Knowledge that Transforms

We provide maximum likelihood estimators of term structures of conditional probabilities of corporate default, incorporating the dynamics of firm-specific and macroeconomic covariates. For US Industrial firms, based on over 390,000 firm-months of data spanning 1980 to 2004, the term structure of conditional future default probabilities depends on a firm's distance to default (a volatility-adjusted measure of leverage), on the firm's trailing stock return, on trailing S&P 500 returns, and on US interest rates. The out-of-sample predictive performance of the model is an improvement over that of other available models.

The representative-agent Lucas model stresses aggregate risk and hence does not allow us to study the impact of agents’ heterogeneity on the dynamics of equilibrium trading volume. In this paper, we investigate under what conditions non-informational heterogeneity, i.e., differences in preferences and endowments, leads to nontrivial trading volume in equilibrium. We present a non-informational no-trade theorem that provides necessary and sufficient conditions for zero equilibrium trading volume in a continuous-time Lucas market model with heterogeneous agents, multiple goods, and multiple securities. We explain in detail how no-trade equilibria are related to autarky equilibria, portfolio autarky equilibria, and peculiar financial market equilibria, which play an important role in the literature on international risk sharing.

In some markets sellers have better information than buyers over which products best serve a buyer's needs. Depending on the market structure, this may lead to conflicts of interest in the provision of information by sellers. This paper studies this issue in the market for financial services. The analysis presents a new model of competition between banks, where price competition influences the ensuing incentives for truthful information revelation. We also compare conflicts of interest in two different firm structures, specialized banking and one-stop banking.

This paper examines how cash flows, investment expenditures, and stock price histories affect debt ratios. Consistent with earlier work, we find that these variables have a substantial influence on changes in capital structure. Specifically, stock price changes and financial deficits (i.e., the amount of external capital raised) have strong influences on capital structure changes, but in contrast to previous conclusions, we find that over long horizons their effects are partially reversed. These results indicate that although firms’ histories strongly influence their capital structures, over time their capital structures tend to move towards target debt ratios that are consistent with the tradeoff theories of capital structure.

This paper examines institutional price pressure in equity markets by studying mutual fund transactions caused by capital flows from 1980 to 2004. Funds experiencing large outflows tend to decrease existing positions, which creates price pressure in the securities held in common by distressed funds. Similarly, the tendency among funds experiencing large inflows to expand existing positions creates positive price pressure in overlapping holdings. Investors who trade against constrained mutual funds earn significant returns for providing liquidity. In addition, future flow-driven transactions are predictable, creating an incentive to front-run the anticipated forced trades by funds experiencing extreme capital flows.

We propose a model that examines the optimal size of venture capital and private equity fund portfolios. The relationship between a VC and entrepreneurs is characterized by double-sided moral hazard, which causes the VC to trade off larger portfolios against lower values of portfolio companies. We analyze the structural relations between the VC's optimal portfolio structure and entrepreneurs' and VC's productivities, their disutilities of effort, the value of a successful project, and the required initial investment in a venture. We also test the model's predictions using a small proprietary dataset collected through a survey targeted to VC and private equity funds worldwide.

I examine the emerging phenomenon of PIPEs (private investments in public equity) invested by venture capital funds (VCs) and hedge funds (HFs) and analyze whether and how these investors add value to firms by comparing a sample of 113 VC-invested PIPEs to a sample of 397 PIPEs with HFs. I find that VCs gain substantial ownership, request board seats, and often keep their stake after the PIPEs. In contrast, HFs rarely join the board of directors and typically cash out their positions shortly after the PIPE. The stock performance of VC-invested firms is significantly better than HF-invested firms both in the short run and in the long run. The positive valuation effect of having VCs as PIPE investors appears to be a certification effect rather than a monitoring effect. A key implication from these findings is that investor identity matters.

This paper investigates the influence of managerial entrenchment on private placements by examining the firm's decision to appoint representatives of the private investors to the board without shareholder approval. By analyzing a sample of U.S. firms that appoint directors in combination with private offerings between 1995 and 2000, we find that firms with greater managerial entrenchment are more likely to bypass shareholder approval. Firms that bypass shareholders are less likely to appoint independent directors or to elect one of these directors as chairman. We also show that the market reacts more positively to the private offering announcement when the firm submits its board candidates for shareholder approval. Further, firms that bypass approval underperform compared to firms that obtain it. Overall our findings suggest that managers avoid shareholder approval to perpetuate entrenchment.

In this paper we use a new method to rank finance journals and study the pattern of authorship/co-authorship across journals. Defined as the ratio of articles authored by faculty at the world's top 80 finance programs to the total number of articles by all authors, the Author Affiliation Index is a cost-effective and intuitively easy-to-understand approach to journal rankings. Forty-one finance journals are ranked according to this index. If properly constructed, the Author Affiliation Index provides an easy and credible way to supplement the existing journal ranking methods. Our ranking system reveals the journal–researcher clientele, and we find that collaboration (co-authoring) between faculty within elite programs exists only in top-tier and near-top-tier journals. Publications in lower-tier journals by researchers of elite programs are driven by their co-authors. Collaboration between faculty in elite and non-elite programs, however, is more prevalent than that within elite programs across all tiers of journals. Co-authorship among top 80 programs, nevertheless, is more common in top-tier journals, while co-authorship between top 80 and other programs is more dominant in lower-ranked journals.

In this paper we develop a contingent valuation model for zero-coupon bonds with default. In order to emphasize the role of maturity time and place of the lender's claim in a firm's debt hierarchy, we consider a firm that issues two bonds with different maturities and different seniorage. The model allows us to analyze the implications of both debt renegotiation and capital structure of a firm on the prices of bonds. We obtain that renegotiation brings about a significant change in the bond prices and that the effect is dispersed through various channels: increasing the value of the firm, reallocating payments, and avoiding costly liquidation. Moreover, the presence of two creditors leads to qualitatively different implications for pricing, while emphasizing the importance of bond covenants and renegotiation of the entire debt.