do firms engage in risk shifting empirical evidence i empirically test whether firms engage in risk shifting contrary to what risk shifting theory predicts i find that firms reduce investment risk when they approach financial distress to identify the effect of distress on risk taking i use a natural experiment with exogenous changes to leverage risk reduction is most prevalent among firms that have shorter maturity debt bank debt and tighter bank loan financial covenants these findings suggest that debt composition and financial covenants serve as important mechanisms to mitigate debt equity agency conflicts such as risk shifting that are not explicitly contracted on received january 8 2015 accepted may 27 2016 by editor david denis

bank incentives economic specialization and financial crises in emerging economies abstract we model the vulnerability of an economy to a financial crisis as arising from the interaction of the degree of economic specialization and bank debt financing the probability of a financial crisis is shown to increase in the degree of economic specialization bank debt financing has the beneficial effect of lowering the degree of economic specialization by increasing access to financing of investment opportunities that would not have been financed due to wealth constraints of entrepreneurs financial access effect however bank debt financing induces risk shifting incentives leverage effect the net effect on the probability of a financial crisis depends on which of these two effects dominates we show that commonly employed mechanisms in managing financial crises particularly bailouts induce an additional agency cost by distorting bank incentives to concentrate loans in specific sectors bank debt concentration effect we propose a tax based ex ante solution mechanism that simultaneously induces optimal investment and eliminates the bank debt concentration effect implementation issues and empirical policy implications are also discussed

financial contracting theory meets the real world an empirical analysis of venture capital contracts we compare the characteristics of real world financial contracts to their counterparts in financial contracting theory we do so by studying the actual contracts between venture capitalists vcs and entrepreneurs the distinguishing characteristic of vc financings is that they allow vcs to separately allocate cash flow rights board rights voting rights liquidation rights and other control rights we describe and measure these rights we then interpret our results in relation to existing financial contracting theories we also describe the interrelation and the evolution across financing rounds of the different rights query 1 query 2

investment and financing activity following calls of convertible bonds abstract the staged financing hypothesis of mayers mayers d 1998 why firms issue convertible bonds the matching of financial and real investment options journal of financial economics 47 83 102 predicts that investment and financing activity will increase following in the money convertible bond calls the prediction for out of the money convertible calls is different no increase is expected we study the rate of both corporate investment and external financing around forced conversions using benchmarks that are analogous to those recommended by barber and lyon barber b lyon j 1996 detecting abnormal operating performance the empirical power and specification of test statistics journal of financial economics 41 359 400 we also examine the cross section of changes in investment and financing activity conversion forcing firms exhibit an increase in both capital expenditures and debt financing around the year of the convertible bond call however the same result holds for the sample firms that conducted out of the money convertible calls further there is no relation between changes in investment activity and changes in debt issuance at the firm level the evidence is inconsistent with the notion that forced conversions serve as a catalyst for staged financing and investment

state contingent bank regulation with unobserved actions and unobserved characteristics abstract optimal bank regulation is studied in a model where bank quality is private information and bank portfolio choice is subject to moral hazard regulators wish to control bank risk solely because high risk adversely affects a bank incentives to improve its mean return numerical methods are developed to study the model capital regulation alone has a limited ability to separate types including ex post fines achieve separation at lower cost resulting in improved welfare low quality banks are fined on high returns in order to control risk taking high quality banks face fines on lower returns mainly to ensure truth telling by low quality banks high quality banks bear the full cost of regulation

search efficiency skill transferability and immigrant relative unemployment rates in australia 1990 search efficiency skill transferability and immigrant relative unemployment rates in australia applied economics vol 22 no 2 pp 249 260

the composition of u s east asia trade and changing comparative advantage abstract this paper examines the composition of trade between the united states and eight asian pacific economies from 1962 to 1992 analysis of the time series pattern of individual commodities at the sitc four digit level reveals economically significant changes in the pattern of trade reflecting changing comparative advantage based on changing factor proportions technology transfer and product cycles the composition of the eight bilateral trade relationships shows both increasing specialization over time and a sequence from japan to the four tigers korea taiwan singapore and hong kong and then to the remaining three east asian economies malaysia indonesia and thailand

