Efficient investment and financial intermediation

Insider trading causes uninformed agents to reduce their investments in assets that are most susceptible to it. This problem may be mitigated by forming a financial intermediary that issues securities with different sensitivity to inside information. In particular, the uninformed agents desire the intermediary's demand debt while the informed agents choose its equity. By separating the uninformed agents' financial payoffs from the intermediary's investment decisions, the intermediary can pursue more efficient investments and achieve allocations that are superior to those of the market.     

AN EXAMINATION OF FEDERAL AGENCY DEBT PRICING PRACTICES

Debt issuance procedures for federally sponsored agency securities differ considerably from the methods used by the U.S. Treasury and most corporate and municipal debt issuers. This paper examines the debt issuing procedures of the three major federally sponsored agencies and the efficiency with which the fiscal agents for those agencies price new debt issues. The conclusions from the analysis are: (1) fiscal agents for the major federally sponsored agencies are extremely adept at estimating the equilibrium competitive yields for new debt issues; (2) pricing errors on new issues are generally due to factors beyond a fiscal agent's control, such as the volatility of debt market conditions; and (3) the debt pricing practices for federally sponsored agency securities are efficient and effective.     

Funding advantage and market discipline in the Canadian banking sector

We employ a comprehensive data set and a variety of methods to provide evidence on the magnitude of large banks’ funding advantage in Canada in addition to the extent to which market discipline exists across different securities issued by the Canadian banks. The banking sector in Canada provides a unique setting in which to examine market discipline along with the prospects of proposed reforms because Canada has no history of government bailouts, and an implicit government guarantee has been in effect consistently since the 1920s. We find that large banks have a funding advantage over small banks after controlling for bank-specific and market risk factors. Large banks on average pay 80 basis points and 70 basis points less, respectively, on their deposits and subordinated debt. Working with hand-collected market data on debt issues by large banks, we also find that market discipline exists for subordinated debt and not for senior debt.     

Competitive risk sharing contracts with one-sided commitment

This paper analyzes dynamic equilibrium risk sharing contracts between profit-maximizing intermediaries and a large pool of ex ante identical agents that face idiosyncratic income uncertainty that makes them heterogeneous ex post. In any given period, after having observed her income, the agent can walk away from the contract, while the intermediary cannot, i.e. there is one-sided commitment. We consider the extreme scenario that the agents face no costs to walking away, and can sign up with any competing intermediary without any reputational losses. We demonstrate that not only autarky, but also partial and full insurance can obtain, depending on the relative patience of agents and financial intermediaries. Insurance can be provided because in an equilibrium contract an up-front payment effectively locks in the agent with an intermediary. We then show that our contract economy is equivalent to a consumption-savings economy with one-period Arrow securities and a short-sale constraint, similar to Bulow and Rogoff [1989. Sovereign debt: is to forgive to forget? American Economic Review 79, 43-50]. From this equivalence and our characterization of dynamic contracts it immediately follows that without cost of switching financial intermediaries debt contracts are not sustainable, even though a risk allocation superior to autarky can be achieved.     

强制性次级债与商业银行的公司治理

对于商业银行而言,次级债除了具有补充资本、融通资金的功能外,还具有特殊的公司治理功效。基于这一视角,本文对次级债在商业银行公司治理中功效的比较优势进行了论述,介绍了强制性次级债市场约束效用的两步骤分析框架,并就强制性次级债政策提供了相应评论。本文得出以下研究结论:恰当的强制性次级债政策有助于商业银行公司治理的完善以及国内金融生态的改善;为了确保MSDP(MandatorySubordinatedDebtPolicy)的投资者确实具备对银行风险变化进行监督和有所反应的动机,应该对由“内部人”持有的债券数量进行限制并完善信息披露制度;加快推进国有商业银行的股份制改革,培育市场化的发债主体和机构投资者是实施MSDP的必要基础条件。     

Public Debt Management and Macroeconomic Stability: An Overview

Recent research suggests that management of the public sector’sdebt can have important effects on a country’s macroeconomicperformance. This article provides an overview of the factorsthat the recent literature has identified as important in determiningthe optimal composition of the public debt. Based on this analysis,it attempts to establish general guidelines for public debtmanagement in emerging economies. To retain market access andpromote domestic financial market development, governments shouldgenerally finance themselves at market rates using a wide varietyof securities. Beyond this general principle, the optimal compositionof the public debt involves a tradeoff between enhancing thegovernment’s anti–inflationary credibility and reducingthe vulnerability of its budget to macroeconomic shocks. Consequently,the optimal composition of the debt depends on a country’scircumstances. Debt should be heavily weighted toward long-termnominal securities for governments that have anti–inflationarycredibility and toward long-term indexed debt for those thatdo not.      

