Essays at the Intersection of Institutional and Consumer Finance

These three essays extend our empirical understanding of financial markets with an emphasis on the effect of law in markets where consumers and institutions interact. The first essay, "Foreclosure Law and Mortgage Risk in the Subprime Era," demonstrates that differences in state foreclosure law affect lenders' willingness to originate subprime loans. Using a state-borders methodology, it finds that areas that had lender-favorable foreclosure procedures experienced more activity in the subprime market at the peak of the subprime bubble. The second essay, "An Empirical Study of Mutual Fund Excessive Fee Litigation: Do the Merits Matter?," co-authored with John Morley, examines another critical consumer-facing financial market: mutual funds. Federal securities law provides that mutual funds can be sued by their investors for charging excessive fees. This is the first empirical study to examine the incidence and effect of these lawsuits, and finds that, while mutual funds sued for excessive fees do charge slightly more, these lawsuits are primarily driven by fund size and do not result in lower fees for consumers. The final essay "Agency Costs and the Price Effects of Corporate Litigation" examines the impact of corporate governance on stock returns of plaintiff firms in corporate litigation, and demonstrates a relationship between lax corporate governance and poor stock returns around the time firms file lawsuits.;Chapter One: Foreclosure Law and Mortgage Risk in the Subprime Era. This is the first study to measure the impact of foreclosure law on subprime mortgage origination, and it finds that foreclosure law played a role in patterns of subprime loan origination during the housing bubble. Foreclosure procedures in some states are considerably swifter and less costly for lenders than in others. In light of the foreclosure crisis, an empirical understanding of the effect of foreclosure procedures on the mortgage market is critical. This study finds that lender-favorable foreclosure procedures are associated with more activity in the subprime market during 2005 and 2006, the peak of the market for subprime loans. The study describes key differences in state foreclosure law and uses hand-coded state foreclosure law variables to construct a numerical index measuring the favorability of state foreclosure law to lenders. Mortgage origination data from state-border areas shows that lender-friendly foreclosure is associated with an increase in the number of subprime originations, the percentage of total lending that is subprime, and the proportion of total dollars lent that fund subprime mortgages. There is no measurable effect on the number of prime originations. The results also show that loan size and loan to income ratio increase as foreclosure law becomes more lender favorable.;Chapter Two: An Empirical Study of Mutual Fund Excessive Fee Litigation: Do the Merits Matter? (with John Morley) This essay is the first comprehensive empirical study of mutual fund excessive fee liability under § 36(b) of the Investment Company Act. Utilizing a hand-collected dataset of substantially all excessive fee complaints filed between 2000 and 2009, this study finds that the size of a fund's management complex predicts which funds will be targeted much more robustly than fees do. In fact, during our study period funds in the smallest one-third of management complexes were almost never sued, even though these funds were by far the most likely to charge fees at the extreme high end of the distribution. We find no evidence that funds affected by excessive fee suits reduced their fees after the filing of the suits relative to unaffected funds, and we find some evidence that affected funds actually increased their fees relative to unaffected funds. We find no evidence that fees were related to case outcomes or that advisers experienced reputational penalties as a result of lawsuits. This paper is relevant to the general debate about whether the merits matter in class and derivative litigation, because in comparison to the merits of most lawsuits, the merits of excessive fee suits are uniquely easy to observe and analyze.;Chapter Three: Agency Costs and the Price Effects of Corporate Litigation. Litigation between corporations is known to reduce the total value of the litigating firms, but the source of this value loss is an open question. The empirical literature on corporate litigation has only recently turned its attention to the interaction between corporate governance and litigation strategy. Haslem (2005) shows that managers at defendant firms with weak governance may be too eager to settle cases in order to avoid embarrassing disclosures. This paper is the first to consider the impact of corporate governance on plaintiff firms' litigation decisions. I find that firms with weaker governance show significantly lower abnormal stock returns around the time they file a lawsuit. These abnormal returns likely result from firms pursuing suits with negative value, and suggest that managers may derive private benefits from litigating. Agency problems may therefore play a role in the value-loss associated with public company litigation.