ICPM Global Research Scanning Service
Each month, a relevant and timely academic paper is reviewed, summarized and featured here. Papers are sourced by pro-active scanning of influential journals and through collaborative efforts with international pension research institutes, think-tanks and like-minded organizations.
We welcome your suggestions for key topics and authors and invite submissions of published articles for consideration. To do so, please contact us. To access all of ICPM’s archived research Search ICPM Research and Archives.
Corporate ESG Profiles and Investor Horizons
Laura T. Starks, University of Texas at Austin, Parth Venkat, Securities and Exchange Commission, and Qifei Zhu, University of Texas at Austin
Many ESG practices, e.g. curbing environmental pollution, contribute to the improvement of firm performance as well as reduction of litigation risks in the long-run but can be costly in the short-term. Therefore, investors with different time horizons may disagree on the value of ESG projects.
‘Since You’re So Rich, You Must Be Really Smart’: Talent and the Finance Wage Premium
Michael J. Böhm, University of Bonn, Daniel Metzger, Stockholm School of Economics, and Per Strömberg, Swedish House of Finance
In a competitive labor market, wages should rise if the marginal productivity of workers increases. A leading explanation for the surge in finance pay has thus been that finance workers have become relatively more productive compared to other sectors over this period.
Patrick Bolton, Tao Li, Enrichetta Ravina, and Howard Rosenthal
Classical financial theory suggests that shareholders’ main concern is the maximization of firm value, and that this determines their voting behaviour. However, the records actually suggest that shareholders disagree substantially when it comes to the vote on governance, social, and environmental proposals, and more than financial theory would predict.
The Power of Percentage: Quantitative Framing of Pension Income
Henriëtte Prast and Federica Teppa
The authors of this paper apply the concept of framing effects to pension communication. They ask whether framing the same replacement ratio in different ways yields different outcomes with respect to the satisfaction with this replacement ratio.
Small cues change savings choices
James J. Choi, Emily Haisley, Jennifer Kurkoski and Cade Massey
Can one to two sentences influence contribution rates to a 401(k) plan, even if the cues do not add information? The authors answer this question by running two field experiments with employees of a large technology company.
Private Equity and Human Capital Risk
Manfred Antoni, Ernst Maug and Stefan Obernberger
We study the impact of leveraged buyouts in Germany on employees’ wages, employment, and career paths. We contrast different views of buyouts, which see LBOs as facilitators of organizational and technological modernization, or as vehicles for transferring wealth from employees to shareholders. We conduct matched-sample difference-in-differences estimations with more than 147,000 LBO employees and a carefully matched control group. LBOs increase annual income in the short term, but reduce income by about 11% in the long term. White-collar workers and middle management lose most, probably because of organizational streamlining. LBOs in our sample do not foster trends related to technological modernization such as skill-biased technological change or job polarization. We find a strong negative impact of LBOs for older employees, but no support for the notion that shareholders benefit from LBOs by forcing employees to accept lower wages. All human capital impairments are borne by employees who leave the firm and become unemployed or employed in a different industry.
How Do Consumers Respond When Default Options Push the Envelope?
John Beshears, Harvard University, Shlomo Benartzi, University of California, Richard T. Mason, City, University of London, and Katherine L. Milkman, University of Pennsylvania
Many employers have increased the default contribution rates in their retirement plans, generating higher employee savings. However, a large fraction of employers are reluctant to default employees into savings rates that are high enough to leave those employees adequately prepared for retirement without supplementary savings. There are two potential concerns regarding a high default: (i) it may drag an employee along to a high contribution rate even when this outcome is not in the employee’s best interest, and (ii) perhaps more importantly, it may cause an employee to opt out of plan participation entirely. We conducted a field experiment with 10,000 employees who visited a website that facilitated savings plan enrollment. They were randomly assigned to see a default contribution rate ranging from 6% (a typical default) to 11%. Relative to the 6% default, higher defaults increased average contribution rates 60 days after a website visit by 20-50 basis points of pay off of a base of 6.11% of pay. We find little evidence that the concerns with high defaults are warranted, although the highest default (11%) increases the likelihood of not participating by 3.7 percentage points. The evidence suggests that erring on the high side when choosing a default contribution rate is less likely to generate unintended consequences than erring on the low side.
