Stablecoins in Cryptoeconomics: From Initial Coin Offerings to Central Bank Digital Currencies

In a recent article, I highlight the links among initial coin offerings (ICOs), cryptocurrencies, stablecoins, and central bank digital currencies (CBDCs).  Although these entities exist in different contexts (securities law and capital formation, payment systems, monetary policy), they are intertwined and share an evolutionary process.

ICOs raise issues related to securities law because digital tokens are tokenized equities and, therefore, securities. At the same time, they have increased the amount of outstanding cryptocurrencies and, as a result, highlighted the problems generally associated with money, in the context of cryptocurrencies.

Cryptocurrencies, including Bitcoin, have suffered tremendous volatility, impairing their role as … Read more

Improving Economic Policies for the American Territories

On October 15, 2019, the U.S. Supreme Court heard oral arguments in Financial Oversight and Management Board for Puerto Rico v. Aurelius Investment, a case that centers on the constitutionality of the appointment process for the members of the federally established board charged with restructuring Puerto Rico’s over $100 billion in debt.  In addition to shedding light on this narrow question about debt, bankruptcy, and the U.S. Constitution, the case highlights the larger, longstanding political and economic plight of over 4 million Americans living in the unincorporated territories of the United States (the “Territories”): Puerto Rico, Guam, American Samoa, … Read more

Welcome to Vilnius: Regulatory Competition in the EU Market for E-Money

If you google “Lithuania e-money,” the auto-fill function will suggest that you search for ”Lithuania e-money license.” If you accept the tip, the first result will be Ecovis, which describes itself as “the most experienced finance institution and FinTech licensing advisor” for Lithuanian licenses. The second Google result is SB-SB Legal Services, which has a more global reach and boasts of being “capable of proposing a wide choice of countries suitable for the registration of payment systems. We offer electronic money licenses in European countries, including Lithuania, Malta, Czech Republic, Cyprus, Estonia, Bulgaria, Switzerland, Great Britain and Gibraltar,” in addition … Read more

Does Litigation Encourage or Deter Real Earnings Management?

Securities class actions may deter financial misreporting and flawed disclosure, but how effective are they at deterring managers from taking actions that sacrifice long-term value for higher profits? In a recent paper, we uncover a novel mechanism that extends the disciplining effect of litigation to such managerial actions, often referred to as real earnings management (REM).

Real earnings management differs from accrual earnings management, in which managers cook the books to overstate earnings, in that REM does not violate financial reporting rules. Instead, it allows managers to report higher profits in the short run via real choices that boost short-term … Read more

Corporate Behavior and the Tax Cuts and Jobs Act

How has the U.S. Tax Cuts and Jobs Act of 2017 changed corporate behavior? In addition to reducing the corporate income tax rate to a flat 21 percent from a high of 35 percent, the TCJA changed other important rules on earnings stripping, expensing and depreciating, net operating losses, and the taxation of foreign subsidiaries. These changes generally reduced the effective and marginal tax rates of U.S. corporations. Using the first set of post-TCJA 10-K reports, our analysis seeks to provide a preliminary assessment of the extent to which these benefits have motivated corporations to do what TCJA proponents hoped.… Read more

Exequity Discusses Valuing Amazon

It is widely accepted among investors that compensation committees should align executive pay with performance in part by using incentive metrics that contribute directly to shareholder value. For this reason, it is common for incentive metrics to overlap with performance highlights relayed in press releases communicating quarterly earnings. Planting its latest performance measurement flag in the ground, Institutional Shareholder Services (ISS) introduced economic value added (EVA), contending that EVA is better than commonly used metrics such as EBITDA, EPS, and others. Compensation committees may wonder, is EVA really a better gauge of value than their earnings release metrics? Does ISS … Read more

Discontinuation of LIBOR

Global financial markets are preparing for the phasing out of the London interbank offered rate, or LIBOR, with the loan, derivatives, securities, and bond markets most affected.  As of mid-2018, about $400 trillion worth of financial contracts referenced LIBOR in one of the major currencies.[1] Supervisory pressure on the financial sector to reduce LIBOR inventories suggests that firms must embrace Risk Free Rates (RFRs) across LIBOR portfolios. The transition presents a multitude of challenges.

