This paper analyzes debt maturity structure for borrowers with private information about their future credit rating. Borrowers' projects provide them with rents that they cannot assign to lenders. ...The optimal maturity structure trades off a preference for short maturity due to expecting their credit rating to improve, against liquidity risk. Liquidity risk is the risk that a borrower will lose the nonassignable rents due to excessive liquidation incentives of lenders. Borrowers with high credit ratings prefer short-term debt, and those with somewhat lower ratings prefer long-term debt. Still lower rated borrowers can issue only short-term debt.
This paper studies reputation formation and the evolution over time of the incentive effects of reputation to mitigate conflicts of interest between borrowers and lenders. Borrowers use the proceeds ...of their loans to fund projects. In the absence of reputation effects, borrowers have incentives to select excessively risky projects. If there is sufficient adverse selection, reputation will not initially provide improved incentives to borrowers with short credit histories. Over time, if a good reputation is acquired, reputation will provide improved incentives. General characteristics of markets in which reputation takes time to work are identified.
This paper provides a positive theory of voluntary disclosure by firms. Previous theoretical work on disclosure of new information by firms has demonstrated that releasing public information will ...often make all shareholders worse off, due to an adverse risk-sharing effect. This paper uses a general equilibrium model with endogenous information collection to demonstrate that there exists a policy of disclosure of information which makes all shareholders better off than a policy of no disclosure. The welfare improvement occurs because of explicit information cost savings and improved risk sharing. This provides a positive theory of precommitment to disclosure, because it will be unanimously voted for by stockholders and will also represent the policy that will maximize value ex ante. In addition, it provides a "missing link" in financial signalling models. Apart from the effects on information production analyzed in this paper, most existing financial signalling models are inconsistent with a firm taking actions which facilitate future signalling because release of the signal makes all investors worse off.
Banks and Liquidity Diamond, Douglas W.; Rajan, Raghuram G.
The American economic review,
05/2001, Letnik:
91, Številka:
2
Journal Article
Recenzirano
Banks, more than other borrowers, benefit from the commitment power provided by a run-prone capital structure. Runs can occur even when they hurt depositors. This implies that banks can be fragile if ...loan payments are uncertain, or if there are episodes of aggregate shortage of liquidity. The desirability of ex ante fragility implies that stability from policies such as deposit insurance, lender of last resort, and suspension of convertibility is costly because each reduces commitment. Fragile bank capital structures are not an aberration, but a consequence of the illiquidity of the underlying assets. To mandate that these institutions finance themselves with less fragile claims may be to impair their economic activities.
This paper by Ricardo Caballero and Avrind Krishnamurthy (CK, 2006) presents a serious and original view of emerging market crises caused by randomly bursting rational bubbles. This is exacerbated by ...self-interested risk management that is not Pareto optimal because of a liquidity externality. They extend their very useful and influential approach to modeling finance in emerging markets with poor property rights.
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.
To address the moral hazard problem that can motivate bank executives to take excessive risks and to fail to raise capital when needed, a group of 13 distinguished financial economists recommends ...that systemically important financial institutions be required to issue contingent convertible debt (CoCos) and to hold back a substantial share -- as much as 20% -- of the compensation of employees who can have a meaningful impact on the survival of the firm. This holdback should be forfeited if the firm's capital ratio falls below a specified threshold. The deferral period should be long enough -- the authors suggest five years -- to allow much of the uncertainty about managers' activities to be resolved before the bonds mature. Except for forfeiture, the payoff on the bonds should not depend on the firm's performance, nor should managers be permitted to hedge the risk of forfeiture. The threshold for forfeiture should be crossed well before a firm violates its regulatory capital requirements and well before its contingent convertible securities convert into equity. The Swiss Bank UBS has paid bonuses to its top 6,500 executives that have been structured in exactly this way. Management forfeits its deferred compensation if the bank's regulatory capital ratio falls below 7.5%, and its contingent convertible debt is set up to convert into equity if the bank's capital ratio falls below 5%. PUBLICATION ABSTRACT
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