We develop a theory of optimal bank leverage in which the benefit of debt in inducing loan monitoring is balanced against the benefit of equity in attenuating risk shifting. However, faced with socially costly correlated bank failures, regulators bail out creditors. Anticipation of this generates multiple equilibria, including one with systemic risk in which banks use excessive leverage to fund correlated, inefficiently risky loans. Limiting leverage and resolving both moral hazards—insufficient loan monitoring and asset substitution—requires a novel two-tiered capital requirement, including a “special capital account” that is unavailable to creditors upon failure.

This review of the literature on the 2007-2009 crisis discusses the precrisis conditions, the crisis triggers, the crisis events, the real effects, and the policy responses to the crisis. The precrisis conditions contributed to the housing price bubble and the subsequent price decline that led to a counterparty-risk crisis in which liquidity shrank due to insolvency concerns. The policy responses were influenced both by the initial belief that it was a market-wide liquidity crunch and the subsequent learning that insolvency risk was a major driver. I suggest directions for future research and possible regulatory changes.

This paper develops a theory of strategic information disclosure with disagreement. Managers of firms are voluntarily communicating subjective information, and prior beliefs about the strategy to maximize project value are rational but heterogeneous, potentially generating fundamental disagreement. Three main results are derived. First, not all firms disclose (subjective) information about strategy. Second, more valuable firms, and those whose strategies investors are more likely to agree with, disclose less information in equilibrium. Third, improved corporate governance leads to lower executive compensation and less information disclosure. An implication of the analysis for banks is that greater strategic information disclosure may increase the probability of bank runs—banks may choose to be opaque because transparency makes them fragile.

One key challenge for the short selling literature is to identify the incremental contribution of various measures of short sale constraints. Although variables such as loan fee, loan supply and short interest are determined simultaneously in the market for borrowing stock, new incremental information may be found in each variable examined. Papers such as Beneish et al. (2015) attempt to disentangle the effect of one particular variable, and attempt to shed light on the parallel challenge faced by investors in determining which variables will make the most impact on returns as well as trading costs. We discuss a number of practical approaches to this challenge, and we also consider a potentially new take that considers accounting-data-driven anomalies as one of the possible exogenously determined variables in the equilibrium of the equity loan market.

Liao ( ) argues that the monitoring by large outside shareholders (blockholders) exacerbates the conflict between debt and equity and in turn affects the choice and structure of debt financing. The study contends that private debt is more immune to the increase in debt‐equity conflict. Consistent with this argument, companies with outside blockholders are inclined to issue private debt over public debt. Further, private debt exhibits less price protection but relies on more protective covenants than does public debt. The findings are interesting and intuitive. I evaluate the economic arguments in the paper and discuss some of the challenges that the study faces. My conclusion is that the interpretation of the results is more complex than the one the study presents. I offer a broader framework that can be used to shed light on why the governance structure combines equity blockholders and private debt issuance. I also discuss several questions to be addressed by future research.

We develop a theory of income and payout smoothing by firms when insiders know more about income than outside shareholders, but property rights ensure that outsiders can enforce a fair payout. Insiders set payout to meet outsiders' expectations and underproduce to manage future expectations downward. The observed income and payout process are smooth and adjust partially and over time in response to economic shocks. The smaller the inside ownership, the more severe underproduction is, resulting in an "outside equity Laffer curve."

Financial relationships can alleviate the adverse effects of asymmetric information and agency costs on outside stakeholders. We examine announcement returns to PIPE transactions, conditional on the contract terms and identity of the investor. We find that the influence of contract terms on announcement returns depends on investor identity. For PIPEs with hedge fund investors, the inclusion of control terms associates with much larger announcement returns. In contrast, announcement returns for PIPEs, involving strategic investors, are less dependent on the existence of control terms. We find the opposite for liquidity terms. Namely, announcement returns are dramatically different for strategic investors with and without liquidity terms, while inclusion of liquidity terms is less influential when PIPEs involve hedge funds. Our findings suggest that investor identity and contract terms jointly influence market reactions to PIPEs.

Since 1991 more than two dozen states have adopted merit-based student financial aid programs, intended at least in part to increase the stock of human capital by improving the knowledge and skills of the state’s workforce. At the same time, there has been growing concern that the United States is producing too few college graduates in science, technology, engineering, and mathematics (STEM) fields. Using microdata from the American Community Survey, this paper examines whether recently adopted state merit aid programs have affected college major decisions, with a focus on STEM fields. We find consistent evidence that state merit programs did in fact reduce the likelihood that a young person in the state will earn a STEM degree.

When future operations are expected to provide information rents, managers concerned with being replaced can entrench themselves with value-increasing firm-specific human capital (SHC). In motivating SHC investment, the firm trades off the incentive effects of an ex ante commitment to asymmetric information against the costs of compensation rents and private benefits. Firm value, therefore, is affected by (1) the accuracy with which the board observes and interprets information, and (2) the strength of the control environment restricting the manager's ability to benefit from concealing and diverting firm value. It is optimal to maintain a partially informed board to the mutual benefit of shareholders and managers, and for firms in a stricter control environment to maintain a more informed board. Due to the indirect effect on SHC, regulations that strengthen control adversely affect firm value unless the information and control environments are sufficiently biased toward managerial preferences.