|
The
Industrial Organization of Banking and Financial Markets in Europe
Papers The papers produced by the Industrial Organization Network fall under three main categories: Discussion Papers produced by CEPR Joint papers produced under the framework of the network Other related publications from the network
The following titles were produced by CEPR within the framework of the network...
DP3244 Deposit Insurance and International Bank Deposits DP3566 When Does Strategic Debt Service Matter? DP3411 Banks versus Venture Capital DP3292 Regulating Insider Trading when Investment Matters DP3195 Psychological Traits and Trading Strategies DP3203 Venture Capital Contracts and Market Structure DP3233 Coordination Failures and the Lender of Last Resort: Was Bagehot Right After All? DP3182 Anti-Competitive Financial Contracting: The Design of Financial Claims DP3080 Informational Externalities, Herding and Incentives DP2935 Internal Capital Markets, Cross-Subsidization and Product Market Competition DP2911 Information Sharing in Banking: A Collusive Device? DP2915 Screening Cycles DP2878 Price Discovery Across the Rhine DP2736 The Seven Percent Solution? An International Perspective On Underwriting Spreads DP2678 Allocative and Productive Efficiency in REE with Asymmetric Information DP2681 The Geography of Equity Listing: Why Do Companies List Abroad? DP2683 What Makes Stock Exchanges Succeed? Evidence from Cross-Listing Decisions DP2643 Managerial Compensation and the Market Reaction to Bank Loans DP2597 Bank Capital Regulation with Random Audits DP2503 Subjective Discount Factors DP2504 Excessive continuation and Dynamic Agency Costs of Debt DP2505 Public Trading and Private Incentives DP2484 Has the Introduction of Bookbuilding Increased the Efficiency of International IPOs? DP2453 Banking Crises and Bank Rescues: The Role of Reputation DP2417 Collateral, Renegotiation And The Value Of Diffusely Held Debt DP2439 Collateral Vs. Project Screening: A Model Of Lazy Banks DP2325 Systemic Risk, Interbank Relations and Liquidity Provision by the Central Bank DP2275 Legal Determinants of the Return on Equity DP2276 Law and Equity Markets: A Simple Model DP2288 Deregulation, Integration and Market Structure in European Banking DP2238 Optimal Bail-Out, Conditionality and Creative Ambiguity DP2128 Competition, Financial Discipline and Growth DP2130 Agency Costs, Firm Behaviour and the Nature of Competition DP2101 Cooperation Among Competitors: The Economics of Credit Card Associations DP2060 Entrepreneurial Moral Hazard and Bank Monitoring: A Model of the Credit Channel DP2045 Bank Competition and Enterprise restructuring in Transition Economies
1.
Marco Pagano, New Research in
Financial Markets (co-edited with Bruno Biais). Oxford: Oxford
University Press, 2001. 2.
Marco Pagano, New Research in
Corporate Finance and Banking (co-edited with Bruno Biais). Oxford:
Oxford University Press, 2002. 3.
Marco Pagano (Salerno), “Collateral vs. Project Screening: A Model
of Lazy Banks" (with Michael Manove and Jorge Padilla (CEPR), RAND
Journal of Economics, Vol. 32, No. 4, Winter, 2001. Many
economists argue that the primary economic function of banks is to provide
cheap credit, and to facilitate this function, they advocate the strict
protection of creditor rights. But banks can serve another important
economic function: by screening projects they can reduce the number of
project failures and thus mitigate their private and social costs. In this
paper, we show that because of market imperfections in the banking industry,
strong creditor protection may lead to market equilibria in which cheap
credit is inappropriately emphasized over project screening. Restrictions on
collateral requirements and the protection of debtors in bankruptcy may
redress this imbalance and increase credit-market efficiency. 4.
Marco Pagano (Salerno), Ailsa Röell (CEPR), Otto Randl (Young
Researcher, Salerno) and Josef Zechner (CEPR), “What Makes Stock Exchanges
Succeed? Evidence from Cross-Listing Decisions”, European Economic Review,
45, May 2001. Despite
the increasing integration of capital markets, geography has not yet become
irrelevant to finance. Between 1986 and 1997, European public companies have
increasingly listed abroad, especially in the U.S. We relate the
cross-listing decisions to the characteristics of the destination exchanges
(and countries) relative to those of the home exchange (and country).
European companies appear more likely to cross-list in more liquid and
larger markets, and in markets where several companies from their industry
are already cross-listed. They are also more likely to cross-list in
countries with better investor protection, and more efficient courts and
bureaucracy, but not with more stringent accounting standards. 5.
Marco Pagano (Salerno), Ailsa A. Röell (CEPR) and Josef Zechner
(CEPR), “The Geography of Equity Listing: Why Do Companies List
Abroad?”, CSEF Working Paper No.
28,
and CEPR Discussion Paper no.
2681, forthcoming in the Journal of Finance.
This
paper documents aggregate trends in the foreign listings of companies, and
analyzes their distinctive pre-listing characteristics and post-listing
performance. In 1986-97, many European companies listed abroad, mainly on
U.S. exchanges, while the number of U.S. companies listed in Europe
decreased. The characteristics and performance of European companies differ
sharply depending on whether they cross-list in the U.S. or within Europe.
In the first case, companies tend to be high-tech and export-oriented, and
pursue a strategy of rapid expansion with no significant leveraging. In the
second case, companies do not grow more than the control group, and increase
their leverage after cross-listing. In both cases, cross-listing companies
tend to be large and recently privatized firms, and expand their foreign
sales after listing abroad. 6.
Jean-Charles Rochet (IDEI) and Xavier Vives (CEPR), “Coordination
Failures and the Lender of Last Resort: was Bagehot Right After All?” FMG
DP February 2002-03-19 Excessive Continuation and Dynamic Agency Costs of Debt by Jean Paul Decamps (GREMAQ-IDEI) and Antoine Faure-Grimaud (LSE and CEPR) forthcoming FMG DP, March 2000. This paper analyses the incentives of the equity holders of a leveraged company to shut it down in a continuous time, stochastic environment. Keeping the firm as an ongoing concern has an option value but equity and debt holders value it differently. Equityholders’ decisions exhibit excessive continuation and reduce firm's value. Using a compound exchange option approach, we characterise the resulting agency costs of debt, derive the ‘price’ of these costs and analyse their dynamics. We also show how agency costs can be reduced by the design of debt and the possibility of renegotiation.
by Philippe Bacchetta, (Studienzentrum Gerzensee, Université de Lausanne and CEPR), and Ramon Caminal (CSIC and CEPR) European Economic Review, forthcoming In this paper, the authors develop a dynamic general equilibrium macroeconomic model where a proportion of firms are credit constrained due to asymmetric information. In general, a macroeconomic shock has additional effects created by a reallocation of funds between credit-constrained and unconstrained firms, as they have different marginal productivities. They show, however, that the output response to shocks is not necessarily amplified, and can be dampened, by the presence of asymmetric information. This depends on the impact of the shock on the composition of external and internal funds for credit-constrained firms.
by Erik Berglof (SITE and CEPR), Gerard Roland (ULB-ECARES and CEPR), Ernst-Ludwig von Thadden, (DEEP and CEPR) This paper integrates the problem of designing corporate bankruptcy rules into a theory of optimal debt structure. We show that, in an optimal contracting framework, having multiple creditors increases a firm's debt capacity while increasing, instead of decreasing, its incentives to default strategically. The optimal debt contract involves giving creditors claims that are jointly inconsistent in case of default. Bankruptcy rules, therefore, are a necessary part of the overall financing contract, to make claims consistent and to prevent a value reducing run for the assets of the firm.