Why Use Benchmarks?

Financial market participants rely on benchmarks primarily to reduce asymmetric information about  the value of the traded financial instrument underlying the benchmark … Read more

Stock Repurchases and the 2017 Tax Cuts and Jobs Act   

On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act (TCJA), which is the largest gross tax cut in American history (cutting more than $5.5 trillion in taxes over 10 years); the act took effect on January 1, 2018. The TCJA has two key elements: (i) a reduction in the corporate income tax rate from 35 percent to 21 percent, and (ii) a one-time tax holiday that cuts the tax on cash repatriation from foreign subsidiaries from 35 percent to 15.5 percent. Furthermore, in connection with (ii), the U.S. corporate tax system also moved from a worldwide … Read more

White & Case Discusses Cannabis Banking Bill’s Implications for Financial Services

On September 25, 2019, the US House of Representatives (“House”) passed, by a vote of 321 to 103, the Secure and Fair Enforcement Banking Act (“SAFE Banking Act”), bipartisan legislation designed to secure and regulate banking services to the expanding cannabis market in the United States. The SAFE Banking Act would bar federal regulators and prosecutors from penalizing banks and credit unions for providing core banking services to cannabis-related businesses (“CRBs”) and ancillary businesses authorized under state law. As the first standalone cannabis reform bill to pass either chamber of Congress, its passage in the House represents a major step … Read more

The Valuation and Governance Bubbles of Silicon Valley

The rise and fall of The We Company IPO bubble is one of those events that, like the subprime mortgage bubble that preceded the financial crisis, calls for an examination of market structures that could have produced such a precipitous turnabout.  Indeed, the two bubbles share similar features, namely, structural features that favor the expression of positive sentiments and make it difficult to express negative sentiments.  We call this “one-sided market sentiment.”

Some of the most famous moments of the financial crisis, memorialized in print and film, turned on how intrepid traders determined that impenetrably complex mortgage-backed securities were overvalued … Read more

The Seller’s Curse and IPO Pricing

Benchmark Capital partner and legendary tech investor Bill Gurley recently declared on CNBC, “It took me two decades to figure this out, but I think Silicon Valley’s been on the bad end of a bad joke for about four decades now, in terms of the way the traditional IPO process works.” He and others believe that direct listings, like the ones recently completed by Spotify and Slack, are friendlier to issuers.

The core of Gurley’s concern is that the traditional IPO process yields unfavorable pricing outcomes for issuers. On average since 1980, the stock price of IPO firms has popped … Read more

Exequity Discusses 2019 Trends in Companies’ Use of Total Shareholder Return

Faced with pressures from varied constituencies, compensation committees striving to demonstrate links between pay and performance regularly consider market-based performance measures such as relative total shareholder return[1] (RTSR). Companies reviewing the mix and designs of their long-term incentives (or being pressured into adopting performance-vested awards) may not be comfortable setting reasonable three-year goals—ones that are not a sure bet, but also not unattainable. As compensation committees and management teams review their alternatives, the use of RTSR as a performance metric is typically part of the conversation. Some compensation committees feel a discussion of long-term incentive metrics is remiss without … Read more

How Do Auditors Determine What’s Material?

U.S. public company audits all include a simple step to determine whether an amount is large or significant for their clients, otherwise known as materiality.  This decision influences the planning and procedures of the other facets of the audit as well as many judgments by both the auditor and manager about how to interpret misstatements and discrepancies in financial reporting and auditing.  In essence, it is the backbone of financial reporting and auditing but kept confidential from investors and often managers (i.e. not publicly disclosed) in the U.S., unlike the UK.  We access proprietary data from the Public Company Accounting … Read more

Evidence of Systemic Risk from Major Cybersecurity Breaches

In general economics, “asymmetric information” refers to information about a transaction in which one party knows more than another party, to the potential benefit of the former at the expense of the latter. An example often occurs when consumers and a business are counter-parties in consumption transactions. Consumers commonly rely on companies to safeguard their personal and company-specific data used in the transaction without explicitly knowing the internal safeguards and standards placed by the data-holding company on their data protection infrastructure (Moore, 2010).

