A model of asymmetric asset value information and nonverifiability of liquidation motives is developed to examine the optimal design and governance of asset-backed securities. Because of adverse selection risk, the liquidation option of whole loan sale results in external price discounting of composite cash flows. The alternative liquidation option of senior/subordinated security design is shown to dominate whole loan sale, since cash flow splitting allows the issuer to internalize some or all of the lemons-related liquidation costs. Security subordination levels must increase relative to full information levels, however, to protect uninformed outside investors. Pool diversification and loan bundling are shown to be packaging strategies that can soften the lemons-related subordination effect and therefore increase liquidation proceeds. With respect to security governance, we show that it is the junior securityholder who should control the debt renegotiation process with pooled debt structures. Better asset value information and a first loss position are the reasons for junior securityholder control in our model. Numerous empirical implications of the model are also identified and discussed.Journal of Economic LiteratureClassification Numbers: D46, D81, D82, G13, G21, G24, G32, G33.

[Information advantage and entry deterrence incentives are investigated as they affect lending outcomes and competitive structure of the U.S. residential mortgage market. In the model, when assessing a loan applicant, the incumbent monopoly lender employs a proprietary screening technology to produce a privately observed estimate of loan credit quality. When faced with potential competitive entry, the incumbent signals poor credit quality by charging high prices to higher-quality borrowers. Market structure and loan pricing strategy are derived endogenously, where the incumbent deters entry first by segmenting consumers into prime and sub-prime loan markets and second by charging prime market borrowers a uniform rate that is higher than the risk-based monopoly rate. Empirical implications of the model are identified, and evidence is presented that is consistent with predictions.]

Paul D. Childs, Steven H. Ott, Timothy J. Riddiough, The Pricing of Multiclass Commercial Mortgage-Backed Securities, The Journal of Financial and Quantitative Analysis, Vol. 31, No. 4 (Dec., 1996), pp. 581-603

Information advantage and entry deterrence incentives are investigated as they affect lending outcomes and competitive structure of the U.S. residential mortgage market. In the model, when assessing a loan applicant, the incumbent monopoly lender employs a proprietary screening technology to produce a privately observed estimate of loan credit quality. When faced with potential competitive entry, the incumbent signals poor credit quality by charging high prices to higher-quality borrowers. Market structure and loan pricing strategy are derived endogenously, where the incumbent deters entry first by segmenting consumers into prime and sub-prime loan markets and second by charging prime market borrowers a uniform rate that is higher than the risk-based monopoly rate. Empirical implications of the model are identified, and evidence is presented that is consistent with predictions.

We analyze a financially distressed owner-managed project. The main results of the model are: (1) borrower default is an endogenous response to the anticipated restructuring–foreclosure outcome; (2) the lender’s restructuring–foreclosure decision depends critically on the interaction between project value and industry liquidity; and (3) the lender waits for the industry to recapitalize before selling assets obtained through foreclosure. Empirical analysis of a large sample of defaulted commercial real estate loans supports many of the model predictions, including restructuring–foreclosure outcomes that are consistent with endogenous borrower default and firesale discounts that vary depending on industry market conditions at the time of foreclosure.

We analyze a financially distressed owner-managed project. The main results of the model are: (1) borrower default is an endogenous response to the anticipated restructuring-foreclosure outcome; (2) the lender's restructuring-foreclosure decision depends critically on the interaction between project value and industry liquidity; and (3) the lender waits for the industry to recapitalize before selling assets obtained through foreclosure. Empirical analysis of a large sample of defaulted commercial real estate loans supports many of the model predictions, including restructuring-foreclosure outcomes that are consistent with endogenous borrower default and firesale discounts that vary depending on industry market conditions at the time of foreclosure.

We study private funds available to retail investors of modest wealth. Our sample covers unlisted real estate investment trusts (REITs) for superior cash flow and fee data. Fee structures are skewed toward performance-insensitive components of the compensation contract, particularly front-end loads. The average unlisted REIT underperforms the listed benchmark by 6.5% per year, 5% of which is attributable to fees. Unlisted REITs underperform institutional-grade private equity real estate funds. Fees paid to investment advisors also explain fundraising success, while past performance does not. The underperformance is consistent with the consequences of managerial conflicts of interest, inadequate governance mechanisms, opaque disclosure, and poor investment advice.