Financial Innovations and the Curse of Safety

16 Pages Posted: 23 Feb 2020

See all articles by Hammad Siddiqi

Hammad Siddiqi

University of the Sunshine Coast-School of Business

Sajid Anwar

University of the Sunshine Coast - School of Business

Date Written: January 25, 2020

Abstract

We show that financial innovations, by letting firms benefit from safe cash flows in new ways, potentially cause a misallocation of resources at the firm level with low net present value (NPV) projects (with larger amounts of safe cash flows) getting preference over high NPV projects. Even negative NPV projects may be accepted. Such financial innovations benefit large firms (with large cash flows) more than small firms; hence, they widen the value-gap between leader and follower firms. These results indicate that productivity slowdown and the rise of superstar firms are not independent phenomena, rather they share the same underlying cause: Financial innovations letting firms benefit from safe cash flows. We show that misallocation towards low NPV projects gets worse as interest rates approach zero. The value-gap between large and small firms also increases as interest rates approach zero. These results cast doubt on the effectiveness of monetary policy in a low interest rate environment.

Keywords: Financial Innovations, Disproportionate Safety Preference, Productivity Slowdown

JEL Classification: G00, G30, G20

Suggested Citation

Siddiqi, Hammad and Anwar, Sajid, Financial Innovations and the Curse of Safety (January 25, 2020). Available at SSRN: https://ssrn.com/abstract=3526183 or http://dx.doi.org/10.2139/ssrn.3526183

Hammad Siddiqi (Contact Author)

University of the Sunshine Coast-School of Business ( email )

Brisbane, QLD 70010
Australia
+61404900497 (Phone)

HOME PAGE: http://www.usc.edu.au/staff-repository/dr-hammad-siddiqi

Sajid Anwar

University of the Sunshine Coast - School of Business ( email )

90 Sippy Downs Drive
Sippy Downs, QLD 4556
Australia

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