A cross-country study of saving and spending in retirement
Jennifer Alonso-García, Hazel Bateman, Johan Bonekamp, Arthur van Soest and Ralph Stevens
Presenting at ICPM Amsterdam 2017 Discussion Forum
Globally, more reliance is increasingly being placed on pre-funding as an ageing demographic renders unfunded social security structures unsustainable. Prefunding creates very large privately held retirement asset pools in pension funds and insurance companies as the system matures. For example, current assets under management total AUD2.2 trillion in Australia and in the Netherlands, more than 100% of GDP in each case. To better design insurance products offered during retirement, insurers and policymakers need to understand the retirement savings preferences of people in retirement. The emphasis of the literature has been on the empirical analysis of rational explanations of individuals saving and spending conservatively during retirement. However, an increasing number of studies suggest that behavioural and psychological motives may be important to explain individual?s financial choices for (retirement) consumption and saving. In this project, we elicit the impact of pension policy design (prescribed longevity insurance versus flexibility of drawdown from a retirement accumulation) and health status (becoming frail and/or losing a spouse) on savings preferences in retirement. We do so by conducting an experimental survey of retirement saving and spending decisions of soon to retire households in Australia and the Netherlands. We find that expected health shocks or death of a spouse are associated with an increasing importance to save for health-related expenses, to provide for your spouse after death (intra-household bequest) and to have a peace of mind. Pension policy design (mandatory longevity insurance or flexibility) seems to have a reduced impact on saving preferences. Our results suggest that Australians and Dutch currently consuming conservatively during retirement do so primarily to save for health-related expenses and to be able to enjoy life at later stages of retirement. Insurance products that better meet the needs of increasingly heterogeneous retirement cohorts should take these insights into consideration.
The Fragility of Market Risk Insurance
Ralph S. J. Koijen, New York University, and Motohiro Yogo, Princeton University
Presenting at ICPM Amsterdam 2017 Discussion Forum
Insurers sell retail financial products called variable annuities that package mutual funds with minimum return guarantees over long horizons. Variable annuities
accounted for $1.5 trillion or 34 percent of U.S. life insurer liabilities in 2015. Sales fell and fees increased after the 2008 financial crisis as the higher valuation of existing liabilities stressed risk-based capital. Insurers also made guarantees less generous or stopped offering guarantees entirely to reduce risk exposure. We develop a supply-driven theory of insurance markets in which financial frictions and market power determine pricing, contract characteristics, and the degree of market incompleteness.
Can strong corporate governance selectively mitigate the negative influence of “special interest” shareholder activists? Evidence from the labor market for directors
Diane Del Guercio, University of Oregon and ECGI, and Tracie Woidtke, University of Tennessee
Empowering shareholders can mitigate managerial agency problems but also empower “special interest” activists. Union and public pension funds, the most prolific institutional activists employing low-cost targeting methods, are often accused of pursuing private benefits. Extant literature finds that workers, and unions representing them, as stakeholders are not aligned with shareholders. Thus, activists who are also stakeholders of targeted firms have potential conflicts of interest. We find evidence the director labor market can selectively mitigate the negative influence that conflicted activists have over firms, especially when directors are younger and have greater career concerns, without stifling all influence of low-cost activists.
Wolf Pack Activism
Alon Brav, Duke and NBER, Amil Dasgupta, London School of Economics, and Richmond Mathews, University of Maryland
Blockholder monitoring is key to corporate governance, but blockholders large enough to exercise significant unilateral influence are rare. Mechanisms that enable small blockholders to exert collective influence are therefore important. It is alleged that institutional blockholders sometimes implicitly coordinate their interventions, with one acting as “lead” activist and others as peripheral”wolf pack” members. We present a model of wolf pack activism. Our model formalizes a key source of complementarity across the engagement strategies of activists and highlights the catalytic role played by the leader. We also characterize share acquisition in pack formation, providing testable implications on ownership and price dynamics.
