influence costs and capital structure this paper analyzes the role of capital structure in the presence of intrafirm influence activities the hierarchical structure of large organizations inevitably generates attempts by members to influence the distributive consequences of organizational decisions in corporations for example top management can reallocate or eliminate quasi rents earned by their employees while at the same time they must rely on these employees to provide them with information vital to their decision making this creates the opportunity for lower level managers to influence top management s discretionary decisions as a result divisional managers may attempt to inflate the corporate perception of their relative contributions to the firm or to take actions that make the elimination of their rents more costly for the firm this incentive to influence is especially acute when managers fear losing their jobs for example in the event of a divestiture since the firm s capital structure can affect future divestiture decisions it can be chosen to reduce or increase the divisional managers incentives to influence top management s decisions the control of influence activities arises at the expense of restrictions on future divestiture decisions hence there emerges an optimal capital structure that trades off the costs of influence activities against the costs of making poor divestiture decisions the findings suggest that capital structure can also be chosen to control influence activities that arise under less extreme motivations we identify several key factors that determine the optimal capital structure the top management s prior assessment of the likelihood that it will be optimal to divest a specific division the costs of influence activities to the firm and to the divisional managers and the difference in the valuation of the division s assets in the current firm and under alternative uses

repudiation and renegotiation the case of sovereign debt a model of sovereign debt is analyzed in this model renegotiation arises in a natural way because information is incomplete the renegotiation game has many equilibria the standard contract theory approach suggests that the parties should agree to choose the efficient equilibrium strategies when the contract is written refinements of the equilibrium notion such as strategic stability suggest that a very inefficient equilibrium may be chosen the tension between these two approaches raises deep questions about the correct way to analyze a large class of contracting problems copyright 1989 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

investment under uncertainty with strategic debt service the presence of a well designed bankruptcy code is an important part of the nancialarchitecture in developed economies by allowing the creditors to seize the assets of theborrowers who fail to make contractual payments the code generates bene cial ex ante e ectson debt capacity and rm value by giving the borrowers options to renegotiate their debtobligations and seek bankruptcy protection the code increases the likelihood that borrowersmay avoid ine cient ex post liquidation as hart 1999 notes the code should balanceex ante rm value maximization with ex post e ciency the bankruptcy codes in di erentcountries weight this tradeo di erently and hence vary in terms of the distribution of rightsand powers between borrowers and lenders in this paper we provide an inter temporal framework to examine how the creditors liquidation rights and the distribution of ex post bargaining powers in uence the rm s in vestment and nancing decisions and a ect ex ante rm value we show that strongerequityholders bargaining power lowers debt capacity reduces rm value and discouragesgrowth option exercising our calibration suggests that the quantitative e ects of ex poststrategic renegotiation on ex ante rm value may be large our paper provides an attempt to integrate nancial architecture into the theory of in vestment growth option exercising by building on two strands of literature investment anddebt pricing we extend the real options approach to investment pioneered by mcdonaldand siegel 1986 and brennan and schwartz 1985 to allow for capital structure decisionsunder strategic debt service we also draw insights from corporate debt pricing capital struc ture literature which focuses on leverage and security pricing after investment has alreadybeen made merton 1974 black and cox 1976 and leland 1994 our paper bridgesthe gap between these two strands of literature by characterizing the optimal investment and nancing decisions and the option value of waiting in closed form we show that the inter action between nancing and investment decisions in the presence of strategic debt servicegenerates new insights and also quantitatively important e ects on ex ante rm value

financing constraints irreversibility and investment dynamics abstract we develop a model of an industry with many heterogeneous firms that face both financing constraints and irreversibility constraints we use this model to examine the cyclical behavior of aggregate fixed investment variable capital investment and output in the presence of persistent idiosyncratic and aggregate shocks our model yields three main results first the effect of the irreversibility constraint on fixed capital investment is reinforced by the financing constraint second the effect of the financing constraint on variable capital investment is reinforced by the irreversibility constraint finally the interaction between the two constraints is key for explaining why input inventories and material deliveries of us manufacturing firms are so volatile and procyclical and also why they are highly asymmetrical over the business cycle

