest asset for most households in the US. As a result, any link between asset prices and consumer borrowing/consumption is most likely to come through the housing sector. This question of how house prices affect borrowing and consumption is of increased importance given recent turmoil in mortgage markets and aggregate price depreciation of the US residential housing stock. We explore the effect of housing on borrowing and consumption behavior with a unique data set that follows a random sample of 200,000 US consumers over the last eleven years. Our data includes individual borrowing and default decisions broken down by credit type (auto, credit card, mortgage, home equity etc.), as well as house prices at the zip code level. We identify the effect of house price appreciation on consumers already owning a home in 1998 by exploiting supply‐induced within‐county variation in home price appreciation.

Home Prices, Consumption, and Delinquency

Atif Mian, Associate Professor of Finance
Amir Sufi, Associate Professor of Finance

Summary: Mian and Sufi’s proposed line of research seeks to understand, (i) how a change in the value of household assets affects household consumption behavior, and (ii) whether the recent surge in sub-prime delinquencies is a result of “over-borrowing”. They use a unique zip code level data set over 16 years that contains information on home prices, household borrowing activity, and delinquencies to estimate how changes in home values affect household borrowing and delinquency patterns.

Soft and Hard Information in Lending: Evidence from Commercial Property Loan Contracts

Tobias Moskowitz, Professor of Finance and Neubauer Family Faculty Fellow

Summary: Theory suggests that large lenders primarily use “hard” information to determine loan acceptance and terms, whereas smaller, local banks use “soft” information to grant loans and set terms. This means that soft info may not travel well (across geographic distance or up a hierarchy) because there are language barriers in interpreting soft info, and no such barriers with hard info. This idea would be particularly useful when dealing with international capital markets where “translating” information is more difficult.  Moskowitz and coauthors Effi Benmelech (Harvard), Mark Garmaise (UCLA), and Jeremy Stein (Harvard) develop a model highlighting the role of ex ante hard vs. soft information in determining who provides financing and the role of ex post quality of information in determining the financing terms. They then test the model using data on commercial loan contracts. They also employ property-specific variables that characterize the importance of soft or hard information, for instance whether the property has available accounting data on recent earnings. In addition, they also test whether the banks that specialize in soft information – small and local banks – make better loans ex post using our panel of property transactions.

Catastrophic Risk and Credit Markets

Tobias Moskowitz, Professor of Finance and Neubauer Family Faculty Fellow

Summary: Moskowitz and coauthor Mark Garmaise (UCLA) provide a model of the effects of catastrophic risk on real estate financing and prices and demonstrate that insurance market imperfections can restrict the supply of credit for catastrophe-susceptible properties. Using unique micro-level data, they find that earthquake risk decreased commercial real estate loan provision by 22 percent in our California properties in the 1990's. The effects are more severe in African-American neighborhoods. They show that the 1994 Northridge earthquake had only a short-term disruptive effect. Their basic findings are confirmed for hurricane risk, and their model and empirical work have implications for terrorism and political perils.

​Value and Momentum Everywhere

Tobias Moskowitz, Fama Family Professor of Finance and Neubauer Family Faculty Fellow

Summary: Well, almost everywhere. Value and momentum strategies generate significant alpha for stock selection within several countries, selection of stock indices across countries, currency selection, selection of bonds across countries, and commodity selection. Based on this broad evidence, we explore the common value and momentum factors across asset classes to shed light on the underlying economic drivers. A long/short value strategy in one asset class is positively correlated to value strategies in other asset classes, momentum strategies are correlated across asset classes, while value is negatively correlated to momentum strategies in its own and other asset classes. Value and momentum across asset classes are both positively correlated with long-run consumption growth. Value is negatively correlated with global liquidity risk, while momentum is positively correlated. Finally, illiquid securities have stronger value and momentum returns and are more sensitive to global liquidity risk.

​State and Local Government Pension Funding and Investment Strategies: Risk and the Distribution of Intergenerational Transfers

Robert Novy-Marx, Assistant Professor of of Finance
Joshua Rauh, Assistant Professor of Finance

Summary: This research examines the extent of intergenerational transfers from future to current taxpayers due to funding and investment strategies in state and local defined benefit (DB) pension plans. We compile a unique and comprehensive dataset of funding, asset allocation, and demographics of the plans from government reports and other sources. We develop plausible discounting assumptions that approximate the true risk profile of accrued state pension promises. The underfunding of accrued benefits in state pension plans is clearly larger than the $798 billion of outstanding US state bonds, and may be as high as $2 trillion if the pension benefits are viewed as more secure than state general obligations. We calculate distribution of future pension funding outcomes (fund-by-fund and in aggregate) given variance-covariance matrices of the different pension fund asset classes and calibrated assumptions about how pension liabilities vary with the asset pricing risk factors. Implied intergenerational transfers are very large under current policies.