by Mathias Dewatripont and Jean Tirole Journal of Political Economy, 1999 The paper’s main contribution is to provide a rationale for advocacy. After observing that many organizations (corporations, judiciary, as well as the executive and legislative branches of government) use competition among enfranchized advocates of special interests to improve policy making, it argues that advocacy has two major benefits. First, the advocates’ rewards closely track their performance while nonpartisans’ incentives are impaired by their pursuing several conflicting causes at one time. Second, advocacy enhances the integrity of decision making by creating strong incentives to appeal in case of an abusive decision. The paper also analyzes the costs of advocacy in terms of manipulation and garbling of information. It further shows that it may be costly for both the organization and interested parties themselves to let these parties plead their own causes instead of being represented. The paper concludes with two applications to comparative legal systems and to the organization of Congress, and with suggestions for future research.
by Mathias Dewatripont, Ian Jewitt and Jean Tirole Review of Economic Studies, 1999 The paper develops a career concerns model with multiple tasks and general performance measurement. It investigates whether the standard results on information structures in the principal-agent model – sufficient statistic, impact of a Blackwell garbling, comparison of inclusive information structures – have counterparts in the case of implicit incentives.
by Mathias Dewatripont, Ian Jewitt and Jean Tirole The paper builds a simple multitask career concern model in order to analyze the incentives of government agencies’ officials. Incentives are impaired by the agency pursuing multiple missions. A lack of focus is even more problematic in the case of fuzzy missions, that is when outsiders are uncertain about the exact nature of the missions actually pursued by the agency. Consequently agencies pursuing multiple missions receive less autonomy. The paper further shows that professionalization creates a sense of mission for the agency, and that the specialization of officials raises their incentives. Last, the paper compares its predictions with the stylized facts on Government bureaucracies.
IAE-CSIC 7.
Ramon
Caminal, “Bank taxation: A theoretical framework”, February 2002, mimeo. The
goal of this paper is to develop a model of financial intermediation to analyze
the impact of various forms of taxation. The model considers in a unified
framework various functions of banks: monitoring, transaction services and asset
transformation. The analysis focuses on: (i) conditions for separability between
deposits and loans, (ii) competition between banks and alternative financial
arrangements (investment funds and organized security markets), (iii)
regulation, and (iv) banks' monopoly power and risk taking behavior. 8.
Cespa G. (UPF) and
Giacinta Cestone (Young Researcher, IAE-CSIC), “Who Likes Incumbent Managers?
The Implicit Alliance Between Small Shareholders and Stakeholders”, mimeo
February 2002. In
this paper we challenge the current view that stakeholders and managers are
always “natural allies,'' arguing that shareholders and stakeholders may as
well form an implicit alliance, to the extent that they both have a common
interest in favoring a more efficient management. We propose a theoretical model
where stakeholders (environmentalists) may actively interfere in corporate life,
while managerial decisions are subject to corporate governance and environmental
rules. It is shown that while, for
given sets of rules, stakeholders may side with incumbent managers to form ex-post
alliances, under some conditions stakeholders and small shareholders may both
benefit when ex ante tighter corporate governance rules and tighter
pro-stakeholder rules are imposed on firms. This result can help understand who
benefits from a legal stakeholder protection as opposed to a vague managerial
mandate to keep an eye on stakeholder welfare. It can also rationalize recent
pressures by shareholder activists towards an institutionalization of social
objectives, as an attempt to deprive managers of the monopoly of relationships
with social and environmental activists. 9.
Fabbri,
Daniela (Young Researcher), “Legal Institutions, Corporate Governance and
Aggregate Activity: Theory and Evidence”, mimeo, February 2002. This
paper investigates the interaction between legal institutions and financial
arrangements and the effects that these have on corporate decisions and
aggregate activity, both theoretically and empirically. We develop a two country
general equilibrium model with overlapping generations and asymmetric
information in the credit market. We show that, at the steady state equilibrium,
firms located in the country providing tighter legal enforcement to the
creditors’ rights receive a larger amount of external finance at a lower price
and have a larger size. While these results rationalise some recent empirical
evidence in the corporate finance literature, we obtain a new result for the
leverage ratio that we show to be independent of the quality of legal
institutions (i.e. it is the same across firms located in the two countries). At
the aggregate level, we show that countries with higher creditors’ protection
enjoy a larger aggregate output level and a bigger capital stock. The driving
force behind our results is that improvements in legal protection of creditor
rights to repossess a collateral asset increase the investment rate of return,
by tempering the inefficiencies due to asymmetric information. In the empirical
part, we provide evidence that confirms our theoretical predictions by using new
data sets at firm and regional level for Spain and Italy. Unlike the already
existing literature, we proxy the degree of legal enforcement by using
statistical information on the performance of judicial districts, i.e. measures
based on the number of backlogs, the number of concluded trials and the average
length of trials. 10.
Fabbri,
Daniela (Young Researcher, IAE-CSIC), “The Institutional Determinants of
Household Credit Allocation and Borrowing
Restrictions”, mimeo, February 2002. This
paper analyzes the relation between the quality of judicial enforcement and the
allocation of credit to households at a theoretical and empirical level. The
theoretical part provides a simple model that outlines two main effects through
which the allocation of credit is affected by the working of the judicial
system: a minimum collateral requirement, which affects the probability to be
liquidity constrained and the price of credit, which affects the equilibrium
debt amount. In the empirical part, we test our theoretical predictions merging
data drawn from a representative Italian sample, the Survey of Households Income
and Wealth, with data on the performance of judicial districts. We find that the
working of justice affects the probability of being credit constrained: other
things being equal, moving from low-costs (typically, in northern Italy) to
high-costs judicial districts increase the probability of being credit
constrained by around 35%. Moreover, the amount of debt of non-rationed
households decreases if the quality of judicial enforcement worsen in the area
of residence. The magnitude of this second effect varies according to how
judicial costs are measured: it ranges from 22% to 70%. 11.
Peyrache, Eloic (Young Researcher, CSIC), “Career concerns and choosing
whether to compete”, mimeo, February 2002 In
many situations, agents have to decide to complete or not, against others in
order to signal themselves. The behavior of researchers, open source developers
or start-ups illustrate this fact. The purpose of the paper is to examine, in a
imperfect signalling framework, the investment strategies of agents who try to
manipulate the beliefs of the market. Our results suggest that in the case of
homogeneous projects, the decision of agents is not relevant for the market
since they will play according to pooling strategies. On the other hand, in the
case of cost-differentiated projects, there will be some scope for separating
equilibria. Their features are that a low agent will always invest on the
“easy!” project whereas a high type, when acting as a follower, will always
differentiate himself. We further investigate the willingness of agents to
postpone their investment decision and the social optimality of their decision
in the presence of reputational concerns. CEPR 12.