Financial Incentives Beat Social Norms: A Field Experiment on Retirement Information Search (Working Paper)
Rob Bauer, Inka Eberhardt, and Paul Smeets, Maastricht University
A lack of pension knowledge undermines adequate savings decisions. To understand what motivates individuals to inform themselves about their pension situation, we conducted a field experiment with 245,712 pension fund participants. We find that a small financial incentive is cost-effective and increases the rate by which individuals visit their personal pension website by 70%. Our experiment directly compares the effect of financial incentives to different social norms, which turn out to be ineffective in the pension domain. Financial incentives are effective regardless of gender, age and income, while nudges are ineffective for each subgroup.
Saving for Tomorrow Today: How Message Framing Can Improve Retirement Saving Rates for Younger Workers
Nicole Montgomery (University of Virginia), Lisa Szykman (College of William and Mary) and Julie Agnew (College of William and Mary)
Most Americans, particularly young people, are not saving enough for retirement, which can have serious financial consequences for their long-run financial wellbeing. It can also cause immediate, short-term problems for employers if enough younger, lower-paid employees do not contribute sufficiently to their company sponsored 401(k) plans. Failure to have broad employee participation in the plan can not only lower employee satisfaction but can also decrease a
company’s ability to recruit top talent. In this paper, we hypothesize that one reason younger workers do not sufficiently save is because retirement seems too far away to warrant action. We build on existing savings research by examining how to adjust communication strategies to improve intended savings rates for this group. In Study 1, we compare the relative responses of two different age groups: younger Millennial workers and older Baby Boomer workers. We find that younger people respond better to abstract versus concrete advertisements, whereas savings rates for older workers do not differ by communication type. We attribute these findings to how differences in distance to retirement alter how each age group construes the event. In Study 2, we show that younger workers’ savings intentions increase further when the savings goal is presented using concrete messaging and as a milestone versus a distant goal. Overall, this research demonstrates that by aligning goal time frames with perceptions of retirement, younger workers can be encouraged to make better long-term savings decisions that benefits themselves and their employers.
Activating Pension Plan Participants: Investment and Assurance Frames
Wiebke Eberhardt, Elisabeth Brüggen, Thomas Post and Chantal Hoet
Whereas pension reforms take place and populations grow older, most pension plan participants are inactive and do not take the time to examine their retirement savings situation. An important challenge that policymakers and pension providers therefore face is how to communicate effectively in order to foster greater awareness of the importance of pensions. In this paper we analyze the difference that communication framing can make in activating individuals. We first show that loss frames can be a powerful nudge, but that they also result in more negative emotions and evaluations compared to the gain frame. Second, we therefore develop two frames for pension communication, which tap into similar gain and loss mechanisms while avoiding the use of loss wording. The investment frame – the gain alternative – emphasizes that pension plan participants can gain by investing in their future and searching for information. By contrast, the assurance frame – the loss alternative – stresses that participants can prevent negative consequences through the sense of security that they obtain when learning about their expected pension benefits. We tested these two frames in the field with 7,315 participants of a defined contribution pension plan and found that assurance framing can be twice as effective in engaging participants to click on a movie link (explaining pension scheme changes). With these frames, we found no differences in evaluation or negative emotions.
The Term Structure of Returns: Facts and Theory
Jules H. van Binsbergen, The Wharton School and Ralph S.J. Koijen, The Wharton School
We summarize and extend the new literature on the term structure of equity. Short-term equity claims, or dividend strips, have higher average returns and Sharpe ratios than the aggregate stock market. The returns on short-term dividend claims are risky as measured by volatility, but safe as measured by market beta. These facts are hard to reconcile with traditional macro-finance models and we provide an overview of new models that can reproduce some of these facts. We relate our evidence on dividend strips to facts about other asset classes such as nominal and corporate bonds, volatility, and housing. We discuss the broader economic implications of our findings by linking the term structure of returns to real economic decisions such as hiring and investment. We conclude with an outline of empirical and theoretical extensions that we consider interesting avenues for future research.
