the evolving landscape of banking the structure of the financial services industry is in flux liberalization deregulation and advances in information technology have changed the financial landscape dramatically interbank competition has heated up and banks face increasing competition from nonbanking financial institutions and the financial markets the predictability of the industry with low levels of financial innovation little innovation in distribution channels and well defined and rigid institutional structures is gone product innovations new distribution channels and emerging new competitors are in abundance moreover the subprime crisis that has hit the financial sector in 2007 2008 appears to have a major impact on the structure of the industry this article emphasizes the importance of understanding the economics of banking for assessing the changes in the industry in particular we point at relationship banking as a prime source of the banks comparative advantage the proliferation of transaction oriented banking trading and financial market activities does however seriously challenge relationship banking in order to focus on these issues in a rigorous way we will evaluate the key insights from the relationship banking literature including the potential complementarities and conflicts of interest between intermediated relationship banking activities and financial market underwriting securitization etc activities we also address the issue of the optimal conglomeration of bank activities including the empirical evidence on scope and scale economies we analyze the strategic positioning of banks in the currently highly uncertain competitive arena and link this to the theory of the firm and particularly firm boundaries and learning

collateral and credit rationing a review of recent empirical studies as a guide for future research abstract the relationship between firms and banks often suffers from informational opacity that may result in credit rationing in theory providing collateral to the bank can have a mitigating effect on these informational asymmetries and thus solve the credit rationing problem even though collateral is already a widespread debt contract feature recent trends predict that in the future collateral will become even more important for informationally opaque firms the aim of this paper is twofold first we provide a review of the recently growing empirical research on collateral as a remedy for credit rationing second we would like to pinpoint gaps and limitations in current empirical research most studies contend with a flawed research design by not distinguishing between business and personal collateral and excluding other information opaqueness reducing tools such as the strength of the relationship between borrower and lender loan maturity and covenants we also discuss the limitations of using a single equation estimation method and the usefulness of incorporating interaction effects into the estimation models finally we provide suggestions for fruitful research avenues that would fill these gaps and enrich the empirical knowledge in this research domain

monitoring liquidation and security design by identifying the possibility of imposing a credible threat of liquidation as the key role of informed bank finance in a moral hazard context we characterize the circumstances under which a mixture of informed and uninformed market finance is optimal and explain why bank debt is typically secured senior and tightly held we also show that the effectiveness of mixed finance may be impaired by the possibility of collusion between the firms and their informed lenders and that in the optimal renegotiation proof contract informed debt capacity will be exhausted before appealing to supplementary uninformed finance article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

why is bank debt senior a theory of asymmetry and claim priority based on influence costs this theory can explain why bank debt is universally senior consistent with the presence of conflict lawyers and absolute priority violations in financial distress better organized banks would more strongly contest priority in financial distress if they were junior because deterrence can reduce creditors total expenses in a priority contest the ex post stronger lobbyist litigant should be senior ex ante for equivalent reasons the theory can advise when public debt should be senior to trade credit and or implicit contracts and can even suggest one rationale for the absolute priority rule apr this article further shows that chapter hi creditor reimbursement procedures can lower overall costs article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

special purpose entities and bank loan contracting abstract in this study we show that a firm s use of special purpose entities spes is associated with unfavorable loan contract terms including higher loan rates collateral requirements and restrictive covenants further analyses suggest that the association between the use of spes and unfavorable loan contract terms is primarily due to the increase in the information risk faced by lenders as firm managers can easily use spes to manipulate earnings and hide losses specifically we find that the use of spes has a more pronounced effect on increasing the cost of loans and causing more stringent non price loan terms when managers have a stronger incentive to manipulate earnings and when banks have less knowledge about the spe sponsor firms due to the lack of prior lending relationship in addition we find that the use of spes is associated with a greater likelihood of accounting restatements and greater information asymmetry between inside managers and outside capital suppliers

do banks provide financial slack we study the decision to choose bank debt rather than public securities in a firm s marginal financing choice using a sample of 500 firms over the 1980 to 1993 time period we find that firms are relatively more likely to choose bank loans when variables that measure asymmetric information problems are elevated the sensitivity of the likelihood of choosing bank debt to information problems is greater for firms with no public debt outstanding these results are consistent with the hypothesis that banks help alleviate asymmetric information problems and that firms weigh these information benefits against a wide range of contracting costs when choosing bank financing why do some firms borrow from public sources while others rely exclusively on private lenders the answer to this question is not well understood existing theories suggest that a firm must consider the tradeoff between the benefits and costs of bank debt financing relative to other potential financing choices the potential benefits of bank financing include low moral hazard and adverse selection costs and ease of renegotiation in financial distress 1 the potential costs of bank financing include monitoring costs suboptimal liquidation outcomes and distortions induced by information monopolies 2 the goal of this paper is to identify whether adverse selection problems influence a firm s choice between new bank debt public debt or common stock in particular we are interested in assessing the empirical validity of the hypothesis that banks have the ability to accurately price a firm s claims thus inducing a preference for firms that are undervalued by the market to

financing constraints and reordering rules abstract constraints on external finance modify a simple inventory investment decision optimal policy is no action when cash holdings are less than threshold levels the control boundaries which are functions of the current level of inventories on the control boundaries additional cash is used for inventory replenishment when inventory holdings are below the level which would be held in the absence of financing constraints and for dividend payment when inventory holdings are equal to or exceed this level a fixed boundary at all inventory levels is used as an approximation to the fully optimal control allowing computation of the behaviour of aggregate inventory and cash holdings for a population of financially constrained firms there is a pronounced and extended dynamic response from inventory investment following aggregate disturbances to cash holdings to prices and to the standard error of the diffusion process for cash holdings this contrasts with the unconstrained case where such shocks have no effect on either inventory holdings or inventory investment