optimal vs traditional securities under moral hazard this paper provides an explanation for the widespread use of traditional securities by wellestablished firms standard moral hazard models predict that equity debt and warrants are almost never optimal financing instruments i show that issuing these securities is nevertheless nearly optimal the issuer would gain very little by using non traditional securities instead combined with equity one debt issue without multiple layers of seniority and one warrant issue without multiple exercise prices suffice to achieve near optimality the near optimality of traditional financing depends crucially on the issuer s ability to use war rants in addition to debt and equity

warrant exercise and bond conversion in competitive markets abstract we develop a theory of warrants held by competitive warrantholders not constrained to exercise their warrants as one block the theory also applies to convertible bonds held by competitive bondholders not constrained to convert their bonds as one block we prove that the warrant bond price in each of the competitive equilibria is less than or equal to the price in an economy with the block constraint and for at least one competitive equilibrium the warrant bond price equals the warrant bond price in the block constrained economy we illustrate the paths of competitive warrant exercise and bond conversion and conclude that under realistic assumptions they can be long

asset substitution and structured financing this article shows how structured financing can be used to solve the asset substitution problem in a dynamic setting structuring induces the firm s owner to optimally choose the first best operating strategy even though the owner s value function might be locally convex concave which would ordinarily lead to overinvestment underinvestment in risky projects this result is demonstrated in two different continuous time settings one that is based on the risk shifting framework of leland 1998 and one that generalizes the scaled return model of green 1984 it is shown that the contractual nature of the structuring is a key determinant of the issuing firm s dynamic asset volatility furthermore unlike nonstructured financing the default conversion probability of a structured debt security may be increasing decreasing in the firm s total assets structured securities are therefore hedge assets which potentially explains the popularity of structured securities among investors and third party issuers

perquisites risk and capital structure in a corporate agency problem perquisites and risk interact to produce novel complex comparative statics for example even if additional debt induces risk neutral insiders to increase risk they never seek to increase the market value of their stock instead insiders decrease the present value of their subsequent conditionally optimal perquisites also the firm s optimal capital structure includes a risky bond with an agreement to remove insiders whenever the bond defaults however the optimal sharing rule between corporate claimants cannot be supported solely by standard securities such as bonds stocks options and their hybrids

dependability and organizational bankruptcy an application of agency and prospect theory this paper proposes and tests a new model of organizational bankruptcy based on agency and prospect theory the paper argues that debtors with unprestigious top managers low liquidity and high leverage signal that they will be undependable exchange partners the model proposes that survival is contingent on maintaining an acceptable minimum level of these financial and managerial assets if a firm falls below that threshold level it has a higher probability of bankruptcy because creditors withdraw their financial support from the debtor consistent with agency theory this implies that bankruptcy can be viewed as the legal resolution of severe shareholder creditor conflicts about the levels of financial and managerial assets that the debtor should maintain this new model proposes that maintaining a minimum level of these assets is a necessary but not sufficient condition for bankruptcy some undependable firms delay bankruptcy by using strategies that create the hope that they will become dependable in the future according to prospect theory these strategies work because creditors wish to avoid recognizing significant losses and thus take on more risk than they might otherwise assume

on the resolution of agency problems by complex financial instruments a comment a convertible debt or b a package of external equity and managerial stock options ii the agency problems resulting from the shareholders incentive to bear unwanted risk also referred to as risk shifting can be resolved by issuing callable debt and iii welfare loss due to informational asymmetry between insiders and the market can be reduced by issuing callable debt in this paper we derive results that contradict these conclusions of bhs and hs we prove that convertible debt cannot costlessly resolve the agency problem due to excessive perquisite consumption farmer and winter 4 have recently shown that managerial stock options cannot resolve the problem we also show that convertible debt in general does not even mitigate this problem next we show that the argument that callable debt resolves agency problems due to risk shifting and informational asymmetry is incomplete the paper is organized as follows section i deals with the perquisite consumption problem section ii deals with both risk shifting and informational asymmetry problems since the basis of their resolution in the bhs argument is the same

migration theories and evidence an assessment abstract this paper presents a critical survey of theories of migration their welfare and policy implications and their empirical relevance we also develop some extensions to the theory beginning with the harris and todaro ht model in particular the ht model is extended to examine risk averse behaviour within families where the migration of members of families serves to diversify risk the welfare implications of the individual migration decision and government intervention in the form of employment subsidies are examined recent evidence on international migration is presented it is shown that migration does not flow automatically in response to wage differentials characteristics of migrants and the process of self selection are found to be important determinants of the rate of migration

