Working Papers

1. Aretz, Kevin, Murillo Campello, Gaurav Kankanhalli, and Kevin Schneider, Uncertainty and Corporate Zombification: Implications for Competition Dynamics and Creative Destruction.

We show how the threat of “uncertainty-induced zombification” — creditors’ willingness to keep distressed firms alive when faced with uncertainty — shapes various industry dynamics. Under a real options framework, we demonstrate that healthy firms become reluctant to invest and disinvest in anticipation that uncertainty induces creditors to convert rival defaulting firms into zombies. We validate our theory model using dynamic, product-market-specific estimates of uncertainty-induced zombification together with loan contract-level data. Empirically, higher uncertainty-led rival zombification prompts unlevered firms to reduce their investment, disinvestment, employment, and establishment-level openings and closures. Notably, these policies are modulated by the anticipation of the extent to which distressed rivals will be subsidized by their creditors. These hard-to-reverse decisions depress healthy firms’ long-run sales revenues, profits, and market values. We confirm those dynamics using granular, near-universal data on the asset allocation decisions of global shipping firms. Our findings highlight a novel channel through which uncertainty influences firms’ capital accumulation, performance, and outcomes.

FIRST VERSION TO BE CIRCULATED SOON.

2. 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 Connecting our empirical evidence to technological progress, we finally show that the managers of firms with outdated capital extract more investment-relevant information from share prices when they are more exposed to technological progress, as measured through patent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.

3. Aretz, Kevin, Hening Liu, and Kevin Schneider, Corporate Real Decisions, Dynamic Operating Leverage, and Seasonalities Everywhere.

We theoretically show that in a world with seasonal output prices and inventory building, firms optimally build up output inventories toward their high-price seasons. Heeding that strategy, they generate endogenous similar seasonality in their sales but inverse seasonalities in their operating leverage and expected returns. Crucially, higher inventory holding costs lower optimal inventory building, dampening the endogenous seasonalities. Supporting our theory, our empirical work reveals that seasonal firms build up inventories toward their high-sales seasons; high seasonal inventory holdings predict low stock returns; and those holdings help explain the seasonal-sales, same-calendar-month, momentum, and ROE stock anomalies.

PRESENTED AT THE ANNUAL MEETING OF THE FINANCIAL INTERMEDIATION RESEARCH SOCIETY (FIRS) IN JUNE 2023.

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.