We develop a theory of optimal bank leverage in which the benefit of debt in inducing loan monitoring is balanced against the benefit of equity in attenuating risk-shifting. However, faced with socially-costly correlated bank failures, regulators bail out creditors. Anticipation of this generates multiple equilibria, including one with systemic risk in which banks use excessive leverage to fund correlated, inefficiently risky loans. Limiting leverage and resolving both moral hazards — insufficient loan monitoring and asset substitution — requires a novel two-tiered capital requirement, including a “special capital account” that is unavailable to creditors upon failure.
{"title":"Caught between Scylla and Charybdis? Regulating Bank Leverage When There is Rent Seeking and Risk Shifting","authors":"V. Acharya, Hamid Mehran, A. Thakor","doi":"10.2139/ssrn.1786637","DOIUrl":"https://doi.org/10.2139/ssrn.1786637","url":null,"abstract":"We develop a theory of optimal bank leverage in which the benefit of debt in inducing loan monitoring is balanced against the benefit of equity in attenuating risk-shifting. However, faced with socially-costly correlated bank failures, regulators bail out creditors. Anticipation of this generates multiple equilibria, including one with systemic risk in which banks use excessive leverage to fund correlated, inefficiently risky loans. Limiting leverage and resolving both moral hazards — insufficient loan monitoring and asset substitution — requires a novel two-tiered capital requirement, including a “special capital account” that is unavailable to creditors upon failure.","PeriodicalId":146991,"journal":{"name":"AFA 2012 Chicago Meetings (Archive)","volume":"26 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-09-11","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"125052989","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Using a measure of operating leverage that directly reflects the importance of fixed operating costs in firms’ cost structures, we show that high fixed cost firms have lower leverage ratios and also much larger cash holdings than low fixed cost firms. This conservative behavior is not solely a result of a trade-off between operating leverage and financial leverage, since even high fixed cost firms without any debt in their capital structure have significantly larger cash holdings than similar low fixed cost firms. We show that the conservative financial policies allow high fixed cost firms to limit the amount by which they have to cut investment if sales are low. Our evidence also suggests that the financial conservatism of high fixed cost firms is value-maximizing. We conclude that operating leverage is an important determinant of financial policies and helps explain why many firms have very low net leverage ratios.
{"title":"Operating Leverage and Corporate Financial Policies","authors":"Matthias Kahl, Jason Lunn, Mattias Nilsson","doi":"10.2139/ssrn.1787184","DOIUrl":"https://doi.org/10.2139/ssrn.1787184","url":null,"abstract":"Using a measure of operating leverage that directly reflects the importance of fixed operating costs in firms’ cost structures, we show that high fixed cost firms have lower leverage ratios and also much larger cash holdings than low fixed cost firms. This conservative behavior is not solely a result of a trade-off between operating leverage and financial leverage, since even high fixed cost firms without any debt in their capital structure have significantly larger cash holdings than similar low fixed cost firms. We show that the conservative financial policies allow high fixed cost firms to limit the amount by which they have to cut investment if sales are low. Our evidence also suggests that the financial conservatism of high fixed cost firms is value-maximizing. We conclude that operating leverage is an important determinant of financial policies and helps explain why many firms have very low net leverage ratios.","PeriodicalId":146991,"journal":{"name":"AFA 2012 Chicago Meetings (Archive)","volume":"11 6","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2014-11-20","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"114130477","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We examine the risk-taking behavior of money market funds during the fi nancial crisis of 2007-2010. We find that: (1) money market funds experienced an unprecedented expansion in their risk-taking opportunities; (2) funds had strong incentives to take on risk because fund inflows were highly responsive to fund yields; (3) funds sponsored by financial intermediaries with more money fund business took on more risk; (4) funds suff ered runs as a result of their risk taking. This evidence suggests that money market funds lack safety because they have strong incentives to take on risk when the opportunity arises and are vulnerable to runs.
{"title":"How Safe are Money Market Funds?","authors":"Marcin T. Kacperczyk, P. Schnabl","doi":"10.2139/ssrn.1769025","DOIUrl":"https://doi.org/10.2139/ssrn.1769025","url":null,"abstract":"We examine the risk-taking behavior of money market funds during the fi nancial crisis of 2007-2010. We find that: (1) money market funds experienced an unprecedented expansion in their risk-taking opportunities; (2) funds had strong incentives to take on risk because fund inflows were highly responsive to fund yields; (3) funds sponsored by financial intermediaries with more money fund business took on more risk; (4) funds suff ered runs as a result of their risk taking. This evidence suggests that money market funds lack safety because they have strong incentives to take on risk when the opportunity arises and are vulnerable to runs.","PeriodicalId":146991,"journal":{"name":"AFA 2012 Chicago Meetings (Archive)","volume":"60 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-03-12","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130521314","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This article proposes a novel method of extracting the cost of default from the change in the market value of a firm's assets upon default. Using a large sample of firms with observed prices of debt and equity that defaulted over fourteen years, we estimate the cost of default for an average defaulting firm to be 21.7% of the market value of assets. The costs vary from 14.7% for bond renegotiations to 30.5% for bankruptcies, and are substantially higher for investment-grade firms (28.8%) than for highly levered bond issuers (20.2%), which extant estimates are based on exclusively. (JEL G21, G30, G33) The Author 2012. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.
