Knowledge that Transforms

We analyze financial contracting in start-ups backed by corporate venture capitalists (CVCs). CVCs' strategic goals can economically hurt or benefit the start-ups, depending on product market relationships between start-ups and CVC parents. Empirically, start-ups receive funding from both complementary and competitive CVC parents. However, start-up insiders commonly limit the influence of competitive CVCs, awarding them lower board power, while retaining higher board representation for themselves. Second, lead CVCs receive lower board representation, indicating heightened concerns about their greater influence in start-ups' early stages. Finally, start-ups extract higher valuations from competitive CVCs, reflecting greater moral hazard problems. Overall, CVC strategic objectives affect their early inclusion in VC syndicates, their control rights and share pricing.

This paper takes advantage of the fact that some stocks trade both in domestic and international markets to characterize the degree of international financial integration. The paper argues that the cross-market premium (the ratio between the domestic and the international market price of cross-listed stocks) provides a valuable measure of international financial integration and the effectiveness of capital controls. Using autoregressive (AR) models to estimate convergence speeds and non-linear threshold autoregressive (TAR) models to identify non-arbitrage bands, the paper shows that price deviations across markets are rapidly arbitraged away and bands are narrow, particularly so for liquid stocks. The paper also shows that regulations on cross-border capital flows effectively segment domestic markets. As expected, the effects of both types of capital controls are asymmetric but in the opposite direction: controls on outflows induce positive premia, while controls on inflows generate negative premia. Both vary with the intensity of capital controls.

Does the presence of arbitrageurs decrease equilibrium asset price volatility? I study an economy with arbitrageurs, informed investors, and noise traders. Arbitrageurs face a trade-off between “inference” and “arbitrage”: they would like to buy assets in response to temporary price declines—the arbitrage effect—but sell when prices decline permanently—the inference effect. In equilibrium, the presence of arbitrageurs increases volatility when the inference effect dominates the arbitrage effect. From a technical point of view, the paper offers closed form solutions to a dynamic equilibrium model with asymmetric information and non-Gaussian priors.

This paper presents an experimental investigation of the factors that affect the dynamics and severity of bank runs. Our experiments demonstrate that the more information laboratory economic agents can expect to learn about the crisis as it develops, the more willing they are to restrain themselves from withdrawing their funds once a crisis occurs. Furthermore, our results indicate that the presence of insiders, who know the quality of the bank, significantly affects the dynamics of bank runs and helps mitigate their severity. We also show that deposit insurance, even of a limited type, can help diminish the severity of bank runs.

Why do private firms stay private? Empirical evidence on this issue is sparse, as most private firms in the U.S. do not report their financial results. We investigate why private status matters by taking advantage of a unique dataset of large, leveraged private firms with SEC filings. Unlike a number of other studies, we find that neither the existence of growth opportunities, nor the desire of firm founders to diversify, is a principal determinant of the decision whether or not to retain private status. Rather, the existence of private benefits of control appears to serve as the most significant incentive to stay private. Family-controlled firms have significantly lower probabilities of filing for an IPO, while a board structure that grants management relatively more autonomy lowers the probability of an IPO filing as well. Cross-sectional analysis of profitability and ex post performance suggests that while private benefits of control may encourage firms to stay private, they do not have detrimental effects on firm efficiency. In contrast, firms controlled by private equity specialists appear to place a low value on control benefits and are likely to go public as a means of cashing out.

This paper investigates whether functional diversification is value-enhancing or value-destroying in the financial services sector, broadly defined. Based on a U.S. dataset comprising approximately 4060 observations covering the period 1985–2004, we report a substantial and persistent conglomerate discount among financial intermediaries. Our results suggest that it is diversification that causes the discount, and not that troubled firms diversify into other more promising areas. In addition, the discount applies to all financial services activity-areas with the exception of investment banking and is stable over different combinations of financial activity-areas with the exception of commercial banking units combined with insurance companies and/or investment banking activities.

In most contemporary economies loan contracts that mandate exclusionary penalties such as imprisonment or other non-pecuniary punishments for defaulting debtors are illegal, despite the fact that in some cases contracting parties might gain by being able to use them. A possible rationale for contracting restrictions of this type is that exclusion imposes negative externalities on individuals not party to the original loan contract. We explore the ability of such externalities to account for these restrictions. We contrast exclusion with enforceable collateral seizure, a widespread feature of developed financial systems. We also consider “behavioral” agents who underestimate their chances of being punished, and show that overconfidence of this type is a less compelling justification for restrictions on exclusionary punishments than is often argued.

We use a unique dataset to show that relationships are an important determinant of banks' ability to access interbank market liquidity. More precisely, we find that: (i) banks with a larger reserve imbalance are more likely to borrow funds from banks with whom they have a relationship, and to pay a lower interest rate than otherwise; (ii) smaller banks and banks with more non-performing loans tend to have limited access to international markets, and rely more on relationships; (iii) relationships are established between banks with less correlated liquidity shocks. These results suggest that relationships allow banks to insure liquidity risk in the presence of market frictions such as transaction and information costs. Our analysis explicitly controls for the endogeneity of bank relationships.

Using a large panel dataset of Chinese industrial firms, we find that poorly performing SOEs were more likely to redistribute credit to firms with less privileged access to loans via trade credit. While that could be consistent with the efficient redistribution of credit, it is more likely that these SOEs extended trade credit to prop up faltering customers that were in arrears. By contrast, profitable private domestic firms were more likely to extend trade credit than unprofitable ones. Trade credit likely provided a substitute for loans for these firms' customers that were shut out of formal credit markets. As biases in lending become less severe, the allocation of lending became more efficient, and the amount of trade credit extended by private firms declined. Our evidence implies that redistribution of bank loans via trade was not a major contributor to China's explosive growth.

Credit derivatives are the latest in a series of innovations that have had a significant impact on credit markets. Using a micro data set of individual corporate loans, this paper explores whether use of credit derivatives is associated with an increase in bank credit supply. We find only limited evidence that greater use of credit derivatives is associated with greater supply of bank credit. The strongest effect is for large term loans—newly negotiated loan extensions to large corporate borrowers, with a largely negative impact on (previously negotiated) commitment lending. Even for large term borrowers, increases in the volume of credit are offset by higher spreads. These findings suggest that the benefits of the growth of credit derivatives may be narrow, accruing mainly to large firms that are likely to be “named credits” in these transactions. Finally, use of credit derivatives appears to be complementary to other forms of hedging by banks, though the banks most active in hedging appear to charge more for additional amounts of credit.