Information Monopoly and Commitment in Intermediary-Firm Relationships

A bank may use the private information that it acquires through monitoring to hold up borrowers. This information monopoly of the bank may inefficiently distort the borrowers investment decisions in environments where moral hazard is prevalent. The paper analyses how this problem is resolved within bank-firm relationships. In the benchmark case when the bank can contractually commit to future actions, the optimal contract turns out to be ambiguous in nature. When commitment contracts cannot be written, firms have an incentive to develop multiple banking relationships in order to decrease the inside banks bargaining power. However, with costly monitoring, this may defeat the initial purpose for contracting with a financial intermediary, namely information production. The paper argues that when contractual commitment is not feasible, bank size may serve as an alternative commitment device that prevents the bank from holding up borrowers in the future.     

The “Rent-To-Own” mortgage and prepayment risk

The most important risk factor in the mortgage and mortgage-backed security market has been prepayment risk. Various innovations have arisen to deal with it but none hedge it fully. The Rent-To-Own (RTO) mortgage discussed here is a mortgage instrument that reduces or even reverses prepayment risk. It does so by creating an incentive structure within the framework of the mortgage contract that penalizes prepayment when interest rates are low and rewards it when interest rates are high. This is the opposite of standard mortgages. The RTO incentive structure is based on a unique buyout feature. Borrowers who want to buy out the financial interest of the lender may do so whenever they want, but the buyout price is a negative function of the market interest rates prevailing currently, that is, at the time of the buyout. Hence the lower these rates, the higher the buyout price. Other advantages of the RTO mortgage are also described.     

Balance Sheets, the Transfer Problem, and Financial Crises

In a world of high capital mobility, the threat of speculative attack becomes a central issue of macroeconomicpolicy. While first-generation and second-generation models of speculative attacks both have considerablerelevance to particular financial crises of the 1990s, a third-generation model is needed to make sense of thenumber and nature of the emerging market crises of 1997-98. Most of the recent attempts to produce such amodel have argued that the core of the problem lies in the banking system. This paper sketches another candidatefor third-generation crisis modeling—one that emphasizes two facts that have been omitted from formal modelsto date: the role of companies' balance sheets in determining their ability to invest, and that of capital flows inaffecting the real exchange rate.     

The impact of tax on foreign direct investment: Empirical evidence and the implications for tax integration schemes

We estimate the impact of taxation on foreign direct investment (FDI) flows, using data on flows between seven countries for 1984 through 1989, and a sophisticated measure of the cost of capital. We find that the choice between domestic investment and total outward FDI is not significantly affected by taxation but that taxation does affect the location of outward FDI. These results are used to examine the impact of tax integration systems. Giving a tax credit to foreign shareholders may induce a large increase in inward FDI from exemption countries but not from partial-credit countries. For the United States, the total effect would be small.     

The Information Content of Bank Examinations

We identify three types of information from bank examinations—auditing information from verifying the honesty and accuracy of the bank's books, regulatory discipline information about the treatment of the bank by regulators, and private information about bank condition. We estimate these information effects by comparing the cumulative abnormal market returns associated with examinations in which the CAMEL rating remained unchanged, improved, and worsened. All three information effects are found to be greater for banks entering the examination process with unsatisfactory ratings from prior examinations. The only consistently strong effect found is that examination downgrades appear to reveal unfavorable private information about bank condition. The evidence also suggests that the information may reach the market in part through loan quality data released in quarterly financial statements.     

A New Approach to Group Structure, Burden Sharing, and the Equilibrium Provision of Public Goods

In the received model of the voluntary provision of a pure public good, the usual practice is to proceed from assumptions about the group characteristics to inferences about an implied outcome. The approach advocated in this paper reverses the traditional direction. Assuming a Nash equilibrium, we ask how to characterize the diverse set of group characteristics which will support it. Approaching the problem from this angle we define three crucial characteristics of a group-equilibrium: consumer's free rider inducing supply, zero contribution-inducing wealth and voluntary surplus tribute which is the amount by which a person's actual income exceeds his/her zero-contribution inducing wealth. Defining these indicators we show how they form the foundation of a complete mapping between the distribution of individual characteristics of a group, and equilibrium public good supply. Certain questions such as the interaction between size of the group and heterogeneity of incomes and tastes not yet adequately addressed are shown to yield easily to this approach.     

What is the Truth About the Scale of Japanese Banks' Bad Debts? Is the Situation Manageable?

