Default, foreclosure, and strategic renegotiation / 1542

Includes bibliographical references (p. 21-24)

Moral hazard and debt maturity

We present a model of the maturity of a bank’s uninsured debt. The bank borrows funds and chooses afterwards the riskiness of its assets. This moral hazard problem leads to an excessive level of risk. Short-term debt may have a disciplining effect on the bank’s risk-shifting incentives, but it may lead to inefficient liquidation. We characterize the conditions under which short-term and long-term debt are feasible, and show circumstances under which only short-term debt is feasible and under which short-term debt dominates long-term debt when both are feasible. Thus, short-term debt may have the salutary effect of mitigating the moral hazard problem and inducing lower risk-taking. The results are consistent with key features of the common narrative of the period preceding the 2007-2009 financial crisis

Do Stock Price Bubbles Influence Corporate Investment?

Building on recent developments in behavioral asset pricing, we develop a model in which dispersion of investor beliefs under short-selling constraints drives a firm's stock price above its fundamental value. Managers optimally respond to the stock market bubble by issuing new equity. The bubble reduces the user-cost of capital and increase real investment. Using the variance of analysts' earnings forecasts as a proxy for the dispersion of investor beliefs, we find strong empirical support for the model's key prediction that increases in dispersion cause increases in new equity issuance, Tobin's Q, and real investment.

How Much Choice is Too Much?: Contributions to 401(k) Retirement Plans

Although extensive choice seems appealing, research shows that it may hinder motivation to buy and decrease subsequent satisfaction with purchased goods. This paper examines whether these findings generalize to employees who are making decisions about whether to invest in 401(k) retirement saving plans. Using data from nearly 800,000 employees, we tested the hypothesis that employee 401(k) participation rates fall as the number of fund options increase. Our results confirm that participation in 401(k) plans is higher in plans offering a handful of funds, as compared to plans offering ten or more options