the impact of contingent liability on commercial bank risk taking abstract from 1863 1935 regulators imposed contingent liability on bank shareholders to discourage risk taking using data from 1900 to 1915 i find that banks subject to stricter liability rules have lower equity and asset volatility hold a lower proportion of risky assets and are less likely to increase their investment in risky assets when their net worth declines consistent with the hypothesis that stricter liability discourages commercial bank risk taking these findings provide lessons for current bank regulatory policy and show that the shape of the residual claimant s payoff function has a significant impact on managerial incentives and firm performance

investment ramifications of distortionary tax subsidies abstract this paper examines the investment effects of tax subsidies for which some assets and not others are eligible distortionary tax subsidies concentrate investments in tax favored assets thereby reducing the expected pre tax profitability of investment and reducing payoffs to bondholders in the event of default anticipation of asset substitution encourages lenders to require covenants in debt contracts which only imperfectly address asset substitution and distort investment the result is that borrowing is made more expensive which in turn discourages investment borrowing rates can react so strongly that aggregate investment may rise very little or even fall in response to higher tax subsidies debt issued by u s firms in risk of default after the 2002 introduction of bonus depreciation for u s equipment investment contained many more covenants than in other periods a pattern that reversed when bonus depreciation was discontinued after 2004 furthermore firms at risk of default borrowed less and were more apt to lease capital than were other firms during the bonus depreciation period

a theory of mandatory convertibles abstract the objective of this paper is to develop a theoretical analysis of mandatory convertibles which are securities that automatically mandatorily convert to common stock on a pre specified date we consider a firm facing a financial market characterized by asymmetric information and significant costs in the event of financial distress the firm can raise capital either by issuing mandatory convertibles or by issuing more conventional securities like straight debt ordinary convertibles or equity we show that in equilibrium the firm issues straight debt or ordinary convertibles if the extent of asymmetric information facing it is large but the probability of being in financial distress is relatively small it issues mandatory convertibles if it faces a smaller extent of asymmetric information but a greater probability of financial distress our model provides a rationale for the three commonly observed features of mandatory convertibles mandatory conversion capped or limited capital appreciation and a higher dividend yield compared to common stock we also characterize the equilibrium design of mandatory convertibles

risky debt investment incentives and reputation in a sequential equilibrium the agency relationship of corporate insiders and bondholders is modeled as a dynamic game with asymmetric information the incentive effect of risky debt on the investment policy of a levered firm is studied in this context in a sequential equilibrium of the model a concept of reputation arises endogenously resulting in a partial resolution of the classic agency problem of underinvestment the incentive of the firm to underinvest is curtailed by anticipation of favorable rating of its bonds by the market this anticipated pricing of debt is consistent with rational expectations pricing by a competitive bond market and is realized in equilibrium some empirical implications of the model for bond rating debt covenants and bond price response to investment announcements are explored

the structure and incentive effects of corporate tax liabilities this paper describes situations in which tax liabilities assume the form of a negative position in a call option this structure motivates an examination of the investment decisions of taxed corporations in the presence of risk it is shown that the structure of the tax liability creates an incentive to underinvest in more risky projects and an incentive for conglomerate merger these effects are then evaluated in the presence of conflicts of interest between stockholders and bondholders and under alternative assumptions about the tax code and about the timing of investment and financing decisions this paper makes an observation regarding the functional form assumed by the tax liabilities of corporations with potentially redundant deductions and evaluates its consequences for investment incentives interest and other deductions against taxable income can be taken for the most part only to the extent of that income in a single period model this gives the net tax liability a familiar structure it can be viewed as a call option where the exercise price on the call is the allowable deductions the tax paying entity holds a positive position in the assets which generate the taxable income and a negative position in a call option on those assets the analogy between options and the structure of tax liabilities calls attention to some interesting incentive effects concerning risk using their model of option valuation black and scholes 5 showed that the value of an option is increasing in the variance of the asset it is written on other authors have generalized this result and studied its implications for corporate financing see jagannathan 16 jensen and meckling 17 and green 15 the importance of the risk attributes of the underlying asset in option valuation suggests that taxation may have important incentive consequences for investment decisions involving risk it has been recognized in the public economics literature for some time that asymmetries in the tax schedule can affect risk taking behavior early papers by mossin 20 and stiglitz 25 studied individual portfolio decisions over a riskless and a risky asset our analysis differs from these in a number of respects the most important of these is our use of market valuation rather than expected utility in the decision maker s objective function this is surely a more appropri