In January 1998, the Japanese Ministry of Finance (MoF, 1998) released figures which suggested that the Japanese banking industry';s bad debts might be as high as ¥77 trillion (since revised upward to ¥87.5 trillion, if cooperative-type institutions are included; Financial Supervisory Agency (FSA), 1998). This compared with the previous official estimate of ¥28 trillion. The revelation was designed to do three things: (1) to convince investors, at home and abroad, who had long suspected that the true level of bad debts was much higher than the authorities (and the banks) were willing to admit to, that the authorities were sincere in their quest to enhance disclosure by local financial intermediaries; (2) to stifle opposition to the government's plans to use up to ¥30 trillion (since increased to ¥60 trillion) of public funds to stabilize the financial system¹ by underlining the gravity of the situation facing the Japanese economy; and (3) to pave the way for the introduction of more transparent reporting by the banks in April 1998 when a regime of prompt corrective action (PCA)² was scheduled to commence. This article explains the evolution of bad debt disclosure by the Japanese banking industry and assesses the significance of the latest figures. In particular, it highlights the extent to which accounting forbearance has been, and continues to be, used to mask the true level of the banks' bad debts and refutes the claim that the industry's bad debt burden peaked in 1995. The banking industry's ability to handle the continuing bad debt problem, in the face of a significant impairment of economic capital and the market's relentless drive for full disclosure and transparency, also is assessed.     

Analyst Following and Equity Offerings Subsequent to Initial Public Offerings

Analyst forecast information is collected for firms following their IPOs and is used in an examination of subsequent seasoned equity offerings (SEOs). Consistent with information asymmetry arguments, the analysis indicates that a larger percentage of firms conducting SEOs within three years of the IPO are covered by financial analysts than those without SEOs, and that analyst coverage is a significant predictor of subsequent SEOs. In addition, the results indicate that long-term earnings growth forecasts are larger for firms with subsequent SEOs, but growth forecasts decline significantly following the SEOs. Further, SEO abnormal returns exhibit a significant negative relationship with earnings growth forecasts. These results are consistent with windows of opportunity arguments since they suggest that SEOs are timed to coincide with the peak of earnings growth expectations, but that market participants compensate by reacting more negatively to offerings by firms with high growth forecasts.     

A General Theorem on the Comparative Statics of Changes in Risk

In this paper, the concept of absolutely riskier than is introduced to generalize Gollier's (Journal of Economic Theory, 66, 522–535) necessary and sufficient conditions for the comparative statics of a change in risk for risk averters. The restrictive assumption that the payoff function is monotonic in the risk is relaxed. The policymaker's choice problem, the newsboy problem, and a farmer's example are used to illustrate how easily the monotonicity assumption is violated. Finally, some important properties of the concept of absolutely riskier than, such as its relation with the concept of second-order stochastic dominance, are illustrated using the farmer's example.     

Interest-only and principal-only mortgage strips as interest-rate contingent claims

Interest-only (IO) and principal-only (PO) mortgage strips are valued in a stochastic interest-rate environment. The prepayment rate of the underlying mortgages is affected by two considerations not present in the pure financially rational model: (1) The property owner's holding period is assumed to follow a Gamma distribution, resulting in the possibility of prepayment due to the sale of the property (i.e., prepayment that is too early based on market interest rates); and (2) borrowers are assumed to face heterogeneous transaction costs related to refinancing the existing mortgage, and delay refinancing when market conditions make it optimal to do so (refinancing too late). Properties of IO/PO strips are identified by the finite difference method.     

The impact of settlement period on sales price

This study is an empirical investigation of the impact of settlement period on sales price while controlling for marketing period and standard explanatory variables. The hypothesized positive relationship between settlement period and sales price is confirmed by the results of this study. The estimated coefficient on settlement period is 0.0008 meaning that our market, on average, exacts a premium of 0.08 percent per day of settlement period beyond a norm of 60 days. The estimated coefficient on marketing period (a control variable) is –0.0003 meaning that our market, on average, requires a discount of 0.03 percent per day of marketing period. Our findings show the relative importance of settlement period in making real estate pricing decisions.     

Explaining intercity home price differences

This paper develops and tests an equilibrium model seeking to explain intercity variation in owner-occupied housing prices. Empirical tests with a reduced form equation using aggregated 1980 data on 94 SMSAs suggest explanation for 84% of this intercity home price variation. Intercity housing demand, based upon homeowner quality of life equilibrium, is successfully represented by the non-monetary income determinant of climate mildness in addition to several monetary income determinants that reflect household residual after-tax real income. Intercity housing supply was found to be influenced by intercity variation in construction costs and limitations upon the available supply of undeveloped urban land.     

Market Signals Associated with REIT IPOs

Previous studies have found significant but time-varying valuation effects associated with real estate investment trusts initial public offerings (REIT IPOs). Because REIT IPOs may disclose relevant information about real estate market conditions, they may serve to revalue existing real estate securities. To determine whether REIT IPOs signal information that is impounded into the share prices of other real estate securities, we assess the returns on rival portfolios of existing real estate securities upon the issuance of the IPO. On average, the rival portfolios experience insignificant effects on the REIT IPO filing date, but negative and significant abnormal returns around the issue date. A cross-sectional analysis of combined effects at the time of the filing date and issue date shows that the negative effects on the rival portfolios are more pronounced when (1) the size of the REIT IPO is larger, (2) market conditions are relatively weak, (3) more REIT IPOs come to market, and (4) the IPO is not associated with an umbrella partnership REIT.     