{"title":"A Market-Based Study of the Cost of Default","authors":"S. Davydenko, Ilya A. Strebulaev, Xiaofei Zhao","doi":"10.2139/ssrn.1571940","DOIUrl":"https://doi.org/10.2139/ssrn.1571940","url":null,"abstract":"This article proposes a novel method of extracting the cost of default from the change in the market value of a firm's assets upon default. Using a large sample of firms with observed prices of debt and equity that defaulted over fourteen years, we estimate the cost of default for an average defaulting firm to be 21.7% of the market value of assets. The costs vary from 14.7% for bond renegotiations to 30.5% for bankruptcies, and are substantially higher for investment-grade firms (28.8%) than for highly levered bond issuers (20.2%), which extant estimates are based on exclusively. (JEL G21, G30, G33) The Author 2012. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.","PeriodicalId":146991,"journal":{"name":"AFA 2012 Chicago Meetings (Archive)","volume":"4 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-03-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"117188540","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper argues that the capacity of financial markets to aggregate dispersed information about economic conditions is diminished in times of distress, resulting in countercyclical uncertainty. Building on a rational expectations equilibrium dynamic environment, I model informed traders as financial intermediaries facing countercyclical fund outflows. As conditions deteriorate, households pull out their funding from intermediaries and force premature liquidations, exposing intermediaries to lower expected returns and non-fundamental price fluctuations. In anticipation, risk-averse intermediaries trade less aggressively to private information and the informational content of equilibrium asset prices is reduced. The model highlights a dynamic interdependence between price informativeness and the endogenous severity of liquidations when both intermediaries and traders who absorb their asset liquidations learn from prices. This mutual reinforcement creates a strong internal amplification mechanism that delivers sharp spikes in economic uncertainty as funding becomes tighter. The mechanism can explain the time-variation in the risk premium, Sharpe ratio and volatility even when risk aversion and the variance of fundamental shocks remain constant. In contrast to theories stressing exogenous variations in preferences or heteroskedastic volatility of fundamentals, the mechanism highlighted suggests fluctuations in the risk premium can be sub-optimal to the extent they arise from the endogenous disaggregation of information in funding-constrained asset markets.
{"title":"Amplification of Uncertainty in Illiquid Markets","authors":"Elı́as Albagli","doi":"10.2139/ssrn.1788216","DOIUrl":"https://doi.org/10.2139/ssrn.1788216","url":null,"abstract":"This paper argues that the capacity of financial markets to aggregate dispersed information about economic conditions is diminished in times of distress, resulting in countercyclical uncertainty. Building on a rational expectations equilibrium dynamic environment, I model informed traders as financial intermediaries facing countercyclical fund outflows. As conditions deteriorate, households pull out their funding from intermediaries and force premature liquidations, exposing intermediaries to lower expected returns and non-fundamental price fluctuations. In anticipation, risk-averse intermediaries trade less aggressively to private information and the informational content of equilibrium asset prices is reduced. The model highlights a dynamic interdependence between price informativeness and the endogenous severity of liquidations when both intermediaries and traders who absorb their asset liquidations learn from prices. This mutual reinforcement creates a strong internal amplification mechanism that delivers sharp spikes in economic uncertainty as funding becomes tighter. The mechanism can explain the time-variation in the risk premium, Sharpe ratio and volatility even when risk aversion and the variance of fundamental shocks remain constant. In contrast to theories stressing exogenous variations in preferences or heteroskedastic volatility of fundamentals, the mechanism highlighted suggests fluctuations in the risk premium can be sub-optimal to the extent they arise from the endogenous disaggregation of information in funding-constrained asset markets.","PeriodicalId":146991,"journal":{"name":"AFA 2012 Chicago Meetings (Archive)","volume":"35 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-11-03","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"114219882","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We propose an ex ante measure of analysts’ production of private information (PPI) based on the correlations between analysts’ forecast revisions and prior stock price changes. We validate this measure by examining whether analysts with lower correlations (higher PPI) provide more information value to various stakeholders and monitor managerial behavior more effectively. We find that the stock price impacts of forecast revisions issued by analysts with higher PPI are larger than those issued by analysts with lower PPI. We also find that firms' investment sensitivity to stock prices is higher and that boards of directors rely more on analysts’ forecast errors in their CEO turnover decisions when firms are followed by analysts with higher PPI. In addition, we find that firms followed by analysts with higher PPI exhibit lower accrual discretion and are less likely to restate earnings. Overall, our findings suggest PPI captures analysts’ ability to produce private information and that analysts with higher PPI are better information producers and monitors.
