The bankers' new clothes Admati, Anat; Admati, Anat; Hellwig, Martin
2014., 20130215, 2013-02-15, 2014-03-23, 20130101, ♭2013, 2013
eBook
What is wrong with today's banking system? The past few years have shown that risks in banking can impose significant costs on the economy. Many claim, however, that a safer banking system would ...require sacrificing lending and economic growth.The Bankers' New Clothesexamines this claim and the narratives used by bankers, politicians, and regulators to rationalize the lack of reform, exposing them as invalid.
Admati and Hellwig argue we can have a safer and healthier banking system without sacrificing any of the benefits of the system, and at essentially no cost to society. They show that banks are as fragile as they are not because they must be, but because they want to be--and they get away with it. Whereas this situation benefits bankers, it distorts the economy and exposes the public to unnecessary risks. Weak regulation and ineffective enforcement allowed the buildup of risks that ushered in the financial crisis of 2007-2009. Much can be done to create a better system and prevent crises. Yet the lessons from the crisis have not been learned.
Admati and Hellwig seek to engage the broader public in the debate by cutting through the jargon of banking, clearing the fog of confusion, and presenting the issues in simple and accessible terms.The Bankers' New Clothescalls for ambitious reform and outlines specific and highly beneficial steps that can be taken immediately.
We examine whether a large shareholder can alleviate conflicts of interest between managers and shareholders through the credible threat of exit on the basis of private information. In our model, the ...threat of exit often reduces agency costs, but additional private information need not enhance the effectiveness of the mechanism. Moreover, the threat of exit can produce quite different effects depending on whether the agency problem involves desirable or undesirable actions from shareholders' perspective. Our results are consistent with empirical findings on the interaction between managers and minority large shareholders and have further empirical implications.
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3.
The Leverage Ratchet Effect ADMATI, ANAT R.; DEMARZO, PETER M.; HELLWIG, MARTIN F. ...
The Journal of finance (New York),
02/2018, Volume:
73, Issue:
1
Journal Article
Peer reviewed
Firms' inability to commit to future funding choices has profound consequences for capital structure dynamics. With debt in place, shareholders pervasively resist leverage reductions no matter how ...much such reductions may enhance firm value. Shareholders would instead choose to increase leverage even if the new debt is junior and would reduce firm value. These asymmetric forces in leverage adjustments, which we call the leverage ratchet effect, cause equilibrium leverage outcomes to be history-dependent. If forced to reduce leverage, shareholders are biased toward selling assets relative to potentially more efficient alternatives such as pure recapitalizations.
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Managerial compensation typically relies on financial yardsticks, such as profits, stock prices, and return on equity, to achieve alignment between the interests of managers and shareholders. But ...financialized governance may not actually work well for most shareholders, and even when it does, significant tradeoffs and inefficiencies can arise from the conflict between maximizing financialized measures and society's broader interests. Effective governance requires that those in control are accountable for actions they take. However, those who control and benefit most from corporations' success are often able to avoid accountability. The history of corporate governance includes a parade of scandals and crises that have caused significant harm. After each, most key individuals tend to minimize their own culpability. Common claims from executives, boards of directors, auditors, rating agencies, politicians, and regulators include “we just didn't know,” “we couldn't have predicted,” or “it was just a few bad apples.” Economists, as well, may react to corporate scandals and crises with their own version of “we just didn't know,” as their models had ruled out certain possibilities. Effective governance of institutions in the private and public sectors should make it much more difficult for individuals in these institutions to get away with claiming that harm was out of their control when in reality they had encouraged or enabled harmful misconduct, and ought to have taken action to prevent it.
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Abstract
Debates on capitalism get muddled by blind spots about essential institutions, particularly effective governments and legal systems that enable corporations to exist in their current form ...and markets to succeed at scale. Across regimes, incentives to maximize profits and power play key roles in determining outcomes, and all institutions are vulnerable to distortions from imbalances in control, information, and expertise. The key problems with capitalism today boil down to failed governance and confusions that obscure the issues and prevent beneficial changes. In recent decades, the forces of ‘free-market capitalism’ have undermined and overwhelmed democratic institutions, leading to intertwined crises in both capitalism and democracy. Deception and the manipulation of beliefs often distort both markets and political systems. The financial system illustrates starkly how key institutions have failed society and how flawed narratives enable recklessness and bad rules to persist. Fixing capitalism must start with seeing the challenges for what they are. The devil is then in the details of improving transparency, norms, rules, and civic engagement so as to prevent the abuse of power and to create more trustworthy and less corruptible versions of capitalism.
Capital regulation is critical to address distortions and externalities from intense conflicts of interest in banking and from the failure of markets to counter incentives for recklessness. The ...approaches to capital regulation in Basel III and related proposals are based on flawed analyses of the relevant tradeoffs. The flaws in the regulations include dangerously low equity levels, a complex and problematic system of risk weights that exacerbates systemic risk and adds distortions, and unnecessary reliance on poor equity substitutes. The underlying problem is a breakdown of governance and lack of accountability to the public throughout the system, including policymakers and economists.
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Excessive leverage (indebtedness) in banking endangers the public and distorts the economy. Yet current and proposed regulations only tweak previous regulations that failed to provide financial ...stability. This paper discusses the forces that have led to this situation, some of which appear to be misunderstood. The benefits to society of requiring that financial institutions use significantly more equity funding than the status quo are large, while any costs are entirely private because of banks’ ability to shift some of their costs to others when they use debt. Without quantitative analysis, I outline improved regulations and how they can be implemented.
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We analyze a model of voluntary disclosure by firms and the desirability of disclosure regulation. In our model disclosure is costly, it has private and social value, and its precision is endogenous. ...We show that (i) a convexity in the value of disclosure can lead to a discontinuity in the disclosure policy; (ii) the Nash equilibrium of a voluntary disclosure game is often socially inefficient; (iii) regulation that requires a minimal precision level sometimes but not always improves welfare; (iii) the same is true for subsidies that change the perceived cost of disclosures; and (iv) neither regulation method dominates the other.
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The past few years have shown that risks in banking can impose significant costs on the economy. Many claim, however, that a safer banking system would require sacrificing lending and economic ...growth.The Bankers' New Clothesexamines this claim and the narratives used by bankers, politicians, and regulators to rationalize the lack of reform, exposing them as invalid. Anat Admati and Martin Hellwig argue that we can have a safer and healthier banking system without sacrificing any of its benefits, and at essentially no cost to society. They seek to engage the broader public in the debate by cutting through the jargon of banking, clearing the fog of confusion, and presenting the issues in simple and accessible terms.
We derive a role for inside investors, such as venture capitalists, in resolving various agency problems that arise in a multistage financial contracting problem. Absent an inside investor, the ...choice of securities is unlikely to reveal all private information, and overinvestment may occur. An inside investor, however, always makes optimal investment decisions if and only if he holds a fixed-fraction contract, where he always receives a fixed fraction of the project's payoff and finances that same fraction of future investments. This contract also eliminates any incentives of the venture capitalist to misprice securities issued in later financing rounds.
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