The crisis is not yet over; the housing market continues to deteriorate and there are spill-overs into other markets. Growth is declining, with potentially self re-enforcing mechanisms between financial markets and the real economy coming into play. A local problem became a global crisis because of poor risk management, lack of transparency and excessive leverage. Not only does the capital base need re-building, but also incentive schemes need reconsideration.

This paper argues that banks must be sufficiently levered to have first-best incentives to make new risky loans. This result, which is at odds with the notion that leverage invariably leads to excessive risk taking, derives from two key premises that focus squarely on the role of banks as informed lenders. First, banks finance projects that they do not own, which implies that they cannot extract all the profits. Second, banks conduct a credit risk analysis before making new loans. Our model may help understand why banks take on additional unsecured debt, such as unsecured deposits and subordinated loans, over and above their existing deposit base. It may also help understand why banks and finance companies have similar leverage ratios, even though the latter are not deposit takers and hence not subject to the same regulatory capital requirements as banks.

This paper argues that the presence of both profit-based and stock price-based components in compensation contracts provides senior managers the incentive to optimally allocate effort to both implementing previously devised strategies that provide current profits and to formulating new strategies that create shareholder value. If managers are concerned about their reputation and if outcomes of strategy implementation are more informative about their ability than outcomes of strategy formulation, compensation based only on profit will incent managers to boost their reputation by over-allocating effort to strategy implementation. To restore the balance the contract needs to contain some stock-based compensation.

Abstract This paper considers share repurchases as the way long-term shareholders preserve their ability to use corporate information for speculative purposes when insider trading regulation is enforced. This use of corporate information increases the adverse selection losses of short-term shareholders. Thus, buy-back programs reduce their incentive to invest in stocks that back the most productive technology, leading to a socially inefficient equilibrium. It follows that insider trading should not be banned when share repurchases are allowed. More generally, the paper argues that the regulation of insider trading and repurchases can not be considered in isolation, and analyzes their interplay.

Purchases and sales of operating assets by firms generated $162 billion for shareholders over the past 20 years. This contrasts sharply with the evidence on mergers. This paper characterizes the behavior of value-maximizing firms, which could grow organically, purchase existing assets, or sell assets. The approach yields an endogenous selection model that links asset purchases and sales to fundamental properties of the firm. Empirical tests confirm the predictions of the model. In particular, return on assets and size strongly predict when firms purchase or sell assets, and the transaction size covaries with the value of capital employed by the firm. These findings indicate that corporate asset purchases and sales are consistent with efficient investment decisions.

Weak bank supervision could give banks the ability to shift risk from themselves to supervisors. We use cross-border bank mergers as a natural experiment to test changes in risk and the impact of supervision. We examine cross-border bank mergers and find that the supervisory structures of the partners’ countries influence changes in post-merger total risk. An acquirer from a country with strong supervision lowers total risk after a cross-border merger. However, total risk increases when the target bank is located in a country with relatively strong supervision. This result is consistent with strong host regulators limiting the risky activities of their local banks. Foreign-owned competitors could then engage in the risky projects, especially if the foreign banks’ supervisors are not strong. An acquirer entering a country with strong supervision appears to shift risk back to its home country. The results suggest that bank supervisors can reduce total banking risk in their countries by being strong.

Consumption expenditure declines sharply at the time of retirement for many households, but the majority maintain a smooth consumption path. A simple life cycle model with uncertainty about the time of retirement can account for this pattern. A richer version of the model is calibrated to data from the Health and Retirement Study (HRS). The median change in consumption expenditure at retirement generated by the model is zero, while the mean is negative, matching the HRS data. However, the magnitude of the drop in consumption among households that experience a decline is too small in the model compared to the data.

This paper identifies the determinants of market-wide issue cycles for initial public offerings (IPOs) using an autoregressive conditional count model. We consider whether IPO volume is related to business conditions, investor sentiment, and time variation in adverse selection costs caused by asymmetric information between managers and investors. We provide evidence indicating that time variation in business conditions and investor sentiment are important determinants of monthly issue activity. By contrast, time variation in adverse selection costs does not significantly affect IPO volume.

[Microstructure researchers have long understood that information quality has an effect on price formation in the underlying asset market. However, option researchers have largely ignored the fact that information quality might also impact the options market. This article characterizes the nature of the impact by showing how option prices and implied volatility levels are related to the forward looking information quality path. This result follows from a noisy rational expectations model that abandons the normal distribution in favor of the gamma distribution, but maintains the standard assumption of exponential utility. Thus the new model bridges the gap between the microstructure literature that relies so heavily on the normal-exponential framework, and the options literature that relies exclusively on models that are consistent with the limited liability of stock prices. The model's tractability allows for a robustness check against the standard framework and provides a viable setting for analyzing the empirical implications of information quality for the options market.]