Knowledge that Transforms

[We embed a structural model of credit risk inside a dynamic continuous-time consumptionbased asset pricing model, which allows us to price equity and corporate debt in a unified framework. Our key economic assumptions are that the first and second moments of earnings and consumption growth depend on the state of the economy, which switches randomly, creating intertemporal risk, which agents prefer to resolve sooner rather than later, because they have Epstein-Zin-Weil preferences. Agents optimally choose dynamic capital structure and default times. For a dynamic cross-section of firms, our model endogenously generates a realistic average term structure and time series of actual default probabilities and credit spreads, together with a reasonable levered equity risk premium, which varies with macroeconomic conditions.]

[This article provides a comprehensive analysis of a new and increasingly important phenomenon: the simultaneous holding of both equity and debt claims of the same company by non-commercial banking institutions ("dual holders"). The presence of dual holders offers a unique opportunity to assess the existence and magnitude of shareholder-creditor conflicts. We find that syndicated loans with dual holder participation have loan yield spreads that are 18-32 bps lower than those without. The difference remains economically significant after controlling for the selection effect. Further investigation of dual holders' investment horizons and changes in borrowers' credit quality lends support to the hypothesis that incentive alignment between shareholders and creditors plays an important role in lowering loan yield spreads.]

[Information on borrower quality is a fundamental issue in debt contracting, corporate and consumer finance, and financial intermediation. We investigate the link between account activity and information production on borrower risk. Based on a unique data set, we find that credit line usage, limit violations, and cash inflows exhibit abnormal patterns approximately 12 months before default events. Measures of account activity substantially improve default predictions and are especially helpful for monitoring small businesses and individuals. Furthermore, early warning indications result in higher loan spreads, and in a higher likelihood of limit reductions and complete write-offs. Our study shows that account activity provides a real-time window into the borrower's cash flows, thus explaining why banks have an advantage in providing certain types of debt financing.]

[A large theoretical literature shows that competition reduces banks' franchise values and induces them to take more risk. Recent research contradicts this result: When banks charge lower rates, their borrowers have an incentive to choose safer investments, so they will in turn be safer. However, this argument does not take into account the fact that lower rates also reduce the banks' revenues from performing loans. This paper shows that when this effect is taken into account, a U-shaped relationship between competition and the risk of bank failure generally obtains.]

[In this article, we derive an analytic expression for the representative agent of a large class of economies populated by agents with "catching up with the Joneses" preferences, but who exhibit heterogeneous risk aversion. As Chan and Kogan (2002) show numerically, the representative agent has stochastic risk that moves countercyclically to the state variable. However, we show that heterogeneity of risk aversion alone is insufficient for explaining empirical regularities—namely the variability of the Sharpe ratio—that Campbell and Cochrane (1999) obtain in a model of a representative agent with stochastic risk aversion.]

[This article, which introduces the special issue on corporate governance cosponsored by the Review of Financial Studies and the National Bureau of Economic Research (NBER), reviews and comments on the state of corporate governance research. The special issue features seven articles on corporate governance that were presented in a meeting of the NBER's corporate governance project. Each of the articles represents state-of-the-art research in an important area of corporate governance research. For each of these areas, we discuss the importance of the area and the questions it focuses on, how the article in the special issue makes a significant contribution to this area, and what we do and do not know about the area. We discuss in turn work on shareholders and shareholder activism, directors, executives and their compensation, controlling shareholders, comparative corporate governance, cross-border investments in global capital markets, and the political economy of corporate governance.]

[We study how much of the top end of the income distribution is represented by four sectors—non–financial–firm top executives (Main Street); investment bankers and hedge, private equity, and mutual fund investors (Wall Street); corporate lawyers; and athletes and celebrities. Wall Street individuals comprise a higher percentage of the top income brackets than nonfinancial executives of public companies. While top executives' representation in the top brackets has increased from 1994 to 2004, Wall Street's representation has likely increased even more. We discuss the implications of our findings for different explanations for the increased skewness at the highest income levels.]

[This paper presents a dynamic equilibrium model of bond markets in which two groups of agents hold heterogeneous expectations about future economic conditions. The heterogeneous expectations cause agents to take on speculative positions against each other and therefore generate endogenous relative wealth fluctuation. The relative wealth fluctuation amplifies asset price volatility and contributes to the time variation in bond premia. Our model shows that a modest amount of heterogeneous expectations can help explain several puzzling phenomena, including the "excessive volatility" of bond yields, the failure of the expectations hypothesis, and the ability of a tent-shaped linear combination of forward rates to predict bond returns.]

[This article examines the information content and consequences of third-party voting advice that arrives as news at an interim stage in corporate proxy contests. We first document significant stock returns around announcements of proxy vote recommendations. We then develop a multi-equation empirical procedure for disentangling the price impact of prediction effects (changes in contest outcome probabilities) from the price impact of certification effects (changes in outcome-contingent valuations). Both effects are present in the data: Voting advice is both predictive about contest outcomes and informative about the ability of dissidents to add value. Consequently, proxy advice plays a dual informational role.]

[This article examines the potential impact of capital supply on security issuance. We focus on the role of convertible bond arbitrageurs as suppliers of capital to convertible bond issuers. We estimate a simultaneous equations model of demand and supply of convertible bond capital, linking the time series of aggregate convertible bond issuance to measures of capital supply: convertible bond arbitrage hedge fund flows, returns, and a proxy for arbitrageurs' use of leverage. We find that issuance is positively and significantly related to increases in all three supply measures. To provide further interpretation, we use the September/October 2008 short-selling ban as a natural experiment to examine the impact of an exogenous shock to the supply of capital from arbitrageurs. Results from both empirical approaches provide evidence that the supply of capital from convertible bond arbitrageurs impacts issuance.]