The Costs and Benefits of Trade Credit

Raghuram G. Rajan, Eric J. Gleacher Distinguished Service Professor of Finance

Summary: While a number of studies have attempted to understand the factors determining the quantity and duration of trade credit from either the side of the creditor or the borrower, there is little work on the nature of trade credit, taking into account the characteristics of both creditor and recipient. The objective of this research is to shed light on supplier financing, and to examine ways of improving its effectiveness. Rajan hopes to use firm- and contract-level data to study the motivation and cost of supplier financing across firms of different sizes and credit risk and countries of different levels of development. This is important for our understanding of access to finance by small and medium sized customers as well as the role of trade credit in development and growth.

Research to support work of Committee on Financial Sector Reforms in India

Raghuram G. Rajan, Eric J. Gleacher Distinguished Service Professor of Finance

Summary: Rajan has been asked to put together a committee to suggest the next generation of financial sector reforms to the Government of India. He would like to base the eventual recommendations of the committee (due in end March, 2008) on solid analysis and facts. He has a number of people in India who will be analyzing data and creating the necessary reports to inform the committee, but will be putting together a small group of research assistants in Chicago, who can analyze the Indian experience and the experience of other countries carefully, and provide the material for the committee to make its report persuasive. This research will be on all aspects of the financial sector including the demand for finance from corporations and households, the supply of finance and financial services, the extent to which different segments of the economy have access, and the macro-economic frameworks for policy (e.g., monetary, fiscal, capital account openness) that will make the financial sector more effective.

Anatomy of the Price Impact of an Order

Jeffrey R. Russell, Professor of Economics and Statistics

Summary: Financial markets are considered to be liquid if a large quantity can be traded quickly and with minimal price impact. Although the idea of a liquid financial market involves both a cost as well as a time component, most measures of execution costs tend to focus on only a single number reflecting average costs and do not explicitly account for the temporal dimension of liquidity. In reality, trading takes time since larger orders are often broken up into smaller transactions or when limit orders are used. This research uses a unique data set consisting of all the trades executed to fill orders by Morgan Stanley in 2005. Russell analyzes the transitory and permanent price impacts of different order execution strategies varying from urgent execution over a short time interval to passive, or VWAP trading over longer time intervals.

​The Tip of the Iceberg: What the Market Knows and When

Jeffrey R. Russell, Professor of Economics and Statistics

Summary: A disconnect exists between theoretical models for how trade decisions should effect prices and the way trade data is analyzed. Traders think in terms of and place orders through brokers, but most empirical studies of price impact consider the impact of a single trade without explicitly recognizing it is part of a larger order. I consider a model in which the market views a single trade as the tip of an iceberg - part of a larger order that is yet to be completed. If the market knows that an initial trade by a broker is likely to be followed by similar additional trades in the same asset on the same side of the market, the price impact of a single trade should reflect not only the observed trade size, but also the forecast of the entire order. Using a unique data set of executed orders from Morgan Stanley I examine the how the market learns and updates prices after viewing a single trade that is likely part of a larger order of unknown and random size. Testable conditions underlying the nature of price discovery are established and can be evaluated with the data.

The Paradox of Default Models

Amit Seru, Assistant Professor of Finance

Summary: We contend that while standardization through the use of default models (like credit scores and credit ratings) can help improve the liquidity in the market, it does have a dark side. The argument is that standardization, much in the style of Lucas critique, alters the underlying parameters which determine the relationship between creditworthiness and the likelihood of default. We examine this in the context of securitization market, where standardization has come about due to use of credit scores. The hope of the project is to convincingly demonstrate that default models are not invariant to the strategic behavior of market participants.

