Comparing Angels and Venture Capitalists as Investors in Entrepreneurial Firms

Angel investors (angels) and venture capital (VC) investors are both important sources of financing for entrepreneurial firms, but some critics, particularly VCs, often believe that angels are less able than VCs to perform due-diligence. However, an alternative view holds that VCs and angels are equally adept at adding value to startups. For example, a recent article by AngelList mentions that the presence of top VCs in a seed funding round of a startup does not affect the probability of its success. It is therefore important to empirically analyze and compare the value added to startups by angels and VCs. However, … Read more

Stablecoins, National Currencies, CBDCs, and Banks

The Federal Reserve is set to release a much anticipated discussion paper on the prospect of a digital U.S. dollar. According to the Bank for International Settlements (BIS), over 86 percent of central banks are investigating the possibility of a digital currency.[1] Although China began a trial for its digital yuan in four cities in 2020, the Commonwealth of the Bahamas was the first to formally issue a sovereign digital currency, known as the Sand Dollar. In our article, Sovereign Digital Currencies: Parachute Pants or the Continuing Evolution of Money, we explore the budding dynamic between cryptocurrencies, particularly … Read more

Economic Downturns and the Informativeness of Management Earnings Forecasts

Economic downturns brought about by events such as the financial crisis and COVID-19 pandemic create substantial uncertainty for companies. While some firms endure the downturns unscathed or even thrive, others see their businesses decline drastically and their bankruptcy risk increase. The heightened uncertainty makes it especially difficult for market participants, such as investors and analysts, who rely on personal experience and public information to assess how a particular firm will perform during a downturn. In contrast, managers – as insiders – are better able to assess their firm’s future performance because they receive timely information about the firm’s operations and … Read more

The Leverage Effect of Bank Disclosures

In a new paper, The Leverage Effect of Bank Disclosures, we challenge the widespread view that disclosure requirements prompt banks to reduce their risk and leverage.  That view has prevailed since at least 2004, when the Basel Committee introduced Pillar 3 (market discipline) into the Basel II Accord, making disclosure requirements a complement to minimum capital requirements (Pillar 1) and the supervisory review process (Pillar 2) (BIS, 2004).  The committee has emphasized that disclosure leads to lower risk and leverage because “the market will require a higher return from funds invested in, or placed with, a bank that … Read more

COVID-19, Corporate Leverage, and Financial Fragility

The COVID-19 pandemic and efforts to combat its spread were an unprecedented shock to corporate cash flows and consequent need for external financing. How did corporate leverage respond? More important, what does the impact on leverage mean for financial stability? In the U.S., firms that were most affected by the pandemic, in terms of drop in demand, are likely facing a debt overhang problem and increased risk of default. We document these recent patterns on corporate leverage and financial fragility in our recent paper, which uses a dataset of about 3,000 U.S. public companies.

Controlling for the effects on … Read more

Attention to Dividends, Inattention to Earnings?

Why do firms pay dividends? A well-known finance theory proposes that, in frictionless markets, dividends are irrelevant for firm valuation because an investor’s wealth does not change if the firm holds a dollar in the bank or if the firm returns a dollar to an investor through a dividend who then holds it in the bank.[1]  Despite this, roughly 40 percent of public firms pay dividends and, because they are rarely cut, dividends provide investors with a predictable stream of cash.  Research has had limited success in explaining why firms pay dividends (i.e. the benefits), but the costs, such … Read more

The Economics of Crypto Funds

Crypto funds are a new financial intermediary that trade in cryptographically protected digital assets, known as coins or tokens. Both the number of crypto funds and investments in crypto funds are soaring. As of the second quarter of 2021, more than 800 crypto funds are active, and their aggregate assets under management exceed $60 billion. The trend is likely to continue, as crypto funds returned an average of 98 percent  (before fees) to their investors in the first quarter of 2021.

