Knowledge that Transforms

Financial relationships can alleviate the adverse effects of asymmetric information and agency costs on outside stakeholders. We examine announcement returns to PIPE transactions, conditional on the contract terms and identity of the investor. We find that the influence of contract terms on announcement returns depends on investor identity. For PIPEs with hedge fund investors, the inclusion of control terms associates with much larger announcement returns. In contrast, announcement returns for PIPEs, involving strategic investors, are less dependent on the existence of control terms. We find the opposite for liquidity terms. Namely, announcement returns are dramatically different for strategic investors with and without liquidity terms, while inclusion of liquidity terms is less influential when PIPEs involve hedge funds. Our findings suggest that investor identity and contract terms jointly influence market reactions to PIPEs.

While a number of countries have tried the use of sealed bid share auctions for initial public offerings (IPOs), few continue to use them. This is a puzzle, since auctions have been successfully used in a variety of situations for other financial securities, particularly for the sale of government bonds. We provide an explanation for this puzzle: Bidding in sealed bid auctions for new issues is complex, particularly when the underlying shares are difficult to value and the auction is open to large numbers of potential bidders, some of whom might be naïve. Participation fluctuations make it difficult for even sophisticated bidders to shave accurately for the winner’s curse, and mistakes by some bidders impose costs on all. Our findings suggest that a hybrid auction mechanism that limits participation in the auction tranche to sophisticated investors, along with a non-competitive tranche that is open to all investors, can reduce such mistakes while at the same time providing the necessary incentives for information gathering.

This paper investigates the effect of corporate diversification on the pricing of bank-loan contracts. We find that diversified firms have significantly lower loan rates than comparable focused firms, and we find no evidence that diversified firms are subject to more restrictive non-price contract terms pertaining to maturity, collateral requirements, and covenant restrictions. We show that the effect of diversification on the cost of a bank loan is channeled primarily through coinsurance in investment opportunities and cash flows and that the effect is nonlinear: as the extent of corporate diversification grows, the cost-reduction benefit of diversification decreases. Our results indicate that the organizational structure of the firm can alleviate its external financing constraints and that it has an important bearing on the firm’s financing capacity.

We examine the dynamic behavior of bank capital using a global sample of 64 countries during the 1994–2010 period. Banks achieve deleveraging primarily through equity growth (rather than asset liquidation). In contrast, they achieve leveraging through reduced earnings retention and substantial asset expansion. The speed of capital structure adjustment is heterogeneous across countries. Banks make faster capital structure adjustments in countries with more stringent capital requirements, better supervisory monitoring, more developed capital markets, and high inflation. In times of crises, banks adjust their capital structure significantly more quickly.

Using variation in payday lending restrictions over time and across states, we study competition in the market for small, short-term consumer loans. We find that banks and credit unions reduce overdraft credit limits and prices when payday credit, a possible substitute, is prohibited. These findings suggest that depositories respond to payday loan bans by taking less risk, bouncing checks that they would have otherwise covered. The decline in overdraft prices is surprising when viewed in isolation, but sensible given that depositories incur lower credit losses as they limit overdraft coverage. We find some evidence that credit unions’ overdraft activities are more profitable when payday loans are prohibited, consistent with decreased competition. In addition to characterizing the impact of prohibiting payday lending, a common state policy change in recent years, our findings illuminate competition in the small-dollar loan market by highlighting the importance of non-price adjustments to credit offers.

Using a multi-period partial equilibrium model, I demonstrate that a combination of management fees and a time-varying information advantage for a fund manager can account for several empirically observed characteristics of closed-end funds simultaneously. The model is consistent with the basic time-series behavior of fund discounts, accounts for the excess volatility of fund returns, explains why the management fee appears to be an insignificant determinant of discounts, and is consistent with many time-series correlations between discounts, NAV returns, and fund returns. The model also generates novel predictions regarding the relations between asset turnover, discounts, and returns.

We investigate the effectiveness of initiating deposit insurance at the outset of a banking crisis. Using a conjoint analysis approach that allows us to consider the simultaneous impact of multiple deposit insurance attributes and various counterfactuals, we ask a multinational sample of respondents how they would view hypothetical account profiles following the failure of a large competing bank. Previous experience matters: respondents from countries without explicit deposit insurance exhibit greater withdrawal risk, suggesting that the introduction of deposit insurance during a crisis may be only partially successful in preventing bank runs. They also impose a higher deposit interest rate premium. Having a long-term bank relationship reduces withdrawal risk, as does the absence of co-insurance.

This paper examines how bank regulation and supervision measures affect the synchronicity of bank stock returns, a measure that is negatively related to variations in bank-specific fundamentals and stock price informativeness. Using data from World Bank surveys in 35 countries, we find that bank stock returns are less synchronous in countries with more stringent capital regulations, more supervision that emphasizes private monitoring, and less government bank ownership. On the other hand, direct government control of bank activities, as well as direct government monitoring and disciplining, do not reduce stock return synchronicity.

We study the behavior of private pension funds as large depositors in a banking system. Using panel data analysis, we examine whether, and if so how, pension funds influence market discipline in Argentina in the period 1998–2001. We find that the disciplining role of pension funds depends on whether or not banks are connected to the pension fund industry through ownership of pension fund management companies. We find evidence that pension funds exert market discipline on unconnected banks but not on connected ones. On balance, pension funds undermine market discipline in the banking system as a result of conflicts of interest. We conclude that regulations aimed at averting these conflicts can enhance market discipline.