Audit Quality and Auditor Reputation: Recent Events in the Japanese Audit Market

Douglas J. Skinner, John P. and Lillian A. Gould Professor of Accounting
Suraj Srinivasan, Assistant Professor of Accounting

Summary: At the same time that Japan is holding itself out as a high quality participant in world capital markets, there have been a string of high-profile accounting scandals, including those at Sanyo, Nikko Cordial, and Livedoor (“Corporate Shenanigans in Japan,” The Economist, March 22, 2007). Regulators at the FSA have reacted strongly to these scandals, arresting auditors and suspending the operations of one of Japan’s Big Four accounting firms, ChuoAoyoama, the PwC affiliate in Japan. These events caused PwC to restructure its Japanese operations, which essentially resulted in the transfer of lower quality clients and staff to its competitors and the formation of a new, smaller boutique operation in Japan (PwC Aarata) to which it transferred prominent, high quality clients such as Sony and Toyota as well as the best of its Japanese staff. These events provide an unusually rich setting to investigate the role of auditor reputation on audit quality in a country where auditors’ legal liability is largely non-existent. The research has potentially important policy implications given regulators’ recent interest in the relation between auditor liability and the increasing concentration of the audit market, and related concerns about the effects of another major audit failure.

Lobbying for Trade and the Industrial Organization of Special Interests

Francesco Trebbi, Assistant Professor of Economics

Summary: The main objective of Trebbi and coauthor Matilde Bombardini’s (British Columbia) project is to build the largest database of lobbying activity by firms and trade associations available up to date in the literature. The data have the potential to become an essential tool for the quantitative analysis of lobbying and special interest influence in the United States from both a research and a policy perspective. In order to achieve this, matching lobbying reports under the US Lobbying Disclosure Act of 1995 to firm-level and industry-level data is necessary. It is an extremely time-consuming and RA-intensive effort. From a research standpoint, the data will deliver material for several projects. Some of these projects are targeted specifically to trade policy and protection, other focus on empirically estimating collective actions models (how do interest groups organize, lobby, and shape economic policy more in general).

International Bond Return Predictability

Pietro Veronesi, Roman Family Professor of Finance

Summary: As a broad empirical regularity bond risk premia exhibit predictable variation across time and maturities in the postwar US Treasury market. Risk premia are affected by numerous factors, including variation of investors risk preferences as well as possibly country specific business cycles or monetary policies. The purpose of this project is twofold: first we search for time variation in bond excess returns outside the US markets to test whether the predictability of excess bond returns is a robust feature of the global treasury markets rather than a distinctive trait of the US data. Second, based on the evidence that a certain degree of predictability can also be detected in foreign markets, we try to establish whether there is a common factor driving the predictable component of excess returns globally and how this interacts with the risk in each market.  This decomposition inform on the component of risk premia due to time varying risk preferences (market price of risk) or country specific macroeconomics or monetary policy risk.

Culture as the Source of the Legal Origin Effect

Luigi Zingales, Robert C. McCormack Professor of Entrepreneurship and Finance

Summary: The seminal papers of La Porta et al. have established a very strong correlation between the family of origin of a country legal system and many relevant outcomes (financial market development, extent of regulation, level of taxation, etc.). Three possible explanations have been advanced: a) the vary nature of the common law; b) political; c) enforcement. Zingales and coauthors Paola Sapienza (Northwestern) and Luigi Guiso (European University Institute) advance a fourth one: the nature of the prevailing culture. They collect a number of indicators of culture across countries and test whether these indicators are able to explain the effects of legal origin.

How Pervasive is Corporate Fraud?

Luigi Zingales, Robert C. McCormack Professor of Entrepreneurship and Finance

Summary: Building on the dataset of corporate frauds in large corporations assembled for Dyck, Morse, and Zingales (2007), our objective is first to infer the unconditional probability that a fraud is committed whether or not it is subsequently caught and then to calculate the expected cost of fraud.  Our main identification strategy uses the increased probability of a fraud being revealed following the forced turnover of external auditors after the demise of Arthur Andersen.  We plan to validate this measure by using Beneish (1999) measures of earning manipulation and the difference in revealed fraud in companies where the incentives for fraud detection are high versus companies where they are low. We then plan to estimate the cost of fraud by using changes in a company’s multiple vis-à-vis industry multiples around the event period. The combination of the two results should give us a sense of the expected cost of corporate fraud, which we can compare with the expected cost or regulation.

Math and Gender

Luigi Zingales, Robert C. McCormack Professor of Entrepreneurship and Finance

Summary: We use the Program for International Student Assessment (PISA) and country level data from World Value Survey and the World Economic Forum to analyze the gender gap in mathematics and readings in 41 countries. Our preliminary findings indicate that 1) 15 years old girls underperform in mathematics with respect to boys and outperform in readings; 2) the gender gap in mathematics is negatively correlated with the level of emancipation of women in society. Our goal in this project is to determine what elements of the educational system of some countries are responsible for the reduction and in some cases for the elimination of the gender gap in math.