Research

Executive Summary:

My research uncovers incentive distortions in the financial markets, and their consequences for financial institutions, corporations, and households: 

• For credit rating agencies, I study their incentive to inflate credit ratings due to the “issue-pays” rating model, contrast these biased ratings to ones under the “investor-pays” model, and derive implications of such rating-inflation incentives in rating analysts’ career path and investor returns. (Papers 1, 2, 5, 6 below)

• For banks, I study how their incentives to monitor borrowers – one of the most important roles played by financial intermediation – is compromised when they face opportunities to unload loans through securitization, such as CLOs and other ABS. (Paper 3)

• For other financial institutions (such as insurance companies), I uncover that managers’ incentive to identify risk may be weakened by high-yielding ABS – which often bear inflated credit ratings to conceal the fundamental risk. This weakened incentive hampers risk management’s efficacy in curbing risk taking. Remedial regulations, through the combination of capital regulation and reporting rules, may be necessary. (Paper 7)

• For institutional investors, I discover that their ownership structure across industrial firms and information intermediaries (such as media companies) may distort the intermediaries’ incentive and news slant, resulting in skewed information disclosure at the expense of less informed market participants. (Paper 12)

• For households, I study how conflicts of interest among one specific type of financial institution – the servicers of student loans (constituting a large part of U.S household debt) – can lead to borrowers’ mismanagement of these loans, resulting in excess debt burden.  (Paper 10)

Notably, incentive distortions do not always arise deliberately from institutions themselves; they can come unintendedly from external public policies: 

• For example, for households with student loans, the government’s (Biden administration) recent efforts in promoting income-driven student loan repayment (IDR) plans – which ties loan payment to borrower income and aims to lower debt burden in bad states – may unintendedly create distortion in supplying labor ex ante, due to a household debt overhang problem (Papers 14, 15)

• Likewise, government procedures in determining eligibility of student loan borrowing may unintendedly foster students’ incentive to divert from studying challenging yet essential courses (such as STEM) amid financial shocks, causing distortion in their human capital decisions. (Paper 13)

• For corporations, government subsidies – such as R&D tax credits – create technology spillovers, allowing firms to better absorb peers’ technological advancement. Such spillovers, however, may at times dampen firms' incentive in creating innovation that breaks the ground and instead, sidetracking them to follow peers’ suit and focus on incremental innovation. Firms facing technology spillovers attain fewer superstar inventors among their human capital – the important drivers of breakthrough technology advancement.   (Papers 8, 9)

• Along the supplier chain, government subsidies benefiting small businesses may spillover to these businesses’ rivals through the presence of common suppliers, unintendedly eliciting the rivals’ tactic response in order to “avoid feeding the mouth that bites.” (Paper 16)

Interestingly, incentive distortions exhibit nuances. The sources giving rise to incentive distortions may also bring up the "bright spots":

• For example, even though institutional investors’ common ownership structure may distortedly shape information providers'  incentive (Paper 12) , such ownership can meanwhile facilitate information pass-through in corporate loan markets, alleviating the hold-up problem and lowering borrowers’ loan interest rates. (Paper 10)

• Even though  the revelation of negative ESG events occurring to their brokers hurt the brokers’ commission revenue from investors, such revelation has a silver lining: it promotes analysts working at these troubled brokers to improve their research quality and alleviates biased assessments. (Paper 17) This finding is in line with the finding that once “investor-pays” rating agencies reveal the lower quality of “issuer-pays” (inflated) ratings, the issuer-pays rating agencies improve their rating quality. (Paper 2)

Publications:

1. The Economics of Solicited and Unsolicited Credit Ratings (with Paolo Fulghieri and Gunter Strobl), Review of Financial Studies, 2014 27 (2).

Best Paper Award in Corporate Finance, Midwest Finance Association Conference 2010

2. Can Investor-Paid Credit Rating Agencies Improve the Information Quality of Issuer-Paid Raters?  Journal of Financial Economics, 2014 111 (2).  [Internet Appendix]

3. Do Lenders Still Monitor When They Can Securitize Loans? (with Yihui Wang),  Review of Financial Studies, 2014 27 (8).  [Internet Appendix]

4. Locations, Proximity, and M&A Transactions (with Ye Cai and Xuan Tian), Journal of Economics and Management Strategy, 2016 25 (3).

