The purpose of our study is to examine the functioning of Internal Capital Markets within business groups in Iran. We document how the ultimate owner's incentive, in terms of its economic interest in the affiliated firms affect firms' investment and dividend policies. Using hand-collected data on the ownership structures of Iranian firms, we first identify group-affiliated firms using Almeida et al.'s (2011) method. Having identified business groups, we test a number of hypotheses concerning the dynamics of the Internal Capital Markets and the implications of the ultimate owner's incentives for affiliated firms' behavior.We first demonstrate that investments of group-affiliated firms are less sensitive to their own cash flow (as compared to stand-alone firms), but is sensitive to the cash flows of other firms affiliated with the same group near or at the bottom of the ownership structure. We next find significant variation in dividend policy within groups with notably higher dividends for firms close to the ultimate owner. Furthermore, we find that higher investments by firms close to the owner lead to lower dividends by firms positioned far from the owner, but the reverse does not hold. We are the first to examine the effect of group-affiliated firms' investments on dividend policies of other firms as a function of firms' position within the group. Our findings shed light on how business groups prioritize funding investments by their closely-held firms over paying dividends to outside investors in firms positioned far from the group owner.

In this paper, we study whether credit rating agencies (CRAs), as they claim, follow the rating through-the-cycle approach as opposed to a pro-cyclical approach. In particular, we compare the behavior of CRAs during the credit crunch and normal market conditions. Using the credit rating data by S&P, we find that CRAs assign lower credit ratings to firms during credit crunch relative to normal times. Nevertheless, this result does not necessarily imply that CRAs show an excessively pro-cyclical behavior if credit crunches have a long-term fundamental impact on firms. Our further investigation reveals that downgrades during a credit crunch will not be reversed over the subsequent one to five years, which supports through-the-cycle credit rating.

This paper documents that in distress periods, liquidity constrained investors sell liquid corporate bonds and hold onto illiquid ones, a phenomenon which we refer to as flight from liquidity. Performing within issuer-time analysis to properly control for credit risk, we find that flight from liquidity results in a decline in the liquidity premium. In other words, liquid bonds that are significantly more expensive in normal market conditions, lose more value in distress periods and trade at a closer, and sometimes at an indistinguishable, yield spread to their illiquid peers from the same issuer. We also find that these shocks to the liquidity premium are short-lived and do not have a long-lasting pricing impact. We provide suggestive evidence that the liquidity clientele effect derives these results. Our findings suggest that investment exposure to liquid bonds entails a unique risk arising during periods of distress.

This paper examines the role of bank-firm relationships in transmitting credit supply shocks to the real side of the economy in an emerging market. Using a hand-collected dataset for Iranian public companies, we exploit firms' exposure to a bank involved in a massive Ponzi scheme in 2011. We document a nearly 8 percentage point drop in annual employment growth rate for firms connected to the troubled bank following the credit dry-up caused by the scandal. We show that the magnitude of the effect on employment and investment is amplified by bank-firm relationship at least as much as by the financial constraint status found in previous studies. The results highlight the role of bank-firm relationships and the importance of access to multiple creditors in alleviating the consequences of credit supply disruptions.

We investigate the relation between fundamental idiosyncratic volatility and stock returns idiosyncratic volatility using data from 56 countries. We find a strong positive relation between fundamental idiosyncratic volatility and idiosyncratic volatility of returns. This association, however, seems to be entirely concentrated in the developed economies, and we find no effect in the emerging markets. Specifically, fundamental idiosyncratic volatility does not lead to more idiosyncratic return volatility in countries with poor legal institutions and weak shareholder protection laws.

Morck, Yeung, and Yu (2000), in their pioneering study of international differences in stock price synchronicity, emphasize the effect of market development on investors' ability to incorporate firm-specific information into prices. We use a unique institutional feature in the Hong Kong market to investigate one of the important tools investors use to do this and hence reduce stock price synchronicity: short selling. Examining the cross-sectional and time-series variation in short-sale constraints in the Hong Kong market, we find that after the removal of short-sale constraints, stock prices become more informative and move less in tandem with the market.