the economics of small business finance the roles of private equity and debt markets in the financial growth cycle abstract this article examines the economics of financing small business in private equity and debt markets firms are viewed through a financial growth cycle paradigm in which different capital structures are optimal at different points in the cycle we show the sources of small business finance and how capital structure varies with firm size and age the interconnectedness of small firm finance is discussed along with the impact of the macroeconomic environment we also analyze a number of research and policy issues review the literature and suggest topics for future research

the role of games in security design we contend that security design should be approached as a problem of game design that is contracts should specify the procedures that govern the behavior of contract participants in determining outcomes as well as the allocations resulting from those outcomes we characterize optimal contracts in two nested classes all contracts including those that depend on the state and state independent contracts we demonstrate that in situations in which the dependence of contracts on the state is limited contracts designed as games can improve the allocation of resources relative to nonstrategic allocation rules article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

business collateral and personal commitments in sme lending abstract using a database of sme credit approvals from a large belgian bank this paper extends the empirical evidence on the determinants of collateral by examining the determinants of business collateral simultaneously with the determinants of personal collateral commitments our results suggest that firm and relationship characteristics seem to be more important determinants of collateral commitment protection than loan and lender characteristics family firms are more likely to offer a higher degree of collateral commitment protection while introducing competition between banks decreases this likelihood the collateral requirement decreases in the length of the bank borrower relationship furthermore trade credit seems to have a signalling effect the lazy banks hypothesis was not supported our results suggest that beside risk arguments also commercial arguments help explain the pledging of collateral using a continuation ratio logit model we discover several differences in the determinants of the collateralisation decision and the determinants of the type of collateral commitments

bank information monopolies and the mix of private and public debt claims this article examines the determinants of the mix of private and public debt using detailed information on the debt structure of 250 publicly traded corporations from 1980 through 1990 we find that the relationship between bank borrowing and the importance of growth opportunities depends on the number of banks the firm uses and whether the firm has public debt outstanding for firms with a single bank relationship the reliance on bank debt is negatively related to the importance of growth opportunities in contrast among firms borrowing from multiple banks the relationship is positive

is there a safety premium in the design of corporate bond contracts this study examines empirically whether there is a safety premium in the design of bond contracts by highlighting a safety attribute of general mortgage bonds in japan which can give especially st

taxes and pensions pension benefit rules depend on individual history far more than taxes do and age plays a much larger role in pension determination than in tax determination apart from some simulation studies theoretical studies of optimal tax design typically contain neither a mandatory pension system nor the behavioral dimensions that lie behind justifications commonly offered for mandatory pensions conversely optimizing models of pension design typically do not include annual taxation of labor and capital incomes after spelling out this contrast and reviewing and rejecting zero taxation of capital income based on the atkinsonstiglitz and chamley judd results this article raises the issue of tax favored retirement savings a topic where the two subjects come together when i was a young economist i thought methodology was uninteresting and unnecessary just something old guys did when they didn t have anything better to do i taught theory and public finance and the applied theory i did was with an eye on relevance for policy questions although i had had almost no experience with thinking about policy just a summer job with the council of economic advisors under president kennedy now that i am at a stage where methodology is age appropriate i think it is important some of this comes from the natural aging process and some comes from my extended involvement in various policy processes primarily about pensions not taxes in particular i am concerned that too many economists take the findings of individual studies literally as a basis for policy thinking rather than seeking inferences from an individual study to be combined with inferences from other studies that consider other aspects of a policy question as well as with intuitions about aspects of policy that are not in the models to me taking a model literally is not taking the model seriously it is worth remembering that models are incomplete indeed that is what it means to be a model we construct multiple models to highlight different aspects of an issue so thinking thoroughly about policy calls for thinking through multiple models and requires recognizing issues that have not made it into any of the

control rights and capital structure an empirical investigation we show that incentive conflicts between firms and their creditors have a large impact on corporate debt policy net debt issuing activity experiences a sharp and persistent decline following debt covenant violations when creditors use their acceleration and termination rights to increase interest rates and reduce the availability of credit the effect of creditor actions on debt policy is strongest when the borrower s alternative sources of finance are costly in addition despite the less favorable terms offered by existing creditors borrowers rarely switch lenders following a violation a fundamental question in financial economics is how do firms choose their financial policies extant empirical research on this question has focused primarily on the presence of taxes and bankruptcy costs e g scott 1976 information asymmetry e g myers and majluf 1984 and more recently market timing behavior e g baker and wurgler 2002 however beginning with jensen and meckling 1976 a large body of theoretical research examines how incentive conflicts between managers and external investors affect corporate financial policies in particular theoretical research on financial contracting shows that in the presence of incentive conflicts optimal debt contracts will allocate certain rights to creditors after negative performance in order to help firms secure financing ex ante e g aghion and bolton 1992 and dewatripont and tirole

covenants in venture capital contracts this paper studies how covenants are included in contracts between venture capitalists vcs and entrepreneurs i show that vcs hold covenanted veto rights even though they are shareholders who have access to other powerful governance solutions unlike bank loans and bonds venture capital vc contracts exhibit considerable variation in their contractual designs i exploit this variation to confirm the argument that covenants are in place to overcome a conflict of interest that arises from debt like contractual features of a venture capitalist s preferred stock in particular i find that contracts with higher fixed payoffs include 1 6 more covenants than do contracts with lower fixed payoffs similarly vc contracts with no vc board majority requirement include 0 6 more covenants than do contracts that require a vc board majority covenants are also more common with older companies and when fewer vcs invest in a round my findings contribute to both the debt covenant literature and the entrepreneurial finance literature this paper was accepted by brad barber finance