financing flexibility the case of outsourcing abstract we investigate the relationship between the extent and timing of vertical flexibility and the financial choices of a firm by vertical flexibility we mean partial total and reversible outsourcing of a necessary input a firm simultaneously selects the vertical setting and the financial sources of investment in flexibility in particular debt and venture capital a loan may come from a lender that requires the payment of a fixed coupon over time and an option to buy out the firm in certain circumstances debt leads to the same level of flexibility of an unlevered firm yet investment occurs earlier the injection of venture capital reduces the quest for vertical flexibility and speeds up investment then there arises a fresh substitutability between a financial venture capital and a real variable vertical flexibility

excessive risk taking and the maturity structure of debt abstract this paper analyses the effect of short term debt on equityholders risk taking decisions we show that if short term debt limits the expropriation of debtholders it also implies a lower leverage which prevents the firm from increasing tax shields we then examine the incentive of equityholders to increase the firm risk when debtholders hold the option to swap a perpetual coupon bond with short term debt we find that this option mitigates equityholders risk shifting incentives compared to standard short term debt this restructuring option deters debtholders expropriation it increases leverage and it reduces the loss in tax shields due to asset substitution

the value of trading consolidation evidence from the exercise of warrants we study the effect of trading consolidation by examining the response of liquidity and stock price to the exercise of deep in the money corporate warrants this enables a relatively clean test of the value of trading consolidation the exercise at the warrant expiration is fully anticipated and has no information content an effect can come from the value of trading consolidation that improves liquidity indeed we find that liquidity and stock prices both increase significantly at warrant expiration further the price increase is positively related to the pre exercise extent of fragmentation to post exercise improvement in stock liquidity and to the proportional increase in the number of shares following the warrant exercise

callable bonds reinvestment risk and credit rating improvements role of the call premium we identify the call premium in nonconvertible callable bonds as an effective contracting provision to address agency conflict due to reinvestment risk and credit rating improvements we analyze 4 495 bonds issued between 1980 and 2012 when interest rates are high a majority of investment grade issues and almost the entire subset with long maturities 20 years include a call premium when interest rates are low virtually all investment grade issues with long and short maturities are callable at par high yield issues are limited to short maturities by about 4 1 they include a call premium regardless of interest rate levels

optimal bank capital with costly recapitalization we study optimal bank capital choice as a dynamic trade off between the opportunity cost of equity the loss of franchise value following a regulatory minimum capital violation and the cost of recapitalization we introduce a recapitalization delay that results in a strictly positive probability of capital adequacy violation we calibrate the model to bank accounting return data and evaluate the model s ability to explain observed bank capital ratios differences in return volatility explain a significant fraction of the cross sectional variation in bank capital ratios differences in the level of capital market imperfections across banks constitute a secondary explanation

bankruptcy and agency costs their significance to the theory of optimal capital structure we support and generalize our original results 1978 in light of potential impediments to a pure market solution to agency problems and potential causal links between liquidation and bankruptcy in the case of bankruptcy costs market impediments are easily elimi nated through the inclusion of simple provisions in corporate charters and bond inden tures further we demonstrate that recent attempts to link liquidation costs to capital structure are without merit if the firm is to be liquidated on the basis of a rule other than one that maximizes the total value of all the claimants arbitrage profits arise and informal reorganization will discipline management to follow the liquidation rule that is optimal for existing securityholders also we find that the pure market solution is not readily generalizable to other classes of agency problems particularly the risk incentive problem how ever the alternative solution of the risk incentive problem through complex financing contracting may be useful in explaining complexities in contemporary financial contracts in a previous paper 1978 we employed arbitrage arguments to show that in a well functioning market bankruptcy costs are an insignificant determinant of a firm s capital structure we also pointed out that the decision to liquidate and its associated costs can be separated from the event of bankruptcy moreover any costs actually associated with the event of bankruptcy must be limited to the costs associated with an informal reorganization of the capital structure in the capital market prior to default these results were argued to hold under a com plex environment with multiple periods multiple securities and heterogeneous expectations we concluded that bankruptcy costs would be a significant deter minant of capital structure only in the face of irrationality on the part of market participants or unavoidable impediments to the arbitrage process since the publication of our paper there has been an accumulation of the

