This paper examines how a shared cultural background between analysts and firms under coverage affects information asymmetry in financial markets. To disentangle cultural proximity from geographic proximity, we extract a sample of firms publicly traded in the U.S. but headquartered in regions sharing Chinese culture (“Chinese firms”), and identify a group of U.S. analysts of Chinese ethnic origin. We find that analysts of Chinese ethnicity issue more accurate forecasts about earnings of Chinese firms. The rise in forecast precision is more pronounced among first-generation Chinese immigrants. Market reaction is stronger if analysts of Chinese ethnicity revise their forecasts upwards or issue favorable recommendations about a Chinese firm. Our results indicate that cultural proximity mitigates information asymmetry that adversely affects foreign firms, especially those from emerging markets.
The Brain Gain in Corporate Boards: A Natural Experiment from China (with Mariassunta Giannetti and Guanmin Liao)
This paper explores whether board members with foreign experience have a positive effect on firm performance in a large emerging market like China. To establish causality, we exploit that at different times, Chinese provinces introduced policies to attract highly talented emigrants studying or working abroad. These policies increased the likelihood that firms in these provinces had directors with foreign experience. We document that this resulted in higher valuation, productivity and profitability for these firms. We also show that the arrival of directors with foreign experience in corporate boards affected corporate policies and improved corporate governance in a way that is consistent with a causal impact of directors with foreign experience on firm performance. These results indicate that the transfer of knowledge to emerging markets may occur not only through foreign investment, but also through labor flows and, in particular, return migration.
Information-based theories of financial intermediation focus on delegated monitoring. However, there is little evidence on how markets discipline financial intermediaries who fail at this function. This paper exploits the direct link between corporate fraud and monitoring failure and examines how a venture capital (VC) firm’s reputation is affected when it fails to prevent fraud in its portfolio companies. We find that VCs who fail to prevent fraud experience greater difficulty in taking future portfolio companies public, and that the negative effect prevails over ten years after the fraud surfaces. In addition, reputation-damaged VCs interact differently in the future with their limited partners, other VCs in the community, and initial public offering (IPO) underwriters because they are perceived by these groups as inefficient monitors.
Existing literature examines how analysts’ conflicts of interest affect investors. Empirically, however, it has been challenging to isolate the impact of analysts’ conflicts of interest, and there is less evidence on how such conflicts affect the firms under coverage. In this paper we develop a novel approach to identify a sample of firms whose coverage is likely driven exclusively by analysts’ private incentives to generate investment banking revenue. We find that the loss of conflicted analyst coverage has little adverse effect on information efficiency, capital investment, cost of capital, and equity issuance. Since conflicted research provides no real benefit to the firm under coverage, our results suggest that firms attain little benefit when offering investment banking business in exchange for analyst coverage.
We develop an equilibrium theory to investigate to what extent, depending on the level of development, financiers allocate capital on the basis of prior connections, instead of collecting information on the productivity of several potential entrepreneurs. We explore the effects of information acquisition (or the lack thereof) on investment efficiency, financiers' returns and entrepreneurial rents and show that there may be both under-investment and over-investment in information acquisition. Our results have implications for the desirability of formal financial markets, connected lending, and the characteristics of markets that are more likely to attract entrepreneurs' capital raising activities.
Ownership Structure, Liquidity, and Investment Efficiencies
By altering the fraction of shares held by shareholders with significant liquidity needs, a firm's ownership structure affects the degree of informed trading in the firm's stock. Extensive informed trading in the firm's shares increases the losses of shareholders who are subject to liquidity shocks, but it improves the information present in share prices, which in turn may improve the firm's investment decisions. Unless shareholders' liquidity shocks are especially severe, a firm with few growth opportunities may favor a structure that places more shares in the hands of a large shareholder that trades infrequently, whereas a firm with significant growth opportunities will prefer a more diffuse ownership structure that favors increased liquidity trading. When small investors' liquidity shocks are especially severe, this result is reversed. If the large shareholder also has access to information about the firm's growth opportunities, it may be optimal to have the large shareholder hold shares with trading restrictions so as to prevent other informed traders from being crowded out.
In this paper we examine how board structure affects the informativeness of board members by comparing the returns earned by officers and independent directors from purchasing the firm’s stock. We investigate whether an exogenous shock to the board structure – the 2002 Sarbanes-Oxley Act and the related mandates – leads to a shift in information asymmetry between officers and independent directors. We find that improvement in board’s information environment is limited to firms whose boards are previously controlled by outsiders. In contrast, information asymmetry rises among firms whose boards are previously dominated by insiders: An increase in independent directors is followed by a significantly larger difference in buy-and-hold returns between officers and independent directors. In addition, the deterioration in board’s information environment is associated with a poor firm operating performance.
We examine whether bilateral political relations can explain investment and trade flows between the United States and other countries. We treat political relations as endogenous using instrumental variable analysis and investigate whether an exogenous shock to political relations, the 2003 war in Iraq, leads to a shift in economic flows. The results suggest that a deterioration in bilateral relations is followed by a significant decrease in economic flows between the United States and that country. These results are robust to country fixed effects, income, industry growth, financial market development, and risk.
We study whether market reactions to earnings news vary over the business cycle. Using a sample of quarterly earnings reports from 1984 through 2003, we find market reactions to earnings news differ between periods of expansion and contraction. The difference depends on firm size - market reactions to small firms' earnings news are stronger during expansions than during contractions, but market reactions to large firms' earnings news are weaker during expansions than during contractions. Further analysis shows that the result is mainly driven by bad earnings news. Our findings cannot be explained by the distinction between value and growth stocks, the entry and exit of new firms in the economy, earnings management, pre-announcements, time-varying earnings persistence, or time-varying investor attention.