Knowledge that Transforms

We consider a theoretical model that offers a rationale for the syndication of venture capital investments: syndication improves the screening process of venture capitalists and prevents competition between investors after investment opportunities are disclosed. The analysis identifies the costs of syndication in terms of investment decisions or post-investment involvement of venture capitalists. These costs depend crucially on the level of experience of venture capitalists. The model generates empirical predictions concerning the determinants of syndication and the characteristics of syndicated deals.

While the too-big-to-fail guarantee is explicitly a part of bank regulation in many countries, this paper shows that bank closure policies also suffer from an implicit “too-many-to-fail” problem: when the number of bank failures is large, the regulator finds it ex-post optimal to bail out some or all failed banks, whereas when the number of bank failures is small, failed banks can be acquired by the surviving banks. This gives banks incentives to herd and increases the risk that many banks may fail together. The ex-post optimal regulation may thus be time-inconsistent or sub-optimal from an ex-ante standpoint. In contrast to the too-big-to-fail problem which mainly affects large banks, we show that the too-many-to-fail problem affects small banks more by giving them stronger incentives to herd.

We analyze venture capital (VC) investments in twenty-three non-US countries and compare them to US VC investments. We describe how the contracts allocate cash flow, board, liquidation, and other control rights. In univariate analyses, contracts differ across legal regimes. However, more experienced VCs implement US style contracts regardless of legal regime. In most specifications, legal regime becomes insignificant controlling for VC experience. VC firms that do not use US style contracts fail significantly more often, even controlling for VC experience. The results are consistent with US style contracts being efficient across a wide range of legal regimes.

This is the first study to examine both how well plan administrators select funds for 401(k) plans and how participants react to plan administrator decisions. We find that, on average, administrators select funds that outperform randomly selected funds of the same type although they do not outperform index funds of the same type. When administrators change offerings, they choose funds that did well in the past, but, after the change, added funds do no better than dropped funds. Plan participants in aggregate change their allocation decisions in a way that accentuates the changes in allocation caused by returns. The change in allocation due to the investment of new money and interfund transfers is about the same size, and in the same direction, as the change due to returns. Participant allocations in aggregate do no better than naïve allocation rules, such as equal investment in each offering.

Of key importance in the governance structure of firms is the role of financial incentives for each major player. The main contribution of this article is an analysis of how an insider's concentration of wealth in his or her bank investment affects incentives to take risk. Major empirical findings are that, first, bank earnings variation falls when bank managers have more of their wealth concentrated in their banks; second, hired-manager banks become less risky when a person who has significant motivation to monitor bank management has his or her wealth highly concentrated in the bank; and third, stock ownership by hired managers can increase total risk of a bank. Further analysis suggests that community banks in our sample control earnings variation by manipulating idiosyncratic risk, credit risk, and leverage but not systematic risk or the loan-to-asset ratio.

We show theoretically that while cash allows financially constrained firms to hedge future investment against income shortfalls, reducing current debt is a more effective way to boost investment in future high cash flow states. Thus, constrained firms prefer higher cash to lower debt if their hedging needs are high, but lower debt to higher cash if their hedging needs are low. We provide empirical evidence that supports our theory. Our analysis points to an important hedging motive behind cash and debt management policies. It suggests that cash should not be viewed as negative debt in the presence of financing frictions.

We analyze the risk-taking incentives of a financial conglomerate that combines a bank and a non-bank financial intermediary. The conglomerate's risk-taking incentives depend on the level of market discipline it faces, which in turn is determined by the conglomerate's liability structure. We examine optimal capital regulation for standalone institutions, for integrated conglomerates and holding company conglomerates. We show that, when capital requirements are set optimally, capital arbitrage within holding company conglomerates can raise welfare by increasing market discipline. Because they have a single balance sheet, integrated conglomerates extend the reach of the deposit insurance safety net to their non-bank divisions. We show that the extra risk-taking that this effect causes may wipe out the diversification benefits within integrated conglomerates. We discuss the policy implications of these results.

In single period models, financially constrained firms invest more in response to increases in their net worth or interest rate cuts. We examine whether or not these results necessarily hold in a multi-period setting. We present a multi-period version of the Holmstrom and Tirole moral hazard model and show that the probability of investment (or the hurdle rate for investment) in the first period of a two-period model is non-monotonic in the level of liquid balances [Holmstrom, B., Tirole, J., 1997. Financial intermediation, loanable funds, and the real sector. Quart. J. Econ. 112 (3), 663–691. August; Holmstrom, B., Tirole, J., 1998. Private and public supply of liquidity. J. Polit. Economy 106 (1), 1–40. February; Holmstrom, B., Tirole, J., 2000. Liquidity and risk management. J. Money, Credit, Banking 32 (3), 295–319. August]. When a risk-free interest rate is introduced in the model, we show that a lower interest rate (or a downward shift or the yield curve) can lead to less current investment due to the interaction of future financial constraints and discounting of cash flows. Our results have implications for the effect of monetary policy on investment by financially constrained firms. They also address several recent empirical debates, such as the relationship between liquidity and the cash-flow sensitivity of investment, and whether or not accumulation of cash balances by Japanese firms can be consistent with the existence of financial constraints affecting investment.

Active equity mutual funds managed by insurance companies underperform peer funds by over 1% per year. There is no evidence that insurance funds make less risky investments; instead they have lower risk-adjusted returns and their fund flows are less sensitive to performance when they perform poorly. Across insurance funds, those with heavy advertising, directly established by insurers or using parent firms' brandnames, and those whose managers simultaneously manage substantial non-mutual-fund assets, are more likely to underperform. We conclude that insurers' efforts to cross-sell mutual funds aggravate agency problems that erode fund performance.

In this paper, we estimate and test a multi-period model of strategic informed trading developed by Foster and Viswanathan [Foster, F.-D., Viswanathan, S., 1996. Strategic trading when agents forecast the forecasts of others, J. Finance 51, 1437–1478]. We employ the GMM using intertemporal patterns of price, trading volume and market depth, leading up to the earnings announcements made by NYSE firms. We find that multiple informed traders with heterogeneous private signals trade prior to the announcements. In addition, by comparing the results from daily and intra-day estimations, we find that the number of informed traders increases while the intensity of liquidity trading decreases, and that the adverse selection problem becomes more pronounced as the announcements approach.