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

political business cycles 40 years after nordhaus the aim of this article is to survey the huge literature that has emerged in the last four decades following nordhaus s rev econ stud 42 2 169 190 1975 publication on political business cycles pbcs i first propose some developments in history of thought to examine the context in which this ground breaking contribution saw the light of the day i also present a simplified version of nordhaus s model to highlight his key results i detail some early critiques of this model and the fields of investigations to which they gave birth i then focus on the institutional context and examine its influence on pbcs the actual research agenda finally i derive some paths for future research

aggregate consequences of limited contract enforceability we study a general equilibrium model in which entrepreneurs finance investment with optimal financial contracts because of enforceability problems contracts are constrained efficient we show that limited enforceability amplifies the impact of technological innovations on aggregate output this implies that economies with lower enforceability of contracts are characterized by greater macroeconomic volatility a key assumption for the amplification result is that defaulting entrepreneurs are not excluded from the market

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

a theory of corporate capital structure and investment this article uses a general equilibrium framework to explore the origins and limitations of financial intermediaries in the model investors have a generic lending technology that they can improve at a cost those who upgrade become intermediaries to exploit their advantage however conflicts with depositors will limit the banks market presence and they will only lend to moderately endowed firms while bondholders will finance cash rich corporations the article also analyzes the extent to which investors adopt the superior lending technique the nature of bank competition and how corporate and bank conditions affect interest rates and investment copyright 2004 oxford university press

managerial compensation contract and bank bailout policy abstract under the incomplete contract framework we consider an optimal regulatory policy for motivating bank equity owners and bank managers to restructure the bad loans of their banks in the presence of managerial compensation contracts with stock options the regulatory policy studied in this paper is mainly concerned with the design of repayment schedules in the scheme of injection of cash funds into insolvent banks by the regulator we show that the regulator cannot necessarily attain the social optimal allocation by injecting cash funds into insolvent banks through the purchase of subordinated bonds with the risk free interest rate however even in that case we also suggest that if the regulator injects cash funds into active restructuring banks through the purchase of subordinated bonds or preferred stocks with less stringent repayment conditions and nationalizes passive restructuring banks the regulator can attain the social optimal allocation by performing such a non linear injection scheme under certain conditions

repossession and the democratization of credit we exploit a 2004 credit reform in brazil that simplified the sale of repossessed cars used as collateral for auto loans we show that the reform expanded credit to riskier self employed borrowers who purchased newer more expensive cars the legal change has led to larger loans with lower spreads and longer maturities although the credit reform improved riskier borrowers access to credit it also led to increased incidences of delinquency and default our results shed light on the consequences of a credit reform and highlight the crucial role that collateral and repossession play in the liberalization and democratization of credit

the political economy of military spending in israel irior scholarly analysis of israeli military spending has focused on national security questions we present a mathematical model incorporating security threats as well as electoral cycles and corporate profits the parameters are estimated empirically the results support the idea that in israel the military budget at the margins is also employed as a political economic instrument to help manage the economy and to provide a favorable election climate for incumbents it is suggested that the political economic dynamic widely attributed to western industrialized societies may be of increasing importance in other societies throughout the world

price floors and technical inefficiency in india s sugar processing industry in india cane is processed into sugar by cooperatives public enterprises and private for profit firms the indian government sets a unique floor price for each processor that is increasing in the firm s effectiveness in converting cane into sugar the floor price binds for public and private firms but not for cooperatives which rebate profits to members we argue that this price floor policy creates a disincentive for private and public firms to be technically efficient in converting cane to sugar in support of this hypothesis an analysis of 593 indian sugar factories from 1992 to 2007 reveals statistically significant differences in technical efficiency with cooperatives being the most efficient and public firms least efficient we estimate welfare losses due to the technical inefficiency attributable to the price floor policy and argue that it can be eliminated by enacting policy to base price floors upon quality of the cane input received by a factory

