Abstract We show that newly hired workers earn higher wages in response to higher firm leverage. Consistent with compensating differential models, these higher wages appear to reflect compensation for the risk of earnings losses in the event of financial distress. For tenured workers, increases in leverage are not associated with higher wages. Our findings suggest that the wage costs of debt and optimal capital structure for a firm depend on expected employee turnover, as well as on the firm’s future growth and hiring plans. Variation in local labor market conditions also significantly affects the relationship between firm leverage and employee pay. (JEL G32, G33, J21, J31, J61) Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

We suggest that transparent bias in management disclosures may result from managers processing information in a heuristic, as distinct from Bayesian, fashion when they face imperfect or head-to-head competition. We predict that transparent bias in disclosures is positively related to the extent of head-to-head competition. In addition, when disclosure is discretionary, we show that managers who exhibit viable, heuristic behavior are less likely to disclose than managers who exhibit Bayesian behavior. Finally, when disclosure is discretionary, we show that the increase in the proportion of uninformed managers who exhibit viable, heuristic behavior encourages more disclosure by an informed manager.

We characterize the steady-state equilibrium in which informed traders who exhibit heuristic (i.e., representativeness, as opposed to Bayesian) and Bayesian behaviors achieve the same expected utility. Then, we show how the endogenous, steady-state proportion of heuristic traders is affected by the quality of public information and other exogenous features of our model. Finally, we discuss how the presence of heuristic traders potentially alters the link between improved public disclosure and market liquidity, the variance in the change in price, and market efficiency.

Abstract Using contingent-claims valuation, we introduce novel hedge ratios for credit exposures using put options. Option hedge ratios are generally in line with the empirical sensitivities of credit spread changes to put option returns and, relative to stock hedge ratios, produce further reductions in volatility for a portfolio of North American firms. We show that option hedge ratios capture option-specific credit exposure related to the VIX index and the default spread, which is unaccounted for by Merton’s (1974) equity hedge ratios alone. Combining stocks and put options for credit risk hedging can be done effectively using the volatility smirk. (JEL E43, E44, G10)

This paper describes the balance sheet adjustments of debt and equity financed firms over time in an economy subject to taste shocks. A model is developed that describes a representative firm with a stochastic diminishing returns technology and a set of financial contracts that resolve a conflict-of-interest problem between differentially risk-averse bondholders and stockholders. The contractual resolution of this conflict-of-interest problem between the two agents is shown to shape certain stylized facts of business cycles ignored in Keynesian and Classical models. Changes in investor risk aversion and equity valuations trigger real investment decisions that can cause business cycles. Bond covenants then have the firm adjusting its financing decisions so as to offset any risk-shifting associated with the investment decisions. Stockholders manage the asset side of the firm’s balance sheet while bondholders (regulators in the case of banks) manage the financing side. In this way the welfare of both investors is coalesced over the business cycle. A similar type of analysis accounts for the age distribution of workers, and the size distribution of firms over the business cycle. Evidence presented here and elsewhere fails to reject these predictions for the U.S. non-financial and financial corporate sectors.

In this paper we show in a thought experiment that in an economy where i) investors hold rational expectations, ii) output is generated by a linear homogeneous production function, and iii) real investment is allocated across sectors according to the CAPM, a fractional reserve banking system is not Pareto efficient and amplifies the business cycle. In developing these results we show that these three well known propositions in economics also imply a new view of the business cycle, one where the business cycle is described in terms of the dispersion of an ex-ante probability distribution. The policy implication of this analysis is that bank regulation should go further than the Volcker rule or the Vickers commission proposal by restricting bank investments to currency and deposit accounts on the central bank. Nonbank financial institutions should then carry out the financial intermediation function now carried out by banks. The paper proposes that post office banking perhaps augmented with blockchain technology sometime in the future is one way to implement the transition from fractional reserve banking to full reserve banking. While little academic work has been done on full reserve banking in the aftermath of the Great Crisis, it is interesting to note that it is part of banking reform proposals now (July 2016) before the parliament in Iceland and a special national referendum in Switzerland.

This article is a review of a 531 page book that in turn is a review and evaluation of the 2319 page Dodd–Frank Wall Street Reform and Consumer Protection Act passed by Congress on July 16, 2010. The overriding theme of the book is to pose two approaches to attaining financial stability in the future. One approach is to establish a council of wise men and women supported by an army of highly skilled professional financial economists to formulate and implement regulations designed to prevent future financial crises that wreak havoc on the real economy and require financial support from taxpayers. This is the approach of the Dodd–Frank Act. The second approach proposed by the authors of this book is to design a taxing system that taxes systemically important financial institutions on the basis of their contribution to systemic risk. Borrowing ideas from the literature on the taxation of negative externalities their view is that financial institutions that create crises should pay for the clean-up. They also argue that requiring the financial polluters to pay for the creation of systemic risk will reduce the supply of systemic risk. The reader is invited to decide which approach is best.

This paper examines the impact of the borrower–lender relationship on the explicit loan interest rate and collateral, as well as the correlation between loan interest rates and collateral. Using a simultaneous equation approach, we find that collateral has a statistically significant positive impact of 200 to 400 basis points on loan interest rates. We find this positive association to be stronger for personal (or outside) collateral than collateral provided by the firm's assets (or inside collateral). Finally, we find the economic impact of the borrower–lender relationship to be 21 basis points for one standard deviation increase in relationship length.