Laura Xiaolei Liu

Investment-Based Expected Stock Returns

We derive and test q‐theory implications for cross‐sectional stock returns. Under constant returns to scale, stock returns equal levered investment returns, which are tied directly to firm characteristics. When we use generalized method of moments to match average levered investment returns to average observed stock returns, the model captures the average stock returns of portfolios sorted by earnings surprises, book‐to‐market equity, and capital investment. When we try to match expected returns and return variances simultaneously, the variances predicted in the model are largely comparable to those observed in the data. However, the resulting expected return errors are large.

Momentum Profits, Factor Pricing, and Macroeconomic Risk

Recent winners have temporarily higher loadings than recent losers on the growth rate of industrial production. The loading spread derives mostly from the positive loadings of winners. The growth rate of industrial production is a priced risk factor in standard asset pricing tests. In many specifications, this macroeconomic risk factor explains more than half of momentum profits. We conclude that risk plays an important role in driving momentum profits.

The Long-Run Role of the Media: Evidence from Initial Public Offerings

The unique characteristics of the U.S. initial public offering IPO process, particularly the strict quiet period regulations, allow us to explore the effects of media coverage when the coverage does not contain genuine news i.e., hard information that was previously unknown. We show that a simple, objective measure of pre-IPO media coverage is positively related to the stocks long-term value, liquidity, analyst coverage, and institutional investor ownership. Our results are robust to additional controls for size, to using abnormal or excess media, and to an instrumental variable approach. We also find that pre-IPO media coverage is negatively related to future expected returns, measured by the implied cost of capital. In all, we find a long-term role for media coverage, consistent with Mertons attention or investor recognition hypothesis. This paper was accepted by Brad Barber, finance.

Securitization and Capital Structure in Nonfinancial Firms: An Empirical Investigation

Contrary to recent accounts of off-balance sheet securitization by financial firms, we show that asset securitization by nonfinancial firms provides a valuable form of financing to shareholders without harming firms’ debtholders. Using data from firms’ SEC filings, we find that securitization is attractive to firms in the middle of the credit quality distribution, which are the firms with the most to gain. Upon initiation, firms experience positive abnormal stock returns, zero abnormal bond returns, and largely use the securitization proceeds to repay existing debt. Securitization helps minimize financing costs by reducing expected bankruptcy costs and providing access to segmented credit markets.

A Model of Momentum

Optimal investment of firms implies that expected stock returns are tied with the expected marginal benefit of investment divided by the marginal cost of investment. Winners have higher expected growth and expected marginal productivity (two major components of the marginal benefit of investment), and earn higher expected stock returns than losers. The investment model succeeds in capturing average momentum profits, reversal of momentum in long horizons, as well as the interaction of momentum with market capitalization, firm age, trading volume, and stock return volatility. However, the model fails to reproduce procyclical momentum profits.

Intangible Assets and Cross-Sectional Stock Returns: Evidence from Structural Estimation

The relation between a firms stock return and its intangible assets is derived under the intangible-asset-augmented q-theory framework. The structural estimation of the model leads to four main results. First, the q-theory augmented with intangible investments captures the value premium and the relation between R&D intensity and stock returns significantly better than the conventional q-theory. Two features of intangible assets, adjustment costs and investment-specific-technological-change, are crucial to the improved model performance. Second, higher R&D intensity, defined as the ratio of R&D expenditure to intangible assets, leads to lower stock returns. Third, the q-theory augmented with intangible investments gives a more reasonable estimate of adjustment costs of tangible investments than the conventional q-theory does. Fourth, the magnitude of adjustment costs of R&D investments is estimated to be larger than that of tangible investments.

Implicit Government Guarantee and the Pricing of Chinese LGFV Debt

Lacking the authority to raise debt on their own, Chinese local governments set up financing vehicles for urban construction and investment to issue the so-called chengtou bonds. While these bonds are commonly understood to carry implicit government guarantee, the identity of the guarantor is rather unclear. By analyzing the yield spread on chengtou bonds, we find that investors began paying attention to city-level fiscal conditions after the well-publicized chengtou debt crisis of 2011. More recently, provincial fiscal conditions became important determinants of chengtou yield spreads as the provinces are allowed to issue municipal bonds to backstop the exploding LGFV debt.

Cost Structure and Capital Structure – A Test of the Stakeholder Theory of Capital Structure

The stakeholder theory of capital structure proposed by Titman (1984) argues that firms will take into account the nonfinancial stakeholders’ preferences when making capital structure decisions. In particular, firms selling specialized products will choose a lower leverage ratio. We propose a cost structure measure to capture the uniqueness of products. We document that this single factor can explain about 16 to 23% of the cross-sectional variation in capital structure. A one standard deviation increase in the cost structure variable relates to an 8 to 10% decrease in the debt ratio. The association is stronger among firms with a higher expected default probability. The results are robust to using the instrumental variable (IV) method. We further discuss three underlying mechanisms: customers’ channel, suppliers’ channel and employees’ channel, through which the cost structure variable captures stakeholders’ concerns. We conclude that, consistent with the stakeholder theory, cost structure has a causal impact on a firm’s leverage choices and is one of the most important determinants of capital structure in the cross-section.We examine the empirical relationship between cost inflexibility and capital structure. We propose a cost inflexibility measure as a direct measure of a firm’s fixed cost proportion. We argue and show that this characteristic-based measure dominates previously used operating leverage measures because the sensitivity-based measure suffers from severe measurement error problems. We document that more cost inflexible firms are associated with lower debt ratio and shorter debt maturity. This single factor can explain about 16% to 23% of the cross-sectional variation in capital structure. One standard deviation increase of the inflexibility variable relates to 8% to 9% decrease of debt ratio. The association is stronger among financially constrained firms, value firms and firms with low profitability. Our evidence suggests that cost inflexibility is one of the most important determinants of capital structure in the cross-section. We thank Peter Mackay for helpful discussions. All errors are our own. We acknowledge the financial support from Hong Kong RGC (Project No: 643611). 2

Historical Market-to-Book and Past Returns in a Partial-Adjustment Model of Leverage

Historical market-to-book and past returns have been shown to explain current leverage. Prior studies attribute the evidence to market timing or passive management. This study shows that with the presence of time-varying targets and adjustment costs, historical variables have a significant impact on leverage even when firms do not time the market and managers actively rebalance the leverage ratios toward the targets. The historical value of alternative market timing proxies, such as insider sales and market sentiment, are shown to have no effects on leverage while the historical value of alternative growth options proxies do. Overall, the evidence is largely consistent with a partial adjustment model of leverage.