Universal Banking Under Bilateral Information Asymmetry

The Gramm–Leach–Bliley (GLB) Act of 1999 repealed many provisions of the Glass–Steagall Act that curtailed competition between banks and commercial firms. Significantly, however, the GLB Act did not repeal the constraint on banks from owning equity in commercial firms (“universal banking”). Should banks be allowed to hold equity in corporate borrowers? If allowed, would banks optimally choose to do so? Despite its relevance from a policy perspective, there are surprisingly few theoretical analyses of this issue of “universal banking”. We develop a model in which the bank's advisory role as an “inside” shareholder hinges on its equity stake. The optimal capital structure and the bank's and entrepreneur's equity stakes are endogenously determined in a world with potential double-sided moral hazard. In certain scenarios, the bank may prefer not to hold any equity. Our analysis indicates that allowing optimal bank equity participation may foster improved corporate performance. This benefit of universal banking should be considered in policy debates.     

Hidden insurance in a moral‐hazard economy

We analyze the general equilibrium of an economy in which a competitive industry produces nonexclusive insurance services. The equilibrium is inefficient because insurance contracts cannot control moral hazard, and welfare can be improved by policies that reduce insurance by increasing its price above marginal cost. We discuss how insurance production costs that exceed expected claim payments interact with moral hazard in determining the equilibrium's inefficiency, and show that these costs can make insurance premia so actuarially unfair as to validate the standard first‐order conditions we exploit in our analysis.     

Evergreening in banking

In the dynamic model of banking, a bank's option to hide its loan losses by rolling over non-performing loans is shown to worsen moral hazard. Contrary to the classic theory, moral hazard may arise even when a bank cannot seek a correlated risk for its loans. The loans seem to be performing and the bank makes a profit although it is de facto insolvent. When the bank's balance sheet includes hidden non-performing loans, the bank may optimally shrink lending or gamble for resurrection by growing aggressively. To eliminate this type of moral hazard, which is broadly consistent with evidence from emerging economies, a few regulatory implications are suggested.     

Procurement with specialized firms

We analyze optimal procurement mechanisms when firms are specialized. The procurement agency has incomplete information concerning the firms' cost functions and values high quality as well as low price. Lower type firms are cheaper (more expensive) than higher type firms when providing low (high) quality. With specialized firms, distortion is limited and a mass of types earns zero profits. The optimal mechanism can be inefficient: types providing lower second‐best welfare win against types providing higher second‐best welfare. As standard scoring rule auctions cannot always implement the optimal mechanism, we introduce a new auction format implementing the optimal mechanism.     

Bank size and risk-taking under Basel II

We analyze the relationship between bank size and risk-taking under the Basel II Capital Accord. Using a model with imperfect competition and moral hazard, we show that the introduction of an internal ratings based (IRB) approach improves upon flat capital requirements if the approach is applied uniformly across banks and if the costs of implementation are not too high. However, the banks’ right to choose between the standardized and the IRB approaches under Basel II gives larger banks a competitive advantage and, due to fiercer competition, pushes smaller banks to take higher risks. This may even lead to higher aggregate risk-taking.     

KSA – Beitritt oder Gründung nicht ausschreibungspflichtig

All in all it can be stated that both, the establishment and the joining of a KSA, is an activity which is exclusively allocated to the right of self organisation of the local authorities. It is a measure of internal organisation without external procurement character. For this reason from the first the application of the procurement rules following the competition law is already excluded.Even if – in contrary to other argumentation – the competition law rules should be regarded as applicable, the principle of in-house award exceptionally takes effect.     

The Valuation of Assets under Moral Hazard

The design of managerial incentive contracts is examined in a setting in which economic agents are risk averse, and the actions of managers can affect asset returns which contain both systematic and idiosyncratic risks. It is shown that in the absence of moral hazard, owners of assets will insure managers against idiosyncratic risks, but with moral hazard, contracts will depend on both systematic and idiosyncratic risks. The traditional recommendation of asset pricing models, namely, to focus only on systematic risks, is thus proved to be valid only when there is no moral hazard. The major empirically testable predictions of the model are (1) managerial incentive contracts will generally depend on systematic as well as idiosyncratic risks, (2) idiosyncratic risks will generally be important in investment decisions, (3) the managers of firms with relatively high levels of idiosyncratic risks will have compensations that are less dependent on their firms' excess returns, and (4) the compensations of managers of larger firms will be relatively more dependent on the excess returns of their firms.     

