2023 Theses Doctoral

Essays on Applications of Textual Analysis in Macro Finance

Teoh, Ken

This dissertation is a study of fundamental questions in macro-finance using modern tools from textual analysis. These questions include how financial constraints affect firm investment and financing decisions when they are not presently binding, and whether stock returns are predictable based on concerns revealed in conversations between firms and investors.

The first chapter examines whether financial covenants are an important consideration for firm decisions when they are not presently in violation. A key empirical challenge is measuring the risk of future covenant violations, which is not directly observed. I propose a novel measure of concerns about future violations by distinguishing between discussions of covenants in earnings calls that relate to the future as opposed to the past or present. As validation, I show that the measure predicts future violations and covaries intuitively with earnings, leverage, and default risk. Importantly, I find that concerns about covenants are significantly associated with reductions in investment as well as debt and equity financing activities. These responses persist even after controlling for standard measures of investment opportunities and are economically large relative to the effects of actual violations.

The second chapter empirically analyzes two explanations for how covenants concerns relate to a firm's investment decisions. One explanation is that covenant concerns coincide with a deterioration in expected profitability, which dampens firms' incentives to invest. A second explanation is that firms become concerned when they expect violations to be more costly, which indicates future difficulties with funding investments. To shed light on the relevance of these two explanations, I examine empirical patterns in analyst expectations of future earnings, loan amendments in SEC filings, and the stock returns of firms that mention covenant concerns. The evidence suggest that both explanations are relevant mechanisms driving the correlation between covenant concerns and firm activity. However, I find that the second channel is more economically significant, suggesting that covenant concerns are informative about the degree to which firms are constrained by financial covenants.

In the third chapter, I investigate how covenant concerns relate to firm policies in a standard model of investments with financial frictions. In the model, the theoretical object that most naturally links to covenant concerns is the expected shadow cost of the borrowing constraint. As in the data, the shadow cost of the borrowing constraint covaries negatively with earnings as well as firm investment and financing activity. Through an analysis of impulse response functions, I show how the empirical correlations between covenant concerns and firm policy arise in the model. One channel is through negative productivity shocks, which raises covenant concerns and leads to a fall in investment, debt, and equity issuance. The second channel is through higher leverage, holding fixed productivity. In the model, firm with higher debt levels are more concerned about covenants when hit by a negative productivity shock, and also choose less investment, debt issuance, and equity issuance. In this chapter, I also discuss several shortcomings of the model and suggest avenues for modifications.

The final chapter investigates a new question: are stock returns predictable based on the extent to which firms are concerned about the macroeconomy? We document that firms that pay more attention to the macroeconomy earn lower average returns relative to firms that pay less attention to the macroeconomy. Differences in returns are economically significant and are not explained by traditional asset pricing factors, such as market beta, size, value, and idiosyncratic volatility. To explain the negative macroeconomic attention premium, we propose a model of attention allocation that links analyst attention to fundamental shocks affecting firm cash flows. In the model, attention to the macroeconomy is increasing in the share of earning news explained by the macroeconomic component. Firms with a greater share of cash flow news explained by the macroeconomic component face lower cash flow risk, hence earn lower expected returns.