liquidation values and the credibility of financial contract renegotiation evidence from u s airlines how do liquidation values affect financial contract renegotiation while the incomplete contracting theory of financial contracting predicts that liquidation values determine the allocation of bargaining power between creditors and debtors there is little empirical evidence on financial contract renegotiations and the role asset values play in such bargaining this paper attempts to fill this gap we develop an incomplete contracting model of financial contract renegotiation and estimate it using data on the airline industry in the united states we find that airlines successfully renegotiate their lease obligations downward when their financial position is sufficiently poor and when the liquidation value of their fieet is low our results show that strategic renegotiation is common in the airline industry moreover the results emphasize the importance of the incomplete contracting perspective to real world financial contract renegotiation

creditor concentration an empirical investigation most of the literature on multiple banking assumes equal financing shares however unequal asymmetric or concentrated bank borrowing is widespread and creditor concentration is only weakly correlated with the number of bank relationships this paper therefore investigates the determinants of creditor concentration for german firms using a comprehensive firm bank level dataset for the time period between 1993 and 2003 we document that corporate borrowing from banks is very often concentrated even for the largest firms in our sample leveraged firms and firms with more redeployable assets concentrate their borrowing from banks as are firms dealing with a relationship lender that is profitable that has lower monitoring costs or that operates in a concentrated regional lending market

excessive continuation and dynamic agency costs of debt abstract this paper analyses the incentives of the equityholders of a leveraged company to shut it down in a continuous time stochastic environment keeping the firm as an ongoing concern has an option value but equity and debt holders value it differently equityholders decisions exhibit excessive continuation and reduce firm s value using a compound exchange option approach we characterise the resulting agency costs of debt derive the price of these costs and analyse their dynamics we also show how agency costs can be reduced by the design of debt

the rise of the pentagon and u s state building the defense program as industrial policy state centered theories stress the potential for states to be proactive as well as reactive but the analytic tools developed in this literature have not been employed to examine the most impressive episode of state building in the postwar united states the rise of the pentagon this article examines the bureaucratic resources at the disposal of the pentagon and concludes that high ranking military officers have operated as relatively autonomous bureaucrats case studies of the aeronautics and microelectronics industries provide evidence that the pentagon has implemented a de facto industrial policy in the name of national defense the substantive conclusion that the autarkic pentagon has implemented a massive industrial policy contradicts the view that the hegemonic u s state is strong in the international arena but too weak and fragmented to plan the domestic political economy

islamic banks and investment financing islamic law prohibits charging interest we study financial instruments used by islamic banks and find that most are not based on profit and loss sharing equity but instead are very debt like in nature we see some bias against providing financing for agriculture and industry long term financing is rarely offered to entrepreneurs our model shows that debt like instruments are a rational response by islamic banks to their contracting environments as agency problems become more severe debt becomes the dominant instrument of finance we give conditions under which banning debt increases social welfare as well as conditions under which banning debt decreases social welfare

product market competition and the financing of new ventures this paper examines the interaction between venture risk product market competition and the entrepreneur s choice between bank financing and venture capital vc financing under bank financing a debt type contract emerges as optimal which allows the entrepreneur to retain full control of the venture and thus yields strong effort incentives as long as the entrepreneur can service the debt repayment however this leads to liquidation in the case of default making the venture s success quite sensitive to exogenous even temporary shocks that may hinder debt repayment under vc financing an equity type contract emerges as optimal although it is not sensitive to exogenous shocks this contract requires the entrepreneur to share a fraction of the rents with the financier thus yielding lower effort incentives for the entrepreneur there exists a threshold level of venture risk such that bank financing is optimal if and only if venture risk is below that threshold product market competition increases the value of stronger entrepreneurial incentives and thus increases the maximum level of risk the entrepreneur is willing to take before switching from bank financing to vc financing this is a robust result that is shown to hold in various models of competition including the hotelling salop dixit stiglitz and cournot to bertrand switch this paper was accepted by lee fleming entrepreneurship and innovation