{"title":"Are Analysts Whose Forecast Revisions Correlate Less with Prior Stock Price Changes Better Information Producers and Monitors?","authors":"C. Hwang, Yuan Li, Y. H. Tong","doi":"10.2139/ssrn.1785102","DOIUrl":"https://doi.org/10.2139/ssrn.1785102","url":null,"abstract":"We propose an ex ante measure of analysts’ production of private information (PPI) based on the correlations between analysts’ forecast revisions and prior stock price changes. We validate this measure by examining whether analysts with lower correlations (higher PPI) provide more information value to various stakeholders and monitor managerial behavior more effectively. We find that the stock price impacts of forecast revisions issued by analysts with higher PPI are larger than those issued by analysts with lower PPI. We also find that firms' investment sensitivity to stock prices is higher and that boards of directors rely more on analysts’ forecast errors in their CEO turnover decisions when firms are followed by analysts with higher PPI. In addition, we find that firms followed by analysts with higher PPI exhibit lower accrual discretion and are less likely to restate earnings. Overall, our findings suggest PPI captures analysts’ ability to produce private information and that analysts with higher PPI are better information producers and monitors.","PeriodicalId":146991,"journal":{"name":"AFA 2012 Chicago Meetings (Archive)","volume":"4 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-03-13","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"134118570","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper investigates whether the securitization of corporate bank loans had an impact on the price of corporate debt. Our results suggest that loan facilities that are subsequently securitized are associated with a 15 basis point lower spread than that of loans that are not subsequently securitized. To identify the particular role of securitization in loan pricing, we employ a difference in differences approach and consider loan characteristics that are associated with the likelihood of securitization. We document that Term Loan B facilities, facilities originated by banks that originate CLOs, and loans of B-Rated firms are securitized more frequently than other loans. Spreads on facilities estimated to be more likely to be subsequently securitized have lower spreads than otherwise similar facilities. The results are consistent with the view that securitization caused a reduction in the cost of capital.
{"title":"Did Securitization Affect the Cost of Corporate Debt?","authors":"Taylor D. Nadauld, M. Weisbach","doi":"10.2139/ssrn.1768862","DOIUrl":"https://doi.org/10.2139/ssrn.1768862","url":null,"abstract":"This paper investigates whether the securitization of corporate bank loans had an impact on the price of corporate debt. Our results suggest that loan facilities that are subsequently securitized are associated with a 15 basis point lower spread than that of loans that are not subsequently securitized. To identify the particular role of securitization in loan pricing, we employ a difference in differences approach and consider loan characteristics that are associated with the likelihood of securitization. We document that Term Loan B facilities, facilities originated by banks that originate CLOs, and loans of B-Rated firms are securitized more frequently than other loans. Spreads on facilities estimated to be more likely to be subsequently securitized have lower spreads than otherwise similar facilities. The results are consistent with the view that securitization caused a reduction in the cost of capital.","PeriodicalId":146991,"journal":{"name":"AFA 2012 Chicago Meetings (Archive)","volume":"17 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-02-23","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"129390629","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We develop a structural equilibrium model with business cycles and use it to examine the economic implications of voluntary filing for bankruptcy. We find that conflict of interests that arises from the voluntary filing option of Chapter 11 causes higher ex-ante losses in firm value in recessions than in booms. These costs amount to approximately 5% of the ex-ante value for a BAA-rated representative firm and are twice as large as those produced by a model that does not allow for business cycle fluctuations. We relate these economic costs to firm fundamentals and to long-run economic uncertainty. We also show that in addition to macroeconomic conditions and liquidation costs, countercyclical distress costs and conflict of interests between debtors and creditors help to simultaneously generate reasonable credit spreads, levered equity premium and leverage ratios. Our framework nests a number of important models in the literature and we provide closed-form solutions for the equity, debt and levered asset values.
{"title":"Business Cycles and the Bankruptcy Code: A Structural Approach","authors":"Redouane Elkamhi, Min Jiang","doi":"10.2139/ssrn.1586494","DOIUrl":"https://doi.org/10.2139/ssrn.1586494","url":null,"abstract":"We develop a structural equilibrium model with business cycles and use it to examine the economic implications of voluntary filing for bankruptcy. We find that conflict of interests that arises from the voluntary filing option of Chapter 11 causes higher ex-ante losses in firm value in recessions than in booms. These costs amount to approximately 5% of the ex-ante value for a BAA-rated representative firm and are twice as large as those produced by a model that does not allow for business cycle fluctuations. We relate these economic costs to firm fundamentals and to long-run economic uncertainty. We also show that in addition to macroeconomic conditions and liquidation costs, countercyclical distress costs and conflict of interests between debtors and creditors help to simultaneously generate reasonable credit spreads, levered equity premium and leverage ratios. Our framework nests a number of important models in the literature and we provide closed-form solutions for the equity, debt and levered asset values.","PeriodicalId":146991,"journal":{"name":"AFA 2012 Chicago Meetings (Archive)","volume":"66 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2010-01-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127242501","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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