Crypto funds differ from more traditionally-managed funds in significant ways. For example, CryptoFundResearch reports that 43 percent of all … Read more

Fragile Financial Regulation

As COVID-19 rocked financial markets in March 2020, the Treasury market failed to perform its role of maintaining financial stability. Unable to respond to the surge of investors liquidating their Treasury holdings to raise cash, the secondary market ground to a virtual halt. Liquidity disappeared. Trading costs skyrocketed. And the price of Treasuries – a common benchmark for financial assets – crashed with other assets, instead of remaining stable or rising.[1]

In a new article, we argue that this breakdown in the Treasury market undermined the credibility of Treasuries as the safe asset in financial regulation, and the collateral … Read more

Public Information and Capital Flows: Evidence from a Betting Market

What are the consequences of increasing public information in a market of risk-seeking participants? Academics and policy makers alike are grappling with this question following the influx of speculative capital flows from individual investors in financial markets. As platforms such as Robinhood take root, the influence of gambling behavior is likely to increase and further affect the functioning of markets. The topic is also a key policy issue in light of the Securities and Exchange Commission (SEC) plan to review new policies aimed at increasing transparency to address market developments such as the frenzy of trading in “meme” stocks like … Read more

Davis Polk Discusses FinCEN, CFTC Penalties on Cryptocurrency Derivatives Exchange

The CFTC and FinCEN recently announced a settlement with BitMEX for $100 million to resolve an enforcement action related to the exchange’s failure to register as a futures commission merchant and failure to establish a BSA/AML compliance program.

The Order

On August 10, 2021, the Financial Crimes Enforcement Network (FinCEN) and the Commodity Futures Trading Commission (CFTC) announced that the agencies had assessed a $100 million civil monetary penalty (CMP) against BitMEX, one of the world’s largest cryptocurrency derivatives exchanges.[1] BitMEX is a peer-to-peer cryptocurrency trading platform that offers its users the ability to trade cryptocurrency derivatives, including swaps, … Read more

The Triumph of a Local Focus in Troubled Times

The emphasis on the contribution of local knowledge to economic growth is a key tenet of classical economic theory. The Hayekian worldview, for example, sees the dispersion of local pockets of knowledge across the economy as the primary reason why centralized planning fails to produce optimal results. In the realm of corporate finance, these considerations emphasize the importance of firms’ reliance on local CEOs with access to social networks where information flows in a subtle and nuanced way that highly depends on specific individuals rather than formal institutions. Focusing on the local, however, comes at a cost, as a rich … Read more

Moving Beyond Mutual Funds

As has become widely known in the past few years, the mutual-fund industry is more concentrated than ever, especially because of the growing use of index funds.  Whether this is a problem and how to respond have been the topics of considerable debate.  Commentators have laid out several possible reforms, including antitrust responses, regulations that limit the number of companies in an industry that an index fund may invest in, and the wholesale removal of some mutual funds’ power to vote.  But many of these responses would disadvantage index funds, which would be unfortunate because index funds have greatly benefited … Read more

ISS on Maximizing Good Results in Global Sustainable Finance Industry

The global sustainable finance industry has been described as an ‘industry in transition’, according to the recently-released Global Sustainable Investment Review 2020. This is reflective not only of the growth of the industry, but also the steps taken by many regional markets in implementing industry best practice standards. The Review marks the 5th iteration of a biyearly study published by the Global Sustainable Investment Alliance (GSIA), a group of the world’s leading sustainable finance industry bodies, that reports on the size, growth and dynamics of the world’s responsible investment market.

