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Cambridge Endowment for Research in Finance (CERF)


Dancing with the Stars: Why Are Star Firms Important in the Market?

Mehrshad Motahari
01 December 2023

  • What Are ‘Star’ Firms?

Large, dominant ‘star’ firms play a pivotal role in financial markets. Star firms, a term conceptualised by Gutiérrez and Philippon (2019), are not just large entities in their sectors;  they significantly impact macroeconomic outcomes in the U.S., especially in areas like exports, foreign direct investment, and research and development, leading to increased profits and industry concentration (Autor et al., 2017; Grullon et al., 2019; De Loecker et al., 2020). Their growing influence is further amplified by advancements in artificial intelligence (Babina et al., 2024). AI-powered growth in sales, employment, and market valuations concentrates among larger superstar firms and leads to their greater influence through product innovation.

The rise of star firms is attributed to factors such as economies of scale, significance of proprietary information technology (Bessen, 2020), accumulation of intangible digital capital (Tambe et al., 2020), better access to human capital (Choi, Lou, and Mukherjee, 2017), and weakened anti-trust enforcement (Döttling, Gutiérrez, and Philippon, 2017). Their market power enables them to create entry barriers, affecting the performance and future earnings of other firms in their industry. The lack of full consideration of these dynamics by market participants like sell-side equity analysts could lead to predictable patterns in the earnings and returns of star and nonstar firms.

  • Information Externalities: What Do Star Firms Reveal About Their Peers?

In the article entitled ‘Star Firms, Information Externalities, and Predictability’, CERF/CCFin postdoctoral alumnus Mehrshad Motahari (Bayes Business School, formerly Cass) and co-authors Vidhi Chhaochharia, Alok Kumar, and Ville Rantala (Miami Herbert Business School) shed light on this phenomenon, exploring the multifaceted ways star firms influence the financial ecosystem. The paper delves into the financial information externalities of these star firms within industries. It seeks to understand how shifts in the performance of star firms can predict future earnings, growth opportunities, and the returns of non-star industry peers. Moreover, it probes into whether market participants, like sell-side equity analysts, have fully integrated this information into their earnings forecasts.

The paper's empirical analysis measures the relative earnings growth difference between star and nonstar firms. This measure is not just a static snapshot; it is dynamic, capturing the variations in earnings growth across quarters. The findings indicate that changes in the earnings performance of star firms are closely mirrored by the earnings growth of nonstar firms in the same industry. This lead-lag relationship is a testament to the gravitational pull exerted by star firms on their industry peers.

Furthermore, the research suggests that security analysts might not be fully cognizant of the information externalities of star firms. This lack of complete integration leads to predictable patterns in earnings surprises and returns of related non-star firms. Essentially, the market dynamics surrounding star firms are complex, and the full scope of their influence is not always immediately apparent to market observers.

Another significant finding of the study pertains to the influence of these firms on stock market returns. It appears that the relative earnings performance of star firms harbours information that is not wholly incorporated in market prices. This insight is crucial for understanding future stock returns, indicating that the market might not be fully efficient in pricing the performance data of these influential entities.

Lastly, the study explores the connection between market anomalies and biased earnings expectations. It posits that the anomalies observed in star firms can be indicative of future returns of connected nonstar firms. This finding suggests that market anomalies contain critical information about peer firms not immediately recognized by the market.

  • Why Do Star Firms Lead Their Industries?      

The impact of star firms is notably more pronounced in less competitive industries. This suggests that market power is a considerable source of their influence. In industries where competition is less fierce, the dominance of star firms becomes more marked, allowing them to exert greater influence on market dynamics and the performance of other firms.

The labour market implications of the study are equally compelling. The research draws a connection between changes in the economic performance of star firms and labour market effects, such as variations in job postings for non-star firms. This aspect underscores the broad spectrum of influence these firms have, extending beyond mere financial metrics to the very fabric of employment and career opportunities in the industries they dominate.

  • What Are the Important Takeaways?

In a broader context, the research contributes to our understanding of lead-lag effects in stock returns. It identifies a pattern where the performance of star firms—both in terms of earnings and stock returns—can be predictive of the outcomes for other connected firms. This insight is an addition to the literature on market dynamics, offering a new lens to view the influence of dominant industry players.

The study offers a nuanced and detailed exploration of the role of star firms in the economy. It reveals that the performance of these firms has far-reaching implications, influencing not just their own trajectory but also creating a ripple effect across the broader economy and the stock market. This research underscores the importance of considering the interconnectedness of firms within industries and highlights the subtle yet significant ways in which star firms shape economic and market dynamics.

For investors, policymakers, and anyone keenly observing the economic landscape, these insights may be helpful. They emphasise the need for a more nuanced approach in analysing market trends and economic patterns, taking into account the often subtle yet powerful influence of these dominant players in the market. As the global economy continues to evolve and as technologies like artificial intelligence further entrench the position of these star firms, understanding their role becomes not just an academic exercise but a necessity for navigating the complex world of modern financial markets.


Autor, D., Dorn, D., Katz, L.F., Patterson, C. and Van Reenen, J., 2017. Concentrating on the fall of the labor share. American Economic Review 107, 180–85.

Babina, T., Fedyk, A., He, A., and Hodson, J., 2024, Artificial intelligence, firm growth, and product innovation, Journal of Financial Economics 151, 103745.

Bessen, J., 2020. Industry concentration and information technology. Journal of Law and Economics 63, 531–555.

Choi, D., Lou, D., and Mukherjee, A., 2017. The effect of superstar firms on college major choice. CEPR Discussion Paper No. 12296.

De Loecker, J., Eeckhout, J. and Unger, G., 2020. The rise of market power and the macroeconomic implications. Quarterly Journal of Economics 135, 561–644.

Döttling, R., Gutierrez Gallardo, G. and Philippon, T., 2017. Is there an investment gap in advanced economies? If so, why? ECB Forum on Central Banking, Sintra.

Gabaix, X., 2011. The granular origins of aggregate fluctuations. Econometrica 79, 733–772.

Grullon, G., Larkin, Y. and Michaely, R., 2019. Are U.S. industries becoming more concentrated? Review of Finance 23, 697–743.

Gutiérrez, G. and Philippon, T., 2019, Fading stars. AEA Papers and Proceedings 109, 312–316.

Jannati, S., Korniotis, G. and Kumar, A., 2020. Big fish in a small pond: Locally dominant firms and the business cycle. Journal of Economic Behavior & Organization 180, 219–240.

Tambe, P., Hitt, L., Rock, D., and Brynjolfsson, E., 2020. Digital capital and superstar firms. National Bureau of Economic Research Working Paper 28285.


Corporate Real Decisions, Dynamic Operating Leverage,
and Seasonalities Everywhere

By Kevin Schneider, CERF Research Associate, Cambridge Judge Business School, University of Cambridge

The article at a glance:  CERF post-doctoral researcher Kevin Schneider studies the effect of seasonal output prices on a firm’s inventory and stock returns. He finds that seasonal inventory holdings help explain several stock return anomalies.


Seasonalities Everywhere

Cambridge economists going back as far as John Maynard Keynes have long recognised that customer demand for numerous goods and services displays strong seasonal patterns over the year, with an ice-cream producer, for example, enjoying the largest demand for its goods in summer, but a toy-maker in the festive season in winter, while the harvesting season for lemon farmers begins as early as February (Keynes (1936)). These reoccurring and predictable cycles dominate firm behaviour and, likely, influence production, investment, and financing policies of firms. Indeed, there is a great literature in financial economics documenting all sorts of seasonal patterns in variables such as corporate earnings (Chang et al. (2017) and Hartzmark and Solomon (2018)), stock returns (Heston and Sadka (2008, 2010) and Keloharju et al. (2016, 2021)), and macroeconomic variables (Ogden (2003)). Recently, Grullon et al. (2020) combine these seasonalities and find that firms earn low average stock returns in their high sales seasons and vice versa.

In this blog post, I summarise a novel angle on the literature using firms’ inventory policy as the key choice variable that ties seasonal patterns in firms’ accounting variables to seasonal patterns in their stock returns. The blog post is based on Aretz et al. (2023) and I will be summarising both the theoretical and empirical contributions of the paper.

Modelling Seasonality

In Aretz et al. (2023), we begin with a standard dynamic firm model in which firms choose their policies to maximise their equity value to which we make two contributions: First, we allow for seasonal patterns in firms’ exogenous product demand. For example, demand may always be high at the end of the calendar year due to Christmas. To model this behaviour, we add a sine function to the drift of the product demand, ensuring a periodic change from seasonal highs to seasonal lows. Figure 1 shows illustrative sample paths for a simulated output price displaying sine-like seasonal periodicity.