Does the currency regime shape unhedged currency exposure?

This paper examines how unhedged currency exposure of firms varies with changes in currency flexibility. A sequence of four time periods with alternating high and low currency volatility in India provides a natural experiment in which changes in currency exposure of a panel of firms is measured, and the moral hazard versus incomplete markets hypotheses tested. We find that firms carried higher currency exposure in periods when the currency was less flexible. Our results support the moral hazard hypothesis: that low currency flexibility encourages firms to hold unhedged exposure in response to implicit government guarantees.     

On the effects of banks�� equity ownership on credit markets

Recent deregulation of the banking sector in the US and in Europe allows commercial banks to hold equity in non-financial firms. We develop a model to investigate the effects of bank equity stakes in firms on credit market competition. The main result is that an equity stake confers a competitive advantage to the holding bank, which in equilibrium results in decreased competition in credit markets and higher interest rates being charged to firms. However, regulatory limits on the size of a bank’s stake may, under certain conditions, be counterproductive: they could actually strengthen the equity-owning bank’s competitive advantage. Our findings shed new light on the role of equity in lending relationships, and highlight that, in addition to the well-known prudential aspects, there is an antitrust dimension in the separation of banking and commerce.     

Ownership Dynamics of REITs

This paper studies the effects that benefits of control and moral hazard have on the evolution of large stakes in REITs. A large risk-averse shareholder trades off the net benefits of REIT business monitoring and control with the cost of bearing risk beyond the level compensated by the REIT return premium. In equilibrium, the large shareholder gradually adjusts his ownership shares level (as long as his marginal benefits from holding shares increase in his REIT stake) towards the long-run competitive equilibrium in which his marginal share valuation coincides with that of the market. Because of the moral hazard, such level of ownership (and monitoring) is, in general, inefficient. The speed of adjustment is positively correlated with the agents risk aversion and company volatility, and negatively correlated with his marginal benefits of control and beneficial monitoring effects.     

Moral hazard,adverse selection,and health expenditures: A semiparametric analysis

Theoretical models predict asymmetric information in health insurance markets may generate inefficient outcomes due to adverse selection and moral hazard. However, previous empirical research has found it difficult to disentangle adverse selection from moral hazard in health care consumption. We propose a two‐step semiparametric estimation strategy to identify and estimate a canonical model of asymmetric information in health care markets. With this method, we can estimate a structural model of demand for health care. We illustrate this method using a claims‐level data set with confidential information from a large self‐insured employer. We find significant evidence of moral hazard and adverse selection.     

Using International Institutions to Improve Public Procurement

The World Trade Organization's voluntary rules on governmentprocurement are a useful mechanism for ensuring that publicprocurement procedures are efficient. They also provide an opportunityto reduce the uncertainty of participants by increasing transparencyand accountability. Yet most developing countries have chosennot to subject their procurement policies to international disciiplinesand multilateral surveillance. Their reasons may include anunfamiliarity with the government procurement agreement (GPA);a perception that the potential payoffs are small; a desireto discriminate in favor of domestic firms; or the successfulopposition of groups that benefit from the current regimes.Although the economic rationales for abstaining from the GPAare not compelling, a quid pro quo for accession may be neededto overcome opposition by special interests. Developing countryprocurement markets are large enough that governments may beable to make accession to the GPA conditional on temporary exceptionsto multilateral disczplines or on better access to export markets.      

Multiple Losses, EX ANTE Moral Hazard, and the Implications for Umbrella Policies

Under certain cost conditions the optimal insurance policy offers full coverage above a deductible, as Arrow and others have shown. However, many insurance policies currently provide coverage against several losses although the possibilities for the insured to affect the loss probabilities by several prevention activities (multiple moral hazard) are substantially different. This article shows that optimal contracts under multiple moral hazard generally call for complex reimbursement schedules. It also examines the conditions under which different types of risks can optimally be covered by a single insurance policy and argues that the case for umbrella policies under multiple moral hazard is limited in practice.     

Competition and the cost of debt

This paper empirically shows that the cost of bank debt is systematically higher for firms that operate in competitive product markets. Using various proxies for product market competition, and reductions of import tariff rates to capture exogenous changes to a firm's competitive environment, I find that competition has a significantly positive effect on the cost of bank debt. Moreover, the analysis reveals that the effect of competition is greater in industries in which small firms face financially strong rivals, in industries with intense strategic interactions between firms, and in illiquid industries. Overall, these findings suggest that banks price financial contracts by taking into account the risk that arises from product market competition.     

