Inelastic U.S. Equity Markets: New Evidence From A Reform of Fiduciary Duties

63 Pages Posted: 12 Aug 2024

See all articles by Stefano Cassella

Stefano Cassella

Tilburg University- School of Economics and Management

Antonino Emanuele Rizzo

Nova School of Business and Economics

Oliver G. Spalt

University of Mannheim - Business School; European Corporate Governance Institute (ECGI)

Leah Zimmerer

University of Mannheim - Finance Area; University of Mannheim - Graduate School of Economic and Social Sciences

Date Written: July 26, 2024

Abstract

We study the equity market implications of a reform in the laws that govern trust investments, implemented in a staggered fashion across U.S. states from 1986 to 2006. The introduction of the prudent investor rule systematically alters the relative attractiveness of stocks within the cross-section of U.S. equities for trusts. As trusts account for a substantial fraction of institutional equity holdings in our sample period, and since the reform does not pertain to other investors, our empirical setting provides a rare opportunity to study the impact of a regulatory change on institutional investor holdings and relative prices in the U.S. equity market. We show that, before the reform, trusts tilt their portfolios towards prudent stocks ("regulatory tilts"). After the law change, trusts undo these tilts which introduces large and predictable changes in demand. Consistent with a model of inelastic equity markets, we find long-lived outperformance of stocks bought by trusts after the law change relative to stocks sold by those funds. In this new and unique setting, we derive estimates of the price elasticity of demand of U.S. equities which are low and support the inelastic markets hypothesis.

Keywords: Inelastic Equity Markets, Demand Effects, Institutional Investors, Trusts, Prudent Man Laws

Suggested Citation

Cassella, Stefano and Rizzo, Antonino Emanuele and Spalt, Oliver G. and Zimmerer, Leah, Inelastic U.S. Equity Markets: New Evidence From A Reform of Fiduciary Duties (July 26, 2024). Available at SSRN: https://ssrn.com/abstract=4907098

Stefano Cassella

Tilburg University- School of Economics and Management ( email )

Professor de Moorplein 521
Tilburg, 5037
Netherlands

Antonino Emanuele Rizzo (Contact Author)

Nova School of Business and Economics ( email )

Campus de Carcavelos
Rua da Holanda, 1
Carcavelos, 2775-405
Portugal

Oliver G. Spalt

University of Mannheim - Business School ( email )

L5, 5
Mannheim, 68131
Germany

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Leah Zimmerer

University of Mannheim - Finance Area ( email )

Mannheim, 68131
Germany

University of Mannheim - Graduate School of Economic and Social Sciences ( email )

D7, 27
Mannheim, 68131
Germany

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