Gale, D. (New York University) and Xavier Vives (CEPR/IAE-CSIC) “
Dollarization, Bail Outs, and the Stability of the Banking System” forthcoming
in Quarterly Journal of Economics. Central
bank policy suffers from time-inconsistency when facing a banking crisis: A
bailout is optimal ex post but ex ante it should be limited to control moral
hazard. Dollarization provides a credible commitment not to help at the cost of
not helping even when it would be ex ante optimal to do so. Dollarization is
good when the costs of establishing a reputation for the central bank are high,
monitoring effort by the banker is important in improving returns, and when the
cost of liquidating projects is moderate. However, a very severe moral hazard
problem could make dollarization undesirable. The results obtained are applied
to assess the desirability of dollarization in a range of countries and the
potential role of the IMF as International LOLR. 13. Vives, Xavier (CEPR)
“Competition in the Changing World of Banking”, Oxford
Review of Economic Policy, 17, 2001, 535-547. This
paper reviews the role of competition in banking against of a transforming
sector. It uses industrial organization and modern financial intermediation
analysis to study the relationships between the level of competition,
risk-taking incentives, and the regulatory frame. The consequences for market
structure of the liberalization process and the need for competition policy in
the sector are highlighted. 14.
Vives, Xavier (CEPR) “External Discipline and Financial Stability”,
forthcoming in European Economic Review. The
paper examines the costs and benefits of external discipline (dollarization,
foreign short-term debt) from the point of view of the stability of the
financial system of an emergent LDC economy. External discipline solves the
time-inconsistency problem of central bank policy to help banks in trouble but
at the cost of excessive liquidation of projects. The latter may be quite
important when the danger of coordination failure of is large. Salerno 15. Marco Pagano (Salerno),
“Information Sharing in Credit Markets: Theory and Evidence” (with Tullio
Jappelli), in Defusing Default: Incentives and Institutions, Edited by Marco
Pagano, Johns Hopkins University Press, 2001. Information
sharing about borrowers’ characteristics and their indebtedness can have
important effects on credit markets activity. First, it improves the banks’
knowledge of applicants’ characteristics and permits a more accurate
prediction of their repayment probabilities. Second, it reduces the
informational rents that banks could otherwise extract from their customers.
Third, it can operate as a borrower discipline device. Finally, it eliminates
borrowers’ incentive to become over-indebted by drawing credit simultaneously
from many banks without any of them realizing. Understanding the effects of
information sharing also helps to shed light on some key issues in the design of
a credit information system, such as the relationship between public and private
mechanisms, the dosage between black and white information sharing, and the
"memory" of the system. Merging the insights from theoretical models
with the lessons of experience, one can avoid serious pitfalls in the design of
credit information systems. 16. Marco Pagano (Salerno),
“Information Sharing, Lending and Defaults: Cross-Country Evidence” (with
Tullio Jappelli), forthcoming in the Journal of Banking and Finance. Theory
predicts that information sharing among lenders attenuates adverse selection and
moral hazard, and can therefore increase lending and reduce default rates. To
test these predictions, we construct a new international data set on private
credit bureaus and public credit registers. We find that bank lending is higher
and proxies for default rates are lower in countries where lenders share
information, regardless of the private or public nature of the information
sharing mechanism. We also find that public intervention is more likely where
private arrangements have not arisen spontaneously and creditor rights are
poorly protected. 17. Marco Pagano (Salerno),
“Information Sharing in Credit Markets: The European Experience” (with
Tullio Jappelli), forthcoming in
Credit Reporting Systems and the International Economy, edited by Margaret
Miller, MIT Press, 2002. We
describe the operation of credit bureaus and public credit registers in Europe
and extract potential lessons for upgrading credit registers in other countries.
The evidence that we report is based on questionnaires directed to private
credit bureaus and central banks, on direct interviews and on official sources.
The European experience highlights a set of important issues. First, European
privacy protection laws affect greatly the amount and type of information shared
between lenders. Second, credit bureaus tend to originate from local lenders.
Third, in Europe as elsewhere there are powerful forces pushing towards
consolidation of the credit bureaux industry. While this process reflects the
"natural monopoly" feature of the industry, its pace has been
accelerated by technological factors and, especially within Europe, by the
increasing international integration of capital markets. Three annexes complete
the paper, reporting detailed descriptions of private credit bureaus activity in
European countries, the main features of European public credit registers, and
privacy protection restrictions to the activity of credit bureaus and public
credit registers in Europe. 18. Marco Pagano, “The Performance
of European Stock Exchanges: Evidence from Listing Decisions”, forthcoming In
Capital Markets in the Age of the Euro: Cross-Border Transaction, Listed
Companies and Regulation, edited by Guido Ferrarini, Klaus Hopt e Eddy Wymeersch,
Kluwer Law International, 2002. The
evidence about the choice of listing location can provide lessons about the
performance of European equity markets. Drawing on recent empirical research
co-authored with Ailsa Röell, Josef Zechner and Otto Randl, this chapter
addresses three points. First, it documents which exchanges attracted more
listings in our sample period (1986-97), and where the cross-listing companies
were actually coming from. Second, it explores the correlation between the
characteristics of exchanges and countries and the cross-listing decisions made
by companies. Third, it describes the correlation between the characteristics
(and performance) of companies and their decision to cross-list. 19. Marco Pagano, “Law and Equity
Markets: A Simple Model” (with Davide Lombardo),
forthcoming in Convergence and diversity of corporate governance regimes
and capital markets, edited by Luc Renneboog, Joe McCahery, Pieter Moerland and
Theo Raaijmakers, Oxford University Press, 2002. We
analyze how the law and its enforcement affect equity market equilibrium.
Improvements in the legal system, while invariably associated with broader
equity markets, have different effects on equity returns depending on the
institutional change considered and on the degree of international stock market
segmentation. The model is useful to interpret the results of recent empirical
work, such as La Porta et al. (1997) and Lombardo and Pagano (2000). In
particular, it can rationalize the observed cross-country pattern, whereby
better institutions are associated both with broader equity markets and higher
risk-adjusted returns on equity. LSE 20.
Charles Goodhart (FMG, LSE), Dirk Schoenmaker (Ministry of Finance (NL))
and Paolo Dasgupta (FMG, LSE), “ The Skill Profile of Central Bankers and
Supervisors” FMG DP April 2001. Using
a new database covering some 91 supervisory agencies, this paper examines how
important various skilled experts are in the regulatory process and the relative
usage of different kinds of such experts. We seek to explore what kind of
perspective supervisors in different institutional settings may adopt: a
macro-oriented perspective or a more micro-approach? The answer to this question
is relevant, as there is evidence that any financial crises have been
macro-induced. It
is found that central banks employ more economists and fewer lawyers in their
supervisory/financial stability wing than non-central bank supervisory agencies.
Next, there are significant economies of scale in financial supervision, though
this can be measured by several alternative variables (e.g. the relative scale
of bank intermediation). Finally, there do not appear to be major economies of
scope. A more complex financial system with a well-developed stock market would
need both more supervisors as well as more skilled ones. 21.
Elena Carletti (LSE/Mannheim), “The Structure of Bank Relationships,
Endogenous Monitoring and Loan Rates” FMG DP July 2001 This
paper investigates, in a simple model of overlapping moral hazard problems
between banks and firms, how the number of bank relationships affect banks
incentives to monitor their borrowers and how, in turn, these decisions affect
loan rates and firms' choice between single and multiple relationships. The
analysis shows that multiple lenders monitor less than a single lender. This is
because they face duplication of effort and sharing of benefits in monitoring.
However, as a consequence of diseconomies of scale in monitoring, multiple
lenders do not necessarily require a higher loan rate. The firms' choice between
single and multiple relationships is not univocal, depending on the relative
severity of bank moral hazard as compared to firm moral hazard. 22.
