Jingxiong (Tony) Hu

Working Papers

Debt and Taxes Revisited 

This paper analyzes optimal capital structure using a model in which firms issue securities in order to (1) finance investments in operations and (2) recapitalize the firm. In this trade-off model, firms balance the tax benefits of debt against the costs of financial distress. Key to the analysis, the marginal tax benefit of debt depends on whether the debt is used for financing investments or financial restructuring. The theory explores leverage dynamics with personal and corporate taxes in a trade-off model with continuous leverage adjustments and no fixed costs of security issuance. Depending on firms’ external financing needs, the marginal source of financing can be debt or equity. There are two local leverage targets for firms with leverage above or below a threshold. The model generates a leverage distribution that closely matches the data, including many zero-leverage firms. Policymakers can reduce the expected bankruptcy loss without losing tax revenue by taxing shareholders more at the personal level and less at the corporate level. A new empirical measure of marginal tax benefits finds that there is no marginal benefit to borrowing for seemingly underleveraged U.S. firms. 

Undercutting the exchanges: private trading, fee competition, and price discovery at the market close with Jiaheng Yu

Passive investment strategies that trade at market close have incurred high transaction fees charged by the primary exchanges. Investment banks undercut the exchanges by executing client orders at close prices set on the exchanges yet charging lower fees. While providing liquidity, banks trade on the order flow information. Using a quasi-experimental shock – an NYSE close auction fee cut – we find that banks’ trading activities improve the informativeness of close prices and reduce the cost of passive investment strategies. To explain this finding, we propose a model where banks’ trading improves price discovery. A bank contributes to price discovery by trading on the informativeness of the orders it receives relative to the market. The implications of our model apply generally to scenarios with multiple trading venues where venue operators trade on order flow data. As an application of our results, the common practice of trading on retail order flow information could potentially improve price discovery.

Conferences: EuroFA 2022, NFA 2022, FMA 2022 (Semifinalist for best paper in market microstructure), AsianFA 2022, Microstructure Exchange, Trans-Atlantic Doctoral Conference 2021, MFA 2020