Decomposition of Japanese Yen Interest Rate Data Through Local Regression

Seven different Japanese Yen interest rates recorded on a daily basisfor the period from 1986 to 1992 are simultaneously analyzed. Byintroducing a new concept of short term trend, we decomposeeach interest rate series into three components, long termtrend, short term trend and irregular. It is obtained by atwo step lowess smoothing technique. After that, amultivariate autoregressive model (MAR) is fitted to the vectorvalued time series obtained by combining those seven irregularcomponents. The decomposition and MAR model fitting were quitesatisfactory. It enables us to understand well various aspects ofinterest rate series from the trends, the MAR (2) coefficientsand its residuals. The result is compared with the decompositionthrough sabl and the advantages of our procedure will bedemonstrated in relations to other parametric model fitting likeARCH or GARCH. Based on the decomposition we can have betterdaily prediction and more stable long term forecasting.     

Conduit Entities: Implications of Indirect Tax-Efficient Financing Structures for Real Investment

As well known, companies shift income from high to low tax jurisdictions. Typically, profit shifting is achieved by direct financing structures whereby companies use debt finance in the high tax entity and equity finance in the low tax entity. However, certain tax policies can lead to indirect financing structures whereby a conduit entity provides an opportunity to achieve at least two deductions for interest expenses for an investment made in the host country. The effect of direct and indirect financing structures on real investment is compared.     

The Impact of Risk-Based Premiums on FDIC-Insured Institutions

This paper examines the effect of a series of announcements leading to the approval of risk-based deposit insurance premiums on returns to stockholders of commercial banks. Utilizing risk-weighted capital ratios and measures of overall risk, we group banks according to one of the nine-tier insurance categories subsequently defined by the FDIC. During the period in which the new insurance system was considered and approved, we found that stockholders of well-capitalized, healthy banks experienced wealth changes significantly different from those experienced by less than well-capitalized, less than healthy banks. Although many argued the premium range in the initial insurance schedule was insufficient, the results show that this initial risk-basing marked an important change in the relative burdens imposed by FDIC insurance.     

Company Tax Structure and Company Tax Incidence

This paper reviews conflicting theories of company tax incidence impliedby the alternative new and traditional views of dividends andexamines their contrasting policy implications. Whereas, under thetraditional view, closer integration of the corporate and personalincome tax systems is suggested, an alternative policy orientationemphasizing the non-distorting features of the classical system is impliedby the new view. Even if the traditional view is accepted, theimplications for design and reform of the company tax vary widely underalternative specifications of domestic and international tax policy objectives. Schedular alternatives to global income taxation are alsoconsidered.     

“Investor sentiment” and the closed-end fund puzzle: A 7 percent solution

Lee, Shleifer, and Thaler (1991) argue that the irrational noise trader model of DeLong, Shleifer, Summers, and Waldmann (1990) ... is consistent with the published evidence on closed-end fund prices. ... However, Lee, Shleifer, and Thaler provide no indication of how much of the variability of a closed-end fund's discounts and premiums is due to such investor sentiment. Using the signal extraction technique of French and Roll (1986) to measure noise, this article estimates that on average only 7 percent of the variance of a standardized measure of weekly changes in discounts and premiums can be attributed to noise-trading activity. Investor sentiment, therefore, seems to account for very little of a closed-end fund's discount and premium variability over time.     

Investor efficiency in the face of takings

Governmental entities at all levels are empowered to acquire private property for the public's benefit, provided that just compensation is paid. The level of compensation typically viewed by courts as just is market value, but questions arise as to whether market value compensation motivates the private owner of land, potentially subject to a taking, to improve the property to a degree that is socially efficient. Earlier works have found market value to be a compensation level too high to promote efficiency. The present paper offers an analysis, based on a simple model of investor profit maximization, that provides a unified view of models presented in some important earlier works. In a special application of the general case, it is shown that market value can be too low a level of compensation to promote efficient behavior by the land owner.     

Optimal Consumption Taxes and Social Security Under Tax Measurement Problems and Uncertainty

A representative individual lives for two periods; works when young and depends on savings and a government operated social security system when old—the returns on both sources of income, when old, are random. Due to administrative problems the returns to savings are observed with some measurement error. Two alternative consumption tax systems are considered; the Registered Asset Treatment (RAT) and the Non-Registered Asset Treatment (NRAT). The advantage of the RAT is that it can perform a social insurance role while the disadvantage is that it imposes measurement error risk. Correlation between the random return on saving and its measurement error can provide a risk-hedging role that can be further strengthened by the RAT version. The NRAT version neither provides social insurance nor imposes measurement error risk. Both tax systems hedge against the uncertainties in the social security system. The taxpayer engages in precautionary saving in response to future uncertainty.