Rosa Lastra (LSE/Queen Mary College, University of London), “The
Governance Structure for Financial Regulation in Europe” FMG SP December 2001 She
examines the unfinished agenda of the governance structure for financial
regulation in Europe. Governance refers on the one hand to the issue of the
allocation of power and on the other hand to the issue of the exercise of power.
She focuses on the second point and provides a framework to understand
accountability and transparency. Finally, she thinks that Europe does need well
functioning financial markets. If the current structure does not work
efficiently enough, then it needs to be reformed. But, grater efficiency cannot
be achieved at the expense of compromising democratic legitimacy and
accountability. 23.
Charles Goodhart (FMG, LSE) “Operational Risk” FMG SP 131 September
2001 This
paper deals with Operational Risk. It proposes a definition of such kind of risk
and gives a critique of the Basel proposal for Operational Capital Requirement.
Finally, the author finds that there is both, little focus or sensible basis for
imposing a specific Operational Risk Capital Requirement. To reduce Operational
Risk (especially fraud), it should be better to control the incentives (pay
structure) than the Capital Ratio. 24.
Jon Danielson (FMG, LSE), Paul Embrechts (ETHZ), Charles Goodhart (FMG,
LSE), Con Keating (Finance Development Centre), Felix Muenniech (FMG, LSE) and
Hyun Song Shin (FMG, CEP, LSE) “An Academic Response to basel II” FMG SP 130
May 2001 It
is our view that the Basel Committee of Banking Supervision, in its Basel II
proposals, has failed to address many of the key deficiencies of the global
financial regulatory system and even created the potential for new sources of
instability. This document highlights our concerns that the failure of the
proposals to address key issues can have destabilising effects and thus harm the
global financial system. In particular, there is considerable scope for
under-estimation of financial risk, which may lead to complacency on the part of
policy makers and insufficient understanding of the likelihood of a systematic
crisis. Furthermore, it is unfortunate that the Basel Committee has not
considered how financial institutions will react to the new regulations. Of
special concern is how the proposed regulations would induce the harmonisation
of investment decisions during the crises with the consequence of destabilising
rather than stabilising the global
financial system. 25.
Clive Briault (Financial Services Authority) “Revisiting the Rationale
for a Single National Financial Services Regulator” FMG SP 135 February
2002-03-19 This
paper reviews developments over the last three and a half years in the UK in an
attempt to measure the performance of the Financial Services Authority (FSA).
Finally, he found that it is too early to draw unqualified conclusions about the
performance of the FSA in delivering the benefit expected from a single national
financial services regulator. However, a promising start has been made in
responding to markets developments; in achieving economies of scale and scope;
in creating a unified approach to standard-setting, authorisation, supervision,
enforcement and consumer education; in introducing risk-based regulation on a
consistent basis across firms and markets; and in working with the Bank of
England and the Treasury to maintain financial stability. 26
Richard K Abrams (Monetary and Exchange Affairs Department, FMI) and
Michael W Taylor (Monetary and Exchange Affairs Department, FMI) “Assessing
the Case for Unified Financial Sector Supervision” FMG SP January 2002-03-19 The
paper reviews the issues raised by the unification of financial sector
supervision. The main conclusion is that no one model of regulatory structure
will be appropriate for all countries. While fully unified agencies- those
regulating banking, insurance and securities- do offer certain advantages over
separate agencies, the advantages appear to vary sharply between countries.
Moreover, they must also be weighed against the disadvantages, the strength of
which will also vary considerably from case to case. The same points apply to
the other regulatory structures considered in this paper. Hence, in each case,
it is essential to first perform a full assessment of the advantages and
disadvantages of applying a particular model developed in one member country to
the conditions of another. 27.
Hyun Song Shin (FMG, CEP, LSE) “Disclosures and Asset Returns” FMG DP
March 2001 Public
information to financial markets often arrives through the disclosures of
interested parties who have a material interest in the reactions of the market
to the new information. When the strategic interaction between the sender and
the receiver is formalized as a disclosure game with verifiable reports, market
prices observed in equilibrium can be given a simple characterization that
relies only on the face value of the announcement. Also, this characterisation
predicts that the return variance following a bad outcome is higher than it
would have been if he outcome were good. When investors are risk averse, this
leads to negative serial correlation of asset returns. 28.
Jan Danielson (FMG, LSE), Hyun Song Shin (FMG, CEP, LSE) and Jean-Pierre
Zigrand (FMG, LSE) “Asset Price Dynamics with Value-at-risk Constrained
traders” FMG DP October 2001 Risk
management systems in current use treat the statistical relations governing
asset returns as being exogenous, and attempt to estimate risk only by reference
to historical data. These systems fail to take into account the feedback effect
in which trading decisions impinge on prices. We investigate the consequences
for asset price dynamics of the widespread adoption of such techniques. We
illustrate through simulations of a general equilibrium model that, as compared
to the case when such techniques are not used, prices lower, have time paths
with deeper and longer troughs, as well as a greater degree of estimated
volatility. The magnitudes can sometimes be considerable. Far from promoting
stability, widespread adoption of such techniques may have the perverse effect
of exacerbating financial instability. 29.
Stephen Morris (Yale) and Hyun Song Shin (FMG, CEP, LSE) “Coordination
Risk and the Price of Debt” FMG DP March 2001 Creditors
of a distressed borrower face a coordination problem. Even if the fundamentals
are sound, fear of premature foreclosure by others may lead to pre-emptive
actions, undermining the project. Recognition of this problem lies behind
corporate bankruptcy provisions across the world, and it has been identified as
a culprit in international financial crises, but has received scant attention
from the literature on debt pricing. Without common knowledge of fundamentals,
the incidence of failure is uniquely determined provided that private
information is precise enough. This affords a way to price the coordination
failure. There are two further conclusions. First, coordination is more
difficult to sustain when fundamentals deteriorate. Thus, when fundamentals
deteriorate, the onset of crisis can be very swift. Second,
"transparency" in the sense of greater provision of information to the
market does not generally mitigate the coordination problem. 30.
David de Meza (FMG, University of Exeter) and David Webb “ Saving
Eliminates Credit Rationing” FMG DP September 2001 Equilibrium
credit rationing, in the sense of Stiglitz and Weiss (1981), implies the
borrower faces an infinite marginal cost of funds. Infinitesimally delaying the
project to accumulate more wealth is therefore advantageous to the borrower. As
a result, the well-known conditions for credit rationing cannot be satisfied. 31.
Ronald W Anderson (FMG, LSE) and Kjell G Nyborg (LBS) “Financing and
Corporate Growth under Repeated Moral Hazard” FMG DP April 2001 This
paper considers the impact of financial contracting on growth by exploring a
model where entrepreneurs initially do R&D but subsequently need both
outside investors to provide funds for capital investments and outside managers
to operate the firm efficiently some time after assets are in place. The source
of contracting inefficiency is that insiders can divert cash flows for their own
benefit. We employ a repeated games framework which allows us to model outside
equity as well as inside equity and debt. We call our framework the two-stage
model of firm growth. A key finding is that outside equity promotes ex post
efficiently (second stage growth) at the expense of ex ante efficiently (first
stage growth) which debt work the opposite way. This is because equity promotes
replacement of the entrepreneur, while debt promotes entrenchment. So debt has
the disadvantage that it is less conducive to the implementation of second stage
growth than equity, but the advantage that it provides the entrepreneur with
more incentives to do R&D in the first place. Furthermore, equity is
fragile, in the sense that moral hazard may be so high that investors will not
finance the firm, regardless of the discount rate. In contrast, debt financing
definitely can be raised for low discount rates. A prediction of the model is
that in a cross-section of firms, we should observe a preponderance of high
levered, closely-held firms which have stagnated after an early growth phase. 32.