In theory, the risk to corporate reputation and the prospect of breach-related legal judgments and … Read more

Regulating Financial Guarantors: Abstraction Bias as a Cause of Excessive Risk-taking

Since the 2008-2009 financial crisis, scholars, regulators, and policymakers have engaged in extensive studies to try to control excessive risk-taking by systemically important financial firms. In a recent article, available here, I argue that those studies do not fully explain the unusually excessive risks taken by financial firms as insurers of bonds and other debt securities, as sellers of protection under derivatives known as credit-default swaps (“CDS”), as providers of credit enhancement in securitization transactions, as issuers of standby letters of credit, and otherwise as guarantors of financial obligations (collectively, “financial guarantors”). Despite their sophistication, financial guarantors tend to … Read more

Time Variation in the Relationship Between News and Returns

How does the stock market respond to news reports about a company? Previous work has found that it takes a few days for prices to fully absorb news, and this underreaction has been attributed to investors’ limited ability to process information. We find evidence for an alternative explanation: Sophisticated institutional investors trade slowly on news to avoid tipping their hands. Once we control for this effect, we find that the market actually overreacts to news.

Academic interest in how markets process information dates back to Eugene Fama’s pioneering work in the 1960’s.  Fama argued that markets are highly informationally efficient, … Read more

Fintech and Banking

In a recent paper, I review the literature on fintech and its interaction with banking. Included in fintech are innovations in payment systems (including cryptocurrencies), credit markets (including peer-to-peer or “P2P” lending), and insurance, with blockchain-assisted smart contracts playing a role. My review paper defines fintech, examines the stylized facts, and then reviews the theoretical and empirical literature. The paper summarizes our knowledge on the main research  questions raised by the literature review and concludes with questions for future research.

Fintech is a hot topic, even though the interplay between information technology and financial services is not a new … Read more

Is the Cost of Equity Greater than the Risk-Free Rate?

As a matter of abstract financial-economic theory, the cost of equity is straightforward. It is the minimum expected return investors require to hold the firm’s equity at the current price. Financial economists may disagree on the best way to estimate the cost of equity or the causal relationships that drive costs of equity, but it is safe to say that we know what we mean by the term when we use it. And, for nearly all equities, we almost always mean an expected return that exceeds the risk-free rate.

But what evidence do we have that the cost of equity … Read more

ICO vs. IPO: Empirical Findings, Information Asymmetry, and the Appropriate Regulatory Framework

Initial coin offerings (ICOs) are a new form of fundraising whereby blockchain-related ventures raise public capital in exchange for newly issued digital tokens. The issued tokens may represent a variety of rights, ranging from financial rights – such as dividend and voting rights – to consumptive rights, such as the right to access a service or a product that the issuer will provide. After the fundraising ends, the issued tokens are generally traded on the secondary market.

ICOs have quickly become popular. While the idea of an ICO debuted in 2013,[1] by 2017, over $10 billion had been raised … Read more

Davis Polk Discusses Financial Action Task Force’s Virtual-Asset Guidance

The Financial Action Task Force (FATF), the inter-governmental body that sets international standards for anti-money laundering (AML) and countering the financing of terrorism (CFT), released a highly anticipated interpretive note and guidance on June 21, 2019, “Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers” (the Guidance), clarifying the application of its 40 Recommendations to virtual assets (VAs) and virtual asset service providers (VASPs).  The Guidance, which builds on steps FATF has taken over several years toward setting international AML/CFT standards for the virtual currency … Read more