Inventory Building and Seasonal Operating Leverage

A second novelty in Aretz et al. (2023) is to allow firms to switch their finished output goods into an inventory to be sold later. Thus, firms in our model can make valuable selling choices. Given this set-up, firms find it optimal to store their production output during seasonal lows in demand and to empty their entire inventory around seasonal highs. Importantly, separating production and sales leads to a timing mismatch between incurred production costs and earned sales revenue. As we show, this timing mismatch leads to a form of seasonal operating leverage where the sensitivity of net profits to sales changes over the seasonal cycle. Using standard finance theory, seasonal operating leverage carries through to firms’ market beta and systematic risk which also display seasonal patterns (see Carlson et al. (2004), Cooper (2006), and Lambrecht et al. (2016)). Intuitively, around seasonal lows in product demand, firms only begin building up their inventory and are thus burdened with a high present value of yet-to-be-paid production costs which translates into high operating leverage. As the firm approaches its seasonal highs, it pays the production costs while its sales revenue comes closer such that the firm operationally delevers. Conversely, if we exclude the option to build up an inventory and force firms to sell their output instantaneously, output price seasonalities do not translate into return seasonalities. Taken together, firms’ optimal selling policies create endogenous seasonal operating leverage that is countercyclical: high (low) during seasonal lows (highs) in product demand.


In the following, I explain how we take the theoretical predictions above to the data and offer novel empirical evidence on the role of inventory building and the pricing of seasonal operating leverage.

Inventory is an Important Choice Variable

Using granular data on orders, shipments, and inventory holdings of seven major industries from the Manufacturers’ Shipments, Inventories, and Orders (MSOI) database made available by the Census Bureau of the United States, we first confirm that new orders are reoccurring with an annual cycle and met with immediate shipments that are accompanied by a significant build-up in inventories. Turning to a broader set of all public firms in the US, we confirm that lagged inventory building is highly explanatory for future sales. The effect is particularly pronounced for industries producing durable consumer goods but less so for healthcare or service industries. We also show that firms’ financing behaviour aligns with the seasonal cycle and that firms deplete their cash holdings and increase their short-term debt over the costly inventory build-up period but increase their payouts to shareholders once the sales revenue has been earned around seasonal highs.


Seasonal Operating Leverage is Priced in Average Stock Returns

Realising that firm capitalise paid production costs of goods not yet sold as “inventory” on their balance sheet, we can directly measure the extent of seasonal operating leverage as abnormal inventory holdings, relative to their annual mean. Importantly, high abnormal inventory holdings indicate high already prepaid production costs (ie, firms close to their seasonal highs that are operationally delevered). As predicted by theory, sorting stocks into portfolios based on their abnormal inventory holdings yields a strong negative return spread that is not explained by leading factor models. Thus, operationally delevered firms earn lower average returns than firms with high seasonal operating leverage. Fama-MacBeth regressions corroborate the results. We also show that market beta interacts with abnormal inventory holdings, suggesting seasonal variation in systematic risk.

Seasonal Operating Leverage and Return Anomalies

Finally, we draw comparisons between seasonal operating leverage and other famous return anomalies such as momentum and quarterly profitability (Jegadeesh and Titman (1993) and Hou et al. (2015)). Both of these anomalies have a seasonal component and are weaker in an “inventory neutral” set-up when their spread portfolio does not include firms with high and low seasonal operating leverage.


Aretz, Kevin, Hening Liu, and Kevin Schneider, 2023, Corporate real decisions, dynamic operating leverage, and seasonalities everywhere, Working Paper.

Carlson, Murray, Adlai Fisher, and Ron Giammarino, 2004, Corporate investment and asset price dynamics: Implications for the cross-section of returns, Journal of Finance 59, 2577–2603.

Chang, Tom Y., Samuel M. Hartzmark, David H. Solomon, and Eugene F. Soltes, 2017, Being surprised by the unsurprising: Earnings seasonality and stock returns, Review of Financial Studies 30, 281–323.

Cooper, Ilan, 2006, Asset pricing implications of nonconvex adjustment costs and irreversibility of investment, Journal of Finance 61, 139–170.

Dixit, Avinash K. and Robert S. Pindyck, 1994, Investment under Uncertainty, Princeton University Press, Princeton, NJ.

Grullon, Gustavo, Yamil Kaba, and Alexander Núñez, 2020, When low beats high: Riding the sales seasonality premium, Journal of Financial Economics 138, 572–591.

Hartzmark, Samuel M. and David H. Solomon, 2018, Recurring firm events and predictable returns: The within-firm time series, Annual Review of Financial Economics 10, 499–517.

Heston, Steven L. and Ronnie Sadka, 2008, Seasonality in the cross-section of stock returns, Journal of Financial Economics 87, 418–445.

Heston, Steven L. and Ronnie Sadka, 2010, Seasonality in the cross section of stock returns: The international evidence, Journal of Financial and Quantitative Analysis 45, 1133–1160.

Hirshleifer, David, Danling Jiang, and Yuting M. DiGiovanni, 2020,Mood beta and seasonalities in stock returns, Journal of Financial Economics 137, 272–295.

Hou, Kewei, Chen Xue, and Lu Zhang, 2015, Digesting anomalies: An investment approach, Review of Financial Studies 28, 650–705.

Jegadeesh, Narasimhan and Sheridan Titman, 1993, Returns to buying winners and selling losers: Implications for stock market efficiency, Journal of Finance 48, 65–91.

Keloharju,Matti, Juhani T. Linnainmaa, and Peter M.Nyberg, 2016,Return seasonalities, Journal of Finance 71, 1557–1590.

Keloharju,Matti, Juhani T. Linnainmaa, and Peter M. Nyberg, 2021, Are return seasonalities due to risk or mispricing? Evidence from seasonal reversals, Journal of Financial Economics 139, 138–161.

Keynes, John M., 1936, The General Theory of Employment, Interest, and Money, Palgrave Macmillan, London, UK.

Lambrecht, Bart M., Grzegorz Pawlina, and Joao C. A. Teixeira, 2016, Making, buying, and concurrent sourcing: Implications for operating leverage and stock beta, Review of Finance 20, 1013–1043.

Ogden, Joseph P., 2003, The calendar structure of risk and expected returns on stocks and bonds, Journal of Financial Economics 70, 29–67.

Trust matters: How social trust shapes international investments


By Marwin Mönkemeyer, CERF Research Associate, Cambridge Judge Business School, University of Cambridge


October 2023

The article at a glance

Marwin Mönkemeyer, Research Associate at Cambridge Centre for Finance (CCFin) and Cambridge Endowment for Research in Finance (CERF), blogs about the role of social trust in the portfolio allocation decisions of global institutional investors.

Investor portfolios remain severely home-biased

Investors’ preference for domestic over foreign assets is well documented in the literature on international portfolio allocation (French and Poterba, 1991). As a result, investors often do not take full advantage of the substantial benefits of international diversification and hold far more domestic securities than would theoretically be optimal.

Historically, the systematic tendency of investors to overweight their home markets has long been attributed to market frictions such as transaction costs, regulatory barriers, and taxes. However, as global financial markets have become more integrated, but the home bias persisted, studies increasingly challenged these explanatory approaches.

In recent years, the field of international finance has broadened its perspective to include psychological and sociological constructs to explain investor behaviour. In a recent study, my co-authors and I build on this paradigm shift and introduce a new factor that helps explain cross-border equity investment: social trust (or lack thereof).

Understanding the influence of social trust for economic outcomes

Economists have long recognised that social trust is particularly important for economic success in society (Arrow, 1972; Coleman, 1990). Consistent with Nobel laureate Kenneth J. Arrow’s notion that “virtually every commercial transaction has an element of trust in it” (Arrow, 1972, p. 357), social trust influences a wide range of economic outcomes. It paves the way for economic growth (Knack and Keefer, 1997) and enhances firm performance (Lins et al., 2017). It affects the size and structure of firms (Bloom et al., 2012), government regulation (Aghion et al., 2010), and even the terms of bank loans (Hagendorff et al., 2023), to name but a few examples.

Existing evidence suggests that social trust lowers the cost of trust-sensitive transactions, that is, economic interactions in which parties rely on the future actions of others (Knack and Keefer, 1997). This finding provides support for the conjecture that trust might also affect investment decisions since they are characterised by the exchange of money for future promises and require the belief in repayment as agreed.

The research study: Exploring the link between trust and investment

To empirically examine the role of trust in portfolio allocation, we analyse a global sample of more than 8,000 institutional investors from 33 countries investing in equities in 84 host markets from 2000 to 2017.

The appropriate measure of social trust

The literature differentiates between personalised trust, which is trust in a specific person, and generalised trust, which is trust in an unknown member of a larger group, such as fellow citizens or people from other countries. For markets and institutions to function correctly, it’s essential for people to trust strangers, referred to as generalised (social) trust. Accordingly, our study focuses on generalised trust within an institutional investor’s home market.

We draw on existing surveys, where trust is defined as the percentage of respondents answering “Can be trusted” to the question “Generally speaking, would you say that most people can be trusted or that you can’t be too careful in dealing with people?” Trust shows considerable variation in the cross-section of countries, ranging from 3.17% for the Philippines to 77.42% for Denmark.


Figure: Boxplot diagrams of social trust scores across countries. Source: Drobetz et al. (2023).

Trust reduces underinvestment in foreign equity

The key finding of our study is that institutional investors from high-social trust countries are less prone to underinvesting in foreign stocks. This has implications for international portfolio diversification: Social trust is different from mere “blind” trust as we document positive consequences for investors’ international risk exposure. Trust leads to a better risk-return trade-off in investor portfolios, as indicated by increased Sharpe ratios.