Frédéric Loss (Young Researcher, LSE) “Hedging, Agency Cost and
Corporate Size” FMG DP November 2001 This
paper studies firms' hedging demand where hedging is used by managers to reduce
agency costs between them and employees. It is shown that the manager's
information on the employee's action is a determining factor of the firms'
hedging demand. The less the manager's information on the employee's action, the
higher is the firm's hedging demand. Therefore, when a merger between firms
leads to a loss of information for the manager, the hedging demand of the merged
firms is generally higher than the ones of the non-merged firms. 33.
Frederic Loss and Antoine Renucci (Groupe ESC-Toulouse and University of
Toulouse) “The Fallacy of New Business Creation as a Disciplining Device for
Managers” FMG DP February 2002-03-19 This
paper investigates a negative externality of new business creation. We show that
when being perceived as a good manager is a necessary condition to establish a
firm in the future a priori talented managers may indulge in undertaking risky
projects now. Indeed, such a choice renders more difficult the updating of
believes process regarding their actual types. Unfortunately, this in turn leads
them to perform less effort, which comes at the expense of economic efficiency.
Hence, the career concerns we examine do not discipline good managers. However,
We show that employers can reduce managerial slack by resorting to financial
markets monitoring. 34.
Frederic Loss (Young Researcher), “Optimal Hedging and Interactions
between Firms” FMG DP February 2002 This
paper studies corporate risk management in a context with financial constraints
and imperfect competition in the product market. We show that the interactions
between firms heavily affect their hedging demand. As a general rule, the firms'
hedging demand decreases with the correlation between firms' internal funds and
investment opportunities. We show that when the hedging demand of a firm is high
in the case where investments are strategic substitutes, its hedging demand is
low in the case where investments are strategic complements. Finally, we also
propose another interpretation of our model in terms of technical choice. IDEI 35.
Jean Tirole (IDEI) “Corporate Governance” Econometrica, 69(1) The
paper first develops an economic analysis of the concept of shareholder value,
describes its approach and discusses some open questions. It emphasises the
relationship between pledgeable income, monitoring and control rights using a
unifying and simple framework. The
paper then provides a first and preliminary analysis of the concept of the
stakeholder society. It investigates whether the managerial incentives and the
control structure described in the first part can be modified so as to promote
the stakeholder society. It shows that the implementation of the stakeholder
society strikes three rocks: dearth of pledgeable income, deadlocks in
decision‑making, and lack of clear mission for management. While
it fares better than the stakeholder society on those three grounds, shareholder
value generates biased decision‑making; the paper analyses the costs and
benefits of various methods of protecting non-controlling stakeholders:
covenants, exit options, flat claims, enlarged fiduciary duty. 36.
Jean Tirole (IDEI) “Inefficient Foreign Borrowing: A Dual‑and
Common‑Agency perspective” December 18, 2001 in seminar at DEEP(Lausanne). In
the wake of recent twin currency‑banking crises, experts have expressed
concern about a number of pervasive features in international lending: the
strong debt bias, the liability dollarization, and the short maturities. This
paper revisits the debate from a "dual‑and‑common agency"
perspective. Its take is that, in private lending arrangements, the investors'
prospect of recouping their investment depends on the behaviors of borrowers
with whom they contract and of the borrowers' government, with whom they don't.
This dual‑agency problem translates into a common agency one in which
pairwise optimal contracts exert externalities on each other through their
impact on country incentives. The
paper first looks at whether and when countries borrow too much or too little in
the aggregate. It then shifts attention to structure issues and analyzes whether
and when equity portfolio investment, international portfolio diversification,
domestic currency denomination and longer maturities enhance borrowing
countries' access to international lending. The paper thereby relates a
country's level and quality of access to international capital markets to a
variety of institutional features
such as the level of domestic savings, their location (home vs abroad), the
extent of control rights held by political authorities, and the interests of
dominant domestic political forces. 37.
Bengt Holmström and Jean
Tirole (IDEI and CEPR) “LAPM: A
Liquidity‑based Asset Pricing Model” Journal of Finance vol. 56(5) The
intertemporal CAPM predicts that an asset's price is equal to the expectation of
the product of the asset's payoff and a representative consumer's intertemporal
marginal rate of substitution. This
paper develops an alternative approach to asset pricing based on corporations'
desire to hoard liquidity to fulfil future cash needs. Our corporate finance
approach to market finance suggests new determinants of asset prices such as the
distribution of wealth within the corporate sector and between the corporate
sector and the consumers. Also, leverage ratios, capital adequacy requirements, and the
composition of savings affect the corporate demand for liquid assets and thereby
interest rates. The
paper first sets up a general model of corporate demand for liquid assets, and
obtains an explicit formula for the associated liquidity premia.
It then derives some implications of corporate liquidity demand for the
equity premium puzzle, for the yield curve, and for the state‑contingent
volatility of asset prices. 38.
Jean Tirole (IDEI) and Bengt Holmström, “Domestic and International
supply of liquidity” American economic review, papers & proceedings. In
an earlier paper (1998) Holmström and Tirole offered a simple model of
aggregate liquidity shortages. That paper argued that the government could play
a useful role as an intermediary between consumers and firms to the extent that
it can make commitments on behalf of (future) consumers. Publicly supplied
liquidity, however, is costly due to tax distortions. Foreign investors may be
in a better position to provide liquidity services, particularly when country
shocks are idiosyncratic. The purpose of this paper is to explore how the
introduction of a foreign supply of liquidity affects the earlier analysis of
liquidity management. How should a country optimally make use of its limited
access to foreign and domestic insurance opportunities? The
paper shows that a country that is credit‑constrained will typically
demand less than full insurance against aggregate shocks even if international
investors find all its pledgeable income acceptable.
Furthermore, when the country's income is not fully pledgeable to
foreigners, domestic liquidity supply wiil
remain an important source of insurance. 40.
Roberta Dessi (Young Researcher, IDEI), “Implicit Contracts, Managerial
Incentives and Financial Structure”, Journal of Economics and Management
Strategy, 10(3), Fall 2001. This
paper examines how managers may be given incentives to exert effort, and to
implement efficient implicit contracts with workers. Under certain assumptions,
this can be achieved by tying managerial compensation to shareholder value.
However, if reputation effects are weak, it is more efficient to adopt an
incentive scheme in which the manager is punished by outside investor
intervention when performance fallls below a critical level, and otherwise
retains control, receiving a fixed reward. The required form of outside
intervention can be implemented through a financial structure combining
“hard” debt with a relatively dispersed ownership structure. 41.
