SUDIPTO DASGUPTA, Hong Kong University of Science & Technology - Department of Finance
Email: dasgupta@ust.hk
THOMAS H. NOE, Oxford (SBS and Balliol)
Email: thomas.noe@sbs.ox.ac.uk
ZHEN WANG, Hong Kong University of Science & Technology - Department of Finance
Email: zwang@ust.hk

This paper documents the short and long term balance sheet effect of cash flow shocks. We show that cash savings in the short run and debt reduction in both the short and the long run account for a substantial fraction of cash flow use. Although, in the long run, investment exhibits substantial sensitivity to cash flows, investment does not absorb the entire cash flow shock. In fact, the tighter the financial constraints, the smaller the fraction of cash flow absorbed by investment and the more by leverage reduction. Firms stage their response to positive cash flow shocks, delaying investment while building up cash flow stocks and reducing leverage. These results suggest that much of the short-run economic effect of cash flow shocks to the corporate sector may be channeled into corporate debt market rather than capital goods market especially when financing constraints tighten.

RONGBING HUANG, Kennesaw State University - Department of Economics and Finance
Email: rhuang1@kennesaw.edu
ZHAOYUN SHANGGUAN, affiliation not provided to SSRN
Email: zshangguan@umassd.edu
DONGHANG ZHANG, University of South Carolina - Moore School of Business
Email: zhang@moore.sc.edu

We examine investment banks' networking function in capital markets, using a sample of Private Investments in Public Equity (PIPEs). We argue that investment banks develop relationships with investors through repeat dealings, and that such relationships form the basis of their networking function. We find that investment banks, especially those with stronger networking abilities, help issuers attract more investors. Investors are more likely to participate in an issue if they have an existing relationship with the issue's investment bank(s). Correspondingly, an issuer that desires more investors is more likely to hire an investment bank than place the shares directly. We also find that issuers pay higher fees to hire investment banks with stronger networking abilities. Our empirical findings suggest that the networking function of investment banks is important in securities offerings.

ALEXEI V. OVTCHINNIKOV, Vanderbilt University - Owen Graduate School of Management
Email: alexei.ovtchinnikov@owen.vanderbilt.edu

Deregulation significantly affects the firms' operating environment and leverage decisions. Firms experience a significant decline in profitability, asset tangibility and a significant increase in growth opportunities following deregulation. Firms respond by reducing leverage. Deregulation also significantly affects the cross-sectional relationship between leverage and its determinants. Leverage is much less negatively correlated with profitability and market-to-book and much more positively correlated with firm size following deregulation. These results are consistent with the dynamic tradeoff theory of capital structure. Also consistent with the dynamic tradeoff theory, the speed of leverage adjustment to optimal leverage increases significantly following deregulation.

BENJAMIN GOLEZ, Universitat Pompeu Fabra
Email: benjamin.golez@upf.edu

This paper proposes a new variable for the analysis of the stock market return predictability. Recognizing that expected dividends are time-varying, I show that the variation in the expected return can be captured by the expected dividend yield. Using options implied dividend yield (IDY) to proxy for the expected dividend yield, I find that the IDY serves as a strong predictor for monthly and quarterly market excess returns. Indeed, IDY predicts returns better than the traditionally used realized dividend-price ratio. Moreover, IDY also outperforms earnings-price ratio, consumption-to-wealth ratio, average implied correlation and variance risk premium.

ZHENXU TONG, University of Exeter
Email: z.tong@exeter.ac.uk

This paper studies how firm diversification affects the value of corporate cash holdings. We develop four hypotheses based on efficient internal capital market, agency problems, coinsurance effect, and shareholder-bondholder conflicts. We find that the value of cash holdings is lower in diversified firms than single-segment firms. We find that firm diversification is associated with a lower value of cash in both financially unconstrained and constrained firms, and that the value of cash is even lower for the diversified firms with more restrictions on shareholder rights. The findings are most consistent with the interpretation that firm diversification reduces the value of corporate cash holdings through agency problems.

LAURENCE COPELAND, Cardiff University - Cardiff Business School
Email: copelandl@cardiff.ac.uk
YANHUI ZHU, University of Wales System - Economics Section
Email: sbsyz19@cf.ac.uk

The seminal Barro (2006) closed-economy model of the equity risk premium in the presence of extreme events ("disasters") allowed for leverage in the form of risky corporate debt which defaulted only in states when the Government defaulted on its debt. The probability of default was therefore exogenous and independent of the degree of leverage. In this paper, we take the model a step closer reality by assuming that, on the one hand, the Government never defaults, and on the other hand, that the "corporate sector" in the form of the Lucas tree owner pays its debts in full if and only if its asset value is sufficient, which is always the case in non-crisis states. Otherwise, in exceptionally severe crises, it defaults and hands over the whole "firms" its creditors. The probability of default by the tree owner is thus endogenous, dependent both on the volume of debt issued (taken as exogenous) and on the uncertain value of output. We show, using data from both Barro (2006) and Barro and Ursua (2008), that the model can generate values of the riskless rate, equity risk premium and credit risk spread broadly consistent with those typically observed in the data.