job search methods and their success a comparison of immigrants and natives in the uk a major issue in the immigration debate concerns whether immigrants take jobs away from natives in this article we present new evidence on the job search methods used by immigrants and their relative success in gaining employment in the uk we find that 1 immigrant job search is less successful than that of natives 2 immigrants are as likely to gain employment through informal methods as via verifiable routes 3 the probability of success increases with years since migration the finding that immigrants do not effectively compete for jobs may help explain why immigration has little impact on native employment

adverse risk incentives and the design of performance bases contracts this paper uses option pricing theory to value and analyze many performance based fee contracts that are currently in use a potential problem with some of these contracts is that they may induce portfolio managers to adversely alter the risk of the portfolios they manage the paper is prescriptive in that it presents conditions for contract parameters that provide proper risk incentives for classes of investment strategies for buy and hold and rebalancing strategies adverse risk incentives are avoided when the penalties for poor performance outweigh the rewards for good performance

financing and advising optimal financial contracts with venture capitalists this paper analyses the joint provision of effort by an entrepreneur and by an advisor to improve the productivity of an investment project without moral hazard it is optimal that both exert effort with moral hazard if the entrepreneur s effort is more efficient less costly than the advisor s effort the latter is not hired if she does not provide funds outside financing arises endogenously this explains why investors like venture capitalists are value enhancing the level of outside financing determines whether common stocks or convertible bonds should be issued in response to incentives

deposit insurance and financial development the authors examine the effect of different design features of deposit insurance on long run financial development defined to include the level of financial activity the stability of the banking sector and the quality of resource allocation their empirical analysis is guided by recent theories of banking regulation that employ an agency framework the authors examine the effect of deposit insurance on the size and volatility of the financial sector in a sample of fifty eight countries they find that generous deposit insurance leads to financial instability in lax regulatory environments but in sound regulatory environments deposit insurance does have the desired impact on financial development and growth thus countries introducing a deposit insurance scheme need to ensure that it is accompanied by a sound regulatory framework otherwise the scheme will likely lead to instability and deter financial development in weak regulatory environments policymakers should at least limit deposit insurance coverage

assimilation changes in cohort quality and the earnings of immigrants this paper reexamines the empirical basis for two facts that seem to be found in most cross section studies of immigrant earnings 1 the earnings of immigrants grow rapidly as they assimilate into the united states and 2 this rapid growth leads to many immigrants overtaking the earnings of the natives within 10 15 years after immigration using the 1970 and 1980 u s censuses this paper studies the earnings growth experienced by specific immigrant cohorts during the period 1970 80 it is found that within cohort growth is significantly smaller than the growth predicted by cross section regressions for most immigrant groups this differential is consistent with the hypothesis that there has been a secular decline in the quality of immigrants admitted to the united states

corporate liquidity and capital structure we solve for a firm s optimal cash holding policy within a continuous time contingent claims framework using dividends short term borrowing and equity issues as controls assuming mean reversion of earnings optimal cash is non monotone in business conditions and increasing in the level of long term debt the model matches closely a wide range of empirical benchmarks and predicts cash and leverage dynamics in line with the empirical literature firm value is quite insensitive to changes in the level of long term debt the model has interesting implications for asset substitution hedging and pecking order growth opportunities do not greatly affect cash holding policy

on the resolution of agency problems by complex financial instruments a reply not always possible to design callable debt to resolve the problem of risk shifting and to mitigate the problem of asymmetric information moreover he incorrectly argues that the rationalization of complex financial contracting as a means of resolving or reducing agency conflicts falls merely because it fails to succeed in every case we feel that narayanan s confusion stems from his misreading of the two underlying articles 2 5 and the original work including chapter 6 of our book 1 consequently we shall reproduce the relevant quotations from the original work by way of responding to the issues raised regarding the three types of complex securities namely executive stock options convertible debt and callable debt

the pricing of convertible debt offerings abstract we present the first empirical evidence on the pricing of convertible debt offerings using a sample of 91 convertible debt offerings from the period 1988 1992 we show a significant mean initial excess return of 1 11 our underpricing result is invariant to zero nonzero coupons maturity issue size or bond ratings further analysis reveals that various types of risk inherent in the new convertible issues are useful in explaining the cross sectional variation in the initial excess returns we offer an explanation for our results based on the arguments of the differential information model

