Employee Sentiment and Stock Option Compensation

The use of equity-based compensation for employees in the lower ranks of large organizations is a puzzle for standard economic theory: undiversified employees should discount company equity heavily, and any positive incentive effects should be diminished by free rider problems. We analyze whether the popularity of option compensation for rank and file employees may be driven by employee optimism. We develop a model of optimal compensation policy for a firm faced with employees with positive or negative sentiment, and explicitly take into account that current and potential employees are able to purchase equity in the firm through the stock market. We show that employee optimism by itself is insufficient to make equity compensation optimal for the firm. Any behavioral explanation for equity compensation based on employee optimism requires two ingredients: first, employees need be over-optimistic about firm value, and second, firms must be able to extract part of the implied rents even though employees can purchase company equity in the market. Such rent extraction becomes feasible if employees prefer the non-traded compensation options offered by firms to the traded equity offered by the market, or if the traded equity is overvalued. We then provide empirical evidence confirming that firms use broad-based option compensation when boundedly rational employees are likely to be excessively optimistic about company stock, and when employees are likely to have a strict preference for options over stock.

Investor Protection and the Coasian View

Some legal regimes leave gaps in the protection provided by the law to firm investors. This paper considers the decision by a firm to opt out of the law and bridge those gaps using contracts. Examining the charters of a sample of Mexican firms, we find that private firms often enhance significantly the protection offered by the law to their investors, but public firms rarely do so. Motivated by these findings, we construct a model that endogenizes the degree of investor protection that firms provide, using as springboard the assumption that legal regimes differ in their ability to enforce what we call precisely filtering contracts, namely, contracts that provide protection only in those cases where expropriation can occur. Our model generates predictions about the types of contracts that would be employed and the levels of investor protection that they would provide across different legal regimes in both private and in public firms

Credit Traps

This paper studies the limitations of monetary policy transmission within a credit channel frame- work. We show that, under certain circumstances, the credit channel transmission mechanism fails in that liquidity injections by the central bank into the banking sector are hoarded and not lent out. We use the term ‘credit traps’ to describe such situations and show how they can arise due to the interplay between financing frictions, liquidity, and collateral values. Our analysis offers a characterization of the problems created by credit traps as well as potential solutions and policy implications. Among these, the analysis shows how quantitative easing and fiscal policy acting in conjunction with monetary policy may be useful in increasing bank lending. Further, the model shows how small contractions in monetary policy or in loan supply can lead to collapses in lending, aggregate investment, and collateral prices.

Liquidation Values and the Credibility of Financial Contract Renegotiation: Evidence from U.S. Airlines

How do liquidation values affect financial contract renegotiation? While the 'incomplete contracting' theory of financial contracting predicts that liquidation values determine the allocation of bargaining power between creditors and debtors, there is little empirical evidence on financial contract renegotiations and the role asset values play in such bargaining. This paper attempts to fill this gap. We develop an incomplete-contracting model of financial contract renegotiation and estimate it using data on the airline industry in the United States. We find that airlines successfully renegotiate their lease obligations downwards when their financial position is sufficiently poor and when the liquidation value of their fleet is low. Our results show that strategic renegotiation is common in the airline industry. Moreover, the results emphasize the importance of the incomplete contracting perspective to real world financial contract renegotiation.

Negotiating with Labor under Financial Distress

We analyze how firms renegotiate labor contracts to extract concessions from labor. While anecdotal evidence suggests that firms tend to renegotiate wages downward in times of financial distress, there is no empirical evidence that documents such renegotiation, its determinants, and its magnitude. This article attempts to fill this gap. Using a unique data set of airlines, which includes detailed information on wages and pension plans, we document an empirical link between airline financial distress, pension underfunding, and wage concessions.National Science Foundation (U.S.) (CAREER award SES-0847392

Vintage Capital and Creditor Protection

We provide novel evidence linking the level of creditor protection provided by law to the degree of usage of technologically older, vintage capital in the airline industry. Using a panel of aircraft-level data around the world, we find that better creditor rights are associated with both aircraft of a younger vintage and newer technology as well as firms with larger aircraft fleets. We propose that by mitigating financial shortfalls, enhanced legal protection of creditors facilitates the ability of firms to make large capital investments, adapt advanced technologies and foster productivity

Credit Traps

This paper studies the limitations of monetary policy in stimulating credit and investment. We show that, under certain circumstances, unconventional monetary policies fail in that liquidity injections into the banking sector are hoarded and not lent out. We use the term "credit traps" to describe such situations and show how they can arise due to the interplay between financing frictions, liquidity, and collateral values. We show that small contractions in monetary policy can lead to a collapse in lending. Our analysis demonstrates how quantitative easing may be useful in increasing collateral prices, bank lending, and aggregate investment