credit rationing and payment incentives a model of borrowing for production is presented where default leads to exclusion from the capital market this means contracts are enforceable provided the current payment is less than or equal to the value of future access to the capital market the main result of the paper is to show that if this constraint binds then credit is rationed

corporate debt overhang and macroeconomic expectations one way in which corporate financial structure affects macroeconomic performance is by creating debt overhang debt overhang occurs when existing debt deters new investment because the benefits from new investment will go to the existing creditors not to the new investors if the economy is booming debt overhang will not bind because the returns to investing are high if the economy is stagnant debt overhang will bind because the returns to investing are low as a result high levels of debt can create multiple expectational equilibria in which animal spirits determine economy activity copyright 1995 by american economic association

financial distress and the business cycle in this paper we argue that firms financial distress should play a greater role in the macroeconomic analysis of the business cycle we provide a non technical account of a general equilibrium model that exhibits financially driven equilibrium cycles we show that the empirical evidence is widely supportive of the key hypothesis and implications of our approach we use the model in order to evaluate the effects of several policy measures it turns out that deepening the market for second hand capital goods subsidizing the interest payments of companies which start up when financial conditions are tight and bailing out some companies in default can indeed stabilize the economy by way of generalization we may say that the policy reaction to a financially driven bust should be accommodating

drilling and debt this paper documents a previously unrecognized debt related investment distortion using detailed project level data for 69 firms in the oil and gas industry we find that highly levered firms pull forward investment completing projects early at the expense of long run project returns and project value this behavior is particularly pronounced prior to debt renegotiations we test several channels that could explain this behavior and find evidence consistent with equity holders sacrificing long run project returns to enhance collateral values and by extension mitigate lending frictions at debt renegotiations

internal vs external financing of r d the empirical evidence suggests that while small firms in united states united kingdom and canada rely on internal funds for financing r d similar firms in japan germany and france have access to bank loans in this paper we analyze the financial decisions of small firms willing to invest in r d we find that their high ratio of intangible assets along with the high risk nature of their investments can explain their inability to raise debt in external capital markets we also show that financing r d with bank loans might be feasible especially if banks are willing to monitor the investment activities of their clients

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

financing durable assets this paper studies the nancing of durable assets in a model with collateral constraints due to limited enforcement durability aects the ease of nancing we show that more durable assets require larger down payments of internal funds per unit of capital making them harder to nance because durability raises the price of an asset and hence the overall nancing need more than its collateral value thus nancial constraints have a bigger impact on purchases of more durable capital such as land structures and durable equipment this basic insight has implications for the choice between new and used capital technology adoption and the rent versus buy decision since new assets are more durable than used ones unconstrained borrowers buy new assets and sell them when they are used while constrained borrowers purchase used assets financial constraints inhibit technology adoption as constrained borrowers may adopt less durable low quality assets that are otherwise dominated technologies more durable assets are more likely to be rented given their larger nancing need legal enforcement aects trade in durable assets and technology adoption with weak legal enforcement economies being net importers of used assets and investing a larger fraction in less durable low quality assets

optimal debt structure and the number of creditors within an optimal contracting framework we analyze the optimal number of creditors a company borrows from we also analyze the optimal allocation of security interests among creditors and intercreditor voting rules that govern renegotiation of debt contracts the key to our analysis is the idea that these aspects of the debt structure affect the outcome of debt renegotiation following a default debt structures that lead to inefficient renegotiation are beneficial in that they deter default but they are also costly if default is beyond a manager s control the optimal debt structure balances these effects we characterize how the optimal debt structure depends on firm characteristics such as its technology its credit rating and the market for its assets

