Debt, managerial compensation and learning

Using a dynamic model with uncertainty and asymmetric information, we study the impact of debt and bankruptcy on managerial compensation and learning. In this model, compensation has two roles to play—providing incentives to the manager and learning about his type. We show that debt, through bankruptcy, acts as a substitute of compensation in both dimensions and derive conditions under which debt lowers average compensation, pay-performance sensitivity and increases learning. We also examine the choice of debt and show that firm value can be increased due to debt's effect on managerial compensation, abstracting from other costs and benefits of debt. Finally, we conduct comparative statics with respect to the underlying parameters.     

Optimal fiscal and monetary policy with sticky wages and sticky prices

We determine the optimal degree of price inflation volatility when nominal wages are sticky and the government uses state-contingent inflation to finance government spending. We address this question in a well-understood Ramsey model of fiscal and monetary policy, in which the benevolent planner has access to labor income taxes, nominally risk-free debt, and money creation. Our main result is that sticky wages alone make price stability optimal in the face of shocks to the government budget, to a degree quantitatively similar as sticky prices alone. Key for our results is an equilibrium restriction between nominal price inflation and nominal wage inflation that holds trivially in a Ramsey model featuring only sticky prices. Our results thus show that when nominal wages are sticky, setting real wages as close as possible to their efficient path is a more important goal of optimal monetary policy than is financing innovations in the government budget via state-contingent inflation. A second important result is that the nominal interest rate can be used to indirectly tax the rents of monopolistic labor suppliers. Taken together, our results uncover features of Ramsey fiscal and monetary policy in the presence of a type of labor market imperfection that is widely-believed to be important.     

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The Gramm–Leach–Bliley (GLB) Act of 1999 repealed many provisions of the Glass–Steagall Act that curtailed competition between banks and commercial firms.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.     

The path-to-profitability of Internet IPO firms

Extant empirical evidence indicates that the proportion of firms going public prior to achieving profitability has been increasing over time. This phenomenon is largely driven by an increase in the proportion of technology firms going public. Since there is considerable uncertainty regarding the long-term economic viability of these firms at the time of going public, identifying factors that influence their ability to attain key post-IPO milestones such as achieving profitability represents an important area of research. We employ a theoretical framework built around agency and signaling considerations to identify factors that influence the probability and timing of post-IPO profitability of Internet IPO firms. We estimate Cox Proportional Hazards models to test whether factors identified by our theoretical framework significantly impact the probability of post-IPO profitability as a function of time. We find that the probability of post-IPO profitability increases with pre-IPO investor demand and change in ownership at the IPO of the top officers and directors. On the other hand, the probability of post-IPO profitability decreases with the venture capital participation, proportion of outsiders on the board, and pre-market valuation uncertainty.     

Venture capitalist participation and the post-issue operating performance of IPO firms

Previous studies have identified the value-added potential of venture capitalist monitoring in the initial public offering (IPO) market. We test this proposition by comparing the post-issue operating performance of venture capitalist-backed IPOs with a matched sample of non-venture capitalist-backed IPOs. We find that venture capitalist-backed IPO firms exhibit relatively superior post-issue operating performance compared to non-venture capital-backed IPO firms. Further, the market appears to recognize the value of monitoring by venture capitalists as reflected in the higher valuations at the time of the IPO. Finally, we find that proxies for the quality of venture capitalist monitoring are positively related to post-issue operating performance.     

Executive Stock Options: To Expense or Not?

In analyzing the decision to expense stock options, we find a greater likelihood of options expensing for firms with greater transparency and a closer alignment of interests between managers and shareholders. These results provide indirect evidence that expensing is more likely in firms that practice good corporate governance. We show that firms are less likely to expense when option usage is higher and that this negative relation is stronger for firms that are smaller, have high growth, and are less profitable. We also find that the announcement period returns are not significantly different from zero.     

Does accounting conservatism deter short sellers?

Review of Quantitative Finance and Accounting - We examine the impact of the corporate information environment on short selling by testing the relationship between short interest and accounting...