Information asymmetry: Trust as a key moderator

Information asymmetry, the notion that some parties possess more information than others, is a prevalent issue in equity markets. Proxying for information asymmetry in the target markets along different dimensions, we show that trust plays a more important role in opaque information environments (Guiso et al., 2008). Social trust emerges as a partial solution to the information asymmetry problem, which is particularly pronounced in foreign equity investing. Our results support an information-based explanation of the relationship between social trust and foreign stock investment.

Social trust as a substitute for formal institutions

We also analyse the joint effect of formal and informal institutions in the context of portfolio allocation. The analysis is important due to the diversity of formal institutions around the world, which is likely to condition international portfolio allocations. Our empirical evidence shows that trust does not mitigate foreign bias per se, but only when the quality of host-country formal institutions is poor. We conclude that the informal institution of social trust can serve as a substitute for the quality of the host country’s formal-institutional framework in international portfolio decisions.

What are the implications for investors and policymakers?

Trust matters in portfolio allocation – it mitigates inefficiencies in cross-border portfolio allocations created by information asymmetries. Investors should recognise that the level of social trust affects their portfolio decisions, and portfolio risk-return trade-off. Policymakers and regulators are well advised to strengthen formal institutions to counterbalance low social trust, making their jurisdictions more appealing for foreign investments.

This blog is based upon my recent research paper with W. Drobetz, I. Requejo, and H. Schröder: Foreign bias in institutional portfolio allocation: The role of social trust (2023), published in the Journal of Economic Behavior & Organization, 214, 233-269.

Featured research

Drobetz, W., M. Mönkemeyer, I. Requejo, and H. Schröder, 2023, Foreign bias in institutional portfolio allocation: The role of social trust, Journal of Economic Behavior & Organization, 214, 233–269.


Aghion, P., Y. Algan, P. Cahuc, and A. Shleifer, 2010, Regulation and distrust, Quarterly Journal of Economics 125, 1015–1049.

Arrow, K., 1972, Gifts and exchanges, Philosophy and Public Affairs 1, 343–362.

Bloom, N., R. Sadun, and J. Van Reenen, 2012, The organization of firms across countries, Quarterly Journal of Economics 127, 1663–1705.

Coleman, J., 1990, Home bias in open economy financial macroeconomics, Journal of Economic Literature 94, 64–115.

Drobetz, W., M. Mönkemeyer, I. Requejo, and H. Schröder, 2023, Foreign bias in institutional portfolio allocation: The role of social trust, Journal of Economic Behavior & Organization, 214, 233–269.

French, K., and J. Poterba, 1991, Investor diversification and international equity markets, American Economic Review 81, 222–226.

Guiso, L., P. Sapienza, and L. Zingales, 2008, Trusting the stock market, Journal of Finance 63, 2557–2600.

Hagendorff, J., S. Lim, and D. Nguyen, 2023, Lender trust and bank loan contracts, Management Science, 69, 1758–1779.

Knack, S., and P. Keefer, 1997, Does social capital have an economic payoff? A cross-country investigation, Quarterly Journal of Economics 112, 1251–1288.

Lins, K., H. Servaes, and A. Tamayo, 2017, Social capital, trust, and firm performance: The value of corporate social responsibility during the financial crisis, Journal of Finance 72, 1785–1824.


Title: Understanding the Impact of Sovereign Accounting Errors on Financial Markets

By Dr Jenny Chu, Associate Professor and CERF Research Fellow, Cambridge Judge Business School, University of Cambridge

September 2023

The article at a glance

Cambridge Judge Associate Professor and Cambridge Endowment for Research in Finance (CERF) Research Fellow, Dr Jenny Chu looks at the market consequences of sovereign financial reporting errors.


What are sovereign financial reporting errors?

The financial market closely scrutinizes corporate accounting quality, but what about the fiscal reporting quality of sovereign entities (i.e., countries)? A recent academic paper titled “Market Consequences of Sovereign Accounting Errors,” coauthored by Jenny Chu and Marion Marion Boisseau-Sierra of University of Cambridge together with Shiva Rajgopal of Columbia University, delves into the implications of sovereign fiscal reporting errors on the broader financial market, shedding light on an overlooked aspect in the accounting and finance literature.


This research explores the repercussions of accounting errors in the context of European countries whose fiscal data reporting undergo regular scrutiny by Eurostat, a division of the European Commission. Eurostat periodically assesses the fiscal data releases of EU member states, highlighting reservations that outline discrepancies in financial reporting. The study spanning from 2004 to 2018 found a significant trend: when Eurostat announces reservations, particularly when mentioning deficit or debt errors in recent fiscal data, sovereign bond yields witness abnormal increases. Moreover, consistent with a home bias, these reservations prompt domestic but not foreign investors to increase their holdings of sovereign debt.


Why should we care?


The sheer size of sovereign debt across the globe—amounting to 98.6% of global GDP in 2020—highlights the critical importance of assessing the quality of this financial asset. Investors, including domestic and foreign commercial banks, central banks, and institutional investors, heavily rely on the credibility and performance of this asset class. Therefore, the accuracy of sovereign financial reporting plays a crucial role in determining global economic stability.


Our findings and implications


The study's findings challenge the traditional belief that sovereign accounting quality might not hold as much weight as corporate or local government accounting quality as countries rarely default. It demonstrates that errors in sovereign accounting significantly impact the market, influencing sovereign bond yields. The impact is particularly strong when reservations specifically quantify errors in recent fiscal data, shedding new light on the country's fiscal health.


This study exploits a unique setting using reservations issued by Eurostat, akin to the enforcement actions released by the US Securities and Exchange Commission in the corporate accounting realm. The results emphasize the importance of these reservations as novel information for investors, prompting market reactions when reservations contain more relevant, precise, and timely data.


The research also unveils an interesting investor behavior termed "home bias" in the sovereign debt market. Following negative news revealed by Eurostat reservations, domestic, but not foreign, investors tend to increase their investment in local sovereign bonds, signifying lower information asymmetry for domestic investors.


In summary, this research reveals that sovereign fiscal accounting errors do matter in the financial world and that investors care about sovereign accounting quality. Furthermore, it paves the way for further research in the areas of sovereign governance, disclosure environments, and sovereign accounting quality on a global scale.


The Impact of Workplace Relationships on Manager Incentivisation and Fund Performance  

By Elias L. Ohneberg, CERF Research Associate, Cambridge Judge Business School, University of Cambridge 

August 2023

In a 2012 survey by Penn Schoen Berland and Georgetown University, 75% of senior executives responded that they witnessed favouritism at work, and 83% stated that it can lead to the wrong people being promoted. More recently, an article by the New York Times uncovered blatant favouritism by Bank of America’s chief operating officer. His favoured employees received bonuses and promotions, while disfavoured employees were put up for pay reductions. Given the prevalence of favouritism, it is important to understand its effect on employee incentives and on-the-job performance. 

The effects of favouritism on employee incentives and behaviour 

Causal empirical evidence on the effects of favouritism on employee incentives and behaviour has so far been sparse. The field of psychology offers some correlative evidence that personal relationships between supervisors and employees can impact performance appraisals and firing and promotion decisions. Causal empirical research in the field of economics and finance is practically non-existent. Work by Prendergast and Topel (1993), nevertheless, provides theoretical support for a negative effect of favouritism on employee effort provision and forms a basis for my empirical work.  

To investigate the effects of favouritism on employee incentives and behaviour more generally, I study the effect of workplace connectedness on 13,347 portfolio managers in the mutual fund industry over a quarter of a century. The mutual fund industry lends itself well to studying the effect of workplace connections on employee incentives. It is highly human capital intensive and sizable, managing $60.1 trillion worldwide. 

First, I construct a measure that quantifies mutual fund managers' connectedness within their company. Two mutual fund managers are defined to know each other if they have a past work relationship – they have co-managed a mutual fund in the past. Connections between two employees can have different importance. Being more connected to a senior employee is likely more important than to a junior employee. Therefore, the measure places a higher weight on connections to more senior employees. 

To link the notion of favouritism to the connectedness of employees I need to establish that well-connected employees receive some sort of preferential treatment. I do this by investigating whether better-connected employees are treated differently in firing and promotion decisions, controlling for objective performance measures that should impact these decisions. My findings suggest that better-connected mutual fund managers are less likely to be fired for poor performance and more likely to be promoted despite lack of good performance. Surprisingly, my analysis suggests that past performance does not matter at all for well-connected managers. These results are consistent with preferential treatment towards well-connected managers.  

The threat of being fired and the reward of being promoted are important incentive mechanisms. They punish people for shirking and reward them for a job well done. Thus, my finding that past performance has a smaller impact on the promotion and firing probabilities for well-connected managers suggests that the incentive effects typically provided by firings and promotions are hampered. If performance does not matter as much for firing and promotion decisions, do well-connected mutual fund managers exert less effort in managing their funds? This is the next question I investigate. 

