Limited Attention to Detail in Financial Markets, with Henrik Cronqvist, Tomislav Ladika and Zacharias Sautner
(Revise & Resubmit at the Journal of Financial Economics)
We show that firm valuations fell after a key expense became more visible in financial statements. FAS 123-R required firms to deduct option compensation costs from earnings, instead of disclosing them in footnotes. Firms that granted high option pay experienced significant earnings reductions, while fundamentals remained unchanged. These firms were more likely to miss earnings forecasts, and they also experienced recommendation downgrades and valuation declines. Prior experience helped analysts learn to overcome attention constraints, and they seem to have learned faster than investors. Our findings are consistent with market participants exhibiting limited attention to option costs before FAS 123-R.
Market-implied equity issuance costs, with Enrique Schroth
(Work in progress)
Existing literature measures the cost of issuing equity using low frequency accounting data from Compustat or specific databases with limited coverage. This paper proposes an alternative measure, motivated by Fama and French (2005), but based on the daily variation in outstanding equity from CRSP. The usefulness of this measure lies in its ability to capture each issuance and relate it to its associated price reaction. The Bolton, Chen and Wang (2013) model serves as the basic set up for the structural estimation. The project is currently at the final estimation stage.
This paper shows that both value and momentum premia arise in a q-theoretic framework that considers optimal corporate policies under uncertain financing conditions. Higher expected growth and higher equity issuance costs make winners riskier than losers during times of overall easy financing conditions. The value premium captures differences in the degree of financial constraints that increase during tight financing markets. These dynamics imply a procyclical momentum premium, a countercyclical value premium and a negative correlation between the two premia. Empirical evidence on observed financing choices and relative measures of constraints in value and momentum portfolio sorts confirm model predictions.
2017 Cass Finance Research Day Best Paper Award
I examine the separate roles of persistent and transitory earnings shocks in explaining price momentum. I find that transitory shocks have significant explanatory power, suggesting financial constraints may be important for momentum firms. In a liquidity management model that accounts for both types of shocks, the most constrained firms end up in the extreme past performance portfolios. High expected cash-flow growth carries a positive risk for constrained firms, driving the difference in expected returns between winners and losers. The model reproduces the average momentum premium and its dissipation one year after formation observed in the data. Empirical proxies for financial constraints and expected growth confirm model predictions.