Three Essays in Financial Economics

Abstract

This dissertation is comprised of three chapters that cover topics in corporate finance, behavioral finance, and financial economics. In ``Managing Human Capital Risk,'' I argue that adjustment costs and firm-specific human capital make labor behave like an asset of the firm, rather than like an externally supplied service ``flow,'' as extant work suggests. I provide empirical support by showing that firms manage human capital risk similar to the way they manage risk from physical assets. In response to an exogenous increase of labor adjustment costs, firms reduce leverage and increase the liquidity of their on-balance sheet asset structure.

``Anxiety and Overconfidence in the Face of Risk,'' joint with Thomas Eisenbach, is the first attempt in the literature to study dynamically inconsistent preferences with respect to risk tradeoffs. We show that higher risk-aversion for more imminent risks can explain a set of well-documented asset pricing patterns, such as earnings announcement anomalies, as well as systematic belief distortions, such as the underestimation of risks known as overconfidence.

``Revealing Downturns,'' joint with Sergey Zhuk, presents a model of Bayesian learning about multiple parameters of firms' fundamentals. We show that the market can better tell apart components of operating performance due to idiosyncratic ``goodness'' or skill from correlation with market-wide factors when the macroeconomy declines. Therefore, stock picking earns higher returns and boards tend to fire CEOs more frequently in downturns rather than in upturns.