To ascertain effort provision by mutual fund managers, I can look at different measures. The job of a portfolio manager is to generate profitable investment ideas and to implement them successfully to generate a high return on investment. Coming up with these investment ideas requires time and effort spent on researching novel investment ideas and implementing them into the portfolio. Instead of exerting effort to generate a novel investment approach, mutual fund managers could simply copy what their peers are doing. Thus, my first measure of effort is how distinctively a mutual fund is managed in comparison to its peer group. I find that mutual funds managed by well-connected managers are less distinct in their sector allocations. This finding suggests that well-connected managers indeed expend less effort in managing their funds. 

Moreover, if well-connected mutual fund managers are exerting less effort in managing their funds, we would also expect their mutual funds to perform worse. Therefore, I next investigate whether mutual funds managed by better-connected managers perform worse than their counterparts. I find that mutual funds managed by better-connected managers exhibit poorer risk-adjusted investment performance than mutual funds managed by worse-connected managers. 

Why is favouritism tolerated? 

My findings, thus far, suggest that connectedness at the workplace can induce favourable treatment in promotion and firing events. This favourable treatment hampers the incentivisation usually offered by these career-altering events, and induces lower effort provision and, ultimately, poorer mutual fund performance. 

Given the negative effects uncovered in the analysis, there is a final question that needs to be addressed. Why is it that mutual fund companies allow this sort of favouritism to exist? It is somewhat puzzling that this value-destroying behaviour is not stopped. There are essentially two reasons why this behaviour would persist. First, there is simply nothing the mutual fund company can do to prevent the favourable treatment of well-connected managers. Second, the mutual fund company does not have an incentive to prevent it. Due to the difficulty of directly empirically investigating the first question, I will focus on the latter. 

To investigate if mutual fund companies have an incentive to tackle favouritism, we have to look at how mutual fund companies make money. Mutual fund companies are compensated through fee revenue. This fee revenue comes directly from annual fees paid by investors to the mutual fund company. Mutual fund fees are typically not tied to performance but instead consist of a fixed annual percentage fee of the money invested in the fund. Therefore, the aggregate fee revenue of a mutual fund is the size of the fund multiplied by the annual percentage fee. I focus my efforts on investigating how the connectedness of mutual fund managers impacts the size and net money inflows into the fund. I find that connectedness does not impact the overall size of the fund or the ability of the mutual fund to attract new money from investors. This would suggest that mutual fund investors are not aware of the negative effects of connectedness on fund performance or are not able to observe the connectedness of fund managers. Furthermore, it offers a rationale as to why mutual fund companies may not prevent the favourable treatment of well-connected managers despite its negative consequences on performance and effort provision, more generally. 

Overall, this study uncovers the notion of favouritism in the mutual fund industry. It shows that connected managers receive advantageous treatment in career-altering decisions unrelated to objective performance measures. This favourable treatment hampers incentivisation mechanisms and induces lower effort-taking by mutual fund managers. Mutual fund companies do not bear the costs of this value-destroying behaviour, however. Instead, mutual fund investors suffer through poorer investment performance. 


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Do Short Sellers Care about ESG? 

By Oğuzhan Karakaş, associate professor of finance at CJBS and CERF fellow

July 2023

Short selling is a financial transaction to profit from prices going down. A short seller borrows an asset and sells it today to, hopefully, buy it back in the future for a lower price. The literature finds that short sellers can forecast firm underperformance and are efficient in processing of public information and uncovering private information. 

In a project titled “What Does Short Selling Reveal About ESG?”, Oğuzhan Karakaş, Pedro Saffi and Mehrshad Motahari analyse whether the short sellers can anticipate negative ESG incidences of firms, and make money from the negative price reactions to the news announcement of such incidences. 

The authors find that short sellers anticipate the bad ESG news months before the corresponding negative ESG incidences occur. This finding corroborates the earlier research findings that short sellers can predict financial misconduct, earnings management, and credit downgrades in firms. The authors find that stock prices decrease following the bad ESG news, particularly companies with above- average ESG scores and abnormally high short selling interest. This suggests that observing the behaviour of short sellers may help identifying greenwashing (a firm’s ESG compliance being overstated, intentionally or unintentionally), which is notoriously difficult to define and detect. 

Short sellers may not be particularly interested in the non-financial effects of the ESG developments in firms. However, their interest in the ESG materiality may prove fruitful for the short sellers’ role in enhancing the market efficiency and in helping the efforts for a more sustainable financial system. 

Green transmission: Monetary Policy in the Age of ESG

By Alba Patozi, Phd candidate, Faculty of Economics, University of Cambridge

June 2023

In the context of the current high interest rate environment, senior central bankers such as Isabel Schnabel from the European Central Bank have pointed out that, despite the large upfront costs, green firms may not be as vulnerable to higher interest rates as previously expected. Her recent speech at the Symposium for Central Bank Independence suggests only a mild impact of rising borrowing costs on the Net-Zero transition and no evidence of funding shortages on green investments (Schnabel, 2023). In my research, I ask: Is this observation true more generally and across time? In other words, are green firms more or less responsive to monetary policy shocks? And if so, what explains their sensitivity (or lack thereof)?

To address these questions I use stock market, credit risk and investment data from a sample of US publicly listed firms, which spans the period between 2008 to 2021. To proxy for firm-level greenness, I collect environmental performance score data from MSCI ESG IVA Ratings.  In its framework, MSCI considers a firm to be green if it aims to limit its exposure to both physical and transitional environmental risks. My findings reveal that green firms are considerably less responsive to monetary policy surprises:  In particular, following a 100 basis point surprise in monetary policy, stock prices of green firms fall by around 10% whereas the stock prices of their brown counterparts fall by around 21%. 

To better understand the underlying drivers of the differential responses of green vs. brown firms to monetary policy shocks, I first look at differences in firm-level characteristics. At first glance, it is not obvious whether differences in characteristics should make green firms less responsive to monetary policy changes compared to brown firms. On the one hand, I document that greener firms are smaller and younger on average, pay lower dividends and are mostly classified as growth companies.  On the other hand, I also show that greener firms tend to be on average less leveraged, more liquid and exhibit a larger distance to default compared to brown firms.  I find that while some of these characteristics are important drivers of monetary policy heterogeneity on their own, they cannot explain the dampened sensitivity of green firms to monetary policy shocks.

Theoretical Framework

I show that this dampened sensitivity is the result of investors' preferences for sustainable investing. On the theoretical front, I consider a stylized framework where investors derive additional utility from their holdings of green assets. This model gives rise to two theoretical predictions. First, investors' preferences for sustainable investing dampen the sensitivity of green asset prices to monetary policy shocks. Consequently, this dampened sensitivity is even more attenuated in states of the world with stronger preferences for sustainable investing. Second, contractionary monetary policy shocks lead to a reshuffling of investor portfolios toward green assets. This result stems from an imperfect substitutability between green and brown assets, leading "green" investors to hold onto their green portfolio positions amidst rising interest rates.

Empirical Findings

On the empirical front, I find evidence in support of both model predictions. To proxy for investors' preferences for sustainable investing, I leverage information from the CRSP survivorship-bias free mutual fund database and identify a set of sustainable index funds (i.e. funds with ESG mandates). In line with the first prediction, I show that green firms held by index funds with ESG mandates exhibit a lower sensitivity to monetary policy shocks compared to green firms held by non-mandated funds.  Furthermore, I find that the heterogeneous response of green firms to monetary policy is more pronounced for green firms held by index funds that are located in: (i) regions with high exposure to natural disaster risk; (ii) US counties where climate change beliefs and risk perceptions are stronger; and (iii) times of heightened climate change concerns. In line with the second prediction, using security holdings data from large US institutional investors, I show that the share of green assets in the portfolios of institutional investors rises in response to contractionary monetary policy shocks. 

Additionally, I go beyond the predictions of the stylised model and investigate whether investors make conscious portfolio rebalancing decisions in response to changes in the interest rate environment. In this vein, I investigate whether there are heterogeneities in the funding behaviour of mutual funds with and without ESG mandates. I find supporting evidence of an "active" portfolio rebalancing channel. Notably, following a 100 basis point surprise increase in the federal funds rate, outflows from institutional non-ESG-mandated mutual funds surpass those from ESG-mandated funds by approximately 7 percentage points. This points to a considerable reluctance of institutional investors to unwind their ESG portfolio positions in the face of adverse macro-financial shocks. 

Policy Implications

These findings have important policy implications. First, they inform the current policy debate on whether the recent monetary policy tightening may discourage green firms' efforts to decarbonise. While green investments have relatively large upfront costs, which leave them highly susceptible to changes in the cost of credit, my results suggest that green firms also benefit from a relatively inelastic investor demand. Second, they shed a new light on the role of monetary policy during the Net-Zero transition: All else equal monetary policy may be less powerful in a world where the share of greener firms in the economy increases, or when preferences for sustainable investing intensify. 

[1] MSCI is an ESG score provider which rates firms according to their environmental performance (E), social responsibility (S) and corporate governance (G).

[2] Green (brown) firms are defined as those in quintile five (one) of the firm-greenness distribution.

[3] Existing literature typically associates these characteristics with higher sensitivity to interest rates. See for example Cloyne et al. (2023), Gurkaynak (2022).