optimal capital structure and investment with real options and endogenous debt costs we examine the joint optimization of financial leverage and irreversible capacity investment in a real options framework with risky debt and endogenous interest costs higher capacity ceteris paribus increases operating leverage and default probability but lowers ex post adjustment costs and generates larger tax shields a key insight is that financial leverage and capacity are substitutes in the debt market equilibrium we develop novel predictions about the effects of capital adjustment costs operating costs and uncertainty on optimal financial leverage and capacity that may potentially help explain ambiguous empirical results in the literature regarding the determinants of capital structure and investment received march 17 2016 editorial decision july 8 2017 by editor itay goldstein

the financing of innovation learning and stopping we consider the financing of a research project under uncertainty about the time of completion and the probability of eventual success we distinguish between two financing modes namely relationship financing where the allocation decision of the entrepreneur is observable and arm s length financing where it is unobservable we find that equilibrium funding stops altogether too early relative to the efficient stopping time in both financing modes the rate at which funding is released becomes tighter over time under relationship financing and looser under arm s length financing the tradeoff in the choice of financing modes is between lack of commitment with relationship financing and information rents with arm s length financing

optimality of investment under imperfectly enforceable financial contracts i introduction a well known implication of asymmetric information in credit markets as studied by stiglitz and weiss 1981 is that when the quality of projects is private information low quality projects will drive highquality projects out of the market resulting in credit rationing this means there is underinvestment compared with the optimal level of investment given full information in contrast de meza and webb 1987 reach an entirely different result using a framework in which the environment and information structure are very similar to stiglitz and weiss they show that asymmetric information causes good projects to draw in bad and leads to too much investment than is socially efficient 1 as pointed out in their article it is their specification of the structure of stochastic project returns that leads to this strikingly different result 2 thus it raises a question regarding the optimality of investment in an environment in which the structure of stochastic project returns plays no role apart from this difference a common feature of the two articles together with a large body of literature is that the financial contracts are perfectly enforceable however borrowers may default either because their investment returns are below what were promised to the lenders or because they can profit more by running away without repaying their debts absconding without repaying debt is feasible only when the lenders have limited control of the investment returns or the savings of the borrowers akerlof and romer 1993 distinguish this aspect of moral hazard dubbed as looting from the pursuit of highly risky investments to gamble for resurrection in this case lenders and the courts are not able to enforce repayments from the borrowers 3 in this article we study the optimality of aggregate investment in a nonstochastic environment with private information and limited enforcement we show that an over under investment occurs if a borrower s capital debt ratio is smaller larger than the ratio of cross period cash flows in other words too much investment occurs when the cash flows of investment returns are accrued relatively quickly or when the stake in a borrower s project is too low this implies that when entrepreneurs prefer projects that yield a faster stream of returns it is more likely to result in over investment because it is either easier for entrepreneurs to be solvent or because this attracts borrowers who want to pocket a higher profit and run away without repaying moreover over investment is more likely to arise where entrepreneurs have a low level of net worth relative to their debt which may be due to a lenient collateral requirement or lax lending practice the results herein have policy implications for economies in which enforcement is costly due to either primitive screening and monitoring technology or inefficiency in the court system we show that a subsidy tax on risk free interest income can close the over under investment gap but in contrast to de meza and webb 1987 this policy tends to reduce social welfare the rest of the article is organized as follows section ii outlines the environment of the model section iii states the decision rules under limited enforceability and then derives the condition for over or underinvestment section iv analyzes the policy implications of this model and section v concludes ii the environment consider a three period economy indexed by t 0 1 and 2 there are a continuum of risk neutral agents with a population normalized to be unity and many competitive intermediaries the gross risk free interest rate r yielded from a safe asset is assumed to be fixed in each period there is only a single consumption good at date 0 each agent is endowed with w units of goods w 0 agents differ in their entrepreneurial ability indexed by e e member of 0 1

