Market-level and firm-level implications of financial distress

Abstract

This thesis consists of three parts, all organized around a unifying theme of financial distress. In the first chapter, titled "The FOMC Announcement Premium Asymmetry", I demonstrate that excess equity returns around Federal Open Market Committee (FOMC) meetings are concentrated in recessions. On FOMC announcement days, the difference between stock returns in recessions and expansions is 73-119 basis points. The asymmetry remains even after accounting for the elevated volatility in economic downturns. Moreover, the pre-announcement drift and the compensation for bearing risk on announcement days are also characteristics of recessions. The second chapter, "Properties of Financial Texts", documents statistical properties of unstructured data. I find that counts of words, their combinations, and measures constructed from them are often non-stationary. I demonstrate the implications by focusing on an already existing application, predicting equity market returns using a text-based measure of sentiment. Non-stationary behavior results in contradictory findings - both forecast errors and prediction beta are higher in recessions than expansions. Using robust inference methods, I establish that the sentiment's interaction with recessions has been severely overstated, and it does not predict equity returns any better in downturns than upturns. The last part, "Trade Secrets Impairment" (written jointly with A. Michaelides, A. Milidonis, and Y. Wiwattanakantang), is an example of firm-level distress due to intellectual property loss. The market value of trade secrets is estimated using a hand-collected sample of U.S. court cases filed under the Economic Espionage Act. Impaired firms are large, operate in industries commonly associated with the dual-use (military and civilian) technology, have lower leverage, and own high-valued patents. For these companies, a lower bound on the mean trade secret value is approximately 1.5% of the firm's market capitalization, significant both economically and statistically. Following the impairment, victim firms make a high number of relatively low-valued acquisitions.