Pension Fund's Illiquid Assets Allocation Under Liquidity and Capital Constraints
Dirk Broeders, De Nederlandsche Bank, Kristy Jansen, Tilburg University, and Bas J. M. Werker, Tilburg University
This paper empirically assesses the impact of liquidity and capital constraints on the allocation of defined benefit pension funds to illiquid assets. Liquidity constraints result from short-term pension payments and collateral requirements on derivatives. Capital constraints follow from the requirement to retain sufficient capital to absorb unexpected losses. Liability duration and hedging affect the allocation to illiquid assets through both these constraints. First, we find a hump-shaped impact of liability duration on the illiquid assets allocation. Up to 17.5 years, liability duration positively affects the illiquid asset allocation. However, beyond this point the effect is reversed as the capital constraint dominates the liquidity constraint. Second, we find no evidence that interest rate hedging affects the illiquid assets allocation. Third, we do find that currency risk hedging positively impacts the illiquid assets allocation.
On the Asset Allocation of a Default Pension Fund
Magnus Dahlquist, Stockholm School of Economics, Ofer Setty, Tel Aviv University, and Roine Vestman, Stockholm University
We characterize the optimal default fund in a defined contribution (DC) pension plan. Using detailed data on individuals and their holdings inside and outside the pension system, we find substantial heterogeneity among default investors in terms of labor income, financial wealth, and stock market participation. We build a life-cycle consumption-savings model incorporating a DC pension account and realistic investor heterogeneity. We examine the optimal asset allocation for different realized equity returns and investors and compare it with age-based investing. The optimal asset allocation leads to less inequality in pensions while it moderates the risks through active rebalancing.
The Best of Both Worlds: Accessing Emerging Economies via Developed Markets
Joon Woo Bae, University of Toronto, Redouane Elkamhi, University of Toronto, and Mikhail Simutin, University of Toronto
A growing body of evidence suggests that the benefits of international diversification via developed markets have dramatically declined. While emerging markets still offer diversification opportunities, their public equity indices capture only a fraction of economic activity of emerging countries. We propose a diversification approach that exploits the global connectedness of developed countries to gain exposure to emerging countries overall economies rather than their shallow equity markets. In doing so, we demonstrate that developed markets still offer substantial diversification benefits beyond those available through equity indices. Our results suggest that relying on equity indices to assess diversification benefits understates diversification gains.
Fintech, Regulatory Arbitrage, and the Rise of Shadow Banks
Greg Buchak, University of Chicago, Gregor Matvos, University of Chicago, Tomasz Piskorski, Columbia Business School, and Amit Seru, Stanford University
We study the rise of fintech and non-fintech shadow banks in the residential lending market. The market share of shadow banks in the mortgage market has nearly tripled from 2007-2015. Shadow banks gained a larger market share among less creditworthy borrowers, with a tilt towards refinancing mortgages. Shadow banks were significantly more likely to enter markets where traditional banks faced more regulatory constraints. This suggests that traditional banks retreated from markets with a larger regulatory burden, and that shadow banks filled this gap. Fintech firms accounted for almost a third of shadow bank loan originations by 2015. To isolate the role of technology in the decline of traditional banking, we focus on technology differences between shadow banks, holding the regulatory differences between different lenders fixed. Analyzing fintech firms’ entry and pricing decisions, we find some evidence that fintech lenders possess technological advantages in determining corresponding interest rates. More importantly, the online origination technology appears to allow fintech lenders to originate loans with greater convenience for their borrowers. Among the borrowers most likely to value convenience, fintech lenders command an interest rate premium for their services. We use a simple model to decompose the relative contribution of technology and regulation to the rise of shadow banks. This simple quantitative assessment indicates that increasing regulatory burden faced by traditional banks and financial technology can account, respectively, for about 55% and 35% of the recent shadow bank growth.
Individual Investor Activity and Performance
Magnus Dahlquist, Stockholm School of Economics and CEPR, José Vicente Martinez, University of Connecticut and Paul Söderlind, University of St. Gallen and CEPR
We examine the daily activity and performance of a large panel of individual investors from Sweden’s Premium Pension System. We find that active investors earn higher returns and risk-adjusted returns than do inactive investors. A performance decomposition analysis reveals that most outperformance by active investors is the result of active investors successfully timing mutual funds and asset classes. While activity is beneficial for some investors, extreme flows out of mutual funds affect funds’ net asset values negatively for all investors. Financial advisors, by contributing to coordinate investments and redemptions, exacerbate these negative effects.
