Four essays on finance

Abstract

The financial market encompasses a broad range of participants, such as households, investors, analysts, and managers. Each of these participants has distinct utility functions and constraints, and varying decision-making processes. This thesis aims to contribute to the understanding of the behavior of these essential participants in the financial market through four empirical essays.

The first essay documents that racial differences in credit distribution during a general mortgage credit expansion can lead to unintended negative consequences on crime. Exploiting a federal mortgage market deregulation, we find a significant increase in mortgage approval for white borrowers, while the approval rate for black borrowers is unchanged. More importantly, the local housing boom induced by this credit expansion leads to an increase in money-related crime rates of black offenders. The results highlight an unintended adverse consequence of credit expansion on the welfare of minorities.

In the second essay, we hypothesize and find that the improved liquidity for large orders disproportionately reduces the execution cost of institutional investors and thus increases their ownership of the treated firms with a larger tick size during SEC’s Tick Size Pilot Program. The effect is concentrated among firms with lower liquidity for large orders ex-ante and mainly comes from dedicated investors and quasi-indexers. We also find that analyst coverage and forecast accuracy increase for the treated firms, plausibly catering to the increased information demand of institutional investors. Overall, we show a bright side of the controversial Tick Size Pilot Program that a widening tick size leads to greater institutional ownership and more information production by analysts.

In the third essay, we propose that the availability of dark trading disciplines managers for their investment decisions. Utilizing the trade-at rule provision in the SEC’s Tick Size Pilot Program, we find that restrictions on dark trading lead to higher levels of corporate overinvestment for medium- and small-cap securities. As dark trading incentivizes informed traders to acquire information ex-ante, we also find the results are more pronounced for firms with a larger short-selling flow before the Program. As a consequence, overinvestment due to the restrictions in dark trading worsens the firms’ future performance. Overall, we identify a novel external governance mechanism via dark trading venues.

In the fourth essay, we adopt a machine learning approach to analyze Q&A sessions of Earnings Conference Calls and create a forward-looking orientation index at the firm-year level for identifying managers with better sustainable development strategies. We find that more forward-looking managers are associated with subsequent lower corporate environmental risks. The results are stronger when firms have more attention from stakeholders, higher holdings from socially responsible investors, and fewer financial constraints. Firms with forward-looking managers reduce more Greenhouse Gas emissions when mitigating environmental risks. Our results are robust to various specifications for index construction and remain after controlling for traditional proxies for managerial myopia.