Essays on Corporate Finance and Asset Management
This dissertation consists of three chapters spanning two areas of finance: corporate finance and asset management. A unifying theme across all chapters is the identification of issues that calls for the action of policymakers in order to improve the conditions of the less empowered, with a special focus on two themes: (1) factors affecting small entrepreneurs in the main street, and (2) agency and transparency problems underlying the management of small investors' wealth. Understanding these issues – and how to mitigate them – is of fundamental importance for regulations and policies aiming at the reduction of income and wealth inequality. I quantify the economic losses generated by (i) the underperformance of funds subject to agency problems, and by (ii) the business underactivity in low-income regions, carefully measuring the benefits of actual and hypothetical interventions by policymakers.
In the first chapter, "Crime Rates, Law Enforcement, and Business Activity", I ask if regions with prevalent violent and property crimes can promote business activity by reducing crime rates with more law enforcement. A short-term increase in the police force leads to a reduction in crime rates and an increase in the total sales of the retail sector. Surprisingly, the economic gains stemming from the reduction in murders is similar to the additional value added by the retail sector, highlighting the importance of accounting for business activity in the law enforcement cost-benefit analysis.
This causal effect from crime rates to business activity, taken together with the finding of the crime literature that increased business activity leads to fewer crimes, implies a feedback between crime and business, which suggests the existence of multiple Pareto-ranked equilibria. I provide evidence that strong – yet temporary – police shocks can create a permanent reduction in crime and a permanent increase in entrepreneurship, consistent with a shift away from the undesirable equilibria. The findings highlight how crime prevention law enforcement could be used as a tool to achieve economic development for economies stuck in a perverse poverty trap equilibrium with high-crime and low-business-activity.
In the second chapter, "Outraged by Compensation: Implications for Public Pension Performance", based on joint work with Adair Morse and Alexander Dyck, we analyze the frictions in optimal contracting emerging from board members' sensitivity to employee and public outrage over high management compensation. We show that relaxing outrage constraints results in substantial incremental value added. The case highlights the importance of governance structures that insulates boards from external political pressures in state pension funds.
In the third chapter, "Mutual Fund Portfolios: The Case of the Missing Value Funds", based on joint work with Martin Lettau and Sydney Ludvigson, we assess the portfolios of active mutual funds and ETFs from the lens of risk (anomaly) factors that have been identified by the asset pricing literature. Our main finding is that mutual funds' portfolios are highly concentrated in growth stocks. Surprisingly, this is true even for funds that advertise themselves as value-oriented. This finding is of great importance for the evaluation of the transparency of the investment strategies in this industry, given that non-sector funds are usually classified in the ``square'' composed by the four combinations of small cap/ large cap and value/growth. We conclude that U.S. retail investors cannot trust the official labels of mutual funds and ETFs.