using deferred compensation to strengthen the ethics of financial regulation abstract defects in the corporate governance of government owned enterprises tempt opportunistic officials to breach duties of public stewardship corporate governance theory suggests that incentive based deferred compensation could intensify the force that common law duties actually exert on regulatory managers in principle a forfeitable fund of deferred compensation could be combined with provisions for measuring verifying and rewarding multiperiod performance to make top regulators accountable for maximizing the long run net social benefits their enterprise produces because government deposit insurance enterprises are purveyors of credit enhancements for which private substitute and reinsurance markets exist their performance could be measured accurately enough to make employment contracts for deposit insurance ceos a promising place to experiment with this kind of accountability reform

monopoly capital organized labor and military expenditures in the united states 1949 1976 in this paper we systematically assess the neo marxian view that military expenditures are used by the state as a countercyclical fiscal policy either to forestall a serious recession or to facilitate economic recovery in particular we examine the post world war ii political economic experience of the united states because the military expenditures thesis was most fully developed initially in an attempt to explain postwar american prosperity we evaluate what we term the naive model of baran and sweezy which suggests that the degree to which national output is absorbed by military spending should be dependent on aggregate economic conditions such as unemployment finding only inconsistent evidence to support the naive view we incorporate the insights of recent neo marxists especially o connor on the linkages among the monopoly corporate sector the unionized sector of labor and the state the empirical evidence appears consistent with this modified view with unemployment in the unionized sect

debt valuation renegotiation and optimal dividend policy the valuation of debt and equity reorganization boundaries and firm s optimal dividend policies are studied in a framework where we model strategic interactions between debt holders and equity holders in a game theoretic setting which can accommodate varying bargaining powers to the two claimants two formulations of reorganization are presented debt equity swaps and strategic debt service resulting from negotiated debt service reductions we study the effects of bond covenants on payout policies and distinguish liquidity induced defaults from strategic defaults we derive optimal equity issuance and payout policies the debt capacity of the firm and the optimal capital structure are characterized

optimal long term financial contracting we develop an agency model of financial contracting we derive long term debt a line of credit and equity as optimal securities capturing the debt coupon and maturity the interest rate and limits on the credit line inside versus outside equity dividend policy and capital structure dynamics the optimal debt equity ratio is history dependent but debt and credit line terms are independent of the amount financed and in some cases the severity of the agency problem in our model the agent can divert cash flows we also consider settings in which the agent undertakes hidden effort or can control cash flow risk

optimal lending contracts and firm dynamics we develop a general model of lending in the presence of endogenous borrowing constraints borrowing constraints arise because borrowers face limited liability and debt repayment cannot be perfectly enforced in the model the dynamics of debt are closely linked with the dynamics of borrowing constraints in fact borrowing constraints must satisfy a dynamic consistency requirement the value of outstanding debt restricts current access to short term capital but is itself determined by future access to credit this dynamic consistency is not guaranteed in models of exogenous borrowing constraints where the ability to raise short term capital is limited by some prespecified function of debt we characterize the optimal default free contract which minimizes borrowing constraints at all histories and derive implications for firm growth survival leverage and debt maturity the model is qualitatively consistent with stylized facts on the growth and survival of firms comparative statics with respect to technology and default constraints are derived borrowing constraints are an important determinant of firm growth and survival 1 such constraints may arise in connection to the financing of investment opportunities faced by firms or temporary liquidity needs such as those required to survive a recession this paper develops a theory of endogenous borrowing constraints and studies its implications for firm dynamics in our model debt is constrained by the firm s limited liability and option to default a lending contract specifies an initial loan size future financing and a repayment schedule the choice of these variables in turn determines future growth the firm s future borrowing capacity and its ability and willingness to repay hence borrowing constraints and firm dynamics are jointly determined we study this dynamic design problem our model builds on thomas and worral s 1994 model of foreign direct investment at time zero a risk neutral borrower firm or entrepreneur has a project which requires a fixed initial set up cost every period the project yields revenues that increase with the amount of 1 there is considerable evidence suggesting that financing constraints are important determinants of firm dynamics gertler and gilchrist 1994 argue that liquidity constraints may explain why small manufacturing firms respond more to a tightening of monetary policy than do larger manufacturing firms perez quiros and timmermann 2000 show that in recessions smaller firms are more sensitive to the worsening of credit market conditions as measured by higher interest rates and default premia evans and jovanovic 1989 show that the liquidity constraints are essential in the decision to become an entrepreneur fazzari hubbard and petersen 1988 among others view financial constraints as an explanation for the dynamic behaviour of aggregate investment and cabral and mata 1996 are able to fit reasonably well the size distribution of portuguese manufacturing firms by estimating a simple model of financing constraints for surveys see hubbard 1998 and stein 2003