bank competition and credit standards this article offers an explanation for the substantial variation of credit standards and price competition among banks over the business cycle as the economic outlook improves the average default probabilities of borrowers decline this affects the profitability of screening and causes bank screening intensity to display an inverse u shape as a function of economic prospects low screening activity in expansions creates intense price competition among lenders and loans are extended to lower quality borrowers as the economic outlook worsens price competition diminishes and credit standards tighten significantly deposit insurance may contribute to the countercyclical variation of credit standards copyright 2004 oxford university press

firm behaviour under the threat of liquidation abstract we study the optimal behaviour of a firm whose cash flow is determined by a diffusion process facing liquidation if internal cash balances fall below some threshold there is a conflict between the desire to pay dividends to satisfy shareholders and the need to retain cash as a barrier against possible liquidation stochastic optimal control characterises the value function and gives optimal decision rules for the firm the firm has a precautionary motive for retaining earnings the internal cost of funds and local risk aversion are both decreasing functions of cash held and in natural extensions to our model output and investment are both increasing functions of cash balances

seniority and maturity of debt contracts abstract this paper provides a model of how borrowers with private information about their credit prospects choose seniority and maturity of debt increased short term debt leads lenders to liquidate too often it also increases the sensitivity of financing costs to new information although better than average borrowers desire information sensitivity the model implies that short term debt will be senior to long term debt and that long term debt will allow the issue of additional future senior debt the model also has implications on the structure of leveraged buyouts and on how various types of lenders respond to potential defaults

short term corporate debt around the world short term corporate debt as a proportion of total debt issued by public firms varies greatly across countries between 28 in the united states and 78 in china this paper argues that the interaction between information asymmetry and legal protection of creditors is an important determinant of debt maturity when short term debt plays a dual role as signaling and commitment devices a reduction in information asymmetry has a larger impact on debt maturity when creditor rights are weaker we find empirical support for this prediction using firm level data from 45 countries around the world

loan collateral decisions and corporate borrowing costs we examine the relation between borrowing costs and the presence of loan collateral we find the presence of collateral increases with default risk consistent with low quality borrowers reducing their risks and borrowing costs through the use of collateral by explicitly controlling for the interdependence between the decision to pledge collateral and borrowing costs we find that secured loans have predicted spreads substantially lower than if they had been made on an unsecured basis alternatively loans made on an unsecured basis have spreads not substantially different from if they had been secured the evidence suggests that collateral pledging decisions are generally consistent with borrowing cost minimization

specialization productivity and financing constraints we analyze optimal financial contracts when the specificity of investments is endogenous specialization decreases the liquidation value of assets but improves the asset s long term productivity while the former is known to make financing more difficult we show that the latter can ease financing constraints and increase financing capacity by improving an entrepreneur s incentive to repay the overall impact of specialization on the terms of financing depends on which effect is more important specialization decisions interact with the nature of investments their timing the need for outside financing and an entrepreneur s ability to commit to a level of specialization the author 2013 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

multiple lenders and corporate distress evidence on debt restructuring multiple banking is a common characteristic of the corporate lending particularly of medium sized and large firms however if the firms are facing distress multiple lenders may have serious coordination problems as has been argued in the theoretical literature in this paper we analyse the problems of multiple banking in borrower distress empirically we rely on a unique panel data set that includes detailed credit file information on distressed lending relationships in germany in particular it includes information on bank pools a legal institution aimed at coordinating lender interests in distress we find that the existence of small pools increases the probability of workout success and that this effect reverses when pools become large we identify major determinants of pool formation in particular the number of banks the distribution of lending among banks and the severity of the distress copyright 2008 wiley blackwell

what s different about banks abstract negotiable certificates of deposit cd s trade in the capital market in competition with other securities like commercial paper and bankers acceptances if cd s must pay lenders competitive monetary interest the reserve tax on cd s is borne by bank borrowers viability of the tax means there must be something special about bank loans that makes some borrowers willing to pay higher interest rates than those on other securities of equivalent risk moreover there must be something special about banks that prevents other intermediaries from competing to assure that it never pays to finance loans with cd s

discussion of the effects of corporate governance on firms credit ratings abstract ashbaugh skaife collins and lafond 2006 the effects of corporate governance on firms credit ratings journal of accounting and economics this issue find that better governed firms receive better credit ratings and poor governance costs the median speculative grade firm 38 million in excess interest they also find that managers choose to be poorly governed to expropriate wealth the results from the primary analysis are persuasive leaving little doubt on whether ratings agencies value corporate governance however the authors estimate of the economic costs of poor governance is likely to be overstated despite the evidence on the costs of poor governance the final analysis leaves the question as to why firms choose to be poorly governed largely unanswered

fear anger and credit on bank robberies and loan conditions we study the impact of emotions on real world decisions made by loan officers by analyzing the loan conditions of loans granted immediately after a bank branch robbery we find significant differences in conditions of the loans granted after a robbery compared to changes in loan conditions that occur contemporaneously at unaffected branches in general loan officers seem to adopt so called avoidance behaviour in accordance with the literature on posttraumatic stress their avoidance behavior is halved within two weeks after the robbery and the effect further varies depending on the presence of a firearm during the robbery

real flexibility and financial structure an empirical analysis i examine the empirical relation between real flexibility and financial structure i test whether real flexibility increases debt capacity by lowering default risk and making assets more marketable or decreases debt capacity by facilitating risk shifting and asset substitution i measure real flexibility as the sensitivity of marginal production and investment decisions to variations in the economic environment i find that financial leverage is negatively related to production flexibility but positively related to investment flexibility this split in results suggests that although asset substitution facilitated by investment flexibility can be prevented contractually risk shifting facilitated by production flexibility is intractable copyright 2003 oxford university press

