Debt enforcement,investment, and risk taking across countries

We argue that the prospect of an imperfect enforcement of debt contracts in default reduces shareholder–debtholder conflicts and induces leveraged firms to invest more and take on less risk as they approach financial distress. To test these predictions, we use a large panel of firms in 41 countries with heterogeneous debt enforcement characteristics. Consistent with our model, we find that the relation between debt enforcement and firms’ investment and risk depends on the firm-specific probability of default. A differences-in-differences analysis of firms’ investment and risk taking in response to bankruptcy reforms that make debt more renegotiable confirms the cross-country evidence.     

Agency Conflicts and Risk Management

This paper analyzes the relation between agency conflicts andrisk management. In contrast to previous contributions, ouranalysis incorporates not only stockholder-debtholder conflictsbut also manager–stockholder conflicts. We show that thecosts of both underinvestment and overinvestment are essentialin determining the firm's hedging policy. In particular, firmsthat derive more of their value from assets in place (lowermarket-to-book ratios), although having lower costs of underinvestment,generally display larger costs of overinvestment. Thus, theymay be more likely to hedge to control these overinvestmentincentives. Our analysis explains why large profitable firmswith fewer growth opportunities tend to hedge more (Bartramet al., 2004). It also provides a number of new predictionsrelating the benefits associated with risk management to variousdimensions of the firm's economic environment.     

Corporate investment and financing under asymmetric information

We develop a dynamic model of corporate investment and financing decisions in which corporate insiders have superior information about the firm's growth prospects. We show that firms with positive private information can credibly signal their type to outside investors using the timing of corporate actions and their debt-equity mix. Using this result, we show that asymmetric information induces firms with good prospects to speed up investment, leading to a significant erosion of the option value of waiting to invest. Additionally, we demonstrate that informational asymmetries may not translate into a financing hierarchy or pecking order over securities. Finally, we generate a rich set of testable implications relating firms’ investment and financing strategies, abnormal announcement returns, and external financing costs to a number of managerial, firm, and industry characteristics.     

Capital structure,credit risk,and macroeconomic conditions

This paper develops a framework for analyzing the impact of macroeconomic conditions on credit risk and dynamic capital structure choice. We begin by observing that when cash flows depend on current economic conditions, there will be a benefit for firms to adapt their default and financing policies to the position of the economy in the business cycle phase. We then demonstrate that this simple observation has a wide range of empirical implications for corporations. Notably, we show that our model can replicate observed debt levels and the countercyclicality of leverage ratios. We also demonstrate that it can reproduce the observed term structure of credit spreads and generate strictly positive credit spreads for debt contracts with very short maturities. Finally, we characterize the impact of macroeconomic conditions on the pace and size of capital structure changes, and debt capacity.     

Can Managerial Discretion Explain Observed Leverage Ratios?

This article analyzes the impact of managerial discretion andcorporate control mechanisms on leverage and firm value withina contingent claims model where the manager derives perquisitesfrom investment. Optimal capital structure reflects both thetax advantage of debt less bankruptcy costs and the agency costsof managerial discretion. Actual capital structure reflectsthe trade-off made by the manager between his empire-buildingdesires and the need to ensure sufficient efficiency to preventcontrol challenges. The model shows that manager-shareholderconflicts can explain the low debt levels observed in practice.It also examines the impact of these conflicts on the cross-sectionalvariation in capital structures.     

Financing and takeovers

This paper analyzes the interaction between financial leverage and takeover activity. We develop a dynamic model of takeovers in which the financing strategies of bidding firms and the timing and terms of takeovers are jointly determined. In the paper, capital structure plays the role of a commitment device, and determines the outcome of the acquisition contest. We demonstrate that there exists an asymmetric equilibrium in financing policies with endogenous leverage, bankruptcy, and takeover terms, in which the bidder with the lowest leverage wins the takeover contest. Based on the resulting equilibrium, the model generates a number of new predictions. In particular, the model predicts that the leverage of the winning bidder is below the industry average and that acquirers should lever up after the takeover consummation. The model also relates the dispersion in leverage ratios to various industry characteristics, such as cash flow volatility or bankruptcy costs.     

Closed-form solutions to stochastic process switching problems

This paper studies the price of an asset depending on both a fundamental and possible interventions of an authority. Using the martingale approach in continuous time, we provide closed-form solutions to switching problems involving irreversible, state dependent and intramarginal switch policies. The martingale approach provides additional information regarding the switching policy, namely the average time before authority intervention, the conditional probability of intervention, or the total time of intervention. Applications in international and financial economics include exchange rates modelling, corporate claims valuation and capital budgeting decisions.