Essays on International Finance, Capital Structure, and Uncertainty

Does corporate capital structure matter in the transmission of macroeconomic or financial shocks across borders? In the era of globalization with an unprecedentedly high level of uncertainty, a better understanding of the question matters for business leaders, policy makers, and scholars alike. This dissertation provides new insights on the topic from three different yet related perspectives: the internal capital markets (ICMs) of multinational enterprises (MNEs), the market value of firms, and agency problems stemmed from business complexity that weakens a firm's risk management./nThe first chapter of my dissertation focuses on the ICMs of MNEs. ICMs allow MNEs to transfer liquidity globally, which connects external capital markets when the related entities also raise external funds. This chapter studies such connection with a model of ICMs that permits two layers of agency problems: those between (the shareholders of) a MNE and its external lenders and those between a parent company and its subsidiaries. When a parent company faces a limited internal monitoring capacity due to complex multinational operations, subsidiary-level external debt can be used to induce monitoring from local lenders that have informational and supervisory advantages. This encourages a MNE to deploy an optimal blend of parent- and subsidiary-level external debt to maintain the lender's incentive to monitor. The model predicts that, in response to higher uncertainty in a foreign country, MNEs can counter the negative effect with an inflow of international capital by substituting subsidiary-level external debt with cheaper parent-level external debt as foreign lenders have a stronger incentive to monitor. I then test this prediction with detailed data on US MNEs at both parent and subsidiary levels, utilizing the surge in uncertainty caused by the UK's unexpected decision to leave the European Union (``Brexit") as a natural experiment. Consistent with the model prediction, I document that the uncertainty shock increased the ratio of parent-level external debt to total assets significantly in the consolidated balance sheet of US MNEs with UK subsidiaries, without changing the ratio of total debt to total assets. Meanwhile, the UK subsidiaries of US MNEs substituted external debt with internal debt significantly on their unconsolidated balance sheet, without changing the ratio of total debt to total assets. Given the global influence of non-financial MNEs, this study provides the first evidence that their ICMs constitute an important channel of cross-border spillovers among external capital markets in response to shocks./nWhile the first chapter of my dissertation focuses on how corporate debt responds to shocks, which generates cross-border capital flows via ICMs, the second chapter of my dissertation, coauthored with Ali Ozdagli, studies the role of corporate capital structure in the transmission of shocks to the market value of firms. Using the 2018-2019 U.S.-China trade war as a laboratory, we confirm that policy uncertainty causes a significant decline in stock prices. In addition, we find that the presence of bank debt in the corporate debt structure significantly mitigates the negative impact, while the mitigating effect does not exist for non-bank debt. We also demonstrate the source of the mitigating effect: We show that the mitigating effect of bank debt is concentrated among zombie firms --- mature firms that persistently do not have enough earnings to cover their interest expenses, where shareholders benefit from obtaining refinances. In specific, we show that a zombie firm that derives half of its capital from bank debt can completely offset the decline in its stock price caused by elevated uncertainty due to the mitigating effect. Our findings provide evidence that bank debt can provide insurance and flexibility for stressed firms that benefit their shareholders, especially during turbulent times./nThe third chapter of my dissertation, coauthored with Anna Chernobai and Ali Ozdagli, studies agency problems stemmed from business complexity that weakens risk management and raises operational risk. As the first chapter suggests, a key ingredient of how corporate capital structure affects the transmission of shocks is the agency problem between the principal of a firm and the firm's local managers. This agency problem exists when business complexity hinders the principal's risk management. However, little is known empirically about this relation. Using the 1996--1999 deregulations of U.S. banks' nonbanking activities as a natural experiment, the third chapter shows that an exogenous rise in business complexity weakens banks' risk management by increasing their operational risk. This result is driven by banks that had been constrained by regulations, compared with other banks and also with nonbank financial institutions that were never subject to these regulations. We further provide evidence that losses from these events substantially offset benefits of strategic risk taking, which empirically supports the significance of the agency problem stemmed from business complexity.

Advisor: Gourinchas, Pierre-Olivier
Obstfeld, Maurice