We use new data on French firms to investigate the role of trade credit links among firms. We find evidence that they result in chains of defaults, and argue that these chains serve a useful role in allocating liquidity from firms with access to outside finance to credit constrained firms. By defaulting on trade credit, credit constrained firms are able to alleviate the effects of adverse liquidity shocks. We find that a large portion of liquidity shocks are ultimately absorbed by unconstrained firms further down the trade credit chain. The evidence supports theories that view trade credit as an important insurance against liquidity shocks for credit constrained firms.
Much recent attention has focused on modeling high frequency stock price behavior. On the theoretical side, the blossoming area of market microstructure is providing valuable insights into the trade by trade stock price process. On the empirical side, a wealth of research has focused on capturing salient features of calendar period stock data, including conditional heteroskedasticity in calendar period price changes, or stochastic volatility. We provide a theory based link among asymmetric information, the behavior of market participants, and stochastic volatility through a market microstructure model of securities markets.
Our work follows on from Kelly and Steigerwald (2000), in which the stochastic properties of calendar period trades and squared price changes are derived from a market microstructure model. In the current paper, we make two principle contributions. First, we consider a model in which trade occurs in an options market as well as the stock market. Working from the microstructure model of Easley, OGHara, and Srinivas (1998) we derive the dynamic pattern of trade across markets as well as the stochastic properties of trades and squared price changes for each market. Second, we obtain analytic expressions for the serial correlation in calendar period squared price changes and so can directly relate stochastic volatility to the parameters of the underlying model.
We study the impact of contractual incentives on the risk-taking behavior and the performance of US mutual funds. We measure incentives using the shape, i.e. concavity, of the fee structure in the advisory contract. Compared to the standard linear fee structure, a concave structure should create a disincentive to take more risk. Our results show that a high incentive contract induces managers to take more risk and reduces the funds’ probability of survival. On the other hand, high-incentive funds deliver higher return. The net of these two effects is that incentives increase the risk-adjusted performance of the fund. In particular, the top incentive quintile of funds outperforms the bottom incentive quintile by about 2.7 percent per year. Moreover, the performance of the high-incentive funds is highly persistent. High-incentive winner funds from one year have a positive alpha of 41 basis points per month in the following year. By focusing on the funds' holdings, we show that active portfolio rebalancing is the main channel through which incentives increase performance.
Agency theory claims that investors can alleviate some agency problems through high-incentive contracts for managers. Such contracts would mean that managers’ pay-offs were more closely related to their performance, which could increase managers’ efforts and thus lead to better performance. At the same time, high-incentive contracts would also induce managers to take more risks. The net effect is less clear. Indeed, if extra performance compensates only for the additional risk taken, high incentives are not beneficial for the principal. In fact, it has been argued that higher incentives lead managers to take excessive risks per unit of performance delivered.
