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PUBLISHED & FORTHCOMING PAPERS
When transparency improves, must prices reflect fundamentals better? (with Snehal Banerjee and Naveen Gondhi), Review of Financial Studies, 2018, 31(6):2377-2414
No. In the presence of speculative opportunities, investors can learn about both asset fundamentals and the beliefs of other traders. We show that this learning exhibits complementarity: learning more along one dimension increases the value of learning about the other. As a result, regulatory changes may be counterproductive. First, increasing transparency (i.e., making fundamental information cheaper to acquire) can make prices less informative when investors respond by learning relatively more about others. Second, public disclosures discourage private learning about fundamentals while encouraging information acquisition about others. Accordingly, disclosing more fundamental information can decrease overall information efficiency by decreasing price informativeness.
Hidden Performance: Salary History Bans and the Gender Pay Gap (with Paige Ouimet and Xinxin Wang), Review of Corporate Finance Studies, 2022, 11(3):511-553
As of 2019, salary history bans have been enacted by 17 states and Puerto Rico with the stated purpose of reducing the gender pay gap. We argue that salary history bans may negatively affect wages as employers lose an informative signal of worker productivity. We empirically evaluate these laws using a large panel dataset of disaggregated wages covering all public sector employees in 36 states and find, on average, salary history bans lead to a 3% decrease in new hire wages. We find no decrease in the gender pay gap in the full sample and a modest 1.5% increase in the relative wages of women, as compared to men, among new hires most likely to have experienced gender discrimination historically.
Trendy Business Cycles and Asset Prices (with Gill Segal), Review of Financial Studies, 2023, 36(6):2509-2570
The data-generating process underlying productivity includes both trend and business cycle shocks, generating counterfactuals for prices under full information. In practice, agents inability to immediately distinguish between the two shocks creates "rational confusion": each shock inherits properties of its counterpart. This confusion magnifies the perceived share of permanent shocks and implies that, contrary to canonical frameworks, transitory shocks are the main driver of long-run risk through trendy business cycles. With learning, the equity premium turns positive, while investment and valuation ratios become procyclical, as in the data. Consequently, rational confusion is key for reconciling disciplined macro-dynamics with equilibrium asset prices.
Choosing to Disagree: Endogenous Dismissiveness and Overconfidence in Financial Markets (with Snehal Banerjee and Naveen Gondhi), Journal of Finance, 2024, 79(2):1635-95
The psychology literature documents that individuals derive current utility from their beliefs about future events. We show that, as a result, investors in financial markets choose to disagree about both private and public information. When objective price informativeness is low, each investors dismisses the private signals of others and ignores price information. In contrast, when prices are sufficiently informative, heterogeneous interpretations arise endogenously: most investors ignore prices, while the rest condition on it. Our analysis demonstrates how observed deviations from rational expectations (e.g., dismissiveness, overconfidence) arise endogenously, interact with each other, and vary with economic conditions.
Learning in Financial Markets: Implications for Debt-Equity Conflicts (with Naveen Gondhi), Review of Financial Studies, 2024, 37(5):1584-1639
Financial markets reveal information which firm managers can utilize when making equity value-enhancing investment decisions. However, for firms with risky debt, such investments are not necessarily socially efficient. Despite this friction, we show that learning from prices improves investment efficiency. This effect is asymmetric, however, as investors learn less about projects which decrease the riskiness of cash flows: efficiency is lower for diversifying investments than for focusing (risk-increasing) investments. This also implies that investors' endogenous learning further attenuates risk-shifting but amplifies debt overhang. Our model provides a novel channel through which learning from financial markets impact agency frictions between stakeholders.
Incentivizing Effort and Informing Investment: The Dual Role of Stock Prices (with Snehal Banerjee and Naveen Gondhi), Accepted, Review of Financial Studies
Stock prices aggregate investor information about investment opportunities and reflect managerial performance. These dual roles may be in tension: when prices are more informative about investment opportunities, they may be less effective at incentivizing managerial effort. This tradeoff has novel consequences. Lower information costs can lead to both more efficient investment but lower firm value. The principal may strictly prefer to delegate investment to a manager who has no informational advantage and makes ex-post inefficient choices. Investment in diversifying and (ex-ante) negative NPV projects mitigate agency problems. Finally, standard measures of price efficiency provide an incomplete picture of firm value.
WORKING PAPERS
Motivated Beliefs in Coordination Games (with Snehal Banerjee and Naveen Gondhi), Revise and Resubmit, Journal of Political Economy
We characterize how wishful thinking affects the interpretation of information in economies with strategic and external effects. While players always choose to exhibit overconfidence in private information, their interpretation of public information depends on how non-fundamental volatility affects payoffs. When volatility increases payoffs, players may endogenously disagree: some under-react to public news, while others overreact. In contrast to rational expectations, public information can increase dispersion in actions while private information can increase aggregate volatility. Our analysis has novel implications for the social value of information and demonstrates how endogenous beliefs can reconcile recent evidence on forecast revisions and information rigidities.
Information Provision and the Curse of Knowledge (with Snehal Banerjee and Naveen Gondhi), Revise and Resubmit, Management Science
Better-informed individuals are typically unable to ignore their private information when forecasting others' beliefs. We study how this bias, known as the "curse of knowledge," affects costly communication and information production in a sender-receiver game. With exogenous information, cursed senders are worse communicators. However, with endogenous information production, we show that cursed senders not only produce more precise information but can, in fact, be better communicators than unbiased senders, leading to higher expected payoffs in equilibrium. Finally, we demonstrate how players' expertise and the diversity of their beliefs amplify the impact of this bias on endogenous information provision.
A risk-averse agent can sell claims to an asset of uncertain value to investors who have private information. When investors can choose how much information to acquire, the agent optimally issues information-sensitive securities in each market (e.g., debt and equity). When the value of the asset varies over time, the agent chooses to retain and, at times, repurchase a portion of the claims for issuance at a later date. The agent's choice to smooth the information sensitivity of the claims issued, across markets and over time, has novel implications. First, the relative information insensitivity of debt can render it a suboptimal security for financing. Second, if the agent has private information about cash flows, he can signal that he has better information by selling, rather than retaining, a larger claim to the asset. Finally, while the sale of illiquid securities generates increased uncertainty at issuance, it can lower the agent's uncertainty when raising capital in the future.
Early-stage firms utilize venture debt in one-third of financing rounds despite their general lack of cash flow and collateral. In our model, we show how venture debt aligns incentives within a firm. We derive a novel theoretical channel in which runway extension through debt increases firm value while potentially lowering closure. Consistent with the model's mechanism, we find that dilution predicts venture debt issuance. Empirically, treatment with venture debt lowers closure hazard by 1.6-4.4% and increases successful exits by 4.3-5.3%. Back-of-the-envelope calculations suggest $41B, or 9.4% of invested capital, remains productive due to venture debt.
WORK IN PROGRESS
Institutional Investors, Short-Sale Constraints, and Learning (with Boone Bowles)
Refinancing risk: aggregate liquidity, debt maturity and firm heterogeneity (with Naveen Gondhi)
Seeing is believing: learning about the "impossible"
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