Heather Tookes

Dynamic Competition, Innovation and Strategic Financing

This paper models the interactions among product market innovation, product market competition, and corporate financing decisions in the context of a dynamic duopoly. One competitor faces an opportunity to adopt a new technology. If adopted, the firm must also determine whether it will obtain public or private financing. Our results allow us to relate current firm and industry characteristics to these decision variables. In particular, larger, more profitable firms with small rivals have the greatest incentive to innovate. The private versus public financing decision depends mainly on the magnitude of the technological improvement and length of the period during which private financing extends the innovators product market advantage. Due to the models formulation it is both tractable and amenable to empirical estimation. We estimate the model and provide estimates of the value of innovation and private financing for a sample of industries and firms.

Related Securities and Equity Market Quality: The Case of CDS

We document that the emergence of markets for single-name credit default swap (CDS) contracts adversely affects equity market quality. The finding that firms with traded CDS contracts on their debt have less liquid equity and less efficient stock prices is robust across a variety of market quality measures. We analyze the potential mechanisms driving this result and find evidence consistent with negative trader-driven information spillovers that result from the introduction of CDS. These spillovers greatly outweigh the potentially positive effects associated with completing markets (i.e., CDS markets increase hedging opportunities) when firms and their equity markets are “bad” states. In “good” states, we find some evidence that CDS markets can be beneficial.

Voluntary and Mandatory Skin in the Game: Understanding Outside Directors’ Stock Holdings

We examine the determinants of equity ownership by outside directors as well as the relationship between ownership and operating performance. Unlike previous studies of equity ownership by directors, we use hand-collected data on firm-level policies requiring director ownership for SP this is consistent with the theory that ownership requirements reflect optimal ownership levels. By contrast, voluntary holdings are positively and significantly related to future performance, suggesting that they perform an incentivizing role for directors.

Trader Leverage and Liquidity

Do traders’ leverage constraints drive equity market liquidity? We use the unique features of the margin trading system in India to test the hypothesis that there is a causal relationship between traders’ leverage constraints (i.e., their ability to borrow to invest in risky assets) and a stock’s market liquidity. In India, the list of stocks eligible for margin trading is revised every month, creating a series of quasi-experiments that provide traders of newly eligible and ineligible stocks with shocks to the availability of leverage. We employ a regression discontinuity design that exploits the threshold rules that determine a stock’s margin trading eligibility. When we compare the liquidity of eligible and ineligible stocks that lie close to the eligibility threshold, we find that liquidity is higher when stocks become eligible for margin trading and that it decreases with ineligibility. Using available data on margin financing activity at the individual stock level, we try to uncover the mechanisms driving this main finding. We find evidence consistent with the idea that the liquidity enhancement that we observe stems from margin traders’ contrarian strategies.Does trader leverage drive equity market liquidity? We use the unique features of the margin trading system in India to identify a causal relationship between traders’ ability to borrow and a stock’s market liquidity. To quantify the impact of trader leverage, we employ a regression discontinuity design that exploits threshold rules that determine a stock’s margin trading eligibility. We find that liquidity is higher when stocks become eligible for margin trading and that this liquidity enhancement is driven by margin traders’ contrarian strategies. Consistent with downward liquidity spirals due to deleveraging, we also find that this effect reverses during crises.

Identifying an IPO's Impact on Rival Firms

We use the IPO setting to demonstrate how the forecasts generated by a dynamic oligopoly model can help researchers overcome empirical challenges associated with establishing causality and identify appropriate control firms. Both of these are common issues in the empirical corporate finance literature. Recent papers report deteriorating performance by rivals following an IPO in the industry. Authors have attributed this to the competitive advantages a firm acquires by going public. When we reexamine this issue via a dynamic structural model, the results indicate that the value reductions across the industry primarily arise from an increased commoditization of the product market post-IPO. Based on the structural model, the paper develops a new causality test analogous to the difference-in-differences methodology and concludes that IPOs forecast future industry changes but do not cause them.

Does Hedging with Derivatives Decrease the Cost of Corporate Debt? The Role of Basis Risk

Non-financial corporations typically cite risk management as the primary reason for their derivatives use. If hedging programs are effective, then firms using derivatives should have lower credit risk than those that do not. Consistent with this idea, we find that CDS spreads are lower for firms with derivatives positions that are designated as accounting hedges (typically low basis risk) compared to firms without the accounting hedge designation as well as firms that do not use derivatives. Surprisingly, we find that firms with derivatives positions without a hedge accounting designation have higher CDS spreads than firms that do not hedge with derivatives at all. We do not find evidence that these non-designated positions are associated with future credit realizations, as captured by changes in either credit ratings or CDS spreads. We examine alternative explanations and find evidence that is consistent with a market penalty for high basis risk positions when overall market conditions are poor.

Does Hedging with Derivatives Reduce the Market's Perception of Credit Risk?

Risk management is the most widely-cited reason that non-financial corporations use derivatives. If hedging programs are effective, then firms using derivatives should have lower credit risk than those that do not. Surprisingly, we find that firms with derivative positions without a hedge accounting designation (typically higher basis risk) have higher CDS spreads than firms that do not hedge at all. We do not find evidence that these non-designated positions are associated with future credit realizations. We examine alternative explanations and find evidence that is consistent with a market penalty for high basis risk positions when overall market conditions are poor.