Roberta Dessi (Young Researcher, IDEI), “Start-up Finance, Monitoring
and Collusion”, last version: February 2002. How should new (capital-constrained) entrepreneurial firms be financed? When active monitoring by a large investor is needed to induce efficient investment decisions, what is the optimal allocation of control rights and cashflow rights among entrepreneurs and different types of investor ? The paper addresses these questions, taking into account the possible incentives for the entrepreneur and the large investor to collude and pursue private benefits at the expense of other investors. I find that the threat of collusion has an important effect on contract design, and on financing constraints (hence aggregate investment). Under plausible assumptions, optimal (collusion-proof) contracts are consistent with several commonly observed characteristics of venture capital financing: (a) the use of convertible securities, (b) the separate allocation of control rights, (c) the practice of syndication. Theories of Soft Budget Constraints and the Analysis of Banking Crises By Janet Mitchell Economics of Transition, March, 2000 In this paper, Mitchell develops a taxonomy for classifying models of soft budget constraints. The taxonomy allows distinction between two classes of models: those where soft budget constraints arise from sunk costs (originating with Dewatripont-Maskin, 1994) and those where soft budget constraints derive from creditors’ passive rollovers of loans in default. Soft budget constraints in each class have differing theoretical origins, and each class of models has distinct policy implications. In the former class soft budget constraints give rise to ex ante inefficiency, which occurs at the stage of initial financing decisions, whereas soft budget constraints in the latter class give rise to ex post inefficiency, which occurs at the stage of continuation and refinancing decisions for loans in default. The author explores the insights yielded by each of these classes of models for the analysis of banking crises. The former class of models has implications for the link between the capital structure of firms and the severity of banking crises; the latter class has implications for regulators’ handling of banking crises and for the behaviour of troubled banks during banking crises.
By Janet Mitchell forthcoming in Anna Meyendorf and Anjan Thakor, eds. Financial Sectors in Transition, MIT Press (2000). This paper presents a taxonomy for classifying models of soft budget constraints that allows identification of two classes of models, one relying on the idea of sunk costs and the other on creditors’ incentives to inefficiently roll over defaulting loans. A model in the second class is used to analyze policy tradeoffs for cleaning banks’ balance sheets in economies in transition, which have been particularly vulnerable to banking crises because of large quantities of bad loans that were inherited from the previous socialist regimes. Although a number of prominent economists had advocated cancelling the inherited loans from state-owned banks’ and firms’ balance sheets – arguing that removal of the inherited loans would eliminate a major cause of banking crises and would have no effect on the value of state-owned assets—policy makers in transition economies chose not to cancel the inherited loans. The paper provides a potential explanation for this choice. The analysis demonstrates that policies to clean banks’ balance sheets have real effects on banks’ and firms’ values even when all banks and firms are state-owned. In particular, debt cancellation may have resulted in lower bank and firm values than other policies that left the inherited debt on firms’ balance sheets, since state-owned firms’ managers would have had complete control over firms in the absence of debt and were therefore free to divert the assets of these firms to private uses. Finally, the analysis illustrates that the method of privatization of state-owned firms also influences the tradeoffs between policies for cleaning banks’ balance sheets and the impact of debt cancellation on bank and firm values
By Giacinta Cestone and Lucy White February 2000, mimeo. This paper presents the first model where entry deterrence takes place through financial rather than product-market channels. In standard models of the interaction between product and financial markets, a firm's use of financial instruments deters entry by affecting product market behaviour, whereas in our model entry deterrence occurs by affecting the credit market behaviour of investors towards entrant firms. We find that in order to deter entry, the claims held on incumbent firms should be sufficiently risky, i.e. equity, in contrast to the standard Brander-Lewis (1986) result that debt deters entry. The model sheds light on the policy debate on the separation of banking as to whether banks should be permitted to hold equity in firms. It also provides an explanation for why venture capitalists hold automatically convertible securities in start-up firms.
By Giacinta Cestone and Chiara Fumagalli February 2000, mimeo This paper explores how internal capital allocation within a conglomerate interacts with the product market behaviour of divisions. Conventional wisdom suggests that the possibility of shifting resources through the internal capital market allows conglomerate divisions to be stronger competitors in the product market game. We analyse competition in R&D efforts between a conglomerate division and a standalone firm, and show that subsidisation from the parent company does not necessarily make the division a tougher competitor. However, when a division enters a market, subsidisation 'protects' it against the incumbent's strategic moves. While this is always an advantage when the rival aims at deterring entry, when entry is accommodated it may be preferable to enter as a stand-alone firm, in order to encourage the incumbent's pro-collusive commitments.
By Giacinta Cestone Februrary 2000, mimeo This paper offers an overview of the main interactions between corporate financing decisions and product market competition. Firm's financial policy may affect the market game in several ways. It can make a firm more or less vulnerable to predation, commit the firm to a particular market strategy, or convey signals to the firm's competitors. Financial policy matters also in that the decision to resort to a common lender can facilitate collusion among competing firms. Finally, an appropriate design of financial claims can commit the lender not to provide potential entrants with funding or expertise.
By David Webb The Economic Journal, vol. 110, No. 460, January 2000
By Frederic Palomino November 1999, mimeo. Newspapers and weekly magazines catering to the investing crowd often rank funds according to the returns generated in the past. Aside from satisfying sheer curiosity, these numbers are probably also the basis on which investors pick a fund to invest in. In this article, we fully characterize the equilibrium in a game between a mutual fund manager of unknown ability who controls the riskiness of his portfolio and investors who only observe realized returns. We derive conditions under which (i ) investors invest in the fund if the realized return falls within some interval, i.e., is neither too low nor too high, (ii) a good mutual fund manager picks a portfolio of minimal riskiness and (iii) a bad mutual fund manager will pick a portfolio with higher risk, "gambling" on a lucky outcome. We also show that regulating the maximum risk a mutual fund is allowed to take may actually decrease rather than increase the expected return to investors, even if the market price of risk is zero: the regulation ends up forcing the investor to pick the bad fund more often.
By Frederic Palomino November 1999, mimeo. Money management is an activity in which agents are often evaluated on the basis of their relative performance. In this article, we consider an oligopolisitic market in which some informed fund managers aim at maximizing their Relative Performance (RP) rather than their Absolute Performance (AP). First, we define a RP Equilibrium and derive conditions for existence of such an equilibrium. Second, we analyze equilibrium strategies. We show that RP objectives provide incentives to choose overly risky trading strategies, i.e., the RP Equilibrium portfolio is riskier than the AP Equilibrium portfolio. When managers are risk-averse, RP objectives also provide incentives to herd: managers acquire non-profitable information for the only purpose of reducing the variance of their relative performance. Our results are consistent with empirical evidence about fund managers' behaviour (choice of overly-risky strategies and herding) and suggest to test further herding among fund managers.
By David Webb and David de Meza The Economic Journal, vol. 109, No. 455, April 1999
By Ulrike Hoffmann-Burchardi FMG DP 316, February 1999 By providing an analysis of sequential going-public decisions the paper outlines conditions under which the likelihood of a second initial public offering increases after a first firm has gone public. Two effects can trigger the rise of hot issue markets in a setting with asymmetric and costly information about both firm quality and industry prospects. The risk-averse entrepreneur can be subject to risk-induced selling pressure because of uncertain industry prospects conveyed by a first IPO in the industry. Also, investors can free-ride on the industry news, and increase their valuation for a second firm by abstaining from further costly information production. Finally, the model offers an explanation for the empirical finding that hot issue markets exhibit a higher degree of underpricing than cold issue markets.
by Ulrike Hoffmann-Burchardi FMG DP 315, February 1999 The paper uses a dataset of German dual-class shares during 1988-1997 to study the relationship between corporate governance rules and the price differential between voting and non-voting stock. In a first step the paper discusses how mechanisms to separate control from cash-flow rights relate to the value of control. Secondly the paper studies the impact of a new takeover regulation which was adopted in Germany in 1995 and introduced the mandatory bid rule. The paper analyses how minority voting and non-voting shareholders participate in transfers of corporate control under the alternative regulatory structures pre- and post 1995. It is further shown that a mandatory bid requirement reduces the potential control value of voting stock by restricting the ration of control to cash-flow rights.
