Signalling with debt and equity: a unifying approach and its implications for the Pecking-Order hypothesis and competitive credit rationing

The paper sets out to tackle the following puzzle when insiders of a firm have more information than outside investors. The insiders’ desire to sell overpriced securities creates an Adverse Selection problem leading to two contradictory results. On the one hand, it leads to Myers & Majluf (1984)’s Pecking-Order hypothesis that says that debt finance dominates equity finance. On the other hand it leads to Stiglitz & Weiss (1981)’ credit rationing whose consequence is that equity finance dominates debt finance. The paper resolves the puzzle by allowing firms to issue both debt and equity together and by having a general notion of what it is that insiders know more about. Then the Pecking-Order hypothesis and credit rationing only emerge as two, mutually exclusive, special cases. The paper shows that combinations of debt and equity can be used to credibly signal information for a wide range of parameters. Thus, it provides a generalisation of the existing financial signalling and rationing literatures and helps to explain some contradictory theoretical and empirical results.

Ethylbenzene dehydrogenase, a novel hydrocarbon-oxidizing molybdenum/iron-sulfur/heme enzyme

The initial enzyme of ethylbenzene metabolism in denitrifying Azoarcus strain EbN1, ethylbenzene dehydrogenase, was purified and characterized. The soluble periplasmic enzyme is the first known enzyme oxidizing a nonactivated hydrocarbon without molecular oxygen as cosubstrate. It is a novel molybdenum/iron-sulfur/heme protein of 155 kDa, which consists of three subunits (96, 43, and 23 kDa) in an αβγ structure. The N-terminal amino acid sequence of the α subunit is similar to that of other molybdenum proteins such as selenate reductase from the related speciesThauera selenatis. Ethylbenzene dehydrogenase is unique in that it oxidizes the hydrocarbon ethylbenzene, a compound without functional groups, to (S)-1-phenylethanol. Formation of the product was evident by coupling to an enantiomer-specific (S)-1-phenylethanol dehydrogenase from the same organism. The apparent K m of the enzyme for ethylbenzene is very low at <2 μm. Oxygen does not affect ethylbenzene dehydrogenase activity in extracts but inactivates the purified enzyme, if the heme b cofactor is in the reduced state. A variant of ethylbenzene dehydrogenase exhibiting significant activity also with the homolog n-propylbenzene was detected in a relatedAzoarcus strain (PbN1)

Market based compensation, price informativeness and short-term trading

This paper shows that there is a natural trade-off when designing market based executive compensation. The benefit of market based pay is that the stock price aggregates speculators’ dispersed information and there-fore takes a picture of managerial performance before the long-term value of a firm materializes. The cost is that informed speculators’ willingness to trade depends on trading that is unrelated to any information about the firm. Ideally, the CEO should be shielded from shocks that are not informative about his actions. But since information trading is impossible without non- nformation trading (due to the ”no-trade” theorem), shocks to prices caused by the latter are an unavoidable cost of market based pay. This trade-off generates a number of insights about the impact of market conditions, e.g. liquidity and trading horizons, on optimal market based pay. A more liquid market leads to more market based pay while short-term trading makes it more costly to provide such incentives leading to lower CEO effort and worse firm performance on average. The model is consistent with recent evidence showing that market based CEO incentives vary with market conditions, e.g. bid-ask spreads, the probability of informed trading (PIN) or the dispersion of analysts’ forecasts. JEL Classification: G39, D86, D82Executive compensation, liquidity, Moral Hazard, stock price informativeness, trading

What do internal capital markets do ? Redistribution vs. incentives

In this paper we explain the apparent "diversification discount” of conglomerates without assuming inefficient-cross subsidisation through internal capital markets. Instead we assume that internal capital market efficiently redistributes scare resources across a conglomerate’s divisions between sucessive production periods. The need for redistribution arises from the fact that resources may sometimes be produced by divisions which happen to be successful in an earlier production stage but which do not have the best investment opportunities in future production stages. In contrast to the existing literature we consider explicitly the incentive problem between corporate headquater and divisional managers using a standard Moral-Hazard framework. We show that although a complete incentive contract can be written bi-laterally between headquarter and divisional managers, the redistribution of resources across divisions creates additional agency costs in a conglomerate. Moreover, assuming that no complete contract can govern the interim redistribution policy by the headquarter, we show how the agency problem with divisional managers constrains headquarters interim redistribution to be ex ante inefficient.

The Benefit and Cost of Winner Picking: Redistribution Vs Incentives

The Benefit and Cost of Winner Picking: Redistribution Vs Incentives |AB| A multi-divisional firm can engage in "winner-picking" to redistribute scarce funds efficiently across divisions. But there is a conflict between rewarding winners (investing) and producing resources internally to reward winners (incentives). Managers in winning divisions are tempted to free-ride on resources produced by managers in loosing divisions whose incentives to produce resources, anticipating their loss, are also weakened. Corporate headquarter's investment and incentive policy are therefore inextricably linked and have to be treated as jointly endogenous. The analysis links corporate strategy, compensation and the value of diversification to the characteristics of multi-divisional firms.Conglomerate, Internal capital market

The determinants of bank capital structure

The paper shows that mispriced deposit insurance and capital regulation were of second order importance in determining the capital structure of large U.S. and European banks during 1991 to 2004. Instead, standard cross-sectional determinants of non-financial firms’ leverage carry over to banks, except for banks whose capital ratio is close to the regulatory minimum. Consistent with a reduced role of deposit insurance, we document a shift in banks’ liability structure away from deposits towards non-deposit liabilities. We find that unobserved time-invariant bank fixed effects are ultimately the most important determinant of banks’ capital structures and that banks’ leverage converges to bank specific, time invariant targets. JEL Classification: G32, G21bank capital, capital regulation, capital structure, leverage

MARKET BASED COMPENSATION, TRADING AND LIQUIDITY

This paper examines the role of trading and liquidity in a large competitive market with dispersed heterogenous information on market-based managerial compensation. The paper recognizes the endogenous nature of a firm’s stock price - it is the outcome of self-interested speculative trading motivated by imperfect information about future firm value. Using the stock price as performance measure means bench-marking the manager’s performance against the market’s expectation of that performance. We obtain two main results: first, the degree of market-based compensation is proportional to the market depth, which is a measure of the ease of information trading. Secondly, using the dynamic trading model of Vives (1995) we show that if the investment horizon of informed traders decreases, at equilibrium the managerial e.ort reduces, and the optimal contract prescribes stock-compensation with longer vesting period.

Interbank lending, credit risk premia and collateral

We study the functioning of secured and unsecured inter-bank markets in the presence of credit risk. The model generates empirical predictions that are in line with developments during the 2007-2009 financial crises. Interest rates decouple across secured and unsecured markets following an adverse shock to credit risk. The scarcity of underlying collateral may amplify the volatility of interest rates in secured markets. We use the model to discuss various policy responses to the crisis. JEL Classification: G01, G21, E58collateral, Credit risk, financial crisis, Interbank Market, liquidity