the structure of multiple credit relationships evidence from u s firms when firms borrow from multiple concentrated creditors such as banks they appear to differentiate their allocation of borrowing in this paper we put forward hypotheses for this borrowing pattern based on incomplete contract theories and test them using a sample of small u s firms we find that firms with more valuable and more homogeneous assets differentiate borrowing more sharply across concentrated creditors moreover borrowing differentiation is inversely related to restructuring costs and positively related to firms informational transparency the results suggest that the structure of credit relationships is used to discipline creditors and entrepreneurs especially during corporate reorganizations

covenants and collateral as incentives to monitor although monitoring borrowers is thought to be a major function of financial institutions the presence of other claimants reduces an institutional lender s incentives to do this thus loan contracts must be structured to enhance the lender s incentives to monitor covenants make a loan s effective maturity and the ability to collateralize makes a loan s effective priority contingent on monitoring by the lender thus both covenants and collateral can be motivated as contractual devices that increase a lender s incentive to monitor these results are consistent with a number of stylized facts about the use of covenants and collateral in institutional lending modern finance theory suggests that financial intermediaries such as commercial banks insurance companies and finance companies monitor and control their borrowers on behalf of other investors 1 this article investigates how the loans made by these institutions can be structured so as to best enhance the institutions role as delegated monitors covenants and collateral are common features of loans made by financial institutions but these features are somewhat difficult to justify consider loan covenants clauses in a loan contract that require the borrower to take or refrain from various actions berlin and mester 1992 magee and sridhar 1994 and park 1994 show that by giving institutions the right to renegotiate or call loans when covenants are violated covenants serve as tripwires that enhance the flexibility and efficiency of financial contracting also as documented in smith and warner 1979 control rights from covenants reduce borrower adverse selection or moral hazard nevertheless by allowing institutions to demand repayment based on any information contractible or not

collateral type of lender and relationship banking as determinants of credit risk abstract this paper analyses the determinants of the probability of default pd of bank loans we focus the discussion on the role of a limited set of variables collateral type of lender and bank borrower relationship while controlling for the other explanatory variables the study uses information on the more than three million loans entered into by spanish credit institutions over a complete business cycle 1988 2000 collected by the bank of spain s credit register central de informacion de riesgos we find that collateralised loans have a higher pd loans granted by savings banks are riskier and finally that a close bank borrower relationship increases the willingness to take more risk

secured lending and default risk equilibrium analysis policy implications and empirical results the authors examine collateral in a competitive equilibrium in which borrowers can choose hidden actions and may additionally possess hidden knowledge apart from explaining the widespread use of collateral despite deadweight costs they show that an increase in the riskless interest rate causes equilibrium loan rates and collateral requirements to increase a decline in the deadweight costs of collateral reduces the equilibrium collateral use under moral hazard and an increase in the borrower s project size reduces equilibrium collateral use under moral hazard some of these predictions are tested and found to be supported by the data copyright 1991 by royal economic society

conflicts in bankruptcy and the sequence of debt issues this paper investigates the optimal sequencing of debt issues our theoretical model suggests that once firms issue debt with one level of seniority they may have an incentive to alternate seniorities because of violations of the priced absolute priority rule apr when we introduce explicit costs of class conflict the model yields cases of alternating seniorities and other cases in which firms issue only one class of debt the implications of the model are consistent with the observed regularities in a large database of debt issues we test several other implications of our model as well

the paradox of pledgeability abstract we develop a model in which collateral serves to protect creditors from the claims of other creditors we find that paradoxically borrowers rely most on collateral when pledgeability is high this is when taking on new debt is easy which dilutes existing creditors creditors thus require collateral for protection against possible dilution by collateralized debt there is a collateral rat race but collateralized borrowing has a cost it encumbers assets constraining future borrowing and investment there is a collateral overhang our results suggest that policies aimed at increasing the supply of collateral can backfire triggering an inefficient collateral rat race likewise upholding the absolute priority of secured debt can exacerbate the rat race

the design of bank loan contracts the unique characteristics of bank loans emerge endogenously to enhance efficiency in a model of renegotiation between a borrower and a lender in which there is the potential for moral hazard on each side of the relationship firm risk is endogenous and renegotiated interest rates on the debt need not be monotone in firm risk the initial terms of the debt are not set to price default risk but rather are set to efficiently balance bargaining power in later renegotiation loan pricing may be nonlinear involving initial transfers either from the borrower to the bank or front the bank to the borrower article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

financial crises and the composition of cross border lending abstract we examine the composition and drivers of cross border bank lending between 1995 and 2012 distinguishing between syndicated and non syndicated loans we show that on balance sheet syndicated loan exposures which account for almost one third of total cross border loan exposures increased during the global financial crisis due to large drawdowns on credit lines extended before the crisis our empirical analysis of the drivers of cross border loan exposures in a large bilateral dataset leads to three main results first banks with lower levels of capital favor syndicated over other kinds of cross border loans second borrower country characteristics such as level of development economic size and capital account openness are less important in driving syndicated than non syndicated loan activity suggesting a diversification motive for syndication third information asymmetries between lender and borrower countries became more binding for both types of cross border lending activity during the recent crisis

estimating the benefits of contractual completeness i provide a revealed preference based framework that uses covenant prices and choices to quantitatively study how covenants generate firm benefits by completing debt contracts i use a rational expectations based panel estimator of covenant prices which does not require quasi experimental variation to circumvent the problem of endogenous covenant choices i find that firms surpluses exceed the spread paid on a loan leverage and interest rate covenants produce the largest benefits lending quantitative credence to several standard theories of covenants once covenants are chosen the benefits from fine tuning them are small thus rationalizing boilerplate covenants i conclude by discussing the extensions and limitations of my method the author 2013 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

performance pricing in bank debt contracts abstract performance pricing links bank debt interest rate spreads to a borrower s performance via two options interest decreasing performance pricing reduces spreads if credit quality improves it is more common when prepayment is more likely or costly and when adverse selection costs are higher and is less common when multiple performance measures better predict credit quality interest increasing performance pricing increases spreads if credit quality deteriorates it is more common when lenders reduce interest rates to add this provision when downgrades are more likely and when moral hazard costs are higher we find lower spreads for contracts with interest increasing performance pricing

