Essays in Financial Economics

This dissertation seeks to examine three well-known problems in three different areas of financial economics: The effects of regulation on the financial sector; the provision of incentives to limit freeriding in teams; and the lack of empirical support for the consumption-based asset pricing model. In the first essay, I address the current debate on the costs and benefits of financial regulation, and I show that financial regulation can increase bank shareholder value by reducing shareholder monitoring costs. I use a regression discontinuity design to study the effect of an unexpected decrease in small-bank reporting requirements to the Federal Reserve. Using the reporting change as a negative shock to regulatory monitoring by the Fed, I find that reduced Fed monitoring leads to a 1% loss in Tobin’s q and a 7% loss in equity market-to-book. I show that these losses come from increased internal monitoring expenditures, managerial rents, and monitoring conflicts between shareholders. My results are among the first to quantify the shareholder value of monitoring. In the second essay (with Benjamin Tengelsen and Ariel Zetlin-Jones), we re-examine the importance of separation between ownership and labor in team production models that feature free riding. In such models, conventional wisdom suggests an outsider is needed to administer incentive schemes that do not balance the budget. We analyze the ability of insiders to administer such incentive schemes in a repeated team production model with free riding when they lack commitment. Specifically, we augment a standard, repeated team production model by endowing insiders with the ability to impose group punishments which occur after team outcomes are observed but before the subsequent round of production. We extend techniques from Abreu (1986) to characterize the entire set of perfect-public equilibrium payoffs and find that insiders are capable of enforcing welfare enhancing group punishments when they are sufficiently patient. In the third essay, I re-examine an important prediction of asset pricing theory which has historically found little support in the data—that expected consumption growth and equity returns should be correlated. I first show empirically that advertising growth is a good proxy for expected consumption growth, as it predicts both consumption growth and equity returns in aggregate post-war US data. To shed light on the link between advertising growth, expected consumption, and expected returns, I then build and calibrate a dynamic model of goods market frictions where firms invest in advertising to build their customer capital (as in Gourio and Rudanko (2014)). Within the model, I show that the severity of goods market frictions is a key element to replicate the predictability patterns I observe in the data.