[4] Jeenas (2019) and Anderson & Cesa-Bianchi (2020) attribute a dampened monetary policy sensitivity to firms with higher levels of liquidity and greater distance to default.


Anderson, Gareth, and Ambrogio Cesa-Bianchi. "Crossing the credit channel: credit spreads and firm heterogeneity." Bank of England Working Paper (2020).

Cloyne, James, et al. "Monetary policy, corporate finance, and investment." Journal of the European Economic Association (2023).

Gürkaynak, Refet, Hati̇ce Gökçe Karasoy‐Can, and Sang Seok Lee. "Stock market's assessment of monetary policy transmission: The cash flow effect." The Journal of Finance 77.4 (2022): 2375-2421.

Jeenas, Priit. "Firm balance sheet liquidity, monetary policy shocks, and investment dynamics." Working Paper (2019).

Schnabel, Isabel. “Monetary policy tightening and the green transition”, International Symposium on Central Bank Independence, 10 January 2023, Sveriges Riksbank, Stockholm.

Why Do Investment Companies Abandon Sustainability?

By Yuxia Zou, CERF Research Associate, Cambridge Judge Business School, University of Cambridge

May 2023

Public commitments to sustainability by investment companies have been widely criticized as greenwashing practices (Fletcher and Oliver 2022). By adopting a public sustainability commitment, such as by becoming a signatory to the United Nations-supported Principles for Responsible Investment (PRI), investment companies can attract substantial capital, regardless of their ability to deliver promised financial or sustainability outcomes (Brandon et al. 2022; Liang, Sun, and Teo 2022; Kim and Yoon 2022). However, from 2009 to 2021, PRI lost over 1,100 signatories collectively managing assets of US$10 trillion. In 2022, the closure of ESG funds rose disproportionately compared to conventional funds, and leading investment companies such as Blackrock voted against climate-related shareholder proposals (Chen 2022; Masters 2022). Why and when would an investment company abandon its public commitment to sustainability?

In a recent study, I address this question by analyzing the circumstances under which companies delist themselves from PRI, for reasons other than merger, acquisition, or liquidation. The PRI setting is ideal for answering this question because the PRI signatory status is the most internationally recognized signal for an institutional investor to “publicly demonstrate its commitment to including environmental, social and governance (ESG) factors in investment decision making and ownership” (PRI 2022). Established in 2006, PRI is the world’s largest institutional network of sustainable investors, with almost 4,000 signatories managing combined assets of over US$120 trillion at the end of 2021.

Why and when do companies delist?

This study is based on a dataset covering 1,280 unique mutual fund investment companies from 55 countries during 2006-2021, including 125 delisted companies and 1,155 companies that have remained PRI signatories since joining. The United States has the largest number of signatories and the highest delisting frequency, while Brazil, Mexico, and South Africa have the highest delisting rates among countries with at least five signatories covered in the sample.

Companies tend to delist from PRI when they cannot realize the expected benefits, mainly improving risk-adjusted returns, portfolio-level ESG performance, and fund flows. However, fund flow attraction only becomes a significant factor recently. These companies often have fewer internal resources and weaker external support for sustainable investment, such as managing fewer assets, receiving less support from PRI, and operating in countries with worse environmental performance or less progressive social norms.

These results suggest a non-negligible cost for publicly committing to sustainable investment. Only companies that derive sufficient benefits to cover the cost afford to maintain this commitment. Therefore, a long-term public commitment to sustainable investment can be a signal for companies that are capable of “doing well by doing good”.

Costs and Benefits of Mandatory Sustainability Disclosure Standards

So, what are the costs of publicly committing to sustainable investment? One major cost can be due to PRI’s standardized sustainability disclosure mandate, which signatories commonly claim as a primary delisting reason.

This study finds that the frequency of delisting spiked when PRI released the first mandatory disclosure standards for public consultation between September and October 2011, when approximately ten additional investment companies delisted per month. About three more investment companies left every month when PRI extensively consulted signatories to finalize the disclosure standards between September 2012 and September 2013. As companies have been mandated to provide standardized sustainability disclosures since October 2013, their delisting decisions have become more sensitive to realized benefits, suggesting that companies demand more benefits in improving financial and sustainability performance to maintain their PRI signatory status.

These results document the real effects of mandatory sustainability reporting standards, particularly reporting companies’ usage of market exit as a strategy to avoid regulation (Christensen, Hail, and Leuz 2021). Such behaviours resemble companies’ strategic avoidance actions in going dark or private ahead of the 2002 Sarbanes–Oxley Act (Engel, Hayes, and Wang 2007; Leuz, Triantis, and Wang 2008; DeFond and Lennox 2011). Therefore, mandating standardized sustainability disclosures may act as a catalyst to filter out companies more capable of pursuing dual objectives in financial and sustainability performance, hence policing the sustainable investment industry.

Informational Value of Mandatory Standardized Sustainability Disclosures

Given the significant effect of mandating standardized sustainability disclosures, a natural question to ask next is: Does the standardized information provided by signatories predict future delisting decisions?

The answer is ex-ante unclear because, on the one hand, the disclosures mandated for PRI signatories focus on management control systems, which theoretically play an important role in achieving dual objectives in sustainability and profits (e.g., Henri and Journeault 2010; Eccles, Ioannou, and Serafeim 2014; Flammer, Hong, and Minor 2019). Moreover, standardized disclosures can benefit stakeholders by improving transparency and enabling differentiation across companies, even if the standards do not increase the quantity or quality of information (Brochet, Jagolinzer, and Riedl 2013; De George, Li, and Shivakumar 2016). On the other hand, PRI signatories are not required to audit their reports and may have incentives to misreport because PRI grades their reports and provides the grading scheme along with the disclosure standards (Cho et al. 2015; Pinnuck et al. 2021). Surprisingly, results show that reported management control practices effectively predict future delisting. Companies are most unlikely to delist if they provide internal training on sustainable investment, internally assure their sustainability disclosures, and assign individual accountability for sustainable investment performance to a specialized department head.

Hence, despite the freedom and incentives to misreport, companies subject to mandatory disclosure standards provide valuable information that can effectively predict the duration of their sustainability commitment.

What happens after delisting?

If companies prefer not to bear the costs of publicly committing to sustainable investment, would they become better off after abandoning the commitment, or would the market punish them?

In the short term, delisted companies continue to receive similar fund flows as before, but experience improved net returns one year after delisting. In the second and third years after delisting, these companies see a statistically significant 1% increase in fund flows. Hence, delisted companies become economically better off. Changes in portfolio composition can explain the improvement in returns. Delisted companies become “browner” as they allocate more assets towards sin industries and stocks with more ESG controversies. Specifically, the percentage of sin stocks held by delisted signatories surges from about ten months before delisting and is twice as much as that held by the matched stayed signatories during the delisting month. Therefore, delisting from PRI is not merely ditching a label but reflects real changes in investment decisions.

Collectively, this study highlights the cost of public sustainability commitments. This cost includes compliance costs such as mandatory reporting and opportunity costs for imposing a constraint on companies’ investment activities in maximizing financial performance. As a result, only firms with internal resources and external environment to “do well by doing good” can afford to maintain a public sustainability commitment in the long term. Mandating standardized sustainability disclosures increases commitment costs, providing valuable information to stakeholders and helping screen out companies more capable of pursuing dual objectives in financial and sustainability performance. These findings shed light on the potential consequences of standardized sustainability disclosure mandate in the financial sector on a national or international level, such as the Sustainable Finance Disclosure Regulation (SFDR) by the European Commission and  ESG Investment Product Disclosure by the U.S. SEC (European Commission 2022; U.S. SEC 2022).


Brandon, Rajna Gibson, Simon Glossner, Philipp Krueger, Pedro Matos, and Tom Steffen. 2022. “Do Responsible Investors Invest Responsibly?” Review of Finance 26 (6): 1389–1432.

Brochet, Francois, Alan D. Jagolinzer, and Edward J. Riedl. 2013. “Mandatory IFRS Adoption and Financial Statement Comparability.” Contemporary Accounting Research 30 (4): 1373–1400.

Chen, Elaine. 2022. “ESG Fund Closures Pile Up as Do-Good Investing Takes Back Seat.” Bloomberg.Com, July 21, 2022.

Cho, Charles H., Matias Laine, Robin W. Roberts, and Michelle Rodrigue. 2015. “Organized Hypocrisy, Organizational Façades, and Sustainability Reporting.” Accounting, Organizations and Society 40: 78–94.

Christensen, Hans B., Luzi Hail, and Christian Leuz. 2021. “Mandatory CSR and Sustainability Reporting: Economic Analysis and Literature Review.” Review of Accounting Studies 26 (3): 1176–1248.

De George, Emmanuel T., Xi Li, and Lakshmanan Shivakumar. 2016. “A Review of the IFRS Adoption Literature.” Review of Accounting Studies 21 (3): 898–1004.

DeFond, Mark L., and Clive S. Lennox. 2011. “The Effect of SOX on Small Auditor Exits and Audit Quality.” Journal of Accounting and Economics 52 (1): 21–40.

Eccles, Robert G., Ioannis Ioannou, and George Serafeim. 2014. “The Impact of Corporate Sustainability on Organizational Processes and Performance.” Management Science 60 (11): 2835–57.