does information sharing reduce the role of collateral as a screening device this is the authors accepted refereed and final manuscript to the article publisher s version available at http dx doi org 10 1016 j jbankfin 2014 02 010

debt priority structure market discipline and bank conduct we examine how debt priority structure affects bank funding costs and soundness leveraging an unexplored natural experiment that changes the priority of claims on banks assets we document asymmetric effects that are consistent with changes in monitoring intensity by various creditors depending on whether creditors move up or down the priority ladder the enactment of depositor preference laws which confer priority on depositors reduces deposit rates but increases non deposit rates importantly subordinating non depositor claims reduces bank risk taking consistent with market discipline this insight highlights a role for debt priority structure in the regulatory framework

short term loans and long term relationships relationship lending in early america recent banking theory holds that durable firm bank relationships are valuable to both parties this paper uses the contract specific loan records of a 19th century u s bank and shows that firms with extended relationships received three principal benefits first firmswith extended relationships had lower credit costs second long term customers provided fewer personal guarantees which were an alternative to collateral third long term customers were more likely to have loan terms renegotiated during a credit crunch these findings support theories that banks realize cost advantages through the use of proprietary information

financial intermediation and delegated monitoring this paper develops a theory of financial intermediation based on minimizing the cost of monitoring information which is useful for resolving incentive problems between borrowers and lenders it presents a characterization of the costs of providing incentives for delegated monitoring by a financial intermediary diversification within an intermediary serves to reduce these costs even in a risk neutral economy the paper presents some more general analysis of the effect of diversification on resolving incentive problems in the environment assumed in the model debt contracts with costly bankruptcy are shown to be optimal the analysis has implications for the portfolio structure and capital structure of intermediaries

risk shifting through nonfinancial contracts effects on loan spreads and capital structure of project finance deals we study capital structure negotiation and cost of debt financing between sponsors and lenders using a sample of more than 1 000 project finance loans worth around us 195 billion closed between 1998 and 2003 we find that lenders i rely on the network of nonfinancial contracts as a mechanism to control agency costs and project risks ii are reluctant to price credit more cheaply if sponsors are involved as project counterparties in the relevant contracts and finally iii do not appreciate sponsor involvement as a contractual counterparty of the special purpose vehicle when determining the level of leverage

income taxation with intergenerational mobility can higher inequality lead to less progression abstract we introduce the notion of social mobility into an optimal income tax model this is done by allowing earning abilities to be partly innate and partly acquired through investments in human capital education the implications for the optimal re distributive policy are studied

capital structure and debt structure using a novel dataset that records individual debt issues on the balance sheets of public firms we demonstrate that traditional capital structure studies that ignore debt heterogeneity miss substantial capital structure variation relative to high credit quality firms lowcredit quality firms are more likely to have a multi tiered capital structure consisting of both secured bank debt with tight covenants and subordinated non bank debt with loose covenants we discuss the extent to which these findings are consistent with existing theoretical models of debt structure in which firms simultaneously use multiple debt types to reduce incentive conflicts jel g32

the information content of distressed restructurings involving public and private debt claims abstract this paper examines debt restructurings by financially distressed firms we develop a model which predicts that in public debt exchange offers firms with unfavorable private information will offer equity claims to convince bondholders that the firm s prospects are poor in contrast offering equity to well informed private lenders conveys favorable private information to outsiders consistent with our analysis we find positive average abnormal returns around restructurings that offer equity to private lenders and senior debt to public debtholders and we find significant negative average abnormal returns when private lenders are offered senior debt and public lenders are offered equity

bank capital and credit market competition will competitive pressure lead to higher capital levels abstract this paper establishes a theoretical model to study the relationship between credit market competition and bank capital in the model bank capital can alleviate the debt overhang problem and the extent to which banks can enjoy the gain of holding capital is decreasing in the competitive pressure in the credit market it is shown that credit market competition reduces banks incentive to hold capital deposit insurance also induces banks to hold less capital in addition bank capital regulation is welfare improving and banks may voluntarily hold capital in excess of regulatory minimums

bridging the gap the design of bank loan contracts and distance how do the distance constraints faced by lenders in acquiring borrower information affect the design of bank loan contracts theoretical studies posit that greater information asymmetry leads to the allocation of stronger ex ante decision rights to the lender the uninformed party consistent with this hypothesis we find that upon inception contracts tend to be more restrictive when firms seek loans from remote lenders this finding is robust to potential endogeneity bias and simultaneity of various loan terms overall we establish a strong informational link between distance and loan contract design

optimal taxation of bequests in a model with initial wealth we formulate an optimal taxation model where parents leave bequests to their descendants for altruistic reasons in contrast to the standard model individuals differ not only in earning abilities but also in initial inherited wealth in this model a redistributive motive for an inheritance tax which is equivalent to a uniform tax on all expenditures arises given that initial wealth increases with earning abilities the introduction of the inheritance tax either increases intertemporal social welfare or has an ambiguous effect depending on whether the external effect related to altruism is accounted for in the social objective

fraudulent claims and nitpicky insurers insurance fraud is a major source of inefficiency in insurance markets a self justification of fraudulent behavior is that insurers are bad payers who start nitpicking if an opportunity arises even in circum stances where the good faith of policyholders is not in dispute we relate this nitpicking activity to the inability of insurers to commit to their auditing strategy reducing the indemnity payments acts as an incentive device for the insurer since auditing is profitable even if the claim is not fraudulent we show that optimal indemnity cuts are bounded above and that nitpicking remains optimal even if it induces adverse effects on policyholders moral standards