Federal financial guarantees and the occasional market pricing of default risk: Evidence from insured deposits

This paper develops a two-date state preference model which demonstrates that investors' valuation of third-party guaranteed debt depends on the financial condition of the guarantor. As the solvency ratio of the guarantor declines, investors demand higher promised rates on the firm's debt securities and price the firm risk variables more sensitively.The empirical results are derived from sample data of FSLIC guaranteed obligations from the late 1980s. Evidence shows differences in the market's perception of FSLlC's insolvency between 1987 and 1988. The market response to a decline in the financial condition of the guarantor affected the value of insured CDs, raising CD rates in relation to the Treasury curve and firm risk pricing of insured deposits emerged.     

Asymmetric Information and Risky Debt Maturity Choice

When capital market investors and firm insiders possess the same information about a company's prospects, its liabilities will be priced in a way that makes the firm indifferent to the composition of its financial liabilities (at least under certain, well-known circumstances). However, if firm insiders are systematically better informed than outside investors, they will choose to issue those types of securities that the market appears to overvalue most. Knowing this, rational investors will try to infer the insiders' information from the firm's financial structure. This paper evaluates the extent to which a firm's choice of risky debt maturity can signal insiders' information about firm quality. If financial market transactions are costless, a firm's financial structure cannot provide a valid signal. With positive transaction costs, however, high-quality firms can sometimes effectively signal their true quality to the market. The existence of a signalling equilibrium is shown to depend on the (exogenous) distribution of firms' quality and the magnitude of underwriting costs for corporate debt.     

The prepayment option on mortgage securities: A random coefficient approach

Using the Swamy (1970) model for pooled data and a Hildreth and Houck (1968) model for individual securities, this article investigates whether the parameters describing the prepayment behavior of the fixed-rate debt underlying mortgage-backed securities are better estimated as a stochastic behavior. Empirical results indicate that differences between securities are random. The Hildreth and Houck model yields additional information on randomness over time. The use of the aggregate data to estimate prepayment of individual securities, as opposed to use of the prepayment history of the individual security, may yield more reliable results.     

The long-run performance of firms that issue convertible debt: an empirical analysis of operating characteristics and analyst forecasts

Many firms issue hybrid securities, such as convertible debt, instead of standard securities like straight debt or common equity. Theoretical arguments suggest that convertible debt minimizes costs for firms facing high debt- and equity-related external financing costs. Theory also suggests that an appropriately designed convertible security provides efficient investment incentives. We show, however, that firms on average perform poorly following the issuance of convertible debt. The empirical evidence suggests that the efficient investment decisions predicted by theory are not in fact achieved by the actual design and issuance of convertible debt securities. An alternative interpretation of convertible debt offers is that investors ration the participation of some issuers in the seasoned equity market.     

Corporate Reorganizations and Non-Cash Auctions

This paper extends the theory of non-cash auctions by considering the revenue and efficiency of using different securities. Research on bankruptcy and privatization suggests using non-cash auctions to increase cash-constrained bidder participation. We examine this proposal and demonstrate that securities may lead to higher revenue. However, bidders pool unless bids include debt,which results in possible repossession by the seller. This suggests all-equity outcomes are unlikely and explains the high debt of reorganized firms. Securities also inefficiently determine bidders' incentive contracts and the firm's capital structure. Therefore, we recommend a new cash auction for an incentive contract.     

Information asymmetry and bank regulation: Can the spread of debt contracts be explained by recovery rates?

We investigate whether the spread of corporate debt contacts can be explained by their ultimate recovery rates. Using the actual realized recovery rates of defaulted debt instruments issued in the US from 1962 to 2007, we find that recovery rate is reflected in the spread at issuance, and that this relationship has become more significant since commercial banks were allowed to underwrite corporate securities. Our further investigation indicates that the enhanced informativeness of recovery rate can be attributed to the lowering of information asymmetry of individual firms. Besides, the relation between the spread at issuance and the recovery rate is stronger for weak corporate governance and non-investment grade issuers. Our conclusions are found to be robust to endogeneity issues, potentially omitted variables and alternative model specifications.     