Engel, Ellen, Rachel M. Hayes, and Xue Wang. 2007. “The Sarbanes–Oxley Act and Firms’ Going-Private Decisions.” Journal of Accounting and Economics 44 (1–2): 116–45.

European Commission. 2022. “Sustainability-Related Disclosure in the Financial Services Sector.” Text. European Commission - European Commission. 2022.

Flammer, Caroline, Bryan Hong, and Dylan Minor. 2019. “Corporate Governance and the Rise of Integrating Corporate Social Responsibility Criteria in Executive Compensation: Effectiveness and Implications for Firm Outcomes.” Strategic Management Journal 40 (7): 1097–1122.

Fletcher, Laurence, and Joshua Oliver. 2022. “Green Investing: The Risk of a New Mis-Selling Scandal.” Financial Times, February 20, 2022, sec. The Big Read.

Henri, Jean-François, and Marc Journeault. 2010. “Eco-Control: The Influence of Management Control Systems on Environmental and Economic Performance.” Accounting, Organizations and Society 35 (1): 63–80.

Kim, S., and A. Yoon. 2022. “Analyzing Active Fund Managers’ Commitment to ESG: Evidence from the United Nations Principles for Responsible Investment.” Management Science.

Leuz, Christian, Alexander Triantis, and Tracy Yue Wang. 2008. “Why Do Firms Go Dark? Causes and Economic Consequences of Voluntary SEC Deregistrations.” Journal of Accounting and Economics, Economic Consequences of Alternative Accounting Standards and Regulation, 45 (2): 181–208.

Liang, Hao, Lin Sun, and Song Wee Melvyn Teo. 2022. “Responsible Hedge Funds.” Review of Finance 26 (6): 1585–1633.

Masters, Brooke. 2022. “BlackRock Warns It Will Vote against More Climate Resolutions This Year.” Financial Times, May 10, 2022.

Pinnuck, Matthew, Ajanee Ranasinghe, Naomi Soderstrom, and Joey Zhou. 2021. “Restatement of CSR Reports: Frequency, Magnitude, and Determinants.” Contemporary Accounting Research 38 (3): 2376–2416.

PRI. 2022. “Become a Signatory.” PRI. 2022.

U.S. SEC. 2022. “Enhanced Disclosures by Certain Investment Advisers and Investment Companies about Environmental, Social, and Governance Investment Practices.” Proposed rule S7-17–22. United States Securities and Exchange Commission.


The Effect of Employee Satisfaction on Performance in Mutual Funds

By Elias L. Ohneberg, CERF Research Associate, Cambridge Judge Business School, University of Cambridge

April 2023

Society increasingly emphasises well-being and the importance of a healthy work environment. A survey conducted in 2022 by Gallup highlights that 23% of the working population in the United States are unhappy in their jobs. With the growing movement towards better treatment of employees and the mounting evidence of widespread dissatisfaction in the workforce, it is crucial to explore the potential consequences of employee satisfaction on individual employee behaviour and performance, as well as the overall success of organisations.

Existing theoretical evidence suggests that policies that improve employee satisfaction can increase employee effort and productivity via the norm-gift-exchange model (Akerlof, 1982). Suppose there is a social norm for reciprocating gifts, such that a gift received requires a gift in kind. Employees may view employee satisfaction improving policies as a gift from their employer. As a result, employees increase their effort provision as a gift in kind. 

Despite existing theoretical evidence, causal empirical evidence on the relationship is sparse. Determining the precise impact of employee satisfaction on performance in an empirical study is, unfortunately, far from straightforward. Acquiring and measuring employee-level data on performance and satisfaction is challenging due to data availability and the difficulty of defining a precise measure of employee performance. Measuring employee performance is particularly difficult because different job positions have various desired outputs, making the use of a single performance measure impossible. Consequently, previous research has primarily focused on correlating firm-wide employee satisfaction with aggregate firm performance, typically assessed through balance sheet items or stock performance (Edmans, 2011; Green et al., 2019; Huang et al., 2015; Symitsi et al., 2021). Unfortunately, these aggregated company measures are not well-suited for examining the influence of employee satisfaction on individual performance. Multiple factors contribute to employee performance, including their knowledge, skills, motivation, engagement, support from colleagues, and the organisation’s overall effectiveness. As a result, it is difficult to isolate an individual’s contribution to organisational outcomes and attribute those outcomes to their performance. 

To address this issue and provide a more nuanced understanding, my paper with Pedro Saffi (University of Cambridge) explores the role of employee satisfaction on performance in U.S. active equity mutual funds. Mutual funds serve as an ideal setting for this research because they offer a tangible, quantifiable connection between employee effort and performance. Portfolio managers’ decisions within asset management companies to construct portfolios can be readily and accurately evaluated through fund performance indicators, such as fund returns and volatility. Furthermore, changes in these indicators can be directly linked to a manager’s effort and risk-taking. Similarly, the efforts of marketing and sales employees of asset management companies can be assessed through the fund’s ability to gather assets. 

We use approximately one million employee job reviews matched to 437 asset management companies managing 3,266 funds from 2009 to 2019 from to measure employee satisfaction. This rich dataset allows us to compute satisfaction scores for specific sub-groups within each company’s workforce. We evaluate satisfaction levels for employees in positions directly related to mutual fund performance and those in marketing and sales roles, which should influence the assets under management of the mutual funds. 
Despite our ability to define clear and quantifiable performance and satisfaction measures in our mutual fund setting, we must remain careful in our empirical design. Due to our reliance on review data from, a mutual fund is only included in our sample if at least one employee decided to write a review on Therefore, our sample of mutual funds may be subject to selection bias. Selection bias may arise if mutual funds with an existing employee job review on are fundamentally different to mutual funds without an existing review. To account for this potential bias, we employ a Heckman-Selection model. This model tackles our sample selection bias by directly modelling the probability of a mutual fund’s inclusion in our sample. As an essential instrument in modelling sample inclusion, we use the staggered adoption of Anti-SLAPP (Strategic Lawsuit Against Public Participation) laws across the United States. A SLAPP suit is a lawsuit that aims to censor criticism by burying the defendant in legal costs. Anti-SLAPP laws provide extra layers of protection to reviewers on As a result, the passing of Anti-SLAPP laws increased the number of reviews written and lowered average employee satisfaction scores on (Chemmanur et al., 2019).

Even after adjusting for potential selection bias, we still face another significant problem: reverse causality. The effect we estimate using our empirical techniques might be due to improved mutual fund performance causing higher employee satisfaction. For instance, if a mutual fund performs well, the company may generate higher profits, which could allow the company to increase employee benefits that, in turn, impact employee satisfaction. To mitigate this reverse causality concern, we implement an empirical design that exploits mergers between asset management companies. We assert that an individual mutual fund manager cannot influence whether a competitor acquires the asset management company they work for. Consequently, when a high employee satisfaction firm absorbs a manager employed by a low employee satisfaction firm through the acquisition of their company, the employee experiences an external increase in employee satisfaction unrelated to their personal attributes or performance. In line with this idea, we analyse if mutual funds acquired by companies with higher employee satisfaction exhibit superior performance post-merger compared to those acquired by companies with lower employee satisfaction scores.

Throughout all our empirical designs, we find that the employee satisfaction of individuals in investment roles positively influences mutual fund performance. Moving from the lowest to the highest possible employee satisfaction score on the 5-point scale increases mutual fund risk-adjusted performance by 1.44% per year. Additionally, we demonstrate that higher marketing and sales personnel satisfaction is associated with larger mutual funds. Our findings, thus, underscore the importance of employee satisfaction in shaping the success of mutual funds. More broadly, the insights provided by our study highlight the need for companies to consider employee well-being as a potential driver of organisational performance and growth. Through a better understanding of the role of employee satisfaction on job performance, organisations may expand more resources into developing strategies and policies aimed at fostering a positive work environment, which in turn, may lead to improved outcomes for both employees and their companies. 

This blog is based upon my working paper, co-authored with Pedro A. C. Saffi, Satisfied Employees, Satisfied Investors: How Employee Well-being Impacts Mutual Fund Returns (February 21, 2023). Available at SSRN: or

Akerlof, G. A. (1982). Labor Contracts as Partial Gift Exchange. The Quarterly Journal of Economics, 97(4), 543–569.
Chemmanur, T. J., Rajaiya, H., & Sheng, J. (2019). How does Online Employee Ratings Affect External Firm Financing? Evidence from Glassdoor (SSRN Scholarly Paper ID 3507695). 
Edmans, A. (2011). Does the stock market fully value intangibles? Employee satisfaction and equity prices. Journal of Financial Economics, 101(3), 621–640.
Green, T. C., Huang, R., Wen, Q., & Zhou, D. (2019). Crowdsourced employer reviews and stock returns. Journal of Financial Economics, 134(1), 236–251.
Huang, M., Li, P., Meschke, F., & Guthrie, J. P. (2015). Family firms, employee satisfaction, and corporate performance. Journal of Corporate Finance, 34, 108–127.
Symitsi, E., Stamolampros, P., Daskalakis, G., & Korfiatis, N. (2021). The informational value of employee online reviews. European Journal of Operational Research, 288(2), 605–619.