monitoring and structure of debt contracts this paper presents a theory of optimal debt structure when the moral hazard problem is severe the main idea is that the optimal debt contract delegates monitoring to a single senior lender and that seniority allows the monitoring senior lender to appropriate the full return from his monitoring activities the theory explains i why debt contracts are prioritized ii why short term debt is senior to long term debt and iii why financial intermediaries usually hold short term senior debt whereas long term junior debt is widely held another implication of the theory is that covenant and maturity structures will be set to conform to the seniority structure

debt and communications technology diffusion retrospective evidence this study has evaluated the relationship between debt in the capital structure of firms and the dynamics of broadband and digital technology adoption in the united states based on a large dataset on local exchange carriers in the united states over a contemporary historical fourteen year period from 1988 to 2001 using treatment effects modeling the impact of debt in impacting the levels of firms broadband deployment has been found to be negative and significant the primary source of debt in the sector has been in the form of arm s length corporate bonds and the assumptions of the monitoring hypothesis associated with such debt that lenders in the face of information and collective actions problems might not be able to control managers and hence invest less in highly technology intensive situations are supported by the data additionally the data set has been split into separate sets for two periods one between 1988 and 1995 for the period before the telecommunications act of 1996 came into force and the other set between 1996 and 2001 and the results have stayed consistent a test of the coefficients between the two periods has shown that the negative impact of leverage on broadband deployment has become stronger after the introduction of competition in the sector and this has suggested that the change in the institutional logics between the two periods has been of material impact in influencing lenders perceptions

executive compensation and the maturity structure of corporate debt executive compensation influences managerial risk preferences through executives portfolio sensitivities to changes in stock prices delta and stock return volatility vega large deltas discourage managerial risk taking while large vegas encourage risk taking theory suggests that short maturity debt mitigates agency costs of debt by constraining managerial risk preferences we posit and find evidence of a negative positive relation between ceo portfolio deltas vegas and short maturity debt we also find that short maturity debt mitigates the influence of vega and delta related incentives on bond yields overall our empirical evidence shows that short term debt mitigates agency costs of debt arising from compensation risk

capital market access and corporate loan structure in this article we use a sample of 14 075 loan packages issued between 1993 and 2007 to examine if borrower access to external capital markets influences corporate loan structure we classify firms into three access categories private unrated public and rated public private firms have the lowest access and to date no large sample investigation of their loans has been done in the literature rated public firms access the capital markets the most we find the level of access influences loan structure in ways that are consistent with having greater or fewer financing alternatives as well as theories on information asymmetry agency and monitoring in particular loans to firms with higher levels of access have shorter maturities fewer loan facilities per package and a lower probability of being secured we also find that a higher level of access results in a higher incidence of single lender loans but among multiple lender loans it leads to a larger number of lenders furthermore we find evidence

collateral and rationing sorting equilibria in monopolistic and competitive credit markets the authors examine how market structure affects credit allocation under universal risk neutrality and asymmetric information about borrowers they consider both monopolistic and perf ectly competitive banks and examine the role of collateral in each ca se when a bank is a monopolist on the loan side they find collatera l is never used and asymmetric information results in reduced bank le nding under perfect competition collateral has a useful sorting rol e moreover rationing is possible even with collateral availability and perfectly elastic deposit supply in this setting the authors sh ow co signers are valuable social welfare properties of the monopoly and competitive equilibria are also compared copyright 1987 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

the design of internal control and capital structure we study the design of internal control and capital structure we pose the question when is control allocated only to shareholders and when is it allocated to other stakeholders such as debtholders or the management team we show that shareholders debtholders get control when the firm s cash flow is relatively sensitive insensitive to managerial effort our theory implies that the signs of the correlations between endogenous variables when shareholders have absolute control are reversed when debtholders have veto power in particular debt level and firm value are negatively positively correlated when debtholders have veto power shareholders have absolute control article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

estimation of rating class transition probabilities with incomplete data abstract this paper shows that the well known duration and cohort methods for estimating transition probabilities of external bond ratings are not suitable for internal rating data more precisely the duration method cannot and the cohort method should not be used in connection with banks ratings generated from internal models structural differences within the borrower monitoring process of banks and rating agencies are responsible for this result a maximum likelihood ml estimation procedure which accounts for the peculiarities of internal bank ratings is introduced and applied to data from a german bank the empirical results indicate that the differences between cohort and ml transition matrices are both statistically and economically significant furthermore evidence of rating reversals business cycle dependent transition probabilities and on the factors which determine the borrower monitoring intensity of banks is provided

capital income taxation and the atkinson stiglitz theorem abstract accounting for the role of financial system and money holdings in an optimal nonlinear income tax model we argue that capital income taxation is a non redundant policy tool even if individual preferences are separable between leisure and other goods

fear of fire sales illiquidity seeking and credit freezes is there any need to clean up a banking system in the midst of a crisis for instance by closing some weak banks and forcing others to sell bad assets or can one wait till the crisis is over we argue that an overhang of impaired banks that may be forced to sell assets in the future can increase the private returns to holding illiquid assets sufficiently that weak banks have no interest in selling them anticipating a potential future fire sale cash rich buyers have high expected returns to holding cash which also reduces their incentive to lock up money in term loans the potential for a worse fire sale than necessary as well as the associated decline in credit origination could make the crisis worse which is one reason it may make sense to clean up the system even in the midst of the crisis we discuss alternative ways of cleaning up the system and the associated costs and benefits