why are convertible bond announcements associated with increasingly negative issuer stock returns an arbitrage based explanation while convertible offerings announced between 1984 and 1999 induce average abnormal stock returns of 1 69 convertible announcement effects over the period 2000 2008 are more than twice as negative 4 59 we hypothesize that this evolution is attributable to a shift in the convertible bond investor base from long only investors towards convertible arbitrage funds these funds buy convertibles and short the underlying stocks causing downward price pressure consistent with this hypothesis we find that the differences in announcement returns between the traditional investor period 1984 1999 and the arbitrage period 2000 september 2008 disappear when controlling for arbitrage induced short selling associated with a range of hedging strategies post issuance stock returns are also in line with the arbitrage explanation average announcement effects of convertibles issued during the global financial crisis are even more negative 9 12 due to a combination of short selling price pressure and issuer issue and macroeconomic characteristics associated with these offerings

voluntary conversion of convertible securities and the optimal call strategy abstract we provide an explanation of why convertibles are called long after the conversion value exceeds the call price delaying the call benefits the firm if enough investors are expected to delay their voluntary conversions consistent with this theory we document that a substantial number of investors do not voluntarily convert when the common dividend exceeds the convertible s dividend plus its premium over conversion value we find that firms would not have increased common stock returns by switching to the strategy of calling to force conversion as soon as possible surprisingly we find that convertible preferreds frequently sell below conversion value

top management compensation and capital structure the interrelationship between top management compensation and the design and mix of external claims issued by a firm is studied the optimal managerial compensation structures depend on not only the agency relationship between shareholders and management but also the conflicts of interests which arise in the other contracting relationships for which the firm serves as a nexus we analyze in detail the optimal management compensation for the cases when the external claims are 1 equity and risky debt and 2 equity and convertible debt in addition to the role of aligning managerial incentives with shareholder interests managerial compensation in a levered firm also serves as a precommitment device to minimize the agency costs of debt the optimal management compensation derived has low pay performance sensitivity with convertible debt instead of straight debt the corresponding optimal managerial compensation has high pay to performance sensitivity a negative relationship between pay performance sensitivity and leverage is derived our results provide a reconciliation of the puzzling evidence of jensen and murphy 1990 with agency theory other testable implications include 1 a relationship between the risk premium in corporate bond yields and top management compensation structures and 2 the announcement effect of adoption of executive stock option plans on bond prices the model yields implications for management compensation in banks and federal deposit insurance reform our results explain the dynamics of top management compensation in firms going through financial distress and reorganization

financial contracting and leverage induced over and under investment incentives this paper investigates the effects of seniority rules and restrictive dividend convenants on the over and under investment incentives associated with risky debt we show that increasing seniority of new debt decreases the incidence of under investment but increases over investment and vice versa under symmetric information the optimal seniority rule is to give new debtholders first claim on a new project without recourse to existing assets i e project financing under asymmetric information the optimal debt contract requires equating the expected return to new debtholders in the default state to the new project s cash flow in the same rate if this is not possible the optimal seniority rule calls for strict subordination of new debt if the expected cash flow in default is small and full seniority if it is large with regard to dividend convenants we show that their effect depends on whether or not dividend payments are conditioned on future investments when they are unconditioned allowing more dividends increases the under investment incentive in contrast conditional dividends decrease the underinvestment incentive and increase the over investment incentive

the commitment problem of secured lending the paper presents a new theory of trade credit in which firms buy inputs on credit from suppliers to restore the benefits of secured bank financing impaired by contract incompleteness in a setting where investment is endogenous and unobservable to financiers we show that a bank secured credit contract is time inconsistent upon being granted credit the entrepreneur has an incentive to alter the original input combination jeopardizing the bank s revenues anticipating the entrepreneur s opportunism the bank offers an unsecured credit contract reducing the surplus from the venture one way for the entrepreneur to commit to the contract terms is to purchase inputs on credit from the supplier the supplier observes the input investment and acts as a guarantor that inputs will be purchased as contracted thus facilitating access to secured bank financing the commitment role of trade credit still holds in a multi period extension that investigates the impact of bank relationship lending on secured debt and trade credit our model provides novel testable predictions on optimal financial contracts in both one period and repeated lending relationships

