Subordinated debt, market discipline, and bank risk

This paper demonstrates that subordinated debt (‘subdebt’ thereafter) regulation can be an effective mechanism for disciplining banks. Under our proposal, investors buy the subdebt of a bank only if they receive favourable information about the bank, and the bank is subject to a regulatory examination if it fails to issue subdebt. By forcing banks to be examined when they are likely weak, subdebt regulation not only reduces the chance that managers of distressed banks can take value-destroying actions to benefit themselves, but may also encourage banks to lower asset risk. It shows that subdebt regulation and bank capital requirements can be complements for alleviating the banks’ moral hazard problems. It also suggests that to make subdebt regulation effective, regulators may need impose ceilings on the interest rates of subdebt, prohibit collusion between banks and subdebt investors, and require the subdebt to convert into the issuing bank’s equity when the government takes over or provides open assistance to the bank.subordinated debt regulation; bank capital regulation; market discipline; moral hazard; contingent capital certificate

Why do bank runs look like panic? A new explanation

This paper demonstrates that, even if depositors are fully rational and always choose the Pareto dominant equilibrium when there are multiple equilibria, a bank run may still occur when depositors’ expectations of the bank’s fundamentals do not change. More specifically, a bank run may occur when depositors learn that noisy bank-specific information is revealed, or when they learn that precise bank-specific information is not revealed. The results in this paper are consistent with empirical evidence about bank runs. It also implies that suspension of convertibility can improve the efficiency of bank runs.bank run; banking panic; suspension of convertibility

The transparency of the banking industry and the efficiency of information-based bank runs

In this paper, we investigate the relationship between the transparency of banks and the fragility of the banking system. We show that information-based bank runs may be inefficient because the deposit con-tract designed to provide liquidity induces depositors to have excessive incentives to withdraw. An im-provement in transparency of a bank may reduce depositor welfare through increasing the chance of an inefficient contagious bank run on other banks. A deposit insurance system in which some depositors are fully insured and the others are partially insured can ameliorate this inefficiency. Under such a system, bank runs can serve as an efficient mechanism for disciplining banks. We also consider bank managers’ control over the timing of information disclosure, and find that they may lack the incentive to reveal in-formation about their banks.bank run; contagion; transparency; market discipline; deposit insurance

Financial Distress and Restructuring Models

In recent years, the literature of financial distress has been enriched by the development of formal models. This paper develops a synthesis of that formal analysis, linking it to related finance literature and corporate strategies for distressed financial restructuring. Several key assumptions generate different results which predict the effects of financial distress on investment efficiency and restructuring strategy. Central to these strategies are the recontracting arrangements proposed between owners, creditors and other relevant stakeholders. The critical factors in the alternative models are: (1) the term structure of the firm’s debt, (2) the role of the seniority of debts, (3) the effects of exchange offers, (4) the effects of an automatic stay on debt payments, and (5) the role of alternative voting rules

Financial Distress and Restructuring Models

In recent years, the literature of financial distress has been enriched by the development of formal models. This paper develops a synthesis of that formal analysis, linking it to related finance literature and corporate strategies for distressed financial restructuring. Several key assumptions generate different results which predict the effects of financial distress on investment efficiency and restructuring strategy. Central to these strategies are the recontracting arrangements proposed between owners, creditors and other relevant stakeholders. The critical factors in the alternative models are: (1) the term structure of the firm’s debt, (2) the role of the seniority of debts, (3) the effects of exchange offers, (4) the effects of an automatic stay on debt payments, and (5) the role of alternative voting rules

The Controlling Shareholder's Personal Stock Loan and Firm Performance

This paper studies companies that have a controlling shareholder. In particular, it examines the relationship between firm performance and its controlling shareholder’s personal loan. We present a model to identify two effects of a personal loan that is secured by stocks. The loan can be beneficial ex ante, because it relaxes the wealth constraint of controlling shareholders and allows firms to invest in good projects. The loan can also be harmful ex post, because it will create an incentive for controlling shareholders to pursue risky projects. We use a sample of listed companies in Taiwan to test our hypotheses and find consistent evidence