Security Design with Investor Private Information

I study the security design problem of a firm when investors rather than managers have private information about the firm. I find that it is often optimal to issue information‐sensitive securities such as equity. The “folklore proposition of debt” from traditional signaling models only goes through if the firm can vary the face value of debt with investor demand. When the firm has several assets, debt backed by a pool of assets is optimal when the degree of competition among investors is low, while equity backed by individual assets is optimal when competition is high.     

Do Banks Provide Financial Slack?

We study the decision to choose bank debt rather than public securities in a firm's marginal financing choice. Using a sample of 500 firms over the 1980 to 1993 time period, we find that firms are relatively more likely to choose bank loans when variables that measure asymmetric information problems are elevated. The sensitivity of the likelihood of choosing bank debt to information problems is greater for firms with no public debt outstanding. These results are consistent with the hypothesis that banks help alleviate asymmetric information problems and that firms weigh these information benefits against a wide range of contracting costs when choosing bank financing.     

Bankruptcy priority for bank deposits: a contract theoretic explanation

Over the past decade several countries, including the US, haveintroduced or redesigned legislation that confers priority inbankruptcy upon all or some bank deposits. We argue that inthe presence of contracting costs such rules can increase efficiency.We first show in a private information model that a borrowercan reduce overall costs of finance by letting informationallyheterogeneous lenders choose between junior and senior debt.In particular, we find that debt priorities reduce sociallywasteful information gathering by investors. We then argue why,particularly in banking, legal standardization of debt prioritiesmay be superior to bilateral private arrangements.     

Treasury Safety,Liquidity, and Money Premium Dynamics: Evidence from Debt Limit Impasses

Treasury securities enjoy a “money premium” because they are ultra-safe and liquid. However, during debt limit impasses, the safety and liquidity of Treasury securities temporarily deteriorate, eroding the money premium. Using past impasses, we find the money premium eroded by roughly six basis points across all Treasury securities and up to 50 basis points for the shortest maturities at the greatest risk of a delayed principal payment. Safety and liquidity each accounted for about half of the erosion. The deterioration of safety and liquidity also appears to interact, consistent with theories of default-driven liquidity risk and the information sensitivity of debt.     

The Valuation Effects of Private Placements of Convertible Debt

Share price reactions to announcements of 61 private placements of convertible debt securities are investigated and a significant positive average abnormal return of 1.80% is documented. This unique result contrasts with the negative average abnormal return associated with public sales of convertible debt securities. The positive effect on common shareholders' wealth appears to be related to the relative size of the private issue and unrelated to the degree to which the convertible bond is “out-of-the-money” at issuance.     

Contrasting the information demands of equity- and debt-holders: Evidence from pension liabilities

In the setting of defined-benefit pension liabilities, we hypothesize that equity and debt investors value these liabilities differently. As expected, we find that investors' valuations of equity more closely align with a going concern perspective that emphasizes the long-term funding needs of pension plans. In contrast, as expected, we find that investors' pricing of short-term and unsecured debt more closely aligns with a settlement perspective that emphasizes pension termination costs. For both equity and debt securities, the settlement (going concern) perspective dominates for short-duration (long-duration) pensions. Overall, our evidence suggests that equity and debt investors perceive complex liabilities in predictably different ways that are consistent with their differing information demands, which in turn vary with the characteristics of the obligation.     

Equilibrium in risk-sharing games

The large majority of risk-sharing transactions involve few agents, each of whom can heavily influence the structure and the prices of securities. In this paper, we propose a game where agents’ strategic sets consist of all possible sharing securities and pricing kernels that are consistent with Arrow–Debreu sharing rules. First, it is shown that agents’ best response problems have unique solutions. The risk-sharing Nash equilibrium admits a finite-dimensional characterisation, and it is proved to exist for an arbitrary number of agents and to be unique in the two-agent game. In equilibrium, agents declare beliefs on future random outcomes different from their actual probability assessments, and the risk-sharing securities are endogenously bounded, implying (among other things) loss of efficiency. In addition, an analysis regarding extremely risk-tolerant agents indicates that they profit more from the Nash risk-sharing equilibrium than compared to the Arrow–Debreu one.     

Pricing the risk of recovery in default with absolute priority rule violation

This paper proposes a simple approach to infer the risk-neutral density of recovery rates implied by the prices of the debt securities of a firm. The proposed approach is independent of modeling default arrival rates and allows for the violation of absolute priority rule. The paper demonstrates that a new statistic, the adjusted relative spread, captures risk-neutral recovery information in debt prices. Interest rates and firm tangible assets are shown to be significant determinants of the price of recovery. An application illustrates the pricing of credit derivatives written on the realized recovery rate.