adverse selection and convertible bonds informational asymmetries between a firm and investors may lead to adverse selection in capital markets this paper demonstrates that when the market obtains noisy information about a firm over time this adverse selection problem can be costlessly solved by issuing callable convertible bonds with restrictive call provisions such securities can be designed to make the payoff to new claimholders independent of the private information of the manager this eliminates the possibility of any dilution of equity or underinvestment and implements the symmetric information outcome in either a pooling or a separating equilibrium the same first best efficient outcome can also be implemented by issuing floating price and mandatory convertibles

resolving the agency problems of external capital through options this paper investigates the role of stock options in resolving the agency problems of external capital as originally identified by jensen and meckling 1976 these problems are precipitated by managerial incentives a to consume excessive non pecuniary benefits or perquisites beyond the optimal level for sole ownership and b to engage in risk shifting in productive decisions so as to transfer wealth from external capital contributors these incentive problems can be resolved through a strategy that judiciously combines call and put options retained by the owner manager and external financiers respectively the resolution of the agency problems through this mechanism provides an economic rationale for the existence of managerial stock options and convertible debt the work by jensen and meckling 7 has brought more realism to the theory of the firm in their paper jm address agency problems in the context of a firm which is viewed as a nexus of contracts among various factors of production the contractual relationships involve incentive conflicts arising from the pursuit of self interest by limiting themselves to an entrepreneur or owner manager who retains complete control of the firm jm have demonstrated that financing through the issuance of common stock or debt to outsiders engenders costs these costs are precipitated in part by the manager s propensity to consume nonpecuniary benefits or perquisites perks by employing certain resources in excess of their optimal usage 1 and by his propensity to engage in high risk investment projects so as to transfer wealth from bondholders to stockholders 2

warrant exercise dividends and reinvestment policy in this paper we examine sequential exercise strategies by warrantholders and the gain from hoarding warrants we analyze several obstacles to acquiring large blocks in order to exploit sequential strategies first we identify several reinvestment policies for which sequential exercise is not advantageous thereby eliminating the gain from hoarding however sequential exercise strategies may be advantageous for monopoly or oligopoly warrantholders even absent dividends because using exercise proceeds to repurchase stock or to expand the firm s scale increases the riskiness of an equity share second oligopoly warrantholders can receive a smaller warrant value than perfectly competitive warrantholders suggesting a potential cost to unsuccessful hoarding

optimal leverage and aggregate investment we analyze the optimal financing of investment projects when managers must exert unobservable effort and can also switch to less profitable riskier ventures optimal financial contracts can be implemented by a combination of debt and equity when the risk shifting problem is the most severe while stock options are also needed when the effort problem is the most severe worsening of the moral hazard problems leads to decreases in investment and output at the macroeconomic level moreover aggregate leverage decreases with the risk shifting problem and increases with the effort problem

taxation agency conflicts and the choice between callable and convertible debt abstract we analyze debt choice in light of taxes and moral hazard the model features an infinite sequence of nonzero sum stochastic differential games between equity and debt closed form expressions are derived for all contingent claims if equity can increase volatility without reducing asset drift callable bonds with call premia are optimal although callable bonds induce risk shifting call premia precommit equity to less frequent restructuring and are tax advantaged convertible bonds mitigate risk shifting but only induce hedging if assets are far from the default threshold convertibles are optimal only if risk shifting reduces asset drift sufficiently

investment incentives debt and warrants abstract this paper models and characterizes investment incentive problems associated with debt financing the decision problem of residual claimants is explicity formulated and their investment policies are characterized the paper also analyzes the use of conversion features and warrants to control distortionary incentives these claims reverse the convex shape of levered equity over the upper range of the firm s earnings and this mitigates the incentive to take risk it is shown that under certain conditions such claims can be constructed to restore net present value maximizing incentives and simultaneously meet the financing requirements of the firm