Why Do Investors Hold Socially Responsible Mutual Funds?
Arno Riedl, Maastricht University; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute) and Paul Smeets, Maastricht University
To understand why investors hold socially responsible (SRI) mutual funds, we use administrative data and link them to survey responses and behavior in incentivized experiments. We find that both social preferences and social signaling are important factors for SRI decisions. Financial motives also play a role but appear to be of limited importance. Socially responsible investors in our sample expect to earn lower returns on SRI than on conventional funds and pay higher management fees. This suggests that investors are willing to forgo financial performance in order to invest in accordance with their social preferences.
First Impressions Matter: An Experimental Investigation of Online Financial Advice
Julie R. Agnew, Hazel Bateman, Christine Eckert, Fedor Iskhakov, Jordan Louviere, Susan Thorp
We explore how individuals assess the quality of financial advice they receive and how they form judgments about advisers. Using an incentivized discrete choice experiment, we show that first impressions matter: consumers more often follow advisers who dispense good advice before bad. We demonstrate how clients’ opinions of adviser quality can be manipulated by using an easily replicated confirmation strategy that depends on the quality of the advice and the difficulty and order of the advice topics. Our results also reveal how clients benefit from their own past experience and how they use professional credentials to guide their choices.
The Pied Piper of Pensioners
Conrado Cuevas and Dan Bernhardt
We document how retirement portfolio recommendations by a pension-advice firm, Happy and Loaded, affect pension investments by individuals in the Chilean social security system. Following H&L’s advice, investors shift amounts that often exceed 20% of a portfolio’s value and 1.3% of Chilean GDP, in a week. We document what drives investment recommendations, and the resulting return consequences for the Chilean stock market, social security portfolios, government bonds, and exchange rates. Paradoxically, investors who followed H&L’s advice would have earned more by sticking with their original portfolios. These findings provide a cautionary tale for the design of privatized social security systems.
Climate Risks and Market Efficiency
Harrison Hong, Frank Weikai Li and Jiangmin Xu
We investigate whether stock markets efficiently price risks brought on or exacerbated by climate change. We focus on drought, the most damaging natural disaster for crops and food-company cash flows. We show that prolonged drought in a country, measured by the Palmer Drought Severity Index (PDSI) from climate studies, forecasts both declines in profitability ratios and poor stock returns for food companies in that country. A port- folio short food stocks of countries in drought and long those of countries not in drought generates a 9.2% annualized return from 1985 to 2015. This excess predictability is larger in countries having little history of droughts prior to the 1980s. Our findings support regulatory concerns of markets inexperienced with climate change under-reacting to such risks and calls for disclosing corporate exposures.
Blockholders: A Survey of Theory and Evidence
Edmans, A. and Holderness, C. G.
This paper reviews the theoretical and empirical literature on the role of blockholders (large shareholders) in corporate governance. We start with the underlying property rights of public corporations; we discuss how blockholders are critical in addressing free-rider problems and why, like owners of private property in general, blockholders are likely to be active in firm governance. We then examine what distinguishes a blockholder from an ordinary shareholder and advocate additional definitions from the typical threshold of 5% ownership. We next present new evidence on the frequency and characteristics of blockholders in United States corporations. Then we develop a simple unifying model to present theories of blockholder governance through both voice (direct intervention) and exit (selling one's shares). We survey the empirical evidence on blockholder governance, emphasizing the empirical challenges in identifying causal effects involving blockholders We highlight the lack of credible instruments for blockholders and argue that exogenous variation should not be a prerequisite for research - a narrow focus on identification may lead to a focus on identifying narrow questions. We emphasize the value of descriptive research with blockholders and how endogeneity concerns can be addressed with economic logic and by directly testing alternative explanations. We close with suggestions for future research.