by Ulrike Hoffmann-Burchardi FMG DP 316, February 1999 By providing an analysis of sequential going-public decisions the paper outlines conditions under which the likelihood of a second initial public offering increases after a first firm has gone public. Two effects can trigger the rise of hot issue markets in a setting with asymmetric and costly information about both firm quality and industry prospects. The risk-averse entrepreneur can be subject to risk-induced selling pressure because of uncertain industry prospects conveyed by a first IPO in the industry. Also, investors can free-ride on the industry news, and increase their valuation for a second firm by abstaining from further costly information production. Finally, the model offers an explanation for the empirical finding that hot issue markets exhibit a higher degree of underpricing than cold issue markets.
by Marco Pagano in European Securities Markets: the Investment Services Directive and Beyond, edited by Guido Ferrarini, Kluwer Law International, 1998 In the last decade, the increased competition between European stock exchanges has reduced the cost of trading and increased the variety of trading mechanisms. The London Stock Exchange, which initiated the competition in 1986 by setting up the SEAQ-I market, attracted considerable trading volume in Continental equities in the late 1980s. Later, however, Continental exchanges recovered most of the trading volume from London upon restructuring their auction systems so as to offer very low trading costs, greater transparency and continuous trading via an automated order book. At the same time, the spreads quoted by SEAQ-I dealers increased considerably. Lately, potential competition by continuous auction systems is threatening even the market for British equities, and prompting the London Stock Exchange to replace its former SEAQ system with an automated order book. As in Continental Bourses, this automated auction system is expected to run in parallel with a dealership market for large trades. So trading systems appear to be converging towards a dualistic structure all over Europe. The paper documents these developments, and considers how the competition between European exchanges is likely to evolve and which opportunities and dangers the future may hold for them.
by Patrick Bolton and Xavier Freixas FMG DP 305, October 1998 This paper proposes a model of financial markets and corporate finance, with asymmetric information and no taxes, where equity issues, Back debt and Bond financing may all co-exist in equilibrium. The paper emphasizes the relationship Banking aspect of financial intermediation: firms turn to banks as a source of investment mainly because banks are good at helping them through times of financial distress. The debt restructuring service that banks may offer, however, is costly. Therefore, the firms which do not expect to be financially distressed prefer to obtain a cheaper market source of funding through bank or equity issues. This explains why bank lending and bond financial may co-exist in equilibrium. The reason why firms or banks also issue equity in our model is simply to avoid bankruptcy. Banks have the additional motive that they need to satisfy minimum capital adequacy requirements. Several types of equilibria are possible, one of which has all the main characteristics of a ‘credit crunch’. This multiplicity implies that the channels of monetary policy may depend on the type of equilibrium that prevails, leading sometimes to support a "credit view" and other time the classical "money view".
by Francesca Cornelli and Leonardo Felli FMG DP 300, August 1998 The restructuring of a bankrupt company often entails a change of control. By efficiency of a bankruptcy procedure it is usually meant that the control is allocated into the hands of those who can maximise its value. In this paper we focus instead on how to allocate control with a procedure that allows creditors to maximise their returns. The conclusion is that creditors should be allowed to retain a fraction of the shares of the company.
by David de Meza, and David Webb FMG DP 297, July 1998 It is typically assumed that equilibrium credit rationing implies insufficient lending. By combining hidden types and hidden action, this paper shows that in the presence of credit rationing, lending may exceed the full-information level and policies which discourage borrowing may yield a strict Pareto improvement.
by David Webb FMG DP 299, July 1998 This paper examines the linkages between banks' ability to renegotiate loans and their provision of demand deposits which allow agents to smooth consumption. On the asset side, banks provide value to firms by standing ready to renegotiate loan terms. On the liability side, banks provide a way for consumers with liquidity needs to smooth consumption. The problem identified is that banks may not be able to provide new funds for borrowers when they themselves are short of cash, because of either the return on their investments being poor, or because depositors are asking to withdraw more funds than expected. Banks subject to liquidity shortages may ration loans to good borrowers. This problem is shown to depend upon the nature of the deposit contract and banks' inability to issue new deposits which are subordinated to existing deposits. An important implication of the existence of rationing is that borrowers may accept to partly insure the bank when there is rationing through making higher payments on their loans if they can. In return for this, they make lower payments in the event that there is no rationing. A further implication is that entrepreneurs may prefer to undertake projects which yield higher returns at the intermediate date and so insulate themselves from being rationed and having to renegotiate loans. This latter phenomena exhibits some characteristics of short-termism. Finally, the role of an inter-bank market in alleviating these problems is briefly discussed.
by Vittoria Cerasi and Sonja Daltung FMG DP 293, June 1998 This paper investigates the issues involved in cross-ownership between banks and firms. The idea is that congruity among the parties in control of the bank and the firm allows to save on monitoring costs, but it gives rise to a conflict of interest between on one hand the parties in control of the bank and on the other hand the outside investors, as for example depositors, of the bank. Moreover, when monitoring of borrowing is important and unobservable by outsiders, there is interdependency among incentives, so that the conflict of interest may reduce even further incentives to monitor all other projects in the bank portfolio. Nevertheless, the paper shows that there are benefits from cross-ownership, whenever the bank involved in the relationship is debt financed and well diversified.
by Giles Chemla and Antoine Faure-Grimaud FMG DP 288, April 1998 In many long-term relationships, parties may be reluctant to reveal their private information in order to benefit from their informational advantage in the future. We point out that the strategic use of debt by an uninformed party induces another party to reveal private information. Our argument, which is consistent with casual observation, is based on the idea that (renegotiable) debt is a credible commitment to end the long-term relationship if information is not revealed. We show that the strategic advantage of debt increases with good durability and we briefly address the financing decision of a regulated firm.
by Erland Nier FMG DP 289, April 1998 This paper reconsiders the strategic effect of debt under the assumption that quantity choices are made by managers whose objective is to avoid bankruptcy. The basic result is that quantity choices, which are strategic substitutes under profit maximisation, may turn into strategic complements under reasonable assumptions on the profit function. The value of delegation, optimal wage contracts, and empirical implications are discussed.
by Vittoria Cerasi, Barbara Chizzolini and Marc Ivaldi FMG DP 290, April 1998 This paper investigates the determinants of the structure of the banking industry by fitting a monopolistic competition model to a sample of banks drawn from nine EC countries over 1989-1993. In the theoretical model, banks decide strategically both entry and the branching size of their network. The estimation then measures the branching costs and an upper bound for the entry costs. It also assesses how these costs evolve over time and to what extent various European directives, aiming at deregulating the banking industry, influence them.
by Mike Burkhart, Denis Gromb and Fausto Panunzi FMG DP 286, March 1998 This paper studies block trades and tender offers as alternative means for transferring corporate control in firms with a dominant minority blockholder and an otherwise dispersed ownership structure. Incumbent and new controlling party strictly prefer to trade the controlling block. From a social point of view, however, this method is inferior to tender offers because it preserves control benefits. This discrepancy is caused by the free-riding behaviour of small shareholders. Moreover, the controlling block at a premium which reflects in part the surplus that the incumbent and the acquirer realise by avoiding a tender offer and the consequent transfer to small shareholders. Therefore factors that alter the payoff of small shareholders in a tender offer (e.g., supermajority rules, non-voting shares, and disclosure rules) alter also the block premium. Finally, the paper argues that greenmail, like block trading, enables the controlling parties to preserve low levels of ownership concentration and large private control benefits.
by Erik Berglöf and Gérard Roland Journal of Comparative Economics, 1998 We analyze the problem of soft budget constraints of enterprises financed by banks in transition economies and review the similarities and the differences in various models addressing that issue. We reconstruct these models as several variants of a basic sequential model of soft budget constraints. In each case, we analyze both the sources of the soft budget constraint and the mechanisms for hardening budget constraints, including the policy implications of the analysis. Despite various mechanisms and channels for soft budget constraints, all models share the same sequential structure where soft budget constraints arise due to the endogenous lack of credibility for liquidation of a project instead of continuation and refinancing. All share the same feature that mechanisms for hardening are mechanisms for endogenously restoring such a credibility for liquidation.
