Working Papers

1. Aretz, Kevin, Hassan Ilyas, and Gaurav Kankanhalli, Technological Progress, Managerial Learning, and the Investment-Stock Price Sensitivity.

Motivated by a real options investment model in which managers learn about the unobservable production costs of brandnew capacity both through their firm's share price and installed capacity, we reveal that the investment-to-stock price sensitivity rises with the time since managers last invested into new capacity, as proxied through capacity overhang. Our evidence is robust to using various investment, employment, and Tobin's Q measures and not entirely subsumed by financial constraints. Interestingly, managers learn less from their share prices when they have better information, investors have worse information, and there are alternative information sources (as, e.g., trade associations). Connecting our empirical evidence to technological progress, we finally show that the managers of firms with outdated capital extract more investment-relevant information from share prices when they are more exposed to technological progress, as measured through patent citations and the exogenous R&D stocks of firms located in the firm's technology space.

PRESENTED AT THE ANNUAL MEETING OF THE AMERICAN FINANCE ASSOCIATION IN JANUARY 2023.

2. Aretz, Kevin, and Anastasios Kagkadis, Construction, Systematic Risk, and Stock-Level Investment Anomalies (First-Round Revise & Resubmit, Journal of Financial & Quantitative Analysis).

We show that stock-level investment anomalies are far stronger in the subsample of firms building new productive capacity (i.e., those with positive "PP&E construction-in-progress" accounts at the start of their investment periods) than in other firms. Despite that, the anomalies also disappear among those building firms after about 3-4 years. To rationalize our findings, we develop a real options model in which firms building brandnew technologically advanced capacity incur ex-ante uncertain extra costs from familiarizing themselves with the capacity (as, e.g., arising from costly mistakes, suboptimal configurations, on-the-job training, etc.) over some period. In the model, the extra uncertainty drives down the systematic risk of brandnew capacity, inducing investments to decrease the expected returns of building firms until the uncertainty disappears. Additional empirical tests support our idea that extra uncertainty arising from firms adapting to new technologies after their implementation explains why investment anomalies are stronger among building firms.

MAJOR REVISION EXPECTED BY MARCH 2023.

3. Aretz, Kevin, Ian Garrett, and Adnan Gazi, The Early Exercise Risk Premium (First-Round Reject & Resubmit, Management Science).

Prior studies use American option data in European option valuation theories, arguing that the ability to early exercise an option is likely to have an only minor effect the option's returns. We examine this claim using put options. We show that neoclassical finance theory predicts that American put options have significantly larger (i.e., less negative) expected returns than European put options, with the gap widening with a higher option moneyness, a lower option time-to-maturity, and a higher underlying asset (idiosyncratic) volatility. In our empirical work, we contrast the mean returns of single-stock American put options with those of "equivalent" synthetic single-stock European put options, using put-call parity on American call options written on stocks not paying out cash to calculate the European put option returns. Our results suggest that the American options have statistically and economically larger mean returns than the equivalent European options, with the return difference relating to the stock and option characteristics as predicted by neoclassical finance theory.

RESUBMITTED - Revised version available here.

4. Aretz, Kevin, Shuwen Yang, and Yafei Zhang, Real Disinvestments & the Distress Anomaly: Evidence from Stocks, Bonds, and Loans.

Using Campbell et al.'s (2008) hazard model corporate distress proxy, we show that, analogous with the negative distress premium in stocks, that same premium is also negative in corporate bonds and loans. In accordance, the distress premium in a firm's assets, as measured through its stock, bond, and loan claims, is also negative. While the negative distress premiums in all asset classes studied by us is bad news for existing explanations of the distress anomaly (as, e.g., the shareholder advantage theorem), it suggests that the anomaly arises through an operating (not financial) channel. Using a standard real options model of a firm with investment and disinvestment options supplemented with a simple exogenous capital structure, we show that disinvestment options can yield negative distress premiums in stocks, bonds, and loans if shareholders and debtholders benefit from disinvestments. Assuming tangible (intangible) asset sale proceeds mostly go to debtholders (shareholders), additional empirical evidence supports our disinvestment rationale.

MAJOR REVISION EXPECTED BY MID 2023.