Limited Shareholder Liability on Corporate Tort Rethink

by Xinyu Hou, CERF Research Associate, Cambridge Judge Business School, University of Cambridge

March 2023

For decades, Manville Corporation (formerly Johns-Manville) concealed the adverse health effects of the asbestos in its products. By 1982, the company was facing over 16,500 lawsuits and filed for Chapter 11 bankruptcy reorganization to resolve the cases. Like other mass tort litigations involving public corporations, none of Manville's shareholders were held personally liable for the damages caused by the company. Although the corporation established a pool of funds exceeding $2 billion to compensate claimants, the mounting claims soon dried out the pool, resulting in only a 5.1% payout rate for successful claimants as of 2019.

Without limited liability, shareholders would have been more cautious before investing in a toxic industry and would have had stronger incentives to monitor the firm. This could have potentially prevented corporations from engaging in practices that harm public health and the environment in a large scale. To clarify, limited liability refers to the legal concept of restricting the amount of liability to the assets of the company, shielding investors from personal liability. The question remains, why should shareholders of entities responsible for damages be absolved of any responsibility?

As we enter an age of innovation where AI, robotics, medical implants, and new materials are transforming our lives, this question becomes increasingly crucial. We should acknowledge that limited liability serves as a crucial safeguard to mitigate the risks of investing in a volatile market, enabling investors to take on risky projects and start new ventures. However, we must also recognize the potential damages that corporations can cause and the need to hold them accountable for their actions. Thus, it is important to strike a balance between limiting liability and holding corporations accountable for the harm.

The Coase theorem suggests that if there are no costs associated with contracting, such as fees for lawyers and accountants and information gathering, it would be optimal to allow voluntary creditors and shareholders to negotiate liability rules. However, since contracting is costly, the default legal rule should be the most likely contract that they would agree on, which is the limited liability rule. If the parties desire to switch to an unlimited liability rule, they could do so. However, if the creditors are tort claimants who are involuntarily involved in cases like Manville's, it is hard to negotiate liability rules ex ante. In this situation, the legal system and policies should consider the interests of both parties, as well as the other stakeholders that might potentially benefit from the firms’ productivities.

In my paper "Limited Liability and Scale," I developed a simple theoretical model to analyze the issue of limited liability. While the paper has a law flavor, it is worth mentioning two notions of fairness that are often considered in the law literature on injuries. The first notion of fairness suggests that injurers should be held accountable for the harm they have caused, even if their actions were not wrongful, a form of "an eye for an eye, and a tooth for a tooth." The second notion concerns compensation that makes the victims whole, which aligns with the Common law tort doctrine. While it would be interesting to discuss the philosophy of these two notions, my paper primarily focuses on the economic efficiency aspect, given that we want firms to conduct proper care while still encouraging innovation and scale.

The model considers a firm’s preferences for care and scale, and it shows that the optimal liability rule is determined by the tradeoff between damages to the tort claimants and benefits to the outside stakeholders, such as consumers, workers, beneficiaries of public services, or members of the community who benefit from job creation and reduced crime rates.  We suggest that increasing liability induces better care but also raises marginal costs, which leads to less-than-efficient scale and even the holdup of a valuable project.  Limited liability improves scale but reduces care, and it tends to be more efficient if the benefit from scale is large enough, i.e., when the outside stakeholders have a larger potential value.  

This implies that a one-size-fits-all approach to liability is not appropriate. For firms with advanced technology and natural monopoly power, the choice of scale does not capture all the benefits and can be too small. In such cases, limited liability can help balance externalities and increase scale. Conversely, for firms operating in highly competitive markets (where products are easily replicable), full liability may be necessary to achieve social efficiency. This finding can also extend to the labor market where firms have varying levels of monopsony power.

This logic can be used to interpret policies. For instance, one reason for corporate income tax can be seen as a safety net for tort claimants. If the only way that the firm is profitable is to generate tort claims, then imposing an income tax that takes away 40% of the upside may improve overall efficiency. The literature has studied policies such as requiring insurance and capital to improve limited liability, which in effect increase actual shareholder liability coverage. The model can be used to analyze the combined impact of these policies and limited liability as well.

In practice, there is still more question to ask: how to allocate liability for firms with multiple shareholders if an extra liability is ideal? One possible solution could be to adopt the "joint and several" unlimited liability rule, which is commonly used in partnerships, where the creditors can go after the deep-pocket investors. This rule works better for closely held corporations but may not be practical for public corporations as it requires significant information gathering and verification.  Additionally, the deep pockets could hide their assets strategically (such as through as trust fund) or find someone without assets to delegate their investments.  Alternatively, a "pro rata" liability rule, which assigns liability proportional to shareholding, could largely solve the information problem. This could be implemented by requiring partial liability coverage on top of the limited liability rule.  However, the question of how to allocate liability becomes more complex when considering shareholders whose interests do not align, as well as bondholders who may also be responsible. These issues are not addressed in the current paper and is left for future studies. 

[1] X. Hou. Limited Liability and Scale, 2023. (paper in progress)
[2] K. J. Delaney. Strategic bankruptcy. University of California Press, 1992.
[4] F. H. Easterbrook and D. R. Fischel. Limited liability and the corporation. The University of Chicago Law Review, 52(1):89–117, 1985.
[5] H. Hansmann and R. Kraakman. Toward unlimited shareholder liability for corporate torts. Yale LJ, 100:1879, 1990.


The Pricing of Foreign Exchange and the Unique Role of US Dollar Risk

By Brandon A. McBride, CERF Research Associate, University of Cambridge Judge Business School

February 2023

Trading in over-the-counter foreign exchange (FX) markets reached $7.5 trillion per day in April 2022 across all FX instruments (BIS, 2022), making it the most actively traded asset class, globally. However, the determinants of exchange rates are still illusive to many in both academic and policy-making circles. Are interest rates the fundamental exchange rate drivers? What role do risk-averse agents play? Can understanding the unique role of the US in the international monetary system better inform our understanding of observed currency prices? These are the questions at the heart of the empirical international finance literature.

FX literature is governed by the central uncovered interest rate parity (UIP) condition, the efficient markets hypothesis of currency markets. UIP states that, given risk-neutrality and rational expectations of agents, expected exchange rate changes must be offset by interest rate differentials. However, Fama (1984) evidenced that, post Bretton-Woods (early 1970s), UIP failed to hold in the data. To reconcile such deviations, the consensus was naturally to relax the unrealistic assumption of risk-neutrality, allowing agents to incorporate risk-averse preferences into the pricing of FX. This, in turn, has led to an international finance research agenda intent on identifying risk factors for which agents demand compensation for bearing their underlying macroeconomic risks, in order to reconcile UIP.

The seminal work of Lustig and Verdelhan (2007) presented a turning point in the FX literature. Their paper was the first to bring the techniques of the asset pricing literature to FX markets, investigating a broad cross-section of currencies, as opposed to bi-lateral time-series studies. This portfolio–sort-based approach has now become the convention in the literature, allowing researchers to incorporate the methods long implemented to study pricing in equity markets; using multi-factor models to capture the variation in the stochastic discount factor (SDF), and provide a risk-based explanation of returns (e.g., Fama and French, 1992).

The SDF is what asset pricing is all about. Throughout the literature, the SDF is a linear model which contains factors. Under some general assumptions, such as the law of one price and no-arbitrage, this SDF is positive, and it represents the observed risk premia in the pricing of FX.

This is captured by the covariation of currency returns with the selected factors, specified to capture shocks that, a priori, are thought to impact exchange rates. It is in the identification, measurement and fundamental understanding of these factors that we gain insight into the drivers of FX prices. Therefore, our question boils down to: which factors are really important?

Lustig, Roussanov and Verdelhan (2011) identify a common two-factor structure, which has formed the baseline risk factors in the literature. The first factor is a level factor, representing the returns to a US investor going long in an equally-weighted portfolio of foreign currencies, which the authors term the Dollar risk factor. The second factor is a carry trade factor, capturing the excess returns investors make to borrowing in low interest rate and investing in high interest rate currencies – a conventional carry trade investment strategy. It is well understood that the carry trade strategy is capturing a premium for investors bearing the risk of FX volatility (Menkhoff et al., 2012). This means that such a strategy pays-off well in good times and poorly in bad times, intuitively causing a more volatile consumption stream that risk-averse agents wish to hedge their bets against. However, the literature is divided on the Dollar risk factor. There appears no consensus on its risk exposures, nor even acceptance of is statistical significance in capturing time-series or cross-sectional variation in FX prices. Could decomposing the underlying risk exposures of this factor allow us to better understand the UIP risk premium component?