credit default swaps and the empty creditor problem the empty creditor problem arises when a debtholder has obtained insurance against default but otherwise retains control rights in and outside bankruptcy we analyze this problem from an ex ante and ex post perspective in a formal model of debt with limited commitment by comparing contracting outcomes with and without insurance through credit default swaps cds we show that cds and the empty creditors they give rise to have important ex ante commitment benefits by strengthening creditors bargaining power they raise the debtor s pledgeable income and help reduce the incidence of strategic default however we also show that lenders will over insure in equilibrium giving rise to an inefficiently high incidence of costly bankruptcy we discuss a number of remedies that have been proposed to overcome the inefficiency resulting from excess insurance jel g30 g32 g33 one of the most significant changes in the debtor creditor relationship in the

the certification value of private debt renegotiation and the design of financial contracts empirical evidence from europe abstract by using a sample of bank loan renegotiations by european firms i show that the renegotiation of financial contracts bears a certification value while deeply changing the contractual features of the loan over time to the benefit of shareholders i find that amendments to financial covenants and to loan amounts increase the cumulative abnormal returns of a borrowing firm by 10 15 early and less frequent renegotiations of bilateral loans with short maturities also imply a positive stock market reaction amendments signaling the early accrual of new and positive information allow increasing firm value

modeling u s budgetary and fiscal policy outcomes a disaggregated systemwide perspective this paper develops and estimates a model of u s federal budgetary outcomes that allows for considerable disaggregation across spending categories while providing through cross equation coefficient restrictions substantially more statistical power than traditional approaches we identify significant top down fiscal policy effects on budgetary allocations primarily within the defense budget budgetary responses to macroeconomic conditions are generally countercyclical although middle class entitlements appear to react procyclically to inflation political control of congress influences budgetary outcomes with democrats giving higher priority to domestic spending programs the relative rate of public sector inflation affects spending growth consistent with baumol s disease public opinion affects defense and low income entitlement spending defense spending has also been influenced by perceived soviet threat as well as the level of armed conflict there appear to be small election year effects although not of the sort predicted by political business cycle models with a few exceptions administration specific impacts are relatively small and not systematically related to the party of the president

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

resaleable debt and systemic risk many debt claims such as bonds are resaleable whereas others such as repos are not there was a fivefold increase in repo borrowing before the 2008 crisis why did banks dependence on non resaleable debt precipitate the crisis in this paper we develop a model of bank lending with credit frictions the key feature of the model is that debt claims are heterogeneous in their resaleability we find that decreasing credit market frictions leads to an increase in borrowing via non resaleable debt borrowing via non resaleable debt has a dark side it causes credit chains to form since if a bank makes a loan via non resaleable debt and needs liquidity it cannot sell the loan but must borrow via a new contract these credit chains are a source of systemic risk since one bank s default harms not only its creditors but also its creditors creditors overall our model suggests that reducing credit market frictions may have an adverse effect on the financial system and may even lead to the failures of financial institutions

default and renegotiation a dynamic model of debt we analyze the role of debt in persuading an entrepreneur to pay out cash e ows rather than to divertthem in the e rstpartof the paper we study the optimal debt contract specie cally the trade off between the size of the loan and the repayment under the assumption that some debt contract is optimal in the second part we consider a more general class of nondebt contracts and derive sufficient conditions for debt to be optimal among these