Essays in Corporate Finance
Despite the importance of understanding the interaction between financial markets and the real economy, the indirect effects of secondary markets on corporate outcomes, however, are not well understood. This dissertation comprises three essays that aim to shed some light on this issue by exploring the unintended consequences for firms in response to trading activities in equity and derivative markets. Uninformative stock price fluctuations induced by volatile mutual fund flows may inflict a hidden financial cost on firms. The first essay proposes a measure of stock-level passive equity mutual fund flow-induced volatility pressure and find it to positively affect bond yield spread at issuance through higher perceived risks revealed by increased equity volatility. Although flow-induced volatility is costly to the borrowing firm, it has no significant association with future firm fundamental risk, in contrast to equity volatility. This study empirically reveals a dark side of passive investing. The second essay examines the effects of options trading activities on corporate liquidity management. Based on a large sample of U.S. non-financial firms, it documents a positive relationship between equity options trading intensity and corporate cash holdings. Along with the instrumental variable approach, the CBOE's Penny Pilot Program as an exogenous shock and the extensive margin analysis using option listings corroborate a causality interpretation of the baseline results. The relationship is mainly driven by firms where financial distress risk is high and debt-financed investments are constrained by liquidity issues. Overall, these results suggest a precautionary saving motive due to active options markets that provide risk-shifting incentives to firms. During 2005-2007, SEC conducted a pilot program that relaxed short-selling restrictions. Using a difference-in-differences methodology and a hand-collected dataset of derivatives usage from a sample of U.S. oil and gas producing firms, the third essay finds a relative increase in hedging intensity among pilot firms compared to non-pilot firms during the pilot program period. This effect is stronger when firms face higher financial distress risk and when managers' incentives are more closely tied to firm value. These results indicate that managers are incentivized to smooth operating income due to concerns about a rise in the cost of financial distress under short-selling pressures.