Political Representation and Governance: Evidence from the Investment Decisions of Public Pension Funds
Aleksandar Andonov, Yael V. Hochberg, Joshua D. Rauh
We examine how political representatives affect the governance of organizations. Our laboratory is public pension funds and their investments in the private equity asset class. Representation on pension fund boards by state officials or those appointed by them—often determined by statute decades past—is strongly and negatively related to the performance of private equity investments made by the fund. This underperformance is driven both by investment category allocation and by poor selection of managers within category. Funds whose boards have high fractions of members who were appointed by a state official or sit on the board by virtue of their government position (ex officio) invest more in real estate and funds of funds, explaining 20-30% of the performance differential. These pension funds also choose poorly within investment categories, overweighting investments in small funds, in-state funds, and in inexperienced GPs with few other investors. Lack of financial experience contributes to poor performance by boards with high fractions of other categories of board members, but does not explain the underperformance of boards heavily populated by state officials. Political contributions from the finance industry to elected state officials on pension fund boards are strongly and negatively related to performance, but do not fully explain the performance differential.
Do Long-Term Investors Improve Corporate Decision Making?
Jarrad Harford, Ambrus Kecskés, Sattar Mansi
We study the effect of investor horizons on a comprehensive set of corporate decisions. We argue that monitoring by long-term investors generates decision making that maximizes shareholder value. We find that long-term investors strengthen governance and restrain managerial misbehaviors such as earnings management and financial fraud. They discourage a range of investment and financing activities but encourage payouts. Innovation increases, in quantity and quality. Shareholders benefit through higher profitability that the stock market does not fully anticipate, and lower risk.
Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
McCahery, J., Sautner, Z., & Starks, L.
Should I stay or should I go? This article provides insights into the actions of institutional investors and reveals their corporate governance preferences when engaging with firms. These insights can contribute to the effectiveness of shareholder engagement practices of long-horizon investors across the globe.
The Smarter Screen: Surprising Ways to Influence and Improve Online Behavior
Benartzi, S. with Lehrer, J.
A compelling look at the delicate balance when designing online education tools to effectively reach, retain and educate people to enable them to make sound (investment) choices. A must-read for pension industry communications professionals.
Private Equity Portfolio Company Fees
Ludovic Phalippou, Christian Rauch, and Marc Umber
Issue: In private equity, General Partners (GPs) may receive fee payments from companies whose board they control. This paper describes the related contracts and shows that these fee payments sum up to $20 billion evenly distributed over the last twenty years, representing over 6% of the equity invested by GPs on behalf of their investors. Fees do not vary according to business cycles, company characteristics, or GP performance. Fees vary significantly across GPs and are persistent within GPs. GPs charging the least raised more capital post financial crisis. GPs that went public distinctively increased their fees prior to that event. We discuss how results can be explained by optimal contracting versus tunneling theories.
Pension Fund Asset Allocation and Liability Discount Rates
Aleksandar Andonov, Martijn Cremers, and Rob Bauer, Maastricht University
This paper studies the regulatory incentives of U.S. public pension funds to increase risk-taking arising from their unique regulation linking their liability discount rates to the expected return on assets, which enables them to report a better funding position by investing more in risky assets. Comparing public and private pension funds in the U.S., Canada, and Europe, U.S. public funds seem susceptible to these incentives. More mature U.S. public funds as well as funds with more political and participant-elected board members take more risk and use higher discount rates. The increased risk-taking of U.S. public plans is negatively related to their performance.
Standing on the shoulders of giants: The effect of passive investors on activism.
Appel, I., Gormley, T. A., & Keim, D. B.
Issue: Shareholder activism is on the rise again after a temporary decline in the number of activist campaigns throughout the financial crisis. With 343 recorded activist campaigns in 2014, the movement reached its peak since 2008 (see PwC study, 2015). Simultaneously, the extent to which firms are owned by passive investors keeps increasing. In a recent working paper, Appel, Gormley and Keim (2016) investigate the impact of passive ownership on the way that activist shareholders target mutually owned companies.
Who is Easier to Nudge?
Beshears, J., Choi, J. J., Laibson, D., Madrian, B. C. & Wang, S.
Issue: Research on pension plan design has increasingly focused on default options. On average, most people stick to a default contribution rate and hardly opt out of pension plans if this requires action. But who is easier to nudge? Is it women, the young, and/or employees with a high income? Why do some socio-demographic groups stick to a default longer than others? And do default contribution rates actually influence the implicit rate that people would like to contribute (called the target contribution rate)? Beshears et al. (2016) answer these questions by analyzing data of the 401(k) plans of ten large US companies.