Business groups include a large number of interlinked companies typically structured in pyramids with several layers connecting them through direct and indirect ownership relations. These pyramidal structures are prevalent around the world with the exception of the US and UK. Kandel et al. (2019) provide evidence that business groups were also dominant in the US before the 1930s, when the government took a number of actions to eliminate them, including intercorporate dividend taxation in 1935. They cite dividend taxes as an important impetus for the dissolution of business groups in the US, as these taxes are compounded depending on the number of layers in the pyramids, and therefore, make multi-layered structures very costly for the ultimate owner. We study the 2002 tax reform in Iran, which, contrary to the US, eliminated the intercorporate dividend tax. We show that before the reform, business groups were far less prevalent and complex, but following the tax code change, business groups with complex and multi-layered pyramids were formed. We also examine the effect of the reform on firm decisions, including dividends, investments and capital structure, as well as their positions within pyramids. Finally, we discuss the public policy implications of our findings.

We examine the bidding behavior of power plants in electricity auctions with price caps using analytical and numerical approaches. We extend the Hortaçsu and Puller (2008) model to show that implementing a price cap causes firms to reduce their bid curve slope before reaching the price cap, leading to a reduction in the market clearing price and increasing the level of market competition and efficiency. Furthermore, we show that the higher the probability of reaching the price cap (perhaps due to higher demands), the stronger this effect will be. In a market with heterogeneous cost functions, imposing a price cap can drive market outcomes closer to competitive conditions by increasing the market share of more efficient firms. We design three scenarios to show that with decreasing demand uncertainty, the market clearing price reduction due to the price cap would be milder. Our findings challenge the earlier models of bidding behavior that neglect price caps and their impact during peak demand periods.

The impact of short-horizon institutional investors' trading on price efficiency and market stability remains a subject of debate. We use a novel strategy to study this question in the context of mutual funds. Building on the previous literature that funds' disclosure of their holdings matters to fund managers and their investors, we classify mutual funds whose next reporting dates immediately follow a particular stock crash as funds with short investment horizon. We find that following a stock crash, funds whose upcoming reporting dates are closer, are more likely to divest from crash stocks. To rule out the possibility of funds with longer distance to their next reporting date selling and then buying the crash stock again before their next reporting date, we also use Thompson Reuters' voluntary portfolio reports that are not freely available to the public, enabling us to observe holdings immediately before and after crash. We examine the consequences of short-termism induced by mandatory disclosures on stock prices and find that stocks held mostly by "short-horizon" funds, experience a larger drop at the time of the crash and a larger subsequent reversal. Our study utilizes variations in mandatory mutual fund reporting dates as a plausibly exogenous source of variation in investment horizon to shed light on the destabilizing behavior of short-horizon investors.

Using the entire trading history of all retail investors in an emerging market, we study the performance of investors with different levels of experience. We compare the portfolio performance of investors with more versus less trading experience during the 2019-2020 boom-bust episode in the Tehran Stock Exchange (TSE). Our preliminary results show a direct relationship between investors' experience and their return. Moreover, we find that more experienced investors are less likely to overtrade or under-diversify. Our findings have important policy implications for promoting market participation, especially for first time investors with little trading experience, and therefore are of interest to both regulators and market participants.

This study investigates the effects of credit expansion resulting from the entry of privately owned banks on firm-level outcomes in Iran. Utilizing a hand-collected bank-firm relationship dataset, we find that the influx of private credit into firms' balance sheets did not translate into improved real outcomes. Further, by employing a position index to measure firm proximity within pyramidal ownership structures, we provide robust evidence of connected lending. Specifically, credit disproportionately benefits firms within the same business group, with those closer to the top of the pyramid receiving more favorable terms. Despite increased access to credit, we observe no significant improvements in investment, employment, or efficiency measures. These findings underscore the influence of ownership structures and favoritism in credit allocation, raising concerns about the effectiveness of credit expansion policies in fostering real economic growth.