corporate financial policy and the theory of financial intermediation this paper examines the optimal structure of financial contracts in an economy subject to two forms of moral hazard multiple information problems are shown to generate a role for multiple classes of financial claimants we then show that economic efficiency is enhanced if the financial structure of the economy consists of both direct and intermediated financial contract markets consequlently our results demonstrate a motivation for the complementarity between capital markets and depository financial institutions the purpose of this paper is to provide an analysis of the complementary roles of direct financial contract markets and intermediated financial contract markets in the modern theory of corporate finance the need to formulate such a model has been emphasized elsewhere by stiglitz 1985 and fama 1985 among others however an adequate explanation of this phenomenon has yet to be formulated the model described in this paper focuses on the role of multiple information problems in a theory of complex financial structure specifically in an environment with private action i e unobservable investment allocations and private information i e partially unobservable project cash flows multiple claimant classes arise to resolve the separate inefficiencies induced by moral hazard in our model the interaction of project risk and observability creates investment distortions which can be mitigated by increasing the number of outside claimant classes our results demonstrate explicitly the way in which a firm s optimal financial structure depends on the assumed configuration of an investment project s risk and observability characteristics under certain conditions we show that the optimal contractuai allocation in an economy with only direct financial contract markets consists of a debt contract and an outside equity claim this contractual configuration restores the efficient investment allocation decision we then consider the feasibility of an intermediated financial contract market in this setting we show that the existence of an intermediated financial contract market improves economic efficiency due to the reduced aggregate costs of

financial innovation and delegation of control the literature on security design has traditionally assumed that control of investment and production rests with the entrepreneur even after flotation in this article i relax this assumption which is both unnecessarily strict and unrealistic the contribution is twofold first i show that when control is delegated during flotation financial innovation is a trade off between agency costs arising from principal agent relationships and targeting costs arising from the inability to split the cash flow second i show that unlevered equity or the use of debt which can be issued without defaulting in equilibrium are optimal means of financing the strand of finance which deals with security design seeks to explain theoretically why certain contracts are used as means of corporate financing if there are zero costs of issuing securities we might well expect to find a myriad of contract designs empirically there are however just a few contract designs which seem to dominate namely debt and equity contracts it is the simple designs which appear to survive as understandably simplicity makes it easy to evaluate the risk of the securities within the class of simple contracts there still are unresolved theoretical issues however some of which i address in this paper perhaps the most puzzling aspect of corporate financing is why controlling securities have residual payoffs and non controlling securities have fixed payoffs this is puzzling in two respects first why is control associated with residual payoff and second why is risk not spread onto more than on security in particular it can be harmftlil to give controlling stakeholders too much discretion as it leads to agency costs green 1984 and risk sharing concerns would normally imply that splitting the risk giving a greater span in the market is the optimal route in this paper i investigate financial innovation in a context where both concerns apply and where indeed the optimal security structure has the properties observed the mnain reason for this which is also the point at which the paper distinguishes itself from most of the literature is that here the floatation is associated with delegation of control to the new owners in the market in particular i consider the problem of optimal security design for an entrepreneur who intends to float a firm when she must delegate the control of the firm to the new owners delegation of control implies two major concern for the entrepreneur first she seeks to design securities which take maximally advantage of existing investor clienteles in the economy as an example we can think of firms that increase their value by issuing tax efficient

investor protection and convertible debt design abstract an important issue that firms consider when designing convertible debt is to specify security features such as conversion ratio maturity date and call period following lewis et al lewis m rogalski r seward j 2003 industry conditions growth opportunities and market reactions to convertible debt financing decisions journal of banking and finance 27 153 181 we employ a single measure that simultaneously considers all of these features the expected probability measured at issue date that the convertible will be converted to equity at maturity we find that firms in countries with stronger shareholder rights issue convertible debt with a higher expected probability of converting to equity the positive association between the expected probability of conversion and shareholder rights is less pronounced in firms for which ownership structures create potentially high managerial agency costs specifically in countries with stronger shareholder rights firms with higher separation of control rights and cash flow rights tend to issue convertibles with lower probability of conversion furthermore we find that large non management block ownership strengthens the likelihood of issuing convertible debt with higher probability of conversion in countries with stronger shareholder rights in contrast firms in countries with stronger creditor rights issue convertibles with lower probability of conversion we also document that the negative association between creditor rights and probability of conversion is more pronounced in firms with higher separation of control rights and cash flow rights

ex ante costs of violating absolute priority in bankruptcy a basic question for the design of bankruptcy law concerns whether value should be divided in accordance with absolute priority research done in the past decade has suggested that deviations from absolute priority have beneficial ex ante effects in contrast this paper shows that ex post deviations from absolute priority also have negative effects on ex ante decisions taken by shareholders such deviations aggravate the moral hazard problem with respect to project choice increasing the equityholders incentive to favor risky projects as well as with respect to borrowing and dividend decisions