The Dollar risk factor has a number of key characteristics. Firstly, in all investment strategies it is the first principal component, capturing most of the variation in portfolio-sorted returns. Secondly, the statistical significance of this factor wavers over varying time-periods, as well as by the magnitude of the sample cross-section. Nucera, Sarno and Zinna (2022) provide the most significant empirical evidence of the importance of the Dollar risk factor to date, highlighting, robust to omitted-variable and measurement-error biases, that the Dollar risk factor is statistically and economically significant in a broad cross-section of FX. Intuitively, this risk premium is compensating for the appreciation of the US Dollar (the short leg of our portfolio strategy) in bad times, which increases the volatility of our consumption. But what drives this risk for which investors demand to be compensated? What are the macroeconomic shocks to the SDF that this risk factor is capturing? What is unique about the US Dollar that it warrants its own risk factor?

The uniqueness of the US and the US Dollar in the international monetary system has been heavily documented throughout the international economics literature, dating back to the early days of Bretton-Woods. The role of the US manifests itself through various channels. The Dollar has a funding advantage, such that safe Dollar bonds have lower returns (Du et al., 2018). There is also a Dollar debt dominance, through which a large, outsized quantity of Dollar-denominated bonds exist relative to the total wealth share of the US (Ivashina, 2015). This reflects the characteristic exorbitant privilege of the US (a phrase first coined by Valéry Giscard d’Estaing, the French Minister of Finance in the 1960s, as France signalled its intent to exchange its US reserves for their gold-backed value, signalling the end of the Bretton-Woods era). As such, the demand for Dollar debt, and particularly the flight-to-safety feature during global downturns (Jiang et al., 2018), allows for the US external portfolio to leverage safe Dollar assets with long risky foreign asset positions (Gourinchas and Rey, 2007). To top it all off, in the face of recent spiralling inflation, we have also observed the impact of the Global Financial Cycle (GFC) phenomenon, through which US monetary policy has a disproportionately outsized role in the macroeconomic outcomes for countries around the world, causing an aggregate excess spillover effect (Miranda-Agrippino and Rey, 2022).

Jiang, Krishnamurthy and Lustig (2022) have developed a structural model to reconcile these unique US features in equilibrium. Their central assumption is that US Treasurys carry a premium, a convenience yield (as evidenced by Jiang et al., 2021), as they are particularly safe and therefore highly valued by foreign investors to hedge against bad times. This emphasises the importance of US-specific shocks, and the global impact of their spillover and contagion effects for foreign countries: the GFC that we observe today, this high degree of co-movement in risky asset prices around the world, is in fact a Dollar Financial Cycle! Furthermore, if this equilibrium is representative, it foreshadows a Triffin (1960) Dilemma of the same style as the Bretton-Woods downfall, with the floating exchange rate regime and free capital mobility mechanism operating under a de-facto Dollar standard with persistent, perpetual asymmetric financial spillovers.

Undoubtedly, there exists a strong theoretical and intuitive basis for the existence of the Dollar as a common risk factor driving FX fluctuations. It naturally explains the general role of the US as the hegemon that we observe in international financial markets. However, we need greater empirical evidence of the central macroeconomic shocks that result in and from this underlying mechanism. Only in better understanding the risks that play-out in the real economy can we determine the risk-return behaviour of agents in financial markets, and provide a better real-world economic foundation on which to develop equilibrium models of FX pricing.


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Jiang, Z., Krishnamurthy, A., and Lustig, H. 2018. “Foreign Safe Asset Demand for US Treasurys and the Dollar.” American Economic Association Papers and Proceedings, 108: 537–541.

Jiang, Z., Krishnamurthy, A., and Lustig, H. 2021. “Foreign Safe Asset Demand and the Dollar Exchange Rate.” The Journal of Finance, 76(3): 1049-1089.

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Menkhoff, L., Sarno, L., Schmeling, M., and Schrimpf, A. 2012. “Carry Trades and Global Foreign Exchange Volatility.” The Journal of Finance, 67(2): 681-718.

Miranda-Agrippino, S., and Rey, H. 2022. “The Global Financial Cycle.” In Gopinath, G., Helpman, E., and Rogoff, K. (Volume 6.) Handbook of International Economics. Amsterdam: North Holland, 1-43.

Nucera, F., Sarno, L., and Zinna, G. 2022. “Currency Risk Premia Redux.” Working Paper.

Triffin, R. 1960. Gold and the Dollar Crisis: The Future of Convertibility. New Haven, CT: Yale University Press.


                                                                                                                                                                     Corporate Social Responsibility Committee: International Evidence

This paper is the Winner of the Cambridge Finance Best Student Paper Award 2022

By Yuxia Zou, CERF Research Associate, Cambridge Judge Business School, University of Cambridge

January 2023

During the past few decades, corporate social responsibility (CSR) issues have attracted enormous attention from regulators and the investment community around the world. Until now, the most widely adopted measure is CSR-related reporting, which is believed to be a critical ingredient in achieving broader CSR goals. Another measure that has grown in popularity among publicly listed firms in recent years is the formation of a separate board committee dedicated to CSR-related issues, the CSR committee. The percentage of publicly listed firms worldwide with CSR committees increased from 5.5% in 2002 to 14.2% in 2018. Given the emerging trend in CSR committee adoption worldwide, the natural questions to ask are: What incentives are behind firms’ decision to establish CSR committees? Does having a separate board committee dedicated to CSR issues bring any real effects to a firm’s operations and CSR performance? In a recent study co-authored with Associate Professors Jenny Chu and Xi Li, we address these two questions using a comprehensive dataset on board committees for more than 19,000 publicly listed firms across 96 countries between 2002 and 2018.

We first explore what motivates firms to have distinct CSR committees on their boards. We argue that CSR committee adoption is associated with both country-level and firm-level incentives. At the country level, we predict that the prevalence of CSR committee adoption is positively associated with CSR-related legislations, norms towards environmental and social issues. Consistent with our expectations, we find CSR committees are more prevalent in countries with effective CSR reporting regulation, more stringent environmental policies, and stronger social norms.

At the firm level, we argue that the decision to form a CSR committee reflects the tradeoffs between both internal and external costs and benefits associated with having a distinct CSR committee. Internally, having a separate committee enhances both the advising and monitoring roles of the board. Externally, establishing a CSR committee signals a firm’s sustainability culture and its determination to tackle CSR issues. Such a signal could help attract CSR-conscious employees, customers, and investors, ultimately enhancing firm value. However, having a separate CSR committee is not costless and the costs mostly incur internally. Existing directors may not have the experience or expertise to advise or monitor CSR policies or activities. Even if they do, assigning them to an additional committee may increase their workload. The searching costs arise when firms need to hire suitable directors to sit on the CSR committee, as the pool of candidates might be limited. Information segregation might also occur with a separate committee when directors outside of the CSR committee are not aware of the committee’s activities. This might in turn reduce the usefulness and relevance of advice made by committee members who lack certain firm-specific information.

We find that firms’ decision to adopt CSR committees is shaped by the tradeoffs between the costs and benefits of having a separate committee dedicated to CSR issues. Externally, the adoption decision is more common among firms with higher shareholder and stakeholder demands for CSR activities, such as firms operating in high-polluting industries, experiencing more frequent negative environmental or social incidents, and having a larger proportion of foreign shareholders and customers. Internally, firms with larger, more connected, and less busy boards are more likely to adopt CSR committees as they benefit more from improved task division and enhanced director accountability and face lower searching costs.

Next, we assess the effectiveness of having a separate CSR committee. On the one hand, having a dedicated CSR committee could improve the firm’s CSR performance by enhancing the advising and monitoring role of the board on CSR-related issues. On the other hand, firms may use CSR committees as a window-dressing device in response to CSR-related concerns raised by various stakeholders and to meet investors’ demand. Furthermore, the presence of a separate CSR committee on the board could be a part of a firm’s overall culture that emphasizes sustainability, and it is often correlated with other organizational structures and policies aiming to achieve CSR goals. Therefore, it is unclear whether the CSR committee itself has any impact on the firm’s CSR performance.

Many investors view CSR issues as a risk factor, hence our primary measure of CSR performance is CSR risk, computed as the frequency of negative environmental and social incidents during a year. To further address the endogenous nature of firms’ decision to establish CSR committees, we employ a two-stage least-squares (2SLS) approach by using the connectedness of non-CSR directors with CSR directors at other firms as an instrumental variable (IV). Our 2SLS regression results indicate that adopting CSR committees is not associated with any changes in firms’ CSR risk in the first year following the adoption. However, when we expand the time horizon of the CSR risk measure, we start to observe a negative association in the second year following the adoption, and this negative association becomes statistically significant in the third and fourth years. These findings suggest that the presence of CSR committees reduces firms’ CSR risk in the long run.

Given the effect of CSR committees in decreasing CSR risk, we lastly explore the influence of CSR committees on firms’ operations. We observe that CSR committees are negatively associated with firms’ subsequent profitability, measured by return on assets (ROA), capital expenditures, and sales growth. This negative impact on operations is long-lasting as firms’ profitability and investment are reduced up to four years after establishing a CSR committee.

Together with the results on CSR risk, these findings provide support for the abandonment argument first put forth in the context of CSR reporting. In our context, due to heightened scrutiny by the CSR committees, firms abandon or scale back CSR-controversial business activities and investments to reduce CSR risk. In summary, our consequences analysis suggests that on average, CSR committees bring about real changes at these firms. Establishing dedicated CSR committees helps reduce CSR risk by increasing board scrutiny of firms’ operations and investments.