The report found that sustainable investments account for

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Debevoise & Plimpton Discusses the State of the LIBOR Transition

On March 5, 2021, LIBOR’s administrator, ICE Benchmarks Administration (the “IBA”), and LIBOR’s regulator, the U.K. Financial Conduct Authority (the “FCA”), announced that LIBOR will no longer be provided (i) for all sterling, euro, Swiss franc and Japanese yen settings, and the one-week and two-month U.S. dollar settings after December 31, 2021 and (ii) for the remaining U.S. dollar settings after June 30, 2023. On March 8, 2021, the Alternative Reference Rates Committee (“ARRC”) confirmed that the IBA and FCA announcements constitute a “Benchmark Transition Event” with respect to all U.S. dollar settings under the ARRC recommended fallback language for … Read more

The Restructuring Landscape in Emerging Markets One Year into the Pandemic

Like advanced economies, emerging economies were buffeted by the global economic slowdown stemming from the COVID-19 pandemic and the associated lockdowns of national economies. In 2020, emerging economies (and developing countries) contracted by 2.1 percent (their steepest decline in many years), but the decline was not as severe as in advanced economies (-4.6 percent), according to the latest data from the International Monetary Fund (IMF), released in July 2021 as part of its World Economic Outlook Update.

Emerging economies and developing countries taken as a whole are expected to experience a major rebound this year, with anticipated growth reaching … Read more

Short-Term Institutions, Analyst Recommendations, and Mispricing: The Role of Higher-Order Beliefs

Discussions on the role of higher-order beliefs (investor beliefs about the beliefs of other investors) in financial markets can be traced back to Keynes’ (1936) comparison of the stock market to a beauty contest. Investors “are concerned,” he famously said, “not with what an investment is really worth to a man who buys it for keeps, but with what the market will value it at [. . .] three months or a year hence.” Interest in higher-order beliefs models continues today. An anecdotal example of the role of higher-order beliefs is the downgrade of Citigroup by analyst Meredith Whitney in … Read more

National Blockchain Laws Are a Threat to Capital Markets Integration

Since its creation in 2008, the blockchain has seemed incompatible with legal constraint. Satoshi Nakamoto, the pseudonymous inventor of Bitcoin, hailed the blockchain’s “unstructured simplicity.” Even now, apostles of distributed ledger technology (DLT) strongly resist the idea that it needs regulation, arguing that it was designed precisely to avoid centralized control.

This did not, however, stop courts and legislators around the world from becoming increasingly concerned about DLT. They are no longer focusing only on the dangers cryptocurrencies might pose to the public, such as its potential use in money-laundering, the financing of terrorism, or tax … Read more

Reforming the Macroprudential Regulatory Architecture in the United States

When the COVID-19 pandemic shuttered major economies in March 2020, it also wreaked havoc on financial markets. In the first few weeks of March, investment-grade corporate bonds lost roughly a fifth of their value, on par with the declines in equity and high-yield debt. (Haddad et al., 2020; Falato, Goldstein & Hortaçsu (forthcoming)). Contrary to the usual flight to quality, in mid-March, U.S. Treasury yields began rising and only stabilized after the Federal Reserve initiated a massive purchase program. (Vissing-Jorgensen, 2020). The distress in the Treasury market accentuated distress in other markets and liquidity challenges for firms. Nonbanks that service … Read more

Why We Need to Verify and Unmask the Identity of Cryptocurrency Users  

Cryptocurrencies are by now widely known as electronically generated and stored currencies that enable users to trade tokens. The tokens are exchanged anonymously through a decentralized payment system: the blockchain. To further anonymity, the parties to cryptocurrency transactions are identified by a unique string of random numbers rather than by a name or other personal information.

There is however a dark side to this anonymity. It makes it easier for criminals and terrorists to launder money and otherwise transact illegal business. For example, anonymous tokens provide terrorists with access to cash that is essential to organizing attacks without dependency on … Read more

How Does Removing the Tax Benefits of Debt Affect Firms?

Almost all countries have historically allowed businesses to write off interest expenses against taxable income. Critics argue that the tax-favored status of debt has created a corporate debt pile-up, thereby exacerbating economic downturns. This argument, which gained more attention after the 2008 global financial crisis, implicitly assumes that the tax incentives have led to a large increase in the use of debt. However, despite extensive efforts by researchers, it is an open question whether the tax incentives are indeed a primary determinant of corporate debt policy. This is mainly because isolating the impact of interest deductions from other tax effects … Read more