Securitization and moral hazard: Evidence from credit score cutoff rules

A growing literature exploits credit score cutoff rules as a natural experiment to estimate the moral hazard effect of securitization on lender screening. However, these cutoff rules can be traced to underwriting guidelines for originators, not for securitizers. Moreover, loan-level data reveal that lenders change their screening at credit score cutoffs in the absence of changes in the probability of securitization. Credit score cutoff rules thus cannot be used to learn about the moral hazard effect of securitization on underwriting. By showing that this evidence has been misinterpreted, our analysis should move beliefs away from the conclusion that securitization led to lax screening.     

Moral Hazard and Adverse Selection: The Question of Financial Structure

This paper looks at the moral hazard and adverse selection problems confronting an entrepreneur offering securities to an uninformed, but competitive financial market. The adverse selection aspect of the problem is generated by the unobservable entrepreneur's ability to transform effort into value. Moral hazard arises because the investment decision is made subsequent to financing. We consider the joint use of both debt and equity, and characterize the equilibrium relation between capital structure and unobservable attributes. It is shown that: (1) investment and financing are not separable; (2) there is an underinvestment problem for “better” firms; and (3) simultaneous use of both debt and equity can resolve this difficulty. We also establish a connection between expected terminal firm value and debt-promised payment level and between share retention and standard deviation.     

Interest Rates in Trade Credit Markets

All things equal, interest rates should increase with the borrower's risk. And yet, Klapper, Laeven, and Rajan (2012) cannot find such a positive relation in a broad sample of trade credit contracts. We shed some light on this puzzle by arguing that competition between informed and uninformed suppliers weakens the link between the trade credit cost and the borrower's creditworthiness. Our model implies that trade credit rates are more likely to increase with the borrower's risk if suppliers are less profitable, have high cost of funds, or sell inputs to firms plagued by moral hazard and financial distress.     

The Role of Lockups in Initial Public Offerings

In a sample of 2,794 initial public offerings (IPOs), we testthree potential explanations for the existence of IPO lockups:lockups serve as (i) a signal of firm quality, (ii) a commitmentdevice to alleviate moral hazard problems, or (iii) a mechanismfor underwriters to extract additional compensation from theissuing firm. Our results support the commitment hypothesis.Insiders of firms that are associated with greater potentialfor moral hazard lockup their shares for a longer period oftime. Insiders of firms that have experienced larger excessreturns, are backed by venture capitalists, or go public withhigh-quality underwriters are more likely to be released fromthe lockup restrictions.     

Briys,Eric, and de Varenne,François,Insurance: From Underwriting to Derivatives: Asset Liability Management in Insurance Companies

Abstract

This paper uses economic principles to analyze alternative recognition schemes for end-of-period retirement plan liabilities; the candidates, using U.S. nomenclature, are the vested benefit obligation (VBO), the accumulated benefit obligation (ABO) and the projected benefit obligation (PBO).

In competitive employment markets with rational contracting we are unable to justify projected costing (PBO-based) for typical pay-related defined benefit plans. Projected costing misrepresents the economic obligations incurred by shareholders and invites moral hazard.

Employee exposure to moral hazard may be minimized by exit costing (VBO-based) which recognizes only those benefits to which an exiting employee is entitled under the explicit benefit contract. But exit costing may not fully inform shareholders about the obligations that they have incurred under implicit contracts that extend beyond the plan document. Accrued costing (represented in the United States by the ABO) may better measure shareholders’ economic commitments.

Small differences between the ABO and the VBO may measure a human capital asset incented by delayed vesting and benefit eligibility. Large differences are a marker for frail benefit design and potential moral hazard.

Moral hazard options exercised by employers disappoint employees and may lead to unwelcome ex-post results-oriented repairs imposed by legislators, regulators and courts.     

Corporate social responsibility,industry concentration,and firm performance: Evidence from emerging Asian economies

Social and environmental performance are two pillars of corporate social responsibility that integrate the desires of firms to enhance their competitive advantages and demonstrate their commitment to society. Based on a sample of eight emerging Asian markets, this study investigates the role of firms’ social and environmental performance in their financial performance, and how this may vary under different levels of industry competition. The results show that the social dimension is more effective in increasing firm performance relative to the environmental dimension. Further, the performance of socially oriented firms is more stable in highly competitive industries relative to environmentally oriented firms. Overall, this study supports the view that socially responsible firms have a competitive edge over their rivals that leads to higher profitability.