By Jenny Corbett and Janet Mitchell forthcoming in the Journal of Money, Credit, and Banking This paper addresses a puzzling feature of banking crises: whereas regulators are often motivated to make offers of bank rescue and recapitalization during banking crises, troubled banks are often reluctant to accept these offers. The authors show that when asymmetric information exists between bankers and outsiders regarding the amount of debt on banks’ balance sheets, bankers’ reputational concerns can cause them to reject a regulator’s rescue offer, even when the conditions imposed on the bankers are very ‘soft’. Accepting an offer of recapitalization requires the bank to reveal its bad loans, which can have a negative effect on the banker’s reputation. Rolling over loans and successfully avoiding detection allows the banker to claim to have no defaulting loans, although at the expense of lower future bank net worth. A key policy implication of the analysis is that when bankers’ reputational concerns are important, the optimal rescue plan offered by the regulator will impose a cost on banks which reject the rescue offer and then perform poorly.
by Philippe Bacchetta and Ramón Caminal European Economic Review, forthcoming In this paper, the authors develop a dynamic general equilibrium macroeconomic model where a proportion of firms are credit constrained due to asymmetric information. In general, a macroeconomic shock has additional effects created by a reallocation of funds between credit-constrained and unconstrained firms, as they have different marginal productivities. They show, however, that the output response to shocks is not necessarily amplified, and can be dampened, by the presence of asymmetric information. This depends on the impact of the shock on the composition of external and internal funds for credit-constrained firms.
by Ramón Caminal and Carmen Matutes currently under revision The authors analyze the impact of the market structure on the probability of banking failure when banks’ loan portfolios are subject to aggregate uncertainty. In this model, borrowers are subject to a moral hazard problem which induces banks to choose between two second best alternative devices: costly monitoring and credit rationing. They show that investment depends on both the lending rate and the information structure. Since monitoring incentives increases with interest rate margins, the relationship between market structure and investment is ambiguous. Also, larger investment levels imply that the expected return of marginal projects is lower and thus banks’ portfolios are more vulnerable to aggregate uncertainty. Consequently, a monopoly bank monitors borrowers more intensively, rations the amount of credit less frequently and hence may go bankrupt wth higher probability than competitive banks.
by Ramón Caminal and Carmen Matutes currently under revision The goal of this paper is to study how banks’ market power affects lending rates, investment levels and welfare in a model where banks choose between credit rationing and monitoring in order to alleviate an underlying moral hazard problem. Caminal and Matutes show that the effect of market power is the result of two countervailing effects. An increase in banks’ market power: i.) results in higher lending rates, which worsens the borrower’s incentive problem and investment is further reduced below the efficient level; (ii.) induces banks to exert higher monitoring effort, which reduces the frequency of credit rationing. Whenever the second effect dominates, it is socially optimal to provide banks with some degree of market power.
by Carmen Matutes and Xavier Vives European Economic Review, forthcoming Matutes and Vives assess the welfare implications of banking competition under various deposit insurance regimes in a model of imperfect competition with social failure costs and where banks are subject to limited liability. They study the links between competition for deposits and risk taking incentives, and conclude that the welfare performance of the market and the appropriateness of alternative regulatory measures depend on the degree of rivalry and the deposit insurance regime. Specifically, when competition is intense and the social failure costs high, deposit rates are excessive both in a free market and with risk-based insurance. If insurance premiums are insensitive to risk then the same is true even if there is no sicail cost of failure. They also find that in an uninsured market with non-observable portfolio risk or with flat-premium deposit insurance deposit regulation (rate regulation or deposit limits) and direct asset restrictions are complementary tools to improve welfare. In an uninsured market with observable portfolio risk or with risk-based insurance deposit regulation may be a sufficient instrument to improve welfare.
by Luis Medrano and Xavier Vives mimeo This paper analyzes the effects of strategic behavior by a large informed trader (an ‘insider’) in a proce discovery process, akin to an information tâttonnement, in the presence of a competitive informed sector. Such processes are used in the preopening period of continuous trading systems in several exchanges. It is found that the insider manipulates the market using a contrarian strategy in order to neutralize the effect of the trades of competitive informed agents. Furthermore, consistently with the empirical evidence available, we find that information revelation accelerates close to the opening, that the market price does not converge to the fundamental value no matter how many rounds the tâttonnement has, and that the expected trading volume displays a U-shaped pattern. We also find that a market with a larger competitive sector (smaller inside) has an improved informational efficiency and an increased trading volume. The insider provides a public good (a lower informativeness of the price) for the competitive informed sector.
by Xavier Vives mimeo This paper surveys recent developments in European banking, putting them into the perspective of general international developments in the sector, and is informed by the theoretical debate on competition and regulation. The following issues are addressed: the transformation of the sector and the role of consolidation and diversification, the impact of the EU Single Market Programme in banking and financial services and its relation to liberalization in national markets, the occurrence of banking failures, the systemic risk problem and the regulatory response. The optimal balance between competition policy in banking and stability concerns is also discussed. Section 2 outlines the trends in banking and in its regulation. Section 3 discusses from a theoretical perspective competition, liberalization and consolidations in the banking sector. Section 4 summarizes briefly some arguments about the optimal regulatory structure and the role of competition policy. Section 5 describes the evolution of banking markets in Europe taking the US as a benchmark. Section 6 considers the banking failures and crisis and their link to the liberalization process. Section 7 summarizes the prospective impact of Monetary Union in the sector. Finally, in Section 7 the lessons of the European experience, and prospective effects of Monetary Union, are drawn.
by Xavier Vives in R. Caminal (coordinator), El Euro y sus repercusiones sobre la economía española, Fundación BBV, forthcoming
By Roberta Dessi This paper studies an economy in which entrepreneurs seek financing for long-term projects from capital-constrained intermediaries, who specialise in monitoring, and uninformed investors. Monitoring enables an intermediary to affect investment decisions, and may confer an informational advantage at the interim stage. Optimal financial contracts are designed to induce both ex ante (choice of investment project) and ex-post (decision to continue or liquidate at the interim stage) efficiency, while economising on the use of scare intermediary capital. Under certain assumptions, a degree of asymmetric information at the interim stage (between informed insiders and uninformed outside investors) makes it possible to improve on contracting possibilities for the symmetric information case. The paper identifies circumstances in which “venture capital” contracts are optimal.
By Roberta Dessi and Donald Robertson A large body of theoretical literature suggests that debt in a firms’ capital structure can play an important role as a managerial incentive mechanism. What of the evidence for the agency approach? One strand in the empirical literature has explored this question by investigating the determinants of capital structure and firm performance. Cross-sectional empirical studies have identified a positive effect of leverage on expected performance (measured by Q) for firms with low g |