Knowledge that Transforms

This paper analyzes the market for syndicated loans, a hybrid of private and public debt, which has grown at well over a 20% rate annually over the past decade and which totaled over $1 trillion in 1997. We identify empirically the factors that influence a bank or nonbank's decision to syndicate a loan and the determinants of the proportion of the loan sold in the event of syndication. The evidence reveals a loan is more likely to be syndicated as information about the borrower becomes more transparent, as the syndicate's managing agent becomes more “reputable”, and as the loan's maturity increases. The lead manager holds larger proportions of information-problematic loans in its own portfolio. Loan syndications, like loan sales, appear to be motivated, in part, by capital regulations, and the liquidity position of the agent bank influences the likelihood of syndication, but not the extent. Our results confirm that information and agency problems affect the salability of debt claims and the extent to which a loan is “transaction oriented” rather than “relationship oriented” in the sense of A. Boot and A. Thakor (2000, J. Finance54, 679–713). Journal of Economic Literature Classification Numbers: D82, G20, G21, G24.

Dealers enter nonbinding expressions of interest during the Nasdaq preopening to promote price discovery and ease stock inventory management when the market opens. But does this practice of “indicating ahead” constitute best execution for an individual customer? Arguments in favor of the practice rely on the notion that best execution is a general condition as opposed to a concept applicable on a trade-by-trade basis. Some customers must sacrifice in individual instances to improve the functioning of the overall market. But the practice of indicating ahead violates the dealer agent's duty of loyalty to her individual customer. Moreover, the dealer's financial self-interest is best served by indicating ahead. Journal of Economic Literature Classification Numbers: G10, G18, K22.

Quoted and effective bid–ask spreads on Nasdaq are two to four cents per share narrower, ceteris paribus, when stocks trade with a smaller tick size below $10 per share. There is no evidence of a reduction in liquidity with the smaller tick size. The largest spread reductions occur for stocks whose market makers avoid odd-eighth quotes. This finding provides support for models implying that changes in the tick size can affect equilibrium spreads on a dealer market and indicates that the relation between tick size and market quality is more complex than the imposition of a constraint on minimum spread widths. Journal of Economic Literature Classification Numbers: G29, D34, N20.

The idea that banks exist to reduce the costs of monitoring is central to modern theories of financial intermediation. The fact that banks are generally granted senior positions on their small-business loans, however, is hard to reconcile with the typical view that junior lenders have the best incentives to engage in this costly monitoring. Our paper addresses this puzzling contradiction by showing that bank seniority plays an important role in encouraging the formation of valuable bank–firm relationships. The intuition behind our model lies in the fact that once the firm's prospects have deteriorated, junior creditors have incentives much like those of the firm's shareholders. Thus, it is the most senior claimant that benefits from helping the firm improve its quality. If banks are made junior to other creditors, they benefit little from additional investment in the firm during times of poor performance and hence will have little incentive to build relationships that enable them to determine the value of such an investment. As a result, making the bank senior improves its incentives to build a relationship with the firm, thereby fulfilling an important function of intermediated debt. Journal of Economic Literature Classification Numbers: G21, G32.

We investigate the determinants of multiple-bank relationships using a new data set comprising 1079 firms across 20 European countries. We document large cross-country variation in the average number of bank relationships per firm, uncovering a richness in European financial systems that extends beyond the standard description of being “bank-dominated”. After controlling for a variety of firm-specific characteristics, we find that firms maintain more bank relationships, on average, in countries with inefficient judicial systems and poor enforcement of creditor rights. Firms also maintain more relationships in countries with unconcentrated but stable banking systems and active public bond markets. Journal of Economic Literature Classification Numbers: G21, C41.

This paper illustrates how non-contractual legal rules sometimes alleviate contractual incompleteness. A serious incompleteness in debt contracts is the borrower's ability to fraudulently transfer assets to third parties, rendering the borrower insolvent. The incompleteness arises because contractual remedies are ineffective against third-party transferees who are not bound by the debt contract, while the borrower has no assets to recover. Fraudulent conveyance law is a non-contractual legal rule allowing recovery against these transferees. This increases debt capacity most dramatically for borrowers with highly liquid assets. Without non-contractual legal rules, high liquidation value implies low debt capacity. Journal of Economic Literature Classification Numbers: G32; G38.

This article examines the effect of asymmetric information on the trading of underwriting risk between insurers and reinsurers and how it is mitigated in a context of long-term relationships. It begins by explaining how information problems affect the efficiency of the allocation of risk between insurers and reinsurers and how long-term implicit contracts allow the inclusion of new information in the pricing of reinsurance coverage. A key feature of these relationships is the reliance on loss-contingent rebates and commissions in the pricing of reinsurance coverage. We argue that when information is revealed only over time, long-term implicit contracts between insurers and reinsurers allow the inclusion of new information into reinsurance pricing. Because of this feature, the allocation of risk between insurers and reinsurers is more efficient. Specifically, such arrangements lead to more reinsurance coverage, higher insurer profits, and lower expected distress in the industry. Journal of Economic Literature Classification Numbers: G22, G13, L15, D81.

When the imminence of news announcements is not public knowledge, many traders will lack information on both the mean and variance of private information. Our analysis of such a setting in both single and multisecurity contexts implies that disclosure of impending information events by firms can bound variance uncertainty and thereby improve investor welfare by mitigating the market breakdown problem. We also find that the equilibrium pricing functions are nonlinear; specifically, convex for small trades and concave for larger ones. In addition, we predict that large transactions will be followed by large levels of volatility. Journal of Economic Literature Classification Numbers: 022, 026, 522.