We examine the impact of a stockholder–bondholder conflict over the timing of the exercise of an investment option on firm value and corporate financial policy. We find that an equity-maximizing firm exercises the option too early relative to a value-maximizing strategy, and we show how this problem can be characterized as one of overinvestment in risky investment projects. Equityholders’ incentive to overinvest significantly decreases firm value and optimal leverage, and significantly increases the credit spread of risky debt. Numerical solutions illustrate how the agency cost of overinvestment and its effect on corporate financial policy vary with firm and project characteristics.

Numerous studies have examined the impact of security issuance upon the value of pre-existing debt and equity but the focus has largely been on changes in equity value. We examine changes in senior unsecured debt risk premiums that accompany new junior debt issues. Additionally, we test several hypotheses regarding the potential impacts of junior debt issues. Extant theory suggests senior debt value may be threatened under certain conditions by the issuance of junior debt. Our results indicate that when junior debt replaces bank debt, senior default risk premiums experience abnormal declines. The result is broadly consistent with the elevation of the senior unsecured debt by way of the elimination of a separate and more senior class of debt claimants. In contrast, we also find that larger junior bond issues are associated with abnormal increases in senior risk premiums, broadly consistent with issue size being correlated with negative information about firm cash flows. We find strong evidence of interaction effects. For example, replacement of bank debt results in greater changes in default risk premiums the larger the issue size. We also find lower credit ratings magnify other effects. For example, if the junior debt issued matures before the outstanding senior unsecured bond, senior risk premiums experience abnormal increases for lower rated debt.

This paper looks at the advantages and disadvantages of mixing banking and commerce, using the “liquidity” approach to financial intermediation. Bringing a nonfinancial firm into a banking conglomerate may be advantageous because it makes it easier for the bank to dispose of assets seized in a loan default. The conglomerate's internal market increases the liquidity of such assets and improves the bank's ability to perform financial intermediation. More generally, owning a nonfinancial firm may act either as a substitute or a complement to commercial lending. In some cases, a bank will voluntarily refrain from making loans, choosing to become a non-bank bank in an unregulated environment.

Understanding the nature and sources of human identity is an important objective in the study of a variety of social problems. Scholarly and popular writing on the cultural determinants of economic disadvantage underscores this point. Some analysts (e.g., Edward Banfield, 1970; Thomas Sowell, 1994; John McWhorter, 2000; John Ogbu, 2003) have hypothesized that a causal connection exists between the poor social performance of a group of people and their “culture.” That disadvantaged people harbor “dysfunctional” notions about identity has been offered as an explanation of a group’s welfare dependency, or its low academic proficiency. It has been said, for instance, that people fare poorly because they focus overly much on their own victimization, or because they disassociate themselves from their more successful fellows, and so on. At the root of such cultural criticism lies the presumption that the disadvantaged should “reform” themselves: If those people would only see themselves differently, the critics hint, they could be so much better off. This mode of social explanation easily accommodates racial overtones. With the present paper we intend to raise serious doubts about such normative criticisms of the poor when applied to their conceptions of identity. We show that the identities adopted by a group of people can be perfectly consistent with rational individual choices, even though feasible alternative configurations may exist under which everyone would be better off. Indeed, we argue that identity choice by interactive agents with ongoing economic relations has a “tragedy of the commons” quality about it: the profile of dominant strategies for the agents can yield a Pareto-inferior collective outcome. Preaching “identity reform” to such people is a bit like trying to counter an overfishing problem by lecturing fishermen on the moral need for forbearance! We wish to be explicit and clear at the outset about what we have in mind when using the term “identity.” Human identity includes both a personal and a social aspect. Social identity deals with how an individual is perceived and categorized by others (e.g., Erving Goffman, 1963). In contrast, personal identity, which is the subject of this paper, and which psychologists sometimes call “ego identity,” deals with a person’s answer to the question: “Who am I?” Our proposed model of personal identity posits that, to answer this question, an agent must provide a “narrative” about her personal history. That is, she has to summarize her life experiences. Because a full personal history is (necessarily) a very complex object, and since their cognitive capacities are limited, answering the “Who Am I?” question requires agents to project elaborate personal accounts onto manageable categories of self-description. We think of an agent’s identity as the mechanism she uses to convert complex personal history into a more simplified account of herself. A group’s “collective identity” is any self-representational mode of this sort which has been adopted in common by (most of) the agents in that group. We formalize the problem of selective selfrepresentation and use the resulting framework to study the efficiency implications of the “identity” choices people make. This, we believe, is one way that economic analysis can contribute to the study of identity-related issues.

The exchange-rate regime is often seen as constrained by the monetary policy trilemma, which imposes a stark tradeoff among exchange stability, monetary independence, and capital market openness. Yet the trilemma has not gone without challenge. Some (e.g., Others (e.g., This paper studies the coherence of international interest rates over more than 130 years. The constraints implied by the trilemma are largely borne out by history.

Theories based on incomplete contracting suggest that small organizations have a comparative advantage in activities that make extensive use of “soft” information. We provide evidence consistent with small banks being better able to collect and act on soft information than large banks. In particular, large banks are less willing to lend to informationally “difficult” credits, such as firms with no financial records. Moreover, after controlling for the endogeneity of bank-firm matching, we find that large banks lend at a greater distance, interact more impersonally with their borrowers, have shorter and less exclusive relationships, and do not alleviate credit constraints as effectively.

We use rolling cointegration to measure the convergence of base money, M2, the CPI and industrial output between Germany and France and recent EU members and some transition countries that are now joining the EU. Countries that joined the EU previously exhibit time-varying cointegration with the core countries over the 1980–2000 sample period. Cointegration for the transition economies was comparable for M2 and prices, but not for monetary policy and industrial output. Thus a peg to the Euro soon after accession is feasible for the East European countries, but the benefits of joining the Euro zone are as yet limited.

We examine how the market's ability to assess the truthfulness of management earnings forecasts affects how managers bias their forecasts, and we evaluate whether the market's response to management forecasts is consistent with it identifying predictable forecast bias. We find managers' willingness to misrepresent their forwardlooking information as a function of their incentives varies with the market's ability to detect misrepresentation. We examine incentives induced by the litigation environment, insider trading activities, firm financial distress, and industry concentration. With regard to the stock price response to forecasts, we find the market varies its response with the predictable bias in the forecast. The efficiency of the market's response, however, varies with the forecast news.

Rising levels of foreign direct investment (FDI) concern growing numbers of policymakers and members of the American public. These concerns stem from the perception that foreign activities of American multinational corporations reduce employment and other economic activities within the United States. While investment flows within the United States go largely unnoticed, in an international setting the lexicon of “winners” and “losers” can be inescapable. Curiously, both capital-exporting countries and capital-importing countries have at times expressed concern over the consequences of international capital flows. Capital-exporting countries worry that too much of their capital goes abroad, while capital-importing countries fear foreign control of domestic assets and the possible macroeconomic instability associated with rapid changes in foreign investment levels. The concerns of capital-exporting countries, while diffuse, often are based on conceptions of outbound FDI as diverting economic activity. Unsurprisingly, growing overseas activities of multinational firms have become a source of economic insecurity for workers, managers, and tax collectors (see e.g., Kenneth F. Scheve and Matthew J. Slaughter, 2001).

A mutual fund manager is more likely to buy (or sell) a particular stock in any quarter if other managers in the same city are buying (or selling) that same stock. This pattern shows up even when the fund manager and the stock in question are located far apart, so it is distinct from anything having to do with local preference. The evidence can be interpreted in terms of an epidemic model in which investors spread information about stocks to one another by word of mouth.