Can the Trade-off Theory Explain Debt Structure?

We examine the optimal mixture and priority structure of bankand market debt using a trade-off model in which banks havethe unique ability to renegotiate outside formal bankruptcy.Flexible bank debt offers a superior trade-off between tax shieldsand bankruptcy costs. Ease of renegotiation limits bank debtcapacity, however. Optimal debt structure hinges upon whichparty has bargaining power in private workouts. Weak firms havehigh bank debt capacity and utilize bank debt exclusively. Strongfirms lever up to their (lower) bank debt capacity, augmentwith market debt, and place the bank senior. Therefore, thetrade-off theory offers an explanation for: (i) why young/smallfirms use bank debt exclusively; (ii) why large/mature firmsemploy mixed debt financing; and (iii) why bank debt is senior.The trade-off theory also generates predictions consistent withinternational evidence. In countries in which the bankruptcyregime entails soft (tough) enforcement of contractual priority,bank debt capacity is low (high), implying greater (less) relianceon market debt.     

Ethics as social science

The author explores overlaps between economics and ethics. A society's moral climate conditions its degree of economic development and prosperity. Policy recommendations necessarily rest on normative as well as positive judgments. Social science contributes to posing and answering questions about the nature and grounding of ethical precepts. Pursuing these questions leads to an "indirect utilitarianism" incorporating insights of David Hume, Ludwig von Mises, Henry Hazlitt, and F. A. Hayek. Criticisms of this approach are answered, including charges that it is collectivistically aggregative, is vacuous, makes a fetish of rules, and encourages immoralities illustrated by "lifeboat cases". Alternatives to it are also appraised, including the natural-rights and "contractarian" approaches that have found favor with prominent economists. Presidential Address at the Fortieth International Atlantic Economic Conference, Williamsburg, Virginia, October 8–11, 1995.     

Aggregate demand shortfalls and economic freedom

Political instability is often exacerbated in periods of aggregate demand shortfall. It has been conjectured that inadequate policy responses to recessions may be inimical to free economic institutions. This paper uses the Economic Freedom of the World index as its measure of economic institutions, and finds that the change in economic freedom in the following five, ten, and fifteen years is negatively impacted by an aggregate demand shortfall as measured by negative NGDP growth.     

Did the repeated debt ceiling controversies embed default risk in US Treasury securities?

We examine whether the financial market charged a default risk premium to US Treasury securities when the US Federal government repeatedly reached the legally binding debt limits between 2002 and 2006. We show that for the first two of the four recurrences since the first episode in 1996, the financial market charged a small default risk premium to the Treasury securities. However, we find no significant evidence of a pricing effect in the last two recurrences. The results suggest that the financial market gradually perceived the budget standoffs as the boy who cried wolf.