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

financial capacity and output fluctuations in an economy with multi period financial relationships this paper motivates a financial propagation mechanism in the context of an intertemporal production economy with asymmetric information and with borrowers and lenders who enter multi period financial relationships a key feature is that aggregate output and borrowers financial capacity the maximum overhang of past debt they may feasibly carry are determined jointly much in the spirit of gurley and shaw 1955 expectations of future economic conditions govern financial capacity which in turn may constrain current production especially in bad times a small but persistent shift in aggregate conditions may have a large impact on financial capacity making the framework capable of motivating large endogenous fluctuations in financial constraints understanding how small disturbances can induce large output fluctuations is an on going quest in macroeconomics this paper develops a simple framework in which shifts in aggregate economic fundamentals are amplified through their impact on financial conditions a distinguishing feature is that output and borrowers financial capacity the maximum overhang of past debt they may feasibly carry are determined jointly much in the spirit of gurley and shaw 1955 expectations of future economic conditions govern financial capacity and financial capacity may constrain current production especially in bad times a number of recent papers have resurrected the view that financial factors may play a part in propagating business fluctuations the underlying theories exploit the idea that with asymmetric information between borrowers and lenders agency costs may drive the price of uncollateralized external funds above the price of internal funds in this kind of setting a borrower s financial position is a key determinant of the terms of credit she faces in the aggregate swings in borrower balance sheets over the cycle amplify fluctuations in investment and output essentially by inducing counter cyclical movements in the required premium for external finance this simple mechanism is broadly consistent with informal descriptions of how financial and real variables interacted in the great depression bernanke 1983 and in the postwar business cycles eckstein and sinai 1986 in addition numerous recent panel data studies beginning with fazzari hubbard and peterson 1988 support the notion of a financial investment accelerator mechanism

bank skin in the game and loan contract design evidence from covenant lite loans in a model of dual agency problems where borrower lender and bank nonbank incentives may conflict we predict a hockey stick relation between bank skin in the game and covenant tightness as bank participation declines covenant tightness increases until reaching a low threshold at which point the relation sharply reverses and covenant protection is removed with a commensurate increase in spread we find support for the hockey stick relation with bank s stake in covenant lite loans averaging 8 0 median we also find that covenant lite loans are more likely when borrower moral hazard is less severe and when bank relationship rents are high

the paradox of liquidity the more liquid a firm s assets the greater their value in a short notice liquidation it is generally thought that a firm should find it easier to raise external finance against more liquid assets this paper focuses on the dark side of liquidity greater asset liquidity reduces the firm s ability to commit to a specific course of action as a result greater asset liquidity can in some circumstances reduce the firm s capacity to raise external finance firms with excessively liquid assets are in the best position to finance illiquid projects this leads us to a theory of financial intermediation and disintermediation based on the liquidity of assets

competitive interest payments on bank deposits and the long run demand for money reply this paper tests two assumptions made in previous demand for money studies the first assumption concerns the role assigned to the interest rate in the demand for money function common practice identifies the rate of interest with the opportunity cost of holding money in section i this formulation is shown to blur an important distinction between the price of money and the price of money substitutes and to implicitly assume that the relevant price variable is the difference between these two distinct prices a second assumption is that the current ban on interest payments on demand deposits is fully effective in section ii i operationally define these price variables and estimate perfectly competitive interest payments on commercial bank deposits this is done by crudely measuring commercial bank marginal costs and assuming that all excess profit is passed on to depositors in indirect ways section iii presents estimates of a more complete longrun demand for money relationship which explicitly includes an own price and a cross price as separate influences and assumes that the prohibition of the payment of interest on deposits is totally ineffective although no firm conclusion is reached concerning the proper functional specification of the demand function the results significantly improve upon previous demand for money estimates which assumed that the interest payment prohibition is totally effective in section iv the results are summarized and implications of the analysis for monetary theory are presented my competitive demand for money formulation leads to a reinterpretation of the existing evidence on what is generally referred to as the interest elasticity of demand for money this estimate is shown to be significantly biased downward it also implies that the demand for and supply of money are more interdependent than is usually assumed

the determinants of contract terms in bank revolving credit agreements the paper examines the determinants of contract terms on bank revolving credit agree ments revolvers of medium large publicly traded companies we model the duration maturity secured status and pricing decisions within a simultaneous decision frame work thereby overcoming the biased and inconsistent estimates in prior single equation studies of debt contract terms we find strong interrelationships between contract terms with significant bi directional relationships between duration and secured status and be tween the all in spread and commitment fees and a unidirectional relationship from both duration and secured status to all in spread we also illustrate how several single equa tion studies of contract terms draw incorrect conclusions because of their inappropriate assumption that other contract terms and leverage were exogenous finally our results sup port the hypothesis that the setting of contract terms plays an important role in alleviating contracting problems

role of collateral and personal guarantees in relationship lending evidence from japan s sme loan market this paper investigates the determinants of the use of collateral and personal guarantees in japan s sme loan market we find that firms riskiness does not have a significant effect on the likelihood that collateral is used we find however that main banks whose claims are collateralized monitor borrowers more intensively and that borrowers who have a long term relationship with their main banks are more likely to pledge collateral these findings are consistent with the theory that the use of collateral is effective in raising the bank s seniority and enhances its screening and monitoring this incentive effect for the bank becomes tenuous for personal guarantees

subordinated debt market discipline and bank risk this paper demonstrates that subordinated debt subdebt thereafter regulation can be an effective mechanism for disciplining banks by reducing the chance that managers of distressed banks can take value destroying actions to benefit themselves subdebt regulation may encourage banks to lower asset risk moreover subdebt regulation and bank capital requirements can be complements for alleviating the banks moral hazard problems to make subdebt regulation effective regulators may need impose ceilings on the interest rates of subdebt prohibit collusion between banks and subdebt investors and require subdebt to convert into the issuing bank s equity when the government provides assistance to the bank

collateral and the choice between bank debt and public debt this paper tests how collateral value affects a firm s choice between bank debt and public debt by considering the exogenous variation in the market value of a firm s real estate assets caused by fluctuations in local real estate prices using local land supply elasticities as an instrument for local real estate prices i estimate that a one standard deviation increase in collateral value causes bank debt as a fraction of total debt to increase by six percentage points this paper was accepted by wei jiang finance