5. Revolving Doors on Wall Street (with Jess Cornaggia and Kimberly Cornaggia), Journal of Financial Economics, 2016 120 (2). [Internet Appendix]

Featured in: Bloomberg news

6. Follow the Money: Investor Trading around Investor-Paid Credit Rating Changes (with Utpal Bhattacharya and Kelsey Wei), Journal of Corporate Finance, 2019, 58.

7. Do Financial Regulations Shape the Functioning of Financial Institutions’ Risk Management in Asset-Backed Securities Investment?  (with Xuanjuan Jane Chen, Eric Higgins, and Hong Zou), Review of Financial Studies, 2020 33 (6).

8. Incremental versus Breakthrough Innovation: The Role of Technology Spillovers (with Seong K. Byun, and Jong-Min Oh), Management Science, 2021, 67(3).

Best Paper Award, Entrepreneuiral Finance and Innovation Conference, 2015 

9. R&D tax credits, technology spillovers, and firms' product convergence (with Seong Byun, and Johng-Min Oh), Journal of Corporate Finance, 2023 80 (102407).

10. Who Mismanages Student Loans and Why? (with Kimberly Cornaggia), Review of Financial Studies, 2024 37(1).

11. Networking Behind the Scenes: Institutional Cross-industry Holdings and Information Frictions in Corporate Loans (with Jie He, Lantian Liang, and Hui Wang), Management Science, 2023, Forthcoming.

Selected Working Papers:

12. The Power Behind the Pen: Institutional Investors' Influence on Media during Corporate Litigation (with Jie He, Yabo Zhao, and Luo Zuo), Revise and Resubmit at Journal of Accounting Research

Conferences: AFA 2022, SFS Cavalcade 2020, EFA 2020, NFA 2020, Semi-finalist for Best Paper Award at FMA 2020

Institutional investors increasingly own equity blocks of both media companies and industrial firms. When industrial firms become defendants of corporate litigation, these institutions nudge media companies they simultaneously blockhold to provide more lenient coverage about the defendants. Doing so props up market sentiment and mitigates negative price impact – benefiting institutions’ portfolios. This strategy is more prominent when institutions are activists and pay closer attention to litigation events. Following the lenient coverage, institutions gradually exit positions in troubled defendant firms and begin to vote more favorably toward the media’s management. Overall, media outlets seem to slant their coverage of corporate litigation to cater to their large shareholders.

13. Natural Disasters, Financial Shocks, and Human Capital (with Jess Cornaggia and Kimberly Cornaggia), Minor Revision at Management Science

Featured in: NPR

We examine effects on productivity, employment, and debt outcomes among college students whose parents reside in areas that experience disastrous climate events. After disruptions, treated students exhibit poorer academic performance, withdraw from more courses and enroll in fewer STEM courses. Effects of disruption are stronger for middle class students relying on family income to pay for college. Students mostly mitigate financial disruption with additional part-time employment. Ultimately, disrupted students are 7% more likely to default on student loans. We find stronger adverse effects among male and non-white students. Overall, these results shed light on the intra-family consequences of financial stress.

14. Household Debt Overhang and Human Capital Investment (with Gustavo Manso, Alejandro Rivera and Hui Grace Wang)

Conferences: Cavalcade 2024, RCFS 2024, AFA2024, AEA 2023, MFA 2023, ASU Winter 2023, Edinburgh Corporafe Finance 2023, CICF 2023, EFA 2023

Unlike labor income, human capital is inseparable from individuals and does not accrue to creditors at default. As a consequence, human capital investment should be more resilient to “debt overhang” than labor supply. We develop a dynamic model displaying this important difference. We find that while both labor supply and human capital investment are hump-shaped in leverage, human capital investment tails off less aggressively as leverage builds up. This is especially the case when human capital depreciation rates are lower. Importantly, because skills acquisition is only valuable when households expects to supply labor in the future, the anticipated greater reduction in labor supply due to debt overhang back-propagates into a reduction in skills acquisition. Using individually identifiable data, we provide empirical support for the model.

