Knowledge that Transforms

Target firms often face a takeover threat from raiders with prior stakes in its ownership (toeholds). Previous literature has shown that, when takeovers are modeled as standard auctions, toeholds induce more aggressive bids from raiders, which has two important consequences for the selling process: (i) the board of directors is no longer indifferent about the sale procedure used to get the highest price, and (ii) the target may not be assigned to the highest-value raider. This paper characterizes how the price-maximizing procedure should be in the presence of asymmetric toeholds. Our central result is that the optimal rule needs to be implemented by a discriminatory mechanism quite different from conventional auction formats. By imposing an extra-charge against high-toehold bidders, the optimal mechanism is able to extract more surplus from raiders who bid more aggressively. As a result, nonbidding shareholders benefit unambiguously from the toehold asymmetry. Furthermore, as this bias restores the symmetry in bidders’ expected payoffs, the proposed mechanism also allows to allocate efficiently the target among them.

This study is the first to link managerial turnover to mutual fund managerial structure in a manner that indicates the strong presence of a conflict of interests between investors and fund sponsors in an area of fund governance where we have been led to believe there are strong and well-functioning mechanisms to guard against the exploitation of investors. I utilize the unique characteristics of mutual funds where managers sometimes manage multiple “firms” simultaneously, something not generally observed in industrial firms. I test the governance mechanisms using the mutual fund complexes management structure; unitary and multiple fund management (UFM and MFM). This study shows that UFMs tend to have higher asset growth rates and higher fees than MFMs, suggesting that sponsors can benefit more from keeping them intact. I find that changing managers under the UFM is more costly to sponsors making them more reluctant to fire poor performers. I document that underperforming UFM are −2.77% less likely to be replaced than their underperforming MFM counterparts. In addition, the conflict of interests affect the replacement decision, as high expense ratio fund managers have a lower probability of replacement for a given level of underperformance.

This paper assesses the impact of introducing an efficient payment system on the amount of credit provided by the banking system. Using payment system reforms in Eastern European countries over the 1995–2005 period as a natural experiment, we find evidence that payments reforms were an important precondition for the credit boom observed in our sample countries. We also find that payment system reforms led to a shift away from cash (outside money) and towards demand deposits (inside money) as a medium of exchange and that this in turn enabled an expansion of credit in the sample countries. These findings have important implications for our understanding of financial intermediation, highlighting the nexus between banks’ role as providers of payment services and as providers of credit.

We study a firm’s investment in organization capital by analyzing a dynamic model of language development and intrafirm communication. We show that firms with richer internal language (i.e., more organization capital) have lower employee turnover, and higher diversity in skill and wages among incumbents who are promoted from within the firm. Our results also suggest that firms in rapidly changing industries are less likely to invest in organization capital, and are more likely to have high managerial turnover. Finally, our model shows that employment protection regulations lead to more investment in organization capital but less innovation.

This study proposes a political interference hypothesis to explain how political considerations depress the performance of government banks. We define political interference as a situation in which government bank executives are replaced within 12months after the country’s major elections (presidential or parliamentary elections). We classify political and non-political government banks as those that experience or do not experience political interference, respectively. The hypothesis firstly suggests that once government banks undertake political interference, their financial performance deteriorates. That is, political banks display the worst performance, followed by non-political banks and private banks have the best performance. Next, we posit that the impact of political interference is greater in developing countries than in developed countries. Finally, we hypothesize that the underperformance of government banks will be reduced if we remove political interference. By employing bank data from 65 countries from the period of 2003–2007, our hypothesis effectively explains why government banks in developed countries escape relatively unscathed, while those in developing countries suffer significantly.

The paper demonstrates that a real options structural model of borrower-creditor debt re-negotiations can help explain the cross-sectional variability of losses on defaulted debt securities. The explanatory power of this approach can be improved even further via a system of equations that incorporates additional information by jointly estimating the market values of debt and equity. Empirical tests with a large number of corporate defaults confirm the usefulness of this method. Moreover, higher volatility and lower discount rates around business cycle turning points can result in stakeholders waiting relatively longer for additional returns from defaulted debt. Such optimal stopping behavior based on a real options model mitigates the reduction in face value of debt but can prolong the duration of financial distress.

We propose and test a simple explanation for institutional investors’ tendency to chase return trends. When investors face uncertainty about the precision of their private information, they wait for subsequent confirming news before establishing stock positions. While such news impact the stock price, at the same time they increase investors’ estimates of the precision of their information. With low information quality the latter effect dominates and causes investors to purchase the stock after confirming good news. We formalize these ideas in a simple model and test the model’s predictions on mutual funds’ stock holdings data. Using mutual funds’ past return experiences with individual stocks as a proxy for their stock-specific information quality, we find evidence for the prediction that trend chasing is more likely when information quality is low.

With extensive cross-country datasets and India firm samples, as well as our own surveys of small and medium firms, we examine the legal and business environments, financing channels, and growth patterns of different types of firms in India. Despite the English common-law origin and a British-style judicial system, Indian firms face weak investor protection in practice and poor institutions characterized by corruption and inefficiency. Alternative finance, including financing from all nonbank, nonmarket sources, and generally backed by nonlegal mechanisms, constitutes the most important form of external finance. Bank loans provide the second most important external financing source. Firms with access to bank or market finance are not associated with higher growth rates. Our results indicate that bank and market finance is not superior to alternative finance in fast-growing economies such as India.

We study the effects of the introduction of a closing auction (CA) on the microstructure on the continuous trading phase in Borsa Italiana and Paris Bourse. We postulate and compare several empirical predictions based on both standard Kyle-type models and more recent models of limit order book. We find that while the CA has no effect during most of the day, its effect on the last minutes of trading is dramatic. We document a sharp decline in volume, associated with a significant reduction in spread and volatility, and an increase in aggressiveness of liquidity suppliers during the last minutes. We show that the differences in the Reference Price algorithm between Milan and Paris have a significant effect: the CA attracts greater volumes when the Reference Price is equated to the CA price.

When setting banks’ regulatory capital requirement based on their contribution to the overall risk of the banking system we have to consider that the risk of the banking system as well as each bank’s risk contribution changes once bank equity capital gets reallocated. We define macroprudential capital requirements as the fixed point at which each bank’s capital requirement equals its contribution to the risk of the system under the proposed capital requirements. We use a network based structural model to measure systemic risk and how it changes with bank capital and allocate risk to individual banks based on five risk allocation mechanisms used in the literature. Using a sample of Canadian banks we find that macroprudential capital allocations can differ by as much as 25% from observed capital levels, are not trivially related to bank size or individual bank default probability, increase in interbank assets, and differ substantially from a simple risk attribution analysis. We further find that across all risk allocation mechanisms macroprudential capital requirements reduce the default probabilities of individual banks as well as the probability of a systemic crisis by about 25%. Macroprudential capital requirements are robust to model risk and are positively correlated to future capital raised by banks as well as future losses in equity value. Our results suggest that financial stability can be substantially enhanced by implementing a systemic perspective on bank regulation.