the benefits of lending relationships evidence from small business data this paper empirically examines how ties between a firm and its creditors affect the availability and cost of funds to the firm we analyze data collected in a survey of small firms by the small business administration the primary benefit of building close ties with an institutional creditor is that the availability of financing increases we find smaller effects on the price of credit attempts to widen the circle of relationships by borrowing from multiple lenders increases the price and reduces the availability of credit in sum relationships are valuable and appear to operate more through quantities rather than prices

on delineating supply chain cash flow under collectionrisk abstract the credit terms for accounts receivable ar offered by sellers to buyers not only create a time lag between supply chain physical flow and cash flow but also increase the collection risk contributed by late collection and default previous studies describing the relationship between the two major supply chain flows did not consider the collection risk which poses a serious challenge to companies with limited cash resources when seeking growth opportunities in sales this study first delineates the relationship between the two flows during a growth period without imposing any constraints a stochastic optimization model is then developed to observe the managerial implications of cash flow risk under tight cash constraints

redistribution with unobservable bequests a case for taxing capital income this paper addresses the question of the optimal taxation of labour and interest income in an overlapping generations model with two unobservable characteristics ability and inheritance we assume realistically that saving can only be taxed anonymously whereas the tax on labour earnings can be individualized and made non linear in such a setting we show that a withholding tax on interest income along with a non linear tax on labour income is desirable the role of interest income taxation is to indirectly tax inherited wealth

credit ratings collateral and loan characteristics implications for yield this article studies how collateral affects bond yields using a large data set of public bonds we document that collateralized debt has higher yield than general debt after controlling for credit rating our model of agency problems between managers and claim holders explains this puzzling result by recognizing imperfections in the rating process we test the model s implications consistent with our model and in results new to the literature we find the yield differential between secured and unsecured debt after controlling for credit rating is larger for low credit rating nonmortgage assets longer maturity and with proxies for lower levels of monitoring

capital income taxation when inherited wealth is not observable this paper extends the atkinson stiglitz model of direct and indirect taxation to a dynamic setting with two unobservable characteristics productive ability and inherited wealth bequests are motivated by the joy of giving a child s inheritance is a random variable with a probability distribution that depends on his parent s investment in a bequest technology public borrowing is assumed and implies the modified golden rule we study the optimal tax policy when two instruments are available a non linear wage income tax and a proportional tax on capital income we show that the second instrument ought in general to be used but that the tax rate is not necessarily positive however a positive tax rate is more likely when there is a positive correlation between inherited wealth and innate ability

a theory of debt and equity diversity of securities and manager shareholder congruence this paper shows how the optimal financial structure of a firm complements incentive schemes to discipline managers and how the securities return streams determine the claim holders incentives to intervene in management the theory rationalizes 1 the multipucity of securities 2 the observed correlation between return streams and control rights of securities and 3 the partial congruence between managerial and equity holder preferences over policy choices and monetary rewards as well as the low level of interference of equity in management the theory also offers new prospects for a reappraisal of the earlier corporate finance literature

strategic ownership structure and the cost of debt we theoretically and empirically address the endogeneity of corporate ownership structure and the cost of debt with a novel emphasis on the role of control concentration in postdefault firm restructuring control concentration raises agency costs of debt and dominant shareholders trade off private benefits of control against higher borrowing costs in choosing their ownership stakes based on our theoretical predictions and using an international sample of syndicated loans and unique dynamic ownership structure data we present new evidence on the firm and macro level determinants of corporate control concentration and the cost of debt jel g21 g32

risk analysis with contractual default does covenant breach matter abstract mergers and acquisitions m a private equity and leveraged buyouts securitization and project finance are characterized by the presence of contractual clauses covenants these covenants trigger the technical default of the borrower even in the absence of insolvency therefore borrowers may default on loans even when they have sufficient available cash to repay outstanding debt this condition is not captured by the net present value npv distribution obtained through a standard monte carlo simulation in this paper we present a methodology for including the consequences of covenant breach in a monte carlo simulation extending traditional risk analysis in investment planning we introduce a conceptual framework for modeling technical and material breaches from the standpoint of both lenders and shareholders we apply this framework to a real case study concerning the project financing of a 64 million euro biomass power plant the simulation is carried out on the actual model developed by the financial advisor of the project and made available to the authors results show that both technical and material breaches have a statistically significant impact on the net present value distribution and this impact is more relevant when leverage and cost of debt increase

the effects of firm initiated clawback provisions on bank loan contracting abstract although firm initiated clawbacks reduce accounting manipulation they also induce managers to engage in suboptimal activities e g reduce research and development r d expenses to achieve earnings targets to assess the effectiveness of clawback provisions we examine their impact from debtholders point of view we find that banks use more financial covenants and performance pricing provisions in the loan contracts and decrease interest rates after firms initiate clawbacks moreover we also find that loan maturity increases and loan collateral decreases subsequent to clawback adoption taken together our findings indicate that firm initiated clawback provisions enhance financial reporting quality thereby reducing the information uncertainty that financing providers face

can lenders discern managerial ability from luck evidence from bank loan contracts abstract we investigate the effect of managerial ability versus luck on bank loan contracting borrowers showing a persistently superior managerial ability over previous years more likely due to ability enjoy a lower loan spread while borrowers showing a temporary superior managerial ability more likely due to luck do not enjoy any spread reduction this finding suggests that banks can discern ability from luck when pricing a loan firms with high ability managers are more likely to continue their prior lower loan spread the spread reduction effect of managerial ability is stronger for firms with weak governance structures or poor stakeholder relationships corroborating the notion that better managerial ability alleviates borrowers agency and information risks we also find that well governed banks are better able to price governance into their borrowers loans which helps explain why good governance enhances bank value