Paola Sapienza

The Role of Social Capital in Financial Development
by Luigi Guiso, Paola Sapienza, and Luigi Zingales
American Economic Review, June 2004, Vol.94 (3), pp. 526-556

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Abstract:
In 1972 the Nobel Prize Winner in Economics, Kenneth Arrow wrote that "Virtually every commercial transaction has within itself an element of trust, certainly any transaction conducted over a period of time. It can be plausibly argued that much of the economic backwardness in the world can be explained by the lack of mutual confidence." The economists hardly noticed. The thesis that the underdevelopment of some regions was due to the lack of social trust was hard to reconcile with the economic models prevailing at that time.

This article investigated the link between the level of social capital and one important factor underlying economic prosperity: financial development. Most financial markets are based upon trust-intensive contracts. Thus, in areas where there is more trust, financial markets are likely to be more developed. Documenting this link not only sheds some light on the mechanism through which social capital contributes to economic prosperity, but also provides a new explanation for the widely different levels of financial development across countries. The finding supports the hypothesis that social capital and trust are important for financial development. In areas characterized by high levels of social capital and trust, households invest a smaller proportion of their financial wealth in cash and a bigger proportion in stock. These households are also more likely to use personal checks and to obtain credit when they demand it.

By looking at the portfolios of households that moved between areas with different levels of social capital, the study tries to distinguish whether social capital affects financial decisions through the norm that individuals inherit from their parents and the community they were raised in, or whether the attitudes change as a result of a different environment. The results suggest that although most of the effect is due to the level of social capital prevalent in the area where an individual lives, a significant fraction - roughly a third - is due to the level of social capital prevalent in the area where the person was born.

	Mitchell Petersen

Does the Source of Capital Affect Capital Structure?
by Michael Faulkender, and Mitchell Petersen
Forthcoming Review of Financial Studies

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Abstract:
In micro economics, we teach that demand and supply determine the market price and quantity of a good which is bought and sold. However, when we teach capital structure (how much debt should a firm use to finance itself), we often assume that only demand matters. Empirical tests of capital structure theory estimate the amount of debt a firm has as a function of firm characteristics which determine its demand for debt (how large are the tax savings from issuing debt and how large are the costs of financial distress). The tests have assumed that firms can borrow as much debt as they want, at the correct risk-adjusted interest rate.

In practice, this may not be true. Since manager's may know more about the value of the firm's assets than the market and managers may not always act in the interests of bond holders, firm can not always borrow as much as they want. In this paper, we asked the simple question of whether firms which have access to the public bond market (and only about 20% of public traded US firms do), have more debt. We find firms with access to the bond market have about 35% more debt then other equivalent firms. The greater use of debt remains after we control for difference in the amount of debt which different firms demand, and the fact that the decision to gain access to the bond market is endogenous. It turns out differences in supply as well as difference in demand both determine firm's use of debt.

	Sergio Rebelo

Large Devaluations and the Real Exchange Rate
by Ariel Burstein, Martin Eichenbaum, and Sergio Rebelo
Journal of Political Economy, 113: 742-784, August 2005

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Abstract:
The real exchange rate is the ratio of the price of the same basket of goods, measured in the same currency, in two different countries. It is well known that the real exchange rate depreciates after a large devaluation. This means that prices become relatively cheaper in the country that suffered the devaluation. In this paper we investigate the post-devaluation movements of different prices and their contribution to the real exchange rate depreciation. This information contains important clues about the impact of large devaluations on the economy. We found a natural hierarchy of price movements. At the top of the heap are prices of exports and imports measured at the dock. These prices move by as much as the nominal exchange rate so, after a large devaluation, these goods become very expensive in local currency. Next are retail prices of imported and exportable goods. These prices move by less than the nominal exchange rate because they reflect local distribution costs (transportation, retailing and wholesaling). Finally, we found that the prices of goods produced only for local markets and the price of the so-called "nontradable" goods (housing, education, health, and transportation) exhibit small changes. Measured in foreign currency the price of nontradable goods becomes much cheaper after a large devaluation. This effect accounts for most of the observed real exchange rate depreciation.

	Annette Vissing-Jorgensen

Mandated Disclosure, Stock Returns, and the 1964 Securities Acts Amendments
by Michael Greenstone, Paul Oyer, and Annette Vissing-Jorgensen
Forthcoming, Quarterly Journal of Economics

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Abstract:
Recent studies of the value of corporate governance reform (notably the Sarbanes-Oxley Act of 2002) are hampered by the lack of a counterfactual, i.e. a group of firms unaffected by the reform. In this paper we go back in time and study the last big corporate governance reform, the 1964 Securities Acts Amendments, which provides a unique setting for evaluating whether investors value increased mandatory information disclosure. The 1964 Amendments extended the mandatory disclosure requirements that had applied to NYSE/AMEX firms since 1934 to large firms traded Over-the-Counter (OTC). We find several pieces of evidence indicating that investors valued these disclosure requirements. First, a firm-level event study reveals that the OTC firms most affected by the 1964 Amendments had abnormal excess returns of about 3.5 percent in the weeks immediately surrounding the announcement that they had begun to comply with the new requirements. Second, we estimate that the most affected OTC firms had abnormal excess returns ranging between 11.5 and 22.1 percent in the period between when the legislation was initially proposed and when it went into force. These returns are adjusted for the standard four factors and are relative to NYSE/AMEX firms, matched on size and book-to-market equity, that were unaffected by the legislation. Consistent with these abnormal returns, the operating performance of the most affected OTC firms improved relative to that of NYSE/AMEX firms. While we cannot determine how much of shareholders gains were a transfer from insiders of these same companies, our results suggest that mandatory disclosure causes managers to focus more narrowly on maximizing shareholder value.