Bankruptcy law and financial structure: The impact of managerial incentives

Abstract

Providing the manager of a firm with suitable incentives to act in the investors’ interest may be socially efficient, but not individually rational for the investors themselves. This paper specifies a second-best arrangement and shows how investors can be induced to implement it by means of an optimal bankruptcy code in the case where only standard financial contracts are available. It explains why bankruptcy law should, in some states of nature, let shareholders and senior creditors decide jointly, and provides a rationale for the existence of junior debt, which never enjoys any power of decision.     

Bank use of sovereign CDS in the Eurozone crisis: Hedging and risk incentives

Using a comprehensive dataset from German banks, we document the usage of sovereign credit default swaps (CDS) during the European sovereign debt crisis of 2008–2013. Banks used the sovereign CDS market to extend, rather than hedge, their long exposures to sovereign risk during this period. Lower loan exposure to sovereign risk is associated with greater protection selling in CDS, the effect being weaker when sovereign risk is high. Bank and country risk variables are mostly not associated with protection selling. The findings are driven by the actions of a few non-dealer banks which sold CDS protection aggressively at the onset of the crisis, but started covering their positions at its height while simultaneously shifting their assets towards sovereign bonds and loans. Our findings underscore the importance of accounting for derivatives exposure in building a complete picture and understanding fully the economic drivers of the bank-sovereign nexus of risk.     

Debt,Equity and Hybrid Decoupling: Governance and Systemic Risk Implications

We extend here our prior work, which focused on equity decoupling ( Hu and Black, 2006, 2007, 2008 ), by providing a systematic treatment of debt decoupling and an initial exploration of hybrid decoupling. Equity decoupling involves unbundling of economic, voting, and sometimes other rights customarily associated with shares, often in ways that may permit avoidance of disclosure and other obligations. We discuss a new U.S. court decision which will likely curtail the use of equity decoupling strategies to avoid large shareholder disclosure rules. Debt decoupling involving the unbundling of the economic rights, contractual control rights, and legal and other rights normally associated with debt, through credit derivatives and securitisation. Corporations can have empty and hidden creditors, just as they can have empty and hidden shareholders. ‘Hybrid decoupling’ across standard equity and debt categories is also possible. All forms of decoupling appear to be increasingly common. Debt decoupling can pose risks at the firm level for what can be termed ‘debt governance’? the overall relationship between creditor and debtor, including creditors' exercise of contractual and legal rights with respect to firms and other borrowers. Widespread debt decoupling can also involve externalities and therefore create systemic financial risks; we explore those risks.     

Bank lending to targets of active takeover attempts: The simultaneous choice of loan maturity,pricing, and security

I investigate bank loans to takeover targets considering the simultaneous decision of pricing, maturity, collateral, and covenants applying Generalized Method of Moments (GMM). Results are largely in line with the Agency Theory of Covenants (ATC) as pricing for new bank debt is lower given greater collateral and covenant protection, consistent with existing literature on public debt. However, poor performing targets demonstrate a positive relationship between pricing and covenants while bank loans to high performers are consistent with ATC predictions. Finally, loan terms tied to ex post observations of merger outcomes suggest banks possess some knowledge of merger outcomes in advance.