15. Student loans and labor supply incentives (with Gustavo Manso, Alejandro Rivera and Hui Grace Wang)

Conferences: MFA 2024

Featured in: LSE blog

We develop a dynamic model showing that student loans --  non-dischargeable in the U.S. bankruptcy -- can alleviate the well-documented debt overhang problem in household labor supply decisions. Non-dischargeability mutes the opportunities for households to strategically pull back from supplying labor at the expense of creditors, thus correcting such incentive distortions. This corrective effect of student loans, however, is partially undone by the option of Income Driven Repayment (IDR) plans, which sets student debt payment as a proportion of households' future income, regardless of borrowing amount and outstanding balance. IDR thus allows households to pseudo "discharge" student debt and re-introduces the debt overhang problem. We supplement our model with calibration and empirical analyses, and derive policy implications speaking to the recently proposed reforms in IDR plans and student debt forgiveness.

16. (Don’t) Feed the Mouth that Bites: Trade Credit Strategies among Rival Customers Sharing Suppliers (with Kayla Freeman, Jie (Jack) He, and Liyan Yang) 

Conferences: MFA 2023, CICF 2023, EFA 2023, NFA 2023

Product market rivals often source upstream inputs from the same set of suppliers. Because these inputs are typically sold on credit, sharing a supplier could create incentives for customers to strategically demand trade credit terms in order to prevent the supplier from providing liquidity to rivals. In this paper, we empirically document this strategy and show that customers prolong payable days with suppliers that also sell to their rivals. For identification, we exploit the U.S. government’s QuickPay reform, which permanently shortened the government’s payable days to small business contractors, creating an exogenous liquidity influx. We find that after QuickPay, affected contractors extend more trade credit to their corporate customers. In response, rivals of these corporate customers begin to extract more trade credit from the shared suppliers, indicating their efforts to pull away these suppliers’ liquidity from the competitors already benefiting from QuickPay. Our paper reveals an underexplored incentive in supply-chain relationships, namely, the incentive to avoid “feeding the mouth that bites,” and how it shapes the allocation of trade credit.

17. Financial Analysts' Response to the revelation of ESG-related misconduct of their brokerage houses (with Hui Grace Wang, Yaxin Wen, and Luo Zuo) 

We study how employees respond when their employers’ negative ESG incidents are revealed to market participants. Using the setting of financial analysts and brokerage houses, we find that following negative ESG news, analysts provide higher quality research by producing more accurate earnings forecasts and reliable stock recommendations. This improvement is mostly driven by analysts dialing down previous overly optimistic assessments, and it is absent when their prior assessments are relatively pessimistic. Analysts largely stay with their employing brokers confronted by ESG incidents; among the ones leaving to join other brokers, we do not observe a significant improvement of their research quality at the new jobs. Our results highlight that the revelation of brokers’ negative ESG profile has a silver lining: it improves analysts’ research and alleviates potentially biased assessments. Because ESG constitutes an important part of firms’ intangible assets, our study has broader implication on how employees react to negative events affecting the value of  intangible assets.

Conferences: Hawaii Accounting 2023

18. College student behavior and student loan default (with Jess Cornaggia and Kimberly Cornaggia)

Conferences: AFA 2021, WFA 2019, NFA 2019

With a license to use individually identifiable information, including college transcripts, we find that students who quit college courses are 13% more likely to default on student loans than their perseverant peers, controlling for conventional risk factors. This effect is especially strong when students quit courses in their chosen major and courses at more selective institutions. Similarly, students who voluntarily repeat courses after performing poorly are 13% less likely to default than peers who give up. This effect is stronger when social / monetary costs of repeating courses are especially high. Students’ early-life behavior provides an observable credit risk indicator.

19. Information asymmetry and labor mobility (with Jesse Davis and Yabo Zhao) Draft coming soon!

Other Working Papers:

20. The Issuer-Pays Rating Model and Ratings Inflation: Evidence from Corporate Credit Ratings (with Gunter Strobl)